Earnings Call: Q3 2020

Oct 27, 2020

Good afternoon and welcome to Kemira's Q3 results webcast. My name is Mick Quahal and I'm from Kemira's Investor Relations. We continue our social distancing measures today. And as in the previous quarters, we only have a webcast from our headquarters here in Helsinki. And here with me, I have our President and CEO, Jeri Ruus Sendal as well as our CFO, Petrikastrein. Earlier today, we published our Q3 results for January, September period. And in addition, we announced that the Board has made a resolution on the second installment of the dividend. During the webcast, Yari and Petri will go through Q3 the main events, after which you will have the chance to ask questions either via the teleconference or then via the webcast tool. But without much further ado, Jari, please go ahead. Okay. Thank you, Micko. Good afternoon from my side also. As you've seen from our numbers, we have continued performing well despite the special circumstances of the COVID-nineteen and the economic downturn it has caused. Q3 operating conditions was mainly a continuation of Q2, but now we are operating more steadily as in Q2, were still learning the new circumstances. Unfortunately, after the summer, the pandemic situation around the world has again gone to the wrong direction, except in China. So these conditions will provide for some time to go. But all in all, I'm pleased how we have been performing during these special times. So some of the Q3 highlights. As said, continued operating all our plants, and there has been no disruption in supply chain or raw material availability. Our revenue has come down, but mainly from oil and gas and printing and writing applications. And those have been hit most by the pandemic effects. Profitability, however, was good as some raw materials helped us, but also majorly our own self help actions have been helping us. We've been doing a lot of self help during the last years, and that's now carrying and contributing and helping our profitability. We reached an operating EBITDA of 113,000,018 point 9% of revenue, which I'm really pleased about. We also updated our outlook in early October and basically returned to the original outlook for the year. And as Mick mentioned, the Board decided on the second installment of the dividend. So let's look at the main figures of Q3 on a group level. Revenue, $597,000,000, down 13% year on year and, as said, mostly from Oil and Gas and Printing and Fragging applications. Without Oil and Gas, the organic drop of revenue was 5%. As said, operating profit, strong. Even if the revenue dropped, we got some help. And really, the efficiencies also from our new investments that started late last year and early this year are really contributing now, and the ramp up is going well. Earnings per share, zero two four and strong cash flow. I wanted to talk about a bit of the longer perspective. We have done a lot of self help actions during the past years and many actions have small increments. It takes time to get into run rate profitability. During the second half of twenty nineteen, most actions started to be in or just coming in, and that got us to a good run rate start from the beginning of the year, which was good and supporting this difficult situation that started then in March. Progress is clear, what you can see from the graph. And there are seasonalities between the quarters. And for instance, the last quarter of last year, we had some start up cost of new plants. So some fluctuation sometimes, but you can see the clear trend in profitability development. Then looking at Pulp and Paper, had a strong quarter. Demand has continued fairly resilient in the big picture, especially Pulp, Packaging and Tissue is resilient. And as said, Printing and Writing down 16% year on year as people are working remotely and newsprint and advertising papers are down. Revenue, euros $352,000,000, only 5% down organically. Also, were maintenance shutdowns by the customers in Q3, which normally hits Q2, but now they were delayed because of COVID-nineteen. The new plant, AKD plant in China, continued to ramp up well and is contributing nicely to the bottom line. Our AKD business before this plant was not very profitable and not meeting our targets. But with this investment, we now get it to a reasonable level, not stellar, but reasonable level. And that's now part of the improvement compared to last year. It's also a bio based sizing product, so it's in the heart of our strategy. As a reminder, with this new plant, we insourced some manufacturing steps that we were buying from outside, which created more cost for us. And now this benefit is shown in the variable cost. We also, in Q3, received an emission trading right compensation that then benefited this quarter more than normal. Looking at Industry and Water. Water treatment chemicals are always needed that supports I and W even if the oil and gas demand is down. Municipal water treatment demand remains steady, actually up year to date, a couple of percentage points. Industrial Water Treatment recovered some from Q2, also some recovery in shale in Q2, not huge, but still the right direction. Organic revenue, down 18%, most drop from oil and gas. Still operating EBITDA reached €47,600,000 and 19.5% from revenue. And the new line for Special Polymers for CEOR applications in Netherlands is running now nicely and contributed to the profitability as we, again, in this case, insource some outsourced steps earlier. And that is going according to our investment plan as designed. Then a bit deeper look into oil and gas. Shale demand, as said, still low, but recovered some from Q2. You can see that we bottomed at 27,000,000 of revenue in Q2 and now 41,000,000 in Q3. But then you compare to 2019 run rate level, still low, but going to the right direction. Oil sands tailings treatment demand also down compared to 2019 as customers were saving cash this year, and that's because of the oil price real volatility in the first quarter. This should the oil sands demand should return to normal next year. And it's a long term thing. They need decades to treat those legacy tailings. The tailings treatment season has now ended. As winter is coming, the next season starts in April, when the snow and ice melts. CER, no changes in demand. Actually, year to date, we are even up 3% in revenue, even if the pricing has gone down through the formula pricing in those contracts. And we signed a multiyear continuation in CEOR with Itaka Energy that operates at the North Sea. This secures good volumes for us for the next years to come and good load to the new line that we have in Bottlek. Short term, we continue to focus on mitigating the effects of the pandemic. And so far, we have succeeded well. When things allow, we start gradually reverting to office. However, during last weeks, as you have seen, the situation has worsened in many countries, and we are being conservative and staying safe. Tight control on cost and running operations and realize the benefits of our new investments. Medium to long term focus areas keep meeting our financial targets, focus more on profitable growth, continue to construct the polymer plants in U. S. And in South Korea and then the expansion for bleaching capacity in Uruguay to support the UPM new pulp mill. All customers are placing increasing focus on sustainability in their operations and in their products. We have increased Kemera R and D focused on barrier based products going forward and supporting recyclability. Finally, I'd really like to thank the Chemera staff for a good quarter. That's my summary for Q3. Next, Petr will give some more color on the financials. Very good. Thank you, Yari. Really, the quarterly report for Q3 has a lot of the same themes as we had in Q2, meaning strong profitability, and I'll talk about the drivers behind that. Volumes on the other hand, obviously driven by the COVID induced economic downturn and then our good cash flow and capital efficiency. I will also touch on the outlook and then assumptions behind it for the full year and second half of the year. Looking at this traditional profitability bridge, revenue declined 13% as Jari mentioned, mostly due to lower volumes. However, with the 3% impact from FX And the currency impact is primarily because of the weakening U. S. Dollar during the quarter. And as Jari mentioned, main customer segments where volumes declined were oil and gas, particularly shale and oil sands, then printing and writing and then within the water treatment to some lesser extent in industrial water treatment. Average prices held very nicely in this environment. Top line was impacted by less than one percentage point from price reductions compared to a period a year ago. Big picture continues to be the same. Decline in sales volumes primarily due to this COVID and related economic downturn as well as the benefit that we have been able to secure through variable costs. Now Jari talked about the self help items, let me spend a bit more time into what all goes into this line item variable costs. So I can categorize them into four categories: one, our own actions, like the efficiencies that we are getting from China and in Netherlands from these new investments. Then second item that is visible in this variable cost is the pass through items. And we sell caustic with a pass through pricing. And then also we have some items like electricity costs, which are really passed on to the customers in short order. Then of course, the raw material price fluctuation and then there's always the other. And the other has some items like change in bad debts, inventory accruals and other. Own actions give typically permanent long term help. And now we can say that the combined annual cost saving from the two investments that Jari talked about is now €5,000,000 compared to a year ago. So obviously, if you analyze that by simple math, it's a run rate of about €20,000,000 benefit. And obviously, Q3 last year was also a good year from the profitability point of view. Then on the other hand, these pass through items do not really help us as the benefit is passed to the customer either immediately or with a very short time lag. Raw material prices, obviously, they tend to fluctuate and this fluctuation has been favorable to us recently. And now what we are seeing, we are seeing the biggest benefit in oil based raw materials and that's visible in the prices. And Jari gave an example of already formula based pricing in CEOR. And then other parts, they are something that has items that we can impact. For example, now we are having lower inventory write offs compared to the period a year ago. And if you remember, a year ago, we were starting up both The Netherlands and the China investments. So initially, we actually had some inventory write offs. So that's helping us as well. There is also another positive one off type item benefiting this quarter and this is the emission compensation payment in Finland. And this was obviously booked as a reduction in variable costs. This helps our Pulp and Paper segment as really the big electricity consumer in Finland is the chlorate plants in Finland. And also this is one of the reasons why we are calling Pulp and Paper quarterly performance exceptional from profitability point of view. There were also some other items like interestingly medical cost reversal as people seemingly are going to doctors less often and this is actually something that we saw during the quarter as well. Fixed costs, we are getting a nice benefit here as well. Travel savings is something that most companies, if not all global companies are reporting as a savings item. For us, that's about half of the CHF10 million fixed cost saving that you see in the picture is just simply reduced travel because of the various travel restrictions during this pandemic. And then on top of that, we are obviously doing our own actions on fixed cost side as well. Particularly in oil and gas, we have done headcount reductions. And elsewhere in the company as well, we have deliberately slowed down replacement hiring. And as a result, our permanent headcount is now almost one employees down from six months ago. So obviously, that is starting to show in the costs. The drivers behind these charts were already quite well discussed. Variable costs came down and the net from these drivers continued to be nicely positive and obviously this is the one big driver supporting the profitability during the quarter. Backward integration benefits from the AKD and Specialty Polymer investments and we expect them to continue to contribute in the coming quarters before they then establish a steady run rate and then the year on year comparison becomes less significant. But still, we expect that to continue for a few quarters. Talking about raw material costs, currently we expect that the outlook for raw materials is now towards slightly increasing raw material costs, nothing dramatic but still a small increase in the costs for 2021. Obviously, during this time, quite a bit of uncertainty regarding the economic activity and the raw material costs. Jari talked about the supply chains. So yes, they have continued to work very well. And obviously, the increasing number of COVID cases will raise the risk again. But I think us and the whole industry has learned to manage the supply chains quite well. Hard Brexit is obviously a risk for us in the coming quarter and we expect that if the hard Brexit really takes place, there will be some local disruptions, but in the sort of a group level, the impact is not expected to be material. Moving to cash flow. Q3 cash flow was good. And year to date, we're now approximately at the same level with last year if you ignore the €50,000,000 one time capital return that we received from our pension fund, Nelie Apila, last year. Also, I may be repeating my comments from Q2, but I'm also very continue to be very pleased about our receivable management. We have been able to maintain our receivable turnover ratio constant or actually even slightly improved during the Q2, even as the sales volumes have come down. Inventory levels, which I flagged at Q2 were at somewhat high level. They have come down during the quarter according to our plans. Finally, I also at this time of the year tend to remind that our net working capital and capital expenditure cycles make our cash generation typically second half weighted, particularly Q4 weighted. This year, I don't quite expect the same type of a big cash release that we saw last year, but still expect that positive cash flow will continue at a good level. For example, one example why this release will be smaller is that we are building some inventory buffer in preparation for hard Brexit. CapEx, no nothing particular there. It's going as planned and with full year CapEx likely to land around €200,000,000 Where it exactly lands obviously depends on the timing of some of the bigger expansion projects that we are underway now. A little bit on the balance sheet, gearing. Due to good profitability and good cash flow generation, net debt is down some €80,000,000 versus a year ago versus last year. And at the same time, leverage ratio has now fallen below two times first time for some years. And cost of borrowing, particularly in higher cost places like in China has come down and that is reducing our borrowing costs or interest expense. Again, or finally, a reminder of our FX position as we now saw some FX impact in our numbers. And now there has been quite a bit of a more focus on where the U. S. Dollar euro rate will fall. So first of all, as you can see, we have a pretty good natural hedge in our business. If you look at the revenue cost breakdown of our currencies, for example, it is 34% of our revenues, which are S. Dollars, but so is 32% of our costs. So from that perspective, we have a nice, pretty good natural balance there. So the U. S. Dollar weakness or strength, but this time it's a more weakness recently comes through primarily through translation The U. S. Profits generating fewer euros. Year to date, the negative FX impact is €4,600,000 and about €3,000,000 of it came now in the third quarter. And then if you sort of try to project into the future, as a sort of a rough rule of thumb, zero one in the exchange rate, euro to U. S. Dollar is roughly 1,000,000 bottom line impact on an annual basis for us. And that's the rough impact before hedging. So hedging activities may smoothen it a little bit, so it doesn't always immediately come through the P and L, but that's roughly the type of exposure that we have to that currency pair. Like Jari mentioned, we updated the outlook on October 9. And due to the lower costs and improved outlook for shale business, we also revised our own estimates for full year 2020. And that outlook now states as operative EBITDA higher than the €410,000,000 that we had in 2019. And why we did? By our own interpretation, the market has sort of taken our earlier withdrawal of the original outlook as placing a gap on the profitability at $4.10. And therefore, we felt it was prudent to update the market as soon as the quarter was closed and the full year forecast was revised and reviewed. However, environment still continues to be difficult and uncertainties. So we expect H2 EBITDA will continue to be will be lower than the H1 level. And we felt that it was also important to leave that part of the guidance in place. Already mentioned the one change in the assumptions from Q2, meaning somewhat improved market for shale oil and gas. Otherwise, we expect that the overall demand for Cheminars end markets during the second half will be approximately at the Q2 level. Good. Then I would like to again invite you all to our Capital Markets Day. So we will host a virtual Capital Markets Day in less than one month's time. So please do join us in a virtual session, November 19, starting at two p. M. With that, I think we're ready to move to the Q and A session. So operator, please. Thank have a question from Martin Rudiger from Kepler Cheuvreux. I'll start with two questions later on. I will queue up again. The first question is on the initial rights compensation. Can you mention the magnitude of it in Q3? And will this effect repeat in the quarters to come? And since when did you benefit from that initial rights compensation? Is it the first time or not? And the second question is actually on selling prices actually because you mentioned that in CE or R, you had a pass through of lower raw material costs. So when I look at your chart on Page 12, and it seems to be that the same prices have been stable overall, which means that some other activities you have increased your selling prices sequentially. So can you help me to understand in which business units you did increase your selling prices sequentially? Thanks. Yes. I'll let Petri answer the first question, but maybe I'll answer the second one. So in our CEOR business, we have such big volumes that the contract is based on a formula pricing. So some feedstock prices that we have coming into our raw materials that goes as a formula to the customer prices. If feedstocks increase, our sales prices increase. If feedstocks come down, our sales prices go down. Same thing we have in oil sands, polymers and in North American, electrical prices for bleaching chemicals. So that's the effect. There are some benefits also on sales prices, but that's more of a run rate comparison. So we were still working on some delayed price fixes this time of last year. And as I said that at the end of twenty nineteen, we got our run rate into the right shape with various things, and that small delta is visible now. Okay. I'll try to cover this quickly, so the emission costs. So obviously, in EU, you either industries are either required to buy carbon credits or then they need the certificates of origin for the electricity that you are consuming if it's fossil free. And as you may have seen, the carbon credits have gotten more expensive over the last few years. And obviously, the EU allowances, idea is that the industry within EU can compete efficiently against the industries against the competition that comes outside of EU. And the Finnish government is giving some compensation for industries in Finland or under this actually to less extent than in many other European countries. And so that's the underlying regulatory framework quickly discussed. And we have received this now for a few years, But as the price of carbon credits has increased, the compensation has also increased. And we do recognize that during the quarter received. So that's why we received those and most of them in Q3. There was something received also previous year quarter three, but the magnitude was smaller last year and that's why we highlighted it this year. This scheme or subsidy will last next year, but then the political environment has sort of made a decision to fade this subsidy away and there will be sort of other ways of using or promoting sort of efficient and fossil free energy. And that sort of framework, I think, is still a bit up in the air how it will work in Finland. But nevertheless, we will see this benefit next year as well. And the effect in Q3 was how much? Roughly €3,000,000 Okay. Thanks. And why it's Finland is that it's happening elsewhere also in Europe, but our electricity consumption due to our bleaching capacity here in Finland is we're a fifth biggest electricity user in Finland. So maybe that gives you the sort of size of it. Thank you. You. We have a follow-up question from Martin Rudiger from Kepler Cheuvreux. I'm obviously the only person who is in this call. I apologize for that. But maybe then I have two follow-up questions or two additional questions. The first one is on bio based products. You mentioned that on Page nine. Can you elucidate what is the exposure today? And what is your expectation of this of the bio based products exposure in five years' time so that we get a feeling of how important that could be? And the second question is on the outlook. You just to clarify, all else equal, is there any reason why the seasonality in Q4 this year should be different to the seasonality we are used to see at Chimera over the last couple of years? Well, probably the seasonality is pretty similar. The oil sands season is over and the winter and snow and ice coming affect some of the water treatment volumes. But probably last year, the shale drop from Q3 to Q4 was more significant. And now that comes from a small base. So most likely, it then continues at a flat rate, let's put it this way, if the weather allows. The other thing is that then the holiday season, there might be some extra stoppages, we don't know, by the pulp and paper companies and potential shutdowns. But we are informed of those only days before if they do take a downtime during the holiday. So other than that, last year, there were no major downtimes from the Pulp and Paper as demand was good. So that's the situation. And on the bio based, we have a portfolio already. AKD in China is one of those. And that AKD product is shipped all over the world. And then so it's our global base. We have others also. And we intend to threefold that business in the next ten years. But that's a topic that we'll be talking more in the CMD. Thank you. Maybe now we can take a question from the webcast tool. Two questions here. This is you briefly touched upon this already, but could you bit more elaborate, Jari? How do you see the maintenance outlook for the Pulp and Paper customers in Q4 as Well, a basically, it's possible. I mean we saw maintenance shutdowns in Q3. They've announced a few in Q4. And then the holiday season is a question mark. So I can't it's not known to us. Yes, indeed. One more question regarding the new investments. This may be more for Petri. So what kind of improvement do you expect to the €20,000,000 run rate from the China and Netherlands investments next year? Somewhat, but not dramatic anymore. And obviously, now one assumes that the starting point, so the comparison point is fixed. So yes, I think it's maybe another €5,000,000 or so on an annual basis one would expect to receive. Obviously, both of these investments and they also not only provide the backward integration help and the cost benefit, but they both have extra capacity so we can grow these businesses. So that's one of the reasons why we are now growing in Pulp and Paper because we have more AKT capacity, so we can grow there. Same thing, Jari mentioned that the polymer plant now, the Itaka provides a good baseload and actually it's growing baseload, But now we can actually start entertaining other customers, which we were not able to do before we had this extra capacity. So there is the also, as we hope and expect that we build the market, this will we will get benefit from the expansion. But then that's on top of the cost saving that we had up to now. And maybe as a reminder, the AKD plant in China, we started that up in November and then obviously have some ramping up issues in the beginning and shutdowns for maintenance and so on. So you can imagine that it was not full run rate until after the summer. And the Specialty Polymer line, we started up in March. So that's the increment that is going to then be there for next year. Now they're running well and ramped up. If we turn to the audio line for questions, if there are still. We have a telephone question from Weiko Silvestin from Nordea Equities. Please go ahead. Your line is open. Hello, and thank you for taking my questions. Could you maybe remind us once again how does your pricing work in an inflationary raw material environment now that we are most likely going to see in 2021? Well, if it comes to the polymers and shale, you could call it frame agreements and spot pricing. And then obviously, then the competitive situation is a factor there, too. In the water treatment side and in the Pulp and Paper side, it's mostly long term fixed contracts, not a lot of spot volumes. And then we have the formula pricing for CEOR and oil sands and bleaching in United States that go with the input costs up or down. If I can see a little bit on that. Weko, if you flip through and go to our Q2 presentation, I had a slide on that one. And off memory, something like 80% of our business is this type of a fixed price, fixed term contracts. But to be honest with you, I don't vouch that the percentage number is correct, but it's in the Q2 presentation. Yes, it's about right. Great. Thank you. I'll have a look. There are no further questions registered, so I hand back to the speakers. Okay. This was the shortest one ever. Right. Thank This was the shortest one ever, so but thank you for participating. If there are still questions after the audiocast or webcast, please, please be in touch with me, and we're happy to take your questions. But as Petr said, so we're looking forward to seeing as many of you as possible at the CMD on the November 19. So we'll catch up then. But thank you for today. Thank you. Thank you. Thank you.