Hexpol AB

STO:HPOL B

Earnings Call Transcript 2020-Q3

[Operator]

Hello and welcome to the HEXPOL AB Q3 results call. [Operator Instructions]Today, I'm pleased to present the acting CEO and CFO, Peter Rosén. Please go ahead with your meeting.

[Peter Rosén, CFO & Head of Investor Relations]

Thank you very much, and welcome, everybody, to the presentation of the Q3 report for HEXPOL. I'll take you through the presentation where we will start with the business performance, then go into the more detailed financials and also give you an update on the -- on status regarding cost savings. And we will, of course, close the session with Q&As.So if I can ask you to turn to the first slide in the presentation regarding the key highlights for the quarter. Obviously, it is still a quarter impacted by COVID-19. However, we've seen a substantial increase in volumes since the second quarter this year, primarily to automotive customers, but also to building and construction.Other customer segments also showed increases, but at a slower pace. And during the quarter, we have seen gradual improvements month-by-month when it comes to sales and volumes.When it comes to our ability to produce and deliver, there are no issues. All our sites are up and running, and have been sold throughout the quarter. We are able to produce and deliver all of what is asked from us. And we've also received positive feedback from customers that our fast and stable deliveries during these challenging times are noted and very much appreciated.As you know, since previous reports and presentations, we worked actively during the year to reduce our costs. We saw significant savings during the second quarter. And as you can see, the costs have continued to come down also during this quarter.The savings are seen both for direct and indirect cost in production as well as for OpEx. Some of the savings come from lower production volumes compared to last year, while some come from use of short-term work and furloughs, but significant savings are structural in nature. And I'll come back to the savings during the presentation.The increased volumes compared to previous quarter, in combination with the lower cost, gave a higher result for the quarter of SEK 593 million. The operating margin increased at the same time to a high 17.8% for the quarter, which again compared to last year Q3 at 13.7%, or previous quarter this year of 8.3%. The high result in combination with further improvements of the working capital during the quarter also gave strong cash flow of about SEK 770 million in the quarter.Our financial position, which was strong already going into the quarter, was further strengthened during the quarter. Our equity asset ratio continues to improve, and so does our net debt-to-EBITDA ratio. And they also both improved versus both last year and the previous quarter this year.The Board also today took the decision to propose a dividend for 2019 of SEK 2.30 per share, which is in line with the original proposal that was postponed in April due to the COVID-19 epidemic. Any Swedish grants related to COVID-19 will be paid back. But from our point of view, they are small amounts and they are about SEK 2 million.If I can then ask you to switch to next page regarding financial highlights. Compared to last year, sales decreased with 22% from SEK 4.2 billion to SEK 3.3 billion this quarter. The lower sales were seen in all geographies to varying degree and to most customer segments, where automotive customers were hit the hardest. At the same time, we saw a strong recovery from the second quarter this year, with improvements in most customer segments, but led by automotive and building and construction.Despite the lower sales compared to last year, operating profit came in at SEK 593 million, which is somewhat above last year. And at the same time, the operating margin increased with 30% to 17.8%.So when we look at this quarter, we saw -- and compared to last year, we saw a sales decrease of 2% (sic) [ 22% ], profits somewhat above last year and the margin that increased with 30%.If I can ask you to switch to the next page, looking at the sales development in the quarter. And as I mentioned, it decreased compared to last year with about 22% to SEK 3.3 billion. Of this decrease, negative FX effects amounted to about 5%, while organic sales were down 17%.The lower organic sales came from lower volumes but also lower sales prices. The lower sales prices came as an effect from lower raw material prices that we pass on to our customers through lower sales prices. Keep in mind that from an acquisition point of view, the sales are comparable to last year since Preferred was included as of third quarter last year. The lower organic sales were seen primarily with the Rubber Compounding and to most customer segments, although automotive showed the most negative impact following -- followed by general industry.When looking at our regional sales development during the quarter, the Americas represent 59% of our sales, while Europe and Asia represent about 35% and 6%, respectively. The Americas saw sales decrease of 27% in the quarter, while Europe showed 13% lower sales and Asia saw an increase of about 3%. And the increase in Asia was driven by sales to automotive customers recovering from COVID-19 effects.If I can then ask you to move over to the next page, looking at the year-to-date sales development, then sales decreased with 15% to SEK 10 billion for the first 9 months of the year. The acquisition of Preferred last year increased sales with 7%, while there were limited FX effects of negative 1% during the quarter. Organic sales came down 21%, affected by COVID-19 effects during primarily the second quarter but also during this third quarter.When looking at our regional sales development for the first 9 months of the year, Americas represent 59%, while Europe and Asia represent 36% and 5%, respectively. And when we look at the year-to-date sales, Americas saw a sales decrease of 15%, while Europe showed 16% and Asia showed 3% lower sales.And if I can then ask you to go to the next page, looking at the sales development during this year, it has certainly been volatile, the sales development. We started the first quarter with sales of SEK 4.2 billion. Going into the second quarter, we saw sales drop as COVID-19 forced both country and industry closedowns, as well as the general downward pressure on demand in most industries, not least after the industry standstill in Europe and the U.S. when it comes to automotive.We delivered sales of SEK 2.5 billion in the second quarter, a drop of 39% compared to first quarter. However, since then -- since the end of second quarter, we've seen monthly improvements, primarily from automotive but also building and construction with -- also with smaller improvements in other customer segments. Following these improvements, sales for this quarter are up 32% compared to second quarter.If I can then ask you to go over and we'll move you into more financials. Overall, we delivered very solid financial results for the quarter with improvements almost across the board. We delivered a quarterly result above last year despite more than 20% lower sales.The EBIT margin came out very strong at 17.8%, following on the cost reductions, and we delivered a strong operating cash flow of SEK 773 million. So despite the challenges put on by COVID-19, we closed this quarter with a very strong financial position.If I can then ask you to go to the next page. And as mentioned, we delivered a profit of SEK 593 million. The lower sales in the quarter impacted negatively with some SEK 183 million. Cost savings in production, in combination with higher volumes compared to second quarter, gave better cost ratios and increased our gross margin, to a large extent offsetting the negative impact from lower sales.Furthermore, continued savings brought total OpEx well below last year levels. And higher gross margin, combined with the lower OpEx, offset the lower sales and delivered a profit above last year.If I can ask you to move to the next page, looking at the operating profit and margin this year. Following the sales development during the year, we have seen significant movements in profit and margins. Even though we saw significant cost savings during the second quarter, we were not able to offset the lower sales we experienced during that quarter. Hence, our results and margin came down compared to previous quarters.Since then, we've continued to see positive effects from our cost reduction programs. The effects are seen both in our production cost and OpEx, and -- where the latter came down a further 9% compared to the second quarter this year. The increase in sales since the second quarter, in combination with the lower cost, gave a very high margin of 17.8% in the quarter.And if we then move over and look at HEXPOL Compounding, we saw sales decrease compared to last year of about 20% from SEK 4 billion to SEK 3.1 billion. To a large part, the lower sales were impacted by COVID-19, but also negative FX effects and lower sales prices.As mentioned before, the lower raw material prices we experienced during the quarter impacted our sales price levels as we passed our raw material price effects to our customers. We saw lower sales to most customer segments in the Americas and Europe affected by the pandemic, main negative impact with the automotive and general industry.Asia saw somewhat higher sales compared to last year, with higher sales to automotive. The Thermoplastic Compounding saw lower sales related to automotive, while TPE generally saw somewhat lower sales in the quarter.While sales were lower compared to the same quarter last year, sales increased with 35% compared to the second quarter this year, led by the recovery in automotive and building and construction. And this increase was seen both in the Americas and Europe. Even though sales came in 22% lower compared to last year, the adjusted operating profit remained at some SEK 550 million, and the margin increased with 31% to 17.9%, following on the lower cost.And if we then take a look at Engineered Products, sales came in below last year with 9% at SEK 237 million. However, lower cost offset this, and profit increased from SEK 36 million to SEK 41 million, an increase of 14%. And the operating margin increased substantially with 25% to 17.3% for the quarter.And if we then move over, looking at the working capital. At the end of the quarter, our working capital stood at SEK 1 billion, which is some SEK 400 million lower than the same period last year. And as you can see, over time, we have some movements in our working capital, and this is primarily driven by the acquisitions that we've done.In general, the companies we have acquired over time operate with higher working capital compared to HEXPOL legacy business. But when we integrate the acquisitions, we work hard to bring them into the HEXPOL way of working and thus bring down the working capital. And the movement that you see in absolute working capital in the graph, the stables are driven by the acquisition of Preferred in 2019. And over time, as we integrate the company, working capital in relation to sales, the orange line here in the graph improves and we are now at some 7% in relation to sales.If we move over and look at the cash flow, where we stand at the third -- during the third quarter, we delivered an EBIT of SEK 593 million in the quarter, which was translated into operating cash of SEK 773 million. During the quarter, we saw further improvement of the working capital, while investments are below that of depreciation and amortization.And that leads us into the next page, and our financial position, which is quite strong. We have SEK 1.2 billion cash at hand. We used some SEK 2.7 billion of our credit facilities, which leaves us with a net debt of SEK 1.5 billion for the quarter. And this gives a net debt-to-EBITDA ratio at 0.69, which is a clear improvement compared to last year and also compared to second quarter this year.Before we close the presentation and open up for questions, I would like to give you a short update of the effects from the cost reductions during the year. Currently, we have some 200 employees in various forms of short time work and furlough. And this can be compared to the -- some 500 people we had during the second quarter.In addition to this, about 200 of our employees left during the quarter following the cost reduction programs launched during the year. And this means that since the end of last year, about 500 employees have left the company, which corresponds to about 10% of all our employees. We've been very careful not to jeopardize core competence such as chemists, for example, when it comes to cost reductions.The levels of our production costs in relation to sales improved further during the quarter, following a combination of cost reduction and also higher production volumes compared to last quarter.When it comes to OpEx, the current run rate is about -- is down about another 9% compared to the previous quarter. At the same time, OpEx, where we stand today, is down some 20% compared to the levels seen since the acquisition of Preferred and until the cost reduction programs started this year. So we see substantial cost savings also on OpEx. And we expect that the cost reduction progress will also have further positive effects during the last quarter of this year.Then to summarize the third quarter this year, our business is severely impacted by COVID-19, but all our sites are up and running. We worked to ensure the safety and well-being of all our employees, and we do not experience supply or delivery problems. COVID-19 continues to be primarily demand challenge for us.We continue with a strong customer focus, and we work on ensuring fast and stable deliveries to our customers. The stability we can show also during these challenging times is, of course, appreciated by the customers.The cost reduction programs initiated during the year gave us substantial savings. Some of the cost in production will increase to a certain extent, once again, demand and volumes increase. However, a large part of the savings, primarily in OpEx savings, are structural and will not increase in line with volume.So despite SEK 900 million lower sales compared to last year, we still delivered a profit above last year with substantially higher margins at almost 18%. We closed the quarter with a strong balance sheet and overall very strong financial position, and the Board also proposes to pay out a dividend of SEK 2.30 per share, the dividend that was postponed during the spring due to uncertainties caused by COVID-19.Looking ahead and currently, it is obvious that COVID-19 continues to create uncertainty. But it's our belief that the combination of financial strength of the company, combined with our decentralized organization, give us very good possibilities to come through this in a very good manner.And that concludes the presentation in itself, and open up for Q&A.

[Operator]

[Operator Instructions] Our first question comes from the line of Johan Dahl of Danske Bank.

[Johan Dahl, Analyst]

Can you just talk about -- I mean you had an incremental leverage here in Q3 of roughly 50%. So it's sort of substantial earnings improvement on that increased sales. And given that it's mostly raw material that pass-through your P&L, there must be something else here that actually impacted earnings positively, such as gross profit per tonne, et cetera. Is that correct that conclusion? And can you tell us what that was?

[Peter Rosén, CFO & Head of Investor Relations]

When we look at the increase in profits, in -- the single biggest driver is the lower cost in combination with increased volumes. And when we look at the cost savings, as I mentioned, we see substantial cost savings in OpEx, and we also see savings in the production costs.And when we look at the savings in production costs, there are both absolute savings in absolute amounts, but they are also cost income ratio improvement. So we are able to add substantial volume increase on the same cost structure. And that gives a high throughput from the sales increase to the EBIT increase.The other part affecting margins is, of course, we -- when we see the lower raw material prices, we need to pass that on to our customers. And that has 2 impacts. One is that the price per kilo sold, everything else being equal, goes down somewhat, but our margins mathematically also go up somewhat since we also experience lower raw material prices. So those are the effects that drive the profitability.

[Johan Dahl, Analyst]

Is there anything in there, sort of improved price points or, sort of, substantially improved product mix profitability or anything like that?

[Peter Rosén, CFO & Head of Investor Relations]

We do -- no, I wouldn't say that there are substantial mix effects in here. It's a good mix, certainly. But it's not a major driver of the profitability improvement.

[Johan Dahl, Analyst]

Is there anything we should be aware of with regards to, I don't know, earn-out reversals or sort of the IFRS 9 provisioning, et cetera, that have impacted profits positively in this quarter?

[Peter Rosén, CFO & Head of Investor Relations]

No. It's a clean -- there are no major, let's call it, onetime or ad hoc impacts here.

[Johan Dahl, Analyst]

Just a final question, organic volumes seem to have been down sort of double digits, 12% something. But it seems that segments outside automotive is possibly weaker than sort of automotive. Any reflections on that weak volume performance for HEXPOL outside of automotive?

[Peter Rosén, CFO & Head of Investor Relations]

I wouldn't say that there are weak developments. It depends very much on the starting point. If we compare to Q3 last year, we certainly see -- I mean most segments are down. Certainly, we do see that. However -- even though we see improvements compared to the second quarter, primarily within automotive and building and construction, we see the highest improvements in automotive. But they also had the biggest drop in Q2.So I think when it comes to the segments outside automotive, they saw a not as dramatic drop in Q2 and they don't see as dramatic improvement. So -- yes, they have a little bit different movements when it comes to impact from COVID-19. But I wouldn't say that they are relatively weaker than automotive.

[Operator]

Our next question comes from the line of Viktor Trollsten of DNB.

[Viktor Trollsten, Analyst]

This is Viktor. Could you comment a bit on how organic growth has developed during the quarter? And maybe give us some flavor on how October started for you in the first weeks here?

[Peter Rosén, CFO & Head of Investor Relations]

Absolutely. If we go back to the second quarter, as you know, April and May were virtual standstill in automotive, and we saw volumes picking up during June. What we've seen since then is an improvement month by month, so July, August, September. When we look at Q3 as a total, we see a 35-ish increase since the second quarter. But also within that quarter, we see improvements where July was better than June, August better than July and September was better than August. So we do see a gradual improvement month by month.We don't guide and we don't give forecast for next quarter or next year. But where we are standing right now, and couple of weeks into October, we haven't seen anything in October that changes that picture with a gradual improvement. So where we stand right now, we have a positive view, and we don't receive signals from customers that, that will change.The big if is, of course, COVID-19. We do see infection rates increasing both in Europe and U.S. What that will mean for countries and industries, it's difficult to say. But currently, where we stand right now, we have a positive view.

[Viktor Trollsten, Analyst]

Okay. And could you put any number on the historical figures for, let's say, September? Are you flat year-over-year or -- in terms of volumes?

[Peter Rosén, CFO & Head of Investor Relations]

No. That's no.

[Viktor Trollsten, Analyst]

Okay. Okay. Also could you split a bit on in the organic growth, how much was the negative impact from raw materials and lower prices?

[Peter Rosén, CFO & Head of Investor Relations]

It's not any number that we public show, but we do see a negative price increase of at least a couple of percentage points.

[Viktor Trollsten, Analyst]

Okay. That's helpful. And also just a question on M&A. Given your solid balance sheet, how would you say that the M&A environment looks right now in terms of COVID-19? And is it, call it, more difficult to go ahead with any targets? Or what are you seeing right now?

[Peter Rosén, CFO & Head of Investor Relations]

Three things to keep in mind. Our strategy remains exactly the same when it comes to M&A. So we are certainly looking for M&A. It's a crucial part of -- a key part of our strategy. Secondly, as you mentioned, we certainly also have the financial resources to do that.So coming to the third part, which is -- there are a number of possible acquisitions that we are following and we've been doing for quite some time. And I think in this environment, it is more a difficulty of agreeing on price levels. But I think if we compare to where we are now, compared to when COVID-19 started to hit, it's more -- it's easier to find common ground. So we are certainly looking and we have the resources to do it.

[Viktor Trollsten, Analyst]

Okay. No, that's helpful. And just finally, on my side, in terms of -- in discussions with your customers, I know you have talked a bit about the out and insourcing trend historically where your customers, in general, start insourcing in bad times. Given that volumes, how soon in a lot of the end markets to actually start to increase again? Could you tell us anything about that trend, what you're seeing right now?

[Peter Rosén, CFO & Head of Investor Relations]

We haven't seen any major impact during this quarter regarding outsourcing. But we certainly don't -- we don't see any major shifts towards insourcing. And as I mentioned during the presentation, we do receive a lot of credit for being able to deliver -- to guarantee fast and stable deliveries, while others having more difficulties. So we do see discussions that are more towards receiving more volumes, but specifically in this quarter, we haven't seen major impact from that.

[Operator]

Our next question comes from the line of Karl Bokvist of ABG Sundal Collier.

[Karl Bokvist, Analyst]

So my first question here has to do with the other announcement today related to the CEO appointment of our former -- well-renowned name, Mr. Georg Brunstam. Just one question related to you. First, it says that you will become Deputy CEO. But will you remain CFO, just to get that right?

[Peter Rosén, CFO & Head of Investor Relations]

Yes.

[Karl Bokvist, Analyst]

Okay. Good. And I realize this is a broad topic, but is it possible to get some further color on the reasoning and the timing of the appointment of Georg? And why the choice fell on him and not an external person or...

[Peter Rosén, CFO & Head of Investor Relations]

I think in my view, and then I will refer most of your questions to the Board and Georg. But just 2 things. One is, we work very well together and have done so since mid-February. So that's one thing which is very clear. We do work very well together. And secondly, it's a permanent solution.And I think the other questions, I'll refer to the Board or to Georg as well.

[Karl Bokvist, Analyst]

All right. And on the cost development, where you mentioned that a lot of these savings can actually become structural. I think you -- maybe you've mentioned this, but I didn't quite catch it. The indications for the cost level going forward into Q4 and possibly 2021, when it comes to percentage of the run rate level as we saw earlier, I think that has been your indication previously?

[Peter Rosén, CFO & Head of Investor Relations]

Yes. when we look at the cost that we have for this quarter, and we only talk about OpEx, we do expect to see further savings also in the last quarter of this year. And when it comes to magnitude, I think one can expect another 5-plus percent compared to where we are in this quarter, to see another 5-plus percent improvement in the fourth quarter.When we come into -- and a large part of these savings are structural. The one thing that can impact a little bit but will not change the picture in its -- is when -- if and when we come back to more normal ways of work in COVID-19, the dust sort of settles, then of course we will see more travel costs coming up, but not to the same extent that we've seen historically. So generally speaking, we are at a new cost level, and we will remain fairly stable at these levels.

[Karl Bokvist, Analyst]

Did I understand you correctly, another 5% compared to this actual quarter, not the rolling 4 or anything like that?

[Peter Rosén, CFO & Head of Investor Relations]

No. This quarter.

[Karl Bokvist, Analyst]

All right. Good. And then my final question here had to do with, more or less, just if you could talk a bit about the progress made in not only Preferred, but also Mesgo.

[Peter Rosén, CFO & Head of Investor Relations]

If we take Preferred -- start with Preferred, we said already during the first quarter that the integration of Preferred followed the time plan that we set up at the time of acquisition. And the -- what we had remaining at that point was to deliver on cost savings from the integration of Preferred. And while we stated that we were following the time line in first quarter, we had by far surpassed that since then. Partly, of course, because COVID-19 sort of changed the picture somewhat. So Preferred is fully integrated from a customer business operation perspective. And from a cost perspective, we were well ahead over during the first quarter. And if we look at the savings now, which is more difficult to distinguish between Preferred and HEXPOL legacy, we are well ahead of that.So -- and when it comes to Mesgo, Mesgo had followed also the original time plan when it came to integration, both from a business perspective and the cost structure, working capital perspective. And as we released the press release earlier this quarter, we also purchased the minority share that was outstanding.So we are very satisfied with both of those acquisitions and both the integrations.

[Karl Bokvist, Analyst]

All right. My final one had to do with, when you initially acquired Preferred, you talked about the synergies of somewhere around -- correct me if I'm wrong here, but if it was SEK 110 million or if it was a bit more than that?

[Peter Rosén, CFO & Head of Investor Relations]

Do you mean -- maybe -- just to understand your question, do you mean integration cost or integration...

[Karl Bokvist, Analyst]

No, targeted synergies when you announced the acquisition?

[Peter Rosén, CFO & Head of Investor Relations]

Yes. We have reached and surpassed the targets.

[Karl Bokvist, Analyst]

Okay. That was my question, if you had reached more than that.

[Operator]

Our next question comes from the line of Johan Dahl of Danske Bank.

[Johan Dahl, Analyst]

Just a follow-up. How sustainable do you think this factor is where your customers appreciate your ability to deliver and your precision in delivery? Is that just a pandemic effect?And secondly, also, how -- again, how is that -- let's start there, I'll be happy with that.

[Peter Rosén, CFO & Head of Investor Relations]

Just to understand it correctly, you asked if the positive feedback that we receive from customers when we deliver, if that is sustainable? Our view is it's certainly sustainable. The positive feedback that we receive and have received during COVID times, we certainly believe that, that is sustainable and something that we will continue to work and develop on.

[Johan Dahl, Analyst]

Does that have a lasting impact on your factory footprint program that was -- you had one plan last year, but slightly different this year?

[Peter Rosén, CFO & Head of Investor Relations]

We're still in a position to determine a little bit where the customer requirements will fall. We took the decision not to close factories earlier this year because we wanted to see where customer demands and where that would land and what it would look like. And we are still at that position where we see that the current footprint supports and services customers and meet their requirements.So at this point in time, we haven't changed our view and we'll keep the footprint as it is. But of course, we are always, on an ongoing basis, looking at whether we should take a different decision. But right now, where we stand, we're comfortable with the footprint.

[Operator]

[Operator Instructions] And there are no further questions at this time. Please go ahead, Peter.

[Peter Rosén, CFO & Head of Investor Relations]

Thank you very much. Thank you for listening in, and thank you for all the questions. And I wish you a very good day. Thank you.