Earnings Call: Q3 2019

Nov 12, 2019

Good morning. This is the Chorus Call conference operator. Welcome and thank you for joining the Karel Nine Months twenty nineteen Results Conference Call. As a reminder, all participants are in a 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 Carel. Please go ahead, sir. Good morning and thank you for joining our call for the presentation of the '9 months 2019 results. I'm starting from page two with a recap of the main events related to the execution of our strategic guidelines. One of such guidelines is to increase our direct sales footprint to have a better control of the market and of the sales process. And accordingly, in January, we set up Ukraine, a branch of Karel Poland in order to better manage and develop the Eastern European market, which is providing very good results and also a very good potential for the future. Also in January, to have a better execution of the strategy, we appointed a Managing Director to whom all the main operating processes of the group report. In July, we did the official inauguration of the new plant in China, three times as large as the previous one, and we also deployed our first line of inverters for variable speed compressors in the region in order to be better prepared and competitive as the sensitivity to energy efficiency and sustainability grows in the region. In September, we did the official inauguration of the enlarged plant in The U. S, which is now two times as big as the previous one. And again, in September, following the previous guideline of having a better coverage of the territory, we acquired EnerSol, a distributor in Quebec, Canada specialized in humidification systems and humidification related services. I'm now moving to page three, where we can find a recap of the main highlights for the period. In spite of a further deterioration of the macroeconomic scenario, in particular in Western Europe and China, the revenues growth rates and the profitability for the first nine months stayed close to the first half proving once again the resiliency of our business model. Overall revenues grew by 18.9% with positive contribution from Aglomatic and Recuperator, but also with a positive contribution organically from all geographic areas. Organic growth is 6%, down from 7.3% in the first half. The difference is entirely explained by two reasons. The first one is the expected normalization in the growth rate in North America, which is now a solid and very positive double digit, but is as expected normalized after an exceptional second quarter where we recovered the backlog. The second reason is the further slowdown of the refrigeration market in Western Europe due to the macroeconomic uncertainty and to a destocking process going on in the supply chain in the industry. We believe this effect to be temporary because all the underlying trends and tailwinds driving expected growth in the market, especially related to efficiency and sustainability do still apply. We have also to remind that refrigeration in Western Europe last year grew close to 24%. So to some extent a slowdown in the growth was to be expected and physiological. Refrigeration is in any case experiencing a very good growth in all the regions outside Western Europe. The overall EBITDA margin is 20%, basically in line with the first half when it was 20.2%. If we exclude the IFRS contribution of €2,900,000 and some minor nonrecurring elements, EBITDA margin is 19.1% again in line with the 19.3% of the first half. We have a robust cash generation with a free cash flow of 18,800,000.0 coming from positive operating results as well as from a further reduction in net working capital. As we would see the cash absorbed by working capital this year is €2,800,000 down from €5,900,000 in the first six months. So we are continuing to execute the expected reduction in working capital after the resolution of the raw material shortages. I'm moving to page four with some additional economic and financial details. Revenues grew by 18.9% total or 17.9% net of the foreign exchange. Looking at the bridge, we start from €208,400,000 in the first nine months of twenty eighteen. We have €11,800,000 of purely like for like organic growth, 2,000,000 of positive effect from the foreign exchange and we lose €1,300,000 from the non core decline. Without this non core decline organic growth would have been one percentage point higher approximately. We then arrive at 2 and €20,900,000 of organic sales to which we have €26,800,000 coming from the M and A and will end at €247,700,000 of total revenues for the period. EBITDA adjusted grows by 15% with a 20.3% profitability, which benefits from €5,700,000 coming from Agromatic and Recuperator and €2,900,000 from the IFRS 16 adoption. But it also discounts approximately €800,000 of recurring costs from the IPO and €400,000 of direct costs related to The U. S.-China duties. These costs related to the duties have not substantially increased in the quarter, thanks to the execution of the supply chain adjusted to the supply chain that we did moving production for The U. S. Outside of China and into the other regions and this has strongly mitigated the effect of the duty costs. Net profit grew by 13.9%. Net profit adjusted is substantially stable compared to last year in spite of higher financial charges. Finally, CapEx grew by 38.1% to 16,300,000 absolutely in line with the plan and mainly related to the capacity expansion roadmap. Moving to page five with the revenue breakdown, we can see that we have positive contribution to growth from all geographic areas. EMEA grew by 21.4% net of the foreign exchange with a slight deceleration compared to the first half when growth was 22.1%. This slight deceleration again is entirely due to the temporary slowdown in the refrigeration market. EMEA, of course, benefits from the consolidation of Agromatic and Recuperator, but in any case we report organic growth in the region. APAC grows by 8.6% net of the foreign exchange, up from 8.3% in the first half. North America grows by 13.2% net of the foreign exchange, which is a very positive result, but is normalized after an exceptional second quarter where we recovered the backlog. So now as expected it reaches the level that we expect for the growth in the region. Latin America grows by 5.6%, up from 2.8% in the first half and this acceleration is related to a very positive result in Brazil despite an economic situation in the rest of the region that remains pretty negative. Looking at the breakdown by sector, HVAC grows by 27.8% net of Forex, basically in line with the first half. And Refrigeration grows by 4.4% net of FX, down from 7.4% in the first six months. And again, this deceleration is entirely concentrated in Western Europe due to the macroeconomic uncertainty and the destocking effect. Again, expect this to be temporary and we report a very good growth in Refrigeration in all the other regions, keeping also in mind that Refrigeration Western Europe last year grew close to 24%. We then have a 25.7 decrease in the non core, which is something that we expect. And without this decrease organic growth would have been approximately one percentage point higher. And organic growth of the core business is of course the main KPI for us. I'm now leaving the word to Giuseppe on page six for commenting the items below the EBITDA. Thank you, Francesco. So looking at the line below the EBITDA, we can comment the increase in the depreciation with an increase of almost €6,000,000 The higher depreciation are mainly due to the change in the scope of the consolidation that it accounts for almost €3,000,000 then to higher CapEx due to the expansion of the footprint and also for the adoption of the IFRS 16 that accounts for almost €2,900,000 Regarding financial charges, the period shows 9 and €90,000 of financial charges compared with €100,000 of financial income last year. This is mainly due to the higher interest expenses due to the loans for the M and A transaction and also for the absence of deposit contribution coming from the life insurance presence in twenty eighteen. Then looking at the line of the taxes, we show in the period a tax rate of 22.3% that is substantially in line with the first half where we closed with twenty two point nine and is also in line with our guidance for the fiscal year. Now I'm moving to page seven where we show the bridge of the net financial position. Last year we closed with €59,100,000 In the period we have generated €18,800,000 of free cash flow with absorption of cash due to the CapEx of almost €17,600,000 Then we have distributed €10,100,000 for dividends, buyback of share of €800,000 and we closed with an organic net financial position of €50,000,000 with a generation of cash of €9,000,000 Then after that, we can notice an investment in the tax step up, which we will give more details in the next slide. And adding the IFRS effect of €14,000,000 we closed the period with €75,400,000 One comment about the net working capital improvement. We have further improved the generation the absorption of cash because in the period we have absorbed €2,800,000 compared with the 5,900,000.0 of the first half. This is mainly due to the improvement of the on the inventory and in the decrease of the tax credits. So moving at Page eight, further details about the tax step up. It is based on the application of an Italian tax rule according to which the parent company paid 11,100,000.0 taxes on the excess cost related to the M and A transaction that has been completed last year in 2018 for the acquisition of Agromatic and Recuperator. The tax burden has been calculated with a favorable tax rate of 16%. The advantage for the parent company consists in the possibility to deduct from its taxable income the excess cost in five installments through depreciation starting from the second year after the tax payment. The tax benefit of the deductible cost has been calculated at 27.9% according to the actual ordinary income taxes. From an accounting point of view, the amount of €11,100,000 represent a tax asset that will be charged to the profit and loss in five years starting from 2021. The estimated gross tax benefit is estimating €19,000,000 and this should be compared with the initial tax burden of €11,100,000 Stage back now to Francesco. Thank you, Giuseppe. So I'm now on page nine. To summarize, even in presence of a difficult macroeconomic scenario in several geographic areas, especially Europe, China and Latin America, we managed to maintain a significant growth rate in revenues also organic and a stable profitability proving once again the resilience of our business model and the balancing of our business portfolio. There is a temporary further deceleration in the refrigeration growth rate, mainly linked to the European economic slowdown and to a destocking happening in the industry. This effect we believe is temporary because all the underlying trends related to efficiency, sustainability and new refrigerants are still there and do still apply. Also considering that refrigeration in 2018 in Western Europe grew close to 24%, So somewhat normalization of the growth rate was to be expected. And the market is still growing very well in all the regions outside Western Europe. We continue to execute our plans according to expectations. The integration process of AgroMatic and Recuperator continues very smoothly. They are absolutely in line with their respective business plans and we have a high single digit top line growth of the two combined entities. The improvement in inventory is also confirmed. We continue to execute the reduction in net working capital after the resolution of the raw material shortage situation and the footprint expansion plan launched in 2018 is substantially completed according to plan. So to conclude, taking into consideration a possible further worsening in the European economic landscape and according to the current order intake level for the full year we expect the revenues growth rate to reach a mid single digit level and a slight reduction in profitability due to the lower impact of the operating leverage and also due to a seasonal effect that we experienced every fourth quarter due to a slightly higher accrual of especially R and D costs. From a mid term standpoint, we don't see any change in the secular trends underlying our reference markets. Thank you so much for your attention. We are now more than happy to answer to your questions. Excuse me. This is the Chorus Call conference operator. We will now begin the question and answer session. Session. The first question is from William Turner with Goldman Sachs. Please go ahead, sir. Hi, good morning everyone. I have a couple of questions. The first one is on this temporary well, this European economic slowdown that you're experiencing in Refrigeration. Are you finding it is specific to the Refrigeration market? The reason why I'm asking is because Hygromatic and Resuperator are obviously also European based businesses and they are growing high single digits top line. So is the drivers for Hygromatic and Resuperator significantly different because they're more HVAC orientated? Or what is the drivers behind that top line growth outperforming the refrigeration and the HVAC existing business? Okay. Thank you for the question. So yes, the temporary slowdown we are seeing is basically mainly concentrated in the refrigeration market. We believe that the uncertainty in the economy as well as the fact that many players increased their stock at the end of last year are leading to this temporary slowdown again concentrated in refrigeration. In fact HVAC in Western Europe even organically, even excluding Eglomatica Recuperator is continuing to grow at a pretty steady pace also thanks to cross selling, which is helping us very much in Western Europe where our market share is still very high. Talking about HVAC, we do see some difficulties, especially in those applications related to the automotive sector in industrial applications related to the automotive sector, but that is compensated by cross selling. So in the end HVAC organically is still showing a steady growth rate. Talking about Diagrammatic and Recuperator, you're right. They insist on the HVAC market. And so they are continuing to grow very well also because we are getting results by a different management strategy of the two companies, which is providing a very good growth. And then is the data centers market performing particularly well too? I can imagine at the beginning of the year that would have could have been an area of weakness, but there seems to have been some improvement in the last couple of months. Okay. Well, the data center market is pretty steady from our standpoint. We don't see any major differences. Of course, recuperator especially is very much can benefit greatly from the growth in the data center market, because the recuperator heat exchanger can be used in indirect evaporative cooling, in the air technology for cooling data centers. So for sure the growth in the data center market is benefiting recuperator and will benefit even more recuperator in the future. Overall, we don't see any major changes in the rate of growth of this market. Okay, great. And then my final question is, obviously, we're now almost halfway through November. Do you have any kind of early ideas for what your expectations are for 2020 in terms of growth and or profitability? Okay. Well, considering the very high volatility on the market, it's still a little bit too early to provide the guidance for 2020. Let's say that all the medium term drivers and expectations that we have are absolutely confirmed. Talking for example about refrigeration in Western Europe, there is still just to mention one, there is still the driver of the natural refrigerants that of course will make the market grow significantly in the coming years. And that's one of the reasons why we expect the slowdown to be pretty short term, also due to the destocking that at some point will end. So this slowdown is temporary. All our midterm expectations and drivers are confirmed. It's a little bit too early to provide the precise guidance for 2020. Great. Thank you. The next question is from Alessandro Tortora with Mediobanca. Please go ahead sir. Yes. Hi. Good morning to everybody. I have, let's say, four questions, if I may. The first one is on The U. S. Market. As you mentioned before, clearly, the trend in, let's say, North America is going to not normalize in the coming quarters. Can you remind me which, let's say, sort of growth we can expect, okay, in the medium term from this market? I have in mind, let's say, something in the, let's say, mid teens area for the EU in Americas also considering clearly the starting point, which is, let's say, pretty small. Do I go with the second question? Or do you want to do you prefer to answer to the first one, Francisco? It's okay. I can answer to the first one. Thank you for this question, Alejandro. So well basically yes, you're right. In The U. S. We our expectations for the medium term is to have a double digit growth. The level of growth that we now have is basically the normal one that we would expect after the recovery of the backlog. So this is a growth rate that we can also project the coming periods. Overall, in the medium term, yes, we do expect a double digit growth rate in The U. S. Of course, this assumes that the economy in The U. S. More or less stays where it is, because if there is a major slowdown in The U. S. That we don't see at this moment then this could change. But for the time being from what we see we can expect to continue growing with this more or less this level. Okay. Okay. The second question is on China or let's say generally speaking APAC. If I remember well, in the previous call, you mentioned that you are going, let's say, to be much closer to the to your final customer and maybe also, let's say, doing some price repositioning considering the price, the premium price of Cabel versus the other local competitors. Can you, let's say, give us an update on how it's growing this strategy? Clearly, it will take, let's say, more quarters, not just one, but just an idea how is proceeding this strategy in APAC? Yes. We are proceeding to execute this strategy with a very strong focus in the region and managerial attention. The very short term action that you correctly reminded is to analyze where we need to adjust the positioning because there is too high a premium price and that is something that we are already doing. In terms of more medium term action, yes, we are moving to a higher direct access to the end users also in HVAC, because this is something we have been doing in Refrigeration also in China, which is providing very good double digit growth in the Refrigeration in the region. We want to do that also in HVAC starting from those applications where the end users are more concentrated, so to some extent more similar to supermarket chains, which is for example data centers. So we are having the first very good and interesting feedbacks from this action having been already specified by at least one very important data center company in China. So we are encouraged to continue with this strategy because it's providing results. As you correctly say, we do not expect this is not a short term strategy. This is a strategy that will deploy its effect in the coming quarters, but we are very satisfied about how it's beginning to unfold. Okay. Let's say the third question then I stop, okay, I promise, is on the service side. Clearly, this year, let's say, we are observing the integration of Iglomatic and Recuperator. Let's say, what's next on the Service side? For instance, maybe if you can also give us an update, maybe next year we may see something on the M and A side let's say in this specific business? Thanks. Okay. Thanks. Yes, that's also another very, very interesting topic. So on the service side, from the digital services for Food Retail, we are starting to have the first very positive feedbacks from supermarket chain. We have a very, very interesting feedback in particular from an important supermarket chain with a contract signed for the provision of digital services and we expect more to come because they are in our pipeline. We are then now ready to start executing a service strategy especially related to the humidification market because the humidification is there it's easier for us to start deploying services, because it's a finished good that we make and not a component. So it's technically easier. We already have a strategy designed and we will start execute pretty, pretty soon. We hired an individual that is coming on board in the next few weeks that is a senior very experienced executive in services in our industry And it will help us execute the strategy starting from humidification, but not stopping through humidification. So that's just the start. We acquired EnaSol. It's a small distributor in Canada, but they are very focused on services for humidification. So that will also be an additional way to learn after what we learned from EgoMatic that taught us several very interesting lessons on the humidification business model. And yes, you're right, services is a very important direction of exploration for us in the M and A strategy. And Francesco, just if I may as a follow-up, considering igramatic investment and clearly your positioning on humidification, maybe you can, let's say, start, I don't know, to focus on Europe in the service side? Or as you said, the idea is to be immediately global? Or just have an idea how you are going to approach this service expansion? Okay. So the deployment of the humidification services strategy I was mentioning will start from Europe because that's easier to start from there. With the second priority, we are also looking at The U. S. And also two possible non organic ways to start developing services in The U. S. But as far as the humidification services strategy is concerned, we are starting from Europe. Okay. Thanks. Very clear. The next question is from Emmanuel De Figueredo with LBV Asset Management. Please go ahead, sir. Good morning and thanks for taking my questions. Just two simple ones. The first one is on Slide five. Can you just clarify what is the organic growth in HVAC? And the second question is on the share buyback you've done this year of EUR 800,000.0. Can you just also help to clarify what is the rationale? Is it capital remuneration? Or is it to do with stock options? Thank you. Okay. Thank you for the question. So the organic growth in HVAC would be more or less 7%, the organic growth in HVAC market in the nine months. Talking about the shares buyback that's basically related to the long term incentive plan for executives in the company that was approved by shareholders meeting last year. And so we bought the shares basically to provide the performance shares related to this long term incentive. And that's the only reason why we did the buyback. Thank The next question is a follow-up from Alessandro Tortora with Mediobanca. Please go ahead. Yes. Hi, good morning again. Just if I may, a follow-up on the tax step up you described in the presentation. So if I understood well, we'll not see this EUR 11,100,000.0 step up on the P and L because it's already accounted like an asset at the net debt level, at balance sheet level. And we will start to see the positive impact, the benefit from these deductible costs starting from 2021. Is it right, Giuseppe, just to understand the mechanism? Yes. The mechanism you described is exactly this, the incentive can be utilized by the company after two years from the payment of the federal tax rate that we paid this year. It means that for the moment for the accounting period starting from this year to the 2020 included this will be considered as a tax asset that will be charged to the P and L starting from the year of the utilization that is the 2021. Okay. In five installments. Okay. Gentlemen, there are no more questions registered at this time. Okay. Thank you so much for your attention and for your questions. And talk to you again for the full year 2019 results. Thank you very much. Have a good day everybody.