Brenntag SE

XETRA:BNR

Earnings Call Transcript 2018-Q3

[Operator]

Dear ladies and gentlemen, welcome to the Q3 2018 Results Call of Brenntag AG. At our customer's request, this conference will be recorded. [Operator Instructions] May I now hand you over to Steven Holland, who will lead you through this conference. Please go ahead.

[Steven E. Holland, Chairman of Board of Management & CEO]

Thank you very much. Well welcome, ladies and gentlemen, and thank you for dialing in for our review of results for third quarter 2018. Today as usual, I'm here with our CFO, Georg Müller. And as always, we're happy to answer your questions after the presentation. Let me start with the highlights of the quarter. Operating gross profit rose by almost 8% to EUR 678 million. Our operating EBITDA of the group amounted to EUR 224.5 million, an increase of 5% on an FX-adjusted basis. The growth, again, was broad based. We're satisfied with the performance of our 2 large regions of EMEA and North America, and we are pleased with the clearly improved performance in Latin America. Through the quarter, we signed 2 further acquisitions and closed the transaction of Canada Colours. Our EPS marched to $0.72, which is an increasing -- encouraging increase of almost 11% compared to the third quarter of last year. I may now move on to the operating EBITDA bridge. In Q3, we have hardly any effects from FX translation. Acquisitions contributed EUR 6 million in the reporting period. In EMEA, we reported organic growth of 3%. North America, we showed again a strong organic growth of 7% in third quarter. Latin America showed improved results and delivered an organic growth of 13%. There were several good quarters in Asia Pacific. The performance in this segment was a bit softer in Q3. Rest of the world includes some costs for project initiatives, which we didn't have last year, and this is reflected in the lower EBITDA of that segment. Just as a side comment, generally, the first 9 months of the year, we've digested an additional cost of about EUR 15 million for transport and fuel across the group.Going to EMEA -- I'd like to now talk about the detailed developments of our regions in last quarter. In EMEA, we showed a growth of operating gross profit and operating EBITDA. Operating gross profit grew by 7.2% to EUR 205 million, and operating EBITDA increased by more than 8% to almost EUR 96 million. Our efficient measures and improvement programs are paying off and provide a positive contribution. At the same time, we have to know the macroeconomic environment in Europe is cooling down somewhat. Industrial production at only around 1% in Q3 compared to more than 2% before. Coming to North America. As you can see, continue to see a positive macroeconomic momentum in North America. We're pleased with the growth in the region. It's almost entirely organic coming from all customer industries. Growth in gross profit and EBITDA is on a good level at 8.3% and 7.5%, respectively. Now the positive macroeconomic environment is clearly good for the demand -- has been clearly good, the demand situation also leads to some of the inflationary effects and increased pressure in our cost base. However, wherever we can, we're applying surcharges to counteract this trend. Into Latin America. Latin America reported much improved results, and the environment remains volatile and difficult in a number of countries. The region grew the operating gross profit by 4.2%, and operating EBITDA grew by 13%. Each of the results line up. We're well positioned in the region to capture growth even in such challenging conditions. Let me come to Asia Pacific. After several strong quarters of growth, the Asia Pacific reported somewhat softer results in Q3. It fit with our mixed picture in the region, however, Asia Pacific continues to be a success story for us, which we feel very well positioned to grow further, and we have a positive outlook. Coming to acquisitions. We've signed 2 transactions in third quarter. First, we signed and closed the Alphamin acquisition in August. Alphamin is headquartered in Belgium and is a distributor of specialty chemicals. In September, we signed agreements to acquire Desbro, which is headquartered in Kenya. In addition to Kenya, it has operations in Tanzania and Uganda. Both acquisitions help to expand our footprint and our product portfolio. Furthermore, we closed the acquisition of Canada Colors and Chemicals, which we announced earlier this year. I'll now hand it to Georg.

[Georg Müller, CFO & Member of Board of Management]

Good afternoon. I would like to speak about our financials for the third quarter in the P&L structure as laid out on Page 11. Sales increased by more than 12% on an FX-adjusted basis. In line with previous quarter, growth in sales was impacted by continuous increase in chemical prices. Operating gross profit rose by almost 8% on an FX-adjusted basis. That's a major part of the gross profit increase brought through organic business development. Operating EBITDA for the group grew by 5% to EUR 224.5 million. The conversion ratio for this quarter stood at 33.1% compared to 34.2% in the same period 2017. I move to Page 12, the part of the income statement below operating EBITDA. There are no major changes for depreciation and amortization compared to previous year. Depreciation for the third quarter '18 amounted to EUR 30 million, amortization amounted to EUR 13 million. The financial result amounted to a net expense of EUR 27.8 million. This is an increase compared to last year, and it is mostly attributable to the foreign exchange result, which reflect the high volatility of exchange rate for many emerging market currencies in the third quarter. In the third quarter, we recorded a tax rate of 28%. This is around 4 percentage points lower than third quarter 2017, and the reduction in tax rate is mainly attributable to the changes in U.S. taxation. Earnings per share stood at EUR 0.72, a strong increase of almost 11% compared to previous year's quarter. On Page 13. In the quarter, we reported an operating cash inflow of EUR 123.5 million, and that's on level with previous year's quarter. The individual line items of the cash flow statement are also broadly on last year's level. As in previous year's quarter, we continue to see an increase in working capital mainly due to rising chemical prices. On Page 14, I would like to speak about the investment and financing cash flow. CapEx in the third quarter was about last year's level, in line with our expectations, and we spent around EUR 109 million for acquisitions to pay out for acquisitions, which is mainly related to Canada Colors and to Alphamin. The difference in the financing cash flow is due to the proceeds for the bonds, which we assumed in Q3 last year. So it's more a last-year event than this year's event.Balance sheet and leverage. Net debt amounted to EUR 1,937,000,000. Leverage ratio stood at 2.3x, unchanged in relation to second quarter this year. Working capital amounted to a bit more than EUR 1.8 billion at the end of the third quarter. Working capital turnover stood at 7.4x in the third quarter, about in line with the levels we have seen earlier this year but somewhat below the level we had reported for last year. On Page 17, briefly on free cash flow. Third quarter 2018 delivered a free cash flow of around EUR 150 million, an increase of 3% compared to last year's third quarter. The presentation goes back to Steve.

[Steven E. Holland, Chairman of Board of Management & CEO]

Thanks, Georg. I'd like to start with current trading and address the outlook for this year going forward. Let me take you through the gross profit, work in day growth on a monthly basis. Starting in July, the growth was 4.3% and 2.1% organically. In August, the growth was 6.4% and 2.1% on an organic basis. September was 7.7%, 4.4% organically, and October was 5% and 1% organically. Coming to the outlook. In the first 9 months of the year, we've clearly grown the business, and we're really pleased about the organic growth and the operational EBITDA, which is above 6% on a year-to-date basis. Also the third quarter, we saw organic growth close to contribution of our acquisitions. Growth rates were slightly lower, partly due to strong -- to stronger comparables in Q3. North America, Latin America and Asia Pacific remained positive. You see a distinct going down in the European environment in terms of production of 1% -- from 2% to 1%. In this background, we confirm our expectation of operating EBITDA in a range of between EUR 870 million and EUR 900 million for the full year 2018. In the first half of 2018, we saw some headwind from the U.S. dollar-euro translation. As of concurrent rates, we don't expect further headwinds for the rest of the year. Just going through CapEx briefly. We expect to spend around EUR 170 million CapEx in total for 2018. It's worth making a note that we've mentioned before, EUR 190 million because of 2 particular movements and spikes in China. From today's perspective, this is more likely to be 2019 expenditures versus 2018. So this changes our previous guidance of EUR 190 million to EUR 170 million now that these projects are moving to 2019. In terms of M&A, we are working on a number of deals, and we're comfortable with a continued healthy pipeline, and we put an emphasis on North America and Asia Pacific as well as the exposure of our specialty chemicals portfolio. I'll now be happy to answer any questions.

[Operator]

[Operator Instructions] We're received the first question. It comes from Rory McKenzie of UBS.

[Rory Edward McKenzie, European Support Services Analyst]

It's Rory here from UBS. Three if I may. I'm sorry if I break up. I'm trying to travel. Firstly on that demand weakness you called out in Europe. Can you be more specific as to any end markets? For example, I didn't think you had much exposure to say the larger orders sizes to be impact by autos delays? So any more detail would be helpful. And then secondly in -- also in Europe, despite that lower growth environment, it feels like you were hit by extra cost increases. Is there anything to flag in there? It feels a bit like the restructuring savings got eaten up a bit this quarter. Maybe just those 2 first on Europe, please.

[Steven E. Holland, Chairman of Board of Management & CEO]

Yes. I think it's -- it's clearly, it's a broader-based perception of slowdown in Europe. I think it's too early to call it in a very specific nature country-by-country. I would say that, for us, we do see some weakness in Germany, and that there may be some elements of demand for the chemical sector. And so suddenly recent discussions with a number of manufacturers suggests that there was some weakness in some of their larger customers. But for us, it really is not a noticeable slowdown, so I don't want you to try and calibrate that. We're just detecting a -- not as a bullish environment as we would have seen say this time a year ago. I think when it comes to operating expenses, we have certainly got the sort of benefits that we expect from the operating expense that we planned in the European program. We do have some extra cost, particularly in the relationship to transport in the European piece. I think one of the things that's sometimes a little bit too difficult to put across, particularly in these sort of calls, is that if you take transport across the whole group, clearly, we've seen inflation in North America and in Europe. But in Europe, the ability to plan surcharges in Europe is a little more difficult than it is in North America. And therefore, it may take some more -- larger growth when you see transport increases across the board. So I think that's maybe the background to Europe at this stage.

[Rory Edward McKenzie, European Support Services Analyst]

Yes, that’s helpful. I had one more question on the cost structure, relates to your all other segments line. I see that increased by more than EUR 5 million year-over-year rather than just kind of EUR 1 million in the previous quarters. What's going on in that line? And should we think about that as a recurring cost into Q4 and into next year, please?

[Georg Müller, CFO & Member of Board of Management]

This is Georg. All other segments is mainly our headquarter costs. Because we run a lot of project cost in the headquarter, it can be a little bumpy quarter-by-quarter. Particularly in the third quarter, we recorded some cost for acquisitions, due diligence work we worked upon that were not there previous quarter. And we had an expense here for one project which deals with -- particularly with data protection regulation in Europe, which we took in Q3. So that's basically the explanation for the cost increase Q3 this year. I would not see the level that you see in Q3 as a new run rate. That's more -- that costs that are a little bit bumpy across the year in Q3.

[Operator]

We have the next question. It comes from Mutlu Gundogan of ABN AMRO.

[Mutlu Gundogan, Analyst]

A few questions. So first on the guidance. Can you tell me why you kept such a broad range with less than 2 months remaining in the year? That's the first question. The second question is on Latin America. Quite a good performance with high organic EBITDA growth. Can you tell us what drove that? Was that gross profit? Was that cost savings? Or any color there would be helpful. And then finally a question on Slide 15. You show a net debt of EUR 1.9 million and net debt/EBITDA ratio of 2.3x, so that implies operating EBITDA in the last 12 months of roughly EUR 840 million. Now if I compare it to your guidance of EUR 870 million, EUR 900 million, I mean, I would usually expect that the last 12 months would also includes recent acquisition so that it would actually be higher than what you guide for, for the year. So what am I missing here? Any explanation there would be helpful.

[Georg Müller, CFO & Member of Board of Management]

Yes. Mutlu, it's Georg. On the guidance range, EUR 870 million to EUR 900 million, if I remember correctly then in several years in past, we left a EUR 30 million guidance range after November. Yes, we also had a couple of years where the environment was super stable. We have narrowed the guidance to a degree. From our perspective, it would not really provide additional information to the market if you would narrow that range. So EUR 870 million to EUR 900 million is what we feel comfortable with at this stage. On the leverage, I'm not fully sure I followed your calculation or your logic. What Page 15 shows is basically -- it uses an LTM EBITDA over net debt. I have to admit I don't have the exact LTM EBITDA number at hand that we use, but I would assume -- I probably can't follow the EUR 833 million that you laid out. We can take that off-line.

[Mutlu Gundogan, Analyst]

Yes, that's probably better.

[Steven E. Holland, Chairman of Board of Management & CEO]

Again just coming through Latin America and -- the Latin American business did do well in the third quarter. We're pleased with the performance. We saw a recovery in terms of overall performance in Chile and Argentina, which were driving the performance back a little bit. And also the business others in Ecuador is of a seasonal nature. So I would expect seasonally the -- much of macro business to improve in the second half of the year in any case. But I think they're doing a very good job, actually, and I'm particularly pleased with Latin America. They've got quite a tough environment to navigate through this last year. And we put expectations there on that to continue with that during the course of the rest of the year.

[Operator]

The next question is from Laurence Alexander of Jefferies.

[Daniel Dalton Rizzo, Equity Analyst]

This is Dan Rizzo on for Laurence. Just following up on the slowdown you mentioned in Europe. Can that be attributed to destocking? Or is it something more permanent?

[Steven E. Holland, Chairman of Board of Management & CEO]

Destocking for this is not really applicable to us because, on most of the products which we sell are relatively small quantities, and therefore, people don't generally take large stock. It wouldn't be the -- you wouldn't be the first person that's actually mentioned destocking for larger suppliers in terms of the [ riser ] from time-to-time in Europe, but some of the -- can we supply in large quantities are taken a much slower approach towards the year-end or even looking at pricing, generally. So not particularly for us, but in the market generally, there may be an element due to destocking, but it's not something that's in our business model.

[Daniel Dalton Rizzo, Equity Analyst]

And then just with your M&A strategy going forward, I mean, is there more of a focus on footprint increase or expanding the portfolio breadth? I mean, do you have a preference?

[Steven E. Holland, Chairman of Board of Management & CEO]

We have -- we actually have 3 preferences, if you like, though. We have both portfolio geographic and specialty or additional services, which we're concentrated on. And to be fair, we've got a Capital Market Day tomorrow, so we'll be going through that tomorrow. But with certain terms of M&A, M&A can be a bit lumpy in terms of what stage the various opportunities are at. So it doesn't necessarily follow logic in that respect.

[Operator]

The next question is from Raghav Bardalai of Exane BNP Paribas.

[Laurent Guy Favre, Research Analyst]

It's actually Laurent Favre. Raghav is on his way to your CMD. And the 2 questions I have, one is on back to the points on destocking. Could you talk about ordering patterns and whether you think that, in your experience over the past 10 years, we are seeing patterns that show that there might be simply lower end demand or whether you're looking at the end customers as for the -- among others into year-end ? That's question number one. And the second question, could you talk about, I suppose, any divergence between your specialties and your commodities portfolio in terms of the demand pattern of the last quarter and at the moment?

[Steven E. Holland, Chairman of Board of Management & CEO]

Yes. Look I think, it's really difficult for me to give you the -- probably the color what you want in terms of destocking in our business. We are only supplying small quantities at regular intervals. It's a repeat order business. I think it would be fair to say, the overall numbers are suggesting that Europe is slowing down. And therefore at the end of the day, that may result in destocking from end customers, but I would like to emphasize that it's not -- doesn't really effect Brenntag, per se, because we're not seeing a change in customer behavior in a meaningful way in Europe or, indeed, elsewhere. What was your second question?

[Georg Müller, CFO & Member of Board of Management]

On the different dynamics in specialty chemicals and industrial chemicals in Q3, as a brief reminder, we generally indicate that we expect in our specialty chemical business a growth which is 1.5 percentage points stronger than industrial, give or take, and we were about that difference in Q3, marginally wider.

[Operator]

The next question is from Rajesh Kumar of HSBC.

[Rajesh Kumar, Analyst]

Couple of questions, if I may. First is, could you help us with the impact of price growth versus volume growth in the LATAM business, please. And second, when you talk about slowdown in Europe, are there any differences between different countries or different end markets? That color may be quite helpful.

[Steven E. Holland, Chairman of Board of Management & CEO]

Okay. We're getting quite detailed now in terms of slowdown in Europe. I don't [ understand someone ] passing it off, but I think it's quite an interesting at least additional color, but it was an interesting demand/supply situation going on, particularly in Germany relatively to the Rhine being so low, and lots of barges not shoving them down the Rhine, and a lot of product being shipped by road, which I think is causing some chemical manufacturers difficulties and some stress in the supply chain, which in itself, has bounced its way through in some of the parts becoming -- even including ourselves. We may, for example, have to pay more for transport in Europe in that particular instance. But I think it's a very broad brush to really give you -- I think, it's too broad of a number to give you a detailed answer, I'm afraid. I think in terms of versus LATAM?

[Georg Müller, CFO & Member of Board of Management]

GP and volume in LATAM or if you want so price and volume in LATAM and the GP growth in LATAM in Q3 and the sales growth in LATAM in Q3 is not coming from a volume base. It's from margin management.

[Operator]

The next question comes from Karl Green of Credit Suisse.

[Karl Green, Research Analyst]

Just a couple of questions, please. You talked about passing through surcharges in North America wherever you can. Is that -- is it fair to say that, that is across the bulk of customer verticals? Or are there any verticals where you're finding that slightly harder to do? And then the second question, Georg, I think you said at the Q2 stage that you expected around a EUR 5 million sequential interest saving from the refinancing. When I look at your sort of underlying interest on loans overdrafts and finance leases, it looks like that's only fallen by close to about EUR 3 million. Is there something that's happened there in terms of rate swaps or some other FX driver which has meant that, that benefit is then perhaps less than you expected?

[Steven E. Holland, Chairman of Board of Management & CEO]

I mean, the surcharges as far as transport in North America, it's right across the board in terms of customer group. I mean, clearly, we have some -- we have arrangements to send customers' way. It's more difficult to implement, to most points in surcharges, but essentially the customer space in North America is very well aware of the -- that the pressure to transport as for everybody else. And it's something we certainly see in terms of our competitors doing similar things. It's a broad-based approach, and there's no one particular vertical that stands out from another.

[Georg Müller, CFO & Member of Board of Management]

The financing cost, the partially offsetting element that partially offset the quarterly EUR 5 million savings from the falling of a bond, it's our growth in emerging markets, particularly the acquisition in India. That's the most relevant growth but also business growth in South Africa, for example, that we finance working capital on a local currency basis. And in these countries, interest rates are pretty significant.

[Karl Green, Research Analyst]

That's helpful. Just one follow-up, if I can. Just back to the point about the cost pressures in Europe within transportation. Is that, from your perspective, more fuel? Or is it driver wage inflation? It's -- if we could just sort of get a sense of what's going on there because other distributors are not really referencing transport inflation so much in Europe. What are you seeing?

[Steven E. Holland, Chairman of Board of Management & CEO]

You can hardly split the 2 really because, in Europe, we have a mixed fleet in terms of some of our countries on -- quite a lot of it on transport, and therefore, it's controlling the cost in a different way, but they have bigger driver wage inflation in newer parts of the European distribution network. But we actually hire the vast majority of transport. So it is a mixed picture, but we have inflation both in travel wages and in transport costs. It isn't one size fits all.

[Operator]

We've received a follow-up question of Raghav.

[Laurent Guy Favre, Research Analyst]

Steve, I was wondering if you could tell us a little bit more about the situation in Germany. I understand it might just be temporary, but can you help us understand the puts and takes because I suppose there might be more requirements on your side for -- on the producer side for axenization of transport, but at the same time higher cost may be higher pricing power on your own fleet. So maybe can you help us understand the pluses and the minuses of the current situation?

[Steven E. Holland, Chairman of Board of Management & CEO]

Yes. Again and look, I'm being very vague and wishy-washy today in terms of being very specific with my answers. But I think with Germany, in particular, clearly, there is a situation in Germany where there's significant traffic, which is moved by river, which is not moving. And I think this is possibly the worst it's been in many, many, many years. And therefore, there is an automatic demand increase for England that transport in terms of tankers and trucks, which doesn't exist normally at this time of year. So and now in terms of pricing power and market, really big pricing power, per se, on transport from our side, especially a lot of our products here are resorting insource in Germany, in any case, and therefore, we do take, to some extent, some of the pain associated with the just the German situation. Bear in mind, this is a temporary situation in terms of we are expecting it to rain at some point. And therefore, there will be a more normalized position in the forthcoming months. And that in itself should ease the situation, but it has caused the European team quite a lot of pain in terms of managing that particular element just at the moment.

[Operator]

Next question comes from Peter Olofsen of Kepler Cheuvreux.

[Peter Olofsen, Analyst]

Three questions, if I may, and I guess all for Georg. Maybe starting with the working capital turnover. I recall from the Q2 call that you were looking for some improvements towards year-end; while it has actually weakened a bit further in Q3, would you still look for some improvements by year-end? That's my first question. The second question relates to IFRS 16 and lease accounting. As we head into 2019, could you already give some indication what the impact will be on your net debts and EBITDA levels? And would the resulting increase in the leverage ratio change your ambition to spend EUR 200 million to EUR 250 million a year on M&A? And then my final question relates to assets held for sale. Is there any progress to report on the planned sale of Biosector in the Nordics?

[Steven E. Holland, Chairman of Board of Management & CEO]

Peter, let me take them in turn. So working capital. Yes, working capital management is a strong focus in our group, and we expect to see improvement in working capital towards the year-end. For sure in terms of absolute working capital, we are also expecting or working on some improvement on working capital terms. But in an environment of still high and even higher chemical crisis with customers having service expectations, it's not an easy area to work through. From IFRS 16, we will deal with the topic on tomorrow's Capital Market Day. If I remember correctly, you unfortunately cannot come. We will have the slide in the presentation that you can read through afterwards, and of course, we are more than happy to take calls. As IFRS 16, I believe, is a presentation issue only but not change the underlying profile of the company. It does not change the cash flow profile. I don't see this as a trigger for reconsidering our M&A policy. Well, it is more about making sure everybody understands what the changes in presentations are. Assets held for sale, you mentioned Biosector. Under assets held for sale, we record small business that we own -- still own in the Nordics, which is up for sale. We are working through a sales process. We mandated a sales side adviser. We are working with interested parties. So I can't report in detail, but it's in progress.

[Operator]

We've received a follow-up question of Mutlu.

[Mutlu Gundogan, Analyst]

Question on Asia Pacific. Can you tell me if I look at the growth, I think, for large parts, the organic gross profits. I think the growth for a large part is driven by acquisitions. Can you tell me if organic gross profit was up for the quarter or not? And you talk about mix pictures in the countries. I mean, we've heard weakness in China. Is it mainly China? Or is it also other regions?

[Steven E. Holland, Chairman of Board of Management & CEO]

I think Georg can you give the actual numbers on the organic part.

[Georg Müller, CFO & Member of Board of Management]

Mutlu, on an organic basis, gross profit in Asia increase Q3 was flattish, so it's mainly the [ right check ] position of which we also reported growth, and then the organic GP development was flattish and actually a mixed picture in the countries behind. Many countries are growing. The 2 areas where we had challenges in gross profit in Q3 is Australia/New Zealand. I'd remark a fair share of our business is export business to China. So it's a little bit China induced. And in that quarter only, we had a little bit of a more challenging situation in Thailand. Thailand has seen a strong recovery, a strong business development for several quarters now, but Q3 flattened a little bit out on very high levels.

[Mutlu Gundogan, Analyst]

And maybe, if I may, if we look at the organic growth that you reported as a group in Q3, is that a run rate that you think you will be able to hold on towards the end of the year? Or would you expect it to come down given some of the weaker demand that you mentioned?

[Georg Müller, CFO & Member of Board of Management]

Not that easy to answer. We have the guidance of EUR 870 million to EUR 900 million out, and we stick to the guidance. As you can relatively easily calculate that for us to be in the guidance range, we should keep that run rate.

[Operator]

Thank you. At the moment, we have no further questions. [Operator Instructions] As we haven't received any further questions, I will hand back to you.

[Steven E. Holland, Chairman of Board of Management & CEO]

Okay. Well, ladies and gentlemen, thank you so much for taking the time to join us this afternoon on our call. And hopefully, we'll see some of you or some of your colleagues at our Capital Markets Day tomorrow. Thank you very much today for taking time.

[Operator]

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