EDAG Engineering Group AG

XETRA:ED4

Earnings Call Transcript 2022-Q3

[Cosimo De Carlo, executive]

Thank you, and good morning, ladies and gentlemen, and welcome to our Q3 earnings call. I'm here, together with my colleague, Holger Merz, who will give you the financial details on the first 9 months of 2022 later on. As usual, I would like to give you an update on our market environment at the beginning.

The global economic environment has not really changed since our last call at the end of August. We continue to experience multiple factors that had a negative influence on the economic output. In addition to the ongoing COVID pandemic and Russia's works of aggression, high inflation and very high energy costs are putting pressure on the global markets. These factors made the IMF to lower its global economic growth expectation from 2023 again to now only 2.7%.

For Germany, the institute now expects a recession in the coming year. This means that the overall macro level is becoming increasingly clouded.

Now let's go one step deeper and look at the automotive market. The supply chain disruptions that heavily influenced the automotive OEM over the last 2 years are easing a bit. Accordingly, production numbers are slow in going up. Nevertheless, the overhang in the order backlog is expected to continue for some time, which is why margins and cash flows at the OEM are still robust.

The demand for new cars on the other hand, is expected to slow down in the coming year. Depending on how badly the global economy slows down, relationship between supply and demand will balance out more quickly or more slowly. Now what does this mean for the market for engineering service providers? The good news is that most of OEMs, especially the German ones, are increasing their R&D efforts and enlarging their spending. Recent studies say that R&D spending on the new electric models, production lines and battery factories are expected to amount to about USD 1.2 trillion until 2030.

This means that ESPs, like EDAG, can assume that demand will continue to grow very robustly over the coming years although the overall economic challenges are increasing. We have to be prepared for the fact that setbacks can occur again and again in the short term and that volatility will increase overall. In all likelihood, we'll not always be able to fully pass on increased cost for energy and personnel to our customers.

We are, therefore, preparing for future challenges with scenario-based planning. On the one hand, we are continuously expanding our technological skills in order to inspire our customers with comprehensive expertise and that position EDAG Group as one of the global champions on the market. On the other hand, we are increasing our efficiency in the provision of services, our capacity in best cost countries and our flexibility through the needs-based purchase of services. With this mix, we will ensure that our company can be navigated safely and stably even under the new framework conditions.

Our declared goal is to lead our company internally with ambition goals and, at the same time, to always give the market a realistic assessment of the current market environment. As we always emphasized in the past, we want to deliver what we promised. I'm here, therefore, all more pleased to be able to present you with the highlights for the first 9 months of the current financial year on the following slides.

Our 9 months revenue are up by 16.5%. We were able to even speed up the growth in the third quarter to 19.9%. And all of our 3 segments were contributing to this growth. Our adjusted EBIT after 9 months level at EUR 37.5 million, which corresponds to a margin of 6.4%. All of our segments continue to grow profitably.

A good indicator for the current market environment, but also EDAG's position in the market, is our extraordinary strong order intake. The 9-month figure is more than EUR 180 million above the previous year's level, a growth of almost 35%. Holger will give you some more insight on order intake in a few minutes.

There are 2 further great news that I would like to share with you. First, EDAG is one of the first companies in the automotive sector to be certified in accordance with the latest standard ISO/SAE 21434 Cybersecurity - Road Vehicles. The independent audit evaluates a wide variety of damage scenarios relating to possible several cyber attacks on vehicles and their digital security architecture.

The standard includes measures for the product development throughout the entire product life cycle, from the concept phase through development and production to maintenance and decommissioning. We spent more than 20 months examining this subject intensively and carefully. In the process, we put all relevant IT connections and processes to the test, changed existing procedures and defined new ones.

For our customers, this certification is an important milestone towards the mobile future in which classic ITs and operational technology will continue to merge and cybersecurity will be an absolute must. EDAG, once again proved its state-of-the-art competence in the field of software and digitalization.

Secondly, EDAG and Eintracht Tech, the independent digital subsidiary of Eintracht Frankfurt, this year's European League winners, have entered into a partnership. We are joining forces to focus on an all-around approach to digitalization. This can also be seen from the Campus FreeCity real lab for the research of a networking fleet of modular robot vehicles project, which has recently been jointly implemented and is funded by the Federal Ministry of Transport and Digital Infrastructure in Germany.

The digitalization of all areas of life and work continues ceaselessly. With this partnership, EDAG Group and Eintracht Tech want to make a sociopolitical contribution towards making our cities quieter, cleaner, more life financing and smarter in the future. For us at EDAG Group, this partnership is an ideal playground to enlarge and showcase our capabilities in the field of smart seat infrastructure.

So overall, ladies and gentlemen, within the first 9 months of the year, we have delivered what we have promised and even exceeded our aspiration a little bit. We are continuously developing our company and are at the forefront of the market with our technological expertise. Our promise to you is that we will continue to pursue this strategy even in times of increased economic challenges.

So far from my side for the moment. Please let me now pass on to Holger Merz, who will provide you with the financial details on our 9 month figures 2022.

[Holger Merz, executive]

Thank you, Cosimo, and good morning, ladies and gentlemen, also from my side.

As Cosimo already mentioned, revenues after 9 months are up by 16.5%. Let me elaborate a little further on all 3 segments. Our biggest segment, Vehicle Engineering, was up by 7.8% after 9 months. In Q3, the growth rate was even up to 9.6%. This growth is backed especially by recovery of our domestic market and also a continued strong international footprint.

Production Solutions continues its recovery path and is posting a double-digit growth of 15.3% after 9 months. In this segment, we experienced an increasing demand from automotive customers. Moreover, the strategy of diversification paid off as Production Solutions is already generating about 30% of its order intake with customers outside the automotive industry.

And Electrics/Electronics is outperforming once again, posting an increase of 20.6% after 9 months. Growth in Q3 even amounted to 27.5%. The demand is driven by all areas of software and digitalization services and coming from almost all of our customers. To enlarge the global footprint of this segment, we have recently started new operations in software engineering and EE in our Malaysian delivery center. All in all, revenue growth is very strong and even exceeding our expectations from the beginning of the year.

Let us move on the next slide, where we show the development of the adjusted EBIT. The group adjusted EBIT leveled at EUR 37.5 million, a very sound increase of 57.6% compared to last year. The corresponding margin levels at 6.4%. Looking at the segments, we see Vehicle Engineering and Electrics/Electronics posting a solid margin of 6.8% and 7.4%. At Production Solutions, we have left the negative territory from the previous year and are now posting a positive margin of 1.4% after 9 months.

The current level of profitability, especially in our 2 biggest segments, is very satisfying. It will allow us to further invest into our company's capabilities and structures, but also to distribute a decent dividend. However, I have to point out that it will become increasingly difficult to offset the high inflation, especially for energy cost and wages. As Cosimo already pointed out, we do not expect to pass on these costs to our customers at full extent. We will have a tight [base shift].

In order to counterbalance rising costs, we have to increase our efficiency driven by digitalization. However, since we continue to grow and want to expand our capacities and competencies, we cannot expect any further increasing margins in the current market environment. Therefore, as long as the inflationary pressure persists, we will focus on securing our earning power and expanding our market position. We will elaborate a bit further on this point at the end of the presentation.

Meanwhile, let us move to our EAT and equity at Slide 7. Corresponding to the development of our adjusted EBIT, earnings after tax are significantly up to EUR 21 million. The EPS after 9 months stands at EUR 0.84. The total equity is up by more than EUR 35 million. The equity ratio has slightly increased, now standing at 21.2%, the only slight increase compared to the previous year's figure is based on a larger balance sheet compared to last year, mainly caused by higher rise of use from leasing and a higher working capital.

Let's move on the development of headcount and CapEx at the next slide. The overall headcount increased by 372 to 8,246 employees compared to the end of September 2021. Within the third quarter, headcount increased by 249 employees, which is underlying our ability to attract talent even in time of fierce competition and war of talent.

We expect the war on talent and the corresponding higher level of fluctuation to be one of the most important factors of success for the coming years. Only those companies who can attract sufficient talent and keep the fluctuation under control will be able to be profitable and have profitably grow their presence. We continue to implement further tools to measure to continue our HR success story and thus outperform our competitors in the field.

Looking at our CapEx, we are posting a year-on-year increase to EUR 17.6 million. The CapEx ratio levels at about 3% of revenue. We continue to expect a further increase in CapEx over the next quarters in accordance with our previous communication and our internal plan.

At the next slide, we show the development of our trade working capital. As we carried out in our last call, the recovery in our overall business and especially with our German customers leads to an increase in working capital. Accordingly, our trade working capital by the end of December is up to EUR 108.4 million.

At the next slide, you will see that we can manage our cash flows pretty well under these circumstances. Compared to the previous year's figures, the operating and the free cash flow has increased despite the working capital outflows. These outflows could be counterbalanced mainly by our increased profitability.

Operating cash flow after 9 months was at a positive EUR 5.9 million, while free cash flow was a negative EUR 11.5 million. For the full year, we are targeting a positive operating cash flow, well in line with our communication of the previous quarter. However, the final figure will be depending on our customers and project mix in the fourth quarter.

Let us continue with the development of our net financial debt at the next slide. On a year-over-year basis, net debt, including leasing at the end of the Q3 was up by about EUR 50 million to EUR 205.2 million. Increased leasing liabilities of about EUR 30 million played a major role. Accordingly, the financial debt without leasing is up to only EUR 24.4 million. The net gearing at the reporting date was at just 16.6%.

At the reporting date, we had about EUR 150 million of cash on hand and more than EUR 105 million of available credit line. Overall, our financial position remains very solid, and it offers more than enough flexibility to cope coming challenges and take future opportunities.

Before coming to our outlook, please let me give you a few more information on our order intake at the next slide. Here, we present our order intake by quarter in the current as well as the previous year. There are 3 facts that I would like to highlight. First fact, after order intake in the second quarter was still below the previous year's figure, the trend reversed significantly and clearly in the third quarter. The Q3 order intake was actually one of the strongest in our company's history.

Second point, all 3 segments were able to increase their order intake in the 9-month period compared to the previous year. For us, this is a clear indication that our market has become more stable and that we have the right offer for our customers.

Third point is the winning of new orders in the third quarter was concentrated in particular on customers from Germany. The increased R&D budgets of the OEMs are also clearly reflected in their outsourcing behavior and thus in our order intake. Against the background of the strong sales growth and this development in incoming orders, we adjusted our forecast for the full year on October 19, as shown at the next slide.

Finally, let us come to our outlook for 2022. Further increasing R&D budgets of our customers and order wins led to a reassessment of the forecast for the revenue development of EDAG in the current financial year. Overall, we confirm our guidance as communicated in our ad hoc statement from October 19. Revenue is now expected to grow in a range of around 14% to 16%. The adjusted EBIT margin is expected in a range of around 6% to 8%.

The investment rate is expected in a range of around 4% to 5%. This estimation depends largely on Russia's war aggression, the China-Taiwan escalation and possible further geopolitical disputes as well as ongoing disruptions in global supply chain and further pandemic developments.

Ladies and gentlemen, concluding, please let me state the following. The 9-month results clearly show that the EDAG Group operates successfully on the market and participates in the opportunities that arise in Germany and abroad. The strong revenue growth and the solid margin are impressive proof of this. As a management team, we want to continue the success story and use the positive momentum for the further development of our company.

A key pillar of our success is a realistic assessment of the potential and also risk factors in our market. The arising -- the right measures from this leads to being able to stay on course, even in economical difficult time. We are currently seeing a very positive attitude from our investors and analysts towards market development. We read that many analysts are very optimistic about revenue and earnings development in the coming years.

There are, as of today, good reasons for this. Above all, our good development in order intake. However, what we believe is that the significant risk of the macroeconomic level are not sufficiently considered yet, in particular a short but very pronounced recession, especially in Europe. In such a situation, as was the case at the beginning of the corona pandemic, our customers could postpone or even cancel projects at short notice, especially if their cash inflows fail to materialize. We currently do not see such a risk reflected in the consensus. From our point of view, now is exactly the right time to temper optimism in order to limit expectations that are too high.

We see the massive increase in energy costs as a further limiting factor in the coming year. This alone will result in additional cost in a single-digit million range. Additionally, increases in personnel costs and staff shortages in some areas will have an impact on both revenue and earnings development.

Without giving any guidance for 2023 yet, I would like to make it clear that we, as a management team, will stick to our principle of being honest and clear. We do not want to promise what we cannot deliver nor ignore any risk. Please be assured that we are closely monitoring further development and that we will act quickly and decide if necessary. We guarantee you that every member of our organization is strongly focused on the execution of our plan and we all set ourselves very ambitious goals to ensure that the success story and positive development of EDAG Group continues even in challenging times.

Ladies and gentlemen, thank you for listening to our report on our 9-month 2022 figures. We are now looking forward to answering your questions.

[Operator]

[Operator Instructions] And the first question comes from Marc-René Tonn from Warburg Research.

[Marc-Rene Tonn, analyst]

And yes, I would like to come to, I think, probably the outlook or your statements regarding the future development in particular. I think you have impressively shown strong order intake in the third quarter, you massively increased the revenue guidance for the current year.

I clearly acknowledge there are a lot of risks ahead of you and ahead of the industry. But would have expected, let's say, a greater opportunity or perhaps more opportunity for you to pass on, let's say, anything you see on the inflationary side through price increases towards customers. I mean, what we hear is that it's a lot about scarcity of capacity in the engineering services sector, that there's a high demand from the customer side, which in general or in principle should be very positive on, let's say, your opportunities to reflect that in better pricing, which I would, let's say, expect to massively support margins.

Or in other words, from the demand side, as -- at least as long as it seems to be today -- or up to today or in the first 9 months, this is, let's say, a very, very constructive environment. So I would have expected, let's say, this to be very, let's say, supportive for, let's say, earnings quality going forward. Perhaps if you could, let's say, give us more details there on where you see, let's say, the greatest challenges or risks or whether you have seen anything, let's say, really on the negative already? Or whether you just want to be, let's say, cautious in principle not to make us overshoot for the next year?

[Cosimo De Carlo, executive]

Okay. Thank you for your question, Marc. It's Cosimo. We'll take the answer of that. As we try to state in the call, of course, we see the market with very high potential if we have a look at the possibility of what our customers are going to spend in the upcoming years for these new technologies also in terms of research and development. So the playground remains, in any case, a positive for us.

On the other side, of course, we are observing all the macroeconomic changes that are occurring. And we want to be, of course, always very conscious when we say something about the future. So we still have a very good playground. But at the moment, all these factors that you already mentioned in your question, the high inflation, the lack of talents on the market...

Concerning prices, of course, we are in very close communication with our customers, and we are trying everything we can to offset the effect of inflation and make sure that we can increase our prices. But as you know, in life, normally you have a curve which is more like an L curve. So you have high inflation on that side and then it takes a little bit longer time to offset all these effects.

So it's a mixture of, let's say, factors. We see a positive playground, but on the other side, we are trying to anticipate what problem could occur at customer side in case the demand should slow down next year. And then you have, let's say, a mismatch between the request and the production side. That's, let's say, from my side. Holger, you want to add something?

[Holger Merz, executive]

Yes, maybe -- you are completely right. We have a lot of -- still, we have a lot of opportunities in the market, and we have a big order intake in the Q3 quarter. But maybe you have to consider and evaluate the following scenario. As you all know, energy costs for private households will increase dramatically in 2023. Consequently, many of the private households would then not come up with an idea to buy a car.

And less car sales have an impact on the cash flow situation of our OEMs. We know that exactly from the corona pandemic. And therefore, they try to implement countermeasures. They simply try to cut costs and one easy measure is to postpone or even cancel R&D budget. And if this said thunderbolt from heaven hits us immediately, then we have also a utilization problem because, yes, we have a high order backlog, but they can simply postpone it. And this risk is not reflected what we think in the consensus in the analyst research reports.

[Marc-Rene Tonn, analyst]

Okay. But just principally speaking, I mean, when we look at, let's say, the ambition you have, let's say, in terms of profitability term, what, let's say, kind of environment would you need, let's say, for the margins to improve, let's say, above at least around 6% level where you're at in the current year, in the mid to long term?

[Holger Merz, executive]

The project margin is [indiscernible]. I think we have a lot of good chances to increase our project margin with our customers. And I think although we are able to shift some inflation costs to our customers, we have maybe a time shift, okay, but we will be able to do that. But utilization is also the next factor. That means if they cancel or postpone a project because they earn less money, then we think we have -- we will get the problem all in 2023. And so we have to consider a scenario-based.

[Marc-Rene Tonn, analyst]

But I think that's what -- up to today, is it scenario base? So there's nothing you already see, but it's just you want to be cautious in advance and not be -- let's say, just wait for, let's say, any kind of weakness, but just prepare for weakness already now, although there may not be that much weakness visible as of today?

[Cosimo De Carlo, executive]

So as of today, Marc, we see a very dynamic environment. So we don't see yet this kind of, let's say, scenarios that could occur next year. We have also only seen in Q4 some small project cancellation but not many relevant. But as Holger also said, we want to try to anticipate and make sure that we are well prepared in case the market will suffer next year. We don't have that as of today, but we want to be prepared and to be also honest and clear in the communication.

[Operator]

At the moment, there seem to be no further questions. [Operator Instructions] There are no further questions.

[Cosimo De Carlo, executive]

Okay. So many thanks for your time. Many thanks for participating to the call and for your questions. We wish you a great day. Thank you very much. Looking forward for the next call that will take place in March next year. Thank you so much. Bye-bye.

[Holger Merz, executive]

Thank you. Bye-bye.