Vestum AB (publ)

STO:VESTUM

Earnings Call Analysis

Vestum's Q3 2024: Profitability Up, Growth Challenges Ahead

In Q3 2024, Vestum showed improved profitability with an adjusted EBITA margin of 11.5%, up from 11.4% last year, despite the market's challenges. The focus on product companies resulted in these companies contributing 50% to group EBITA. The Water segment thrived, reporting a 43% sales growth, primarily in the U.K. However, organic growth fell by 10.7% overall. With a solid operational cash flow of SEK 200 million and net leverage at 2.8x EBITDA post-acquisition of PDAS, the company is positioned for future growth, especially anticipating a return to volume growth in 2025.

Navigating Market Challenges with Strategic Focus

Vestum's Q3 2024 earnings call reveals a resilient company operating under challenging market conditions. Despite organic growth turning negative at -10.7%, management has successfully increased profitability, achieving an adjusted EBITA margin of 11.5%. This margin improvement stems from a strategic pivot towards product-focused companies which now account for 50% of the group’s EBITA. As these companies maintain strong market positions, they bolster profitability even in less favorable economic conditions.

Segment Performance: Water, Services, and Infrastructure

The Water segment shines brightly in this report, showcasing a remarkable 43% sales growth driven by both organic progress and the impactful PDAS acquisition. Despite this, EBITA growth was lower at 35%, partially due to the high-margin acquisition's initial integration period. The U.K. remains a key growth area, and the market outlook appears positive as management anticipates further demand growth. In stark contrast, the Services segment struggles under real estate market pressures, though there's hope for a turnaround in 2025 with expected volume growth. Meanwhile, the Infrastructure segment maintains solid profitability with an EBITA margin of 13.1%, mainly thanks to product lines outperforming expectations.

Financial Health and Cash Flow Dynamics

Vestum reported robust cash flow figures with operational cash flow of SEK 200 million for Q3 and a free cash flow of SEK 87 million. The company's net debt decreased from SEK 2.4 billion to SEK 2.1 billion year-over-year, reflecting effective cash management. However, leverage has seen a slight uptick to 2.8x EBITDA, primarily due to the PDAS acquisition, necessitating careful financial management moving forward.

Future Outlook: A Balanced Approach to Growth

Management remains cautiously optimistic, citing market uncertainties but signaling a positive shift in outlook. The company expects to return to volume growth by 2025, especially in the Water and Infrastructure segments, and has initiated several organic growth initiatives. The focus on maintaining financial health while pursuing acquisitions underscores a strategic balance in capital allocation. Furthermore, with an EBITA share of 50% from product companies, growth opportunities abound, particularly as these firms typically command higher margins.

Reinforced Commitment to Acquisitions Amid Improving Market

The company's ongoing commitment to M&A is evident, as they aim to bolster product segments through strategic acquisitions. With high-margin companies leading their product offerings, Vestum anticipates significant enhancements in profitability going forward. Despite current leverage being above target levels, the strong cash flow generation allows for continued investment in growth while managing debt prudently.

Earnings Call Transcript 2024-Q3

[Operator]

Welcome to the Vestum Q3 2024 Report Presentation. [Operator Instructions]

Now I will hand the conference over to the speakers: CEO, Simon Göthberg; CFO, Olof Andersson. Please go ahead.

[Simon Gothberg, executive]

Hello, everyone, and welcome to our presentation of Vestum's report for the third quarter 2024. My name is Simon Göthberg, CEO of Vestum. And together with me, I also have Olof Andersson, CFO of the company.

Let's have a look at some highlights from Q3. Despite a rather challenging market conditions, we have successfully improved profitability in the quarter with an adjusted EBITA margin of 11.5%. The margin uptick is mainly driven by our increased focus on product companies. And these companies have market-leading positions and have, in general, experienced a solid market.

Products now represent 50% of group EBITA, both in the quarter and on an LTM basis. And looking at overall demand, the positive shift in market outlook from Q2 has continued, but organic growth remains negative at minus 10.7% driven by the softer economy.

That said, we continue to see very strong demand in the Water segment, not least in the U.K. And thanks to solid cash flow in Q3 with operational cash flow of SEK 200 million, leverage has only increased slightly to 2.8x EBITDA, even though we made a rather large acquisition in August. And going forward, we remain balanced in our capital allocation between acquisitions and reducing leverage.

Now let's have a look at the segments, starting with the Water segment. Demand has continued to be strong with sales growth of 43%, driven by both the PDAS acquisition and organic growth. Essentially, all markets have performed well. And as with previous quarters, highest growth was seen in the U.K. EBITA grew by 35%, of which 9% organically. And the margin was slightly lower than last year, driven by the acquisition of PDAS.

PDAS has, however, performed in line with expectation and continues to improve its EBITA margin driven by the highly scalable and profitable subscription business of intelligent monitoring systems. And we have also already extracted procurement synergies with Pump Supplies by significantly increasing the discount rate with the largest supplier, and we're actively pursuing additional acquisitions to the segment.

Moving on the Services segment, The property market remained challenging in the third quarter, which impacted both volumes and profitability. However, sales decreased at the lowest rate since at the beginning of the year, and the lower margin in the quarter was mainly driven by lower volumes and increased competition in the market. As in the second quarter, we continue to see an improved market outlook with shortened lead times to our customers, and we expect to be back at volume growth in 2025.

Lastly, let's have a look at the Infrastructure segment. Profitability was strong in the quarter with an EBITA margin of 13.1%, mainly driven by our product companies. Products represented 30% of the segment's EBITA in Q3 compared to 23% last year. And the decrease in sales in the quarter was driven by certain businesses that are between project completion and project start. And as for the Services segment, we continue to experience an improved market outlook, even though short-term challenges remain.

Now we have, for over a year, talked about the importance of products in our portfolio. And as mentioned, 50% of group EBITA on an LTM basis is made up by market-leading product companies investment. And as seen by the pink bars, this share has increased rapidly since 2021 and continues to do so. These companies have leading positions with price leadership and accumulated EBITA margins above 15% and EBITA over net working capital of 67%, which I think really stands out.

Some companies have own products that can be exported to other markets and some are value-added distributors. Our capital allocation in M&A is focused on acquiring additional market-leading product companies, and one should expect the EBITA share of 50% to increase substantially going forward.

Now over to Olof.

[Olof Andersson, executive]

Thank you. And so let's have a look at our net sales and EBITA development over the past couple of 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 just like the previous quarter by the Services and Infrastructure segments, as Simon also mentioned.

And if we move on to the chart in the middle showing adjusted EBITA development, we see pretty much the same pattern with a decrease, again, driven by the Services and Infrastructure segments. However, finally, in the chart to the right, the adjusted EBITA margin actually strengthened compared to the same period last year from 11.4% to 11.5%.

And moving on to net sales development. And Q3 net sales decreased by 8% compared to last year, with the organic growth being negative by 11%. And worth noting is also that we had some negative impact on net sales growth due to the divestment of Plåtslagaren in the second quarter, while the acquisition of PDAS in the third quarter contributed positively.

We'll proceed to have a look at operating cash flow during the last 12 months. The operating cash flow decreased versus last quarter, driven almost entirely by net working capital. And the cash conversion also decreased somewhat compared to previous quarter, but still remains quite solid at 100%.

So that was operating cash flow, now let's look at 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., investments 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 379 million, down from SEK 441 million in the previous quarter, and the main driver of the decrease was the net working capital development. And the free cash flow of SEK 379 million amounted to 69% of EBITA. So basically 69% of EBITA was converted into free cash flow.

Now if you strip out the change in net working capital from free cash flow, you get a free cash flow for the last 12 months of SEK 325 million and you're still close to 60% of EBITA. And we think that, that is a quite strong number to emphasize when you consider the fact that we still have a quite [ expensive ] capital structure with a bond of SEK 600 million with a margin of 638 basis points plus stable.

And let's move on to net debt and leverage development. The net debt is represented here by the pink bars and amounted to SEK 2.1 billion, down from SEK 2.4 billion same period last year. And leverage increased from 2.7 to 2.8x sequentially from last quarter, driven by the acquisition of PDAS. It is worth noting that we've reduced the earn-out debt from SEK 80 million to SEK 62 million in Q3. And when taking into account earn-our debt, the leverage multiple increased from 2.8 in Q2 to 2.9x. Again, driven by the acquisition of PDAS.

And by that, I hand it back to you, Simon.

[Simon Gothberg, executive]

All right. Thank you. So in summary, we have successfully improved profitability, although market conditions remained challenging. And this is driven by our increased focus on product companies, which now represents 50% of group EBITA, both in the quarter and on an LTM basis.

Cash flow was solid in the quarter with operational cash flow of SEK 200 million and free cash flow of SEK 87 million. And we'll continue to experience strong demand in the Water segment, in basically all markets, but with highest growth in the U.K., where we have also successfully onboarded the acquisition of PDAS. And further acquisitions are expected mainly in the U.K.

That said, we remain balanced in our capital allocation between reducing leverage and investing in growth. But we also acknowledge that we generate strong cash flows. And as with previous quarters, in 2024, market uncertainties remain in the short term, but the positive shift in market outlook has continued in Q3, and we expect to return to volume growth in 2025. And we have already initiated several organic growth activities across the portfolio that will show results next year.

And with that, we open up for questions.

[Operator]

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

[Simon Jönsson, analyst]

First, a few questions on Infrastructure. Can you maybe just elaborate a bit more on the sales volume? If I understand correctly, EBITA for product companies in the segment increased year-over-year, and I wonder if that was due to stronger profitability? Or did you also see sales increase for the product companies?

[Simon Gothberg, executive]

Yes, sure. Simon, it's Simon here. Well, yes, I would say that the increase in margin in the Infrastructure segment is mainly due by margin expansion for the product companies. They also had a slight decrease in volumes as with the services companies, but lesser so. So it's not really driven by volume growth, but more so margin expansion driven by, I would say, favorable product mix, but also efficiency measures. So for example, some of these companies are selling more of their renovation products versus products for new production.

[Simon Jönsson, analyst]

Excellent. And on the service-oriented side of Infrastructure, you talked about a few companies that are between contracts basically. How should we view that in coming quarters? Or was it more isolated to Q3? Or how should we think about that?

[Simon Gothberg, executive]

Yes. I mean I think it's basically the same as in Q2, right, where we had similar patterns. And what we said that we're expecting to see this pattern for the remaining of the year. So I would say that, basically, what we saw in Q2 and Q3, we're expecting to see that in Q4 as well for the services side of the Infrastructure segment. But as with Q2, the order books are filling up. And basically the same as in the Services segment, the market outlook is looking a bit better for 2025.

[Simon Jönsson, analyst]

Got it. And when you talk about '25, is it mainly -- you talked about the full year, that you expect volumes up. But is that true for the first half as well, you think? Or when do you think we should look forward to the volume increases?

[Simon Gothberg, executive]

Yes. It's a bit early to guide on specific quarters in 2025, I would say. But I mean, if anything, looking at the Water segment, we're expecting that segment really to continue to perform quite nicely, although we're looking at some more sort of difficult reference figures in that segment going forward. And in the Services segment, I would expect the volume growth to be rather Q2, Q3, Q4 rather than in the first quarter. And you might be a little bit faster in the Infrastructure segment.

[Simon Jönsson, analyst]

Okay. Just a last one on working capital. You had stronger performance on the product companies. I mean how does that translate into working capital changes? You had a slight working capital increase this year compared to a release last year. So I'm just wondering if a stronger contribution from the product side has anything to do on the working capital? Or maybe you can elaborate a bit more about the moving parts in working capital development compared to last year.

[Olof Andersson, executive]

Simon, this is Olof speaking. No, I wouldn't say that the change in net working capital is largely due to the product companies. I think it's -- net working capital development does swing a bit between the quarters, and I think that has more to do with the dynamics of like timing throughout the quarter. So for instance, if business after summer has picked up late in the quarter, then you will have a larger capital tie-up than if it has picked up early in the third quarter. So I think it's mostly timing aspects, actually, rather than the product -- than the company mix.

[Operator]

The next question comes from Jakob Marken from Danske Bank.

[Jakob Marken, analyst]

So first question from my side, if you could help us a little with the Infrastructure and how we should think about the margin going forward. So very strong margins here, of course, and I guess driven by the higher share of product sales here. But how should we think about the companies with larger contracts and projects? I guess those were weaker here than last year, sales were down quite a bit. How should we think about the margin development? When do they start to pick up, how would that affect margins?

[Simon Gothberg, executive]

Yes. Jakob, it's Simon here. Well, I mean, I would say that historically, we've been at margins of above 11% or around 11% and 12% in the segment. And as the product companies are growing as a share of EBITA in the segment, both organically but also from further acquisitions going forward, one should expect that the margin in that segment should increase. And as you correctly mentioned, some of the larger infrastructure companies on the Services side with projects have come down really throughout 2024, right?

And as we expect them to sort of normalize next year, it may have a slight impact on the margin. But again, the organic growth for our product companies is quite good in a more normal market, and we can also control the organic growth in a better way, meaning that we can actually export these products and really bring them cross-border into other markets. And again, adding acquisitions to the segments, one should expect that we will continue to grow with product companies when it comes to M&A. And those companies typically have higher margins and price leadership.

[Jakob Marken, analyst]

Okay. Perfect. That's very helpful. And then a question on cash flow. So could you just help us with -- I mean, there's been some changes to the portfolio here in the last year and so it's quite hard to look back at it, and I mean the market has been going downwards and stuff like that. So could you just help us with what do you think is the normal seasonality here? Do you expect Q2 to be the biggest working capital tie-up quarter? How should we look about Q3 in the future? And is it still like Q4, Q1 where we should expect releases?

[Olof Andersson, executive]

So this is Olof speaking. So it will swing a bit between the quarters. So I think the underlying trend is that you have a net working capital release in Q4 or Q1, and that can swing a bit depending on calendar effects on bigger projects being finalized in Q4 or not. And then typically, you see a net working capital buildup in Q2. And then Q3 can go a bit either way actually, because it depends a bit on if the -- how quickly the business has picked up in Q3. So if you have a lot of intensity in the second half of the quarter, you will have -- you will likely have a quite big capital buildup during the end of the quarter. Whilst if that is not the case, it might be a net working capital release instead. So I would say that's a very general description of the net working capital dynamics.

[Operator]

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

[Simon Gothberg, executive]

All right. Yes, so we have 2 written questions here. The first one goes like this. You mentioned that margin in the Water segment is lower driven by the acquisition of PDAS, should we expect lower margins in this segment going forward?

Well, so the acquisition of PDAS, right? So the margin in PDAS is roughly 11%, 11% to 12%. And as seen in the report when we talk about acquisitions, right, the PDAS company has increased its margin throughout 2024, which is driven by the highly scalable and profitable subscription business. So I think year-to-date, January to September, the company had a margin of I think 9%, and it was something like 13% in Q3, and the margin is continuing to increase in that company.

As you may or may not remember from when we made the acquisition, they have basically 3 business areas. And the biggest one, called Proactive, has a margin of some 25%. And it's biggest in profits, but it's the smallest one in sales, but it's also growing faster. So as that continues to grow, the margin will continue to increase.

And on top of that, we have lots of nice synergies with Pump Supplies. And I mentioned some of these in this presentation, right, earlier with the procurement. So in the short term, yes, the margin will likely come down just a little bit in the Water segment. But as the PDAS company continues to generate higher margins, the profitability will come back essentially.

So that was the first question. The second question goes like this. "From a capital allocation perspective, we are balanced between reducing leverage and pursuing acquisitions." That was in quotation. And the question is, does this mean that you might embark on acquisitions despite leverage being above target?

Well, I think as mentioned in Q2, right, we got a leverage of 2.7x EBITDA. And I mean, given the refinancing that we did earlier this year, we have significantly reduced our capital costs, which means that 2.7 or 2.8x is less of an issue now than it was a year ago. That said, we are very serious about our financial target of maximum 2.5x. So if we are to -- if we were to stretch our leverage to above 3x, we wouldn't make acquisitions.

But we also acknowledge that we have a very strong cash flow generation. Looking at our free cash flow on an LTM basis, it's SEK 379 million. And if you were to divide that by a multiple of 6, which is basically where we have made acquisitions historically, you would arrive at basically SEK 60 million, SEK 65 million in acquired EBITA, right? So we feel like we can continue to grow by acquisitions just given our strong cash flow, really. But we are balanced between leverage and acquisitions.

So I think that marks the last question for today's presentation. And with that, we wish everyone a great day, and thanks for all the good questions.

[Olof Andersson, executive]

Bye-bye.