Brenntag SE

XETRA:BNR

Earnings Call Transcript 2022-Q1

[Operator]

Dear ladies and gentlemen, welcome to the Q1 2022 Results Call of Brenntag SE.

At our customers' request, this conference will be recorded. [Operator Instructions] May I now hand you over to Thomas Altmann, Head of Investor Relations. Please go ahead.

[Thomas Altmann, executive]

Thank you, Lisa. Good afternoon, ladies and gentlemen. On behalf of Brenntag SE, I would like to welcome you to the earnings call for the first quarter of 2022. On the call with me today are Dr. Christian Kohlpaintner, our CEO; and Dr. Kristin Neumann, our CFO. As usual, after the presentation, we are open for your questions. Our relevant documents for Q1 2022 have been published this morning on our website at brenntag.com under the section Investor Relations. In the same area, you will find the playback of this conference call later today.

Before we begin, allow me to point you to our safe harbor statement, which you will find at the end of the slide deck. Having said this, I will now hand over to our CEO, Dr. Christian Kohlpaintner. Christian, the floor is yours.

[Christian Kohlpaintner, executive]

Well, thank you, Thomas, and good afternoon to everybody. I'm particularly delighted to have, for the first time, Kristin Neumann, in her role as CFO of Brenntag SE, with me on this call today. Together, we will walk you through today's presentation, and I will start with the highlights of the first quarter 2022.

The first quarter this year was a strong quarter for Brenntag. We delivered the best results our company has ever achieved in a single quarter. I am particularly pleased that the strategic rationale for our new operating model with dedicated commercial teams and the differentiated steering has been confirmed by the results of the first quarter.

Brenntag Specialties grew significantly faster than Brenntag Essentials, substantiating our strategic decision to create our new operating model. On group level, quarterly operating gross profit exceeded for the first time the EUR 1 billion mark with a growth of almost 31% compared to the first quarter of last year.

Operating EBITDA increased by 49% to EUR 463 million. Our free cash flow came in at EUR 49 million, and earnings per share stood at EUR 1.61 compared to the EUR 0.63 a year ago, representing a significant increase, mainly driven by strong earnings growth. Overall, we are very satisfied with these strong results, but they also need to be put into the context of an exceptional market environment impacted by severe geopolitical challenges we are all facing right now. I will talk about this in a minute.

In the past quarter, we progressed on our transformation program Project Brenntag well and are ahead of schedule. The contribution to operating EBITDA of Project Brenntag amounted to EUR 165 million since the inception of the program. Furthermore, we continued on our successful and proven M&A path with the acquisition of Ashkenazi, the largest specialty distributor in Israel, enabling us to enter successfully in the chemicals and ingredients market in that country.

With respect to the further business developments, we confirm our guidance, we published in early March. For the full year 2022, we expect the operating EBITDA to be in the range of EUR 1.45 billion to EUR 1.55 billion. And finally, I'm particularly delighted to present some details of Brenntag's new ESG strategy today.

Ladies and gentlemen, currently, we find ourselves in an unprecedented macroeconomic and geopolitical environment. The war in Ukraine is the prevailing topic for all of us. We strongly condemn the invasion of Ukraine by Russia. First of all, we have taken care of our employees in the Ukraine, and we have experienced extensive support from our people in the neighboring countries. In March, we suspended all imports to and exports from Russia and Belarus. This applies for all shipments from and to any Brenntag entity and subsidiary.

Also, we discontinued the business of all Brenntag entities and subsidiaries in Russia and Belarus for the time being. These decisions are valid until further notice and are executed in a controlled manner. These geopolitical developments and uncertainties came on top of the trends that we observed already in the last 2 years. Even before the war in Ukraine due to various cumulating effects, global supply chains have been and still are under severe pressure, further impacting production and supply.

The market conditions were characterized by high price volatility and strongly increased costs for raw materials and transport. The situation in Ukraine as well as international sanctions imposed on Russia have accelerated energy price increases and hampered supply chains of certain chemicals. Our ability to maintain supply and provide products and services was once again key in Q1 and was highly valued by our customers. We benefited once again from our global market leadership, our excellent relationships to our suppliers, our product knowhow and our operating model.

Against this background, we continued with our strong margin management. And in addition, our capability of passing prices through was proven again. While the dramatic developments in Ukraine are the predominant topic, we must not forget about the COVID-19 pandemic. In Q1, Asia-Pacific and particularly China, suffered from further lockdowns that impacted and continue to impact global supply and demand balance as well as logistics. We view the current situation in China is critical, particularly with regard to supply of products from China into other parts of the world.

Coming to Project Brenntag, our transformation program continues to progress well. Project Brenntag is designed to build a strong basis for sustainable organic earnings growth in the coming years and will expand Brenntag's global market-leading position. Since its inception, Project Brenntag has contributed EUR 165 million of additional operating EBITDA. The additional operating EBITDA contribution coming from top line measures amounted to EUR 50 million, and savings from bottom line measures were EUR 115 million since project start.

We structurally reduced more than 960 jobs out of the approximately 1,300 jobs in total by 2023. We continued with the optimization of our global site network. So far, we have closed 76 sites out of about 100 plant site closures across all regions by 2023. In addition, we keep investing in upgrading and expansion of our existing networks. Expenses amounted to EUR 74 million as per the first quarter of 2022. We are very satisfied with the progress of the program and are well ahead of plan to deliver the EUR 220 million operating EBITDA impact as promised.

Now I would like to talk about a topic that is particularly important for Brenntag. In 2021, we have intensively worked on our new ESG strategy. As the global market leader in chemicals and ingredients distribution, Brenntag plays a vital role in the value chain of the chemical industry. We will take on that responsibility to contributing all ESG areas in the industry and society as a whole.

Our unique business model offers us many opportunities to engage even further in many fold ESG aspects. We will continue to drive this and accelerate our efforts. We have set up a comprehensive strategic framework for sustainability that will be embedded in our corporate strategy. It features diverse and ambitious medium and long-term goals for our businesses, for our regions and for our functions.

We base our sustainability management as well as our new strategy on well-defined ESG criteria. It creates a picture of Brenntag's future as a strong long-term global market leader of our responsible chemicals and ingredients distribution industry. It will lead us to our future sustainable Brenntag vision. We identified 6 most relevant sustainability focus areas that build the new ESG framework. For each of these focus areas, we have developed clear midterm targets, which contribute to 8 U.S. sustainable development goals. These 6 focus areas are the key competencies and business activities to which Brenntag can make the greatest contribution to. For example, we are committed to net zero emissions by the year 2045. This greenhouse gas emission reduction target is set in line with the Paris Agreement's 1.5 degree Celsius ambition level.

Along the way, we have defined clear and transparent milestones. In 2021, we have joined the global RE100 initiative and have thus committed ourselves to switching our electricity consumption completely to electricity from renewable sources by the year 2025. Moving towards an operation entirely with green electricity is an important measure for our business to position us even more future-proof and responsible in terms of reducing CO2 emissions.

The transformation is supported by our unique internal carbon management program with an internal price on carbon that we will introduce within our organization. Further details on our medium and long-term targets can be found in our sustainability report, which was published on April 29.

And with this, I would like to hand over now to Kristin Neumann, who will lead you through the numbers in detail. Kristin?

[Kristin Neumann, executive]

Thank you, Christian, and good afternoon, everybody. For those of you who don't know me yet, I started my position as CFO of Brenntag SE beginning of April. Before joining Brenntag, I worked different top-level management positions in finance. Most recently, I worked for LSG Lufthansa Service Holding AG, where I was CFO since mid of 2014. I'm very pleased to be here today presenting the financial performance of the group in Q1 2022. As a reminder, when talking about growth rates, we generally talk about FX adjusted growth rates.

I will start with the operating EBITDA bridge on the left-hand side of Slide 10. In the first quarter 2021, operating EBITDA amounted to EUR 300 million. The translational foreign exchange effect was a tailwind of EUR 11 million. Our acquisitions contributed EUR 21 million to the operating EBITDA growth. Our FX adjusted EBITDA growth rate for the whole group came in at 49%.

On the right-hand side, you'll find a granular view by division and all other segments. Brenntag's 2 global divisions, Brenntag Specialties and Brenntag Essentials are coming off with strong year 2021 and have continued this trend into the first quarter of 2022. Both divisions strongly contributed to the results with operating EBITDA growth of 77% for Brenntag Specialties, exceeding Brenntag Essentials growth rate of 34% significantly.

Very strong performance of Brenntag Specialties is fully according to our expectations and guidance. Brenntag Specialties reporting -- reported operating EBITDA growth of EUR 96 million, and Brenntag Essentials grew by EUR 78 million. Both divisions saw a tailwind in FX translation. Within Brenntag Specialties, it amounted to EUR 2 million. And within Brenntag Essentials, the tailwind was EUR 9 million.

Acquisitions contributed EUR 17 million in Brenntag Specialties and EUR 4 million in Brenntag Essentials. We again managed to translate the strong gross profit growth into an over proportional operating EBITDA growth, which is reflected in a very strong conversion ratio for the group of 45%. In Q1 last year, the conversion ratio stood at 39%. So this is an increase of more than 500 basis points. For the full set of figures in this regard, please refer to Pages 22 and 23 in the appendix of this presentation.

On Page 11, we've provide some details on the Brenntag Specialties performance. The division accomplished an operating gross profit increase of 46% to EUR 426 million. The conversion ratio for Brenntag Specialties improved substantially and rose to more than 50% compared to 42% in Q1 2021.

Our operating gross profit increased stronger than our operating expenses. Operating EBITDA amounted to EUR 215 million, an increase of 77%, where 80% are from organic growth. This growth was broad-based across all segments. Operating EBITDA within Brenntag Specialties grew by almost 82% to EUR 207 million and Brenntag Essentials achieved an operating EBITDA of EUR 240 million. Thus, our Brenntag Specialties division contributes almost 50% to our total results now.

Brenntag Specialties Americas and EMEA showed a very strong performance. Life Science industries such as nutrition, personal care, HI&I and pharma performed particularly well. Despite these strong results, the overall macroeconomic environment was impacted by an inflationary cost development as well as supply shortages and increased transport costs.

Brenntag Essentials also showed a strong performance and achieved excellent results. The division's operating gross profit grew stronger than operating expenses. It amounted to EUR 603 million, an increase of 22%. This resulted in a strong operating EBITDA conversion ratio of more than 45% compared to 41% in Q1 2021.

Operating EBITDA reached EUR 272 million. All segments contributed to this positive performance. North America and EMEA showed a particularly strong performance. Operating EBITDA development was almost entirely driven by organic growth. Our Essentials division continued to face various challenges such as high energy prices and inflationary cost development, particularly for transportation, fuel and energy. In this environment, we managed to maintain deliveries to our customers and utilize business opportunities.

In summary, we are very satisfied with the performance of the group, but I would also like to emphasize again what Christian Kohlpaintner already mentioned at the beginning of this call. These results have to be seen in the context of the current very exceptional macroeconomic and geopolitical conditions. While we feel very well positioned and confident about the business development of the group, we are currently looking at various scenarios depending on potential political and economic development as well as decisions of government bodies.

Coming to our income statement on Slide 13, we generated a strong operating gross profit of more than EUR 1 billion. Currently, we are operating in an inflationary market environment. We continue to see increasing chemical prices, but also rises in other cost items. This development is reflected in our operating expenses. Operating expenses increased by 19% in the first quarter this year. Besides higher logistics, fuel and energy costs, we also had higher variable personnel expenses due to our strong business development.

Special items in the past quarter amounted to EUR 3 million and are mainly related to Project Brenntag and further efficiency measures. Amortization increased slightly to EUR 18 million compared to EUR 11 million in Q1 2021. Both profit after tax and earnings per share were particularly strong in the reporting period. Profit after tax amounted to EUR 254 million, an increase of more than 153% and EPS came in at EUR 1.61, an increase of more than 155%. This rise is mainly due to our excellent performance but also due to the provision for alcohol tax payments we made in Q1 2021, impacting the EPS in 2021.

Coming to Page 14 and the free cash flow, free cash flow generation in Q1 was EUR 49 million below prior year level. We saw strong price increases driving the outflow for working capital and thus impacting free cash flow negatively. Working capital amounted to EUR 2.5 billion at the end of the last quarter. This is an increase of almost EUR 1 billion compared to Q1 2021, and it is mainly driven by higher chemical prices caused by pressure on global supply chains as well as product shortages.

On top, we have invested more into our inventory to make sure we are able to maintain supply to our customers despite supply chain disruptions and product shortages in the market. The working capital enabled us to maintain deliveries to our customers and working capital management measured by working capital turns continues to be on a good level at 7.9x. Our net financial liabilities amounted to EUR 2.2 billion at the end of the first quarter. This is about stable compared to the end of last year. Our leverage decreased slightly to 1.4x.

And with this, I would like to hand back to Christian Kohlpaintner.

[Christian Kohlpaintner, executive]

Thank you, Kristin. Ladies and gentlemen, let's talk about the outlook for the full year 2022 now. First of all, as already mentioned, we confirm the guidance for our full year 2022 operating EBITDA to be in the range of EUR 1.45 billion to EUR 1.55 billion. The further developments resulting from the war in Ukraine and its geopolitical and economic consequences are very difficult to predict.

Major influencing factors on the outlook are coming from: First, rising energy costs and supply disruptions in Europe. Secondly, the inflationary trends in the United States and in Europe; and thirdly, as well the lockdowns due to the pandemic situation in Asia Pacific and particularly in China. These lockdowns impact global demand patterns and trade flows. While we expect a strong first half 2022, the current situation contains great uncertainties and the forecast for the development in the second half of this year is hardly possible at present.

On the other hand, we navigated the different challenges of the past 2 years prudently. We feel well positioned to manage particularly difficult conditions proactively and with foresight. So despite the high level of uncertainty in particular for the second half of 2022, we currently expect to achieve an operating EBITDA for the full year 2022 at the upper range of our guidance. Our high diversification and the resilience of our business model as well as our excellent relationships to our suppliers and customers will support the positive performance of our company.

Ladies and gentlemen, let me summarize what we have accomplished so far. Strategically, it was the right decision to set up our new operating model with the global -- with the 2 global divisions with dedicated commercial teams and a differentiated steering approach. This is confirmed by the strong results in the first quarter with Brenntag Specialties growing substantially faster than Brenntag Essentials. We reported the best results the company has ever achieved in a single quarter.

Our transformation program, Project Brenntag progresses fast and is well ahead of plan. For the full year 2022, we'll not only confirm our guidance, but expect to deliver results at the upper range of our guidance. In an exceptionally challenging market environment, we have been working hard on our goals and we delivered on our promises.

And with this, I would like to finish the presentation and open the Q&A session. Thank you.

[Operator]

[Operator Instructions] And the first question comes from Rajesh Kumar, HSBC.

[Rajesh Kumar, analyst]

First question is, so far, momentum is clearly very strong, well ahead of, I think, what any of us had expected. Could you help us understand the price versus volume balance of that growth? The second question is, if I look at the working capital trends towards end of the quarter, very clearly, you've been adding inventory, working capital pattern sort of suggests momentum might have continued in Q2. Can you confirm, if you've seen any slowing in Q2 so far? And last but not the least, a lot of people are quite puzzled by the fact that you have just reiterated the guidance given how strong Q1 trading has been. A lot of people are equating that to mean that you are potentially indicating that by end of Q3, Q4, you are likely to see a decline in growth rates or sort of 4% growth for second half on EBITDA. Is there any specific issue you're aware of, which is driving you to start? Or is it just too early in the year for you to change the guidance?

[Christian Kohlpaintner, executive]

Okay, Rajesh. I will answer the question on price volume and on the momentum into Q2. Kristin will talk about the working capital trends towards year end, and I will talk a little bit about what has led us to that guidance we have reiterated by the way. Let me start with the first question about price volume. Volumes are more or less in line with previous year. Again, let's differentiate a little bit between Specialties and Essentials. So in Specialties, we count on innovation, application knowhow and how we are providing services to our customers. So the volume number here is less relevant or not a relevant number at all. When we look on the volumes in the Essentials and the more industrial chemicals side, volumes have been in line and rather on the previous year level. So it is a strong impact on pricing right now. But we also need to be conscious of the fact that we took some delivery choices when it comes to our volume development. So we don't see that necessarily reflecting market share gains or losses here. And I just want to give you a couple of examples of what we mean by that.

If you -- for instance, look in the Essentials business, in our warehouse business, this is the majority and the core of our business. Actually, those volumes from our warehouses are up. But we have other businesses where we specifically have withdrawn, so what I call this spot business, low margin, big volume, spot businesses, which we have not maintained. We also -- we are taking delivery choices when we have, for instance, with large municipalities, in particular in North America, sort of fixed-base pricing attempts. We again took our strong position and decided to not supply if necessary or have a different commercial discussion here. But let's not forget, we have rather big volumes, but low-margin business coming out of Russia and Belarus, in particular in the fertilizer area, which we are exporting into Latin America.

So you see here a rather large volumes not being there. And then again, we need to be also very cognizant of that fact that we're still dealing with a massive supply shortage. So supply is not where it needs to be. We have the topics around China. Massive, massive concern on our side, I must say, because you have seen the export numbers of China yesterday for April. And we don't see here a quick or fast resolution of that. So that will accompany us in the second quarter and probably even further into the year. And then we had even some force mature declarations in the first quarter and many turnarounds with large suppliers. So I think -- why I'm selling all of that. I think it is for me important that there's no joint understanding that actually a volume development has so many moving parts. There's so many influencing factors that simple equation volumes are down or up and you're losing organic market share is not really a valid one.

Coming to the topic on the on the momentum in the second quarter. I think the momentum we have seen in the first quarter continues into the second quarter, at least what we have currently on our belt. So as I said in my speech recently or previously, we expect indeed a strong first half. But the outlook or the view of the second half is very opaque. It's hard to really predict what further escalations we might have on the geopolitical tensions. What impact we might have on, let's say, further energy embargoes in Europe and impacting the ability of supply in Europe and the competitiveness of the European chemical industry is just another example. And we have, of course, the China topic, which is currently unpredictable of how long that will last. And just imagine China is the by far largest chemical market in the world with a strong export orientation. If those volumes cannot leave the country, you will see impacts on the trade flows. You will see impacts on supply chains to a quite significant extent.

So that has led us very clearly answering the third part of the question about our guidance that we see a second half is highly, highly unpredictable where there could be some surprises waiting for us. So this is why we are here guiding -- confirming the guidance range, but again, giving you an indication that we do expect that we need the upper range of that guidance going forward for the time being. Again, we have given that first guidance early March, very early in the year, and now we are 6 weeks later. And that is what has brought us basically to that view and guiding as we have just said it. And then on the working capital, I'll hand over to Kristin to laid on this one.

[Kristin Neumann, executive]

Thank you, Christian. So if I look at our working capital development in the third quarter, we could see that the increase in our working capital, and that is driven by the inventory is to a major extent, really price driven. But of course, on top, we also have some quantities on top, and that is due to the fact that we wanted to make sure that we can maintain deliverable deliveries to our customers. That is really crucial for us. And with the longer lead times in our supply chain, we decided at the one or the other point that we need to increase our inventory in order to make sure that we can satisfy all of our customers.

And I think that is also a very positive sign that we could do that and that our customers can really rely on us. And that's also the feedback we get from our customers. If you look at the Q2, of course, the momentum, as Christian described it, the momentum is still ongoing, and that also means that our working capital is at that high level in terms of inventories receivables payables as we saw it in the first quarter. I hope that this answered your question.

[Rajesh Kumar, analyst]

These are very helpful insights. Just the points you make about volume market share and the fact that you are stocking up to help your customers because shortages are building. Have you seen a bit of discussions with potential customers and suppliers around outsourcing? You do provide quite an important service in between the 2 parties. And given the disruptions we have seen in supply chain, I'm sure the value proposition of Brenntag, which can execute well, must have gone up for both parties. So any commentary on that would be very helpful in thinking about the future volume share?

[Christian Kohlpaintner, executive]

I think I reiterate what I said the last 2 years. I believe, and for my almost 30 years of experience in the chemical industry, the position of a chemical distributor is stronger than the chemical distributor think. And I think the value proposition you mentioned, Rajesh, is exactly the point, being able to service a customer segment, which can typically not touched by large manufacturers is our strength and drawing on the global supply chains and maintaining supply is also our strength. And that is increasingly, of course, recognized by large suppliers, where they also think about how can they utilize chemical distribution in their favor better going forward.

And then of course, you see a lot of movements and activities, for instance, to try to consolidate distributors within suppliers because sometimes they use 50, 70-plus different chemical distributors. And Brenntag is always, of course, in the game because we offer the broadest service, the broader accessibility and the broadest global reach. So I think, indeed, I believe all those trends and all those tensions and complexities we see or have seen over the last 2 years is actually strengthening our value proposition going forward.

[Operator]

And the next question comes from Markus Mayer, Baader.

[Markus Mayer, analyst]

Christian, Kristin and Thomas, I have 3 questions, if I may. You flagged potential risk of a gas embargo. Can you shed more light on potential effects of Brenntag, what would this mean on direct effects, I guess, indirect effects outpaces, but what kind of direct effect would you have? That's my first question. The second one is more on custom behavior. I've heard that customers are moving away from just inside watering behavior, what kind of structure effect out of this from your business. And in relation to this, we also hear that there are restocking at customers do also kind of restocking trend and how long do you expect this to last? And then lastly, more customers seem to switch to chemical institution companies, given the supply chain issues, at least can this specialty company are saying this, also chemical production companies. Do you think that this trend is sustainable or might customers move away when the supply chain issues might disappear maybe in 2023 or beyond?

[Christian Kohlpaintner, executive]

Markus, thanks for the questions. And let me try to answer that. Maybe the second question on customer behavior any of more clarification. But let's start with the gas embargo. For the European chemical industry, in particular, the thermochemical industry, the discussion around a gas embargo is an utmost importance. On the direct impact on Brenntag, we have done the analysis and looked at this. It's rather small because we are not a production company. We are actually running our warehouses. We're running our offices. So dependency on gas is rather small and can be compensated. So we would not be directly impacted. But what is the big topic is the indirect impact. And the indirect impact means that large parts of the chemical value chain could be not served anymore. And we have seen examples of that already in Q1.

You might remember in our full year call in March, I mentioned the topic of gas and ammonia and then from ammonia to fertilizer and down to AdBlue is just as an example for transport, that is still there. So we see clearly, particularly in the energy-intensive value chains, chemical value chains, shortages in supply, and that could be, how should I say, exponentially getting worse if there is a gas embargo in Europe. And that is something which we, of course, carefully watching and preparing for. Again, here, Brenntag is well positioned. We can draw on global supply chains in different ways. And I believe medium to long-term, there is a question mark around the long-term competitiveness of the chemical industry in Europe, but that's a different discussion we could have at a different time. So I would say direct effects small or almost ignorable for Brenntag, indirect effects could be quite massive.

On the customer behavior and restocking, I think there could be an element of restocking, but let's face it. We are still in a situation where supply is not being able to keep up with demand. And that limits the capability of a lot of big inventories build up, so we have very little or even no indication at all that this is happening, although there's a big desire for that due to the inflationary environment where people know that what they buy today is cheaper today than it will be in 2 weeks. So it's a very quick now price volatility, fast price adjustments, which do have, of course, an impact. On the long-term fuel distribution chemicals and how business is actually developing, I believe the outsourcing trends in principle will continue also going forward.

You have situations like we have right now where this is maybe more pronounced than others. But always, let me be very specific. Our typical customer is ordering EUR 3,000 per order. This is a customer segment, a manufacturer cannot and will not touch. And this is, I think, largely underestimated that we are occupying a spot in the chemical industry, which is hard to cover directly. But also, let's face it once we have built a business to a certain size, then also suppliers are taking that business back into direct. I mean -- this is our normal business. This is what we do since decades, and this is what we experienced all the time. So I would say the fundamental trends are not changing. They are a little bit more pronounced year-by-year, but the overall strong position of distribution and the strong value proposition we have, I see rather than changed going forward.

[Markus Mayer, analyst]

Okay. Maybe I had a question, if I might deal with, this current environment, which is pretty healthy for you and also for other chemical distribution companies. Do you see the difference in between larger and smaller distribution companies? Is this in particular helping the larger ones? Or is this a situation, which is good for everyone?

[Christian Kohlpaintner, executive]

I would say, in principles, global distributors like we are in a slight advantage because we can draw on the various supply chains. We have numerous examples where we actually can supply product from, let's say, a failing supply chain out of China and can replace it with volumes out of Europe or replacing with volumes out of America -- North America, particularly in times, where availability today is more important than price. This is not -- there's a huge advantage. It's not a disadvantage to bring in products from different regions. So I believe having that modular supply chain approach we have as the global distributor is actually playing to our advantage. This is a disadvantage for maybe smaller regional players who only rely on the regional supply chains they are operating in.

[Operator]

And the next question comes from Dominic Edridge, Deutsche Bank.

[Dominic Edridge, analyst]

Just a couple from myself, a little bit more detailed questions. Just firstly, just in terms of employee numbers, I did notice that you're about 200 down on the specialty side of the business sort of quarter-on-quarter. I'm just wondering, is that entirely due to Project Brenntag? Or is there sort of anything else we should be thinking about? It was just that I've noticed that the Essentials employee numbers were actually up quarter-on-quarter. So I was just wondering if you could just give us an idea of what's going on there, particularly given obviously the very strong performance in Specialties.

And then the other thing was on the split on the North American business, and it was just to sort of ask if the margin, there is sort of the structural -- a structurally going to be lower than some of the other regions. And just given the fact that obviously, it does seem to be having a lower margin even after the recovery from last year's issues? So is it had a mixed effect there?

[Christian Kohlpaintner, executive]

Dominic, thanks a lot for the question. I think, mostly, I will let Kristin answer the question in particular FTE, but also maybe the margin question on North America.

[Kristin Neumann, executive]

So Dominic, coming back to the 200 FTE so that is more, a little bit of a statistic effect. Because last year, we started to allocate the FTE to the different divisions and we always said that, this is a bit of preliminary work we did. And we have sorted it out right now. And therefore there's a bit of difference from Specialties to Essentials. No, the other way around, sorry. In terms of cost and euro locations, that does not play a major role because we have allocated the cost in the right way. This is more about statistics in FTE.

And coming back to your margin question, we saw last year, the first quarter of North America, especially for Essentials business, was quite weak due to some external factors, the winter storm and so on. And therefore there is a bit of recovery this year, and we can see that right now.

[Dominic Edridge, analyst]

Just to sort of -- just on the second one. Is there structurally any reason why different regions within the segments should have different margins? I know there must be different mix effects going on in terms of the type of business that you do in each region? I'm just wondering, on a longer-term view, should we be seeing them coming together in terms of whether its EBITDA conversion ratios or gross profit margins?

[Kristin Neumann, executive]

That is quite true. Of course, different products have different margins I think that is quite obvious. And on top, there's also a different level of scale, and also a different level of costs. So if you look at South America, for instance, there's a huge difference between, for instance, Latin America and Europe. And I think that is also reflected somehow in the margins.

[Christian Kohlpaintner, executive]

And then finally, I would add, it's also an expression of the competitive environment sometimes. I mean, when you take the solvents business in Asia, fierce competition, where it's in margin, compared to solvents in the EMEA, or solvents in North America, totally different. So I think, region-by-region it is heavily reflecting also not our only cost position, as Kristin said, but also the competitive environment we're operating in. And that I think, explains it to even better than maybe a product mix debate.

[Operator]

And the next question comes from Suhasini Varanasi, Goldman Sachs.

[Suhasini Varanasi, analyst]

I have 2, please. I think one of the key questions that generally the market has is there has probably been a level of overrunning and I think there's a concern that the market has that your GP per unit has been artificially high. And as that normalizes, how should we be thinking about the normalized conversion margins in the medium term, I appreciate, there is a lot of uncertainty near term, but if you just take Project Brenntag, maybe can you reference 2019 and conversion margins and say that, okay, half of these Project Brenntag tax savings stick, then maybe that would be not a bad way to think about normalized conversion margins beyond 2023?

And then the second one is, it's pretty nice to see the growth that's coming through in the Specialties business. And you mentioned innovation solutions over there, in particular. Can you maybe give us some examples on what is driving this growth in innovation Solutions? Is it like because of the supply chain constraints, the customers are being -- are asking you for help and reformulations because they're not able to get their hands on inventory? Or maybe is it because of focus on more sustainable products, for example? Just some color there would be helpful.

[Christian Kohlpaintner, executive]

Yes. Thanks for the good questions, particularly the last one. I will elaborate it a little bit more on the gross profit per tonne in normalized margin and impacts of Project Brenntag, and how much it is sticks to that. And again, yes, I know that there's a big concern about, is there, gross profit per tonne on non-sustainable part of that of that earnings there. We all know that, the market conditions are very, very special right now, product availability is key that allows us to actually play to our strength of having a price power, in that -- in our position we have in the value chain. One also needs to recognize that at a given time, price levels and margin levels start to create a new reference point going forward. In particular, in the Specialties field, I don't believe that this is, now a really volume and only supply/demand driven price scenario, I think it is has also to do with what I will answer in the second part of your question about, what do we actually provide to the markets? And what do we actually give as a service to the markets, which is less supply/demand driven or dependent than one might think.

So how the normalized margins look like and when they will kick in, it's really, really hard to predict. So we are developing different scenarios to try to understand that and what could it be? I don't see that happening now in the next quarter, as I said, momentum is still good. And then we need to also understand of how the second quarter -- second half of the year will look like with all those tensions. But overall, I believe, we will be able to -- if you want to call it enjoy that level of margins and enjoy that gross profit per tonne going forward for maybe a longer period of time, then one might think. But again hard to predict, because of those many, many influences what we have.

Now the sources of growth for Specialties, I have been talking about this frequently that Specialties, and Specialties position is actually I believe stronger than then we have in the past meaning played out, particularly when it comes to innovation, and when it comes to developing sustainable solutions about this. Why I'm more talking publicly about the innovation space, which exists within chemical distribution, which today is largely untapped by large suppliers. But we have around 60 application labs globally -- 60 application labs globally, where we work with those typical EUR 3,000 customers together, about technical solutions, about new innovations, about even sustainability solutions for them, because if they would go to one of those big suppliers we are representing, they will be an unknown customer to them, and also not interesting because it is just typical EUR 3,000 customer.

But there's a lot of innovation happening in those application labs. And that innovation we use for creating new formulation, which creating a different value proposition. And that allows us to play also margin setting, and the pricing setting and the value proposition which is different than typically what you would expect from a chemical distributor, more and more suppliers start to recognize it, that there is an innovation space in chemical distribution actually quite extensively. And I know what I'm talking about, because I was sitting 28 years on the other side of the table. So I think this is also a huge opportunity for specialized distributors like ours, to drive the innovation or at least catalyze the innovation momentum in large suppliers, but also towards more sustainable solutions going forward.

And this is what I tried to reflect in my comment that we take up the responsibility also driving the sustainability agenda of the whole chemical industry by bringing this kind of innovation, this kind of needs into the chemical industry. So it's a very interesting topic. And thanks for asking the question.

[Suhasini Varanasi, analyst]

No problem at all. If I may just ask a follow-up, I mean, would you say that this current market environment, which is so uncertain and volatile, has actually helped to accelerate the push towards more innovation? And maybe -- can you maybe discuss how you expect the growth prospects to be not -- it's not supply/demand, it's just the innovation side of things? Is your pipeline looking good, order book looking good? Any color there would be helpful.

[Christian Kohlpaintner, executive]

Yes. No, I think it is -- it's exactly that. I think, I mentioned in the call before. Sometimes, it's only half a sentence, but I mean it's very solidly. Our intensive product knowhow, which we have in the Specialties field is really an advantage and an asset in such a situation. Because just imagine your customers sometimes using formulations where there are 7, 8 products used in a combination, in a mixture, in a recipe. And then all of a sudden, due to a hiccup in the supply chain, this one specific product is not available. So that means they have 7 other products they have on hand, but the eighth product is missing. So they cannot make their formulation. So they come to us.

In the application lab, and we can say, okay, as this eighth material is missing, we can provide an alternative and we will help you to make it work in your formulation. And then you create a new formulation with a product, which was not in the recipe originally. Why? Because we can draw on our global supply chain and we can supply alternative products, if needed, and also gives the technical advice of how to apply it. And I think this capability is largely underestimated today when we talk about chemical distribution. And you will see us talking more and more about this innovation space, as I said. And our pipeline, if you want to call it that way, is very healthy. We have in those 60 application labs worldwide, a 4-digit number of current active development works going on due to that supply chain constraints and difficulties which force us even more to innovate together with our customers in that segment I have mentioned.

[Operator]

And the next question comes from Chetan Udeshi, J.P. Morgan.

[Chetan Udeshi, analyst]

Yes. Clearly, today, it seems like there is like a rising board -- the rising boat lifting -- sorry, rising tide lifting all about sort of an environment. But beyond that, I was wondering, Christian, is there an evidence in the numbers today of change in the pricing strategy at Brenntag, because I think you've alluded in the past of launching or rolling out value-based pricing, et cetera, et cetera. I mean, is there any of that in the numbers today? Or is the other numbers today reflecting the environment primarily and nothing that has been done on pricing strategy so far?

[Christian Kohlpaintner, executive]

Chetan, yes, it's both. I must say. One is, of course, the price volatility, which we are, again, consequently utilizing to quickly pass on to the full extent, the price increases we have on the supply side and maybe a bit more. But very clearly, Project Brenntag, but also what you will see in the next years coming has a strong element of improving of how we are managing our margins when it comes, for instance, to low-margin business. I used the example of that we deliberately walked away from low-margin, big volume spot business where we, at the end of the day, are recognizing that this is a nice volume. But at the end, it doesn't add really to our margin. Now take what we just discussed previously about Specialties and the innovation capability, the formulation capability we have rarely talked about but is a vast, vast activity. We'll also materialize more and more as we go forward.

And also, I believe the value suppliers and in particular, our customers seen us by being able to supply and being able to offer services is also more and more recognized. And particular, when you are able to supply, which is driving a lot of this today. So I would say, yes, there are multiple of things coming nicely together, but a majority will be our strategy going forward, that we actually come to a different level of margins and margin management based on the value proposition we offer to the whole chemical industry.

[Operator]

The next question comes from Rikin Patel, BNP Paribas Exane.

[Rikin Patel, analyst]

Just thinking about 2023, I mean, your guide has said that the momentum from Q1 has continued into Q2. And I guess, if we take the implied hedge of this year, and annualized run rate, do you think that's a good base upon which we can sort of get to our 2023 forecast from? And then secondly, I guess, on the digital side of the business, in keeping with the strong results in both Specialties and Essentials? I'm just wondering if you've seen, I guess, greater customer penetration there. And then any just general updates on that side of your business would be quite helpful?

[Christian Kohlpaintner, executive]

Yes. I think I would caution for taking the run rates we see now in first half and just translating it into the second half, because of the -- and I don't need to go through it again, on all those uncertainties we see right now. So I think it's -- every day, it's a new challenge, I have to say, because what we reiterate on our financial numbers is for our people daily, a big, big challenge, to keep up supply to organize products to maintain our customers up and running and feverishly developing new solutions and formulations for them. So I think operationally, it is quite challenging every day. And the second half is for me, really, really very difficult to predict.

Particularly, I'm concerned about the gas embargo. If that really hits us, I mean, the world will be a different world, at least in Europe and it will impact the global product streams massively. And so if that can happen, it can happen from one day to the other and then everything what we had in frontline is obsolete. So I would cautious of -- cautious of using now in Q1 and maybe a good momentum in Q2. And then basically say, this is the end, I think, give you a good indication that we are confident that we will reach the upper range of our guidance and we stick to that and now give us just a little bit more time to get in or a little bit more time under our belts than to give you more guidance going forward if necessary.

On the digital side, we are massively expanding our connected platform and our approach to digital. So this is not yet the call to talk about it. But when we talk about the Q2 earnings call in August, we will give you more granularity and more seasonality to that journey, which we have about almost completed to develop similar like our ESG strategy, which we have now outlined a couple of weeks ago. So you will hear in August talking more about this and how that it look like. But I think it will be a very exciting story they can tell about our digital efforts going forward. And so I'm quite optimistic that we have that side of the business, as you call it, delivering and participating in the nice growth we have been seeing this year as well.

[Operator]

And the next question comes from Christian Cohrs, Warburg Research.

[Christian Cohrs, analyst]

Yes. Just 2 left for me. First, personnel expenses in the first quarter have been up 16% year-over-year despite a stable workforce. So during the past few quarters, you had some headwind from the variable compensation. Does this also apply in the first quarter? And is this something which will gradually vanish in the quarters to come? And secondly, on Project Brenntag, you mentioned that this initiative is well ahead of plan. And also the top line lever is already above target. So is there any chance that you will raise the envisaged EBITDA uplift? And is there also maybe a specific date scheduled for review?

[Christian Kohlpaintner, executive]

Yes. I'll let Kristin answer the question around tax cost development and then I will take a crack on the Project Brenntag question.

[Kristin Neumann, executive]

So if we look at the tax, we can see that there's an increase in personnel expenses, as you outlined, it's quite correctly. First of all, there's an element in there, which is driven inorganically. If you look like-for-like at the numbers, then you can see that there's an increase of around 8%. And part of that is fixed salaries increases, which are in a low single-digit percentages up. And then on top there is that also that variable element in -- we just mentioned. We saw that last year and this year we see that even early on, because also in Q1 we had also a very strong performance already was last year that very strong performance started only later on within the year. And therefore, we saw that already here that we had to account for that also in the variable expenses. So variable expenses are up strongly and we expect that this will also continue not at the same level compared to last year, because last year, when we started later with providing for this.

[Christian Kohlpaintner, executive]

And referring your question to Project Brenntag, we are -- we said very satisfied with the progress. We are well ahead of our original plan to deliver the EUR 220 million, but also, let's face it. The mountain gets steeper and steeper to climb. And so I think it is something we also need to bear in mind, I think we will give you a more granular forecast, and we'll see Q2 results in August. So that we can guide you directly what you can expect by the end of 2022 and maybe by the end of 2023. But I'm sure that the EUR 220 million has exactly been our target. And we will deliver on that one. I have no doubt about it.

[Operator]

And next question comes from Simona Sarli, Bank of America.

[Simona Sarli, analyst]

Just a follow-up on the potential scenario of the Russian gas embargo, you have roughly more than 40% of your EBITDA that is related to EMEA. So I would assume that most of the sourcing of this 40% plus of profits is done locally. You mentioned before that in case of Russian gas embargo, you might find some solutions in terms of supply chain. So the question is, how much of the sourcing that is done locally in EMEA could be potentially redirected to other geographies? And does it make financially sense only for Specialties or also for Essentials? Thank you.

[Christian Kohlpaintner, executive]

The gas embargo is indeed an important topic. And again, we are still when you look on the German chemical industry and particularly on Europe in a broader sense, but in the German chemical industry, dependence on the Russian gas is still very high. So it was, I think, 55%, it has been reduced now to about 35%. And the government, the German government who has done a fantastic job, I have to say, to stay course in that very, very important question is doing its utmost to now reduce that dependency as much as possible. So that means if there should be a gas embargo coming, then we will see an impact.

Then it will be a question, how do we actually allocate gas in the government, in a country like Germany, across industries, across consumers, but if you even look into industries, who will get gas and who will not get gas. The glass industry, the steel industry, the chemical industry, so I think when you when those 35% of gas Russia is missing, there will be a big debate about who is still getting the gas allocation? And to be very clear and very specific about it, it's impossible. It's impossible to do this in a coordinated manner.

So if the gas exports stops from one day to the other day, there you need to shut down large parts of the industries, which are concerned within hours, within hours to really work with that declining pressure you have in the gas pipelines, and that will actually move from east to west. So it will start in eastern parts of Europe, and then it will work gradually towards the rest.

So at the end of the day, we will talk then about a scenario where probably most likely who is paying the highest price for gas will get it. And then you can imagine what that means on the inflationary scenarios and what it would mean on the energy prices and what it would mean for the generally downstream production coming forward.

I'm just talking about describing a scenario which could have doesn't have to happen, but it could happen. We are preparing for that. We are in fact looking into this one, when we have this potential change in trade flows, because this, I believe, is not a short-term topic, it is a long-term topic, because the overall competitiveness of the European chemical industry, industry, I see in the next 12, 24 months under severe pressure.

And you see already that, that change of trade flows are happening. So we see LNG coming from the U.S. to Europe exactly before that and then you will see that working down the value chain step-by-step. And we are preparing ourselves for that. I can give you not firm number now of what we can replace. But our global position here really, really helps us to play it. In case this is really happening.

Again, it's still a hopefully a remote scenario, but it can happen rather unexpectedly. But we are expect, I guess, as I mentioned also in the call with Foresight and prudence, we are navigating through the situation, and that is one element of that.

[Operator]

[Operator Instructions] And it looks like we haven't received further questions at this point. I would like to hand over to Thomas Altmann, Head of Investor Relations to conclude this conference call.

[Christian Kohlpaintner, executive]

Thank you, Lisa. This brings us to the end of the conference call. Thank you very much for joining us today and your interest in Brenntag. If you have any further questions, please don't hesitate to contact us. We will publish our Q2 2022 results on August 10, 2022. Until then, we're looking forward to further discussions with you. I wish you all a good day and a great week. Thank you and goodbye.

[Operator]

Ladies and gentlemen, thank you for your attendance. This conference has been concluded. You may disconnect.