Earnings Call: Q3 2016

Nov 16, 2016

Good morning, ladies and gentlemen. Thank you for holding and welcome to the IMCD analyst call for the first nine months 2016 results. During the presentation, all lines will be in listen-only mode, and later we will conduct a question and answer session. I would like to hand over the conference now to Mr. Van der Slikke. Go ahead, please, sir. Good morning to you all. I'm sitting here with Hans Kooijmans, and we will be happy to answer your questions regarding our press release of this morning containing our first nine months results for 2016. I start with some highlights. Our gross profit growth was 15%, 19% on a constant currency basis. Our operating EBITA increased with 17% to EUR 112.8 million, which is an increase on a constant currency basis of 21%. I'm happy to report that our cash earnings per share increased by 23% to EUR 1.48. Last but not least, we completed in the third quarter a small acquisition in Kenya, which will complement our existing successful operation in South Africa. The results in EMEA over the first nine-month period were satisfactory, with a 3% EBITA growth, 7% on a constant currency basis. The third quarter was flat, mainly due to weak July, as indicated by me in the previous call we had with you in August. Asia Pacific's EBITA grew with 1%, 4% on a constant currency basis and has continued to improve its results after the first weak quarter. The Americas are in line with what we reported earlier in the year. Our industrial business in Brazil continues to be impacted by the difficult economic situation in this country. Now I give the word to Hans, who will give additional remarks on the numbers. Good morning, ladies and gentlemen. I would like to give you a short summary of the IMCD financials of the first nine months. I would like to start on page nine of the presentation, where you could see that reported revenue and gross profit both increased with 15% compared to the same period of last year. On a constant currency basis, IMCD reports 18% revenue growth and 19% gross profit growth. The 19% gross profit increase is a combination of the first-time inclusion of acquisitions, adding 14% to our growth profit, and an organic growth of 5%. Gross profit in percentage of revenue slightly increased from 21.9% to 22%. Reported EBITA increased 17% to EUR 112.8 million. On a ForEx-adjusted basis, operating EBITA increased 21% compared to the same period of last year. This increase was again a combination of organic growth and the first-time inclusion of acquisitions. The operating EBITDA margin increased from 8.5% in 2015 to 8.6% in the same period in 2016. The conversion margin further improved from 38.6% in the first nine months of 2015 to 39.3% in 2016. As indicated in previous call, please be aware that IMCD calculates the conversion margin as operating EBITDA, so without it as a percentage of gross profit. Net result before amortization and non-recurring items increased 28% to EUR 97.2 million. Our free cash flow was strong, whereby the cash conversion margin of close to 90% was relatively high for a first nine-month period of a year. Main drivers of this strong cash flow were a higher operating EBITDA combined with lower working capital investments. As indicated before, our year-to-date cash earnings per share of EUR 1.48, a currency-adjusted increase of 27% compared to the same period of last year. On the last line of this page, you could see a 10% increase in our number of employees. The majority of this increase is, of course, the result of the first-time inclusions of acquisitions made. If you move to page 10, you will find revenue, gross profit, and EBITDA split per operating segment. The activities in EMEA include all IMCD operating companies in Europe, Turkey, and Africa. This EMEA segment generates about 62% of IMCD's total revenue and 66% of total gross profit. Despite modest macroeconomic circumstances, uncertainty due to the Brexit, and some turmoil in Turkey, IMCD generated in the EMEA region 6% organic growth profit growth. Gross profit margin further improved from 23.2% in the first nine months of 2015 to 23.6% this year. On a constant currency basis, operating EBITDA increased 7%, and the EBITDA margin further improved from 9.4% to 9.6%. As the small acquisition in Kenya in September hardly had an impact on year-to-date figures, it's fair to say that all EBITDA growth in this region was organic growth. In the second column, the results of Asia Pacific. A slow start in Q1 was followed by stronger quarters, resulting in 7% year-to-date revenue growth and 6% gross profit growth on a constant currency basis. Gross profit and percentage of revenue slightly decreased from 18.9% to 18.7%. Local market circumstances, currency fluctuations, and the usual fluctuations in the product mix were the main drivers of this decrease. Operating EBITDA increased 4% on a constant currency basis. The next column, Americas. Americas consists of the operations in Brazil and the U.S., whereby the comparison of the first nine months of 2016 with the same period of 2015 is rather difficult due to the three recent acquisitions in this region. As you all know, we acquired MF Cachat in the U.S. in June 2015, Selectchemie in Brazil end of December 2015, and recently Mutchler in the U.S. in July 2016. When considering difficult market circumstances in the U.S., IMCD US, the former MF Cachat, had a reasonable result in the first nine months, whereby gross margin was slightly higher compared to the same period in 2015. Mutchler, with a focus on the pharma market and acquired on the 1st of July this year, performed in line with expectations. The same applies for Selectchemie Pharma business in Brazil. As indicated by Piet, our industrial activities in Brazil have a more difficult time. Price erosion, difficult market, difficult economic industrial climate had a severe negative impact on our local Brazilian industrial results. In the last column, you will find the cost of the holding companies. This includes all non-operating companies, including head office in Rotterdam, the regional support offices in Singapore and New Jersey in the U.S. On page 11, a summary of the IMCD free cash flow. As mentioned before, free cash flow was very strong in the first nine months, resulting in a cash conversion ratio close to 90%. Main drivers of the strong cash flow and high conversion ratio were increased operating EBITDA combined with lower working capital investments. CapEx of about EUR 4 million was mainly IT related. By the end of October, we finalized two different processes to further improve the flexibility and conditions of IMCD's loan structure. First, we initiated a so-called amend and extend of the existing EUR 500 million syndicated bank facilities. On page 12, you will find a summary of the most important amendments, being the extension of the maturity, the swap or reallocation between term loans and revolver facilities, and some improvements in the leverage covenants. Following this amend and extend, we did a DCM issuance. We issued so-called Schuldscheindarlehen of EUR 100 million plus $90 million, with partly fixed, partly floating interest rates and various tenors of five and seven years. The proceeds of this new loan were used to repay most of the drawn revolver facilities from our syndicated banking loans. The changes made in the financing structure are summarized on page 13. Here you will find on the left-hand side a specification of our net debt position end of September. You can see the maturity dates of the loans in black, net debt positions in blue, and the undrawn revolver in the red bar. On the right-hand side of this sheet, a pro forma overview summarizing the situation as if the amend and extend and subsequent DCM transaction would have happened end of Q3. Total net debt, of course, still the same EUR 404 million, with a change in maturity date in red, a new Schuldschein loan, and a large undrawn revolver position. We believe that the new debt structure will provide further flexibility with appropriate cost levels and leverage ratios. Last but not least, on the next slide, the outlook on page 15, where you can read that we expect operating EBITDA growth in 2016. That was a short summary of our year-to-date financials, and Piet and myself are happy to answer any questions. Okay. Who has a question? Ladies and gentlemen, for your question or remark, please press star one. Star one for your question or remark at any time. Go ahead, please. The first question is coming from Mr. Mutlu Gundogan, ABN AMRO. Go ahead, please. Yes. Good morning, Piet. Good morning, Hans. I have a couple of questions. Let me start with the Americas first. If I look at your gross profit, that grew 8% quarter-on-quarter, which is more than what I would have expected Mutchler to add. Can you tell us what drove that growth? As I think the business is usually seasonally weaker in Q3 versus Q2. That's the first question. Secondly, relating to that, sticking with the Americas, the conversion margin shows actually a significant drop year-on-year of 880 basis points to 44.3%, and that's solely looking at Q3. Can you tell us why that was? Third question is on EMEA. What was the currency impact from the British pound and the Turkish lira, and how do you see that evolving in the next few quarters, assuming current spot prices? Finally, getting to the outlook. Piet, you said it yourself, you sounded a bit cautious, I must say, on the macro picture at the H1 results. Today you reported 1% increase year-on-year in operating EBITA in the third quarter. Can you tell us how you see the two most important drivers going forward, i.e. organic growth and currencies? Thank you. Mutlu. I'm looking at Piet who will answer what. Perhaps to start with the easiest one, the drop in conversion margin in Q3 in the Americas. That is a combination of a couple of things. First of all, the acquisition of Mutchler was a company that we bought with a conversion margin, which is lower than the average conversion margin of the group. That had a negative impact. Further in the Americas, we have the impact of our industrial activities in Brazil that suffered. The other thing is that usually due to the seasonal pattern, the holiday period always leads to a lower conversion margin in a third quarter. The combination of these four elements explain the drop in the result there. I think on your first question on the margin increase or the gross profit increase, I think it's two factors. You indicated yourself already, of course, there's an inclusion of Mutchler. The second element is that we work very hard to get our gross margins up in IMCD US, and we have some success there. That's a continuous process, not only there, by the way, but also elsewhere in the group. On average, the margins in the U.S., gross margin percentages are a bit lower than elsewhere. That has country-specific reasons, but we still feel that there's also room to improvement. That's part of the effect. I'm not sure if we're going to specify that, Hans. No, not country by country, quarter by quarter. I think, Mutlu, you can imagine that our U.K. operations is sizable in Europe like France and Germany, and the drop in pound has a negative impact on two ways. On the one hand, translating pounds into the euro, so a translation effect. The other thing is that the people in the U.K. need to work harder to keep the margins where they are. Turkey is much smaller, and I think it's fair to say, Piet, that Turkey came back to normal. Yeah, I think of these two areas which we, let's say, briefly touched in our previous call. First of all, the U.K., I can say that we have worked very hard to keep our % margins intact. I think that we have been successful so far. Nevertheless, of course, we have a significant translational impact that Hans indicated. In Turkey, we see that after the July events, business got back to normal, although of course, there's a significant, let's say, cautiousness with customers. So we have to work hard to do our job and also to see that we are getting paid. On your fourth question, I think it has to do with outlook. Can you repeat that, Mutlu? Hello? Apologies. That was the mute button. You sound a little bit cautious at the H1 results indeed, on Brexit, on Turkey. In Q3, you report a 1% increase in operating EBITA in the third quarter alone. Can you tell us how you see the two most important drivers going into Q4, i.e. organic growth and currencies? Well, currencies, if I knew, I would immediately take appropriate measures. I don't know, of course, the currencies. We feel that there will not be a significant difference with what we have seen earlier this year or in Q3. I'm not going to give a forecast about Q4. You say I'm cautious. I'm always cautious. I'm a cautious person. I'm relatively relaxed about the state of our business. I think the business remains a very strong business. Unless we have events like we had in July, it's business as usual. Yeah. Okay. Thank you. Okay. Can I just follow up with a quick question? On the Americas, I also know that you announced a contract with BASF on personal care. That probably requires some investments. Were they already taken in Q3 in the OpEx? No. Well, the investments are related to recruitment of people. Yes, we did that in Q3. That's, of course, a continuous cost. Right. Okay. Thank you. Okay. The next question is coming from Ms. Silvia Holte of Deutsche Bank. Go ahead, please. Hi, good morning. A few just clarifications and a few questions, please. If I just start with the clarifications. Your Q3, is it possible just to kind of get an idea of what the Q3 group and EMEA organic gross profit growth was? Apologies, was it about 3% in both? Is that fair? The other clarification is just to confirm, in the U.S. business, did you see gross profit up organically, or was it just the margin that went up? Thank you. Silvia, Hans here. EMEA margin growth was organic, as indicated, because Kenya had hardly an impact. I missed your other one, to be honest. Americas. The Americas. That's where I indicated in the call that the biggest business there is the former MF Cachat, where we saw margin growth in the first nine months compared to the year before. The other two is just two acquisitions that were not included. Selectchemie and Mutchler were not included the year before. In the Brazilian activities, the industrial activities, we struggled with the market circumstances. If I had said then the gross profit organically within the MF Cachat business would have been down a little bit, or? No, in MF Cachat- In Q3. It went up. It went up? Okay. Yeah. Right. Just going back to the previous one. The group, because obviously you gave us a kind of rounded up 6% for organic gross profit growth in the first half. We've gone from kind of a rounded six now to the rounded number in the nine months. Is it fair to say that it's about 3% for the quarter? Is that kind of the run rate that you're seeing? I did not do the math, but I think that will be close. Yeah. Okay. You obviously spoke about within EMEA, on the previous call, you spoke about July being quite weak and seeing a little bit of a better kind of August. Was September better than August, or what was the actual kind of run rate through that? That's an easy one. September is always better than August. That's because August- Okay. Year-on-year kind of if you look at it. Yes. Yes. Yes. Okay. The U.K., obviously, you were speaking to us probably when people are still very much panicked by Brexit. That's all kind of come back to normal a little bit. You said that Turkey's come back to normal. It's just- Yeah the July panics, basically. Yeah. Okay. Yeah. That 3% potentially could be a higher or around 3% could be a higher exit rate, would be kind of fair to say. On the BASF agreement that you signed on personal care in the U.S., could you talk a little bit, I'm not sure that you can say very much, but in terms of personnel investment within the sales force, then is it actually going to be material on the organic growth in the Americas for next year, even if you can't quantify it? I'm not going to quantify individual contracts, we have to see. What I think the message was is that it's an important, let's say, signal that we are able to diversify our business from purely industrial to also the other market segments that we are strong in. This is an example of that, the other example is, of course, Mutchler, which is strong in pharma, has strong suppliers. We have been able to also replace some of the existing Mutchler suppliers with our core suppliers now for the U.S. We're very happy with that development. The message was more, we are diversifying into other markets and not so much now to specify what that exactly means. Okay, sure. In terms of investing in the sales force for pharma and for personal care, I guess Mutchler would have come with the sales force already. Is that done end of Q3? Yeah selecting the team? That was done already? That would have been partially why the conversion margin was a little bit weaker, I guess. Yeah, there's a little bit more cost in there without the business, because the business started later. Yeah. November. Yeah. Right. Okay. That conversion margin, just going back to the previous caller's question, then the conversion margin potentially should improve a bit in Q4, kind of in terms of the year-over-year run rate. Let's see when we present Q4, Silvia. Okay. Sure. Thanks very much. The next question is coming from Mr. Padal Birnenberg. Go ahead, please. Yeah. Hi, good morning. My first question's on the new loan structure. I just wondered what impact that might have on your coupon going into next year. Secondly, on working capital, are you able to say what components drove that improvement in working capital? And was there an underlying improvement or was there anything just on timing issues? Thirdly, on M&A, your leverage is falling pretty rapidly. I wondered if you can comment on what you're seeing with regard to the pipeline Further deals. And then just a final question on the U.S. I wondered if you could give an initial assessment of what a Trump presidency, how that might affect your U.S. business. Thank you. Jos, first coming back on the coupon of the new loan structure. It won't move the needle a lot. It will be slightly higher, but not a big amount. Working capital, two reasons, partly timing issues, having a positive impact, and partly in a couple of territories, some additional focus helping us to reduce working capital. Also to be completely honest, partly also a bit of currency tailwinds that we have. The weakening of the pound leads to, in Euro terms, a slightly lower working capital amount, helping us a bit there. Okay. Peter, you are the expert on Trump. Trump, and the other one was? M&A pipeline. M&A. Yeah. Okay. The first one is easy, the Trump, but I can talk with you half an hour about it, if not longer. I don't know exactly, we all do not know. The only thing you can say maybe is if he is really successful in investing heavily in the infrastructure in the U.S., that that will have a positive impact on many industries, including the chemical industry. Then subsequently, of course, also for ours. Construction is good for the chemical industry. Other than that, I don't know what kind of other benefits or dangers Mr. Trump will bring us. On M&A pipeline, I start to hesitate a little bit to give every quarter a comment on that, whether or not it's full or not full. What you need to understand is, first of all, that this company is always active in finding opportunities and talking to potential acquisition candidates. The problem we have or let's say the fact that is out there is that very often we talk to SMEs, to private individuals or families, that the pace, let's say, is determined by, as normally, of course, by the sellers. We cannot predict when we are successful, but you can rest assured that we are constantly talking, constantly have projects that it is up to circumstances whether or not that shows, let's say, very abundantly in one year or a little bit more less abundant in another year. Let's say in the history of this company, I don't see any change in our activity level. You can rest assured that we will come with projects that are closed in the future. I'm not sure if I should say it's full or empty or whatever. There are always projects that we are working on. Okay. Thanks very much for that. The next question is Mr. Panavis Kampen. Go ahead, please. Good morning, thanks for taking my questions. Just first on the new financing structure. You now have an ability to go up to four times net at the EBITDA. Does that sort of signal a willingness to run with higher leverage than before in a publicly listed environment? Jaap, what we basically did is we created the flexibility to get a bit higher than the maximum that we had in the previous structure. The maximum leverage we could have under the loan documentation was 3.25, coming down in the upcoming half years. What we did is we created a structure with a base leverage of three and a half times and some flexibility, what they call cover of acquisition spikes, to move up to four times for subsequent periods of two years. It is not the intention to lever up to four times, but it's always good to have a bit of headroom there, a kind of safety cushion. Only because previously when you did a big acquisition, you issued a bit of equity. Would you sort of now be comfortable with slightly more leverage than back then? I think, Jaap, it's pity. I think that what we will try to do in the future is to optimize, let's say, our balance sheet, for the benefit of our shareholders. We will listen very carefully to our shareholders in this respect. We feel that, depending on the opportunity, that it is not impossible, but it's not now also the intention. I don't want to signal now that we are going to do it, but it's obvious, as Hans said, that if we have the possibility and there is an opportunity that we would really like to have, we'd rather leverage up a little bit than issue shares. Perfect. Just a follow-up question. In previous calls, we sort of talked a little bit about price deflation in the chemical industries and how that made your ability to grow, especially in the U.S., quite difficult. Has that picture started to improve in Q3 and perhaps into Q4? No, not really. A little bit. I think there are now a little bit signals that prices are going, let's say, not decreasing anymore, but too early to tell. I think it will be very good news for everybody if there's some price flexibility upwards, but it's still early days. There are some signals, but not noticeable, at least in our results that we now present. Should we track the oil price for that, or how can we track that return to prices? No, I think that's very difficult. You see, for us, it's also very difficult. We have tried to link all these products that we have to some effect of the oil price. Of course, in petrochemical, somewhere down the line, there is an effect. At the same time, of course, there's also demand that plays a role. I don't think that you can put it in a graph and then make predictions for that, for our business. All right. Then perhaps one last question. On the previous call, we talked about, for instance, the win that you had with Givaudan, which seems like a nice win. How is this sort of portfolio performing in terms of new product and supplier additions currently? Yeah, it's a project that is, let's say, being implemented. These projects are significant in terms of making yourself ready to do the job and that is in full process. The cooperation is going well. It's not a switch of a knob and then it happens. We're very happy with the progress that we make. In terms of new product and supplier wins, that pipeline is still very full as it has been in the past? Yes, we have some interesting projects and working hard on that. I hope that will deliver, let's say, the growth of the future. Perfect. That's very helpful. Thank you. The next question, Ms. Milou Berg, Goldman Sachs. Go ahead, please. Hi. Good morning. Thank you for taking the questions. A couple coming back to the North American margin, or, sorry, the Americas margin. I was just wondering if there was also a transactional impact in Brazil, in that. Also second one on ForEx. Within the U.K., you said that you managed to keep your margin stable. Can you just allude to how much of your product you import into the U.K.? If that's still also the case now running into the fourth quarter, that you see stability in this margin? Okay. The last question, most of our products, I think, we import. I should really dig in my mind to find products that we source in the U.K. in pounds and sell in pounds. I don't think it's much. Assume that most of our products are imported either in euros, dollars, sometimes in pounds, sometimes in yens. A myriad of currencies, and that they have been, of course, becoming more expensive and that we have to pass on that price increase to our customers and that so far it has been successful and I have no indication to believe that that will not be successful in the fourth quarter. Your first question, Hans, is that something you want to I didn't get it. Milou, also for me to Your question related to Brazil and then the industrial activities. The Brazil, yeah. Just the conversion margin that we saw some deterioration in the third quarter. Was any of that related to a transactional impact in Brazil, or was that not- Yeah, that was also absolutely affected by transactional issues and mainly a strong price erosion in the industrial market segments in Brazil that had a negative impact on profitability and conversion margin. Okay. Maybe one more on the U.S. I think, the fourth quarter last year was the first quarter, industrial production really go negatively. We're now heading into a territory where comps are a little bit easier. Are you seeing current trading improving a little bit, that you're turning perhaps some more organic growth than previously? I made the mistake to comment on one month ahead of last time on July, I'm not going to comment on the fourth quarter. Let's see what comes out of that. Too early to tell. Okay. Understood. Thank you. The next question, additional question from Ms. Silvia Frteva, Deutsche Bank. Go ahead, please. Hi again. Just a few follow-ups, please. Just a quick one on the 4 times net debt to EBITDA. Can you just tell us how long these spikes are allowed for? Just the technicality around it. Just coming back to the Brazilian weakness. Can you just quantify, is it still 2%-3% of the business, Brazil? Why was that price erosion apparent in the third quarter? Finally, just what are your thoughts on high inflation in the U.S.? Should that generally be a good thing for your business? Thanks. First, the acquisition spike. We are allowed to have times a period of a year, over the life cycle of these loans. I think the second one, no, we don't want to make the impression that the price erosion started in the third quarter. It has been a constant factor in the last, I would say, 12-15 months. It starts to bite, it bites already, we wanted to flag that it has an effect on, a certain effect, a smaller effect, because you said, I don't know exactly how big the business is in relation to our total, but it's relatively small. Nevertheless, it has an effect. Great. Thank you. Just general thoughts on inflation picking up in general. Oh, inflation. Yeah. I think you always have to be careful there, but I think some inflation is good for us, allowing us to increase prices and often a little bit more than inflation. Of course, if you get a lot of inflation, it's probably bad for the general economy. I think some inflation is good for everybody and also for us. Thanks very much. The next question, Mr. Sarikonda, HSBC. Go ahead, please. Hi, this is Srini Sarikonda from HSBC. I have two quick questions, please. First one, have you seen any changes in the discussions around the 2017 supply agreements? Are there any of the European suppliers going to the U.S. with you or vice versa? The second question, how comfortable are you with the consensus, EBITDA of EUR 152 million? Thank you. Well, on the second question, I think we do not make a forecast other than the forecast that we made. No further comment on that. On the first, yeah, we are constantly working on expanding and bringing supply agreements to other markets. We are positive about it successful, but I don't want to go into names nor quantify that. Yes, we are. One example I gave you, we will work with our biggest pharma supplier now also in the U.S. because of the Mutchler acquisition. That was not a Mutchler supplier. That's quite a nice example of that. Other than that, it's a part of our business model that we constantly try to cross-fertilize our supplier relations. Okay? Understood. Thank you. Yeah. Thank you. Ladies and gentlemen, for any additional question or remark, please press star one. Additional question from Mr. Gundogan, ABN AMRO. Go ahead, please. Yes. A bit of a general question. We briefly talked about the contract win with BASF on personal care. Just wondering, to what extent is that helping you to win new business? Maybe relating to that, from your experience, how long does it take to win new contracts? Especially in the U.S., where you're entering life sciences, I'm leaving Mutchler out for a second, just setting up that business, how long do you think it takes to win new contracts? Thank you. That's a good question, not easy to answer because it's First of all, of course, it's important to gain credibility in a certain market segment. I think that our entry into this personal care business in a part of the U.S., and let's not overstate it's in a part of the U.S., gives us a platform to attract complementary business. How long that will take is very difficult to say. Normally, you should take into account that, let's say, changes of suppliers to new distributors is not an easy or quick situation. Again, the fact that we have that platform, that we have a very strong personal care business, allows us to convince suppliers to work also with us in that new area. It's a little bit what the previous question was about cross-fertilizing our business, and of course, we're very much focused on that. That requires credibility, and I think that we made a first step in personal care in the U.S., and we made a big step in pharma with Mutchler there. Okay. Thank you. Yeah. Ladies and gentlemen, for any additional question or remark, please press star one. Star one for your question or remark. Okay. Mr. van der Slikke, there seems to be no further questions. Thank you very much. Ladies and gentlemen, this will conclude the IMCD analyst call. You may now disconnect your line. Thank you. Have a nice day. Thank you.