Kloeckner & Co SE

XETRA:KCO

Earnings Call Transcript 2024-Q3

[Operator]

Good afternoon, ladies and gentlemen, and welcome to today's Q3 2024 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 Joseph.

[Fabian Joseph, executive]

Yes. Thank you very much, 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. As in recent analysts and investor conferences, financial statements were prepared according to IFRS 5 and include our continuing operations. This means Q3 '23 figures have been adjusted in accordance with the requirements of IFRS 5, and I would like to start right away with the highlights of this quarter. 



Shipments came in slightly above previous year's level despite the ongoing challenging macroeconomic environment, mainly driven by the continued strong development of our segment, Klöckner Metals Americas. This strong development, clearly outperforming competitors leads to significant market share gains in the U.S.



Sales came in considerably below previous year as a result of the overall lower average price level despite increasing shipments. Gross profit for the third quarter '24 is below the figure of Q3 '23, driven by negative price effects as a result of the steel price correction. Despite the persistently difficult macroeconomic conditions with a decline in demand in Europe and an ongoing correction in steel prices, EBITDA before material special effects came in at EUR 21 million in Q3 '24, a result within the guidance range. 



I would like to highlight that OpEx remains largely stable compared to previous year as a result of our successfully implemented efficiency measures and active cost control. You can clearly see that all the losses coming in our results are coming from gross profit. So the OpEx base was mainly stable in an inflationary environment. So that's why we had to be pretty strong on cost control and efficiency measures to make it to only that effect.



Operating cash flow came in at minus EUR 62 million after positive operating cash flow in Q2 '24 and the first half of the year. But for the year-end, you will see in the guidance, we're positive on being positive for the overall cash flow for the year. Net financial debt was significantly reduced year-over-year after we close the acquisition of National Materials of Mexico in Q3 '23.



Let's now focus on our strategic achievements in the recent months. As we stated before, generating less volatile earnings while increasing our underlying profitability base is a key part of our group strategy, Klöckner & Co '25, leveraging strength and developing our high value-added business is a key lever to achieve this goal. 



The first 9 months of '24 with a significant steel price correction over large parts of the year so far show exactly why we strongly believe we're on the right track with this strategy. Firstly, our steel service center business and our HVAC are significantly less dependent on these steel price developments due to the high proportion of contractual business and therefore, less volatile compared to the distribution business. Secondly, especially our HVAC is highly profitable and a reliable contributor to our group EBITDA and makes up more than half of our EBITDA before material special effects in the first half of the 9 months '24.



Let me briefly emphasize again that the divestment of parts of our European distribution business in Q1 '24 was a milestone for us to focus on the more stable and more profitable HVAC. The sold entities were mostly active in the low-margin cyclical commodity distribution business. Hence, the sale significantly reduced our exposure to the steel price correction over large parts of the year. Going forward, we will capitalize on our strong footprint in North America and the DACH region and press ahead with our group strategy, Klöckner & Co '25, leveraging strength. We will now have a closer look on the strategic initiatives and how we further strengthened HVAC in the recent months. 



In the recent month, we achieved important milestones to accelerate the transformation of commodity warehouses into leading HVAC centers. In the U.S., the transformation of our sites in Dallas and Charlotte are proof point for this. These sites historically were exposed to the low-margin distribution business. In order to transform them and to reduce their dependence on steel price development, we've already built significant state-of-the-art laser capacities in response to increasing demand for innovative and leading-edge services in the recent past. 



The next step included investments in automated welding capabilities. These investments aim to perform more downstream and complex services along the value chain of our customers. And the investments pay off. Dallas and Charlotte are now reliable contributors to our group EBITDA. In the future, we intend to further expand our capacity, especially in Charlotte to accommodate for strong growth we sense at Industrial Manufacturing, the company we acquired in Q4 '23. With our investments and the acquisition of NMM in the past in the last year, in particular, we are well underway to establish an unrivaled product offering in the North American market. 



In Germany, we pressed ahead with our strategy as well. In Landsberg, we installed a fully automatic sawing and drilling line in order to increase our HVAC footprint and to enable profitable growth. With our new capabilities, we serve the construction and automotive industry, especially in Eastern and Southern Germany and continue our HVAC expansion as planned despite the currently challenging market environment. We could already grow our customer base with bigger customers than we had historically in this distribution business. Further, we continue to actively position ourselves in order to benefit from growing demand in the defense sector.



With that, I'd like to hand over to Oliver to have a closer look at the financials.

[Oliver Falk, executive]

Yes. Thank you. As Guido stated, the market environment continued to remain challenging in the first 9 months of the year with significant steel price corrections. You can see the negative steel price development in 2024 on the left-hand side of the slide. Despite those steel price declines paired with the ongoing challenging macroeconomic environment, especially in Europe, we achieved an EBITDA before material special effects of EUR 21 million in quarter 3 2024, which is within our guidance range.



In the first 9 months of 2024, we achieved an EBITDA before material special effects of EUR 104 million, solid results taking into account the environment we operate in and the significant headwinds we faced during this year. The result, as you have seen on Slide 5, was once again driven by our strong service center business and our higher value-add business. Hence, we are committed to increase our exposure to HVAB further to reduce the volatility of our earnings and the dependence on steel price developments while generating more stable cash flows. 



In addition, we continue to leverage our digitalization and automation initiatives. The number of digital quotes for continuing operations increased by more than 27% year-on-year in the first 9 months of 2024, therefore, continuing to release salespeople for manual work related to quotes.



Let's have a look at shipments, sales, gross profit and gross profit margin for the third quarter of 2024. Shipments were slightly up by around 3% year-on-year. The increase was again driven by the strong development of our segment, Klöckner Metals Americas and our acquisitions in the second half of 2023. Sales were down significantly year-on-year due to the overall lower price level and came in at EUR 1.6 billion in quarter 3 2024. 



Gross profit came in at EUR 262 million in quarter 3, 2024, up the gross profit of EUR 282 million in quarter 3, 2023. Gross profit margin went slightly down year-on-year from 16% to 15.9%. We will now focus on the EBITDA for the third quarter of 2024. EBITDA before material special effects came in at EUR 21 million. In quarter 3, we had a positive year-on-year volume effect by EUR 8 million and a negative year-on-year price effect of EUR 24 million. OpEx, as Guido just mentioned, only increased by EUR 7 million year-on-year, and this is despite the overall inflationary environment and the result of our European efficiency program for the distribution business, which we successfully executed well ahead of our competitors. Lastly, we had minor negative FX effects of below EUR 1 million.



We are now coming to cash flow and net debt development. In the third quarter of 2024, we had a net working capital buildup of EUR 51 million. Taking into consideration interest, tax payment and others totaling to EUR 25 million, our cash flow from operating activities came in negative at EUR 62 million in quarter 3, 2024. Including net CapEx of EUR 31 million, free cash flow was negative at EUR 94 million.



Let's have a look at our financial debt. Positive cash effects were visible for FX and swaps, while negative cash effects were visible for leasing and assets. Accordingly, our net financial debt increased quarter-on-quarter from EUR 779 million to EUR 872 million, however, decreased compared to quarter 3 2023 from EUR 923 million. Further, we maintained an equity ratio of 48% with equity of around EUR 1.7 billion. In addition, we continue to possess a diversified financing portfolio with a total volume of EUR 1.6 billion, excluding leases.



Recently, we agreed on a new USD 115 million ABL facility in Mexico. The facility mainly serves to finance the working capital of our Mexican units and is provided by 3 international active core banks. With this new facility, we now have facilities in all our core markets in place.



I'll now hand over to John to have a closer look at our end markets in North America.

[George Ganem, executive]

Thank you, Oliver. Let me start with a general overview of the market situation in North America. The U.S. economy continues to outperform expectations with third quarter GDP growth coming in at a better-than-expected 2.8%. Resilient consumer spending and still low unemployment continue to support a soft-landing scenario. Steel consumption in the U.S., however, continues to face headwinds with higher for longer interest rates and political uncertainty combining to constrain business investment.



We now expect a very subdued full year result with demand flat to down modestly by 1%. This general weakness in steel demand can be clearly evidenced by the U.S. manufacturing sector where the ISM Purchasing Managers Index has indicated contraction every month, except one since November of 2022. 



The situation for manufacturing in Mexico, however, is more positive with strong demand growth being realized as a result of ongoing reshoring investments. With underlying steel demand temporarily under pressure and steel prices moving down continuously over the first 9 months of the year, buyers have focused on destocking, which is causing overall buying activity and apparent demand to be significantly reduced in both the second and third quarters.



North American prices have now likely reached a cyclical bottom in the early fourth quarter and import volumes into the U.S. are starting to decline materially. As such, overall U.S. market conditions should turn much more positive as we head into the new year. 



Now looking at the expected development in specific market segments. Construction activity is moderating and nonresidential building square footage forecasted to be down 7% in 2024. Residential activity, on the other hand, is trending lower, but still showing positive year-over-year trends. Nonbuilding investment in infrastructure continue to grow strongly and should be up approximately 11% year-over-year, providing a partial offset to slowing growth trends in the nonresidential building sectors.



As already mentioned, manufacturing activity continues to be stuck in neutral. New orders for industrial and off-highway equipment have come under significant pressure and are expected to be down between 6% and 8% in 2024. Lower interest rates should help these key consuming segments to regain more positive momentum in 2025. The Transportation segment is seeing a more stable development, but will not be the significant growth engine we have experienced over the past few years. 



North American auto production is now expected to be slightly down year-over-year. Here again, the situation in Mexico is much stronger with production forecasted up 5% in 2024, while the U.S. will be stable to down by approximately 1%. Thanks to strong consumer spending and still positive residential construction trends, appliance, HVAC and electrical have really surprised to the upside and are trending anywhere from plus 1% to plus 6% year-over-year. These are major markets for KMC Americas and are helping us deliver the solid year-over-year growth on a same-store basis referenced earlier. 



Similar to automotive, the long-term outlook in Mexico for these segments is somewhat more positive than the U.S. due again to the dynamics of reshoring. Energy continues to be a split between weaker extraction activity versus strong demand for both renewable power and power transmission projects. Power Transmission is now expected to grow by approximately 15% in 2024, while extraction-related demand remains muted with rig counts down by close to 10% year-over-year in September. 



I will end with a quick summary and more specific to KMC Americas as follows. Despite these difficult market trends related to both demand and pricing, the Klöckner North American business continues to outperform the competition with strong year-over-year growth and record market share achieved in both third quarter and through the first 9 months of 2024. Our recent acquisitions in both the U.S. and Mexico have been seamlessly integrated and we have successfully implemented what we call our One Klöckner go-to-market strategy, which is allowing us to capitalize on growth synergies across our entire North American network. 



Current new business momentum for 2025 is extremely positive, and we fully expect to continue gaining meaningful market share again next year in both the U.S. and Mexico. Also as seen by recent investment and as mentioned earlier by Guido, we remain highly committed to expanding our portfolio of higher value-added products and services. This strategy is clearly paying dividends as shown by our resilient Q3 performance despite weaker-than-expected demand and continued severe price volatility across our core product lines. 



Finally, and as I mentioned in our last call, we remain strongly optimistic about the long-term demand fundamentals in both the U.S. and Mexico and are committed to strategically positioning our North American business to take advantage of the growth opportunities that will arise as markets recover and steel demand begins expanding again in the not-too-distant future.



I will now turn it back over to Thilo for some final comments.

[Thilo Theilen, executive]

Yes. Thank you, John. And with the current results of the election that we see, I think for '25, the outlook can only get stronger for the U.S., and it looks like we're well positioned to participate in that. Now with that, coming to the European businesses. Overall, as a result of the challenging macroeconomic environment, we now expect wheel steel demand in Europe to develop slightly negative in '24 with minus 3% to minus 1% compared to the previous year.



Coming to the sectors. Construction. Overall, we still expect a slightly negative development in '24 as a result of high interest rates, the increase in construction material prices, coupled with labor shortages and growing economic uncertainty. However, these are near-term headwinds as the structural drivers of the sector remain intact and interest rates decline on behalf of ECB are becoming recognized by market participants. So there is some hope of a recovery in '25 somehow.



Manufacturing, machinery and mechanical engineering is projected to see a slight decline in mechanical engineering with weakness primarily concentrated in Germany. The sector continues to be dampened by still tight credit conditions and overall economic uncertainty. When it comes to defense, however, we continue to benefit with strong demand leading to higher order intake than in the past and continue our active positioning in the sector. 



Transportation. First, automotive sector where we sent the downturn compared to the last conference call. Of course, you have seen the cascade of profit warnings of large automotive manufacturers in Europe. The automotive industry is expected to see a significant decline in '24, in particular in the context of EVs.



Shipbuilding, we continue to position ourselves to benefit from projects in the gray ship sector. So defense here again, is helpful. Household and commercial appliances, a segment with marginal impact on our European business, we now expect a stable to slightly negative development in '24 as consumer confidence remains low. However, we sense improving sentiment in the sector on the back of interest rate declines. 



Energy industry, the path towards green energy generations remains intact. We position ourselves to benefit, especially with our green solutions have been awarded by the way, again for the second time with the German Sustainability Award. Before I come to the financial outlook for '24, I would like to emphasize that taking into account our development in the first 9 months this year in a challenging market environment, we feel more than ever that we are on the right path with our group strategy, leveraging strength, where we prioritize our high value-add business.

HVAC is not only more profitable than the distribution business, but also less volatile. Going forward, we will consistently expand our exposure here. And we continue with all our investments as planned, which is new to Klöckner and this is despite the recessionary developments in many of our core industries. Our good strategy pays off as we were able to improve our operational positioning and underlying profitability base despite the significant windfall losses in the first 9 months of '24 due to the steel price corrections.

Let's now come to the financial outlook for the full year. We continue to forecast EBITDA before material special effects between EUR 120 million and EUR 180 million. And this is despite the challenging macroeconomic environment, especially in Europe and the significant steel price corrections over the large part of the year. Furthermore, we expect a significantly positive operating cash flow, but below the level of the previous year.

With that, we're now happy to answer your questions.

[Operator]

[Operator Instructions] So the first question comes from Christian Cohrs, Warburg Research.

[Christian Cohrs, analyst]

I have 4 actually. First of all, can you split out the increase in shipments in Klöckner North America? To what extent this was organic and to what extent this was driven by M&A?



Second question relates to the material special effects. You've had EUR 8 million last quarter. Can you shed some color on that? And from today's perspective, are there any one-offs to be expected in the final quarter? 



And then for an actual reason, assuming the possibility of an increase in trade barriers and tariffs due to the changing political landscape, is your business entirely local in terms of sourcing and selling? And maybe you have some general ideas or thoughts about trade barriers and tariffs and how it's going to affect your commercial prospects?



And lastly, given the muted earnings performance so far due to the steel price corrections, are there any risks in your balance sheet with regards to write-downs, goodwill impairments we should be aware of?

[Guido Kerkhoff, executive]

Maybe, Oliver, you want to start with the split out of the shipments and the special effect?

[Oliver Falk, executive]

Yes. Regarding the shipments, if you take out the Mexican acquisitions and those which we have made in the U.S., we would be down by to 0.3% in the segment of Americas.

[Christian Cohrs, analyst]

Sorry, 0.3% is this for Q3?

[Oliver Falk, executive]

0.3%.

[Christian Cohrs, analyst]

Yes. Is this for Q3 or 9M?

[Oliver Falk, executive]

This is for Q3.

[Christian Cohrs, analyst]

Understood.

[George Ganem, executive]

Maybe Oliver let me comment on that.

[Oliver Falk, executive]

Sure.

[George Ganem, executive]

Just -- it's a very difficult question to answer because, as I mentioned, we are going to market as One Klöckner. And as we optimize assets, we are moving business around amongst facilities. So it's not a cut and dry answer. If you look at the year-to-date on a pro forma basis, in other words, taking into account the shipments from the acquired companies in 2023 pre-acquisition, we estimate that our average -- our shipments are up year-over-year 2% across the U.S. and Mexico. And I'll put that in context, the MSCI service center shipments are reported down minus 2.7%, and that's what's driving the record market share gains that we're talking about.

[Oliver Falk, executive]

For special effects. So year-to-date, there is a special effect of EUR 11.5 million included, whereas a minor stake is coming from the Klöckner Metals Americas. The major amount is from the European operations and here related to a repositioning or restructuring of the assortment in Germany. Regarding the outlook for quarter 4, there is a smaller effect continuing from the German business, which we might expect, which is also related to assortment topics and smaller restructuring topics.

[Guido Kerkhoff, executive]

Yes. With that, let me come to the tariffs you were mentioning. First of all, let me again highlight 60% of our business is North America. And if you take a look into our earnings even bigger, we're currently outperforming the market and growing compared to our competition. The current outlook that John was referring to and the development we saw this year is, from our perspective, weaker than the underlying situation overall in a nonelection year in the North American and especially in the U.S. market should have been. With all the reindustrialization and the growth and the demand in that country, we think now with the clear result that we see, growth should come back to normal terms and not stay as muted as it was. 



Now coming to your question, we largely procure locally and sell in the North American market. It's, by the way, the same here in Europe. So we largely order locally or within Europe and sell European material. And there's not that much going across the borders just in case largely where the quality grades are not available. So therefore, the tariffs, we don't see it that much. And even in Mexico, we're largely selling into affiliates of U.S. companies in Mexico. So they are basically buying there. 



But I think regarding the outcome of the election and the fear of tariffs, maybe, John, you elaborate a bit more on it.

[George Ganem, executive]

Sure. I think it's highly speculative at this point what the impact is going to be. I think clearly, the focus is likely to be on China specifically. And I think any goods coming into the U.S. through Mexico from China will be a point of contention. But I don't see a dramatic shift in trade policy necessarily with our closest allies.

[Guido Kerkhoff, executive]

Yes. And with that, coming to the topic of the further write-downs, as we seem to be at the bottom of the cycle and the trough of where prices could be, we would have had to reflect them right now. So we don't see any big risks on the balance sheet coming up.

[Operator]

[Operator Instructions] There seems not to be any question anymore. So back to Fabian. There are no more questions.

[Guido Kerkhoff, executive]

Thank you very much for the call. If you have any further questions, just reach out to Fabian or us. We're available. Thank you very much. See you next time. Bye.