Earnings Call: Q3 2018

Nov 13, 2018

Summary

Q3 EBITDA reached a record DKK 1.045bn, but Brexit-related volume softness, currency losses and one-off costs pressured earnings. FY EBITDA guidance narrowed to DKK 3.0bn–3.1bn as cash flow strengthened and leverage declined.

Hello, and welcome to the DFDS Q3 report for 2018. Today, I am pleased to present Niels Smedegaard, the CEO. For the first part of this call, all participants will be in a listen-only mode, and afterwards, there will be a question and answer session. As a reminder, this call is being recorded. I will now hand over to Niels Smedegaard. Please begin. Thank you very much, and welcome everybody to our Q3 call. Joining me, as usual, we have Torben Carlsen, our CFO, and Søren Brøndholt, head of investor relations. Let's dive straight into this and turn to page 3, where we show you on the right-hand side, another best-ever Q3 result, DKK 1 billion and 45 million in the quarter, driven primarily by the acquisition of U.N. Ro-Ro, boosting revenue with 12% and EBITDA by 7%. As we all know, in the quarter, we have had a couple of things to deal with. One is the Turkish lira crisis in August, but also the ongoing Brexit discussion is putting a little impact into our numbers in the third quarter, which we'll talk more about. Based on what we have seen, we have narrowed the outlook range to now DKK 3.0 billion-DKK 3.1 billion on an EBITDA level. At the very bottom of the page, you will see our net interest-bearing debt over EBITDA is on a pro forma full year basis at 2.3%, so we continue to pay back debt also in Q3. Let's turn to the next page, and let me talk a little bit about some of the headwind we have experienced in the third quarter. Brexit is a key topic, not only in London and Brussels, but something we are following as well. I think for the first time, we are seeing a slight impact in our volume numbers in Q3, that all or most of the routes touching the U.K. do not have the same positive growth as we have seen in the past. A few have actually had a little drop in the volumes. When we talk to our customers, the main explanation we get for this development is the uncertainty around Brexit. We are now so close to a decision, and people will not make any major investments decisions or otherwise big decisions until they have a clarification. So, it's fair to say that everybody's a little fed up with the uncertainty and want to have clarity one way or another in order to go back to a more normal operating mode. Good news, I think, in the quarter is that we've seen a stabilization in Turkey and also in the network we are operating there. There were a few raised eyebrows earlier in August when we saw the depreciation of Turkish lira, but things have stabilized somewhat. We have also seen the Turkish lira bounce back after Q3, something Torben will talk a bit more about. Overall, we think in this environment, a fairly robust performance on our key Mediterranean routes. More long-term, too early to say what will happen with Turkish economy, but we expect a decline in the growth next year, but that the Turkish export, which has become more competitive, is expected to somehow lead a recovery in the overall Turkish economy. More about that next quarter. As I said, we are reaffirming the outlook. We will have an EBITDA above DKK 3 billion, which is a 10% increase versus last year. With those introductory remarks, I will now hand over to Torben. On page 5, we see that we have 12% revenue growth, of course, driven mainly by our addition of U.N. Ro-Ro. EBITDA, as Niels mentioned, record level of DKK 1 billion and 45 million, up 7%, driven also by U.N. Ro-Ro. As we saw, our North European freight earnings reduced from the Brexit slowdown and also importantly from some non-comparable items. Depreciation increased DKK 65 million from the acquisitions and our increased investments in digital and IT, slightly offset by DKK 18 million from change in ship depreciations, leading to a close to flat EBIT compared to last year. Finance cost increase, DKK 70 million of that from currency losses on receivables due to the depreciation of the Turkish currency, and then also the interest cost related to the acquisition. All in all, profit before special items and tax, a decrease of 13% to DKK 622 million. Moving to page 6 with a little more detail, you see that this U.K. link business units that are impacted by some Brexit concerns. North Sea business unit down DKK 28 million, 2% lower volumes. Driven by the Brexit slowdown and also importantly, a dip in automotive volumes primarily between Sweden and Russia. An important negative Swedish krona impact from the Swedish currency depreciation. Baltic Sea is behind DKK 4 million compared to last year, with higher Pax contributions having partly offset lower freight earnings. Channel, the Dover Strait is up again due to strong Pax contribution, a timing difference on our Newhaven-Dieppe route of DKK 13 million negative leads overall to business unit Channel being down DKK 4 million. Mediterranean, our new business unit, up DKK 67 million as there was no unit last year. We have the existing route from Marseille to Tunis also here, which is actually dragging down the total business unit. Passenger down DKK 19 million, of which DKK 16 million comes from higher bunker cost. Logistics up DKK 5 million, led by our acquisition of our special cargo unit, but also positive impact from closure of some of the loss-making activities in Italy and Belfast last year. Again, automotive volumes are hurt from an expired contract, and we are struggling in logistics also somewhat with recovering increased fuel cost and increased haulage cost from drivers. Turning to page 7. You see again a strong cash flow and a geared leverage operating cash flow up 9%, free cash flow up 10%, including investments of close to a quarter of a billion related to ships, net interest-bearing debt of DKK 7.7 billion, and our net interest-bearing debt EBITDA multiple decreased to 2.7 times from 2.9 times end of Q2, and a pro forma full year basis, the multiple is now down to 2.3 times as Niels mentioned. The board, taking this strong cash flow into consideration, the board will in February 2019, when we announce our Q4 result, review capital structure and distribution. Moving to page 8, with a little impact on the finance cost from the Turkish acquisition. In general, depreciation and inflation in Turkey has been relatively high, but have increased further this year with October levels of around 25% inflation. Typically, you will see their currency depreciating in parallel with this, which we have seen with the huge drop in August, which led to the currency loss in Q3 of DKK 70 million that we showed. Again, this is a EUR denominated business, but we invoice our customers in Turkish lira, which means that we have an open position on around 60 days, which means that over a year, we typically see one-sixth of the depreciation of the currency hitting our P&L on the finance cost, which constitutes DKK 70 million in Q3. There's been a strong rebound in Q4, so the net impact to us is now around DKK 30 million for the year. With that, I will pass back to Niels, who will talk about the volume development in the Mediterranean. It's clear we had a few worries in August when we saw this development, a few lifted eyebrows, so to say, but if we look at the volume graph here, you'll see the impact in August, partly due to the strong depreciation of the Turkish lira, but also coincided with two public holiday days or periods in the latter part of August, which caused the volumes to drop significantly, the combination of those two elements. Year to date, September volumes are still up 3% over last year. In Q3, the volumes were down 0.8%, so those are the levels we are talking about. So a fairly stable situation, and as you can see in September, there is a rebound. Going forward, we expect to have some stimulus to the export volumes out of Turkey, whereas the import naturally will be somewhat impacted negatively due to the decline in the Turkish lira. But overall, our key message here is the situation has stabilized. Torben mentioned the rebound also, the significant rebound in the currency. We are, I think, set to achieve what we expected with this acquisition back in April for the year 2018. If we turn to the next page, you will see the outlook. I have mentioned that a couple of times already. Outlook is a little bit impacted by the drop in European growth we expected, or we not expected, we saw in Q3. The European real GDP growth is now just below 2%. We have seen the slowdown in the U.K. market, as Torben also mentioned, and those factors together makes us narrow the EBITDA range to 3.0 billion-3.1 billion Danish kroner. We also reduce the investment by 300 million. There is some postponement of investments into 2019. Goes for some of the terminal investments and a couple of other items. You will see on the right-hand side the breakdown of this guidance to the various divisions. I will not take you through that, but instead turn to the last page, where you will see an overview of some of our current priorities. Not surprisingly, we have preparation for the Brexit transitioning as a key focus area. We are, I think, very clear to a clarification right now. Our main scenario is still that there will be an agreement, and the so-called soft Brexit. We need to prepare for both scenarios. That is clear, and that is what we are doing. We have, over the past six months, intensified our preparation for both scenarios, and a number of steps are undertaken as we speak so we can assist our customers no matter which scenario will eventually develop. I think it is prudent to assume that we will have this ongoing uncertainty at least until mid-January next year. Then we have a number of items here, customer satisfaction, efficiency improvements, et cetera, which is standard operational procedure for us. We continue those activities. We are working also on the integration of U.N. Ro-Ro. That is tracking very well. We will be done with the integration by the end of 2018. We are deeply involved with both IT and digital execution on our strategy. We have some exciting things being introduced in the market during the next quarter. More on that later. We prepare for the first of the two new buildings we get in 2019, Ro-Ro new buildings. The first one we hope we will be able to deploy towards the end of March next year. As always, we are looking on the M&A side for any valuable opportunities. So lots of things we can impact and improve on and develop in the company, and that is our main focus right now. With this little presentation, we now hand over to any questions you may have. Please go ahead. Thank you. If you have a question for the speakers, please press 01 on your telephone keypad, and you will enter a queue. After you are announced, please ask your question. Our first question comes from the line of Dan Togo of Carnegie. Please go ahead. Your line is now open. Yes, hello. I have a few questions from my side. Firstly, on U.N. Ro-Ro, could you give a number for the depreciation that you had here in Q3 in U.N. Ro-Ro? Also a bit on the seasonality in U.N. Ro-Ro. Because to reach the DKK 350 million you initially guided for at EBITDA level, you in my calculation still need a healthy Q4, so to speak. That was the first question. That was a long question, Dan. Let me start with the second part first. The seasonality, there is some seasonality in U.N. Ro-Ro, which means that Q4 is one of the strongest quarters. We are quite confident that the DKK 350 million will be reached on that. In terms of the depreciation, sorry, the, yeah, the depreciation, then I am not sure we have the exact number, Torben. It is just above DKK 25 million per month. Mm-hmm. Okay. Yes. Then, okay, thank you. Then could you just remind us a bit about your, because clearly you cannot be satisfied with current return on capital invested in U.N. Ro-Ro. There are some improvements needed. What are the most important, so to say, tools that you will introduce, and how rapid will they have effect? You mentioned here yourself a new Ro-Ro vessel is delivered, for instance, in March. So what are the steps to take return on capital invested above WACC in this business? Thanks. The return, we definitely expect it to be above WACC even in the current situation. Do we reach our 10% threshold the first year of acquisition? We do not think so. That was also what we communicated when we made the acquisition. We have no concerns about reaching the cost of capital. The measures that we are taking is that we are going through with the integration, identifying synergies with the remaining business. That work is progressing well. In addition, we are, of course, seeing how we best adjust our fleet and operation to the new reality, which is that there is growth on the export leg from Turkey and some reduction on the import side. Local management, together with the group, have made various decisions in that relation, and we are quite confident that we will come out very close to our original expectations on this transaction after maybe one or two quarters more. Sounds good. Then a question on the automotive volumes in the North Sea that you mentioned. There is an old contract that has run out, a new contract has replaced it. It has commenced here in Q4. Can you elaborate a bit on the size of these contracts? How big is the new contract relative to the old contract, and also in terms of profitability? Thanks. We don't guide that specifically, but the new contract is ramping up during Q4. We are quite comfortable with that contract plus other new contracts and initiatives that we'll be back on a growth path in Q4. Okay, so growth, you mean growth also. I guess when you say that, Torben, it means growth vis-a-vis Q4 last year. Correct. Thank you. Thank you. Our next question comes from the line of Finn Bjarke Petersen of Danske Bank. Please go ahead. Your line is now open. Finn Bjarke Petersen, you may go ahead and ask your question. Yes. Good morning. Thank you. I have a couple of questions regarding the U.K., not surprisingly. The English Channel, the one-off you have down there on the concession route, could you explain a little bit of the mechanism that affects these DKK 13 million on the English Channel? What is going to happen in the next quarter? In the next quarter, we expect it to be more or less in line with last year. This is a catch-up of the preceding quarters this year. It has to do with how the cost is split with the concession grantor. This should not be something we are seeing going forward. It is a non-recurring thing. It is not something that happens next year, then you have a catch-up certainly in a quarter. Or is it? You could say year-to-date it is on level with last year. It is a quarterly timing difference. What about the North Sea? I understand what happens on Gent. That is clear. That would return when the Volvo contracts resume in the fourth quarter. Could you say a little bit about how the development had been in the southern part of the North Sea and the northern part of the North Sea? Do you see any movements from the channel to the North Sea? The last thing is, of course, that we just received the numbers this morning for October for Eurotunnel, which shows quite a significant rebound of 7% in the trucks volumes. Is that something you see as well? You do. It is a lot of questions here, Finn. Yes. Overall, we see an impact on the North Sea, both south and north. It is, of course, difficult to say exactly what it is, but when we talk to our customers, we get the Brexit uncertainty as a contributing factor. It is not huge dramatic numbers, but it is enough for us to detect it, and we can see there seems to be a slowdown. I am not sure we are seeing the movement to the same extent from the channel to the North Sea, which we have seen in the past. I think that seems to be leveling out somewhat. There is still a driver issue. It is difficult for the hauliers to get the drivers, and they are optimizing as much as they can. There are still some concerns also on the migration security issues around the channel. I think the main factor is with increasing bunker costs, as we have seen also in Q3, it puts the Eurotunnel in a slightly better competitive situation given their electricity power operation. It is our impression they have used that advantage to increase their market share. I think we are doing reasonably well vis-a-vis the other ferry competitor, but the tunnel is gaining market share. That's because they're lowering prices or- Yeah, but you can say with the increased oil price and the BAF mechanisms we have in all contracts, we are effectively increasing prices to our customers, and if they keep their price stable, then it translates into a higher market share. We need to get our bunker cost increase covered, so we are very careful to compromise on that. In recent weeks, you can say the oil price is heading a bit south, so that will hopefully improve the situation without us having to do any sort of dramatic changes on the pricing. Then hard Brexit, how do you prepare for that? What is your worst-case scenario? We have a long list of things and initiatives we have had during the year. A steering committee, which is organizing the efforts. We have monthly calls with all operations. We have dedicated three sessions at the recent management conference for top 200 managers with external experts and workshops, et cetera. All of this work is ongoing, and I will not go into the long list of actions we are taking, but just give you a few examples. Of course, we are increasing, to the extent we can, onsite and offsite capacity in the terminals if we need to have trailers standing for a slightly longer period while the custom work is handled. We have delayed our dry docking of our freight vessels trading to the U.K. from typically Christmas, New Year, first weeks of January, to now the summer period, where freight volumes are low. If we do get a hard Brexit, we can accommodate the needs of our customers. We would expect that volumes would pick up significantly during the first quarter as people are trying to fill up inventories to be able to handle if you get, let us say, X number of weeks of breakdown until the system sort of clears itself. We have a number of things, and it goes into IT, goes into training of colleagues, getting special status with the custom authorities, et cetera. All of that work is ongoing for preparation for hard Brexit, if that were to occur. Yes. Thank you. Thank you. Our next question comes from the line of Lars Heindorff of SEB. Please go ahead. Your line is open. Thank you. The first one is regarding the CapEx. You are postponing a little bit of the CapEx, you said DKK 300 million. Can you give us any indication of what kind of CapEx you expect for next year? We are not at this stage guiding for next year on CapEx. Okay. The graph that you show us on page 9 with the volume in the Mediterranean, is it fair to assume that that pretty much reflects the seasonality in earnings that you have in connection with the U.N. Ro-Ro? Yeah, I would say so. Correct. When you look at the 2017 volume graph, yes. Okay. That is also where you see that Q4 is a strong quarter. Yeah. Then a follow-up on the previous question that was regarding the preparation for potential hard Brexit. How many days and what kind of costs is normally associated with dry docking in the first quarter? What kind of movement in terms of operating days and earnings should we expect then from being moved from Q1 into Q2 next year? That is probably too detailed for here. I suggest you reach out to Søren to give you a little insight into that. We do not have the exact numbers present right now, Lars. Okay. Some of that is also still being discussed with the yards, so we do not have the final docking schedule either. You can talk to Søren to get more insight. Yeah, will do that. Lastly, regarding the Baltics, now we had 3 quarters here with close to zero growth in lane meters for you guys. I think we have been talking about this before. One of your competitors is growing quite a bit. They have been adding capacity. Is this a trend that we will see in the coming quarters, or do you intend to do something to, I think, regain some of that capacity or that volume, something that apparently has been grasping, and what kind of average market growth do you see in the Baltics? We have seen some challenges in the northern routes, our newest route, you can say, in the Baltic. And quite healthy demand from our Swedish and German routes into Lithuania. We did have a challenge with one of the vessels, but in general, we see continued market growth on those lines, whereas we are still seeing how we can reverse the trend in the most northern route that we have from Estonia to Finland. We have one vessel, you probably read about that early October, who had an engine failure. The spare parts will now be manufactured. It is something we can repair while in operation. We have switched the vessels around, so it is now on a shorter route in the Baltic. We needed a few days in dock to remove a propeller and the same when it is supposed to go back in. So there will be a little impact in Q4 of this, but then we will be back in full operation. But I think market growth is, as Torben mentions, following the general GDP. Okay. The 2 new buildings that you have coming in next year, you said the first one is in March, and the second one, I do not know when that will come. Is it still the plan that those vessels will be deployed on, I think it is Rotterdam to the U.K., or where is the plan to put those others in? I am not sure we have mentioned that. The location you mentioned there is not the first priority. We have a couple of other competing interests, but we will determine at the very end which location will get it. One place could be Sweden and another place could be Turkey, but it is still up in the air. Okay. All right. Thank you very much. Thank you. Our next question comes from the line of Marcus Bellander of Nordea. Please go ahead. Your line is now open. Thank you. Question on pricing on the North Sea. It seems like it has been pretty flat if I take revenue and divide by the number of lane meters for quite some time now. It is flat compared to Q3 last year, it is flat compared to Q3 2016, which is a little bit concerning, of course, given that bunker costs have risen quite substantially. Could you talk a little bit about the pricing dynamics on the North Sea? Swedish krona is down in this period 8%-ish, which is, of course, hitting our rate per meter, but of course, also reducing some of our costs, although, the impact is, of course, bigger on the revenue. The Swedish krona demise is part of the explanation. Then, of course, you can say in a market where we see these Brexit concerns and little growth in volumes, it is harder to get price increases. We actually don't see the prices as our main challenge. We've been able to hold on to prices in general and also gotten some smaller increases. It is the volumes that have been our challenge more than the prices. It's also been the closure of the Rosyth route, which you should adjust for versus last year. Okay. Yes. Understood. Thank you. Also a question on ship operation and maintenance costs. I realize U.N. Ro-Ro may cause some difficulties with the comparisons, but it seems it's pretty high in the quarter, especially as a percentage of sales. Is that just fuel costing increases or is there anything out of the ordinary in there? Yeah. We do have Finlandia, which was the vessel operating on the Rosyth to Zeebrugge route, as Søren just mentioned, which had a big major engine failure, and we have been struggling for a while to get the spare parts and should the engine be completely replaced. We have found a solution, and it was introduced back into operation beginning November, but it has been out since that incident in April. Given what we experienced with these critical spare parts, we changed everything on a sister vessel as well in order to avoid the same incident there. So there are, in the quarter, significant impacts around that in the tune of 15 million Danish kroner, if I remember correctly, just associated with what I just mentioned here. Okay. That's helpful. Thank you. A slightly broader question. I guess, we're seeing for the first time the EBITDA margin decline significantly. If we adjust for U.N. Ro-Ro, at least. At what point will you start thinking about some kind of efficiency program or cost cuts? We are thinking about that night and day, and that's of course continuously performed, and there are exercises ongoing as we speak. There are, however, in the quarter, a number of non-comparable items or just things impacting the quarter, which one needs to sort of look at. You have the ship maintenance costs, the impact of Finlandia I just mentioned. You have the Swedish krona, which Torben mentioned. You have increasing bunker costs in the tune of DKK 16 million hitting the passenger business. There are the Newhaven, timing difference. There's the B60 Volvo project, which is ending earlier this year and ramping up, and will be ramped up, we believe, like December this year. So there's a number of actions or a number of items explaining this. But of course, we are not just sitting back. We are trying to counter this with various initiatives, both on the passenger side and on the freight side as we speak. So we are not just accepting the decline in margin. We will do whatever we can to make sure this bounces back. Good to hear. Thank you. Thank you. Our next question comes from the line of Ruairi Cullinane of RBC. Please go ahead. Your line is now open. Good morning. A couple of questions, please. Firstly, could you expand on the increased competition that you are seeing between Turkey and Italy that was mentioned in the release? Secondly, I think you have ongoing talks with your Turkish customers on billing in euro rather than lira. Should we expect them all to move across to euro next year? Yes. The increased competition, I think, is a function of one line, which is our Mersin line to Istanbul. Sorry, to Trieste, of course. There is no competition directly in Mersin, but customers who are located a certain number of kilometers from the port in Mersin versus Istanbul versus Izmir, have decided to move volumes to one competitor, in particular to his own route network. So, we are not seeing any new competitors in the Turkish market as such. We do not expect any competitive increase in the market as such. The main impact on that route is really what is happening in Syria and Iran and the sanctions also now in Iran. This is in the eastern part of Turkey, and a lot of transit goods have been coming to that route. It is the smallest route, occupying two out of the 12 vessels in the Turkish operation. Great. The other question was On billing in EUR rather than lira. Sorry. We have carefully tested out the sentiment in the market with our customers on this topic and have engaged in discussions with the market. The idea is not necessarily that this is a cost that we think our customers should absorb, but it is a cost that manufacturers primarily should absorb. So there are two chains here that needs to work together to make this happen. But we are somewhat optimistic that from Q1 2019, there will be some movement in this area. Okay. Thank you. Thank you. Our next question comes from the line of Finn Bjarke Petersen of Danske Bank. Please go ahead. Your line is now open. Yes, just two follow-up questions. One, all the one-offs. The list was long. How much is it in Danish kroner in total affecting EBITDA? Some 80 million-90 million Danish kroner. 83. 80 million-90 million? Okay. Yeah. Okay. Then, I think it was you, Torben, said on the question about pricing on the North Sea, you said you have kept prices. Is that just because you exclude BAF from your pricing? Yes. This is excluding BAF. Okay. With BAF, they would have gone up. Yeah. So your prices are down. All inclusive is unchanged, but excluding BAF, prices are down. Is that the correct answer? Well, if you adjust also then for currency and closure of the longer route, prices are flattish. Okay. Thank you. Thank you. Just to remind everyone, if you would like to ask a question, please press 01 on your telephone keypads. Our next question comes from the line of Ruairi Cullinane of RBC. Please go ahead. Your line is open. Hi. Yeah. One more question, please. I was just wondering, perhaps what we should expect in a soft Brexit scenario, if there is a deal, based on your customer conversations, do you think we should expect a return to normal growth or perhaps a rebound in volumes on North Sea routes? It's difficult to say. I think it could lead to a small rebound, because then the timeline will be pushed sufficiently into the future. That's sort of the optimistic view. The pessimistic view is, of course, that there can be hiccups along the way, so it depends on how solid and how much backing the Brexit agreement will get. I think we need to see that and then, we can be a little firmer at that stage. Okay. Thank you. Thank you. There are no further questions at this time. Please go ahead, speakers. Well, thank you everybody for joining us this morning and for some good questions. We wish you all a great day. Goodbye. This now concludes our call. Thank you for attending. Participants, you may disconnect your lines.