Earnings Call: Q1 2021

May 12, 2021

Good morning, ladies and gentlemen. Welcome to the SKF Holland SE Content Call Regarding Q1 2021 Results. At this time, all participants have been placed in a listen only mode. A floor will be opened for questions following the presentation. Let me now turn the floor over to your host, Mr. Ihean Schickling. Yes. Good morning, and welcome to our Q1 2021 analyst and investors conference call. This morning, we have published a full set of numbers as well as the presentation slides used in this call. Your host today will be Alexander Geist, our CEO and Inger Kolljorn, our CFO. We will start with the presentation followed by a Q and A session. I now would like to hand over the microphone to our CEO, Alexander Geist. Thank you, Mr. Schickling. Good morning, ladies and gentlemen. A warm welcome to our Q1 2021 call. This is Alexander Geist, and together with our CFO, Ittak Kolljonen, we will be explaining you how your SFRON performed in the Q1 of this year. Our presentation consists of our highlights presented by me, followed by our financial performance explained by Inka and the future outlook for the remainder of the year done by myself. Please, let's get started on the next page with our main KPIs. In the upper left corner, you can see that we came in with €286,000,000 versus €283,000,000 the year before. Sales performance was mainly driven by the APAC and EMEA region. Due to structural cost cutting pressures in all regions, combined with a higher gross profit margin and our adjusted EBIT increased from 6.5 percent in Q1 2020 to 7.7% now in Q1 this year. Due to the rebound of markets and steady demand, our net working capital ratio increased from 13% to 14.4% in the Q1. This inventory buildup and filling of supply chain is the main reason for a breakeven in regards of operating free cash flow. And last but not least, our CapEx ratio with 1.9% was a bit lower than in Q1 2020. Some more details to the crew performance on the next page. Starting again with the upper left, our sales increased by 0.8%. Adjusted by FX, sales increased by 5.6%. Worthwhile to mention that despite increased OE sales, we maintained a high aftermarket share with roughly 27%. And speaking of our adjusted EBIT margin of 7.7%, the main drivers are the structural work we did in 2020 and, as I explained before, an improved gross profit margin. I am also happy to report that we are done with restructuring now. In Q1 2021, our restructuring costs were only €200,000 What is only left then is our PP and A. But Inka will speak about this later on. Now let's take a look how the regions performed on the next page, please. Sales in EMEA came in with €168,000,000 which is a 7% increase compared to last year's quarter. Adjusted by FX, the increase was 9.4%. As a reminder, our OE business in Europe is 90% plus in the trailer business and less than 10% in the truck business. And the trailer builders are not much affected by the semiconductor shortage and are sold out already into summer or winter, depending on the trailer application. We, as SF Holland, are booked out in our 2 German and 1 Turkish plants already until autumn. And beginning of April, we moved the biggest axle plant for here in Germany from a 2 shift operation to a 3 shift operation already. And beginning of May, the other two plants, the other one in Germany and the other one in Turkey, also from a 2 to a 3 shift operation to fulfill the demand of our customers. In the meantime, we do have a good mix of small, medium and big customers and also further increased our XL market shares. So I'm confident to further increase our sales in the remainder of the year. EMEA's adjusted EBIT reached a solid 9.6% in Q1 'twenty one, and we are confident to be able to counterbalance also the material price increases in Q2. On the next page, we speak about Americas. And here, our sales came in with €90,000,000 which is a decline of 14.2% or adjusted by FX, still a decline of 5%. The main reasons are the cleanup of loss making products and product lines and unfortunately, the 2 winter storms we had in Texas in February where we lost nearly 2 weeks of production. Truck business, which includes the 5th wheels and truck suspensions, is running very well. And in the trailer business, we are now adjusting our strategy to a much better customer mix, means we are focusing on medium and small trailer builders rather just focusing on the big five. And results to come will be risk mitigation, product packages to all customers and higher margins. The work we did last year is paying off. And thus, as you can see, the adjusted EBIT margin increased from a 3.9% last year to now 6% in Q1 2021. APAC on the next page, please. And here the good news upfront. We don't earn any money anymore in APAC. Sales increased from €21,000,000 to €27,000,000 in Q1, which has increased by 28% or adjusted by FX by 32% increase. Our adjusted EBIT margin came in with a positive 1.4% versus a negative 2.4% the year before. Main drivers were the volume increases in India, good performance in Australia, and our China business is now trending in the right direction. And also here, worth mine to mention, no more restructuring to be done in APAC. And here, I would like to pause for a bit and hand over to Inka. Thank you, Alex. So good morning from my side. It's Inka Kollinen speaking. And I would like to continue with the investments. As you know, our CapEx guidance for the full year was about 2.5% of sales. Year to date, we are at 1.9%, which is normal since the CapEx expenditures do not occur on a linear basis. So the full year guidance is valid and will be achieved. If we look at the absolute numbers due to the sales increase versus previous year, we will be spending additional CHF 2,000,000 to CHF 4,000,000 in absolute terms versus last year. The focus of this additional CapEx spending is efficiency improvements and further optimization of the production process processes at the German and especially also in the U. S. Locations. Then let's have a look at the net working capital. Here, the gray bars are the 2020 numbers and the orange bars are the 2021 numbers. You see net working capital ratio for Q1 is at 14.4%, which is higher than previous year rate of 13%. Main driver here is the basis for the ratio, which is the sales of the last 12 months, which were now lower than the year before due to the pandemic. Nevertheless, it's clear that in a boom phase and in the revenue growth phase, we are building up net working capital versus the end of 2021 2020, sorry. Main reasons here are tightness in the supply chain, the raw material availability and also the higher costs of the inventories. So at the end, it's our conscious management decision really to secure delivery performance and invest into inventories. And at the end, it's really a growth driven increase of the net working capital. If we look further into the year, definitely this ratio will be decreased going forward, coming back to a more normal level towards year end. Then on the next page, the cash conversion rate. This is clearly the math. So we see that the cash conversion rate is affected by the net working capital increase and is going down to a level of about 30%. Here also, in the course of the year, there will be a significant improvement, which is already expected for Q2. Then our leveraging ratio on the next page, please. Balance sheet structure has further improved. It's a very positive development. Here we see the development of net debt to EBITDA ratio in the past quarters. And you see that we are clearly coming down from the peak in the pandemic of where the ratio was at more than 4x to a level of 2.25, which is clearly within our range of 2 to 3 and represents a really healthy balance sheet structure. Our focus going forward will be to keep and further enhance this ratio, but it's clear also that this financial profile provides us good flexibility for future growth, which is mainly targeted in the organic area. So with that, I would hand back to Alex to provide a view of the outlook. Thanks, Inge. Ladies and gentlemen, how we see the markets developing in 2021, you can see on Page 13, please. Starting on the left side with Europe, you can see new now truck plus 22%. Of course, we have to see how the shortage of the semiconductors will be developing in the remainder of the year. Trailer with a strong plus 20 percent North America, truck, plus 42, trailer also plus 42, South America with a strong 30% plus in truck, trailer plus 16. Percent China, a little bit of a mixed picture truck with still a little bit of a decline from minus 5% to minus 10% trailer, nearly on the same level with 0% to plus 5 And last but not least, booming India at the moment with truck plus 114% and trailer with 182%. So to summarize that, as you can see, significant rebound in North America and India and also higher volumes in Europe and South America and China with declining truck volumes. We have to see how that develops in the rest of the year. And on the next page, we come to our guidance for 2021. And as you have seen on the pages before, we already delivered a solid Q1 in 2021. But given the circumstances like the COVID developments in India, slow vaccination speed in Europe, the raw material and supply chain challenges, we would like to remain cautious with an unchanged guidance and sales to be in the range of €1,050,000,000 to €1,150,000,000 adjusted EBIT margin to be around 7% of sales and as Inger already mentioned, CapEx to be at around 2.5% of sales this year. And on the next page, I would like to summarize as follows. So we are benefiting from the upswing in Europe, Brazil and India based on our leading market positions. And as I mentioned before, the U. S. Trailer business to follow shortly to a new strategy. Our structural cost cutting measures bearing fruit and are sustainable. We focus on a disciplined approach to manage accelerating customer demand and working capital investments, and a further deleveraging is expected and can be expected. And material price increases are already included in our full year guidance. Dear ladies and gentlemen, we did our homework in 2019 2020. EMEA performs very well. Americas is back on track with an upside potential. And APAC is going into the right direction with more to come. Thanks for your trust in us. And I think we are open for questions now. Thank you. And first question comes from Philip Horaei of Zarzaur. Two questions from my side, one on the market and the output perhaps and also the second one on the product portfolio in the Americas. So I start with the one on the market. Can you raise substantially your outlook for the truck and trailer markets, yet you keep the same guidance unchanged? You've mentioned as well that you want to be cautious, especially with regard to the supply situation and the ship shortage and so on and so forth. I also appreciate that FX can have an impact there. And you mentioned that you're fully booked for until the autumn in EMEA, which is just backing your guidance so far. But what would be holding you back from raising the guidance on sales at that stage? Is it just the effect of blocking what you see on the market in terms of supply situation? Or perhaps there's something else, but I don't really understand, especially since you mentioned as well natural price increases included in the full year guidance. Okay. Good morning, Filipe. This is Alex Geiser. I would like to take that question, of course. Well, we learned our lessons in 2020, let me see. Let me say, due to the COVID circumstances that you could not really plan what's going to happen in the next upcoming months or quarters. We see at the moment, there is no shortage in our trailer business, starting with EMEA in the trailer business. So there is not much effect on the shortage of the semiconductors. What we might be seeing is and what is a little tight at the moment is the supply chain across the world. So there is a shortage of sea containers coming from Asia to Europe but also to the Americas. This is what we are watching carefully. But also the availability of plastics and rubber is getting tighter. Also the material prices are increasing. So we talked a lot with our trailer companies, especially here in Europe. We are watching that very carefully. And this is why we would like to remain cautious because we don't know what's maybe there's something popping up in June, July or August. We don't see that on the radar at the moment, but we would like to remain cautious. But as I said before, we increased the production capabilities in our plants, and we are looking forward to a very strong Q2. This is what I can already say. Okay. I think that's fair. So just to clarify, the market outlook that you show on that slide, that's not what you used for the sales guidance. And that's also worth not what you are using when you are presenting the full year numbers. Well, it's a combination. Of course, we use the guidance the market developments for the remainder of the year, but we incorporated a safety, let's say, safety level for us because we don't know what is going on in the Q3 Q4. We don't see anything on the radar popping up, but we would like to remain cautious. Okay. And the safety net is basically, I mean, it's increased just because you're starting the year with a related issue in H1, but you just want to make sure that you reach all the targets? Yes. Okay. Perfect. And the second question was just on the Americas and the product portfolio there. You mentioned that you had some effect as well resulting in the sales decline and that was related to the cleanup of the product portfolio as well as all the rest, like with the retail related storms and so on and so forth. When should we expect the cleanup of the product portfolio to be finished completely? Well, what I already at this stage can say that we cleaned up about 50% of our product portfolio in the U. S. Americas is mainly driven. Our production facilities are mainly in the U. S. Canada, Mexico and Brazil, we can put a check mark behind that. They are running quite well for us. We have a couple of plants in the U. S. And as I said, we already cleaned up about 50% of all the plant numbers, which then enables us to really focus on the main parts and the main product groups. This is what we did already. So we are nearly done. And just to give you some examples, specifically in the trailer business, what we did, we stopped loss making products for trailer applications like bucket tubes, okay? We saw bucket tubes as a loss. That's high sales, but it doesn't make any sense because we are losing money. And we are refocusing also, as I explained earlier, now on the medium and smaller trailer customers in the U. S. And also Canada. This is what we changed a couple of years in EMEA, not so much focusing anymore on the big ones rather than now focusing on the small ones because then it's a wider range of customers and this comes also with a better sales and a better profitability. This is what we are changed already in Q1 now. Okay. That's fair enough. Do I understand that correctly? Did you have as well like some kind of product portfolio adjustments outside the U. S? Or was it just like me understanding that? The main product portfolio adjustments were done in the U. S. Europe, we did that already a couple of years ago, but this is an ongoing process all over the world. But the main drivers we see in the U. S. Where we had an inflation of different products, which added a lot of complexity. And so we put them back now, and we are on a good way to further or finish this. And this is also the reason why we increased the profitability in the U. S. Less complexity, more focus on the main product groups, and this is also what we'd like to continue in the remainder of the year and the years to come. Okay. Thank you very much. Pleasure. We have a couple of more questions. The next questioner is Mr. Jan Erik Schmidt of Lloyds AP. The floor is Hi. Thanks for taking my question. I just have three quick questions. So the first one would be on EMEA, the margin development. So we've seen in Q3 and Q4 really good margins given a lower sales number. I was wondering kind of like what happened in Q1 that even though we had a higher sales number, margins were a bit lower? Okay. Specifically, in the last quarter of last year, we had a little bit of a mixed percentage OE versus aftermarket. Aftermarket traditionally comes in with a higher profitability or much higher profitability. This is the reason why we had a little bit higher adjusted EBIT margins in Q4. And in Q1, we already saw an increase in OE business, which is a good thing for us. But the lower the aftermarket percentage, of course, that has a mix on the an impact on the overall margin. But we came in with a 9.6%, which is still a very good number for us. All right. So it's just a pure product mix effect and margin? It's a product mix effect, yes. All right. Okay. And then on the networking capital side, I think you mentioned that you due to the tightness in supply chain, you want to increase it. So kind of like what is the charge that you're aiming for in absolute terms? I mean, percentage wise, it's obviously going to decrease or kind of like normalized a little bit just to increase the sales numbers given you're calculating it in the last 12 months. So just wondering like what's the absolute level of networking capital when you say you want to increase it a little bit to make sure you kind of like have all the supplies you need? Yes, sure. Maybe I can take that. So I would say the main increase was really done in the Q1 when we saw that raw materials prices are increasing and when the situation has started to really gain dynamic regarding the tightness. So I don't expect any further, I would say, conscious increase outside of our normal system. At the end, we are not guiding towards an absolute net working capital level. Clearly, towards year end and in the further course of the year, the ratio will substantially improve. And already into Q2, we will have a significant improvement. All right. And the factoring is lower at roughly €30,000,000 to €40,000,000 right? Yes, it is more or less at the same level. So no effect out of the factoring to the net working capital. All right. Okay. And then lastly on the leverage. So if we assume just kind of like increase in EBITDA given the better results throughout the year, I'm just wondering what you're going to do with the cash you were talking about purely organic growth. So what's the cash usage basically? Is that going to be in some sort of buyback dividends? Or is that just going to be accumulated or what's the target there? Yes. So I mean, I would say we are looking and evaluating all options. Of course, the primary focus and target is to keep and enhance balance sheet structure. So we clearly don't want to come back to the levels where we were and the 2 to 3 times is really a maximum leverage ratio that I think is a good one. At the same time, yes, on a regular basis, we are looking at potential targets. But if we were to go for something, we think that this should really make a difference for us. And also with the multiples being at the moment where they are, it's not that we are running after these extensive targets. So if everything adds up, timing, the situation, the target, I think it could have a flexibility, but really the focus is on organic growth. All right. Okay. Thank you so much. We have one more question. It comes from Mr. Harald Hedling of ODDOS. Yes. Good morning. Thank you for taking my question. Basically, I was wondering how you or what your vision is for EPIC region. Basically, I'm wondering what you see as a midterm EBIT margin potential and how steep the trajectory could be given that I assume it's mainly OE driven business for the time being. So do you see the potential to be in 3 years on group margin level? Arald, this is a very good question. Of course, what we are not going to do is to guide different regions. But being with the company for quite a while and see what EMEA was capable of developing to and also now seeing that Americas is trending in the right directions and we already had better margins in the past there. The target is clear for us that region shouldn't be margin dilutive to the group result, okay? We have a good setup. We restructured the whole region a lot. We closed a lot of companies, loss making subsidiaries. We have now the spread in Australia. We have a base in Singapore and India. We are the market leader in trailer axles and suspensions. We have now our new setup in China, and this is only one setup now. And the clear target is to be further increase in sales. We have good products and a good team. We are ready now. And also, this should be coming with a certain capability. But without guiding anything, it is clear that region shouldn't be margin dilutive to the group. Okay. Thank you. There are no further questions in the queue. Therefore, I will repeat. Yes. And we have one more question coming from Mr. Johannes Reiss of Ableton. Please go ahead. Yes. Hello. This is Johannes Reiss. Maybe 2 short follow on questions. Maybe again on the U. S. Market, if I see your market forecast for the U. S. Market, which is quite strong compared to your own figures and some measures you meant, the reason why you may be having weaker in Q1. Is it right to make it clear again that there could be a stronger uptick in the further development of the year, especially in the second half for your S business? Johannes, I will take this question. Alexander here. You are totally right. We have we predicted a strong increase in truck and trailer after a massive dip the year before. We are doing very well in the truck business. So the 2 main product groups in truck is the 5th wheels where we are market leader and also truck suspensions. So we are fully booked. We have one dedicated plant in Texas for the 5th wheels. In Dumas, Arkansas, there is one dedicated truck suspension plant. We are also fully booked. And we see a strong increase in the Q2. Hopefully, we can solve the material and supply chain because this is really a struggle in the specifically in the U. S. Now. On the trailer segment, it's also the market wise. It's an increase where we saw a huge drop in the last year. So the drop in trailer was more than in the truck business last year. Here, we were focusing a lot on eddies brake axles. This paused a little bit in 2020. And also what we did in the past was only, as I said before, focusing on the big 5s trailer builders. While you are really reliable on those customers and we changed now our focus on the medium and the smaller ones, which is about 100 to 150 different trailer builders, We have a new team in place, a new head of sales. We also would like to participate in that. We for sure will in the truck business in Q2, and we see already the numbers kicking in. In the trailer business, we have a little bit more to do, but I also confident that the team will manage that in the remainder of the year. So maybe stronger second half is there a good chances if maybe the shortage of component maybe is not a hit, that's maybe the risk. And second question regarding Asia. How optimism is your optimism that you can go on with a strong upside? Obviously, is the situation in China, especially in India, where you have a strong market, what do you hear from other sectors, for example, today from the technology sector, as we see a clear hit from the COVID situation there? Is it only a short term impact? Do you see anything at the moment? And therefore, is there a risk that maybe at least in Q2 this could contribute in some regard, especially in India? Yes. Okay. So we don't see any tendency that APAC will not be developing in the right direction also in Q2 and going forward, okay? As I said before, we did our homework, and now the teams are working on profitable sales. So I'm confident that we can achieve that and further increase our, let's say, sales numbers and also the margin numbers. India, we already had a good April. This is what I can say, very outstanding. In May, for sure, there will be a hit, not because we cannot produce. So our team, knock on wood, is healthy. We don't have so many COVID cases. So we can produce, but we can see that our customers, specifically in the trailer, but also in the truck business, and in India, mainly a trailer gets sold with a truck combined as one unit, that they have to take out shifts, close productions. So we see that the sales is slowing down in May. We will see how that will be developing into June. What we heard is that a lot of areas in India will be closing now down for 2 weeks, okay, in total. This will hopefully get a release. But we are watching that, but we are confident that we can overcome that. And we are not only selling our engine products made in India into India. We also have a good export business. And this is what we keep running there. Thank you. We have one more question. This is a follow-up question from Mr. Philippe Laray. Please go ahead. Yes. Thanks for taking the follow-up question. It's just regarding the U. S. Market, something back on Johannes' question. Did you observe as well that cycles there tend to be shortened now? And if that's the case, how are you coping with that in terms of preparation for strong upswing and also possibly strong and forecast declines as well? So first of all, we don't see that the cycles are becoming shorter. At the moment, we are in constant talks with our people there and our customers also. Well, the cycles are in the U. S. Always, let's say, very tough, not as in Europe. The cycles are really huge in the U. S. What we see now is order intake specifically in the truck business is outstanding. We are still capable of dealing with the material and supply chain, but it's getting tough and specifically getting good workers. So if you have to install a couple more shifts and well, the shortage of workers, blue collar workers, this is ongoing, and this is tough, I guess, for the whole industry and not only for our industry. We could do that. We are dealing with that. How this will be developing in the future, I cannot say. But we don't see that the cycle will be coming shorter. Okay. That's interesting. Thanks. Thank you. Mr. Gentlemen, if you still have There are no further questions in the queue. I'm Henry will come back to the company. So ladies and gentlemen, thank you very much for your participation and your questions. If you have any further questions, please do not hesitate to contact Investor Relations. Have a good day and take care. Thank you, everybody.