Kloeckner & Co SE

XETRA:KCO

Earnings Call Transcript 2022-Q4

[Operator]

Good afternoon, ladies and gentlemen, and welcome to today's Q4 2022 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. Felix Schmitz. Please go ahead, sir.

[Felix Schmitz, executive]

Thank you very much. Welcome, everyone, to our Q4 2022 call. With me today are our CEO, Guido Kerkhoff; our CFO, Oliver Falk; our CEO, Europe; Bernhard Weiß; and our CEO, Americas, John Ganem. They will guide you through the presentation. Afterwards, we are happy to answer your questions.

And with that, I'd like to hand over to you, Guido.

[Guido Kerkhoff, executive]

Yes. Thanks, Felix, and welcome to our full year '22 call. I'm happy to present to you again a very strong set of results. But before I go into the details, let me start with a short summary.

The year '22 was a year of 2 different halves. The first half was driven by strong demand, and based on the Ukraine prices and war, increased prices, strong demand, very high returns for us as well. The second half was exactly the opposite, with price declines of up to 60%.

Now in this environment, what we have achieved is a strong EBITDA number overall of more than EUR 400 million EBITDA and an operating cash flow that was above EUR 400 million. So we turned early and switched to a mode where we went for cash and margin over volume. In the second half, despite the sharp decline in prices, we managed at basically 0 EBITDA. In former times, that would have clearly been negative.

Now I'm giving you a short spoiler for the upcoming year and the guidance going ahead. We've clearly said we're through the trough. We have a guidance of EUR 40 million to EUR 90 million on EBITDA for the first quarter, and shipments will increase. And I can clearly tell you what we've seen in January and February is positive EBITDAs for the group, and they are increasing. So we're through the trough, and we're now working towards higher volumes and solid and strongly improving margins compared to Q4.

With that, I will jump into the highlights of this year. Shipments for '22, slightly down year-over-year, is due to our disciplined margin-over-volume strategy at the beginning of the year and also due to muted demand in the second half as the macroeconomic environment clouded significantly. However, positive impact of our margin-over-volume strategy is clearly visible in our profitability. Sales were strongly up due to a higher average price level in all our regions. Gross profit is down as we encounter less favorable price dynamics compared to the record year '21.

EBITDA before material special effects came in strong at EUR 417 million and reported EBITDA even EUR 481 million. We again, benefited from our smart networking capital management from our aforementioned consistent margin-over-volume strategy at the beginning of the year. Once again, a remarkable result, thanks to all our employees who make this possible.

Also operating cash flow came in strong at EUR 405 million. This marks again a proof point of our dedicated networking capital management with a focus on creating value for our shareholders. Consequently, net debt was slightly down. Just to put it in the context, EUR 405 million operating cash flow is more than we spent on dividend and the acquisition of National Material of Mexico, just to put it in a [ frame ].

Digital sales share, still at a high level with 44% in Q4 and up 1 percentage point quarter-over-quarter. In financial year '22 Kloeckner Assistant processed more than EUR 1.3 billion sales volume and continues its strong performance. We're going to develop our digital KPIs further. We'll cover that topic in the next earnings call.

Due to our robust operating performance in '22, we're proposing to the AGM to pay a strong dividend of EUR 0.40 per share, which is balanced out against our recently announced growth acquisition in Mexico, and potential net working capital needs in light of financing profitability in times of again rising prices.

Before we dive into the update on our strategy highlights, let me recap what we achieved during the last very challenging 2 years to showcase how the company has transformed and progressed. Looking behind, I'm proud of what we have accomplished at Klöckner with a strong team and lots of dedication. Our strong performance significantly improved our substance and the overall profitability basis. This is clearly another company.

In total, we generated EBITDA of around EUR 1.4 billion. This is exceptional and demonstrates our success in translating the upcycle during the last 2 years into record operating results, while managing down cycle proactively. And again, EUR 1.4 billion means 140% of our current market cap. Besides record profitability, we significantly improved our company [ substance ]. Equity is up by nearly 90% and stands at almost EUR 2 billion as of year-end with a strong equity ratio of 51%.

Further, we funded our [ so far ] unfunded pension provision in '21 and therefore, significantly reduced our pension provisions. This relieves our operating cash flow by around EUR 15 million annually and improved our balance sheet structure. We generated an operating cash flow of EUR 342 million before the pension funding in the last 2 years, and there is more to come in '23.

Thanks to our strong operating performance and rock-solid balance sheet, we proposed a total dividend of EUR 1.40 shares -- per share over the last 2 years and proved that shareholder remuneration remains a top priority with the aim of being steady and sustainable dividend payer going forward.

But we're not stopping here. Let's now dive into our strategy update. We're encouragingly pressing ahead with our strategic initiatives. As we laid out in earlier calls, we perceived the sustainability transformation of the steel industry as a huge opportunity to grow our business and to improve margins. And we let our words speak and actions by having made remarkable progress in '22. We were the first company on the planet to have all its net 0 carbon targets recognized at science-based in the standard validation process in accordance with the latest SBTi standard. With those targets, we've committed to reducing emissions throughout the entire value chain to net 0, ambitiously and science-based. This is the [ fundamental ].

I'm proud to announce that we already reduced our Scope 1 and 2 emissions in '22 by around 43% compared to the base year 2019, a great success and the level that according to our SBTi target path is not envisaged until 2028. And it's reduction, not compensation, real reduction. Another important milestone for us, but also for the sector, was the introduction of our categorization for CO2-reduced steel, stainless steel and aluminum, which was adopted by market participants and proved to be an important tool comparing CO2-reduced products.

What makes me especially proud is that we were awarded for our innovative initiatives with the German Sustainability Award '23 in the Climate Transformation category. The jury recognized our metrics as the fundamental basis for the steel industry transformation. But we didn't stop here. We believe in commercial and technology solutions. Already in '22, we delivered first qualities of CO2-reduced steel to our long-standing customers Siemens and Mercedes-Benz. Others follow meanwhile.

One further major step in '22 was the launch of our Nexigen brand, under which would bundle all CO2-reduced solutions. With our partner Outokumpu, we secured also access to CO2-reduced stainless steel for our customers. We're leading the sustainable transformation of the steel industry, and this is why we are already undertaking next big steps in order to enable our customers to build truly sustainable value chain. Thanks for all employees involved in these projects, who work with dedication to achieve these important milestones.

Let's go on to the next slide to see what we already achieved since the new year began. We recently announced another important milestone. In January, we launched our innovative Nexigen PCF Algorithm and are thus able to offer our customers individualized Product Carbon Footprint for nearly all of our 200,000 different products. The Nexigen PCF Algorithm is unique in its complexity and informs about the individual Product Carbon Footprint of a product reflecting the emissions of the entire value chain from the raw material extraction until the product reaches the customer's gate. The accuracy of our declaration is superior to comparable certificates, such as [ EPDs ], which often provide an average of products or production types.

Another aspect where our Nexigen PCF Algorithm stands out is that the TÜV SÜD. methodology according to all relevant ISO standards and the GHG protocol. After Siemens and ZF started out to be the pilot customers, multiple already followed, which underpins the urgency to improve transparency in this sector.

Let's turn to the next slide in our presentation of our new growth platform in the North American market. Despite our progress regarding building sustainable business models, we announced another important milestone in December. We agreed on the acquisition of NMM, National Material of Mexico, to our U.S. subsidiary, our Kloeckner Metals Corporation, KMC, with a purchase price, USD 340 million on a cash and debt-free basis and an EV-multiple of around 6.7 based on NMM's expected '22 EBITDA.

Core ambition of our strategy, leveraging strength is to grow again, and we are ready for it. With the acquisition of NMM, we acquired a leading independent service center, servicing automotive, around 60% of sales and industrial end markets, around 25% of sales, and build a new growth platform in the North American market. NMM supplies carbon and electrical steel, aluminum and stainless steel and is a significant player with USD 610 million sales and around 500 employees in fiscal '21.

We financed the transaction largely by our existing liquidity, which demonstrates our strong financial position and balance sheet structures. Our strong operating cash flow and our improved company substance are a huge asset in this manner. We expect closing of the transaction to take place before summer '23. We'll keep you updated. Going forward, our M&A strategy remains opportunistically and highly growth oriented.

Now over to you, John, to give us a deeper dive into the strategic fit of NMM.

[George Ganem, executive]

Thank you, Guido, and welcome, everyone, to the call from my side. I want to quickly highlight why we feel the acquisition of NMM offers a great strategic fit in how we can create value for our shareholders through the combination with Kloeckner Metals Corporation.

First of all, the transaction provides us with a platform for growth in the United States and more importantly, in Mexico, a market where we are active, but with a minor stake for some time. Cost advantages for labor and the proximity to the U.S. to shorten unstable supply chains make Mexico the onshoring destination to service the automotive and large OEM customers that we currently support. As OEMs are moving production to Mexico, we plan to optimize our footprint in North America and establish one of the leading service centers in Mexico.

We will also be able to provide a rare access for our customers regarding electrical steel, a soft magnet material needed for electrical motors in cars and transformers by acquiring also substantial and valuable sourcing expertise with respect to a product where production capabilities are extremely tight. In combination with our various strategic sustainability initiatives I mentioned previously, we will be in a position to benefit substantially from the growing demand for renewable energy and e-mobility in North America.

What is also most important to point out is that Mexico offers a well-educated young and relatively low-cost labor pool. By comparison, U.S. labor costs, for example, are 6 to 10x higher than in Mexico.

NMM's footprint and distribution network expands KMC's reach to key customer targets that currently cannot effectively be serviced by the smaller KMC Mexican footprint. Therefore, the combination of both companies will lead to significant cross-selling opportunities going forward, while establishing one of the leading flat-rolled players in the North American service center industry. Thank you.

[Oliver Falk, executive]

Yes. Thanks, John, and let's continue with the financials. Yes, we are committed to a strong through-the-cycle performance. That means fostering upside risk, but also mitigating to the [ downtime ].

Now that the trough is behind us, and demand as well as prices are clearly improving, it makes sense to analyze what we initiated. In this context, full year 2022 is another proof point that we again, managed our net working capital very disciplined and proactively, enabling us to perform on relatively higher highs and higher lows. Now after multiple repetition, we call it our new normal. The price development in the first half of 2022 were once again translated into strong operating results. We started already in Q2 to actively enforce our inventory reduction, and this initiative clearly paid off.

First, the lower stock levels mitigated large parts of negative windfall losses and led to a strong EBITDA in full year 2022. Secondly, as we are through this trough now, we are in a position where we have reset our stock products with improving demand and in an environment of rising prices. Supported by the inventory reduction, we generated an exceptionally strong and positive operating cash flow. We will have a deeper look in these numbers of this year and the last quarter and in more detail now.

Let's take a look into shipment, sales, gross profit and gross profit margin for the fourth quarter. Shipments were 5.5% below the previous year's level due to the very challenging macroeconomic environment. Sales were nearly stable year-on-year at EUR 2.0 billion. After rising sales prices at the beginning of the year, steel prices corrected significantly during the course of the year. However, higher average price levels occurred in almost all operating segments. Gross profit came in at EUR 269 million after gross profit of EUR 439 million in quarter 4 2021. Gross profit margin went down year-on-year from 21.6% to 13.5% and up from 12.9% to 13.5% quarter-on-quarter.

We will now focus on EBITDA for the full year 2022. EBITDA before material special effects came in at EUR 417 million, below prior year's figure of EUR 848 million. The result was, of course, impacted by the positive price dynamics in the light of tight supply, however, also driven by our consistent margin-over-volume strategy. The year-on-year price effect was exceptionally strong at EUR 163 million for the quarter and around EUR 346 million for the full year.

OpEx is again complex to compare on a year-on-year basis in such a dynamic environment. OpEx was up mainly due to higher cost for shipping, logistics and packaging. Lastly, we had material special effects of EUR 64 million from disposal gains from the sale of sites in Switzerland and France, and provisions through us from [ funding ] the Surtsey project. A low double-digit amount of these one-off effects will be used for the growth-oriented streamlining project in France. These effects will be largely compensated by positive effect from site disposals in the midterm.

On the next slide, we are now coming to cash flow and net debt. Full year 2022 already saw a net working capital release of EUR 100 million year-on-year, fully aligned with our net working capital management initiatives. Net working capital came down by around EUR 400 million quarter-on-quarter. Taking into consideration, interest and tax payment of, in total, EUR 129 million, cash flow from operating activities came in strong at EUR 405 million in full year 2022. Thus, we did not just achieve strong EBITDA performance, but also an outstanding operating cash flow performance. Including net CapEx -- net CapEx of EUR 34 million, free cash flow was at EUR 371 million. Therefore, our net financial debt decreased from EUR 762 million at the end of quarter 4, 2022 to EUR 584 million despite our record dividend [ scheme ].

Let's jump to the next slide. Our balance sheet remains very strong and solid. Our equity is up, and the equity ratio remains robust at 51% as well as gearing was 30% and leverage at 1.5x. Overall, this very strong balance sheet enables us to manage our inventories dynamically, also going forward and will support us to further grow the business according to our strategy.

With this, I hand back to Guido.

[Guido Kerkhoff, executive]

Thanks, Oliver. As we indicated in the last quarterly update and pointed out again earlier, we reset our inventories now that opportunities arise again when prices go up with the trough being behind us. Overall, we sense improving demand as the macroeconomic situation and the energy price in Europe improved significantly over the recent months.

Due to our footprint in infrastructure and nonresidential as well as geography wise with Switzerland, pressure in residential construction is not touching us meaningfully. What is further important to find out is that the various supply chain shortages eased more and more.

With that, I'd like to hand over to Bernhard.

[Bernhard Weiß, executive]

Yes. Thanks, Guido. Let's come to the regional business outlook for Europe. As Guido pointed out, the recession fears and possible energy shortages, many market participants and customers feared by the time of our last quarterly update did not materialize further. The overall picture has improved strongly since then, and so has demand, prices and forecast. In total, we expect steel demand to be 1% to 2% for Europe in 2023. However, apparent demand will develop stronger.

Coming to our sectors. Construction, no significant change to our last call. Of course, the rising interest rates does negatively impact demand, especially in the residential area. Infrastructure projects to partly compensate that with special focus on green materials. Machinery and mechanical engineering, we still see strong order books, which should provide tailwinds going further into 2023, and we do not see a negative trend. The potential production disruption mainly due to energy scarcity, however, the situation improved significantly in the last couple of months.

In the energy sector, we see a positive market trend for greener energy generation [ window ] and opportunity to accelerate green steel offerings for our customers. In automotive, still impacted by supply constraints on other critical materials, such as semiconductors and other electric vehicle specific components, like rare earth. We expect the sector to improve further during the year, however, with the production still below pandemic levels. Shipbuilding, this sector remains still under pressure.

With that, over to John and the U.S. market.

[George Ganem, executive]

Thank you, Bernhard. Looking at North America, economic conditions in North America are developing more positively than I think many had predicted. Labor markets remain tight with the U.S. unemployment rate reaching near historic lows in January. This is supportive of resilient and still strong consumer spending trends, which drive 2/3 of U.S. GDP. Of course, it is also clear that the Federal Reserve will continue increasing interest rates in an attempt to cool still high inflation, which means the risk of a possible recession remain elevated. However, expectations seem increasingly in favor of a shorter and more mild downturn, which has likely now been delayed until sometime later in 2023.

With some uniquely steel-related tailwinds coming from certain industry segments, it is looking more likely that the potential impact of any economic downturn on [ 2023 ] steel demand will be more muted than previously anticipated. Given the improved near-term -- near to medium-term economic outlook and what is becoming a clearly positive impact of a more consolidated and disciplined producer base, pricing trends across most product lines have turned higher in early 2023, which, of course, goes against predictions of many industry experts.

Stable underlying demand, reduced import volumes and the end of the aggressive destocking experienced over the second half of 2022 are combining to provide a more balanced supply-demand situation. And as such, we expect prices to continue to move up, but at a more moderate rate over the next 60 to 90 days.

Turning to the specific segments. Overall, we expect real demand to be up a modest 1% to 2% in line with Europe in 2023. But also, like Europe, apparent demand will likely be even stronger due to the previously mentioned end of destocking.

Turning to construction. Construction spending has generally been stable. Spending has been generally stable over the last 6 months, but the situations in residential and nonresidential are starkly different. The residential outlook continues to be under pressure from higher mortgage rates and still elevated housing prices, with housing starts hitting a cyclical low of EUR 1.3 million in February. They are now expected to be generally stable at this low level before beginning to recover in late 2023 and then accelerating higher in 2024.

Nonresidential spending, on the other hand, was up 19% year-over-year in January, but is likely to cool somewhat as the year develops. This will vary significantly based on specific segments within non-res, geography and ultimately, the timing of the long-awaited demand infusion coming from infrastructure spending. Currently, we continue to experience consistently strong activity from non-res markets across our network, and we don't expect this to change in the near to medium term.

Overall, we are forecasting only a mild pullback in construction demand with still positive momentum from nonres and nonbuilding activity, offsetting the clear pullback in residential. Any improved timing in any large infrastructure-related projects could spin this back to a net positive.

Turning to manufacturing, machinery and mechanical. Manufacturing is facing some clear headwinds with ISM Index stabilizing at 47.7% in January, which was slightly improved from December, but still reflective of an industry segment under pressure. Demand from appliance is expected to be down as it is directly impacted by the downturn in housing. HVAC and electrical, likely to be stable to slightly higher as commercial activity and replacement activity remain robust, and both segments are carrying large backlogs over into 2023.

Off-highway and industrial equipment markets remain stable, and we see no indication of a pullback. Inventories remain low, while demand is stable. We continue to expect low single-digit growth from these sectors.

Energy markets are expected to continue on a modest recovery trend. Drilling activity is improving, but is still somewhat below historical standards. Rig counts are steady at around 750 as oil prices have been recently ranged out. However, with the summer driving season in the U.S. expected to set records, we expect oil prices to rise in coming months, which will likely spur further demand from drilling and extraction activity. The investment in renewable energy continues to accelerate at a rapid rate and the demand for steel products is expected to increase significantly in 2023 and beyond. Both the short-term and long-term impact from the renewable sector should not be underestimated.

Turning to automotive. In line with expectation, January production was up 4.5% year-over-year and is fully expected that this trend will continue throughout 2023. February automotive sales came in at EUR 14.9 million on a seasonally annualized basis, which was slightly below the January rate of EUR 15.7 million. Despite economic headwinds, pent-up consumer demand remain significant and auto production is expected to expand year-over-year as supply chain constraints are addressed and minimized.

And then finally, looking at shipbuilding, our defense business remains a real bright spot with solid growth -- and is going to be a solid growth contributor in 2023, but also through 2025 based on some new naval programs we were recently awarded.

So in summary, and very similar to previous comments, despite any potential near-term headwinds from inflation and rising interest rates, we remain quite positive on the underlying base case for steel demand for 2023 and beyond. These positive fundamentals, coupled with a more consolidated and disciplined domestic producer base, continue to support a very positive outlook for the North American service center industry.

Back to you, guys.

[Oliver Falk, executive]

Yes. Thanks, John. Let's come to the outlook for the first quarter of this year and full year '23. As Oliver pointed out, we're now in a position where we have to reset our stock price in an environment of improving demand and rising prices. With the ongoing [indiscernible], we expect a considerable increase of shipments in sales each quarter-over-quarter. Moreover, we expect EBITDA before material special effects to increase very considerably quarter-over-quarter and to come in at a strong level between EUR 40 million to EUR 90 million. It's not largely due to price increases, which, by the way, were partially negative. We were rather able to [ showcase ] new normal and improved margin levels, which we will also see throughout '23, expecting it to be on a relatively strong level here.

In addition to that, we have material special effects from disposal gains and provisions [ through us ] concerning the Surtsey project of EUR 64 million in '22. We will use a low double-digit amount of these one-off effects and minor parts to finance streamlining project in France, where we're preparing for future growth by implementing a very efficient hub structure, which will improve our net working capital management efficiency going forward. These effects will be largely compensated by positive effects from site disposals in the midterm. Moreover, the negative effect will be partly compensated already in Q1 due to a positive one-off gain from the disposal in [ Germany ].

For the full year '23, we expect considerably increasing shipments against the backdrop of stronger demand with sales below previous years now. This is due to the lower average price level we anticipate compared to last year. We expect a strong EBITDA before material special effects as well as a strong operating cash flow in a now more normal environment, in which we will demonstrate our new improved underlying margin. Clearly, stronger than in '17 or '18 despite lower shipment levels compared to these years.

However, as the sizable price dynamics of '22 are not expected to repeat again, both will come in, of course, below '22 numbers. Further, we're confident that our again, positive performance and outlook, together with our proven track record to deliver strong results in any market cycle, prepares the fundament to [ rerate ] our stock as one of you has pointed out just recently. Our focus remains on growing the company, again, with the ability to generate significant shareholder returns. To sum it up, we expect once again, a strong set of results and are therefore fully on track to achieve our ambitious 2025 targets.

We're now happy to take your questions.

[Operator]

[Operator Instructions] We will now go to our first question. One moment please. And the first question comes from the line of as Rochus Brauneiser from Kepler.

[Rochus Brauneiser, analyst]

Two questions. The one is on your shipment outlook. I guess you're flagging this as a positive for this year. And can you give us maybe a bit of a range where you see the shipment growth for the whole of '23? Maybe, can you also flag, based on what you see in terms of demand, how you see the sequence between the H1 and the H2? Is this following the usual seasonality? Or are you seeing anything, which makes the one or the other half comparably stronger or weaker? That's the first question.

[Guido Kerkhoff, executive]

Well, Rochus, on H1, H2, I think that's a bit too early. What we see is indeed our shipment outlook. We're growing stronger than what we project here as market increases. So we're gaining that. And it seems that our customer base, be it in the U.S., but to some degree in Europe as well is participating or is more in a stronger segment than the weaker one. So overall, that's why we think we should be stronger than the market forecast we see somewhere in the single digit, but higher than the 1% to 2% we indicated.

[Rochus Brauneiser, analyst]

Right. And on...

[Guido Kerkhoff, executive]

Mexico? Yes, go ahead.

[Rochus Brauneiser, analyst]

Is this more -- are you -- what are you saying in your expectation? Is this a kind of a -- will it be closing in Q3? Or will there be at half year stage? And can you also say something about goodwill associated with the transaction? And how we shall think about EBITDA this year compared to the last 3 years?

[Guido Kerkhoff, executive]

So we -- look, to predict antitrust approvals is always difficult. Mexico is a bit slower on this one. We hope that it's going to be in the summer. So we hope it's rather sooner than later in the summer. But to give an exact prediction, it's always difficult. We filed and everything is going well so far. So nothing unexpected coming up and showing up there. So on that part, we're rather positive. Final outcome of a [ PPA ] will take some time. Might have some goodwill, but that doesn't really concern us.

[Rochus Brauneiser, analyst]

And on earnings release...

[Guido Kerkhoff, executive]

Sorry?

[Rochus Brauneiser, analyst]

And on the EBITDA level that -- we shall think about for '23. '21, '22 was probably not a good base. So maybe you can help us a bit on what you think is kind of a normalized earnings level for the guys?

[Guido Kerkhoff, executive]

No, no, no. Let's say the EUR 40 million to EUR 90 million Q1 and then with Q1, let's see how we get to Q2 and then see what the second half is. This is too early to just give -- because it's been kind of floods in the coffee. So let's take it quarter-by-quarter. As I outlined, Jan-Feb were both positive, in our case, and growing. And compared to our internal expectations when we started the year, they developed better than we internally expected. Clearly, on both sides of the [indiscernible].

[Rochus Brauneiser, analyst]

Yes, Guido, sorry. I was referring to Mexico. I just want to get a sense how much -- you have a step up on earnings. So just -- I think that you gave some data points, which were a little bit outdated, I think, referring to '21. Any direction what we shall think about EBITDA here for this year?

[Guido Kerkhoff, executive]

Too early. Let's wait until we have it. But on Mexico, I'm pretty confident. The market looks good. Well-run entity. So no concerns from that far.

[Operator]

[Operator Instructions] There are currently no further questions. I will pass the call back to you.

[Guido Kerkhoff, executive]

Well, then there are no further questions. Thank you all, and Felix and team are ready to take your questions when you have them. So give them a call whenever you have something else. Thank you very much. Talk to you soon.

[Operator]

Thank you. This concludes today's conference call. Thanks for participating. You may now disconnect.