Earnings Call: H2 2019

Mar 5, 2020

Good morning. This is the Corusco conference operator. Welcome and thank you for joining the Karel Industries Full Year twenty nineteen Results Conference Call. As a reminder, all participants are in listen only mode. After the presentation, there will be an opportunity to ask questions. At this time, I would like to turn the conference over to Mr. Francesco Nalini, CEO of Carrel Industries. Please go ahead, sir. Thank you very much. Good morning, everybody, and thanks for joining this presentation of the 2019 results. I'm starting from Page two with a recap of some key milestones related to the execution of our strategy during the year. We followed mainly three strategic directions in 2019: the sales footprint expansion, the manufacturing footprint expansion as well as the development of services. In January, we set up Ukraine as a direct sales branch of Karel Poland to better control the Eastern European market, which is, by the way, providing very good growth results. In July, we did the inauguration of the new facility in China, three times as large as the previous one, and we deployed our first line of inverters in the country for high efficiency solutions. In September, we inaugurated the enlarged facility in The U. S, twice as big as the previous one, and we also acquired EnerSol, a distributor in Canada specialized in humidification and humidification related services, so establishing our first direct presence in the country. At the end of the year, we entered into our first multiyear recurring contract for the provision of digital services through a big food retail chains in Europe according to our digital services strategy. And at the very beginning of 2020, we received the official confirmation from the Chinese authorities of the renewal of the high-tech enterprise status also for the twenty nineteen-twenty twenty one period. So it's retroactive for 2019. This means we have a tax rate of 15% instead of 25% for the period. And it's also a very important recognition by the Chinese authorities of our efforts in the country in terms of innovation, R and D and intellectual property development, thanks to the efforts of our 50 strong R and D base. I'm now moving to Page three with some highlights. We are very happy to report a solid top line growth for 2019 as well as a nineteen point five percent profitability despite challenging macroeconomic conditions, especially in Europe and China. This is completely in line with the guidance that we provided for the third quarter results. So overall, revenues grew by 16.8% with a positive contribution net of foreign exchange from all geographic areas. We have a contribution of €32,700,000 from the consolidation of Agromatic and Recuperator that in 2018 were present for just one month, and they grew basically by 10% as a combined entity, which is completely in line with the business plans and it represents a strong acceleration compared to their previous performance as stand alone entities. Organic growth was 5.1% or 5.9% if we just consider the core business, which is by far the more strategic. EBITDA adjusted was 19.5% during 2019. As expected, we had a slight reduction compared to the third quarter by 80 basis points due to a seasonal cost trend that happens every year. If we exclude the IFRS contribution by €4,000,000 then the EBITDA adjusted margin would have been 18.3%, again, 80 basis points below the third quarter, again, for an expected seasonal phenomenon that we also anticipated in the guidance. The cash conversion was very good. We had a very good cash generation in 2019. We had a cash conversion of 74% despite the higher CapEx for the footprint expansion, up from 54% in 2018. That's thanks to positive operating results as well as from a significant positive contribution from the net working capital reduction, as we will see in a few minutes. Moving to Page four with some more economic and financial details. Looking at the revenue bridge on the top left right, sorry, we start from €280,000,000 at the 2018. We had €13,700,000 of organic growth contribution, euros 2,500,000.0 of positive contribution from the foreign exchange and then we lose 1,800,000 due to the NOCCOR. So organic sales were €294,600,000 to which we can add €32,700,000 from the M and A and will end at 3 and €27,400,000 of total revenues for the period. EBITDA adjusted grew by 15.8% in the period, including €7,200,000 from the consolidation of the two entities as well as €4,000,000 from the IFRS 16 adoption, but discounting higher costs like €800,000 of recurring IPO costs not present in 2018 and €800,000 approximately of additional costs related to The U. S.-China duties as well as some additional indirect manufacturing costs related to the manufacturing footprint expansion. Net profit grew by 14.2%. Again, we had the contribution of the two acquired entities that is offset by higher interest charges for the loans for the M and A transactions as well as a higher tax rate since in 2018, we had the one off contribution of €2,100,000 from the Patent Box. CapEx were €23,600,000 completely in line with the expectation. We completed the footprint expansion according to our road map. And we proposed a dividend distribution of €0.12 per share, which is a 20% increase over 2018 with a payout ratio of approximately 34%. Moving to Page five with the revenue breakdowns. To the left, we have the breakdown by region. We can see that all regions grew net of foreign exchange and provided a positive contribution to the top line growth. EMEA grew by 18.9%. There's also, of course, the contribution from the two acquired entities. EMEA had a slight deceleration in the fourth quarter due especially to the applications exposed to automotive, whereas we had a restart of the acceleration in refrigeration in Western Europe, as we will comment in a minute. Asia Pacific had a solid 6.2% net of foreign exchange despite the difficult economic situation in China. North America had a very good 13.6% growth net of foreign exchange, and South America had a very strong acceleration at 11.1% net of foreign exchange, thanks to the very good performance of the Brazilian market despite market conditions in the rest of the region that remain challenging. To the right, we can see the breakdown by sector. HVAC grew net of foreign exchange by 24.4%. Again, here, we had a slight deceleration for the applications exposed to automotive. Refrigeration grew by 4.5% net of foreign exchange. We saw in Q4 the reversal of the negative trend for refrigeration in Western Europe that we reported in Q2 and Q3. And I can say that this positive accelerating trend of refrigeration in Western Europe is confirmed also in these first weeks of twenty twenty, confirming our expectation that the deceleration was a pretty short term phenomenon. We then have a 29.4% net of foreign exchange decline in the non core. And if we just consider the core business, the growth would have been approximately one percentage point higher. I'm going to page six for the items below the EBITDA. D and A are €16,800,000 up from €9,100,000 in 2018, and that's mainly due to the change in perimeter for 3,400,000.0 to the higher CapEx as well as the adoption of the IFRS 16 for €3,800,000 Financial charges amount to €1,400,000 up from €100,000 in 2018 due to the loans for the M and A transactions, the absence of the positive contribution from the life insurance policies that we had in 2018 and the interest coming from the IFRS 16 adoption. The tax rate was 22%, in line with the nine months and in line with the guidance. We have the positive retroactive effect of the high-tech enterprise status in China, but that is offset by higher ERAP taxes in Italy and some other minor elements. In any case, we expect this 22%, 23% to be the range of our tax rate also for the future. Page seven, looking at the net financial position bridge. We start at the 2018 with a net financial position of €59,100,000 We have then €51,700,000 of free flow from operations, so very strong and more than enough to cover the higher CapEx as well as the dividend. We have €8,000,000 of positive reduction of the net working capital due to the stock reduction normalizing after the increase of 2018 due to the shortages of raw materials as well as a reduction in credit and in tax receivables. We have €23,600,000 of CapEx as we have seen, so we arrive at the free cash flow of €32,000,000 If we consider the €10,000,000 dividend and some other minor elements, we arrive at an organic net financial position of €34,600,000 which is €25,000,000 better than the net financial position we had in 2018. So if we don't consider the IFRS 16 and we don't consider the tax step up investment that we made in the third quarter, basically, our net financial position would have improved by 25,000,000 If we then consider these final elements, we land at the net financial position of EUR 62,100,000.0 with a 74% conversion rate. Moving to Page eight with a focus on the COVID-nineteen situation. Now we are very pleased to say that this situation is confirming the validity of our key strategy of a duplication of manufacturing in several different plants in different regions of the world because this is helping us very much to mitigate strongly the effects of this situation on the supply chain. We have one plant in China, in Suzhou, out from the Hubei province. The plant normally represents 30% of the production of the group, and we have 120 blue collars there. The plant was closed for one week from the February 3 to the February 10 after the New Year vacation. It reopened on the February 10 gradually. And as of now, we have more than half the employees fully working. So we have more or less 60% of the capacity operating in that plant in this very moment, and we expect to have 80% of the capacity by mid March. So the plant is operating at a very good level, also considering that, of course, the Chinese market has been slowing down. Since the January, we started moving manufacturing out of that plant into other plants. For example, we moved the manufacturing of the low end refrigeration controllers into our Brazilian factories that add spare capacity, and that was done very quickly. We moved the manufacturing of a very important line of programmable controllers manufactured in China into our Croatian plant, and that then the Chinese plant focused on the remaining intercompany business as well as on the Chinese local market, which, of course, had been slowing down. And as of now, we didn't have any disruption in the plant. All the Tier one suppliers have reopened and on average, they are working at slightly more than 50% capacity. So, we don't have any issues in terms of logistics. Our warehouse in China has been working at full capacity almost since the reopening. We don't have any problems with custom duties. We don't have problems with air freight, neither with sea freight. On the other hand, the prices for especially sea freight are pretty cheap in this moment. So, don't have any disruption. Italia's plants are all operating 100%, so we don't have any problems, any disruption in our Italian plants. Also, all our Italian Tier one suppliers are operating without any disruption. We can estimate, of course, the recent impact, especially on the Asian market about the virus. We can estimate the impact, especially on the Asian market, for the virus in Q1 to be in the range of €3,000,000 to €4,000,000 approximately. We expect to recover part of that in the following quarters as the situation hopefully improves. Of course, if the situation worsens, it will be a different story, but we cannot foresee that. Moving to Page nine with some conclusions. So talking about 2019, we continue to deploy effectively our strategic guidelines and execute effectively our strategy. Even in presence of a difficult macroeconomic scenario, we managed to reach an organic mid single digit growth in the top line with a positive contribution from all geographic areas. We completed our production footprint expansion plan in line with the road map that will support our organic growth for the next three to five years. We continue the integration process of the two entities, Diagrammatic and Recuperator, which is going on smoothly. The results are in line with the business plans and are accelerating compared to their previous performance as standalone entities. We acquired Enerso, a Canadian distributor active mainly in the humidification and humidification related services. And as far as the services are concerned, we entered into the first multiyear recurring contracts with big food retail chains in Europe for the provision of digital services, and we created a new profit center after sales and service to develop more and more the service business for the group. So to conclude, our medium term expectation remains the same. There is high single digit organic growth rate and a profitability in the range of 19% to 20%. Of course, in 2020, the visibility in this very moment is limited by the coronavirus situation. So, we it's difficult to foresee what the organic growth rate will be for 2020. The visibility will improve in the coming quarters. We expect, in any case, the growth rate to accelerate during the year. In this very moment, what we see in our order portfolio is a positive growth, so we are growing despite the coronavirus. In particular, we are seeing a positive growth result in Europe. So, we are seeing a rebound, especially in refrigeration in Western Europe, as we expected, that already started in Q4, but it's strengthening in this Q1. We are seeing some positive inputs from the heat pumps application, especially related to natural refrigerants in Europe. On the other hand, the applications related to automotive are still suffering. In North America, we will probably have the first month of the year some consolidation after a very strong 2019, which is somewhat to be expected as physiological, but in any case, we expect the growth for the full year. And in Latin America, we continue to see positive results, thanks to the excellent performance of the Brazilian market. So, thank you very much for your attention. We are now more than happy to answer to all of your questions. Excuse me, this is the Chorus Call conference operator. We will now begin the question and answer session. You. The first question is from Alessandro Tortora of Mediobanca. Please go ahead. Yes. Hi. Good morning to everybody. I have, let's say, four questions, if I may. The first one is related to, let's say, the last comment you made on the outlook, but also the expectation by region. Can, let's say, you tell us sorry, probably on the APAC side, the order intake, short term order intake trend, considering that you mentioned before North America basically stable and let's say some positive trend in Europe because I missed the indication on APAC? Then the second question was on the let's say cash generation. If you can give us an idea of, for sure, the CapEx level for 2020, if you can, let's say, defer some investment or, let's say, you keep going with the planned investments? And then on the cash generation side, if at least we can assume a similar level of cash generation, free cash generation also €25,000,000 on the one you got this year also for 2020. Other question was on the Refrigeration. As you mentioned before, Refrigeration is improving in, let's say, last quarter but also in the first part of the year. Can you give us an idea? Because we remember that in the past, this was a strong booster for, let's say, the group top line organic growth. Do you have any idea, any feeling of, let's say, the growth normal growth that we may achieve this year on the Refrigeration side? Thanks. Okay. Thanks for the questions, Alessandro. So, yes, you're right. I forgot to mention some indications on the Asia Pacific market as we see it in these first weeks of twenty twenty. Let's say that we are seeing orders coming from China and from the region, so our Chinese customers have restarted. We are seeing orders coming, so we are pretty confident that this loss we're having in the first quarter that I estimated in total region between 3,000,000 and €4,000,000 can be recovered in the following quarters. But in any case, are already seeing orders coming from our customers. So the situation, especially in China, is as of now improving significantly. Of course, if the virus situation continues to improve there. Talking the cash generation, so the CapEx level that we expect for 2020 is something in the range between €15,000,000 and €18,000,000 We, in this moment, we don't foresee to slow CapEx down because we don't see the reason to do that, but of course should there be any problems, we can easily postpone CapEx, but it's not something that we foresee to do now because I mean we don't see reason to delay investments now. These investments are mainly related to R and D and let's say, our maintenance CapEx level for R and D for the digitization of our manufacturing process as well as the continuous deployment of individual assembly lines. Concerning the cash generation for 2020, let's say, of course, all the uncertainty on the visibility for the growth rate that I just mentioned applies also to the cash generation. But let's say that in general, if the situation of the virus does not worsen, we could expect in principle a cash conversion in the range of 60% to 70% more or less. We have to consider also that probably we have a very good net working capital level in this moment below 14%, so it's very, very low Due to the virus situation to better cope with the supply chain issues, we could increase the stock levels this year somewhat. So probably the net working capital could increase a little bit, not much. So let's say that we expect to stay at a very good level of no more than 18% in any case of net working capital. Considering the refrigeration market, so yes, last year, we had a slowdown in Western Europe because the other regions were still performing very well in refrigeration. So we had a slowdown in Western Europe due to a destocking effect as well as some economic uncertainty that basically led to a postponement of some investments, but also partly physiological after an excellent twenty eighteen, where refrigeration in Western Europe grew by 24%. Now we expected that to be short term and actually in Q4 we already started seeing a reversal of the trend and this is confirmed also in these first weeks of 2020. So we expect refrigeration to continue being an engine of growth for us. Of course, all the again, the visibility difficulties we have for the top line apply also to refrigeration. Refrigeration last year was growing in an excellent way in North America and also in China. But of course, now that the visibility in China is somewhat limited, so now it's a little bit too early to provide an indication for refrigeration. We hope to be to have more visibility in the near future. Okay, okay. Understood. And just if I may, a follow-up on, let's say, your point on the COVID-nineteen. I understood that clearly focusing on China, you have already an idea of, let's say, initial impact. But in Europe, you mentioned that on the supply side everything is fine and it is growing, let's say, on a normal production rate. On the demand side, clearly now focusing, for instance, on HVAC, what is your feeling on the behavior, okay, of your clients' demand in this context? Because clearly, if we are talking about, let's say, some normalization in, let's say, Europe, okay, for the Refrigeration, some normalization. On the HVAC side, considering the different, let's say, client base, what's your view on this segment? Okay. So with the exception of the automotive sector and the applications that for us are related to automotive that, as I mentioned, are still suffering. In general, we're not seeing so far, we didn't see any demand reduction in Europe due to the virus. So our customers are as we see them, they going on as usual. So just the applications related to automotive are struggling. The rest, as I mentioned, refrigeration is improving. We're seeing some good interest for the solution of heat pumps with natural refrigerants. So in general, in Europe, on the demand side, so far, apart from automotive, we are not seeing any problems. Okay. Thanks. The next question is from William Turner of Goldman Sachs. Please go ahead. Good morning, everyone. You touched on some of the questions that I was going to ask just then, but a couple I have is, do you foresee in like in 2018 when you had an electronics supplier shortage coming from China, do you foresee that becoming an issue going forward again? And how do you expect to cope for that? And then my next question is sort of related to kind of to COVID-nineteen is that how do you feel prepared if your plants in Italy got disrupted and you had to move production, say, to Croatia or another region? Do you think you have sufficient flexibility to manage that? Okay. Okay. Thanks, William, for the questions. So in terms of supply chain, the supply chain situation, so we didn't face any disruption as of now, not on the supplier side nor neither on our manufacturing capacity and not on transportation or custom duty side. Of course, there could be some delays in the coming weeks because we can see in the coming weeks some effect of the supply chain disruption that happened in China at the February. It can be probably visible, more visible in a few weeks, but we don't expect that to be a major disruption. What we are seeing is probably some there could be some tensions on the prices of some raw materials because some wholesalers and distributors could be increasing prices. We are now coping with that by we're coping with both situations. So the possible, let's say, delays in supply that, again, we don't expect to be major, but there could be. So we're trying to cope with the possible delays in supply as well as the price increasing price increases by increasing a little bit our stock level. Now it's very low, so we managed to have a very good reduction in 2019. So now we have plenty of room to increase a little bit the warehouse if needed to cope with this new supply chain challenge. So there could be some tensions on the cost of raw materials, some delays, but nothing major from what we can expect in this moment. Concerning our Italian plant, should it be forced to reduce its capacity, then we can, let's say, in Croatia, we're able to manufacture more or less two thirds of what we can manufacture in Italy. Brazil has still some capacity left after the production we moved from China. And then, of course, we have the Chinese plant that in the meanwhile will have probably restarted 100%, so we can utilize the what is now available on the Chinese plant that has been just increased and large, there is plenty of capacity to continue working. So should the Italian plant be forced to reduce its capacity, there would be some disruption, but we will be able to cope thanks to the additional capacity that we have and the resiliency of manufacturing footprint. Great. Thank you. And then just two other follow-up questions. Firstly, regarding Recuperator and Heidelberg, 10% growth that you had organically in those businesses is quite strong and impressive given their history. Can you just discuss a bit more about like how you generated that and what you expect going into 2020 and 2021 for those businesses? And then my last question for now. Obviously, your lower tax rate in China, that's a benefit. What do you expect to be taxed into 2020? Okay. So talking about Diagrammatic and Recuperator, we managed to basically the strategy we have for to start for recuperator is mainly based on cross selling and commercial synergies. So we are using the Karel sales network to cross sell the recuperator, efficiency solution to our customers for increasing their efficiency. That is providing the result. The recuperator was underdeveloped before in terms of sales network because they didn't have a sales network even if they had an excellent product. So we're now using our sales force starting from Europe, but then in the future we will expand also to other regions to promote the product to our customers, especially in the air handling unit sector. On the other hand, the recuperator also on the cost side, we achieved some already in 2019, some significant synergies in terms of manufacturing efficiency and SG and A. For Hygromatic, the strategy is basically to have to add a humidification brand to our portfolio, the premium brand Hygromatic. What we are doing starting what we did in 2018, starting from the German speaking countries, so Germany, Austria and Switzerland, we started cross selling the Karel humidification product using the IGLOMATIC sales force, which is very strong there. So they started cross selling the Karel brand position with a different positioning to customers and that has been already providing very interesting results. As time goes by, we will extend this cross selling strategy also to other parts of the world. The expectation for the two companies for 2020 is not very different from what we achieved in 2019, of course, taking into account the uncertainty coming from the COVID situation, of course, because all issue of visibility where for the COVID, of course, applies also to a dramatic and operator. But having said that, in general, the expectation is more or less to maintain the performance we had in 2019. Concerning the tax rate, yes, we had the reduction in China. The tax rate that we expect looking forward is more or less in line with the one we have now, so between 2223%. That's our expectation for the medium term for the tax rate, including 2020. Thank you. You. Mr. Nalini, there are no excuse me, there's a follow-up question from Alessandro Tortora of Mediobanca. Please go ahead. Yes, thanks. A very, let's say, qualitative follow-up, Francesco, on what you mentioned before looking at, let's say, the whole year. Considering, let's say, the comparison base and also the trend in order backlog you mentioned, do you expect, for sure, let's say, assuming that COVID-nineteen situation will, let's say, stabilize at a certain point, you are assuming, let's say, a better second part of the year. Just to have an idea, do you believe that according to all, let's say, the assumption you mentioned, let's say, the first part will be a sort of, let's say, stable growth environment and then having, let's say, some growth in the remaining part of the year? Is it, let's say, a reasonable assumption? Okay, Alessandro. Yes, what I can tell you is that in this very moment, our order portfolio despite the COVID situation is positive already. So of course, we will have an effect in Q1, the €34,000,000 I mentioned, but we are regardless that we are we have a positive order portfolio in this moment. So there could be already a growth in the first part of the year, in the first half of the year. There could already be a growth that we expect in any case to improve as the year goes by because the COVID situation results, we recover part of the sales we lost in Asia due to the COVID and also because hopefully the general industrial economy also in Europe improves. So yes, we expect an improving during the year. As of now, we see a positive order portfolio even as of now, let's say, despite the COVID situation. But of course, everything is very uncertain at this moment. Okay. Okay. Thanks, Francesca. Mr. Nalini, there are no more questions registered at this time. Okay. Thank you very much everybody for your attendance. Looking forward to speaking with you for the Q1 twenty twenty results. Have a good