TECO Electric Machinery Co Ltd

TWSE:1504

Earnings Call Transcript 2022-Q2

[Andy Chien, executive]

Ladies and gentlemen, good afternoon. Welcome to TECO Electric & Machinery 2022 Second Quarter Earnings Conference. I'm Andy Chien, Director of Corporate Governance Center. I'm joined by 3 executives. First of all, we have Chairman, Chwen-Jy Chiu.

[Chwen-Jy Chiu, executive]

Ladies and gentlemen, good afternoon.

[Andy Chien, executive]

Second, President, Thomas Fann.

[Thomas Fann, executive]

Ladies and gentlemen, good afternoon.

[Andy Chien, executive]

Last but not least, Anbin Liu ], Director of Corporate Administration Performance Development Office.

[An-bing Liu, executive]

Ladies and gentlemen, good afternoon.

[Andy Chien, executive]

In today's meeting, I'll first go over TECO's second quarter results then President Fann will talk about the performance of our 3 main business groups, and I'll provide a recap of our recent major events. After the presentation, Chairman Chiu will host the Q&A session. [Operator Instructions]. The presentation materials have been uploaded to the homepage of our website. You may go there and download them now.

Page 3, financial highlights. Q2 net sales came in at TWD 14.544 billion, up 13.5% Y-o-Y and up by 4.7% Q-o-Q, mainly thanks to the persistent growth of Green Mechatronic Solutions business in North America, Europe and Taiwan as well as the continued increase in Intelligence Energy business. Q2's gross margin was 23% down by 0.9 percentage points Y-o-Y due to rising raw material, freight, logistics, labor and warehouse rental costs. Meanwhile, it was up by 1.1 percentage points from Q1 due to product price adjustments. Operating margin was 8.9%, up by 0.7 percentage points Y-o-Y due to effective expense control. Our Q2 EPS was TWD 0.48, up by TWD 0.31 Q-o-Q, boiled by a dividend income of TWD 730 million, while down by TWD 0.2 Y-o-Y, mainly due to an unrealized loss of TWD 420 million in financial asset evaluation recognized in Q2. In comparison, during the same period last year, we had a financial asset evaluation benefit of TWD 710 million. Net sales in the first half was TWD 28.441 billion, up by 16.8% Y-o-Y with an EPS of TWD 0.65, down by TWD 0.56 Y-o-Y, again due to the loss in financial asset evaluation.

Page 5, OP revenue and gross margin. Last year due to certain raw material prices and transportation costs, our gross margin dropped from nearly 24% in the first half to about 21% in the second. However, in the first half of this year, with product price and program mix adjustments, the OP margin has seen an upward trend every quarter.

Page 6, OP profit and OP margin. Q2's OP margin was 8.9% up Y-o-Y and also up from previous quarters, which have a positive impact on the company's profitability.

Next, I'll hand over to President Thomas Fann, who will talk about the performance of the 3 major business groups.

[Thomas Fann, executive]

Ladies and gentlemen, good afternoon. I'd like to go over the performance of the 3 business groups. In Q2, Green Mechatronic Solutions posted revenue of TWD 780 million, up by 13.9% Y-o-Y despite the negative impact of lockdowns in China. We benefited from strong growth in North America and persistent revenue growth in Europe and Taiwan helping to boost Green Mechatronic Solutions performance in Q2.

Revenue of Intelligent Energy increased by 37.5% Y-o-Y, mainly thanks to the growth of engineering project revenue including IDC projects and Taipower's Longtan UHV substation energy storage system projects. Air and Intelligent Life's Q2 revenue came in at TWD 3.6 billion, up by 5.6% Y-o-Y on the back of growth in AC product sales.

Next slide, Q-o-Q-wise, Green Mechatronic Solutions maintained its upward trend. Despite some ups and downs due to cyclicity overall Intelligence Energy has been on an upward trend. In terms of Air and intelligent Life, a major project finished in the middle of Q2 resulted in a slight drop towards the end of the quarter. However, it still posted Q-o-Q growth trend compared with last year.

Next page. Revenue breakdown by business group. Our what -- first half consolidated revenues increased by 16.8% Y-o-Y. The revenue contribution of the 3 major business groups was basically even, but the share of Intelligence Energy increased to 14.1% in Q2, thanks to a larger number of orders secured.

Next slide. Q2 consolidated revenue jumped by 4.7% Q-o-Q and 13.5% Y-o-Y. Intelligence Energy posted bigger Q-o-Q growth, thanks to the stronger order stream in Q2. Air and Intelligent Life revenue share stood slightly in Q2 following the delivery of the major project in Q1.

Next slide. Here is an overview of our key energy saving and carbon-neutral projects. On July 1, Taiwan's electricity rates were raised by an average of 8.4% and 15% for heavy users. Since last year, TECO has launched highly efficient smart electromechanical systems that can contribute to emissions reduction, including high-efficiency motor drive systems, medium- and low-voltage inverters and more efficient cooling towers. We are also working with major manufacturers in Taiwan to help them lower-power consumption energy bills. We continue to move ahead with the efforts leading to Y-o-Y growth of more than 30% for our energy saving products and services with annual revenue expected to reach TWD 4 billion this year.

Next slide. Here is a new offering from TECO Westinghouse, especially designed to meet the electrification requirements for the oil and gas industry imposed by the Clean Competition Act. It is a medium voltage inverter equipped with a high-efficiency motor for replacing traditional compressors driven by diesel generators used in supply stations so as to slash emissions. Meanwhile, efficiency will also be boosted greatly. More importantly, this product is movable. And of course, the unit price is very high. At the moment, we have more than USD 20 million worth of orders on hand. At the same time, business opportunities for more than 100 sets are under discussion. So this product will be a new pillar of our business in North America in the future and will be an important revenue contributor to the company.

Next slide, we continue to pursue major energy management opportunities in Taiwan. The first is the onshore transformation substations for offshore wind farms. There are 2 projects with a total installed capacity of 1,200 megawatts and combined contract value of more than TWD 8 billion. The second is equipment and systems for offshore substations. The requirements of offshore substations are very different from those of onshore ones. They must have high weather tolerance and high short resistance, and they must be lightweight as well. Currently, we're working with experienced international manufacturers to capture growing opportunities and pursue technological breakthroughs in the market. In the field of energy storage, we are competing for Taipower's Dongshan energy storage system project, which is a 60-megawatt more than TWD 3 billion worth project expected to be tendered in late August.

Next slide, revenue breakdown of our Green Mechatronics Solutions business by region. In the first half this year, North America posted stellar growth with its share growth growing to 29% from 25% a year ago. China's Q2 revenue was affected by lockdowns, causing the region's revenue share to drop from 24% to 21%. The performance of Taiwan, Europe and other markets such as ASEAN countries and India was relatively more stable. Overall, our revenue contribution is fairly distributed and is in alignment with our market expansion moves. There is much room for growth in other markets, especially in Southeast Asia, from Vietnam, Indonesia, Thailand to Malaysia or India, where TECO is now building a new plant. These are all important sources of future business growth for TECO.

Next slide, geographical distribution of the upper value of Green Mechatronic Solutions. Compared with 2021, in the first half of this year, the output value of China decreased slightly due to lockdowns. Europe share increased Y-o-Y due to sales growth, and Taiwan was relatively stable compared with its high revenue contribution. North America's output value represents a relatively low percentage at present. Therefore, TECO plans to expand the scale of production in North America to increase supply chain resilience. In addition, in Southeast Asia, we have production bases in Vietnam and Malaysia. And we're also building a new plant in India. We expect to see bigger growth in the output value contribution of these markets. So this is an overview of our supply chain operations.

Next slide. Our Q3 guidance. We project Green Mechatronic Solutions revenue to increase by 14% by 18% Y-o-Y in Q3, benefiting from large projects. Intelligence Energy is projected to post stronger growth. as high as 58% to 62%. Air and Intelligent Life's Q3 revenue may see a slight slide by 3% to 5% Y-o-Y due to the conclusion of major projects in the second half of 2021. Company-wide gross margin is projected to reach 21% to 25%.

Next slide. At HANNOVER MESSE this year, which is a very important exhibition around the world. We demonstrated our key solutions around e-mobility, carbon neutrality and smart manufacturing. This vision was very well received by visitors. Thank you.

[Andy Chien, executive]

Thank you, Thomas. This concludes the presentation session. Now we will proceed to the Q&A session.

[Andy Chien, executive]

[Operator Instructions] Okay. We have received several questions. The first question is that, is TECO participating in [indiscernible] recent fund raising? How far along are you with the asset vitalization projects? Are you still aiming for a payout ratio of 80%? Will the same stock payout principal applied to next year as well? Lastly, any share buyback plans?

Chairman Chiu will answer the questions.

[Chwen-Jy Chiu, executive]

Okay. On stock dividend, we have set the goal for 80% payout ratio, which will not change. As for the stock price currently, there are still many uncertainties. We strive to deliver strong operating performance. And currently, we don't have share buyback plans at the moment.

As for asset vitalization, this involves 2 projects. One is our facility development project for which we have secured a partner. In that partnership, TECO will provide the land and the partner will provide the funding. The joint development project involves the change of land use rights. So we're seeking the approval of the local government. All the work is undertaken. The Songjiang building project is making progress as well as we planned. But the only problem we encounter is that costs for materials and labor and construction are much higher than expected. Therefore, we are working on budget and cost control. We participated in [indiscernible] capital increase program at less than TWD 300 million.

[Andy Chien, executive]

Moving on to next question. Air and Intelligent Life had a big profit in 2021. Because of that, you said the group would see Y-o-Y slide this year. Could you provide more details? Another investor also asks if we could explain more about the outlook look of Green Mechatronic Solutions and Intelligence Energy business group as well as the company's competitive -- competitiveness. President Fann, would you please?

[Thomas Fann, executive]

The flight in Air and Intelligent last Q3 sales is attributable to the AC for our elementary and middle school program implemented last year. It was the nationwide AC project that the government launched for which TECO secured a significant portion. The installation work was done from Q3 last year through Q2 this year. So in Q3 this year, we no longer have the contribution from that project, although it may look like our sales declined, in fact, excluding the AC project, the performance is on par with last year.

In terms of the outlook, and the advantages of Green Mechatronic Solutions and Intelligence Energy. Despite the macro uncertainties around the world, one thing is very certain, that is the demand for energy saving and the emission's reduction is very strong. This is the case, not just in Taiwan, but also in North America, Europe, Mainland China and Southeast Asia countries, TECO's products from motor drive systems to cooling towers, including E-Skid from TECO Westinghouse in the U.S. are very helpful to carbon emission reduction.

The investment benefits are also materializing quickly. These offerings attest to the advantages of TECO's products and allow us to meet the demand and capture opportunities driven by policies of governments around the world.

In terms of Intelligence Energy, we are putting our electromechanical integration capability to use. In recent years, we have been actively pursuing IDC and substation related opportunities. In fact, we have been enhancing our project management, resource integration and system integration capabilities, which is why customers home and abroad like to cooperate with TECO.

[Andy Chien, executive]

[Operator Instructions] Okay. We have more questions coming in. First, as the EU will soon impose a carbon tax. In addition to smart manufacturing, Taiwan's Eurobond smart machinery also needs to adopt high-efficiency motors. The TECO have product that can help Taiwanese OEMs and supply chain manufacturers reduce their Scope 1 to Scope 3 emissions.

Chairman Chiu, please?

[Chwen-Jy Chiu, executive]

Thank you for the questions. As President Fann said earlier, we are quite focused on developing high-efficiency motors and using our product range to create carbon-neutral energy saving solutions. Many of our customers may be imposed with carbon tax when they export products to Europe. In fact, if high efficiency motors or PM motors can be widely adopted. Many firms will be benefited from motors to drive systems, we have launched low-carbon certified product series, which help the users to achieve Level 2 emissions reduction. I think these offerings will be of great help to the users.

In terms of our carbon emissions reduction efforts. From the perspective of production, we promote carbon-neutral solutions, including cooling solutions and magnetic bearing chillers. They can also help manufacturers trim emissions during production, which I think should help result in reduction of Scope 1 and Scope 3 emissions besides E-Skid, which we mentioned earlier, is able to recover heat as we generate heat. In fact, we do not just provide individual products. Instead, we can provide customized solutions. Currently, we are working very hard engaging relevant manufacturers one by one in hopes of enabling us to provide solutions for emissions reduction. I think as long as we have the opportunity to talk directly with customers about this matter, we should be able to help them identify the right emissions reduction solutions.

[Andy Chien, executive]

The next question is about the government's plan to increase the subsidies for energy-saving home appliance purchases. How much will that contribute to TECO's revenue?

Chairman Chiu, would you please?

[Chwen-Jy Chiu, executive]

In terms of the revenue of Air and Intelligent Life, the government's energy saving subsidies more or less have a bearing on the sales of home appliances, We progress from Level 5 energy efficiency all the way to Level 1 energy efficiency in line with the trend of energy efficiency improvements, and the subsidy programs of governments around the world.

Taipei City's decision to increase the subsidies will certainly help boost sales, but I think investors may be more concerned about commercial AC as the Bureau of Energy has made a list of the so-called heavy users of electricity, including buildings and energy-intensive manufacturers. Entities on the list are required to report the power consumption of their chillers every hour. As part of the government's attempt to encourage the heavy users to replace their traditional AC systems and install higher efficiency AC systems.

We are engaging many customers to help them assess their power use profiles and identify power-saving opportunities or replace existing systems with higher efficiency ones. I think the relevant business opportunities will actually be greater based on our business pipeline now. The commercial AC segment actually benefits more from the energy saving demand. And we are expecting this year's revenue to grow by more than 20%. So we are placing a sharper focus on this business and expecting it to become an even bigger growth driver for TECO.

[Andy Chien, executive]

Thank you, Chairman Chiu. Next, an investor asked, what our estimated EV powertrain sales is this year and how much we expect it to grow next year besides e-bus and e-cargo truck? Will TECO invest in the development of electric passenger cars. Any plans for that? President Fann, would you please?

[Thomas Fann, executive]

Okay. Thank you for the questions. Regarding electric vehicle powertrain systems, this year, in addition to a few products in development. The main work has been to cooperate with our customers to prepare for production as well as in commissioning and testing. In fact, much work is slated for the second half. According to our customers' time lines, a bigger part of the shipments will be completed this year and next year rather.

So Y-o-Y wise, we expect to have 30% growth this year with bigger growth next year. At the moment, we are focusing on e-buses and e-trucks. And we have a lot of projects on hand but we are also conducting feasibility studies with different manufacturers for 2-wheel electric vehicles as well. Meanwhile, we are assessing the feasibility of next-generation EV powertrain systems. So this is our progress in the field of EV powertrain.

[Andy Chien, executive]

Okay. [Operator Instructions] A new question is coming in. An investor asked whether TECO has sufficient capacity to support the increasing demand for electromechanical systems? And what are the loading rates? Last year, TECO's gross margin was affected negatively by the increased raw material and transportation costs. Whether it's your cost structure, will the recent drops in material prices have a positive impact on the gross margin?

Chairman Chiu will answer these questions.

[Chwen-Jy Chiu, executive]

The industry general -- in general holds a more considerative view about the economic outlook, while we enjoyed strong demand and order momentum for electromechanical products in the longer term, I think there will be a period of correction. It is especially important today because the supply chain must shift from centralized to distributed production. Over the longer horizon, there will be capacity surplus because besides our existing basis, we may need to ramp up in other locations such as in Vietnam, India and so on.

The additional capacity will likely be underutilized in the beginning. However, if we can make additional investments in periods of slower demand. When demand bounces back again, we will be able to put our capacity to good use. So I think the future is still quite promising in the longer term. However, capacity utilization actually varies from product-to-product. For example, Thomas, our President talked about the E-Skid product in the U.S. He mentioned that we are now negotiating with the customer for a project of 100 units in fact because this product is so new, we are quite concern ourselves.

So we asked the customer how many units exactly they would request. The answer that we got from them is that we will order as many as you can provide. So it's quite obvious. This is a big business opportunity actually, these 100 units alone will generate more than USD 100 million in sales for us. We don't have sufficient capacity in our facilities. The loading rates may be lower in some locations, but may be below demand in other places Therefore, we need to be able to allocate our production capacity more flexibly.

Currently, we place more focus on larger motors in North America, especially the demand for production capacity is very significant. E-Skid, for example, consumes substantial capacity. So our capacity in the U.S. may not be sufficient. But in Asia, especially in China, the demand may slow down a little. So overall, our revenue will still rise and the impact of capacity utilization on our cost is still quite manageable. While raw material costs have come down a little, supply and demand will ultimately determine market prices. When supply and demand is not balanced or not stable, chances are not high for big price drops to materialize in the short term, especially in the channels.

Raw materials are now slowly coming closer to past levels in terms of prices, but they're still a little higher than in the past. This provides an opportunity for us to regroup and improve our profitability. Of course, for us, the longer the period, the better. But we still have to be very nimble and very agile in how we respond to the market supply and demand conditions as well as how we adapt to our competitors' price adjustments. The ups and downs of costs are not directly correlated with our profit performance. It all boils down to how a company responds to market changes quickly to safeguard its own market share and margins.

[Andy Chien, executive]

As there are no other questions online, this concludes the Q&A session. Thank you for your participation today. This ends the investor conference day. The recording will be made available on MOPS under IR conferences 4 hours later. Thank you.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]