Vestum AB (publ)

STO:VESTUM

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Simon Gothberg, executive]

Hi, and welcome to our presentation of Vestum's report for the second quarter 2024. My name is Simon Gothberg, and I'm the CEO of the company. And together with me, I also have Olof Andersson, CFO of the company. Now let's have a look at some highlights from Q2. We have successfully continued to reduce financial net debt, including earn-outs by some SEK 53 million. And we have seen a general positive shift in how our businesses view their market outlook.

At the same time, activity was lower than in the previous year with organic growth of minus 9% and a decline in EBITA margin of 9.7%. As with earlier this year and also in 2023, really, the Water segment continues to develop strongly and is characterized by strong structural growth with a limited sensitivity to the economic cycle. This has made us to complete Vestum's first acquisition in 2 years after end of the quarter, which further strengthens the Water segment and our position in water infrastructure.

Operational cash flow amounted to SEK 118 million, bringing cash conversion on LTM basis to 107%. Leverage increased slightly to 2.7x. And going forward, we have a balanced focus in capital allocation between acquisitions and reducing leverage.

Let's have a look at the segments and starting with the Water segment. As mentioned, we are experiencing continued stable demand and profitability with the strongest development in the U.K. during the quarter. There are some really strong reference figures for this segments as there was an extreme drought in the Nordics in April, May 2023, which had a positive impact on volumes and profitability in the previous year.

And this year, extreme weather was absent, but we still managed to improve the EBITA margin and deliver an EBITA of SEK 48 million, which is in line with last year. And we're expecting solid demand and profitability going forward, and we'll continue to explore acquisition opportunities after I completed a really great add-on acquisition to the segment again, as mentioned after end of the quarter, and we currently have ongoing discussions with targets in all of our markets.

Moving on to the Services segment. Here we're exposed to the property market, which remained a bit challenging in the second quarter, and this has impacted both volumes and profitability. The lower margin was mainly driven by our product companies, which constitute some 25% of the segment we have, for the first time since the market began to decline seen a positive shift in market outlook, and this is mainly true for the product companies, but also in installation, although there are some -- they are more natural or neutral in their growth prospects with an expectation to return to growth in the latter part of the second half of 2024.

Now lastly, let's have a look at the Infrastructure segment. We are generating lower volumes and profitability compared to last year, mainly driven by the economic downturn, but also strong reference figures and project timing. This segment is generally positioned later in the economic cycle and services and water, which means that we are now experiencing a downturn for the first time since the economic cycle shifted downwards.

And this, however, shouldn't be exaggerated as it explains only a part of the decline as again, some businesses face tough reference figures while some of the larger companies in the segments are between product completion and project starts. And we have similar to the first quarter, continue to win new projects and the overall market outlook is now we are more positive than earlier this year. That said, the performance in the second quarter is expected to spill over to the second half of the year, and the short-term market challenges remain.

Now let's talk a bit about acquisitions. We are very pleased that we have completed the first acquisition in 2 years, and this is an acquisition of PDAS, a U.K. market leader in wastewater pumping stations. PDAS is an add-on acquisition to pump supplies, which is Vestum's largest company and naturally the largest company in the water segment. And the U.K. water infrastructure market is heavily underinvested and therefore, growing rapidly and pump supplies has developed extremely well in the last 5 years and continue to do so.

And with add-on of PDAS, we have now further improved our strong position in this exciting market. PDAS generates a majority of its profits from intelligent monitoring systems using remote telemetry and cloud-based technology with a subscription business model. And this means that roughly 60% of their profits are coming from recurring revenue streams and we can now use the broad customer base in pump supplies, which have been built over the past 4 decades to further accelerate growth.

Both management teams are super excited and already getting started with working on synergies between the companies. As shown in the slide here, sales and pump supplies is nearly doubling after the acquisition as PDAS generates sales of some SEK 210 million per year and growing. Now over to Olof.

[Olof Andersson, executive]

Thank you. So let's have a look at our net sales and EBITA development over the past quarters. And let's begin with the chart on the left, which shows net sales where we saw a decrease compared to the same period last year, driven by the Services and Infrastructure segments, as Simon just mentioned. And if we move on to the chart in the middle showing EBITA development, we see pretty much the same pattern, again, driven by the Services and Infrastructure segments. And finally, in the chart to the right, the EBITA margin basically followed the same pattern as EBITA decreasing from 11.6% to 9% -- 9.7% compared to the same period last year.

And moving on to net sales growth. Q2 net sales decreased by 10% compared to last year, and the organic growth drove that decrease by being negative 9%. Worth noting is also that we had some negative impact on net sales growth due to the divestment of Plåtslagaren. We'll proceed to have a look at operating cash flow during the last 12 months. And the operating cash flow decreased compared to the previous quarter due to lower EBITDA and the LTM cash conversion was slightly lower than the previous quarter than in Q1, which in turn was due to a slightly negative net working capital development.

So that was operating cash flow. Now let's look at the free cash flow. And we define free cash flow as cash flow from operating activities. So that is including interest and taxes paid and change in net working capital and then we subtract CapEx spending, i.e., investment in fixed assets, and we also subtract leasing amortization. So basically, free cash flow is cash that can be used for dividends, acquisitions and repayment of debt. And for the last 12 months, the free cash flow amounted to SEK 441 million, down from SEK 496 million in the previous quarter. And the main drivers of the decrease were lower operating activities, including the net working capital development.

And let's move on to the net debt and leverage development and the net debt is here represented by the pink bars and amounted to SEK 2.0 billion, down from SEK 2.6 billion in the same period last year, which corresponds to a decrease of 20% compared to last year. Leverage increased from 2.5 to 2.7x sequentially from last quarter, driven primarily by paid-out earn-out debt but also to some extent by lower EBITDA.

We reduced the earn-out debt by SEK 127 million from SEK 207 million to SEK 80 million in the second quarter. And when taking into account route, the leverage multiple increased from 2.7x in Q1 to 2.8x in Q2, driven by a decrease in EBITDA in the EBITDA over the last 12 months. And by that, I hand it back to you, Simon.

[Simon Gothberg, executive]

All right. So in summary, the quarter generated lower volumes and profitability than last year. But as in the last 18 to 24 months, we have successfully reduced our net debt, including earn-outs, the Water segment, which is rather insensitive to the economic cycle continues to generate solid profitability with an improved EBITA margin of 23.7%. We have gladly resumed acquisition agenda after 2 years of full focus on the balance sheet. And we will continue to evaluate acquisitions in the Water segment that can generate high returns.

Capital allocation wise, we're balanced between further M&A and reducing leverage, and we will invest our capital where we can achieve the highest returns at reasonable risk. Leverage increased slightly in the quarter to 2.7x and is expected to remain above our financial target of 2.5x for the remainder of the year. Overall, Vestum positioned early in the economic cycle. And even though market uncertainties remain in the short term, we have seen a general positive trend shift in the market outlook for our companies throughout the quarter. And with that, we open up for questions.

[Operator]

[Operator Instructions] The next question comes from Simon Jönsson from ABG.

[Simon Jönsson, analyst]

A few questions from my side. First, starting with the Water segment, where top comps were a bit tougher here and more specifically less help from weather conditions, as I understand. So far, how has that translated into Q3, you think? In other words, do you think you will have more help by the weather in Q3?

[Simon Gothberg, executive]

Simon, it's Simon here as well. Well, yes, so I would say that we could -- I mean, obviously, we did quite well in the second quarter in the Water segment, although extreme weather was absent, and this was mainly due to the U.K. operation where the demand remains high, and we're expecting stable demand really throughout the in the second half of the year. And Q2 2023 had some extreme weather. But in Q3 and Q4 last year, there wasn't really anything extraordinary. So I would say that the reference figures aren't at the same level in the second half now as they were in Q2.

[Simon Jönsson, analyst]

Got it. That's clear. Then moving on to services, where the market remains challenging. You commented specifically that product companies drove the weaker performance. Could you just elaborate a bit more on that, you mentioned briefly that there is a positive shift in the market outlook. So maybe elaborate a bit more on that, please?

[Simon Gothberg, executive]

Yes, sure. So I would say that overall, the lead times are much, much shorter on the product side than they are on the installation side. So basically, there was a bit of a downturn starting in the second quarter for the product companies. But we have seen a rebound in sort of customer confidence for those companies. So we're expecting to get back to sort of more normal figures for the product companies in the second half of the year.

That being said, they represent roughly 25% of the segment. And for the remaining 75%, those companies are exposed to energy efficiency measures in properties, mostly installation companies, and they are a bit more neutral in when they can start achieving growth again. I don't think that will happen in the third quarter. But in the latter part of this year, we're expecting to see a rebound for that part of the segment.

[Simon Jönsson, analyst]

Okay. So you expect a rebound for the service part of services basically. But can you also talk a bit about what you saw here in Q2 compared to Q1, for example, in recent quarters for the service businesses, if there are any changes in the performance and the underlying market? Or was it more similar?

[Simon Gothberg, executive]

Yes. I would say it was slightly better in the installation side of things, right? So if you were to only look at the installation companies, then the margin would have been higher in the second quarter for the services companies. And I guess we're expecting that sort of similar performance in the third quarter for those companies. So a bit better than Q1 for the installation companies in the second quarter.

[Simon Jönsson, analyst]

Got it. And on the PDAS acquisition, you talked briefly about synergies between pump supplies that you expect to realize. But can you talk a bit more specifically about what kind of synergies you are seeing?

[Simon Gothberg, executive]

Yes, sure. So both businesses are obviously procuring water pumps. And there will be some procurement synergies for these businesses that are rather -- that should be rather quickly to extract. And then on the sales side, we have -- in the acquiring company, the company that we already own, obviously, right, pump supplies. They are extremely busy as seen in the water segment throughout the last couple of quarters, and they don't really have time to take on the services contracts that they receive from clients and now we can sort of pass those over to PDAS. So I think there will be both revenue and cost synergies, both in the short term and in the long term really.

[Simon Jönsson, analyst]

Got it. And maybe you already said this, but when do you expect the acquisition to close?

[Simon Gothberg, executive]

Yes, sure. So it closed on the day that we announced so it was closed last week. So we will consolidate into the third quarter and impact both balance sheet and income statement and so forth.

[Simon Jönsson, analyst]

All right. And one last question for me on the working capital. How should we think about the development into the second half of this year, specifically in regards to project completions and starts in infra.

[Olof Andersson, executive]

Simon, this is Olof speaking. So the way we should think about that is the net working capital can swing quite a bit between the quarters. And when it comes to the third quarter, which we're entering now. So usually, you have a kind of a net working capital release during the summer as a result of the business that has been occurring during Q2. However, you typically see a net working capital buildup during the later part of Q3.

And the net working capital development depends a lot on how intensive that business ramp up in Q3 is. So you can see actually quite substantial net working capital build up in September if the business is quite intense. On the other hand, if it's a slower ramp-up during the autumn, then obviously, you might not see that kind of tie-up of net working capital. So to note, it's quite difficult to know how it's going to look, but that is the dynamics.

[Operator]

The next question comes from Karl Bokvist from ABG.

[Karl Bokvist, analyst]

Just some follow-ups there. Curious about the lead times within your product businesses. Would it be fair to assume some form of between like 1 to 2 quarters being normal lead times from a placed order to delivery?

[Simon Gothberg, executive]

Karl, it's Simon. I think that's a very good question. And I think you're right when it comes to sort of the average, right, but it could also be longer. And this is one of the reasons why the infrastructure is facing tougher figures now in Q2 as the order book in general has improved, and we're taking on several new projects. And for example, we won a terrific project on the railway earlier in the second quarter of SEK 287 million, there will be worked throughout 2025 to 2030, and that is really in the subway actually, which is a great project. But again, it starts next year, right?

So there are some longer lead times in the Infrastructure segment in comparison to Services and Water, which is what we're diluting to when we say that they are exposed a bit later in the economic cycle than Services and Water. So when we see the sort of profit bottom in Services, you can expect that Infrastructure would be maybe lag in one quarter.

[Karl Bokvist, analyst]

Okay. Understood. And then just to understand these effects in Services here. Was there anything in particular affecting the product service companies? Or was it just lower margins because of lower volumes year-over-year and this kind of, let's call it, usual drivers.

[Simon Gothberg, executive]

Yes. I would say there was pure usual drivers, nothing extraordinary on the product side of things and really nothing to mention in particular for any of the companies that stands out.

[Karl Bokvist, analyst]

Understood. Then 2 questions, perhaps mainly directed towards Olof. And the first one on the -- I understand now with the acquisition, which perhaps changes things a little bit. Net financials, if I just look at the pure like interest cost, it looks like based on what you wrote at least, they came down in Q2 versus Q1. Again, I understand the acquisition now makes things a bit more difficult. But would you say that the interest costs are now gradually subsiding or coming down to lower levels based on what you've done historically with the balance sheet?

[Olof Andersson, executive]

Yes, that is correct. Since the refinancing activities that we -- that took place in Q2. The overall effect of that is that the running interest costs are coming down. As we wrote in the report, where we saw some onetime effects due to this actual process. So you had some negative impact in the month of April. But now in the -- but in the coming months, interest costs have come down, and we expect them to going forward, of course, adjusting them for -- you have to adjust then for the acquisition, as you rightly mentioned.

[Operator]

The next question comes from Johan Sundén from Carnegie.

[Johan Sundén, analyst]

Two more from my side. The first one, it's to get a little bit more color on the comparison during the second half of this year. Given the divestment you made late last year, the historical reports are -- the comments are maybe not that useful anymore. So it would be very helpful if you can just give some brief comments on if you view the comparisons in the infra and the service segment tough or maybe more neutral or easy in the coming 2 quarters?

[Simon Gothberg, executive]

Yes. No, I would say that, Johan it's Simon. Starting with services. This is where we had a Plåtslagaren that we divested in April, I think, right? So that company generated some SEK 5 million in EBITDA in the second half of the year, basically SEK 2.5 million per quarter. So I guess that stands out, right? And overall, I would say that the margin in Q3 and Q4 in the Services segment, it's not a weak margin of 11% to 12% in the economy that we're now operating in. So I wouldn't say that they are on the weak side of things. And looking at the Infrastructure segment, I mean, these are restated figures, and there hasn't been any divestments or acquisitions in this segment. And really, the same thing for the Services segment. I would say that the margin is rather solid than especially the third quarter here of almost 12%.

And I think as we mentioned in the report now and in the CEO comments, what we've seen in the Infrastructure segment in the second quarter, similar, I guess, performance is expected at least in the third quarter as we remain sort of between project start and for completion? And how much of that could be extracted already in Q3 remains to be seen. So we won't guide any further than that. But yes, so I guess that's what you have to calculate with. And in the Water segment, you obviously have PDAS that we have acquired, that will impact the third and fourth quarter.

[Johan Sundén, analyst]

And my final question is on acquisitions. And just curious to hear how you reason regarding acquisitions going forward and how kind of forward leaning you want to be during the fall. I understand that it's tough to comment on specific timing, but should -- is there reasonable to assume that they can come in more acquisitions during H2 this year or the kind of discussions you have on that more probability to bring acquisition being closed in '25 or so.

[Simon Gothberg, executive]

Yes. I mean I think we will remain balanced in our capital allocation strategy between reducing leverage and making acquisitions. And in a sort of normal economy, I think 5 to 10 acquisitions per year is reasonable. But that's not this year and most likely not next year either. We are very keen on ensuring that leverage remains at reasonable levels. And our financial target of maximum 2.5x.

I mean, we're very serious about that, right? So we have no ambition in driving up leverage to really high numbers just to make acquisitions. So we now made the acquisition of PDAS because it's a terrific acquisition that will add so much value to Vestum overall into the Water segment. That could potentially be some additional add-on acquisitions going forward as well. But again, we will be -- we will look closely at returns versus risk. If we can achieve a high return at a reasonable risk, then we might go ahead and make an acquisition. But again, leverage is on top of our mind.

[Operator]

There are no more phone questions at this time. So I hand the conference back to the speakers for any written questions and closing comments.

[Simon Gothberg, executive]

Okay. Thanks so much for taking the time. Now we take questions at this point. Much appreciate it, and enjoy your day. Thanks so much. Bye-bye.