Kloeckner & Co SE

XETRA:KCO

Earnings Call Analysis

Challenging Q3 Buffeted by Strategic Gains

In a turbulent Q3, sales dipped from EUR 2.4 billion to EUR 1.9 billion due to lower prices, though gross profit margin improved from 12.9% to 16.3%. The acquisition of HVAC companies NMM and Sol Components prompts optimism for North American growth despite a market downtick. EBITDA stood at EUR 41 million within forecast, and the company remains confident with a solid balance sheet despite a rise in net debt from EUR 596 million to EUR 923 million. Free cash flow was negative at EUR 304 million, largely due to the EUR 310 million KMM acquisition. With firm operating cash flow expected, the full-year 2023 EBITDA forecast is EUR 170 million to EUR 200 million.

Navigating Turbulent Markets: A Testament to Resilience

In the face of a challenging macroeconomic environment, this quarter presented a tale of steadfast performance and strategic maneuvers. Even with fluctuating steel prices and a global economic downturn, the company showcased its ability to excel through strategic acquisitions and diligent net working capital management. The closure of the Mexican NMM acquisition on August 1 was a highlight, contributing to a slight shipment increase year-over-year despite market headwinds. Although sales dipped due to lower price levels than in the previous year, there was a notable stabilization in prices indicating the possible end of the downward trend. Impressively, gross profit saw a slight uptick, and the gross profit margin expanded significantly from 12.9% to 16.3% year-on-year due to efficient capital management strategies.

Strategic Expansion and Cost-Optimization Initiatives

The company accelerated its focus on HVAC, acquiring Mexico-based NMM and US-based Sol Components, both enhancing its position in respective markets. Particularly in North America, demand remains robust, bolstering optimism for future performance. Additionally, a European efficiency program was announced, poised to reduce headcount by approximately 10%, translating into increased operating income around EUR 25 million annually starting from 2024. Such initiatives underscore the company's commitment to fortify its profitability base and generate stable cash flows, while minimizing earnings volatility.

Financial Steadfastness Amidst Increasing Net Debt

Operating cash flow remained strong at EUR 131 million for the first nine months of 2023, with a solid quarter performance of EUR 36 million. Net debt rose, primarily due to the NMM acquisition, yet the balance sheet remains robust with equity nearly at EUR 2 billion and a formidable equity ratio of 46%. Noteworthy is that net debt increased less significantly than the NMM acquisition price due to organic net debt reduction over the past 12 months.

Confidence in the North American Market Outstrips Eurozone Uncertainties

North America is painted as a beacon of hope with better-than-expected economic growth and significant market share gains, particularly in the manufacturing and transportation sectors. On the contrary, Europe is ensnared by swelling headwinds, with macroeconomic pressures potentially impacting demand in sectors such as residential construction and manufacturing machinery. However, a stable order intake, particularly in automotive and energy, offers some solace.

EBITDA, Cash Flow, and Debt: A Mixed Financial Picture

Performance in terms of EBITDA remained solid at EUR 41 million for the quarter, aligning with prior forecasts and reflecting the company's resilience. Yet, the group faced headwinds with a negative volume effect and lower sales year-over-year due to market conditions in Europe. Operational efficiencies enabled the reduction of operating expenses, and the group withstood foreign exchange challenges. Free cash flow was negative, largely due to KMM acquisition expenses, leading to an increase in net financial debt from EUR 596 million to EUR 923 million.

Forthcoming Outlook: The Road to a Stronger Year

Guided by a rise in shipments driven by the NMM acquisition, a robust business base in North America, and strategic initiatives to bolster HVAC exposure, the company looks forward to a stronger 2024. While remaining cognizant of enduring uncertainties, particularly in Europe, the forecast for 2023's EBITDA before material special effects is EUR 170 million to EUR 200 million, coupled with the expectation of a significantly positive operating cash flow. The company remains focused on increasing its underlying profitability and expects this to culminate in a notably stronger performance in the ensuing year.

Earnings Call Transcript 2023-Q3

[Operator]

Good afternoon, ladies and gentlemen, and welcome to today's Q3 2023 Conference of Klöckner & Co SE. For your information, this conference is being recorded. At this time, I would like to turn the call over to your host today, Mr. Fabian Jose. Please go ahead, sir.

[Fabian Joseph, executive]

Thanks, and welcome to our Q3 call. With me today are our CEO, Guido Kerkhoff; our CFO, Oliver Falk; and our CEO, Americas, John Ganem. They will guide you through the presentation. And afterwards, we are happy to take your questions. With that, I'd like to hand over to you, Guido.

[Guido Kerkhoff, executive]

Thanks, and welcome also from my side to our Q3 call. I would like to start right away with the highlights of this quarter in which we once again demonstrated our ability to perform in a difficult market environment. Please note that this is the first quarter in which the results of our new Mexican entity NMM are partially included as we successfully closed this transaction on August 1. Shipments came in slightly above previous year's level as a result of the acquisition of NMM and despite the ongoing challenging macro environment.

Sales went down year-over-year as a result of the overall lower price level compared to last year's quarter. Prices, however, are showing signs of a sustained stabilization with a trough now behind us. Despite the lower average price level in this quarter, we achieved a slight increase in gross profit as a result of our consistent net working capital management.

Once again, this quarter, operating performance marks a proof of our ability to perform in any underlying economic environment. Despite the ongoing challenging macroeconomic environment, along with steel prices declines in Q3, we achieved a solid operating result within our forecast guidance and EBITDA before material special effects came in at EUR 41 million. Our solid operating performance, along with our consistent net working capital management led to a significantly positive operating cash flow of EUR 36 million. In total, we generated an operating cash flow of EUR 131 million in the first 9 months of 2023.

As a result of the NMM acquisition, net debt increased year over year. Further, the convertible bond issued in 2016 with an outstanding amount of EUR 141 million was fully repaid as scheduled. Despite the increase in net debt, we remain a rock solid balance sheet with equity of almost EUR 2 billion and an equity ratio of very solid 46%. And you may have seen that net debt increased less -- far less than the acquisition price of NMM. So we were able, throughout the last 12 months to reduce organically our net debt.

But let's now focus on our strategy and update for the quarter. As laid out in the previous calls, we have the clear goal to substantially increase our underlying profitability base going forward and to generate stable cash flows while reducing the volatility of our earnings. Thus, I want to first dive into the successful transactions we've executed to increase our HVAC exposure.

As we announced a few weeks ago, we closed our Mexican NMM acquisition on August 1, an HVAC pure play. By integrating NMM into Klöckner Metals Mexico, KMM, we can clearly see a strong momentum. We're dedicated to leverage our competitive advantage, and we already see strong results. Automotive and industrial customers have already requested an additional volume of 70,000 tons since closing due to the significantly expanded product and service portfolio as a combined company. So now overall, KMM provides a strong growth platform for the fast-growing Mexican market and will also help us to establish a more meaningful automotive and electrical steel business in North America.

The great addition only further enhances the already strong development in the U.S., especially on HVAC. Further, in early October, we acquired Sol Components a market leader in end-to-end structural solar solutions for the commercial utility solar sector in the United States. This acquisition expands our sustainable supply chain solutions and also further increases our exposure to HVAC. And there is more to come as we're committed to establish an unrivaled product offering in the North American market.

Now under a highlighted program we recently initiated as a reaction of the ongoing challenging macroeconomic environment and to increase the resilience of our European distribution businesses, we initiated a European efficiency program. By implementing precise efficiency measures in the segments, Klöckner Metals EU and Klöckner Metals non-EU, we will reduce our head count in the European distribution business by around EUR 300 million. This represents a reduction of approximately 10%, and we plan to achieve 80% of the FTE reduction already by the end of this year.

This efficiency program will significantly improve our underlying profitability base by increasing our operating income by around EUR 25 million annually, with the effects already being visible in 2024. Negative material special effects arising from the implementation of the European efficiency program will be largely offset by positive material special effects from asset disposals related to the program. This program will ensure that the resilience of our European business is significantly strengthened. Let's now focus on another HVAC initiative.

We've invested in a state-of-the-art aluminum slitting line in Switzerland. The new machine will significantly increase our processing capacity, especially in regard to mechanical engineering customers and establishes a leading service center in Switzerland. Additionally the market in neighboring countries can be served, will pave the way for further profitable growth. What I also want to point out is that our Swiss business in general continues its positive development with order intake for rebar on a record level in Q3 '23. That's it on the strategy part.

Oliver, please take a look for the financials.

[Oliver Falk, executive]

Yes. Thank you. As Guido already stated, we achieved a solid operating performance with a positive cash flow generation despite the ongoing challenging market environment. Again, we mitigated large parts of negative price risks during the steel price corrections. Prices, however, appear to have bottomed and stabilized in October. Therefore, we are confident that we are now through the trough with a still very lean inventory situation in our warehouses. As a result of our consistent net working capital management, we continue to expect a strong and significantly positive cash flow for the full year 2023.

Further, the European efficiency program will substantially increase the resilience of our European business activities and improve our operating results considerably going forward. Our efforts in digitalization and automation continue to complement these efficiency measures. The number of digital quotes, meaning quotes handled automatically by the Klöckner system have more than doubled year-on-year in the first 9 months of 2023 and continue to benefit from the rollout of the e-mail to text feature in the recent months.

Further, also driven by the rollout of the e-mail to text feature, the average number of manual changes per digital order further decreased by 14% in the first 9 months of 2020.

Let's take a look into shipments, sales, gross profit and gross profit margin for the third quarter. Shipments were up by 3.7%, including Klöckner Metals Mexico. Excluding KMM, shipments were 3.1% below the previous year due to the challenging market environment, especially in Europe. Sales decreased from EUR 2.4 billion in quarter 3, 2022 to EUR 1.9 billion due to the overall lower average price level. Gross profit came in at EUR 314 million after a gross profit of EUR 305 million in quarter 3, 2022. Gross profit margin went up considerably from 12.9% to 16.3% year-on-year.

We will now focus on the EBITDA for the group. This quarter was -- we once again delivered a solid EBITDA performance despite the challenging market environment and the negative volume effects, but supported by our Mexican business. EBITDA was at EUR 41 million for quarter 3, 2023. Excluding KMM, we saw a negative volume effect of EUR 10 million year-on-year due to the challenging macroeconomic environment especially in Europe, partly offset by our strong U.S. business. The positive price effect of EUR 16 million year-on-year resulted from the favorable price dynamics compared to last year's quarter.

OpEx was down significantly year-on-year, mainly driven by lower personnel expenses and shipping costs as well as lower consulting expenses.

Lastly, we had negative FX effects of EUR 4 million and our KMM business contributed EUR 7 million to the group EBITDA in just 2 months. We are now coming to cash flow and net debt development. We had a net working capital release of EUR 24 million, driven by our consistent net working capital management.

Taking into consideration interest and tax payments of in total EUR 29 million, cash flow from operating activities came in at EUR 36 million in quarter 3, 2023. Including net CapEx of EUR 340 million, of which EUR 310 million relates to the acquisition of KMM, Free cash flow was at minus EUR 304 million. As a consequence, after negative FX effects, leasing and other effects, our net financial debt increased quarter-on-quarter from EUR 596 million to EUR 923 million. I now hand over to John to have a closer look at our markets in North America.

[George Ganem, executive]

Thank you, Oliver. The economic situation in North America has certainly developed much better than previously expected, with a very robust U.S. GDP growth in the third quarter. and the much discussed soft landing scenario looking more and more likely for the U.S. economy. From a steel demand perspective, we continue to experience a fairly stable development but with significant variation between key market segments. We estimate for the full year, the overall market will be flat to up modestly. At the service center level, the Metals Service Center Institute reported year-over-year third quarter U.S. industry shipments were down by over 3%. While Klöckner Metals on a same-store basis, delivered greater than 4% growth indicating meaningful market share gains have been achieved.

The market also continues to experience unprecedented price volatility with prices on flat products dropping by over $600 a metric ton from May through October, but now have seemed to have found a bottom. Turning to the specific situation in market segments looking at construction. Overall construction activity is down, driven by weaker but still relatively resilient residential building activity and to a lesser degree by a modest decline in nonresidential buildings. The lower year-over-year combined building activity is being partially offset by strong growth in nonbuilding spending specifically related to infrastructure.

We do expect usual seasonal pressures in the fourth quarter, followed by a solid recovery at some point in 2024 in residential and continued positive growth from infrastructure-related investments. Turning to manufacturing machinery, overall manufacturing sector has been under pressure with the ISM manufacturing index in negative territory for 11 straight months but showing a more positive trend towards the end of Q3. Despite the negative sentiment, the actual situation on the ground has been somewhat different as we continue to experience stable demand on a year-over-year basis and current OEM forecasts do not indicate any major change to this trend other than usual Q4 seasonality. We see an even stronger situation developing in Mexico coming from the positive effects of reshoring.

Turning to Transportation. North American auto production looks to be up between 6% and 8% in 2023. And we should see similar gains in 2024. Obviously, the recent tentative labor agreements between the UAW and the Detroit Three helps remove any uncertainty relative to the short to near-term outlook. Our shipbuilding business has also been a strong contributor with double-digit year-over-year growth and new defense related contracts recently secured taking us through 2030.

Looking at appliances and HVAC, year-over-year growth has been somewhat negative, at least through the first half of 2023 as OEMs work to rebalance supply chain inventories. We subsequently experienced a decent recovery in Q3 shipments to this sector with production now seemingly better aligned with underlying demand. We now expect generally stable shipments with usual seasonality followed by some further modest improvements in 2024. And Mexico, again, is expected to experience even stronger growth trends due to the effects of reshoring and nearshoring.

And finally, in energy, the oil and gas sector has gone through a somewhat softer period in Q3 with declining rig counts but the situation is now expected to improve again as rig counts have recently started to expand in response to higher oil prices. The renewable sector continues to experience explosive growth, especially in solar and this is 1 of the key segments that is driving the previously mentioned market share gains that KMC in North America has been achieving. And finally, the transformer market is and should remain extremely strong with multiyear backlogs in many cases, our entrance into electrical steel market as well timed from this perspective.

So finally, in summary, overall current demand situation is expected to remain on stable footing with only usual seasonal factors affecting Q4. Prices, especially for Flat Roll have found bottom and are clearly trending higher as we head into 2024. KMC in North America is well positioned within the right industry segments with strong growth as we -- in 2024 as we leverage the incredibly strong momentum that Guido mentioned earlier, that has been created by the National Material and Sol Components acquisitions.

We will also continue to modernize and enhance our core service center business while expanding our portfolio of higher value-added products and services. We are extremely optimistic heading into next year and are very confident that the Americas will continue to generate consistently positive financial performance through all market cycles as we deliver strong growth and continue to develop complex, differentiated and sustainable supply chain solutions that create more value for our customers. Thank you, and I'll turn it back over to Guido.

[Guido Kerkhoff, executive]

Yes. Thanks, John. Let's now focus on the European end markets. Coming to the sectors. If we take a look at the construction industry, we, of course, see that interest rate hikes and central banks and higher mortgage rates continue to affect the overall demand, especially in residential. However, we expect infrastructure projects to partly compensate for the negative effects in residential construction. Manufacturing, machinery and mechanical engineering, we still sense reasonably filled order books. However, the order intake continues to decline, and therefore, existing buffers for production are gradually decreasing.

On the transportation sector, we will dive in the outlook for the automotive sector before moving onto the shipbuilding. We see no major change since our last call in automotive, general consumption remains stable, continued easing of supply chain disruptions allow existing order backlogs to be worked off. We're still following the potential risk of resurging supply chain constraints closely, but so far, we don't see it.

So order is still in line and above -- clearly above previous year. Now let's come and move to the shipbuilding sector. The commercial segment is still under heavy pressure. However, the German site in [indiscernible] starts to become gradually visible in the gray ship sector, and we're also participating there and have some good order intakes.

Now household and commercial appliances segment with marginal impact on our European businesses. However, we still expect somewhere to stable development. And on the energy industry, segment where we also sense no major changes since our last call took place. The general growth trajectory remains intact, and we see the opportunity to accelerate green steel offerings, especially into this sector. With that, I'd like to come to the financial outlook for the full year '23.

As John and I pointed out, some uncertainties persist for the remainder of the year, even though the trough now clearly behind us as prices continue to stabilize. In total, we expect the macroeconomic environment to remain challenging, especially in Europe. We still forecast shipments to slightly increase in financial year and full year '23 driven by KMM. Sales are expected to come in below the previous year's figure in '23 due to an overall lower average price level. For the full year 2023, we now forecast EBITDA before material special effects of EUR 170 million to EUR 200 million.

Moreover, we still expect operating cash flow to come in strong and significantly positive. However, what I would like to point out is that our general development towards further HVAC exposure to substantially increase our underlying profitability base going forward remains intact. This is especially supported by our strong business in North America. We are, therefore, looking forward towards a substantially stronger year 2024. We're now happy to take your questions.

[Operator]

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

[Guido Kerkhoff, executive]

Well, with that we thank you all very much. If there are still remaining questions, feel free to contact Fabian Joseph or us directly, IR and Communications, and we are available Thank you very much for the call.