Knorr Bremse AG

XETRA:KBX

Earnings Call Transcript 2023-Q2

[Operator]

Hello, ladies and gentlemen, and welcome to the Knorr-Bremse AG Q2 '23 Earnings Call. [Operator Instructions] Let me now turn the floor over to your host, Andreas Spitzauer. Please go ahead.

[Andreas Spitzauer, executive]

Good afternoon as well as good morning, ladies and gentlemen. I hope all of you are very fine. My name is Andreas Spitzauer, Head of Investor Relations of Knorr-Bremse AG. I want to welcome you to Knorr-Bremse's conference call for the second quarter results of 2023.

Today, Marc Llistosella, our CEO; and Frank Weber, our CFO, will present the results of Knorr-Bremse, followed by a Q&A session. The conference call will be recorded and is available on our homepage, www.knorr-bremse.com in the Investor Relations section. Here, you can find today's presentation and later a transcript of the call.

It is now my pleasure to hand over to Marc Llistosella. Please go ahead.

[Marc Llistosella Y Bischoff, executive]

Thank you, Andreas, and welcome, everybody, to our conference call also from my side. Before we get started, I would like to take the opportunity to express my deep sorrow about the sudden death of Daimler Truck CFO, Jochen Goetz.

For me, personally, Jochen was a highly valued former colleague, always fair, always great. Our heartfelt condolences, which are expressed on the half of the entire Jochen Goetz family to whom I wish much strength at this particular time.

[Frank Weber, executive]

Thanks, Marc. Let me tell you that for me, words can hardly express what I feel. I'm deeply saddened about Jochen's sudden passing. Jochen was much more to me than a very long time colleague in various functions. He was a friend. He was an exceptionally knowledgeable persistent, pragmatic and fast full professional as well as an outstanding and down-to-earth individual. For me, he was unparallel in terms of reliability, integrity and kindness. I will forever miss him. My heartfelt condolences go out to his wife and kids as well to my former colleagues at Daimler Truck.

[Marc Llistosella Y Bischoff, executive]

Thank you, Frank. So as usual, I will start with an overview of the highlights before Frank dives into the details, followed by a Q&A session. Let's kick it off on Chart #2, which with our main messages of today and move on.

We continue to see strong customer demand across all regions in both divisions. As a result, order books reached record levels and are a solid foundation of our outlook for 2023. Now 2, as promised at the quarter 1 '23 presentation and our strategy update in July, we saw a turnaround of profitability in the past quarter. This is a consequence of our successful Profit and Cash Protection Program, PCPP.

Together with Indian Railways #3, we could find a mutual solution to solve the technical issues with [ Freiberger ] in India, and we concluded a settlement. We are, therefore, confident that the outstanding payments by Indian Railways will decrease near term.

Number 4, a meaningful part of our BOOST program is brownfield, housekeeping, which we presented to you in our strategy update. A major cornerstone of this is the focus on portfolio optimization. It took quite some time, but we could sign a deal to sell our group subsidiary, Kiepe Electric to [ Aramba ] [indiscernible] We are confident to close the deal soon.

Number 5. Let's talk about our company's efforts to find climate change. We have increased our Scope 1 and 2 target a reduction of 75% by 2030. In addition, we have defined an ambitious scope 3 targets and we delivered on our commitment to same target validation through the Science Based Target Initiative, SBTi, this was a major step forward and shows our strong commitment to sustainability.

Number 6, last but not least, we confirm our guidance and increase our revenue target for 2023 from EUR 7.3 billion to EUR 7.7 billion to EUR 7.5 billion to EUR 7.8 billion.

Next chart, please. On Chart 3, I want to share our market view that view and focus on 5 main markets. Overall, the good demand in the rail industry continues driven by the political to support green mobility. After corona ridership levels and rail traffic are recovering across the globe. As a result, aftermarket business growth and performance decreased which result in high order books of our global OEM customers. The market in China is back and it's already showing a positive effect on our AM business. The demand in April are very still challenging at the provinces and municipalities suffer from the weak real estate market and the accumulated debts burden of the past corona days.

The truck market shows high demand in Europe and North America. Truck production rates specifically increased in both regions in past quarter and are also expected to grow slightly in full year basis. Overall, in terms of demand, we haven't seen any signs of weakening in addition consistent vehicle growth to support this CVS. After the Chinese stock market struggled last year, we see strong recovery in 2023. CVS benefited from this recovery due to our leading market position and leading position in the field of technology.

In addition, there are good opportunities regarding constant revenue growth, which was driven by rather lower safety standards and move towards innovative and reliable technology also in China.

Chart #4. Let's move to the second quarter, KPIs on the Chart #4. All major financials moved higher year-over-year. The most important one for me was the operating EBIT margin is up by 60 basis points to 11.1% in the second quarter 2023. This development was driven by higher revenues and the success of our cost initiatives. In addition, order book reached a new record high with EUR 7.1 billion. It provides good visibility and confidence for the quarters ahead regarding utilization rates. Last but not least, free cash flow. It turned positive in quarter 2 as planned, and we expect and we expect this good trend to accelerate further between now and the end of the year.

With this word, I would like now to hand over to Frank for the financial insights.

[Frank Weber, executive]

Thanks, Marc, and [indiscernible] from my side as well. Let's move to Chart 5. CapEx in the past quarter amounted to EUR 75 million, representing 3.7% of our revenues. They were stable in absolute terms year-over-year, but lower in relation to revenues and currently well below our target range of 5% to 6%. I expect some higher spending towards the end of '23 as usual. Net working capital increased by roughly EUR 180 million versus last year's level, but [indiscernible] sales improved slightly year-over-year. I will go into more detail regarding this development on the next chart.

We also believe that the level of EUR 1.56 billion should mark the peak in '23 and the scope of days will strongly decrease in the second half of the year. ROCE for the second quarter '23 increased slightly to 17%. There is still some way to go before we reach our target margin of more than 20%, but the development was definitely in the right direction.

On Chart 6, I would like to provide you more details regarding our free cash flow, which was positive as expected and came in at plus EUR 34 million in the past quarter.

With that, some EUR 69 million better than in the previous year. In the first half of '23, the improvement even added up to around EUR 100 million. Traditionally, our free cash flow is significantly weaker in the first half of the year in '23 is not an exception. The biggest impact on the development of our free cash flow is still the higher net working capital. The major driver for this was the increased accounts receivables among some larger customers, which tend to delay some payments. In addition, we still maintain a high level of inventories and also be flexible in response to customer requests and to ensure a high degree of supply security.

Due to the currently further improving supply chain situation, we also expect the scope of days to improve. We have launched project Connect, which is made up of cross divisional teams such as direct and indirect purchasing, logistics, supply chain as well as sales and after sales in order to systematically improve our net working capital again.

Therefore, I expect in the quarters ahead that we will improve KPIs also driven by higher payments from Indian Rail again after the finalization of the performance. I am still confident that Knorr-Bremse will reach its free cash flow guidance of EUR 350 million to EUR 550 million in '23.

Let's take a closer look at the divisional performance in Q2, starting with RVS on Chart 7. In the second quarter of '23, order intake in the Rail division was again very strong and above EUR 1 billion. The lion's share of this absolute performance was in Europe, followed by Asia and North America. The book-to-bill ratio is now about 1.27 negative quarter and reached 1.07. This development will support the positive trend of RVS. It is particularly important for me to mention that the current price quality for new long-term models at the same as it was before the sharp increase in inflation last year. So order backlog of 30th of June amounted to EUR 5.1 billion, reaching again a new record high.

Let's move to Chart 8. Revenues of RVS in Q2 amounted to EUR 958 million, an increase by more than 16% year-over-year driven especially by aftermarket business, which outperformed OE business in the quarter. Additionally, price increases supported this development too.

Operating EBIT for RVS in the second quarter '23 was EUR 141 million, up 19% year-over-year. As a result, the operating EBIT margin increased from 14.3% to 14.7% in the second quarter. The main drivers for our margin improvement were -- first of all, good operating leverage driven by higher revenues in all regions.

Second, the aftermarket revenues in China, which increased double digit versus the previous year's quarter, because of the sharp increase in ridership following the end of the zero COVID policy.

We also recognized pulled forward effects on train maintenance and spare parts deliveries. Therefore, it remains to be seen whether this level of the second quarter will be sustainable in the upcoming quarters. Last but not least, price measures and cost improvements could offset some of the inflation as well. We also expect a solid development of profitability in the [indiscernible] driven due to a very solid revenue development and further successes of the profit and cash protection program. But at the same time, adding to our forecast that RVS margin for the full year '23 would be below last year's level.

Let's continue with our Truck division on Slide 9. Sustained high demand, which was already mentioned by some truck OEMs has led to significantly increased truck production rates since the beginning of the year in Europe, North America and especially China. Intake coming orders for CVS amounted again to more than EUR 1 billion, which is an increase of 18% year-over-year. Main drivers for this significant growth were Europe and APAC, especially China. On good demand for transportation services. The order book of our truck division amounted to almost EUR 2.1 billion, which is again remarkably 7 percentage points higher year-over-year.

Let's move to Slide 10. Thanks to price increases and higher volumes, CVS posted a 15% year-over-year increase in revenues to EUR 1.05 billion in the second quarter of '23. The division was stable and with increased revenue in all this.

Operating EBIT in our CVS division amounted to EUR 98 million in the second quarter, up 31.5% year-over-year. As a consequence, the operating EBIT increased from 8.1% to 9.3% due to the strong aftermarket, successful implementation of cost measures and higher customer pricing.

We are close to successfully finish our second round of price increases also called Wave 2, which will support CVS, EBIT and EBIT margin starting from the third quarter.

And with that, I hand over to Marc for the guidance '23 and final remark.

[Marc Llistosella Y Bischoff, executive]

Thank you, Frank, and sorry for my coughing. I don't know, it's my allergic reaction. I want to finish with our guidance for 2023 on Chart 11. Our main assumptions are out and is outlined on the right side of the page. As one aspect of those, we expect that all net extra costs due to the inflation also this year will be once again compensated with our comprehensive [indiscernible] measures. For 2023, we now expect an increased revenue target of 7.5% and EUR 8 million. This uplift was mainly due to a higher-than-expected truck production rate and a better development of the aftermarket in the Rail division.

Furthermore, we expect an operating EBIT margin between 10.5% and 12.0% and a free cash flow between EUR 350 million and EUR 550 million, which confirms our guidance.

On Chart 12, as you can see, quarter 2 results have shown first signs that we are heading into the right direction. We all know [indiscernible] doesn't make a [ summer ]. We'll use the following months to rigorously implement and execute our plan for value creation that we showed you a few weeks ago in our BOOST presentation. We say what we do and do what we say. So the heat is on. And we will not pull off in autumn nor in winter. We announced a further relevant update for our [indiscernible] for February next year and [indiscernible] rail matures will deliver on time.

Thanks for your attention. Thank you very much. Franc and I, Llistosella, myself, we will look forward to hear and to answer your questions now.

[Operator]

[Operator Instructions] And the first question comes from Sven Weier.

[Sven Weier, analyst]

Yes. First one is on RVS where you mentioned on the EBIT side that the price increases compensated higher inflationary costs. In Q1, you were still a bit more reserved on that in terms of only partial compensation. So are you making quicker progress there in terms of the impact of the legacy contracts that you assumed so far?

[Marc Llistosella Y Bischoff, executive]

Sorry for the delay. We had a technical issue here. Thanks, Sven, for your question. Basically, the plan going forward in regards to the degree of compensation of costs via pricing has not changed, maybe kind of understanding issue that we have here. It's clear that last year, overall, we were able to roughly compensate 66% of our cost increases via pricing only. This year, we should overall for the whole group be able to achieve roughly 80% and towards next year, it will then, again, get better until it's completely consumed, so to say. And this plan has not changed. It's gradually getting better, but it's not fully compensated yet.

[Sven Weier, analyst]

I think in Q2, it was, we at least.

[Unknown Executive]

Pardon, Sven. In Q2, it -- it wasn't. It was compensating, but not to the full extent.

[Sven Weier, analyst]

Okay. Because I just referred to the comment on the slide, on Slide #8, where you said price increases and cost measures compensated higher inflationary costs. So maybe not fully.

[Marc Llistosella Y Bischoff, executive]

Prices and cost measures fully compensated, but not price measures only.

[Sven Weier, analyst]

This is -- and then just on the second point regarding China and ridership and reopening. I mean, were you also a bit surprised by this, because on the strategy update, you found it's a little bit more defensive on China, as you said aftermarket was already relatively sound also during the pandemic or the catching up there was maybe not so much needed. I was just wondering what has changed between now and the strategy update?

[Marc Llistosella Y Bischoff, executive]

In the very general outlook, we -- I wouldn't say we're very surprised. We said that we do expect out of this change -- drastic change of the Zero COVID policy, some tailwinds on the aftermarket side, but not on the OE side, we still see in actual results and also in our outlook for the full year in regards to the production assumed for metros as well as the high-speed trains, the same numbers that we have talked about just several months ago. Sven, we do think that maybe on the OE side, we can reach some 100 high-speed trains throughout the year. And we can see a same level of roughly 5,100 metros within China. So it isn't the big lever for entices in '23 for us. This is still confirmed.

On the aftermarket side a bit, as ridership levels have really grown strong there in the first quarter and in the second quarter, which were even higher above 2019 pre-COVID levels already and this is a bit better than we thought indeed this resulting aftermarket business, including some pull forward effects in the second quarter is stronger than expected.

[Sven Weier, analyst]

Could you quantify the improvement you saw in China sequentially on the aftermarket?

[Marc Llistosella Y Bischoff, executive]

Yes, it's a double-digit euro revenue number, I would say, in the quarter alone. And the big question out of that is you can hardly distinguish clearly what are really pull ahead effects from customers trying to get their shelves uploaded. This is difficult to say what's out of that kind of sustainable, but low to mid double-digit revenue figure in terms of million euros.

[Operator]

And the next question comes from Akash Gupta.

[Akash Gupta, analyst]

It's Akash from JPMorgan. My first one is on the guidance. So while you have raised your revenue guidance, but if you look at the implied second half, the midpoint is kind of implying flat year-on-year growth after you reported 15% revenue growth in the first half. So can you elaborate like is this only because of the accelerated clearing of backlog in the first half or you're just taking a more conservative view on the second half development? That's the first one.

[Frank Weber, executive]

I think that this distribution between the quarters and the half year 1 and half year 2 has also not changed. If we look at our forecast level, in fact it's just a bit stronger quarter 1 and probably we came in on the CVS side. You know that we have been a bit more cautious potentially there over in curtailments and then giving you the guidance a bit for CVS development, but we're already back there. So that towards the second half of the year is getting a bit weaker in terms of revenues, and this has nothing to do yet with a significant drop in order intake that we would expect.

I mean, we have a quarter coming up, first quarter, which is usually a rather weaker one. On the supplier side, at least this is also our customers going to kind of some of vacation in regards to their plans. So this is typically a lower one and the fourth quarter is still a bit out there given the current EDI numbers that we have. We also see it a bit on the weaker side, so that, so to say, hints to the imbalance that you point out in between 0.5 year, 1.5-year, 2-year.

[Akash Gupta, analyst]

And my follow-up is on the guidance again from the Kiepe Electric divestment. Can you elaborate more on the financial implication of this divestment and whether there will be any impact that we should see later in the year?

[Frank Weber, executive]

First of all, as we talked about the Kiepe Electric overall, isn't that much of a performing unit of ours. That's the reason why we are in the current process and as we're already now in August and we have baked in basically -- already kind of 6 to 8 months into our actual results that it will not make a big difference, so to say, for our guidance levels, whether it will be closed in August or in October. So if we could, so to say, close the deal as soon as possible, there would be a slightly positive effect for the remaining months to come. That is clear, but this is not the make-or-break point for reaching our guidance.

[Operator]

And the next question comes from Gael de-Bray.

[Gael de-Bray, analyst]

I have 2 questions, please. The first one is about CVS. Could you quantify or at least provide more color on the magnitude of the Wave 2 pricing agreements, which were concluded in the first half? And then the second question is on the strategic program and following the update you had in July, I think it would be useful if you could provide some color and maybe regular updates on the growth and margin performance of the EUR 1.4 billion of revenue that's under review and perhaps starting now?

[Frank Weber, executive]

Gael, thank you for your questions. First, I mean, the Wave 2 that we're currently basically finalizing as we speak, this is in the dimension of similar magnitude like we have had in last year, so to say, but comes needless to say on process, last year's negotiations have been also sustainably increased than the price levels.

So a similar amount to what we were talking about last year. Last year, we were always that kind of 2/3 of the inflation compensated by pricing only. On the group level, 2/3 of that last year came from trucks and in that similar amount we are talking year-over-year than for the CVS colleagues in '23. That's the Wave 2.

In regards to the EUR 1.4 billion that we talked about in the strategy update, it's like you can also see back in the days on the slides that we showed in the margin walk, we roughly expect a level of 200 basis points of EBIT margin improvement out of the respective countermeasures, those non-performing units that we're having. And they could either be selling those units or fixing them or bringing them up to the levels that we strategically target. So we confirm that we said back then, 200 basis points roughly.

[Operator]

The next question comes from Vivek Midha.

[Vivek Midha, analyst]

I have 2 questions on demand. So the first question is on rail. Your rail orders remains the high level so far this year. Do you expect to be able to continue to get orders at around that EUR 1 billion per quarter run rate in RVS for the rest of the year? And maybe could you any update on how your order pipeline is developing?

[Frank Weber, executive]

Thanks for the question. We also do think that after now very, I think, more than 4, 5 quarters in a row with more than EUR 1 billion of order intake on the RVS side. And you know also kind of this project business is not kind of a sustainable work you can like cutting coupons, forecast into the future. We do expect that order intake should be a bit lower, moving in -- given all the tenders that are out there, and we have the transparency basically all around the world in issues. Just given the tenders that are out there, we do expect order intakes to go a bit down going into the next quarters.

But this does not at all fundamentally change our core and strong belief of a fully intact growing markets in RVS in basically all regions, like we said, except for maybe China, if we take or India as a case. So this is the situation a bit less order intakes will be expected, but not at all a change in the fundamentals.

[Vivek Midha, analyst]

That's very helpful. My next question is on trucks. With the comments on trucks remaining at a good level. I was wondering if you could give any latest thoughts on where the truck cycle will develop into 2024? Maybe you have it.

[Marc Llistosella Y Bischoff, executive]

When you speak about trucks, you speak about regions, right. So in Europe, we see stabilization on the high level. In North America, we see it's the same; and in Asia, mainly in India and especially in China, we see extremely a recovery.

The question is now we see a slight slowdown in the recovery in China. Is there a steady increase in India, which is also, unfortunately, not that important so far for us because this content per vehicle in India is not 1/3 of what we have used in other markets. So the significance of this market will be an upside for the near future and the next future, but it will not be a game changer for the next 6 or 12 months to come.

What we see in China is that -- it will be the question when the Chinese truck market is picking up to the level of the cars. And that is something which will come from our point of view, relatively (31:00) [indiscernible]. It can be faster, it can be slower than expected. So we cannot say where it is coming. But one thing's for sure, we see the acceleration in the truck market by volume. And now the question is, when is the acceleration coming by content per vehicle and by the level of technology. That is the name of the game in China. It's less the volume itself, whether it's 700,000 or 800,000 units this year. It's more the question when do we see that the latest technology will be built in. That's more a driver for the Chinese market.

Besides the others, we are always and you know that now for at least the next 6 months, last 6 months, we have been a little bit modest, and we would moderate with all numbers because if it gets better, it's good for you, it's good for us. And if it gets what we expect and it's okay that it's the baseline. So we say -- we've seen no significant acceleration in growth in the key markets, Europe and [ NAFTA ], but we see a massive interesting shift will come up for the next 5 years in China. So for the next 6 months, it could not be, but it could be very, very easily the case in 12 months to 18 months.

[Operator]

And the next question comes from Lucas Ferhani.

[Lucas Ferhani, analyst]

My first question is on RVS. There was a big step up sequentially in the margin. How do you see the margin moving going forward? Is it back to be a bit more stable? Could it be a bit lower? I think you said there was some kind of pull forward of aftermarket demand in China, for example, that potentially could impact in nature. So how do you see a little bit of the margin development in earlier, specifically in H2?

[Marc Llistosella Y Bischoff, executive]

RVS. Yes. I would like to start that. As you are right, effect we had, certainly from surprising uprise of the aftermarket in China, which was in fact with lower margin. But in order to be also very clear, even there is a certain flow of downside in this like a [indiscernible] we can say that in the overall business and the overall also in the OE business, we see a release of the pressure. Because now more and more of the new orders are coming into and falling into place. That means, as you rightly know, because we communicated is very clear, from the activated OE business this year, 31% of this business in RVS was to price this before Ukraine, but costs after, okay.

So this was a certain from burden of the business. More and more in the year to come, we will see the release of this 31 for the whole year, and we will see new contracts coming into and falling into place. So this will have -- this is more a tailwind.

When you see the performance of RVS sales market and the orders and the building in China for RVS that is a slight headwind for us in the next 6 months to come. This would be a slight tailwind will come. But in 2024, we have only 10% to 15% of the so-called pre-inflated pricing or that means, the real kick in of the margin improvement will come then the next months to come, especially the next year to come.

So for the next half year, we don't expect any acceleration of our margin, directly don't see a massive increase of the margin. What we see then for next year is supported by what I just described. Now, Frank please, at [indiscernible]

[Frank Weber, executive]

Yes. Thanks, Marc. Absolutely correct. I mean, going towards the half year too, I would guide you with the kind of level that is roughly on the half year 1 level, which is potentially in a quarter, even below quarter 2 level, but definitely above quarter 1 level, yes. So this is what we can see. And as it's the project business, it's totally different kind of revenue scope that you would potentially have in the first quarter compared to the one that you would have in the fourth quarter. So that's just the kind of volatility that you cause, have in the structure of product mix.

[Lucas Ferhani, analyst]

Perfect. My second question is on kind of the guidance. Again, you increased the revenues, very strong orders in H1 that gives you visibility into H2. You kind of know the moving parts in terms of what going to be the margin. I'm just surprised you're not narrowing maybe a little bit EBIT margin guide -- seem quite conservative now to kind of be at the lower point. So what risk specifically do you see which would lead to kind of a lower margin in H2 or you not being towards kind of the mid or top half of the range by the end of the year?

[Marc Llistosella Y Bischoff, executive]

Basically, this is just a fact that -- to say that all of after the negotiations Phase 1, Phase 2 you have, in the meantime, a very good kind of back-to-back insurance in regards to inflationary cost increases, but at the same time, also in regards to cost reductions that we would potentially see. So you have to give away then also a certain pricing once costs come down compared to your assumptions like energy costs or personnel costs on our supplier side, Tier 2, Tier 3, Tier 4 will help you if this is coming down, then we also have to reduce the price levels again towards the end customer. That's just the nature of the game.

And as this is kind of a situation that is ongoing, there's not so much fluctuation around the margin anymore. And I think with the midpoint -- as a result of this, with the midpoint of the margin you are on a safe side so to say. And narrowing it down further compared to this, I mean, there's still an issues out there in regards to the project dimensions on the RVS side, more or less, which is, of course, not that plannable as there are big tenders usually out there and big deliveries out there, which can easily -- so to say close to 50 basis points up or 50 basis points downside. That's the reason.

[Operator]

Okay. So at the moment, there seem to be no further questions. [Operator Instructions].

[Unknown Executive]

Okay. In case there are no further questions, then thank you very much for your time, and your attention. We wish you a great summer holiday. Looking forward and the fact that we talk to each other again, and thanks a lot. Bye-bye.