Hexpol AB

STO:HPOL B

Earnings Call Analysis

HEXPOL Posts Strong Q3 Results with EBIT Up 11%

In the third quarter of 2023, HEXPOL achieved an EBIT of SEK 930 million, marking an 11% improvement from last year, and a robust EBIT margin of 17%, rising by 280 basis points compared to the previous year. The company also reported a powerful cash flow nearing SEK 1 billion, a 37% year-over-year increase. While sales in the Automotive & Customer segment remained stable, Building & Construction saw a significant downturn in all markets. Americas outperformed Europe, with Asia also making gains over the previous year. Notably, the increase in operating profit is attributed to higher gross margins, offsetting slightly elevated OpEx due to acquisitions, FX effects, and inflation, though quarter-on-quarter costs remained consistent. HEXPOL's net debt-to-EBITDA ratio stood at a solid 0.5, indicating a strong financial standing after Q3.

Welcome to HEXPOL's Strong Third Quarter Performance

The third-quarter conference, led by acting CEO and CFO Peter Rosén, revealed HEXPOL's impressive financial strength despite varying market conditions. HEXPOL reported a robust EBIT of SEK 930 million, an 11% boost from the same quarter last year. The company's EBIT margin also expanded to 17%, indicating a 280 basis points growth year-over-year and a 50 basis points improvement from the previous quarter. Contributing to these impressive margins was tight execution of HEXPOL's business model, honed price management, and an advantageous product and price mix that also led to a strong cash flow of nearly SEK 1 billion.

Diverse Sector Performance with a Focus on Stability and Efficiency

HEXPOL witnessed a stable demand in sales to the Automotive & Customer segment, though the Building & Construction demand plunged significantly across all markets. Despite the lower raw material prices leading to reduced sales prices, the impact on EBIT was neutral. The company has been fine-tuning price management strategies to adeptly navigate these market shifts. Furthermore, the company's operational efficiency led to sustained high-quality financial figures, with an equity asset ratio of 63% and a return on capital employed well above 19%.

Persistent Growth Amidst Economic Headwinds

Although HEXPOL’s operating expenses increased slightly, linked to McCann's acquisition, inflationary factors, and unfavorable foreign exchange effects, these were balanced by a higher gross margin leading to the increase in operating profit. The operating profit's rise was also supported by a consistent cost structure in comparison to previous quarters this year. The compounding segment delivered 8% lower sales at SEK 5.1 billion compared to the previous year, and the Engineered Products segment maintained sales at SEK 360 million, nearly on par with last year's figures.

Strategic Management Leading to Improved Working Capital and Strong Cash Flow

HEXPOL demonstrated intelligent capital management, with working capital below the prior year's levels, an achievement even after taking into account the McCann acquisition which increased working capital by about SEK 70 million. The improvement in working capital ratio to sales was notable and is a testament to the company's strategic focus on efficiency, resulting in a nearly 40% surge in cash flow compared to the same period last year.

A Financially Solid Quarter with Forward Momentum

With a strong emphasis on EBIT growth and cash flow, HEXPOL concludes the quarter on a financially solid note. The company reported a profit of SEK 930 million from EBIT, with margins that have risen both over the last quarter and year-over-year, along with a significant cash flow achievement totaling SEK 1 billion. This performance cements the company's leading position and their ability to generate value amidst market uncertainties.

Earnings Call Transcript 2023-Q3

[Operator]

Welcome to the HEXPOL Q3 presentation. [Operator Instructions] Now I will hand the conference over to the acting CEO and CFO, Peter Rosen. Please go ahead.

[Peter Rosén, executive]

Thank you, and welcome to the presentation of the third quarter for 2023. I will first give you a business update, then go through how we continue to execute on our business model, then go through the financials and then summarize the quarter before we finish off with a Q&A session.

So if I can ask you to turn to Page 4 in the presentation, and I'll take you through the quarter. As you've seen, we delivered yet another strong quarter with an EBIT of SEK 930 million, which is 11% above what we did the same quarter last year.

And at the same time, the EBIT margin continues to improve, and we delivered 17% EBIT margin, which is up about 50 basis points compared to Q2 this year, and it's up 280 basis points compared to third quarter last year.

The drivers of the higher margin is the stringent execution of the business model, which includes price management and good product and price mix. And following on the strong EBIT and also the improvements that we saw in working capital, we also delivered a very strong cash flow of close to SEK 1 billion in the quarter.

When looking at demand and sales during the quarter, we see a similar picture as we did during the second quarter this year, with stable demand on sales to the Automotive & Customer segment, while the demand from Building & Construction was down substantially in all our markets. And we also see a similar picture when it comes to consumer-related products, and to a lesser extent, some areas within general industry.

Sequentially, we also saw somewhat lower prices on raw materials, resulting in lower sales prices during the quarter. At the same time, the trend of decreasing raw material prices seem to flatten out here during the quarter, and it sort of remains to be seen how this will develop going forward.

Work on sustainability continues with development of products and discussions with our customers on their needs. And also, as mentioned before, the M&A strategy favors acquisitions with high recycle content and capacity.

And if I then ask you to turn to Page 5 and we continue on the performance during the quarter. We see that for compounding, the Automotive & Customer segment shows improvement, but still with varied development across our markets, with Americas being more positive market than Europe when it comes to this area.

The automotive strike in the U.S. had no material impact for the group in the quarter. We did see some parts of our business was impacted, where demand was lower for some specific compounds, but it was not material for the group as a total.

As during the second quarter this year, we continued to see lower -- very low demand from Building & Construction, as well from the consumer-related and customer segments. And this lower demand offset the automotive demand as a total.

On a positive note, there is stable supply of raw materials and the supply chains for HEXPOL work overall very well.

During the quarter, we continued to see the raw material prices come down, some both sequentially and especially compared to the same quarter last year. At the same time, we do see the decrease flattening out and prices going forward can be expected to be either flat or increase some.

And overall, as mentioned, Americas showed relatively better market performance compared to, for example, Europe, while Asia improved versus the same period last year.

And overall, we delivered good EBIT and further improved margins. Engineered Products delivered sales in line with last year and also strong EBIT. EBIT was down some compared to last year, but this is fully driven by negative FX effects in Sri Lanka that we saw during the quarter.

When looking at M&A, we have a pipeline that we're working on, and we certainly have the financial resources to do more acquisitions when we can complete those. And the acquisitions that we've done during the last 2 years are now fully integrated into the HEXPOL business.

And then if I can ask you to turn to Page 7, and the business model. We've mentioned this several times before, but I still want to highlight one of the key aspects of the business model, which is price management. It is key for us, not only when raw material prices move upwards, but also when they decrease, as we've seen during this year. And it is important for us, and we are very agile when managing the price movements, whether they go up or they go down.

And if I can ask you to turn to Page 8, and looking at the sales development. We delivered sales of about SEK 5.5 billion this quarter, which on the total level is down some 8% versus the same period last year. Organic sales were down 14%, while the acquisition of McCann added plus 2% in sales. And in addition to this, we also saw some positive effects of about SEK 250 million.

Sales of automotive-related customers in total showed improvement, but still varies from market to market. And following on the lower demand sales to Building & Construction as well as to consumer products are down compared to last year.

Our sales process are down compared both to last year, and also somewhat sequentially this year as well following on the lower raw material prices. As mentioned before, lower sales prices impact our sales amount, but everything else being equal, it has no impact on EBIT in absolute terms.

And then if I can ask you to turn to Page 10, and we look at the financial overview for the quarter. As mentioned, we delivered a strong EBIT of SEK 930 million, and a good increase of 11% compared to Q3 last year. The margin came in at 17%, which is 280 basis points above last year, positively affected by good product and price mix. And it's about 50 basis points above second quarter this year.

The equity asset ratio remains high at 63%, and the return on capital employed is high and above the 19%. And again, we delivered a very strong cash flow here of almost SEK 1 billion, which is an increase of about 37% above the same period last year.

And if I can ask you to turn to Page 12. Looking at the operating profit. Looking at the profit drivers, we see that the increase in operating profit, compared to same period last year, is mainly driven by the higher gross margin.

OpEx is up somewhat compared to last year, and this is driven by the acquisition of McCann, negative FX effects and inflation, not least the salary inflation. And at the same time, the costs in the quarter are in line with the previous quarters this year. So no change there.

And then if I can ask you to turn to Page 13. We'll take a look at HEXPOL Compounding in the quarter. The segment delivered SEK 5.1 billion in the quarter, which is 8% below Q3 last year. And as mentioned before, the lower sales are driven partly by lower demand from Building & Construction and consumer-related products or customers, but it's also the lower sales prices.

However, the operating profit came in at SEK 862 million, which is well above last year with a strong margin improvement, positively affected by good product and price mix.

And if I can ask you to turn to Page 14, looking at the Engineered Products segment. Sales for that segment were in line with last year at SEK 360 million. Operating profit came in just below SEK 70 million, which is somewhat below last year. And also, the margin is down a little bit compared to Q3 last year. However, the decrease in margin is fully driven by negative effects in Sri Lanka for the quarter.

And then if I can ask you to turn to Page 15, we'll take a look at the working capital. And the working capital came in below last year in absolute terms despite the acquisition of McCann that added about SEK 70 million in working capital. And also sequentially, we see some improvement in absolute terms.

And also, working capital in relation to sales continued to improve compared both to last year but also sequentially during this year. And the movement is related to -- primarily to inventory improvements. There is no change in the underlying payment terms.

And then if I can ask you to turn to Page 16. Looking at the cash flow. As mentioned, we delivered a very strong cash flow in the quarter, SEK 963 million, which is well above last year's SEK 700 million. So it's an increase of almost 40% compared to the same period. And this is driven both by a strong EBIT but also lower working capital in the quarter.

And all of this translates into what we can see on Page 17, on our net debt, which decreased further. And at the end of third quarter, it stands at SEK 2.2 billion, with a net debt-to-EBITDA ratio of 0.5.

So all in all, when we look at the pure financials, we continue to stand with a very strong financial position here after third quarter.

And then just to summarize the quarter on Page 17, without going into all the comments. But it's a strong quarter from an EBIT perspective, with SEK 930 million in profit. And the margin that improved both sequentially but primarily versus the same period last year. And also, we delivered a strong cash flow in the period here of SEK 1 billion.

We saw that lower demand from end-customer segments, primarily with Building & Construction and consumer-related products offset sales to automotive and had negative impact on our organic sales development during the quarter. Also, this lower sales prices, it's driven by lower raw material prices impact the sales amount negatively, however, not EBIT, as you can see.

Our work on sustainability continues, both in the product development in close cooperation with customers, but also when looking at the M&A agenda, which is supported by our very strong financial position and our strong balance sheet here after third quarter.

And that is the presentation of the third quarter, and then I happily open up to Q&A.

[Operator]

[Operator Instructions] The next question comes from Julia Utbult from SEB.

[Julia Utbult, analyst]

The first question is on pricing. You delivered a good EBIT margin improvement and even better gross margin. So I assume you have a favorable cost price balance, just as you write in the report. And here you -- you've seen raw material price has been falling.

And on the other hand, I assume that negative volume had negative impact. So I would like to ask for the price and volume split here. And you also mentioned you had some positive mix effect. So any guidance here would be helpful, please.

[Peter Rosén, executive]

Yes. As mentioned before, during the quarter, both sequentially and compared to Q3 last year, we see volumes coming down a bit and also prices. And if we take the 2 different periods versus -- if we look at Q2 this year, volume is down, low single digit and price also low single digit, which makes up the difference compared to Q2 this year.

When we look at Q3 last year and the difference on the total, we see volume is down about mid-single digits and price is also down mid-single digits.

[Julia Utbult, analyst]

Okay. So relatively similar there. And on the mix effect?

[Peter Rosén, executive]

Yes. That one is -- what we do see is that we have -- when we look at the total, we have a somewhat better product mix and more -- a little bit more higher profit margin mix sold, compounds sold during the quarter, which supports the EBIT margin.

[Julia Utbult, analyst]

Okay. And then a question on the construction-related demand. So looking at the construction market in North America there, my general impression is that there are large differences between the communication around residential and infrastructure projects. So -- and the latter has been holding up relatively well.

So can you say anything about the exposure here among your customers? And have your transparency is here among your customers? Like how is your construction exposure both in Europe and Americas?

[Peter Rosén, executive]

Yes. When we look at Building & Construction, it's grouped together. But the part that is down substantially is new housing, new buildings. And infrastructure in the U.S. is somewhat more positive than compared to what we see in Europe. But the thing to keep in mind is when we look at how much of our compounds go into new building, new housing, compared to infrastructure projects, we see a lot more of our compounds going to new buildings. So when new housing drops substantially, as it has done, our content in new housing is bigger than it is for infrastructure projects.

So it's a double hit in the sense that, yes, new housing construction is down. And then our share with those customers is much higher than it is for infrastructure projects that are more stable.

[Operator]

The next question comes from Douglas Lindahl from DNB Markets.

[Douglas Lindahl, analyst]

I have a few. I'll ask them one by one. Just starting with a few follow-ups there. On pricing, which you comment is now flattening out. When do you think that will sort of entail more of a neutral year-over-year impact with regards to your organic growth impact or sales growth impact? Will we see it already in Q4 or more towards Q1, as it stands right now?

[Peter Rosén, executive]

Good -- very good question, difficult to answer. And the reason why it's difficult to answer is that some of the raw materials that we have -- that we that we use are severely impacted by what happens in the world around us.

So for example, even though oil is -- the price of oil is, in the long term, one key driver, and that is moving up and down very much what happens both in Ukraine, but also in the Middle East. So it's difficult to say exactly when we will come to a point where there is -- prices are.

[Douglas Lindahl, analyst]

Sorry, just base it on what prices are right now, then. Assuming [indiscernible].

[Peter Rosén, executive]

Yes. As I mentioned, we've seen prices -- raw material prices on asset total starting to flatten out now, and we can expect those to remain flat for a while.

[Douglas Lindahl, analyst]

Okay. And typically, the impact would be a few months or weeks?

[Peter Rosén, executive]

Right, more months than weeks, yes.

[Douglas Lindahl, analyst]

Okay. And then just a follow-up on the construction exposure there, which has been obviously tough. And appreciate the clarification of new housing versus infra.

But are you starting to see the new housing components, the second derivative maybe flattening out a bit? So falling less sharply year-over-year.

[Peter Rosén, executive]

I can only say that we see big decreases, both in second quarter and third quarter. I don't think we've seen it flatten out yet. Hopefully, it has, but difficult to say.

[Douglas Lindahl, analyst]

Okay. Appreciate it. And then just finally, your balance sheet now is extremely strong and cash flow, obviously very strong as well. And I think you mentioned M&A in the presentation, also in the report, very much on top of your agenda. But my thinking is that you have room for M&A and extra dividend and buybacks or potentially buybacks.

How -- what's your thinking with regards to your balance sheet and maybe being a bit more aggressive there with deploying that?

[Peter Rosén, executive]

As I mentioned, and you know our priority and focus is M&A, and that's what we want to do, and that's what we plan for. If, and perhaps, when we come to a point where we, and the order board, and together feel that we're overcapitalized, then we will look into how to manage that, extra dividend or share buyback or various options. But for the moment, priority and focus is M&A.

[Douglas Lindahl, analyst]

And -- but the M&A landscape, would you say that there are large M&A deals available that you're looking at, because it really seems like you could do both.

[Peter Rosén, executive]

We have a good pipeline, and there are a number of companies that we're interested in acquiring. The challenge that we face a little bit right now is that -- is simply to -- do we agree on where businesses are today, and how they will perform in the near midterm, from a timing perspective, and has impact on expected prices. So I think that we're in such a period where that's a fairly big discussion point.

[Douglas Lindahl, analyst]

Yes, we seem to hear that quite a lot, so.

[Operator]

The next question comes from Johan Dahl from Danske Bank.

[Johan Dahl, analyst]

A few questions. Just on this product mix. Peter, do you agree with the picture that it has improved sequentially throughout the year, that you've seen sort of step by step throughout the year? Or is that sort of exaggerating it?

And also, I wonder, to what extent is the improving mix a function of the -- how your different customer segments is developing? And to what extent is it that you're actually providing more value-added compounds on sort of new clients, new contracts? Just to understand the stickiness here of that product mix.

[Peter Rosén, executive]

Yes. When we're talking about product positive mix, it's primarily versus last year. During the year, this year, if we look at sequentially, there hasn't been that big movement. So it's primarily positive product mix compared to last year.

When it comes to which customer segments, that is, I would say, it's more related to which kind of products customers order than driven by a mix of customer segments. So within a customer -- end-customer segment, we can have a fairly, we can have different compounds with different profitability. So it's more driven by which type of compounds that are requested than the mix of end customer segments.

And then when it comes to the stickiness, of course, it's our ambition to remain -- to keep those compounds being sold to our customers.

[Johan Dahl, analyst]

But do you have any visibility there? Or is it sort of, it is what it is, or?

[Peter Rosén, executive]

No. I mean we have visibility into what our customers order, of course, and what we do to be able to continue to deliver those specific compounds.

[Johan Dahl, analyst]

All right. On the -- I think you talked about the accelerating pace to recycle. I just wonder what's the risk here that -- because it seems to be going really, really quickly from primarily automotive, I guess. The demand is recycled products. But are there M&A opportunities available in this space? What's the risk here that those assets are becoming really pricier, everyone have to adapt here to demand taking off?

[Peter Rosén, executive]

Put it this way, I mean, the demand for recycle -- our view is that the demand for recycled products will continue to increase. And for us to be able to meet that demand going forward, it will be -- it will require a combination of both doing M&A and also develop the products internally with the resources that we have today. And whether those assets acquisitions would become more pricey because they contain more recycled content. That might be the case. But then also the profitability of those companies should increase. So I don't view it as a risk that they will become too expensive to acquire. I think that's the way the development, for example, within automotive will develop. And we can do both acquisitions and develop our own products to meet that demand.

[Johan Dahl, analyst]

Is there an organic opportunity for HEXPOL to start collecting and providing sort of more raw materials for recycled? Or is that not something you're looking at the moment?

[Peter Rosén, executive]

Yes, we are looking at it. But it's early days, but we're looking at it. And I think that one should make the distinction between when it comes to TPE, for example, almaak or sorry, TPE, we have [indiscernible] is doing this. And we're also looking into what we can do on the rubber compounding side.

[Operator]

The next question comes from Andres Castanos-Mollor from Berenberg.

[Andres Castanos-Mollor, analyst]

Congratulations on the strong print and margin expansion. Lots of good questions being asked already. I just have one more, on the strength of the auto end markets and the impact of the strike. You mentioned it's not meaningful in Q3. How is it going to be for Q4?

[Peter Rosén, executive]

It's a very good question. I think when it comes to the automotive strike in the U.S., it changes almost by the day. But if I take the easy part first, as I mentioned, in third quarter, we didn't see any material impact for the group as a total. We had some impact on parts of our business, but not for the total as such.

If this goes on for longer and expands, it may have more impact, but it's too early to say. And why do I say that? Well, just see what happened the last 2 days. Firstly, the union extended the strike to include a bigger facility producing trucks, which was negative, and then it only took a day or two, and there was a message that a tentative deal had been done with one of the automotive producers.

So it moves quickly. But I think over time, if we just assume that the demand for vehicles still remain, then it's more a question of timing because then the cars still need to be produced.

So where we stand today, our view is it can have some impact, but in the long run, it shouldn't have any big impact.

[Operator]

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

[Peter Rosén, executive]

Thank you very much, everyone, for listening in and posing questions. And yes, thank you. And I wish you a very nice week and when you get that far. Thank you. Take care. Bye.