Earnings Call: Q3 2018

Oct 25, 2018

Ladies and gentlemen, welcome to the AAK Q3 2018 Report. Today, I'm pleased to present the CEO, Johan Westman and the CFO, Frederik Nielsen. 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. Speakers, please begin. Thank you very much. Good afternoon, everyone, and welcome to the AK Q3 2018 earnings call. Together with me today, I have Fredrik Nielsen, our CFO, and we will jointly do this presentation today. On Page number 2, you will find the agenda for today. We will obviously cover the Q3, some area per business some information per business area, our company program, the AK Way. And in the end, we will take any questions that you might have after today's call. With that, turning into Page 3, a few highlights from the quarter. All in all, a solid quarter with continued growth for the company, some 4% year over year volume growth with an operating profit of SEK 526,000,000, which is an increase year over year by 11%. Our return on capital employed is at the moment at 15.7%. Continuing into next page, Page 4. Also within the quarter, we have taken an important step in our Southeast Asia operations with the grand opening of an innovation center in Singapore. Singapore is really an important hub for us in Southeast Asia. With this innovation center, we are well located. We are equipped to support really our co development business model, where we, together with customers, continue to work closely together. We can now invite them to us. And with this innovation center equipped with what we need within chocolate and confectionery, bakery, ice cream, dairy, special nutrition, we can continue to develop new solutions for our customers and together with our customers. On the next page, just very quickly, our trends continue. A strong earnings growth in absolute numbers will continue to grow at a steady pace, so also in Q3 of 2018. Page number 6, looking at the overall trends for volume, operating profit, operating profit per kilo, all in all, a stable continued positive trend. Page 7. We will now go into some more details on our P and L sheet, balance sheet and so forth. And I hand it over to Fredrik Nielsen, our CFO. Thank you, Johan. If we start with the FX exposure and the translation impact we had in the quarter, We had a positive of SEK 16,000,000 in the quarter, where SEK 9,000,000 was related to food ingredients and SEK 7,000,000 related to chocolate and confectionery fat. Based on our current cancer rates, we should expect to see a small positive impact in the next quarter as well. If we then turn to Page 8 and look at the working capital days, we can see an increase with 4 days since year end 2017. Starting with inventory, we have been able to keep it flat. Accounts payable down one day, as you can see, and that's mainly related to the mix from new markets. Looking at receivables, up one day and here we can see also a mix issue and that's mainly related to getting more specialty solutions we see a pressure upwards. Then you have plus 4 days in other working derivatives. With declining raw material prices, you will get a cash outflow when you're rolling the hedge portfolio and then the positive cash flow will come back when we're getting paid by our customers. If we then turn to Page 9 and look at the raw material prices, you can see in the chart that the palm and the rapeseed price has turned in different direction during the quarter. The palm oil price has decreased during the quarter, while the rapeseed oil has started to increase. I would also like to remind you as well that the change of 10% in all our raw material prices will have a working capital impact of around SEK 300,000,000 with a time lag of 6 to 9 months. If we now move to Page 10 and look into the cash flow, we have a good EBITDA increase in the quarter of €69,000,000 Paid interest is slightly up in the quarter. That's two reasons for that. It's increased borrowings in high interest rate countries, but we're also seeing increased interest rates in a few markets, and it's mainly Turkey, which have a material impact. Pay tax is down. We are also seeing a lower reported tax cost in the quarter, which is mainly related to U. S. Tax reform. And I would also like just to remind you about the guidance we are giving for the tax rate, and we remain at the 27% to 28% in that guidance. Non cash items mainly related to the mark to market impact of our financial instruments. Looking into the cash flow from working capital, you can see a slightly negative number in the quarter. It's mainly the receivables that has driven the negative working capital. And that's due to the continued volume growth, but also normal seasonality. Looking from an inventory point of view, we have a good inventory control and had a good inflow from inventory. It was partly offset by reduced payables, which was a consequence of the lower raw material prices. Looking at the investments, I will say it's mainly regular maintenance investments, but also related to increase in the capacity at our existing facilities. Let's move to page 11 and return on capital employed. We see a good increase in the quarter. We are now up to 50.7 percent as Johan said. We were at 50 point 6 percent at year end and it's also good improvement versus the 2nd quarter. The main reasons here is the good profit growth combined with a very stable capital employed. By that, I turn back the microphone to Johan. Thank you very much, Fredrik. We are now heading to Page 12 in the deck. And as mentioned in the beginning, all in all, solid quarter for AK Inc. In Q3 2018. Now some details and further comments per business area or segment. We'll start with Food Ingredients, some more meat to the bone here. We have seen an organic growth of 3% in the quarter. The operating profit increased steadily by 11% year over year, and this is really on the back of a good margin improvement, where bakery continues in a positive trend, as mentioned earlier in the last few quarters. Very happy for that. Also, Special Attrition continues to contribute nicely. And also within this segment, we see as well the region Europe with a really strong performance on the back of both product mix and margin improvements as such. Operating profit per kilo for the segment was 8% year over year, an 8% improvement year over year, I should say. On the next Page 13, you see the trends. Not allowed to say more than a continued positive trend in earnings and earnings per kilo. Page 14, heading into chocolate and confectionery. We've seen a continued growth in organic growth in the quarter, also growth in operating profit, but a slight reduction in operating profit per kilo. And a few comments to that. We've seen a slightly positive development on pricing or our prices, especially on the high end product segments. However, at the same time, we are at the moment pretty much on capacity within this segment. The really positive thing is that the demand keeps pushing us forward. There is a higher demand compared to our current capacity. But at the moment, we're also experiencing a lower than average raw material yields, and that leads to a lower output and a higher cost. And that is really what you see in the higher cost per kilo that we've seen in the quarter. So all in all, a stable segment, stable performance. And with the high demand, the good opportunities, we keep investing. So we have taken new investments into operations during the quarter, and we also have decided on further capacity improvements in the quarter. And at the same time then keeping in mind that in this segment, we are also using raw material that comes from a wild crop in West Africa. And with that, at the moment, we are running at below average. So we expect this to be better in the future, but that might take a bit of time. Next page just quickly. The cocoa butter price has been coming down through the year now at around US6 $1,000 per tonne. Next page, Page 16. Again, the trend per business area or segment for Shop Floor and Confectionery is slight improvements year over year with operating profit and a flat to slight reduction in operating profit per kilo. Heading into the next page 17. In our Technical Products and Feed business, we saw a significant growth, a good growth in our organic volume growth, but a significant growth in operating profit and operating profit per kilo. So with that, this has been mainly due to a solid performance in our crushing operations and also a very good development in our feed and fatty assets business. Page 18 shows the trends for TPF or Technical Products and Feed. As you can see, a steady improvement from last year where we had some operational difficulties during the quarter 2 and quarter 1, but since then, a really steady improvement. With that, I conclude the further comments to the different business segments. Heading into Page 19, just quickly on our company program. We see a steady performance here. Most of the activities are on track or ahead of plan. And this program is now a little bit more than halfway through. So we continue to push forward and to push forward into 2019 where we are finalizing this program and developing the next company program. Page 20, a few comments on our earnings growth. We have a management ambition of growing our EBIT by 10% on average, and we are currently 18 months into the program at 11%. Page 21. We continue to see positive underlying trends in the food industry. And with that, we also remain prudently optimistic about the future for AK. Before we move on to questions and answers from our side, I would also like to take the opportunity to remind you all about our Capital Market Day that is coming up on November 21 this year. So very soon, we will have the chance to meet again for those of you that take that opportunity. And with that, I will end this presentation, and we are now happy to take any questions from our listeners. Thank you very much for calling in. Thank you. Ladies and gentlemen, we are now ready to take your questions. And we have a question from Kasper Blom of ABG Sundal Togia. Gentlemen, three questions from my side. Please, I'll try and mention all the 3 and then you can always revert. First of all, regarding Food Ingredients, you mentioned that Special Nutrition is, as usual, doing well. Could you give maybe a little bit of more granularity on where you are on Senior and Medical? I understand, of course, that these are not big areas yet, but maybe sort of a bit more guidance on when we would expect to see that as something that sort of stands out and can really impact the numbers here? Secondly, on the chocolate and Fractionary Fats, you did mention that it might be a little bit of a while before you return to sort of normal here after the investments you're doing. How long would you sort of expect us to have to wait here? Is it that we will get back to normal in 2019? Or is it more like a 12 month period we will have to wait? And then finally, a question I pretty much find myself asking all companies at the moment, but are you seeing any kind of potential impact on your business from the mentioning of trade wars that you have all the time in news? And maybe also if you can give a bit more comment on certain emerging markets like Turkey, Argentina, those kind of areas where there seems to be a bit of turmoil at the moment, if that is in any way impacting your business? Thank you. Thank you very much, Casper. Good questions, all of them. Starting with the question on senior and medical. I might disappoint you by not giving you all the details, but what I can assure you is that these are two areas of importance for us. So we continue to push in these areas. We have a specific focus on these areas in parallel with within Special Nutrition. Obviously, as you know, infant fat nutrition is a large segment for us already. Personally, I would say nutrition is a key area for AK. Nutrition is an area where we can contribute with our co development approach, with our innovations, with the capabilities and the knowledge that we have within our company. Within that, senior is very interesting, medical is very interesting, but there are other areas as well. So what we are doing is that we are continuing to move forward. We are organizing ourselves to be able to take advantages in these segments. But before when can you get something significant and so forth? Well, we have to wait and see a bit. Our organic growth is obviously happening, but from very small numbers. But we as you know, we are a company that also looks at M and As. So maybe the first big reaction might be with an M and A coming up, but in parallel, and we are growing it, but from low levels. So if that is okay, Asana, for the first question? I wasn't hoping for very specific numbers, but maybe you could shed a bit of light if this is something that you maybe a bit more into detail on at your upcoming CMD? We will talk about it. Yes, I will mention, but I wouldn't expect us to be more detailed compared to what was now because we are at low levels today. So they are not the numbers, the earnings are not significant to 8 ks at the moment, but it is a significant focus area for us going forward. So in other words, we believe in this in the long term perspective, but not in a short term perspective. That's fair. All right. So then CCF, as I mentioned, 2 things to bear in mind or 3 things to bear in mind. First of all, a strong underlying trend in chocolate and confectionery. We strongly believe in this market. It has been a growth driver for us in the past, and we believe it to be a growth driver for us going forward. We have had a lagging capacity strategy in this area. So we have reached a capacity ceiling now that we are investing in. So we're investing in bottlenecks. Some of that has already been taking place, but more we have to do more and just decided on that. So and some of these investments take a 9 months to a year to get implemented. But on top of that, as I mentioned, we also have a raw material, and I'm talking about shea from West Africa, a wild crop that has to be collected once a year, and we are in that season now. We are storing that in our warehouses before we use it in production. So at the moment, we're seeing and experiencing somewhat lower than average yield. So we are trying to get as much out as possible by mixing and using the best possible mix that we can. But I foresee us having to use raw material input with a somewhat lower yield a bit into 'nineteen. And then by the end of 'nineteen, we will see capacity increases coming. And on top of that, most likely an improvement in yields as well, but that's nothing that I can promise since this is a wild crop and we have to see what we can get in our sourcing programs. And again, mentioning that we are a significant player in West Africa. This builds nicely into our sustainability work as well with our women program in West Africa. So we are investing in the back end of this. We're investing in our own operations. But as of now, we have the is it a problem or is it something positive? We can debate that. But I would have liked to be able to sell even more. But at the same time, we're glad that we are looking at a high demand that we now have to balance with how we can get our capacity increase moving and at the same time getting as much output as possible. But it is limiting us a little bit at the moment. With regards to financial impact from some of the in some countries, you mentioned Turkey, Argentina. Obviously, that is impacting us for our South Latin America operations. Yes, Argentina is impacting us, but not to the degree that you would see that in the numbers we present today. Same thing for Turkey. We have had the strongest quarter and the strongest month in September ever in Turkey. So we are doing well. We are growing. We are well established in the market, so we are there to stay. But obviously, everything around that in the economy is impacting us. But the most important thing is our business is growing. We are there to stay, and we are taking actions to mitigate any risks that we have. And I'm feeling very comfortable about how we do that. So of course, there might be, as Fredrik mentioned, we see some interest rates impacting immediately, but we're taking actions to that as well. The long term impact on the business in terms of what is the earnings we're getting after currency translation and so forth, we'll have to see. But at the moment, I'm confident about us doing the right thing in Turkey. So not a major impact to us as of now since we are a truly global business with many markets that builds into our total results. That's very clear. If I may just follow-up a little bit. Do you see any potential hit from introduction of tariffs between any countries? Or yes, you kind of know what the drill like. I guess most is between China and the U. S, but is there anything anywhere that can sort of potentially have an impact on you? Short answer is yes. Obviously, anything can have an impact. But if I rephrase your question, is there anything we see today that we have a significant impact? No, we don't see that today. We don't see that with our the way we're spread and the way we operate. We don't see significant impacts. But that if it is that due to visibility or to our business Well, we have to see a little bit. But again, I think our setup is pretty well balanced. Our next question comes from the line of Karl Melodeau of Nordea. Yes. Hi. Thank you for taking my questions. My first one relates to the financial net, which was high in Q3 versus previous quarters this year. Should we expect this level to remain also for Q4? Q4? And then secondly, I noted that you removed the comment on outlook for each individual segment. If you could comment on the reasoning behind this? Thank you. If I start with the financial net, yes, you should expect to see the same level in the Q4. All right. Thank you, Feroen. With regards to guidance, we are giving the type of guidance that I personally think that we should do and in a way that it builds to our store and at the same time, don't bank on too much guessing. So really the underlying driver that we comment also in our in my comments in the CEO comments, is really the growth in the fluid industry. And with our exposure, that is really the main driver. Then we will see certain segments being stronger and or weaker in certain quarters. And therefore, we believe that this is the best and the best balanced view that we can give. And we're also commenting a bit more specifics on why we're operating the way we are in certain segments. So nothing more, nothing less. Our next question comes from the line of Oskar Lindstrom of Danske Bank. Three questions from my side. First off, in the food ingredients business area, I the bakery recovery has been going on for a while now and then also you mentioned Europe is improving. What's driving these improvements? Anything specific? And then sort of how long term should we expect them to be? Thank you, Oscar. We what we are doing and what we have been doing and this fits very well to our overall strategy as well. So what I'm very pleased with is that within these segments, it's really the result of a purposeful and strategic move within the segments. And as you know, we're focused on customer co development. What is it that we want to achieve? Well, we want to achieve high value added solutions, and that's also where we focus. So we have been bettering in term, call it, the mix and selling high value added solutions, but also better in communicating the value that we deliver, meaning that we have been able to drive margin improvements on based on the true value that we deliver, not just adjusting the price, but really delivering a higher value and also charging for that. But in that sort of mix change, I mean, is it sort of that you're sort of getting rid of some less attractive contracts and then moving into more attractive contracts and that, that shift comes to an end and then you're sort of back to the normal sort of continuous mix improvement. What I'm trying to get at is, is there sort of a specific shift going on that's sort of finite within this part of the business? The short answer would be no. There is not a specific shift where anyone, including myself, went in and said, cut the tail. That is not the majority of this. A part of this is, obviously, we don't want to do bad business that is not the right one for us. So a little bit of that is looking at the tails and focus on where we want to be, but a lot of it is really driving the value within our current portfolio and focusing on the high value added business opportunities and increasing the price on the back of a value proposition throughout the portfolio more than really a short term shift by cutting the chainsaws. Okay. My second question is in the CCF business area. And you mentioned these debottlenecking investments that you will do, which will take, if I understood correctly, 9 to 12 months. And then after that, they'll be done. Should we expect this to drive CapEx sort of more than usual in this period? No, you should not. These are not the heaviest investments we are doing. So they are bottleneck investments, not driving CapEx, nothing. This is really normal business. We have had for some period of time, we have had overcapacity fluctuations in the yields and so forth we've had in the past as well. Now we just reached capacity limit in certain areas of the value chain, and we have to debottleneck this. But these are not heavy investments. And in parallel, we're looking at other opportunities to balance capacity between our plants and so forth. So it's not as simple as to say it's a one process step and this is a one and done investment. So we are debottlenecking as we speak and finding ways to improve slightly. But we have a very important debottlenecking that we just made, took a decision on that will come in, in like Q4 next year. But besides that, we're still working on smaller steps by optimizing the manufacturing footprint that we have. Okay. Thanks. But it's not driving investments and CapEx over anything that is normal for us. And should we expect sort of a lower organic growth for the coming 9 to 12 months then or an impact on earnings? Well, obviously, what I'm obviously, it impacts since the when you have a capacity limit, it impacts our total volume and with that sales. But we're also seeing a strong demand in the market, And this is not AK unique. We're seeing a strong demand in the market within shockers and confectionery and especially within our high end solutions. So we have also already seen an improvement in pricing and so forth. So with regards to earnings, there is also an opportunity to get more out of this market for the coming period as I see it. So the net effect on earnings, we'll have to see. We are continuing to pushing for the high end solutions for pricing our values, the propositions to our customers. And with that, we'll see what we get. But obviously, from a volume perspective, it is limiting a little bit the growth for, call it, 2019. Okay. So we should sort of think perhaps earnings shouldn't be so much volume driven, but perhaps mix driven. Is that okay? And just my final and third my third and final question is that in the Food Ingredients segment, you mentioned the U. S. Market being slightly continued to be weak. Could you shed a little bit more light on that? Sort of what are the reasons where is it being expressed? I think you mentioned foodservice and this is something that we should just sort of think of as temporary or is it an accelerating problem or do you have a is it company specific or more market driven? A few things. First of all, we're not so we're commenting on what we're seeing, meaning that this is a shift. We're still doing well in U. S. And North America, but we are not doing as well as we want to. So we're taking actions on that. And part of this, as we mentioned, is the foodservice business where we see increased competition, and we are reviewing this business model and see how we can get back on track and come back to the earnings levels that we want to see in North America or U. S. In this case specifically. So we do not see an accelerated problem, but we see we have actions to take us back up to the profit levels that where we want to be and to continue to grow in U. S. And we see significant and good opportunities to do so. But at the moment, we have seen for some quarters that we are weaker compared to our plan, and that is really what we're mentioning. But we are not accelerating this downwards, but we are taking actions to turn the trend around to the positive one again. I mean is there any way you could give us sort of the magnitude of sort of the loss versus desired level or the difference between where you are now and the desired level in terms of We're not showing the details on specific markets and or factories. So this is nothing to panic about at all. It's just a little bit weaker than our plan, and we are taking actions to get back to our, call it, normal growth trend in U. S. All right. Thank you very much. Those were my questions. Thank you. Thank you. Our next question comes from the line of Oliver Knobach of Pictet. Most of my questions have been asked already. I have one. Maybe you can comment it, but probably not. Has LOTUS under the new ownership different commercial approach now? Do you see the more aggressive or less aggressive, more rational in the market in their behavior? You for your question, Oliver. And I have I will never comment my competitors and friends in the industry in any specific way. So I leave that to your judgment whether they are or not. We are focused on being a highly valued partner to our customers. And if we can beat competition, then we're happy to do that. And but I am more focused in driving the market together and really focusing on delivering good value to the food industry. Industry. Our next question comes from the line of Per Jorgensen of I and Ting Asset Management. Yes. Thank you, gentlemen. Just coming back to the new investments that you did in Brazil, in China, in cattle oil and so on, you mentioned that the U. S. Situation was teasing you a bit. Is the how are they doing the new plants compared to your expectations and especially compared to EBIT per kilo from the new factories? That's my first question. Coming back to the CapEx plans, I know Frederic has been before been very specific about the CapEx plans. Do you see any change? I mean, it's basically compared to what you mentioned about Carmani, important investments, upgrades significantly in Louisville and so on. Will you keep the CapEx plans for 2019, 2020? Or will we actually see an acceleration in the CapEx going forward? Thank you, Per. Very good question. So and thank you for reminding a bit nuances to the U. S. To start with, Kaller. Kaller is doing well, and we're doing better. And my comments on U. S. Is more to the, call it, the historic AK U. S. Where we're a bit lagging our own plan. But alloy, as an investment, is doing well, better than planned. So that's all good. And we see also the we see continued opportunities throughout the U. S. And I'm especially glad for us now having a footprint in California and reaching the market around California. And I think there are great opportunities there and good market trends that fits us well if you look at the megatrends and with our end consumers in our industry. So that fits well. So Caloi, we're very happy with. With regards to China Brazil, we're now moving. Nothing has changed really compared to what we mentioned before. We see both plants doing plants doing well in a slightly different setup where we get slightly more volume in China and working on getting to the value added piece of it and slightly better margins in Brazil, but slightly weaker volume. So good opportunities. They are both moving on well without being specific on EBIT per kilo or so. But these are investments in the right locations and but with different market dynamics. And we would John, it's fair to assume that when you look back from the investments when you made them, I know that's before your time, But when you look at the product mix, one should argue that the EBIT per kilo when the factories are up and running, that they should actually be enhancing to the group level? That's my understanding as I remember it. Well, at least, yes, it's difficult to I don't know all the comments being made in the past. I think it's fair to say that when we have them up and running and with a good utilization and delivering the type of business that we normally do, it should be accretive to our earnings and so forth. But then whether the Chinese plant is higher in EBIT per kilo than another plant, that is not something you can assume because we are delivering to the same type of customers and markets through a large degree, Not the same market, but the same type of customers and product solutions. And then you had also questions about CapEx plans. We don't see any big shift at all in our CapEx plan with our ongoing operations. So I think that what we've communicated before pretty much holds. And Furdik is nodding here in front of me. And with regards to Kemani, Luevo and so forth, these are just examples of continuous improvements and investments that we are doing to meet demand and to improve our operations. That will continue with the other plans going forward. Yes. Okay. Thank you. Thank you. Thank you. Our next question comes from the line of Kenneth Tolya Hansen of Carnegie. Please go ahead. Your line is open. Thank you. Yes. So continuing to discuss CapEx plans and so on, the balance sheet is pretty strong right now. You have a good cash flow and you haven't made acquisitions for a couple of years. So are you more active to look for acquisitions now? Are you more prepared to do acquisitions? Or do you wonder about doing something else with the cash? Good question. I'll leave the last question. I'll leave that to shareholders and future decisions if we do something else. But to focus on our business, yes, we have it's in the eyes of the of you whether we have a strong or not balance sheet. But the balance sheet definitely allows us to make acquisitions. Are we focused more or less? I cannot jest whether we are more focused or less focused, but we are focused. And it is a very important part of our growth journey. In the past, it is a key part of our growth journey going forward. So yes, we're looking at acquisitions. And whenever we find the right one, we will try to engage and do those. And we believe that we have a both the way the company is performing, but also our standing or rating in the market and our balance sheet supports an acquisitive growth combined with an organic growth. Great. Thank you. Thank And there are no further questions at this time. Please go ahead, speakers. All right. Thank you, everyone, again for calling in, and thank you for these questions. Good questions. I hope that our answers fulfilled what we wanted. And with that, I will close today's earnings call. Thank you very much. And again, don't forget our Capital Market Day coming up within a month. All right. Thank you very much.