Earnings Call: Q2 2019

Jul 16, 2019

And gentlemen, welcome to the AAK Q2 Report for 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. Johan, please begin. Thank you very much. Good afternoon, and welcome, everybody, to the AK Quarter 2 report and presentation of our results. Together with me today, I have as previous quarters, Fredrik Nielsen, our CFO, and we will run this presentation together. On Page 2, you find today's agenda. We will start with comments on the Q2 2019. We'll comment on a few strategic activities, some area by some information by business area, and we will end with a Q and A session as we usually do. With that, turning to Page 3, some initial comments on the quarter and our results. We have continued with a very strong momentum with regards to our operating profit. Our profit is up 14% year over year, and adjusted for currency, we're up 10% right at the target of the management ambition. We closed the quarter at SEK518,000,000 in operating profits. And we saw some softer volumes, but really good development with regards to our margins. Our operating profit per kilo continued to improve, up 11% year over year, now at $0.92 per kilo. Our earnings per share grew even further, grew by 18% year over year. And behind this, we had a really good trend and good development in Food Ingredients. As expected, we had higher than normal costs or rather lower than normal yields in with our sheet kernels in the chocolate and confectionery business. That's basically nothing new compared to the latest quarters. So that was more or less an expected result. Strong volume growth, but offset a bit by increased costs for every produced kilo in CCF. If we turn to Page 4, our trend quarter over quarter. With quarter 2 2019, we continue this nice trend, a really strong quarter where the management ambition was delivered right on target. Some quarters, obviously, lower, some higher, and this was a good quarter for AAK. On Page 5. During the quarter, we've also introduced or launched 2 important products or one product portfolio and a product to the market. Starting with AquaPlanet. AquaPlanet is a portfolio of products for plant based alternatives, alternatives to meat and dairy products. We are very proud to launch this, and we do believe that this is a market space that will continue to have a very positive outlook for the future. We see a really strong trend in the consumer market with regards to using or starting to eat plant based alternatives to dairy and meat. Today, at small volumes in the market as a total, but we do expect this trend to continue for quite some time. We also launched Cubao Pure. Cubao Pure is a unique and patented solution that will deliver really good blooming retarding effects, and it will also extend the shelf life of the products our customers produce. So both these launches were really good in quarter 2, and we do hope that this will deliver nice growth going forward, again, starting though from small volumes. With those comments on the quarter results and our launches in quarter 2, I will hand it over to Fredrik Nilsen, our CFO, for some further comments on the financials. Thank you, Johan. Going into some more financial details. We had a positive FX translation impact on $19,000,000 in the quarter, dollars 12,000,000 was related to food ingredients and $7,000,000 was related to shockers and confectionery effect. Based on current cancer rates, we should expect see continued positive impact going into the 3rd quarter, but most likely slightly smaller than we have seen during the 1st and the second quarter. Let's move on to Page 7, looking at the working capital days. Inventory days, we have been able to improve by one day during the quarter, and that's due to good inventory management. Improved product mix on more specialty solution and the strong volume growth in chocolate and confectionery fats put some underlying pressure upwards on our accounts receivable days, but we had to good work manage to keep them flat. Accounts payable are the main disappointment here, down 3 days, but it's also an area where we focus a lot and try to improve. Let's move on to Page 8 and looking into the cash flow. We have a good EBITDA increase of 16 percent or $93,000,000 in the quarter. Cash flow from working capital was slightly negative in the quarter. Lower raw material prices had a positive impact on the inventory and accounts receivable. However, that was offset by lower payables. Interest costs paid to banks are down in the quarter. That's positive. Paid tax is also down despite that we have a higher earnings before tax. And I would like to highlight that we have also been able to continue to reduce the tax rate from 27% down to 25%, and that's due to the lower tax rate in Sweden combined with further optimization of the capital structure. Looking at cash flow from investments, we had an outflow of 280,000,000 SEK111,000,000 of those was related to acquisition, and that was the minority shares increase in India. And the remaining capital expenditures was related to regular maintenance investments and capacity increases. And then you can also find other noncash items, and that's mainly the mark to mark impact from our financial instruments. So to summarize, the free cash flow of $128,000,000 in the quarter. Let's move to Page 9 and return on capital employed. Looking at the 12 months rolling, we have 15.5% in the quarter comparing to 15.8% at year end. And that's explained by the impact of IFRS 16. As you can see on the light blue line, we are at 15.8%, the same as the year started if we adjust for the IFRS 16 impact. Moving to Page 10 and loaner duration profile. We have, during the year, been able to increase the average duration in our loan portfolio due to our MTN points, which has been a positive to increase the duration in the portfolio. And then I would like to hand back the microphone to you, Johan. Thank you very much, Fredrik. And with that, we head into Page 11 and further comments by our business areas. Food Ingredients first. Food Ingredients improved profit by 18% year over year, and this is on the back of a solid margin expansion and a good product mix more or less across all sub segments within Food Ingredients. We saw continued improvement in bakery and dairy and really strong product mix in Special Nutrition. And with that, in spite of, call it, only 1% volume growth, we grew profit by 18%. Also, Foodservice had a good development with really strong margin improvement in the portfolio. With that, Page 12 and chocolate and confectionery. Very strong growth in the Chocolate and Confectionery business area, but the highest growth was within the low end and semi specialty products in this product group. And with that, you saw an impact on operating profit per kilo. Also impacting operating profit per kilo is the increased cost that we have due to the lower yields in our sheet based solution. So in spite of that, we saw a stable quarter with increased operating profits, although we still have the, call it, challenge with capacity as well as lower yields, resulting in higher cost per produced kilo of high end chocolate and confectionery solutions. We reiterate what we have said before. We have capacity expansion activities ongoing. They follow plan. We see good results, and we have to use our stock with somewhat lower quality kernels throughout the year. And therefore, we are expecting improvements by the end of the year, and that is still a plan that we stick to. On Page 13, Technical Products and Feed. A strong quarter again for Technical Products and Feed. We had volume growth in the fatty acid business and we also improved mix. And in the total business area, we are focusing on operating profit per kilo, really driving value in that portfolio as well. So with that, a solid quarter for Technical Products and Feed. Page 14. Our current company program, the AK Way, is progressing really well. We are now literally on the final stretch, 1.5 of a year left in this program. And as I mentioned before, we are now also making a strategic review, and we are about to create the next company program for 2020 and forward. This is running well with good progress. We see that we are in a good space in the market. We have a good position in our market. So we do expect our direction for AK to continue, but with a more laser sharp focus with adding a segment or 2, but we do not expect a 180 degree turnaround with the new strategy. So more about that as we go further into 2019. Expect feedback by the end of 2019 with regards to the updated strategy in our new company book. Page 15, our management ambition. We have the ambition to grow our operating profit by 10% year over year, adjusted for currency and acquisitions. And as I mentioned earlier, we did that this quarter. As a consolidated view, after 2.5 years, we are at plus 9% with regards to operating profit improvement. So we continue to progress well, and we reiterate our ambition as an average. Some quarters might be higher, others are lower, but we reiterate our target by growing 10% operating profit year over year. As concluding remarks, we do offer plant based, healthy, high value adding oils and fats solutions, and we're using our customer co development approach. We see favorable underlying trends in our markets, and thus, we continue to remain prudently optimistic about our future. With those comments from myself and Frederik, we would like to open up for questions and answers. Thank you very much. Thank And our first question comes from the line of Oscar Lindstrom from Danske Bank. Please go ahead. Your line is now open. Yes. Good day, gentlemen. I have 3 questions or 3 sets questions. The first one is on Food Ingredients. And what's the reason behind the sort of rather weak volume growth in that division in this quarter? Yes. Oscar. Hi. I will say what's explaining in Food Ingredients is, of course, we have lower commodity volumes in the quarter, but also as we have seen a little bit lower volumes in foodservice despite we see a good evolution with more high end specialty solutions, but we are a little bit softer on the volume side. And then also on the bakery side, we continue to work with the mix, but we have maybe also said no and for well to some of the low end semi specialty volumes in the bakery segment. All right. Is it are these sort of developments with lower commodity or fewer commodity volumes and being more selective in terms of bakery, is that related to sort of a lack of capacity in your facilities? In some areas, yes, we need to optimize, but we have continuously invested in capacity increase in AK for many years. If anything, we continue to really push forward for our high end solution. That's where we want to play. That's where we should play. So we are challenging our teams to go for that type of cell and not just taking volume for volume. So in other words, when the mix is improving and if that is on the back of missing a contract or 2, that is the priority. But at the same time, we also focus on growing organically our volumes, but it has to be with the right type of products. Okay. My second question then is moving on to chocolate and confectionery fats. And where you still have the opposite situation. You had very strong volume growth, but perhaps weaker or not as strong earnings growth. What is behind that sort of development there? Yes. A few things in the dynamics here. If we take the volume first, so we had volume growth across the board, but proportionally higher volume growth in the low end and semi specialty versus the high end. So in other words, higher volume growth on lower margin products versus the growth on higher margin products. And adding to that with our high end products, that is where we also have the challenge with the lower yield. So the cost per kilo goes up and in that case, impacting the net margin even in that segment for this time when we have the lower yield. The combination of those 2 impact the profit per kilo, but high volume growth and significantly higher volume growth in lower end and semi specialty. And is that a situation which we should expect to continue in coming quarters or say, let's say, the second half of the year? At least the cost per kilo produced chi based solutions, we know that we will continue to use our stock of lower quarterly kernels throughout the year, and we are ramping up our capacity improvements towards the end of the year. So we know that, that will stay, and then we need to trust the new crop and so forth coming in during the fall. So that should be expected if we can maintain a significant high growth on the lower end and the semi specialty. Let's see. It was a really strong growth in this quarter. Okay. And my final question then is on those two effects, which we should see next year. You mentioned one of them is the more normal shea bean harvest or kernel harvest. And the other one being your capacity or your investment projects, which should also, you said, ramp up next year. On the harvest, do you know already that, that is a normal harvest and that you're going to be sort of not have this effect next year as well? No, that is too early. We have just started to source. And to be more specific, it's not a real issue about this harvest or the last year's harvest. It is about the worst yield we get is from the old safety stock that we have. So that has not as much to do with the new harvest. Obviously, every harvest has its, call it, quality of the kernels with higher or lower FFA values that impacts our yield. But the really low yield that we have comes from older kernels that we have had in safety stock and that we have used and need to use during this year. So if we get a normal crop or normal kernels, we will get a normalized yield going forward. And with capacity improvements, that should give us opportunity to increase volume as well as reduce cost. All right. Very interesting. Thank you. I mean, those were my questions. Thank you very much. Thank you. And our next question comes from the line of Kenneth Pol Jafson from Carnegie. Please go ahead. Your line is now open. Yes, thanks. So I'm curious about the Cobao Pure introduction. You introduced the Tropicao solution that should solve similar problems for chocolate from a couple of years ago, but that solution didn't really take off in a big way or haven't done yet. So could you talk a little bit about the difference between those 2, between Tropicao and Cobao, please? Yes. I will thank you, Ken. I will comment it from a business point of view rather from a technical point of view. And so for Tropekau, it's still a good solution with regards to what it solves. But the issue with Tropicao has been the commercialization of that project due to that it includes a change in the customer's process, an increased investment by the customer and also change to the process, which limits how many of that wants to go that route, so to say. The Cobalt Pure is a solution that our customers can use much more easily directly into their processes. So with that, we do hope that this will be a better success from a commercial point. Okay. But it's basically solving the same thing. And is it the sort of base same sort of chemicals or the same solutions in the back end somehow? It's 2 different products. It has yes, it has some of the same improvements to the chocolate, to the product of our customers, but it's not the same product as such. So but the Cubao has positive impact on blooming and a positive impact on shelf life. Okay. So how is pricing for these two products? Is Topicao much more expensive? Or is this one more expensive? Or is one of the products targeting more the high end and the other one the low end chocolate products or We are targeting our main customers with both of these products. We do believe Cobalt will have a smoother ramp up and commercialization and industrialization, and we have already started. And I'll just mention why I believe Tropicao had a somewhat tougher start. We'll see in the future how we can possibly ramp up Tropicao. But pricing, we will not comment in the public domain. Okay. And then does this introduction of Cobao, does it take some years because you need to test it? And then yes, is the testing phase also long so that the volumes of shipments for Cobao is not going to take off until a year or 2? That's a good assumption. We it will be some 1 to 1.5, 2 years of testing and before, call it, serious production, what we expect. Okay. Thank you. Thank you. And our next question comes from the line of Heidi Vesterinen from Exane BNP Paribas. Please go ahead. Your line is now open. Yes. I've got 3 questions as well. Maybe going back to Food Ingredients, where we talked about the very high EBIT per kilo. Do you think that the sort of level we saw in Q2 is sustainable? Or were there any positive mix effects do you think this quarter? Well, I mean, the sustainable without commenting specifically on the 0.91, what's sustainable is the focus that we have and the work that we do to lead us to this. That is sustainable, meaning that we as AAK, we focus on improving the value creation, improving on the higher end solutions. And higher end solutions and high margin product has a higher priority versus commodity low end products. That is sustainable. Then obviously, a quarter can be depending on the exact volume mix and products delivered, obviously, operating profit per kilo can fluctuate a bit. It was a really strong pickup, as you've seen. So difficult to make a very precise forecast, but I do expect us to be able to continue at high level, and our efforts are clearly targeted on improvement. So can you add to that? It's about looking at the long term. We have clearly the ambition to improve EBITPA kilo year over year. But as Johan said, that could be a quarter that will be a little bit better, and that could be a quarter that will be a little bit lower. But definitely, long term, Heidi, we have an ambition to continue to improve EBIT per kilo. Okay. And then last quarter, we had talked about the U. S, how you said there was a pickup in momentum. I think the quarter before was weak, and then last quarter was quite reassuring. You said trends are improving. Can you update us on the U. S, please? Yes. It continued. We have a good improvement year over year in U. S, really on the back of, again, like the segment as such, a good mix. So a good improvement of the margin also for U. S. And last question, I think Johan, when you were talking about the strategic review, you talked about potentially adding a leg or 2. Does this refer to splitting out a new segment from your existing businesses or adding something potentially through M and A? Well, obviously, if anything more specific like what you're asking is going to be that we will come back to that when we communicate and launch the updated strategy going forward. Us to have a 180 degree turnaround or expect us us to have a 180 degree turnaround or expect us to focus on the segments we have, but we can focus on subsegments more or less than I expect us to do so. We need to be more laser sharp in where we focus, and that fits well to what we talked about and how to improve our margins and focusing on the right product segments where we can compete better. We also see continued good momentum and market trends within Shoppe and Confectionery. Obviously, plant based, we are already 100% plant based. But as an industry, you can call it, or a part of our food ingredients industry, plant based is something is an area of market space we expect to grow significantly going forward. And with that, we need to take the right actions and have the right structure to support that. So that type of focus, how we focus and what strategy and tactics we use in certain business areas and segments. That is what the major part of the strategic direction will be about. And then potentially, we might add an adjacency through an acquisition or a focused effort, but that we will have to come back to later. So does M and A remain a big focus? Because that's the impression we got last November. Is it still a big focus for you? And you had talked about acquisitions of all sizes, so very big ones as well as small ones. Is that still the case? That is still the case. We continue to push forward. We have a good pipeline of M and As. We always look at M and As. We will always do not always, but we will continue to really look at M and As out there in the market for geographical expansion as well as for potential adjacencies and or really strengthening our high priority business areas. Thank you. Thank you. Thank you. And our next question comes from the line of Alexandra Belzynovskiy from Nordea. Please go ahead. Your line is now open. Yes, hello. I have two questions so far. Could you just similarly to Cabao, us a bit more about EcoPlanet and where the product is available right now and what customers you're targeting? And also sort of what potential you see from that product going forward? So just so that I understood, was the question about Cobao and AquaPlanet or about the No, mainly AquaPlanet since you just talked about Cobao. Yes. Okay. Absolutely. So with AquaPlanet, I think it's worth I mentioned it before, it might come it's crystal clear if you look at our product before, everything we do is basically plant based. We use a variety of raw materials. We have a multi oil product offering to the total food ingredients space. But with the development that you see in plant based dairy as well as plant based meat, there is obviously a high demand for ingredients and combination of ingredients to get to the right structure, the right taste so that we as consumers really see it as a high quality product, a good tasting product and potentially even a better product. And with that comes also the drive supported by sustainability. How do we reduce the use of animal based products. And many of the customers, the producers of plant based meat and plant based dairy also have a brand promise very much linked to sustainability. So when we look at these product offerings, it's on the one hand, we do the same thing as we do with any customer within the food and grocery space. It's customer co development. It's finding out what oils and fats you could use for the right taste, for the right texture, for the right applications. And that is something that we have a strong track record of doing. That fits very well with the need with this industry where a lot of changes are happening, the development and the pace of the development is really strong And the need of also improving the product quality is high for us as a consumer to really use it. And with that, we expect the plant based market space to require lots of co development, product improvements, innovations going forward. And we are one of the companies that are geared towards doing that. So that is basically what we do. And with that regard, the AquaPlanet portfolio is grouping together products that serves the purpose but also has sustainability promise to it. And this is something we will continue to develop. And also, we as a supplier will focus on development, co development, innovations for this marketplace. Sure. And so my second question would be in regards to your increased ownership in your venture joint venture with Kamani. You now own 64%, if I'm correct. Is this a level that you're comfortable with now? Or do you see yourself increasing this level potentially going forward? This is joint venture we have has been working out really well for us. It continues to do that. And these acquisitions are more on the back of the joint venture agreement that we have with put call options that the counterpart has decided to trigger. And we are happy with this change, and we will be happy with buying more or staying where we are. It's a company and operation in India that fits well to AKI, and we continue to deliver good value in India. India. Thank you. Thank you. Thank you. And our next question comes from the line of Rinta from Handelsbanken. Please go ahead. Your line is now open. Yes. Thank you. Carter Rinta, Handelsbanken. A follow-up on the agko planet question. Firstly, when we think about future potential for maybe a few years down the road, should we focus more on the nondairy segment or on the non meat segment in terms of total addressable market and maybe total addressable market for specifically for AAK? So where do you think that you will put your laser sharp focus in that respect? And then secondly, how should we think about the sort of the competitive dynamics in that? Is this more of a similar to sort of bakery where you have a large number of players both competing with you as well as in terms of customers? Or could this be more like infant nutrition, which is dominated by a few multinationals and thereby also the number of suppliers to them is limited and that therefore the EBIT per kilo is significantly higher than in more sort of commoditized categories? Thank you. Thank you. If we start with the first one, we focus on both plant based alternatives to meat and plant based alternatives to dairy. And so at the moment, they are both very important for us. We see great opportunities in both, and we are delivering to both segments as we speak. So in our leisure sharp focus going forward, I expect them both to be in the portfolio focus. With regards to the competitive dynamics in the industry, I think if you have followed kind of the development over the last few years and quite significantly this year with regards to attention, we see a mix of established food ingredient companies and start up companies. And the dynamic through some of these start ups are like start ups in some other high growth industries. So I think it's too early to determine what kind of product it is, but I think it's fair to say that in an industry where a lot of change is happening fast and demand is growing fast and the interest from consumers is growing fast, there are dynamics around improving product quality fast, improving product characteristics fast and being able to deliver that in a steady pace and being able to also ramp up and be agile enough to do that, that is suited for certain type of companies and maybe less suited for others. But exactly with regards to delivering oils and fats to this industry, we and others can do it. I believe AK is well positioned as one of the companies that can do it, one of the companies that has the co development approach and the speech market to do. Okay. Maybe a follow-up on that. So what is how would you sort of summarize AK's unique selling points when it comes to Agoplanet compared to, for example, compared to startups and then maybe compared to your more established ingredient competitors? Well, what we are good at in AK is our co development approach, where we are able to take our customer needs, our customer pains, our customers' application need and turn that into solutions. We do that often together with our customers, and that is really what I see plant based meat plant based dairy needing as well. That is the type of work we're doing as we speak with customers in this space. So that is what we will use. That is what we are using. And in addition to that, obviously, there is a focus on in the total industry, what are the best solutions for making the taste and the structure mimic or develop an even stronger value proposition in the eyes of the consumer. All right. Thank you. That's very helpful. Thank you. Thank you. And our next question comes from the line of James Targett from Berenberg. Please go ahead. Your line is now open. My question is really going back to Food Ingredients. And I think it's you've made it clear that one of the reasons for the weaker or soft, sorry, volumes is the shift towards higher margin products. And I wonder, however, within that slowdown, are there any end markets or sort of custom segments which have seen any softness, which is also a reason for the slowdown in volumes or is it just this mix shift? And then regarding the sort of dynamic between lower volumes and a bit higher EBITDA kilo, based on the sort of visibility you have into your customer pipeline, how long do you expect sort of this level of volume and margin improvement to continue? Hi, James. If we look for food ingredients, I will not say that the market as such, the underlying demand has slowed down. So I will say the shift you have seen towards a higher EBIT per kilo is driven by the mix. And that is a quite significant change if you compare 1 kilo of high end or semi specialty comparing to 1 kilo of commodity from an EBIT per kilo point of view. And if you look at more, you talk about the pipeline, I think it's more important to look at also at our track record and also what the ambition going forward with our ambition to improve year over year. I would not like to promise you that there will be a Q3 at a certain level or Q4 at a certain level, but we clearly have the ambition to continue to improve the EBIT per kilo. And to be able to do that, we need also to improve the mix. Okay. But do you I mean, what's your kind of maybe perhaps it's something you'll cover in when you do the new strategy update in Q4. But have you changed your view towards what your sort of volume potential volume growth potential is in Food Ingredients? No, I will not say that there's that kind of a change. This is the result of work we have done for quite a long time to work towards more specialty solutions and more customer care developed solution. Okay. Thank you. Thank you. There doesn't seem to be any more questions registered at this time. So I'll hand the call back to you, speakers, for your closing comments. All right. So with that, we conclude the earnings call for AK Quarter 2. A strong quarter with a really strong operating profit growth and an earnings per share growth. I thank you very much for listening in and for good questions. Thank you very much. And this now concludes our conference call. Thank you all for attending. You may now disconnect your lines.