Hello, ladies and gentlemen, and welcome to today's Brenntag AG Q3 2015 results call. Throughout this call, all participants will be in listen only mode, and afterwards there will be a question and answer session. Just to remind you, this is being recorded. Today I am pleased to present Steven Holland, Chief Executive Officer of the Brenntag Group. Please begin.
Well, welcome, ladies and gentlemen, and thank you very much for joining our review of Q3 2015. I am on the phone today together with Georg Müller, our CFO, and we will be happy to answer your questions after the presentation. Let me begin with some words on the macroeconomic environment. Over the summer, we saw the recent global economic developments characterized by a slow momentum, especially North America, which shows a clear slowdown, a more unfavorable situation in the oil and gas industry. Nevertheless, for Brenntag gross profit, we grew this as well as operating EBITDA meaningfully in Q3. Gross profit increased by 9.7% to EUR 570.5 million and operating EBITDA by 7.5% to EUR 204.4 million. The growth was supported by a strong tailwind from the strengthening U.S. dollar. On a constant FX basis, gross profit grew but slightly by 1.2%.
This slower growth is mainly attributable to some decrease in gross profit with customers in parts of the oil and gas industry in North America. Adjusting for this customer industry, the gross profit for the group grew by approximately 3.6% on an FX adjusted basis. The operating EBITDA of EUR 204.4 million represents a slight decrease of 2% on a constant FX basis. Earnings per share amounted to EUR 0.61, which represents an increase of 8.9% year-over-year. We continue on our acquisition path and announced a number of strategically important acquisitions over recent weeks and as early as today. I can move on to acquisitions now. First of all, you will have all seen the announcement today regarding J.A.M. and Berlin-Windward. We are delighted to announce those acquisitions. J.A.M. is an integrated lubricants distributor headquartered in Houston, Texas.
The company provides a highly diversified customer and product portfolio, mainly servicing industrial, commercial, automotive, and marine markets throughout the Gulf Coast and Texas. For Berlin-Windward in parallel, Berlin-Windward is headquartered in Manchester, New Hampshire, and operates 10 warehouses in nine states in the northeastern region of the United States. The company carries a wide variety of premium branded lubricants, delivering to over 17,000 customer locations. To the combined financials for these two acquisitions, which are both in top five lubricant distributors in the United States, we have closing expected for 2015. For the financial year 2016, we expect a combined sales contribution of around $780 million USD. The contribution from gross profit and EBITDA is expected to be $127 million USD and $50 million USD respectively. The total investment amount will be $440 million USD.
I'll just skip the next slide and come back to that in the outlook. If I move on to the slide with TAT. TAT is a very important strategic step in our Asia Pacific market. TAT is a leading distributor of industrial chemicals with focus on value-added services. It has modern and sophisticated infrastructure across Asia Pacific, and TAT has an excellent warehouse and logistics infrastructure in Singapore. In 2015, TAT's revenues were expected to be around about EUR 145 million and has an EBITDA of EUR 9 million. The investment amount will be EUR 87 million at the closing, which the transaction is expected to close in December. This is a particularly important acquisition for us as it develops our industrial chemicals business in Asia Pacific. Two further acquisitions. In September, we signed an agreement to acquire Pakotek in Turkey.
Pakotek is a distributor of specialty chemicals with particular focus on the personal care industry. With this acquisition, we strengthen our strategy in Turkey and extend our existing personal care portfolio. In 2014, sales were approximately EUR 14.3 million with the EBITDA of EUR 3 million. The investment was just under EUR 21 million. We closed this transaction in November. In addition to Pakotek, we have entered into a joint cooperation with chemical distributor Trychem, and up with the ownership of over 51%. Trychem is located in Dubai and is active in the distribution of solvents, serving the paint, ink, and coating industries in the Middle East. This joint venture opens up the Middle East distribution market for us.
It's a region where there is a lot of chemical production and where a lot of our global customers are more and more looking to have available to them distribution services such as we provide them in other parts of the world. I'd now like to hand over to Georg.
Thank you, Steve. Good afternoon. I'll move on to the review of our financials for the quarter, and I will start on page nine. On page nine, you will see the first part, the upper part of our income statement for the quarter. The strong as reported gross profit growth, supported by currency tailwinds, and the more moderate but still positive FX adjusted growth have already been addressed, and that's likewise for EBITDA. You will see the conversion ratio information towards the bottom of the page, and the conversion ratio for the quarter is 35.8% after 36.5% a year ago. The subsequent page, you will find the income statement information below EBITDA. Depreciation for the third quarter amounted to EUR 26.8 million and amortization to EUR 9.4 million. As a reminder, the amortization in our income statement mainly comes from acquisitions that we have undertaken.
The financial result amounted to an expense of EUR 27.3 million. That takes us to an overall earnings before taxes of EUR 140.9 million, which is 5.4% ahead of last year. We recorded a tax rate of 32.7% in the third quarter 2015, which is slightly more favorable than the range of 34%-35% that we typically indicate. Earnings per share are at EUR 0.61 per share, 8.9% ahead of previous year. If you exclude amortization from the earnings per share, earnings per share amount to EUR 0.65 per share. With respect to cash flow on page 11, in Q3, we achieved a very strong operating cash flow of EUR 166.9 million after EUR 107 million a year ago. The higher operating cash flow is partly driven by higher earnings.
In addition to that, working capital management and price development of chemicals permitted a reduction in working capital in Q3 and a corresponding cash inflow. Briefly on the other parts of the cash flow statement, namely investment cash flow and financing cash flow. CapEx amounts to EUR 27 million, which is slightly above last year's level. We are on track to meet our full-year CapEx guidance of EUR 120 million to EUR 130 million. The line repayment of proceeds from borrowings reflects repayments of short-term borrowings in course of Q3. As none of the acquisitions that we discussed earlier was closed in the quarter, the corresponding cash outflow is not yet reflected in the cash flow statement, but will only come in Q4 of this year. Let me move directly to the financial debt and leverage information on page 14. On the page, you will see the net debt and the leverage.
Thanks to the positive cash flow development, net debt decreased during the quarter by EUR 168 million to EUR 1.371 billion. The group's leverage decreased to 1.7 times, which is below the levels seen earlier this year. If I were to perform even the two acquisitions that we announced this morning, this would take the leverage back up again, very moderately, to about 2.1 times. Trade working capital at the end of the quarter amounted to EUR 1.296 billion. On a year-to-date basis, we turned working capital about 8.1 times, which is roughly the same level we reported a quarter ago. Another look at cash flow on page 18. It's our free cash flow presentation. This quarter delivered a very strong free cash flow of EUR 191 million. It's significantly up against the EUR 138 million for the third quarter 2014.
The increase was driven by lower working capital as well as an increase in EBITDA compared to prior year's quarter. We included into this presentation a couple of slides on oil and gas. I would now like to focus on the oil and gas situation, beginning on page 19. It is obviously no news that the oil price is in the mid-40s. Therefore less than half what it was in summer last year. However, earlier this year, in early summer this year, there was an expectation in the market of a moderate recovery when the oil price trended back towards $65. That recovery early summer this year did not last. Consequently, our customers in the oil and gas industry slowed down their activity once more. You see that, for example, when you look at the rig count, lower left-hand side of the page.
Obviously, the rig count is not the one and only indicator for our oil and gas business, but it has some meaning, particularly for the upstream part of our business. The oil and gas impact on the results that we report today and on our guidance is pretty relevant. We estimate that our gross profit with oil and gas customers will be about EUR 30 million lower this year than it was last year. To put it into perspective, that reduction of gross profit of EUR 30 million takes off 1.5% of the group's gross profit or 3% of the North American gross profit. We certainly are able to overcome this reduction through growth in other customer industries. But if you look into the total package out of oil and gas and other customer industries, you see some impact on the overall group figures.
I would hand back to Steve to a continuation of the oil and gas picture.
Thanks, Georg. On the next page, if you look at the left-hand side, you'll see the gross profit development of our oil and gas business in North America for the first three quarters of 2015 in comparison to 2014. Over the first nine months, we were down by 9.4%. The highest shortfall was in Q3. But actually, this sequential development is not too bad. Q3 2015 was about on Q2 level. The highest shortfall against the previous year only results from the strong levels the business had, particularly in the second half of 2014. We have taken steps within our oil and gas business to reduce operating costs, which has resulted in some headcount reduction of around about 6%. On the right-hand side, you can see how all the rest of North America is coping. The business is offsetting some of the reductions of the oil and gas weakness.
In all other customer industries, we have grown gross profit by 5.1% in the first nine months of 2015, but this has become more difficult recently with a loss of macroeconomic momentum in North America. If you just turn to the next page, I think we can see. That's shown in the PMI index. The PMI index in North America is clearly backtracking since summer, and the IP growth has lost momentum completely. When we look at the very recent PMI numbers for October, we see further weakness in the PMI index. We, of course, are closely monitoring these developments and plan for our own business to cope with the weakness in this respect. If I take you into the segments now, if I could first come to Europe. Europe's operating gross profit increased by 3.5% and operating EBITDA increased by 2.1%, both on an FX-adjusted basis.
After strong growth rates in the first half of 2015, momentum in the market slowed in the third quarter. Nevertheless, operating gross profit and operating EBITDA continued to show growth. In North America, in Q3, our business in North America was clearly affected by the combination of the weakness of oil and gas industry and a cooling of economic activity as a whole. In this environment, operating gross profit decreased by 3% on an FX-adjusted basis. Excluding the business with customers in oil and gas, we were able to increase gross profit by approximately 2.1%. Operating EBITDA increased by 9% on an FX-adjusted basis. Strong translational tailwinds lead to a strong growth of 7.6% on as reported basis. Coming to Latin America, Latin America continued to report strong increases in earnings in Q3, with gross profit growing by 11.3% on an FX-adjusted basis.
The region benefited from an efficiency enhancement program, which we introduced in the past, resulting in a strong growth in operating EBITDA of 25% on an FX-adjusted basis. Particularly in view of the declining industrial production in the region in Q3, we are very satisfied with this result. In Asia Pacific, in Q3, Asia Pacific grew operating gross profit by 2.6% on an FX-adjusted basis. In the first half of the year, an increase in operating efficiency resulting in higher conversion ratios, compared to prior year, led to an operating EBITDA growth of 8.8%. If I now come to the outlook for 2015, I'll start with our monthly gross profit per working day trend. In July, gross profit per working day grew by 1.6% and was flat organically. In August, the growth rate was flat and organically down by 1.4%.
The growth rate was positive, 0.7% and organically slightly negative to zero. In October, the growth was minus 0.5% and organically minus 2.1%. To calibrate these numbers, these trends partly are driven by stronger comps in the course of last year, and only in part reflecting a softening trend within this year. Given the state of oil and gas and the slowdown of economic momentum, we've taken a more cautious look at the full year. On a full-year basis 2015, we are expecting our operating EBITDA to be between EUR 790 million and EUR 810 million. This compares to an operating EBITDA of EUR 727 million in 2014. Coming to the next page. Very briefly, I'll go through the strategic rationale relative to J.A.M. and Berlin-Windward, the acquisitions we announced today. The lubricants distribution market is very attractive to us in terms of size, growth, profitability, and resilience.
The industry has been consolidating for the past several years, and there are now a few major players. However, the market is still highly fragmented. Consolidation is expected to go on driven by larger players. J.A.M. and Berlin-Windward hold market-leading positions in lubricants distribution. Geographically, the two acquisitions are a perfect match for us as the footprint is complementary to our own operations, and we'll actually fill some white spots in for ourselves in terms of our own network. Both of these acquisitions add further diversity and resilience to our North American customer industries and expand both products and services for the region as a whole. To reiterate, gross profit generated by the two acquisitions is expected to be $127 million, with an EBITDA of $50 million on full year 2016. I will now happy to take your questions.
Okay, ladies and gentlemen, if you wish to ask a question and you haven't already, could you please press zero and then one on your phone keypad now in order to enter the queue? After I announce you, simply ask that question. If you find that question has been answered before it's your turn to speak, just press zero and then two to cancel. There will be a brief pause while questions are being registered. Our first question is from the line of Sebastian Bray of Berenberg. Please go ahead. Your line is open.
Good afternoon. If I can maybe start with a couple of questions. The first one is about the implication of your guidance on Q4. When I look at the EBITDA that you imply in Q4, I get to a year-on-year fall of between 2% and 12%. Obviously you probably benefit from some effects. I estimate a fall of between 7% and 17% in Q4, which is obviously a lot worse than the -2% that you saw in Q3. You seem to be implying a significant deterioration in Q4 again, and I was wondering where is that coming from? Maybe, in terms of the second question. When I look at cost inflation in the U.S., as you say, just 1.4%. Nonetheless, it was positive against obviously a GP which was down 3%. I was wondering if GP continues to fall in the next quarters.
Is it realistic to expect that you're able to cut costs year-on-year, or is that simply not feasible? Thank you.
Simon, it's Georg. Maybe I take your first question on the implications of the guidance on Q4. We do not expect a further deterioration of the business on a sequential basis.
We have some seasonality in Q4, which will impact Q4, but that does not impact the year-over-year comparison, just the sequential view that we expect higher negative growth year-over-year in Q4 as a comps issue. Q4 last year was a very strong quarter. Not sure I got the second question.
Yeah. I hope I got this correct. In terms of GP versus costs, I guess probably the challenge in terms of GP is if you look at oil and gas in 2014, it's probably one of the highest quarters for the year. In fact, it peaked in October of last year. We do have a high GP generation going into the comparison to prior year. I would say, though, in terms of costs and actually the performance of oil and gas, generally, oil and gas now, when we look at it trend-wise, it's stabilizing. We have taken some steps to reduce operating costs in our oil and gas business, but we are taking more steps to reduce operating costs in oil and gas.
It is also the case that due to a general slowdown in economic activity in North America, we are seeking to reduce costs in other parts of the business. We would expect the effect of the conversion ratio to be affected positively in that respect.
In terms of, if I can follow up on the conversion ratio, would it be feasible, would it be realistic to expect that conversion ratio in North America to stabilize over the next quarters? Is it not possible as gross profit would presumably continue to fall?
No, I think we are certainly looking at a stabilization of the conversion ratio. As far as we're concerned, we are able to reduce operating costs where necessary. To be fair, we look at oil and gas in particular, we didn't really abandon ship, as it were, as far as oil and gas is concerned in terms of our capabilities, despite a fall in the market, because there was perhaps a bit of a faux rally in the early part and towards the middle of the year where we thought maybe we were going to see some appreciation in oil prices and maybe an increase in activity. That's fallen away.
We're now taking the view that in the short and medium term, we're not expecting any recovery in activity, and therefore it is appropriate to reduce operating costs, which in effect will increase the conversion ratio for the rest of the business.
Thank you.
Our next question is from the line of Suhasini Varanasi of Deutsche Bank. Please go ahead. Your line is open.
Hi. Good afternoon. Could I please ask in the U.S., if you could give us any detail about the demand by sector? Obviously, you did say that that slowed down, and we can see from your charts that kind of ex oil and gas, that slowed down quite materially from kind of Q1 and Q2. I know that all your different end markets are not very material individually, if you could give us some guidance around it, that would be interesting. The acquisition profit contribution for next year that you've given us. Could you just give us a little bit around the assumptions that you've got underlying, kind of organic growth, any potential cost that you're taking out at those 2 businesses? How much cost could you potentially take out in the future?
Finally, if you could just update us on your pipeline. Obviously, you have done 2 big acquisitions, but the net debt EBITDA remains quite reasonable. Thank you.
Right. Just in terms of industries, I really can't give you an outstanding example of where a particular industry has fallen away. I think, which is really noticeable of a general slowdown in North America because clearly, we do track individual industries, and there isn't one which you would say outside of oil and gas that is significantly affected. I think to be fair, if you want to pare it down to individual customers by customer basis, there are some customers who are particularly hard hit in terms of exports, and we are aware of some customers and some of our international customers who are saying that their orders are not as good as they were due to the strength of the dollar. I think that is probably about the best I can give you there.
In terms of the acquisitions and the recent acquisitions that we've made, we're not expecting a significant cost reduction exercise in the new acquisitions. We do see upsides in terms of synergy gains between the acquisitions and our existing business. There is a number of products in cross-selling which we expect to introduce. Just try and give you a little bit of flavor to this. We are a very large distributor of Diesel Exhaust Fluid in North America in terms of through Brenntag's North American business. These 2 lubricant distributors will benefit from significantly improved purchasing and distribution capabilities by being part of Brenntag. There will be some synergy gains there, but I don't see this as a cost reduction exercise in terms of these 2 acquisitions. We see it very much an expansion of our share of the lubricants market. I think probably finally on pipeline.
In terms of pipeline, clearly, as we've always indicated, we are constantly looking at acquisitions on a global basis, the pipeline of acquisitions remains full. As is always, we really can't say for sure until the deals are done. Again, those that know us well, we are prepared to walk away from deals that don't meet our criteria. At this stage, I wouldn't say there's any major acquisitions expected before the end of the year, but at this stage, I can't comment more than that.
Thank you. Just to follow up on the acquisition assumptions. Could you give us a little bit of color around how much they've grown by kind of historically and what growth you're assuming for 2016, please?
Yeah. It's hard to give a gross picture on a year-by-year basis for the acquisitions. They have grown historically their earnings order of magnitude high single-digit. That is in principle what we would also expect going forward. We have taken a little bit of more cautious stance on a standalone business. We have reduced in our business plan the growth somewhat below the historic earnings profile. On top of that will come the synergies that we already mentioned. The synergies will take a little while, so most of the synergies will come in 2017 and 2018 only, and not really in 2016 over 2015.
Okay. Thank you very much.
Our next question is from the line of Robert Plant at JPMorgan. Please go ahead. Your line is open.
Good afternoon, Steve and Georg. Latin America continues to hold up well. I remember at Q2 you said that the Brazilian business had benefited rather conversely because the Brazilian currency had come off and that was good for exports. I wondered if that was still the case. Also should we be more worried about that business in the future given the macro has deteriorated in Brazil? Thank you.
It's confirmed, Rob. Hi. The Brazilian business is still doing good and had a pretty strong third quarter. The overall macroeconomic situation in Brazil is obviously not helping, but the devaluation does, and our strong ties to local producers do. We would only see this coming under pressure if the devaluation reverses, which is not really expected.
Thanks, Georg. Latin America probably continues to hold up. Would that be your view for the end of the year?
Yes.
Okay. Thanks.
Our next question's from the line of Matthew Lloyd at HSBC. Please do go ahead. Your line is open.
Two questions. First, a quick follow-up on Robert's question. How much of the Latin American growth is a product of the fact that the amount they're paying you in local currency has gone up because it's a product that is effectively priced in dollars? In other words, is it an organic growth or is it in effect a currency driver on that organic growth? The second question is to do with inventory FX costs. I was just trying to understand if you're hedging your inventory, your currency risk in your inventory, where does that sit on the P&L? Is that inside the gross cost line or does it come inside financials?
First of all, I don't have an exact quantification at hand how much of the gross profit growth comes from the devaluation effect you explained. It is a smaller portion of our growth, so it's by far not the case that our growth is actually only triggered by devaluation. It's only a relatively small contributor. Apologies, I don't have an exact number at hand.
Okay.
With respect to hedging of inventories, the hedge effect is basically in the financial result and the offsetting operating effect in gross profit.
Okay. Thank you very much.
Yeah, I would actually just like to add in terms of Brazil, we did make an acquisition of Gafor now 12 months to 18 months ago, which has proved to be very successful, and with a range of specialty chemical products in the market. To some extent, we have a degree of insulation into the performance of the products that we're selling. It's not just a question of a currency or speculation. We very much improved the quality of our business in Brazil, and we're benefiting from that.
Okay. Thank you.
The next question is over the line of Rory McKenzie at UBS. Please do go ahead. Your line is open.
Yeah, afternoon, guys. A few from me. Just a couple of divisional trends I want to go through. Just to drift back to the table on page 22. Firstly, the conversion margin in North America with EBITDA down 9%. Are you still to get the average margin in oil and gas so we can understand the mix impacts within that margin decline versus any natural negative leverage? Secondly, on Europe, looks like growth is now too low to offset cost inflation. What's your outlook for margins here, given growth isn't going to change for the rest of the year? Just those two first, please.
Can you take the European?
Yeah. Well, I'll do European first, but yeah, clearly growth in Europe is roundabout the 2% mark. Inflation could be of 3% in terms of underlying inflation. We do have the ability to turn down our variable cost in the transport over time, handling cost and what have you. Also, we are constantly, and I know it sounds to some people I know as well, it's an old story, but nevertheless, a continuing story of driving efficiency in our European business, and we are constantly seeing ways of improving efficiency throughout the region, and that has not stopped. Therefore, our plan very much is to neutralize the effects of inflation within the European operation to create organic growth.
Rory, it's Georg. On the conversion ratio, oil and gas, North America, it's pretty much in line with the overall North American conversion ratio. In fact, it's marginally lower. From a decline in oil and gas business, you don't really have a mix effect on the conversion ratio, not a meaningful one.
That's just negative operational gearing then.
Right.
Just one other question if I can. Have you carried out any goodwill impairment test, given all the acquisitions you've done in oil and gas over the last few years? I guess the outlook there must be structurally low. Any comments on that?
We do goodwill impairment annually, and/or if there is an additional triggering event in between, we don't see a triggering event right now. We do test goodwill on segment basis. For the segments Europe, North America, Latin America, Asia Pacific, there's no requirement to do an individual oil and gas impairment test because oil and gas, the way we structured our business, is not an own cash-generating unit. We do operate very significant cushions under our goodwill impairment test. From today's basis, the situation in oil and gas is not at all expected to trigger a goodwill impairment.
Okay. I guess just given some acquisitions were purely focused on the area, things like Philchem, I just wondered if that would be a triggering event, I guess not yet.
First of all, Philchem is not particularly in oil and gas, even if it were, as soon as we buy and integrate, the goodwill in the group's balance sheet is not tested on the level of the individual acquisition, on the level of the segment only.
Okay. That's clear. Thanks.
Just to add on oil and gas. The acquisition we did make in oil and gas was the LSI, which is actually a lubricants distribution business within oil and gas, which is very much a part of our development plans for the region.
Okay, great. Lubricants are more upstream.
It is well ahead of plan.
Which is well ahead of plan.
Okay.
Do not impair it.
Okay. lubricants are more upstream, is that right?
Yeah. Downstream, effectively.
Downstream.
Yeah. to the end application, yeah.
Okay. I got all mixed up there. Thanks.
We're now over to Peter Olofsen of Kepler Cheuvreux. Please go ahead. Your line is now open.
Good afternoon. Three questions, if I may. First, on the CapEx, the guidance for the full year assumes quite of an increase in Q4. Will that normalize again in Q1, or could it stay at a higher level also going into next year? Coming back on the oil and gas business. In the press release on the two acquisitions, there was a reference to a structural change in oil and gas earnings. Could you elaborate on what you mean by that? My final question is on the organic growth in gross profit per working day. I think in June, July, it was up slightly. What has been the numbers for the recent months?
I'll take the structural change. What we actually meant by that, or what I meant by that, is if you look at oil and gas in the context of Brenntag, clearly a reasonably strong part of the oil and gas business that we operate was servicing the rigs, actual drilling rigs in North America that were operating in the shale gas. The structural change is clearly that the number of rigs that were previously operating has reduced significantly. That structural change has come as a result of the dramatic fall in oil prices. At this stage, we can't see that changing in the short or medium term. That is a structural change, and clearly, we're dealing with that.
To a large extent, as you can see, the acquisitions that we've announced today, which are very much downstream, if you like, to the lubricants, but lubricants sold not into oil and gas. Lubricants sold into automotive and marine and industrial sectors are a way of effectively increasing diversity and resilience of our North American business. It's reaction to something which we can't change, but we effectively have improved our business by going in a different direction with the two acquisitions.
Peter, it's Georg. On CapEx, we started into the year with the full year CapEx guidance of around EUR 120 million for the full year. CapEx is, like our earnings, a little bit subject to translational FX. The strengthening of the dollar will work the CapEx number up a little bit towards a number between EUR 120 and EUR 130. CapEx is seasonal in our business, a lot of CapEx you will find in Q4. That would not imply that the Q4 run rate runs into next year. I would fully expect next year's Q1 to be lower again. We haven't given yet a CapEx guidance for full year next year, it will be some organic forecasting development out of the EUR 120 to EUR 130 that we have for this year. No structural change at all expected.
On gross profit per working day growth rates, I'm not sure I got your question. I think we gave the number in the presentation. I'm happy to repeat the numbers. Gross profit per working day growth on an FX-adjusted basis was 1.6% in July. Flat organically. It was flat in August, marginally down organically. In September, it was +0.7%, organically slightly negative, October was -0.5% and organically -2.1%. Be aware, it does not indicate a negative sequential trend. What it really indicates is that the second half of last year was pretty strong.
Okay. That's clear. Thank you.
Next question is from the line of Geert Van-Gansewinkel of Exane BNP Paribas. Please go ahead. Your line is open.
Good afternoon. On the oil and gas business today, I understand you correctly at the beginning of the presentation that for Q3 only, the gross profit growth would have been 3.6% if we take out oil and gas. Is that right? If I look at slide number 20, my understanding was that your U.S. oil and gas business is pretty evenly split between upstream, midstream, and downstream. In Q3, we've got about a 20% decline in gross profit year-on-year, which would suggest that the upstream is pretty much gone. Is this a run rate that we can mix the $64 million gross profit that we can see going forward? Do you see any risk spill over into the midstream as well? Probably another $20 million-$30 million gross profit at risk here.
Geert, hi, it's Georg. First of all, to confirm, yes, the gross profit growth in Q3 only for our group's business, excluding oil and gas, was 3.6%. Actually, with respect to sub-segmentation, the business is not evenly split between upstream, midstream, downstream. Midstream is currently the biggest part. Midstream is roughly 60% of the business. Upstream, a little bit less than 20. Downstream, a little bit more than 20. With respect to run rate, on page 20, you can see that our oil and gas gross profit was $65 million in Q2, $64 million in Q3. Some level of stability, and we would expect that level of stability to continue going forward.
You don't see any wells that are producing oil being turned off in the near term?
Well, I think it's very difficult for us to make that estimation. I think we are where we are. I think we've had now two, three, four months of relative stability in probably the most difficult period that we can ever remember as far as this particular industry is concerned. We don't anticipate any significant change to the current status quo.
Okay, thank you. Maybe a question on your acquisitions in the U.S. Can we model them in basically for the full year of 2016 and assume that they probably close by the end of this year?
Yeah, we expect them to close in December.
Okay. Do you own any of the other top five lubricant distributors in the U.S.?
No, we don't.
This is new business for you?
It is.
Maybe just on the multiples, it looks slightly on the high side if I compare it to historics. Can you confirm that it still hits your 14% IRR targets, even with the lower growth forecast that you have than what they achieved historically?
Gerd, it's Georg. First of all, I'm not sure I heard you correctly. We do have a lubricants business already in Europe and also in North America, but it is part of our general regional organization. We don't own any of the other top five lubricants distributors, but we do have some business into our existing organization. We do have a knowledge level and experience, some infrastructure.
Okay.
With respect to the IRR of the acquisition, they are pretty close to the 14%.
Okay, thank you.
Next question is from the line of Rajesh Kumar at HSBC. Please go ahead. Your line is open.
Good afternoon, gents. Before I ask any question, can I clarify a particular definition? If I've got that wrong, then all the questions are nonsensical.
Go ahead.
When you calculate constant currency growth, am I right in assuming it's being calculated on last year's exchange rate, and the weighted average is calculated on last year's sales numbers, gross profit numbers? Or do you?
It's on this year's exchange rate. We basically compare this year's result at this year's exchange rate with last year's result at this year's exchange rate.
That's very useful to understand. Good. When you restate last year's numbers in this year's exchange rate, do you restate it versus $ or versus your accounting currency EUR? Because if I'm a
Accounting currency.
Okay, I'm a chemist, and I've never seen chemical prices quoted in any other currency than dollar, which is why I was a bit careful in clarifying that.
I understand. We would probably comment that while we distribute chemicals, we are not a chemical company. The product prices themselves and the volatility of the product prices does not really impact our gross profit.
Yeah. To be fair, when you're looking at dollar-denominated currency for chemicals, you're really looking chemical trading, which isn't our business.
Okay. When you distribute chemicals, you don't take it on your balance sheet in terms of the inventory. You do take it on your balance sheet?
We do. Yes, definitely. We do take it onto our balance sheet, and generally speaking, we're actually functional. Both the sale and the purchase is in the currency where we're operating. We buy in U.S. dollars, we sell in U.S. dollars. We buy in euros, we sell in euros.
I totally understand that. Suppose if I'm selling in Brazil and I sell BRL 100 last year and I sell BRL 100 this year, I've actually contracted in real terms because the nominal price is in U.S. dollars, and that means either a volume or pricing decline, isn't it? It does flow through your accounts in that fashion.
I'm not sure I got your point.
Okay. In very simple terms, if suppose I sell you something, a customer comes and buys something for $100 last year. Suppose the trade is happening in Brazil, you obviously will quote the price in Brazilian real. But most chemists, most chemical engineers are going to look up the price in dollar and then convert it in real. That is how the industry works, if I understand it.
Okay.
If last year, I looked up $100 worth of sodium hydroxide, and this year I do $100 worth of sodium hydroxide, local currency-wise, I would have got 35% growth. That brings me to my first question, because if LatAm currencies on an average have derated versus dollar by 15%-20%. Your constant currency, 1.5% decline tells me volumes must have been off double digit. Am I completely getting it wrong or not?
First of all, I would point out for the benefit of the larger group, the example you are addressing, the Brazilian example, is a relatively specific example that does play a role in our group, but it's by far not so relevant in our group because the 80% of the business are actually in Europe and North America. Nevertheless, taking on that example, you are right, that probably all other things being equal, the selling prices and our gross profit in Brazil this year in real is higher than it was last year for exactly the effects you mentioned.
Again, the real devaluated against the euro. If I state constant currency growth rates, I lose that advantage back again. There is no meaningful technical effect in our group accounts which impacts growth in that respect.
How do you lose that at 100? I mean, you reported 1.5% decline.
Can I suggest we take that offline to IR? I think it's a long explanation that goes beyond this call.
Okay. If I can just clarify the second question.
Of course.
If I look at the inventory turn in US dollars, which perhaps is the natural currency to calculate that has been coming down and you have guided towards that because obviously you're getting more business out of specialty chemicals. Could you give us some color on how much of that is mixed between bulk versus specialty, and how much of that is dollar weakness?
None of it is dollar weakness. A little bit of it is-
Right
a little bit of it is mix shift.
Not too much. The remainder of it is being challenging market conditions.
Great. Finally, just the last one. I promise this is the last one.
No problem.
If your accounting for inventory is done at the average cost, I mean, if I look at any American chemical distributor, they would tell you what the FIFO reserve was, because obviously in a falling price environment, the impact on gross margin with a FIFO accounting would be greater. Just trying to get a sense of would the underlying gross margin decline would happen if the accounting was FIFO.
It's absolutely marginal. We are turning inventory very quickly. We are turning inventory on average every five, six weeks. It's a very price volatile product. We very often turn within days. The average pricing impact on inventory is very marginal.
Thank you.
We're now over to the line of Carl Raynsford at Credit Suisse. Please go ahead, Carl. Your line is open.
Thank you very much. I've got two or three questions. I'm sorry to go back to this FX question, which I'll try and ask in a very different way, just on Latin America. Could you just explain to me in simple terms why there's only a four percentage points FX impact in Latin America when you're invoicing in the dollar, which has strengthened versus the euro or local currencies, which have weakened against the euro? Is it just a mix of those two items or what else is going on there? I'm just not clear as to what's being invoiced and how much of that is local currency. That's my first question.
Can you shoot the second question?
Yeah. Sure
about the answer on the first one.
The second question is more about European growth, profit growth. If you strip out Fred. Holmberg and Kemah, then it looks like organic growth profit growth in the third quarter was only about 0.7%, which is lower than industrial production. I just wondered, is there something specific going on there, given that you have got exposure in the Spanish market, which is recovering quite nicely? Are there any countries where you've seen a material deterioration in the third quarter? Is there any greater competitor activity going on in Europe? My final question, which might somehow be linked to FX, but I'm not sure, is the other financial results within your interest line. That's been very volatile over the last three quarters. It was +EUR 0.3 in the second quarter, and it was -EUR 10 in the third quarter.
Can you just talk me through exactly what's in there and why is it moving so erratically?
Maybe just on Europe. There's not one particular industry or country that's showing major variations at the moment. That 1.5% sort of growth rates in Europe at the moment seem to be what we're able to achieve. We're not totally satisfied with the performance, but there isn't one particular element that you could point at and say, "That's pulling down the results.
On the relatively modest difference in Latin America between as reported growth rates and the FX adjusted growth rates, my best estimate at this stage is that by far, most of the devaluation took place relatively early this year, so that on Q3 this year, over Q3 last year, the devaluation impact is actually not that big. I have to reconfirm this with the data and we have to come back to you with reconfirmation.
Okay. Thank you.
The other FX result is part of financial result. It's basically FX gains and losses from hedging, and it goes back to what was asked on this call a little bit earlier. That's the operating effect on devaluation, you basically have in gross profit, but the offsetting hedging effect in financial results.
Just to be clear, does most of that hedging apply to Latin America, or is it equally applying to Asia Pac as well?
The higher share applies to Latin America, but a fair share also applies to Asia.
It's kind of best to look at the emerging market performances in light of that result rather than in isolation. Okay, thank you very much.
I agree. Mm-hmm.
We're now over to the line of Christian Faitz at MainFirst. Please go ahead, Christian, your line is now open.
Thank you very much. I just have three small questions. First of all, I would like to ask if there are any implications on 2016 from your guidance on the Q4 for this year. I guess that the negative effect on your earnings development within oil and gas business will persist as long as the situation in oil and gas is unchanged. On the other hand, do you think that you might overcome any shortfall in the first half of 2016 already thanks to the headcount reduction you mentioned and any efficiency gains? Second theme is around the guidance for 2015. You say that the oil and gas does leave around EUR 30 million leak in 2015 or shortfall, which should roughly translate into EUR 12 million on EBITDA, if we take into account 40% conversion ratio.
Taking into account that you cut your 2015 EBITDA guidance by around 5% or EUR 45 million on midpoint, I just would like to ask where the difference is coming from then, and I think it would be very helpful if you could please break that down a bit from this side. Lastly, on the working capital effects for the remainder of the year, do you expect the current trends to continue, and also the cash flow to continue? Thank you very much.
Just in terms of 2016 relative to gross profit development and general growth of the business. We will go into 2016, so the Q1 will be quite a strong comp, versus 2015, which we're expecting. We do see that clearly there's still structural growth in our business. We still see outsourcing. We still see all the elements that we might expect to enjoy as a large distributor. Therefore, we will be seeking to regain effectively our momentum in terms of growth by capitalizing on those elements of our business. We think we will be through oil and gas in terms of the oil and gas situation is likely to be stable, and therefore, we've a solid platform there, which will not have the effect that it's had this year. I'm expecting the business to start moving forward again in 2016 with our normal business plan.
If I understood your question correctly, a little bit of detail and color, where the guidance reduction is to be allocated to. I would first of all say, if you take the EUR 30 million gross profit reduction in oil and gas and translate it into an EBITDA shortfall, we don't have an exact number, but you would have to use a higher conversion ratio than 40% because there is some operating leverage which works somewhat towards the negative in this end. You probably more end up with a EUR 20 million, if not a little bit higher, EBITDA impact from that. The other effects, which we basically saw over the last quarter, I would like to point you again to page 21 of the presentation, which on the right-hand side has quarterly industrial production growth figures in North America.
Kind of a proxy of the development in all our other customer industries. The industrial production growth came down sharply. It was 3.3% in Q1, 1.8% in Q2, and 0.9% in Q3, and that is basically what impacted the remainder of our North American business. We have a similar, but by far not that strong effect in Europe, where also industrial production growth came in at pretty low levels.
Just to add to what Georg is saying on oil and gas, I think I referred to it earlier, that we did not automatically reduce our cost base severely in our oil and gas business to reflect the lower operating conditions. We now realize, well not realize, but we now recognize that we're not looking at a short- or medium-term development here, and therefore, we will seek to reduce that in the course of the next two, three months. Georg's completely correct in terms of the conversion ratio that you should use. Give you a nearer EUR 20 million as opposed to the 12, I think, which you mentioned.
Thank you very much. That's already very helpful. Just to come back on the working capital effects that we might see, and secondly, one follow-up. What time frame would you think is needed to, let's say, work a little bit on the efficiency, just to get some kind of feel? Thank you very much.
The working capital, we generally point out that price levels of chemicals are not very relevant for our profitability, for gross profit and EBITDA. Price levels of chemicals are relevant for working capital and can cause a little bit of volatility. From today's perspective, we do not see an upward trend in chemical prices. We see stability to some further declines. In that scenario, we do expect a continued, very strong cash flow from working capital towards the end of the year. A time frame on efficiency gains, the easy wins, three to six months.
That's great. Thank you very much.
Thank you.
Okay, looks like we've got a final question in the queue, that is going back to the line of Carl Raynsford at Credit Suisse. Carl, back to you.
Thank you very much. It is just one small follow-up on the working capital. We heard from Univar earlier this week about them pushing up inventories to improve their service levels to customers. Are you seeing similar demands from your customers just in terms of thinking about those pressures on working capital terms over the next 12 to 18 months? In addition to that, is there any kind of pressure on payment terms you're seeing from any particular customer segments? Thank you.
Well, firstly, I'm not quite sure why Univar's changing their policy on stocking, but our business is already configured in the shape you might expect it to be to meet customer service, so I won't be changing our policy on that. What was the other part of the question? I'm so incensed by this.
Payment terms, customer suppliers.
Yeah. Look, I think there's pressure in just about every direction under payments terms. Both suppliers and customers are all searching for payment terms, and we're pushing back as hard as we can. I think the important thing is that we are on top of that, but I don't see us being in a position where we should be significantly affected by this, and I think the working capital term is a number which we look at very closely.
Thank you.
Okay, gentlemen, as that was the final question for today, may I please pass it back to you for any closing thoughts or comments?
No, I think that's it. I think thank you very much indeed for all your questions, ladies and gentlemen. I think we can probably end the call there.
Okay. Well, this now concludes today's call. Thank you all very much for attending. You may now disconnect.