Earnings Call: Q3 2019

Oct 24, 2019

Ladies and gentlemen, welcome to the AAK Q3 Report 2019. Today, I am pleased to present Johan Westman, President and CEO. For the first part of this call, all participants will be in listen only mode. And afterwards, there will be a question and answer session. Speaker, please begin. Thank you very much, and good morning, everyone. Welcome to the AK Quarter 3 Investor Call. As usual, I have also our CFO, Fredrik Nielsen, with me to present a few of the slides as well as being here for the Q and A session at the end. The agenda is on Page 2. We'll start with some comments to the Q3, talk about a few of the strategic initiatives as well as some update on the business areas. And after that, we do a normal Q and A session. So with that, I am turning to Page number 3. Some of the highlights for the quarter. We continue to grow our EBIT. We are adjusted for acquisition cost. We are up 8% year over year with an adjusted operating profit of SEK 569,000,000. We have had a strong improvement within bakery and dairy. So food ingredient is up, and within that, there is a nice improvement on margin, especially within baker and dairy. We have also reached a milestone in EBIT per kilo. We are now at SEK 1 SEK in EBIT per kilo adjusted for acquisition cost. We also see a good continued growth within our plant based food solutions, although from a small level, but it's really nice to see the strong demand in the market. Turning to Page 4, just highlighting that our quarter over quarter trend, we do continue to grow our EBIT year over year. Heading into Page 5. So with regards to acquisitions, we have in the quarter acquired soya International, which is a company focused on lecithin, and in this case, non GMO specialty lecithin. The reason for this acquisition for us is that we want to continue to strengthen our value proposition to our customers. And we have looked at are there any adjacencies, ingredients where we would, by adding that to our portfolio, increases increase the value proposition or improve the value proposition to our customers. And with lecetine and specialty lecetine, we have seen an opportunity to strengthen our offerings, especially within shoptail and confectionery, but also within other business areas of AK. With a focus on non GMO and specialty, we've also found a company invested in a market which is similar to the oils and fat market where you have commodity volumes, but you also have semi specialty and specialty volume, and we have invested in the semi specialty and specialty. We are now integrating this company, and so far everything is working according to plan. We're very pleased with adding Soya International to AEK. Next page, a few more comments. So why do we do this? We by adding this, we are adding lecithin to our portfolio, and that is an ingredient used very much in the shocktail and confectionery space. Shocktail and confectionery is a strategic priority of AK. And with this, we intend to really strengthen the way we go to market with our customers. We also see strong market growth on the back of global trends. Lezzettin has good underlying trends like the shocker and confectionery space. As such, we will focus on the non GMO clean label organic as well as sustainability, traceability and health. And this fits very well in that context. This adjacency is also the adjacency that is one of the adjacencies that is really close to the oils and fats. It is derived from the same raw materials that we are using also in other solutions. So with that, it is a good fit to AK. And we see this also as a scalable platform. So with this acquisition, we have the focus on strategic intent to increase the sales of Lexington going forward but as well as including that in our total value proposition to our existing customers. With that, I'll come back to some more comments on the business areas later, but I will hand it over to our CFO, Fredrik Nilsson, on Page number 7. Thank you, Johan. Going into some more financial details, we have a positive FX translation impact of €24,000,000 in the quarter, €17,000,000 was related to food ingredients and €7,000,000 was related to chocolate and confectionery fans. Based on current currency rates, we should expect to see a continued positive impact in the next quarter. Let's move to Page 8, a look at working capital days. Inventory days have increased one day. Strategic purchase of key raw materials to shock at the confectionery fats has impacted the inventories negatively. But I would also like to stress that we have good controls of our oils and fats inventory levels. With improved product mix on more specialty solutions, we have seen underlying pressure upwards on our accounts receivables, strong pressure from customers also to get extended payment terms. Accounts payables are down 3 days. With most of our suppliers, we have normal payment terms. But in some new markets, most of the options from the supplier point of view is still cash against document. And the volume growth we are seeing in the emerging markets have impacted payment days negatively. It's a focus area to improve. Let's go to Page 9 and looking at cash flow. We have a good EBITDA improvement in Q3 with 11% or SEK 71,000,000 in the quarter. Cash flow from working capital is negative in the quarter by SEK 552,000,000. As you can see, inventory is minus SEK705 $1,000,000 and that's entirely due to the strategic purchase of key raw materials into chocolate and confectionery effects. We are seeing a positive cash flow from accounts payable, so that's good. Accounts receivable is negative, and that's mainly due to continued organic volume growth but also normal seasonality between Q2 and Q3. Interest costs paid to banks were down in the quarter. Paid tax is up in the quarter, but that's entirely related to timing of payments. I would also like to highlight that the reported tax cost corresponds to an average tax rate of 25%. The lower corporate tax rate in Sweden, combined with further optimization of the capital structure, has reduced the average tax rate. Cash flow from investments minus €433,000,000 were up €207,000,000 was related to acquisition. It's soya international that Johan mentioned. We have also bought part of the minority in AK Kamani in the quarter. Noncash items is mainly related to the mark to market impact of our financial instruments we are using for hedging raw materials but also changes in pension provision due to actuary updates. Let's move to Page 10, a return on capital employed. Capital employed in the quarter on a row to 12 month basis was 15.1%. We see a negative impact by 0.4% percent due to the new accounting standard for leases, IFRS 16, but we also, the strategic purchase of key raw materials have impacted Rokke negatively in the quarter. Let's move to Page 11 and lower the duration profile. We have, during the year, been able to increase the average duration in our loan portfolio. And by end of Q3, we have total committed credit facilities of SEK 7,200,000,000. By that, I would like to hand back the microphone to Johan. Thank you very much, Fredrik. And with that, we go to Page 12 and we start with comments on the business areas. Starting with Food Ingredients. Food Ingredients had a really good profit improvement year over year with 13%, and the strong EBIT growth is really linked to an improvement of EBIT per kilo. We had a 2% volume growth, organic volume growth, but we have continued the good trend on improving EBIT per kilo and really focusing on the value added solutions. And especially, this is within bakery, dairy as well as plant based. Although from a low base, we are increasing our business and also our business opportunities rapidly within the plant based food solution area. A bit of a mixed bag with regards to special attrition, where we continue to see growth, although a somewhat lower growth rate for the high end specialty solutions for special nutrition versus the low end and team and specialty has seen a reduced volume growth for the quarter. The reason for this is that we see birth rates in China being down and China is really the main receiver of infant nutrition solutions, which is the largest sector within our Special Nutrition business area. We have also seen customers due to this and other factors doing a bit of destocking in the quarter, and the total impact of that results in a slower growth rate for high end solutions and a reduced volume for the semi specialty and low solutions. So still a good margin improvement with regards to still growing the high end segment, but still a somewhat lower pace than we had seen earlier this year. All in all, very good development for food ingredients. Next Page 13 with CCF or chocolate and confectionery fats. Here we have seen more or less flat quarter year over year development, both in terms of organic volume growth and operating profit. And the reason for this is what we have been communicating earlier this year, we continue to have a significant cost impact due to the fact that we are using the last batches of old kernels with a lower yielding result, and we expect to continue to use the last batches up until the year end. So by year end, we will have consumed the old kernels with which are lower yielding, but we will also be done with our capacity improvements. So heading into 2020, we expect to be in line with improved production process, which is resulting in higher capacity, to be starting using the new kernels that we are getting in and getting back to more normal cost levels from mid Q1 and forward. And mid Q1 is just because we're also having a maintenance stop, a planned maintenance stop, but we're having that in the beginning of Q1. The sourcing of new kernels has started really well. So we are really on track with regards to sourcing the new kernels for the year to come and forward. So I'm very pleased with that. So all in all, we are following our plan. The capacity is about to be finalized, the capacity improvements. The new kernels are coming in, and we know that we will now use the last batches of old kernels. But all in all, for the quarter, that has had an impact on our results. We've also seen that some customers have been rolling volumes forward, so a bit lower volume for the quarter than expected. With that, heading to Page 14 and the Technical Products and Feed. For Technical Products and Feed, we continue to operate on a higher level in terms of earnings compared to some years back. On a quarter over quarter perspective, we have seen a drop versus quarter 3 last year, but we should also keep in mind that last year, we were helped by the fact that we had a dry weather in Scandinavia where farmers purchased more feed products and so forth compared to normal in quarter 3. We also have had a very strong quarter 4 last year. So but all in all, we expect GPF to continue to operate on this level that we see today. With that, continuing into Page 15, just a short kind of summary of the quarter three highlights. So our new platform for plant based food solutions, AquaPlanet, has been well received by the market. We see strong growth for our solutions to the plant based food area for dairy alternatives as well as meat alternatives. We have a strong pipeline development. So just over the last quarter, we have seen the pipeline of new opportunities double. So very promising for this sector. We've also, as mentioned, seen a very good development in dairy, bakery and foodservice with EBIT per kilo being improved. In other words, our margin is improving. We're continuing our M and A journey and have now stepped into an adjacency, Lecetin, and we were pleased with that. And we continue to focus on new opportunities with regards to strategic acquisitions. Some of the challenges in the quarter, as I mentioned, special attrition with lower birth rates in China and destocking by some customers has led to a somewhat lower volume than expected. And within chocolate and confectionery, the combination of rolling contracts by customer as well as our known and planned higher cost due to the lower yielding Qi kernels that we're using impacted the results negative. With that, a few comments on our program, the AK Way, on Page 16. We progress according to plan with good results. We are now really in the last stretch of the AK Way, and we are building the foundation for the future. As you know, we have been reviewing our strategy during 2019. And with our upcoming Capital Market Day, we will launch the updated new strategy for AK Way. And based on that, we will also have a new strategic road map going forward. Page 17. Our management ambition is to reach average year over year EBIT improvement by 10%, slightly below that in quarter 3. But all in all, we are at plus 9% since this ambition started 33 months ago. So all in all, a good track record for AK. Page 18, concluding remarks. We are well positioned with our offering of plant based, healthy, value adding oils and fat solutions using our customer co development approach. And we do continue to see, in an overall perspective, favorable underlying trends for our market. And with that, we do remain prudently optimistic for the future. And before we head into Q and As, I'd also like to remind you about the Capital Market Day coming up November 20. And with that, we are happy to take questions. First question from Karl Melunoby from SEB. Sir, please go ahead. Yes. Hi, good morning and thank you for taking my questions. My first one relates to discussion on nutrition and the comments you make regarding both China and destocking effect. Is it possible to quantify this impact in Q3? And also, if you expect this to continue going forward? And secondly, for the CTS division, this pressure from customers to roll existing contracts forward, can you give more details on this and also the sequential impact going forward? Thank you. Thank you. So with regards to birth rates and destocking, so we just see that this is kind of a this is a normal pattern when you see a decline like we've seen in the birth rates. We see customers also adjusting accordingly. But we are not specific on exact numbers in that case. There is what we have seen is that we do see a continued growth for the high end solutions and a slightly lower development for the low end and semi specialty. On a longer term basis, we do see that the market for high end infant nutrition is on a good trajectory going forward. So on a long term perspective, there is still capital and money being spent in this sector, and we are well positioned. But we have seen, due to the lower birth rates and customers having in this sector, also quite long or high stock levels. And with that, when they are adjusting, that has an impact to us, but we're not specific on the numbers. With regards to Shoppe and Confectionery, the situation we have been in and the market have been in, if you followed us, you know that there has been quite a strong demand over the last years on high end shocker than confectionery solution, and it's really for these products where we reached also the capacity limit and challenges with our cost base due to the low yielding kernels that we have had to use. So on the back of that, there has also been with a high demand also a pressure up on prices. So now when the demand is getting back, we it's quite natural that we see customers are starting to optimize the portfolio a little bit. So it's nothing more, nothing less than that. We do see the underlying growth for Schoppels and Confection being strong for the years to come. And what we do know now is that we will have our cost base back to, call it, normal by mid Q1 and forward. Okay. Thank you. Thank you. Thank you. Next question from Kamer Toh from Carnegie. Sir, please go ahead. Yes. Thank you. First, on the Soller International acquisition in Lesothines. One thing that you have been strong at historically is to consolidate a fragmented market. Do you think that there are more acquisitions to do to consolidate this market? Or do you feel that you get a strong position already with this acquisition? Thank you. So first, yes, we believe we get a strong position with this acquisition. But are there other opportunities going forward? Yes, there are, without being more specific than that. So this is a sector where there are opportunities for M and A going forward, but there is also already with this an opportunity to grow organically and especially combining now our total offering and on the back of that really driving the growth of this through our normal channels, but also improving the value proposition that we can make in the future. Great. Then also from the older times when you were more open on what segments the performance per end market segment in the Food Ingredients division before 20 17, you showed that the bakery business had been lowering profits for quite some time and the area was also struggling a bit. But now in this quarter, you say that you increased profitability in food ingredients due to dairy and bakery among others. So what has turned and what has improved now? Is it a specific region? Or are there new products? Or yes, what happened? Yes. Thank you. And it's not a quarter it's not a happening in Q3. This is a gradual improvement. We have been commenting as well that bakery has been improving over time. We have seen really strong development with the focus on high value added solution with our co development approach and our approach to value selling to our customers, we have been able to improve these sectors, although being on an average level, slightly lower than some of the other products that we have, still improving this and focusing on selling the more high value added solutions and using our co development approach. So on an average, the total dairy and bakery has improved. Regions where this is particularly strong, for example, Europe, Northern Latin America, to name a few, really good developments and strong performance by the total teams around this. So this is more across the board and focusing on selling the right products where AK has a good value proposition. Okay, great. And then also my last question is on the plant based product you have. You commented earlier that this is quite a small part of the food ingredients division in terms of sales volumes and so on. But still now, you mentioned it as one of the reasons for the improved EBIT per kilo that you have success in the plant based side. So should we interpret this that this product range is really starting to add to in a more significant way to EBIT now? Well, let's separate it. Incrementally, yes, it is within Food Ingredients, one of the areas where we're growing faster, but we are growing from a small level. So if you look at the total number, it's still a smaller add, but it's still an add. So let's not read too much into it. So So starting from a small level or a low base, but it is in fact growing fast and we do see a strong interest in the market. There is a strong increase of customer co development opportunities and projects with our customers, both in the dairy alternative space as well as the meat alternative space. So it's still too early to say that this is significant in the total numbers, but it is a good sign off, call it, to the focus of the whole total industry and also our position to be able to serve this industry. And you also say that it's both for Europe and the U. S. And this is interest At the moment, we do see global interest. But at the moment, U. S. And Europe is still the largest markets for plant based food as we see it. Okay, great. Thanks. Next question from Ulf Ghanlin from Stenbank. Your microphone is open. You can go. Oskar Lindstrom. Oskar Lindstrom. Sorry, I didn't recognize how you pronounced my name or the name of the bank. Sorry. I have three questions. The first one is regarding rolling contracts from your customers. Should that be understood as some kind of price pressure? Or what's the sort of what's happening there? Yes. What we see is that under some under the forecasted, call it, volume pickup from our customer, we have seen a bit of rolling that forward. So slightly lower sales than we had expected. And the reasons for that, we can partly speculate in, but we know that after a period of price increases and shortage of demand, there is more demand and a bit price pressure down, but still a strong market out there. So incrementally, we see slightly lower volume than expected in the quarter 3. All right. So it's more on the volume side rather than on the pricing side? Yes. But the effect of that is obviously price and demand optimization in the market. Okay. Should that also go on into Q4, I presume? Or It's normal market conditions. So it's about you lower your price, you can sell more and you keep your price high and you sell a bit less. So it's an optimization for the customers as well as for us. So we do see that continuing going forward, but not that it's margin erosion. We also see cost improvements. Last year was a high cost year, both for us but also from sourcing kernels in West Africa for the market. All right. And that actually comes into my second question, which is on the will you say anything about the size of the impact of the kernels that, that has had this year that we should not expect to see next year? What you can see is obviously our flattened or reduced operating profit per kilo, which has been significantly impacted by the fact that we had increased costs, but we offset part of that with also managing price versus demand. What we do see going forward is that we will go back to normal cost levels. So with that, there is an opportunity to improve margins, but there is also a market out there. So we need to play the game and be very competitive in the market. So I would say that the guidance going forward here is that we will go back to normal, slight sliding into an improved cost structure and then follow the market. But there is a good forecast for chocolate and confectionery in the long term. And just following up on that also on the chocolate and confectionery, the new capacity that's coming on stream, as I understood it, mid Q1, I mean, will you use that fully utilize that fully, I mean, immediately mid Q1? Or is it something where there's like a gradual increase in production volumes? The capacity is going to be there. The utilization of that will be a function of supply and demand. But it's if anything, we will slide into using more and more while we grow with the market and with our market share. So the capacity will be there, but the utilization of it is obviously depending on how much we sell. And we haven't contracted all that capacity day 1 because we wanted to make sure that we have it before we sell it. And also how bad of capacity will be there end of Q4 this year. Yes. And how much capacity are we talking about in tonnes, I presume? We are not mentioning tons and capacity, but we do talk about 10% to 20% increase of capacity compared to before. For chocolate and confectionery or For the high end solutions. For this high end solutions that we referred. So this is one of the product ranges that we have, but one of the most important ones. Okay. My final question is on the destocking. How much of that has been done already? And should we expect more destocking to impact Q4 as well? What's your feeling? With the information we have without specific comments on customers, we have a few that say that it will be to year end and then we're done. And with others, half the first half of twenty twenty as well. Next question from Alexandra Banovsky. Can you hear me? Yes. Okay. So my first question relates to the food ingredients segment where you previously have stated that you're sort of prioritizing customers in high end solutions that perhaps provide you with lower volumes. It sort of relates, I guess, to the last question as well. But is this your strategy also going forward? Well, our focus is to continue to really develop the specialty solution for our customers being there with our co development approach where customers needs our help or where we have new solutions to offer. And that is where our focus is in terms of investments and in terms of innovation and in terms of the day to day co development improvement of our customers' product. And that is leading us to doing business where it is a call it higher priced solutions, more complex and difficult solutions. But whether that is a lower volume or not, that is not the same equation, right? We're certainly looking for the high volume opportunities within this. But if we talk about priorities, it is the high value that is our priority versus moving volume. Sure. And my next question relates to the Chinese sort of demand. When you claim that you are seeing sort of lower or impact from lower birth rates in China, and at the same time, you are obviously investing in your Chinese factory. Do you expect that going forward, that factory will have sort of lower capacity needs? Or do you still expect it to have the same increase as you anticipated when you and progress in investing in it? So that's a good question. We haven't changed any forecast on the usage of that plant. And this is where there is still a strong demand or a push for high value added solutions. So the high end solutions, the more advanced infant nutrition solutions are still forecasted to have a high demand in the world and in China specifically. And China is already today the main receiver of these volumes being produced in China or being produced elsewhere and sold into ships into China. So for us, this is installing our next capacity improvement in the market where it is consumed. So we believe that is the right thing to do strategically. It gives us a better opportunity to serve international customers as well as domestic Chinese customers. And we're also moving the cost base to where we sell and distribute. So all in all, the investment in China really stands on its own. The total demand for AK and the market will obviously have a is a factor of birth rates, but also the shift into more high value added solutions or more, call it, the penetration of advanced solutions. And that's where the forecast is still strong even though birth rate is going down. Thank you. Thank you. We don't have any more questions for the moment. We have a new question from Oliver Klukar from Degtym. Please go ahead. Yes, hello. Good morning. I have 2 questions and a little bit unusual question as a follow-up. I was wondering about the kernel, the shea kernel harvesting quality. Could you elaborate? Was it so good? This is one of the reasons why you built a strategic inventory. And the second question is regarding to Fuji's oil forward integration by Vloma. Is this an opportunity for AAK? Or is it rather a threat for your contractory and Chocolate business? Okay. I'll start with the first question. So what we are seeing in terms of quality is that we're seeing, as far as we can judge, we still haven't used the new kernels yet. So we don't know the actual yield until we start using it. I would like to remind us all about this is a natural crop that is grown in West Africa. So the actual yield and the actual, call it, quality or the volume we get out of it, we will only know when we crush it. But with the analytics that we have and the measurements that we can do, it seems like a normal crop. It seems to be a normal crop. And we have sourced significant volumes because we believe in the market going forward, and we needed to replenish our inventory to make sure we have enough Kvaerner for the year to come, but also safety stock and also some buffer into 2021 and hopefully improved and still growing strong market. With regards to competitors and their acquisitions, we will not comment that specifically. We remain where we are. So we are still a oils and fat flexible oils and fat solution provider, where Schokkeland and Confectionery is one of the most important markets. Even with customers taking, call it, outsourcing from the consumer products producers. We do see strong demand across the board for our solution, either going directly to the business to consumer producers or to the business to business chocolate compound producers. And we haven't seen really an impact of the latest movements here. So we have both sectors as customers today, and we expect to have that going forward. We believe in staying where we are and focusing on being a really strong provider of plant based oils and fats. Then a rather unusual question. The picture you're showing on your presentation in front of the vegetable burger, Can you give us some hint what the AAK content in this burger is? Well, I will not comment the customer specifically, but the content when we supply, we typically supply the total fat content in the burger. So in the ingredients list, we have the opportunity to sell product by product, but we have seen that we have an opportunity to be able to supply the total demand for plant based oils and fats. And then depending on the recipe, how much that is, that becomes then the volume that we would sell into a burger or the volume per burger, if that makes sense. And so this is regardless what kind of oil or what kind of vegetable is used, whether it's palm or whether it's soy oil, you can offer the total fat content for a burger? We have strategically focused over many years to be a supplier of many different oils and fats from different raw materials. So we are a multi oil plant based focused company already to start with, and that's how we also focus going forward. So our development in this area will be to make sure that we, 1, sell to the customers what they need today, but also 2, co develop with them and bring new solutions to make these products even better, more tasty, better structure, healthier and so forth. So I expect the total market to go into reformulating new recipes as we see it developing. And with that, we will remain as a multi oil and solutions provider. So yes, in other words, we have the oils and fats that can be used. Thank you. Thank you. Thank you. We don't have any more questions for the moment. We don't have any more questions. Back to you for the conclusion, sir. Then with that, we thank you, everyone, for listening in and for your questions. And talk to you soon. Have a good day. Ladies and gentlemen, this concludes today's conference call. Thank you all for your participation. You may now