Dear ladies and gentlemen, welcome to the Q2 2019 results call of Brenntag AG. At our customer's request, this conference will be recorded. As a reminder, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. If any participant has difficulties hearing the conference, please press star key, followed by zero on your telephone for operator assistance. May I now hand you over to Steven Holland, who will lead you through this conference. Please go ahead, sir.
Thank you very much. Well, welcome, ladies and gentlemen, thank you for dialing in for our Q2 results. As usual, I'm here with our CFO, Georg Müller. We're happy to answer your questions after the presentation. Having already pre-released the EBITDA in mid-July, we'd like to provide further details on the quarter today. Our operating gross profit rose by 4.1% to €722.9 million. This reflects the organic growth of the business as well as the positive contribution from acquisitions. Raw business activity was in line with the developments in the first quarter. Our business in the Food & Nutrition industry again developed particularly positively in this quarter and we grew the gross profit by a high single-digit percentage. The operating EBITDA increased by 12.2% in the second quarter, reaching €266.3 million.
We are, of course, applying the new IFRS accounting standard on leases for the first time, which has a positive effect on EBITDA. On a frozen GAAP basis, EBITDA is on previous year's level. The free cash flow increased by 21%, amounting to €179.1 million in the quarter. Also, in the second quarter, we continued to execute our M&A strategy and signed and closed for the spur of acquisitions. Clearly, you may not surprise, during the quarter, we noticed a slowdown in economic environments which has impacted the demand situation overall. At the same time, many companies in the manufacturing industry are slower, with a number of companies reporting weak results. This situation, together with a rather weaker first half of the year, does not support our initial view that the second half of 2019 will be much stronger.
For what we decided in July to adjust the guidance for operating EBITDA moderately downwards. We're now expecting operating EBITDA to grow between zero and 4%. As before, this range includes FX effects-- I'm sorry, excludes FX effects, as well as the positive impact from the IFRS leasing standards. I'll come back to the revised outlook in the course of the call. We move on to the operating EBITDA bridge, showing the developments from Q2 2018 versus Q2 2019. In Q2, we had a positive effect from the FX translations of EUR 6 million. Acquisitions contributed around EUR 9 million in the reporting period. This number is net of the operating EBITDA associated with the Biosector business, which you may recall we sold at the end of 2018.
The application of the new accounting standard on leases results in a positive effect on our operating EBITDA of EUR 28 million for the group. In EMEA, the organic growth was -4% compared to -10% in Q1. Into a more challenging environment, the organic EBITDA in North America was down to around 3%. Latin America showed another very positive quarter. The organic EBITDA growth was -2% to 3%. Our Business Unit Specific is currently facing a weaker demand and some cost challenges in China, which is reflected in the organic EBITDA development of around -3%. We closed the quarter with an operating EBITDA of EUR 266 million. Coming to the segments themselves, EMEA first. The economic environment in Europe continues to be very weak. We've seen a pronounced weakness, especially in those countries with high exposure to the automotive industry.
All in all, we were able to achieve the same gross profit level as in the previous year under these conditions. As a result of the flat gross profit and the slight increase in the cost base, organic EBITDA development was minus 4%. The new accounting standard on leases has an effect of EUR 10 million on operating EBITDA in the EMEA region. Moving to North America. The North American economic environment remained rather solid in the second quarter. Current uncertainties are affecting some customer confidence, which is making our order patterns more unpredictable. We attribute some of these uncertainties to market concerns around trade tariffs. Our gross profit in North America grew both organically and through the contributions from acquisitions. There are no particular industries that stand out, but also North America, the Food & Nutrition industry did well, and our repositioning continues to bear fruit, no pun intended.
The operating EBITDA declined slightly in organic terms. This is the first time we've seen in several quarters. The effect of the application of the new accounting standard on leases amounts to EUR 13 million in the region. Moving on to Latin America. We recorded another very good quarter in Latin America. We're very pleased that we significantly increased gross profit and EBITDA in the second quarter. The IFRS 16 changes amounted to EUR 3 million for the region. Moving on to Asia Pacific. In our view, Asia Pacific remains a growth region. The general conditions do create a mixed picture. In some countries, we saw a slight growth in the second quarter. In other countries, individual industries experienced some slowdown. For example, in China, we saw products in the coatings and construction industry were significantly weaker during the period and throughout the market generally.
Overall, though, we were able to increase our gross profit organically, and acquisitions of recent months have made a significant contribution. On the cost side, we are facing some cost increases that are well within the typical range for emerging markets. As you know, the cost base in China continues to be a burden in terms of increased logistics costs. This is the fact that we are currently working on as we are building new sites in China, and many of you will be aware that is the case. For information, we expect a new site in China to come on stream in Q1 2020. Region operating EBITDA of around 25%, which was also driven by initial application of the new accounting standards and leases effect amounted to EUR 2 million in the quarter. Coming to acquisitions, a very busy period in terms of acquisitions and deals.
During our last conference call, we already talked about Tee Hai Chem acquisition in Singapore. In the meantime, we closed the transaction and acquired a 51% stake. We made two interesting acquisitions in North America with Marlin. We're strengthening our range of value-added services as the company specializes mainly in mixing of liquid and powder products. B&M, again, in North America will support our lubricants division, which we've been continuously expanding in the region over the last year. Neuto is an established chemical distributor in Taiwan, which will strengthen our presence within the country. In addition, we have two small transactions in South Africa. First, we acquired the remaining 50% of the joint venture of Crest Chemicals, and the company will be fully consolidated on the closing date. Secondly, we acquired Chemgrit Cosmetics, another distributor of specialty chemicals with focus on the cosmetics and cleaning sectors.
In total, so far in 2019, we've a total enterprise value of around EUR 200 million spent on acquisitions thus far. Now I'd like to hand over to Georg.
Hi, good afternoon. I would like to talk you through our financials for the second quarter, 2019. We addressed gross profit and EBITDA already. I'll move to the P&L lines below EBITDA that you'll find on slide number 12. Depreciation in the second quarter amounted to EUR 59.8 million. That is significantly higher than in the previous year. The increase in depreciation is mainly attributable to the first time application of the new accounting standards on leases. Financial result amounted to a net expense of EUR 24 million. Earnings per share amounted to EUR 0.81. This compares to last year's earnings per share of EUR 0.76. We'll spend some time on the cash flow statement, starting on page 13. Operating cash flow in the second quarter amounted to EUR 145 million.
It was approximately EUR 70 million above the operating cash flow of previous year, so this is a quarter with a pretty strong cash flow. The significant increase is mainly due to working capital. The outflow on working capital in the second quarter 2019 was significantly lower than in the second quarter of 2018. With respect to the investment and financing cash flow on page 14, CapEx in the first quarter was on last year's level and amounted to EUR 40 million. In addition, we spent EUR 55 million on acquisitions in the second quarter, so most part of this relates to our acquisition, Tee Hai, in Singapore. In the financing cash flow, the dividend payment from June is particularly noteworthy. After the general shareholder meeting, we paid a dividend of EUR 1.20 per share, which corresponds to a total cash-out of EUR 185.4 million.
Coming to our free cash flow presentation on page 15, the free cash flow amounts to EUR 179 million in the second quarter, and that's 21% higher than in previous year. It should be noted that we have adjusted the definition of free cash flow appropriately in order to ensure comparability with previous years. Free cash flow now also includes leasing payments, which are reported in the income statement below EBITDA. Addressing balance sheet and leverage, net debt amounted to EUR 1.9 billion, excluding lease liabilities. The increase compared to the end of the first quarter is mainly attributable to the dividend payment of EUR 185 million. The leverage is at 2.2 times. Trade working capital amounted to around EUR 1.9 billion at the end of the second quarter, and the working capital turnover stood at 6.9 times for the quarter. That turns the presentation back to Steve for the outlook section.
Okay, Georg. I'll start with the current trading and just then very briefly cover the outlook for the year. In terms of trading numbers, we just show a slowdown which we talked about. In April, growth was 5.6% and 3% organically. May was 5.4% and 2.5% organically. June was 4.7% and 1.8% organically. July is 3.1% and 0.5% organically. In terms of the outlook, clearly in July, we adjusted the outlook for 2019, and we expect our operating EBITDA to grow between 0% and 4% in 2019. The growth rates are on an FX adjusted basis and include acquisitions. Also this growth is on a sort of frozen GAAP basis. The range, therefore, is an operational range of EBITDA for 2019 between EUR 995 million and EUR 1.03 billion. I think at that point we can open it up for questions.
Ladies and gentlemen, we will now begin our question and answer session. If you have a question for our speakers, please dial zero one on your telephone keypad now to enter the queue. Once your name has been announced, you can ask a question. If you find your question is answered before it is your turn to speak, you can dial zero two to cancel your question. If you are using speaker equipment today, please lift the handset before making your selection. One moment please for the first question. The first question is from Rory McKenzie, UBS. Your line is now open. Please go ahead.
Afternoon, guys. It's Rory here. Three for me, please. Firstly, in terms of that tough backdrop that clearly got worse for you in June, July, was most of that in North America? Can you expand more about your comments on how the trade war uncertainty has fed through to your business? We normally think about you guys as being quite resilient and exposed to kind of a broad range of markets. Where exactly have you seen that impact in North America? Secondly, on the costs in EMEA, it looks like the cost inflation is going to come down a bit in Q2, and you talked about, in particular, pushing on logistics costs to reduce that there. Is there still more that you think you can work on through H2 or is this the right run rate to think about?
Lastly, just on working capital, are there any prospects for a working capital inflow through H2 given the falling chemical prices? Thank you.
Right. Okay. Just in terms of the comment on the trade test, I think that was more a comment on customer confidence, where there are certainly some customers who are having issues with exports into China, where their exports clear and subject to tax, which most weeks they weren't. We also have some aspects of products which would previously been sourced in China and into, say, for example, U.S., which are more expensive and there's a slight dislocation of the supply chain in that respect. I wouldn't say that this is particularly a Brenntag affecting issue other than there's a lack of a momentum in customer demand at this stage, and there is certainly some concern to the supply chain. I wouldn't say I'd point to particularly as a Brenntag issue directly.
In terms of costs, in terms of EMEA, for a start, you're right, actually, in terms of the overall operational cost in EMEA are obviously under scrutiny. We are now seeing a sequential reduction in transport costs in the EMEA region, which by no means at the final stage of that process. We expect to see some further improvement in the next two quarters in transport costs for the EMEA region. Equally, in North America, we have some cost issues related to transport and other elements of North American cost base, which we are looking at, particularly in view of the reduced guidance that we've given you. Clearly, costs are a focus for the whole group, and we are rolling out certain initiatives to attack that as a principle.
I think where you also had a question about the regional split of the gross profit per working day trajectory. Europe was relatively slow earlier this year and continued slow into May, June, July. North America had clearly more healthier levels early this year but did slow down in June and July.
Great. Thank you. Just on the working capital, any comments on if chemical prices keep on the trajectory they're on, would you guys expect to see an inflow in the working capital through H2 or just kind of again, a low outflow?
To a fair degree, it will depend on chemical price development, which makes the prediction difficult. If chemical prices are stable to marginally falling and considering that the H2 seasonality typically is an inflow, there is a good likelihood of some inflow in H2. Again, the question of chemical prices will be the decisive question for this.
I think there's also some questions regarding price of oil in the call analysis, just because clearly there's some concern over the security situation in the Middle East and things like, for example, fires at the Exxon refinery in North America don't help much. I think that anything that's oil-based is a little bit more volatile at the moment in terms of the overall base stock being somewhat variable in terms of that price.
That's great. Thank you guys very much.
The next question is from Stephen Golden, Deutsche Bank. Your line is now open. Please go ahead.
Hi there. Thanks for taking my question. Can I just dig in on the cost side again? It looks like you had roughly 4% cost inflation in EMEA and North America. Can you give us a bit of a steer as to where that's coming from? Obviously, wage inflation has been a problem for many of your competitors, but my understanding is that sort of tracking at around 2.5%, 3%, and that's about 60% of your cost base. If you could give us a bit more color on where that's coming from, if there's been projects, front loading of IT spend, that sort of thing, and whether or not you expect that to materially ease in the second half. Sorry, on that point as well, I just missed your response to the North American cost.
I think you said that you were focusing on that, but I missed the actual detail around the response.
In terms of cost generally, clearly we've reduced our guidance for the rest of the year and the costs are absolutely in focus. In fact, not just North America, Europe, but on the group as a whole, because we want to make sure that we hit our guidance as well as we guided you. There are a couple of things which are happening in terms of costs which are perhaps outside of day-to-day insofar as in North America, we do have a number of new distribution deals which require us to employ new staff, new technicians, new certain expertise to support the new deals. Those are more front loaded in terms of providing resources before you see a flow of GP into the business. That's going ahead and we're pretty happy to see that. That's for future development.
Certainly we are providing to some extent, some more investment in infrastructure and logistics to access certain parts of the market which we believe are more attainable now than perhaps they were this time last year. As far as Europe is concerned, I think we've touched on that already in terms of things like transport and distribution costs. However, there was a point about IT, but maybe Georg, you could answer that one.
Yeah. The European cost inflation, as Steve says, goes through different P&L lines, particularly through transport and to a degree through IT. We are ramping up staff more and more in our work to harmonize European ERP systems. There is some resource and therefore cost element in there.
Great. Thanks. Sorry, just a quick follow-up on that. I mean, in terms of organic EBITDA development, you did around minus three and a half in the first half. To hit the midpoint for the full year, you'd probably need to be up two or so. I do realize comp fees, and they particularly ease on the EBITDA side. Is it fair to say that we're probably looking at the lower end of the range as a realistic target than the mid-end of the range, just given what you have to deal with and the fact that there's still some cost inflation there?
I wouldn't really comment from a company's perspective now on lower end, mid of the range, upper end of the range. We put out a range, and that's what we feel to be comfortable to end up in. If you want to make up your mind on where you see us within the range, don't forget that last year's second half was relatively soft half year.
Great. Thank you very much.
The next question is from Raghav Bardalai, Exane BNP Paribas. Your line is now open. Please go ahead.
Hi there. I have two, please. Just on that U.S. CapEx plan, I think you're still considering a EUR 40 million investment program. Could you give us a sense for what the latest is there and whether the maybe recent drop in macro momentum has affected your approach at all? Secondly, on the M&A pipeline, can you maybe just talk through the outlook for the second half? Obviously, you've been very active in the first half, and should we be expecting spend over EUR 250 million of foreign acquisitions given the pace you've been at? Thanks.
Well, with M&A, we do have a number of transactions and projects which are in due diligence. As is usual, it's very difficult to nail it down when these will arrive. I think the guidance that we give of say between EUR 200, EUR 250 or up to EUR 300 is about right. Certainly, I would expect to have at least some more acquisitions during the course of this year.
In fact, I got your question around CapEx slide, and to trade, then you referred to the about EUR 40 million CapEx program. We have to address changes in market circumstances in North America. To respond to market opportunities that come from mergers of some competitors. There is kind of the answer. This is driven by market opportunities that are not depending on macro. From today's perspective, we fully expect to go through with that program.
Can you just remind us what is the anticipated timing for that? Is it on a two, three year view?
The EUR 40 million is a two-year program. We are working on realizing a couple of projects. I would not be surprised if the majority of this comes late this year, but if it is early next year, it wouldn't be very relevant for us.
Understood. Thanks.
The next question is from Isha Sharma, MainFirst Bank. Your line is now open. Please go ahead.
Hi. Thanks for taking my questions. I just have two, please. In terms of your new guidance, if you could please give us some color as to your assumptions of the guidance. Do you see the market, expect the market deteriorating from today, or is it based more on a mark-to-mark basis? The other question would be on the CapEx. We have a guidance of EUR 220 million for the year, and there's an expected compensation back in China of around EUR 15 million. Should we expect the CapEx to be EUR 220 million and the compensation to come in the next year, or should we already net it as an assumption for this year? Thanks a lot.
Maybe if I take the second question first. You should expect the compensation to arrive basically the same point in time where we undergo the CapEx. We laid it out gross to you because it will happen in different lines of the cash flow statement. You would see the CapEx gross and the EUR 25 compensation will basically be an inflow from sale of assets. That's why we have shown it separately. It will happen same moment in time, give or take a little. The zero to 4% guidance range that we have is under current market circumstances. We don't have a particular assumption for weakening nor a strengthening market in that range.
Perfect. Thanks a lot.
The next question is from Rajesh Kumar, HSBC. Your line is now open. Please go ahead.
Hi, good afternoon. Couple, if I may. You gave some color on what sort of cost commitments you might have with suppliers when you sign a new deal. Can you give us some color on what sort of contract negotiations you're having with the suppliers as the volumes get weaker around minimum service levels, minimum inventory or vendor rebate, that sort of discussion. Basically, are you preparing for a slower growth environment with the suppliers? The second one is, if I've understood it correctly, at the current run rate, your inflation in Europe and the U.S. gets easier in the second half. Is that an accurate summary of what you said on costs so far?
Just coming to the supplier question. Generally speaking, we don't have a scenario where we are effectively engaged in contracting certain tonnages. Normally, our contracts are framework contracts where essentially these are the terms in which we do business together, but don't normally involve commitments of versus tonnages. Any change in the business environment means we automatically change our inventory relative either inventory even in stock or reduce the number of times that we replace the products. Clearly, we are focused on making sure that our stock turnover is maintained at current levels. We can adapt our stock holding to whatever is appropriate to the market conditions that prevail, and there's nothing contractual that would stop us doing that. Understood.
When we indicated that the comparables for the second half of this year are a little easier because second half of last year was weak, this was more addressing the gross profit level than the specific cost situation.
Yeah. I was asking about the cost pressure in terms of freight cost, labor cost, transportation. At the current run rate, would you see a bit of easing of cost inflation?
Yeah. Well, firstly, we are making progress in terms of European region logistics. We talked about that over the last couple of quarters. We have actually invested more in our own transport, our own personnel to effectively reduce the dependence on external service providers. We should expect to see a benefit from that during the course of the third and fourth quarter. Besides that, we are clearly looking at our overall cost of operations because in the current market conditions, which are not particularly buoyant, we are certainly looking at all our costs relative to the operations. As a result, we should see some shaving of costs in that regard.
Thank you.
The next question is from Tom Burton, Berenberg. Your line is now open. Please go ahead.
Hi, guys. Thanks for taking the questions. I just wanted to come back and sorry to dwell on the cost point, but I guess it is important vis-a-vis your guidance. On the comment around IT deployment costs, remember in Q1 there was a comment that they would still be flowing through IT deployment costs in Q2, but were expected to drop out in Q3. Can you confirm that they were in the P&L in Q2 and they will in fact drop out in Q3 as was initially guided? Again, just thinking about the sequential cost developments, sticking with EMEA, is your guidance premised on an assumption that we will get quarter-on-quarter cost improvement, i.e., Q3 better versus Q2 and Q4 better versus Q3? Just lastly on free cash flow, any more color in terms of quantifying that guidance?
You've talked about a significant increase year-on-year. I mean, you're basically run-rating at double the free cash flow of last year. Is that a sensible sort of run rate for the full year out turn, or how should we be thinking about that, please?
Just coming to the cost base, and I think I've said a few times now, it clearly is our focus for us. Whether or not we can call it sequential or not, but it certainly the second half of the year, we certainly have our costing focused for both major regions, so North America and Europe. We will see, we expect to see some improvement in logistic costs in the European region, which have actually been quite a burden for the European business in the course of 2019. In that regard, I'd expect to see a reduction. It's a focus for the whole group, not just the two big regions.
We probably can't be too helpful in narrowing free cash flow guidance. Free cash flow through working capital movement and in turn through chemical prices, can be a volatile element. It would really be a little artificial if we were to narrow guidance on that end.
Okay, thank you.
I'm sorry. Was the question answered?
Yes. Thank you very much.
Okay.
I'll drop now.
The next question is from Markus Mayer, Baader Helvea. Your line is now open, please go ahead.
Yeah, good afternoon. I have two questions. Firstly, again, coming to the potential trade war impact. Given the large petrochemical capacity additions in North America, not only petrochemicals or other chemical additions and the negative impacts from the trade conflict, do you see already higher chemical trade flow volumes from North America to Europe? If so, is there any kind of positive impact in particular for you as the largest chemical distribution company in Europe? Secondly, coming back to the cash flow, the working capital reduction, do you think that most of the reduction was now done in the first half, or do you see further upside from the working capital side for your cash flow in the second half? Thank you.
I think in terms of trade flows of petrochemicals, there isn't really a significant impact on our business. As you'd be aware, we've got a very straightforward price pass-through model, and therefore fluctuations in pricing, whether it be by virtue source of the product, by manufacturing in Europe or manufacturing in the United States, doesn't really affect us. It may be more pertinent to very large users and refineries, but in chemical distribution, it's just not an issue.
We're trying to be helpful on working capital forecast. It's not easy as working capital very much depends on chemical prices. We have an expectation that we see further reductions of working capital in the second half, partly also seasonal, but chemical prices can easily move the needle one or the other direction.
Okay. Sorry to add on question for the first one. The question was less related to the price, it was more related to the volumes, basically that you see more petrochemical volumes from North America to Europe.
Oh, sorry, I misunderstood your question. I wouldn't say that we are tracking particularly larger volumes from North America into Europe. You've got to bear in mind that from our perspective, even though we are a large distributor of solvents in the European region, there are also very significant production facilities in the European space in any case. It's more a case of, if there's a refinery outage like we see, for example, with Exxon, you may find the reverse flows of the product coming into Europe. It's not really an item for us.
Okay. Perfect. Thank you.
The next question is from Laurence Alexander. Jefferies, the line is now open. Please go ahead.
Hi, this is Adam Davis on for Laurence Alexander today. I was wondering, as we look out into 2020, if you could kind of just touch on different levers that could maybe be pulled next year to provide any tailwind.
I think, clearly, we would hope that we're going to see ourselves in a somewhat more stable position relative to the macroeconomic development. I think it's fair to say that we're pretty pleased with the development of our Food & Nutrition business in terms of the way that's moving on. In addition to that, I would expect to see some upside from our investment in new specialty chemicals in North America and some of the logistics investments that we're putting through the business to take advantage of demand from the customer base in North America. I think there's a couple of industry initiatives and market initiatives that should help Brenntag above and beyond the market in general.
Okay, great. Thank you. My last question. Should we expect the current pace of M&A to continue, or how should we think about M&A going forward?
Well, there's actually no reason why M&A shouldn't continue at the current pace. Clearly, the market remains difficult for everybody. I think one of the great characteristics of this business is cash flow, and you'll be aware that cash flow into small chemical distributors in the second half is equally as good. Many business may well be seeing maybe low EBITDA and strong cash flow. It does tend to make people hang on to their businesses a little bit longer, as clearly valuations tend to be driven by EBITDA. Having said all that, we have a very active pipeline, and therefore, I don't think it'd be any expectation that we spend less in 2020 compared to 2019.
Okay, great. Thank you, guys.
There are currently no further questions. As a reminder, if you would like to ask a question, please press zero one on your telephone keypad now. We haven't received any further questions.
Okay, in that case, thank you. Thank you very much to everybody who joined us, and we'll close the call at that point. Thank you very much.
Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.