Earnings Call: Q3 2017

Oct 26, 2017

Hello, everybody. Ladies and gentlemen, please be very welcome to AK's press and analyst conference call for the Q3 of 2017. It has been a very special quarter. It was with great grief we received a sad notification that our CEO and President, Arne Frank, passed away in July. Arne will, of course, be deeply missed within AK, both on a personal and professional level. In this unfortunate situation, I must say that the management team together with its local teams have very professionally continued to execute on the company's strategy and deliver an all time high operating result, and this is not without some material challenges. Regarding the recruitment of a new CEO and President, AK's Board of Directors is expecting to announce the name during the 4th quarter. Let's move on to Page 2. Today's agenda will be, I will start by reviewing our current performance, then I will go into some more details regarding our business areas And then that will be followed by an update of our company program, the AK Way. And by the end, we should have ample time for questions. So let's move to Page 3. We are happy and proud and almost satisfied for a few nanoseconds with a new good quarter. For the 27th consecutive quarter, we achieved a record high operating profit And the quarter was also an all time high whatsoever with €475,000,000 in EBIT compared to the previous record from the Q4 last year when we reached 435,000,000 dollars We saw good organic volume growth in the quarter with plus 4%, and we are taking market shares. And total volume was up 8%, including mergers and acquisitions. Sales, up 15% in the quarter. That was mainly due to higher raw material prices, a positive product mix, continued organic volume growth and the effect from the acquisitions in 2016. This was partially offset by negative currency translation impact of SEK200 1,000,000 in the quarter. Looking at EBIT, as I said, an all time high of SEK475,000,000, an improvement of 10%. And in this good result, we have absorbed negative currency translation effects of $14,000,000 That means that we have another quarter where we are a little bit ahead of our long term management ambition. EBIT per kilo continued to grow nicely with 6% to a new record 0.87%. And we continue to see a good underlying improvement of the product mix, which is partly still offset by ramp up costs related to the greenfield investments. And we also had the negative currency impact that has impacted negatively on EBIT per kilo. Part of the management ambition for the coming years was deliver a good earnings per share improvement. I would say with an EPS improvement of 20%, we are definitely delivering according to plans and maybe a little bit better than our initial plans on earnings per share. Net debt is less impressive, as you can see, an increase with 23% year to date. But as early communicated, that has been impacted by higher raw material prices during the 1st and the second quarters. But we have during the 3rd quarter started to see positive cash flow from working capital and we expect that will continue during the Q4. So let's move to Page 4 and look at the trends. Total volume continued to grow nicely and were up 8%. The important part here is that also the specialty and semi specialty volumes was up 4% in the quarter and that's definitely faster growth than the underlying market. If we then look at the rolling 12 months trend, we have now passed 2,100,000 tonne in sold volumes and the good trend continues. As I said, an all time high operating profit despite some challenges And looking at EBIT per kilo or operating profit per kilo, it's the highest ever despite the ramp up cost for the new factories. And looking at the quarterly EBIT growth year over year, we have a new quarter that was on 10% or more. So let's move on to Page 5, the working capital days. As you can see, a very stable trend. We are down one day since year end 2016. And starting to look a little bit more into the details, looking at the receivable days, they are flat, but that despite an improved product mix. Inventory days are down and that's due to good inventory management during the last quarters, and we have also been able to make some further improvements with our accounts payable. So let's move to Page 6, look at the raw material prices. There has been a decrease in raw material prices since mid Q1, which will have a positive impact on the cash flow with a time lag of 6 to 9 months. However, we have started to see a modest increase in raw material prices since some months. And I would just like to take the opportunity to remind you that the 10% change in all our raw material prices will have an impact on working capital of approximately SEK300 1,000,000 with a time lag of 6 to 9 months. So I suggest that we move to Page 7 and look at the more detailed development of the raw material prices. The significant price increases during the second half of twenty sixteen explains the negative cash flow for working capital in Q1 and Q2 this year. Having said that, we are starting to see a positive cash flow now during the Q3 and that's due to the lower raw material prices since the mid-1st quarter. And we should expect to see a continued good cash flow from working capital during the Q4 as well. But due to the modest increase in raw material prices, which is roughly speaking 10% since some months ago, we should expect that that will have a negative impact during the 1st 6 months in 2018. So let's move to Page 8 and look at the more detailed cash flow analysis. We have a good EBITDA in the quarter, which is $66,000,000 better than Q3 last year. Paid interest continued to be down versus last year despite a higher net debt. The lower financial costs are down due to optimizing the financing in a few high interest rate countries, and we have also temporarily benefited from the structure in the interest market. Paid tax, dollars 36,000,000 lower than Q3 last year. But as I communicated both after Q1 and Q2, there is a timing always when you're looking on paid tax. And the important thing here is that the underlying tax rate is the same as we have communicated earlier. Looking into non cash items, that's mainly related to changes in pension provisions and mark to market impact of our financial instruments, which we are using for our hedging of raw materials. Change in working capital, we had an inflow of $1,000,000 in the quarter, which was very good and that explains by the lower raw material prices, but also very strong inventory management in the quarter. This was partly offset by the strong organic volume growth, which implies more accounts receivables and also some more working capital tied up for the new factories in Brazil and China. Investments are very much in line with previous guidance where we communicated that we will end the full year between $700,000,000 to $750,000,000 in investments. So let's move to Page 9 and look at the return on capital employed. Calculated on a rolling 12 month basis, the return on capital employed reached 15.4%, which is a small improvement since last quarter. And with the lower working capital that we expect for Q4 and continued EBIT improvement, we should expect Rocket to continue to improve the coming quarters. So if we then continue on Page 10 and looking at the business trends for the Q3. The business trends we are showing here is based on how AK look upon the trend in their each region from our perspective. And they are very similar compared to how we presented the trends after the 2nd quarter. There's actually only 2 changes. The first change is related to Technical Products and Feed, where we have changed from a red arrow to a yellow arrow in the Nordics. And the other is for food and greeters in U. S, which is now back to green arrow after 1 quarter with a yellow arrow. And I will go back now and go in a little bit more into the details for each region. So if we start with Nordics, which is an important part of AK, and there is a good trend in many parts of the business, but there are also some challenges, and that's mainly related to bakery and foodservice. But I feel clearly that we are doing the right activities in foodservice and we will start to see an improvement from the Q1 next year. And then as I said, after some challenging quarters, Technical Products of Feed was back to more historical levels on EBIT. If we then look at our business in Western Europe, the CCF business is performing really well, but we continue to be challenged in the bakery segment. In U. K, we are holding our positions, We are growing in some segments and we are struggling a little bit more in some other segments, particular bakery is tough here as well. U. S. Continue to develop nicely. And I will say, particular dairy, special nutrition and chocolate and confectionery fats are doing really well. And we're also seeing good development for California Oils and they are developing according to plan have now started to contribute to the profit still from a small level, but we see an improvement quarter by quarter. Central and Eastern Europe is improving in both Food Ingredients and Chocolate and Confectionery Feds. CAS continued a very strong trend from previous quarter with a very good development in Russia for the chocolate business. And Asia, a very good trend from Turkey in West to China in East and there is a good momentum both in food ingredients and chocolate and confectionery fats. And then finally, Latin America, which is mainly Mexico and Brazil in the AK world and also a few other countries. I will say Food Ingredients continue to grow very nicely. And also CCF, despite the challenges with economical situation in Brazil, I will say are doing a really good job. So let's move to Page 11 and look into more details regarding food ingredients. The demand for specialty and semi specialty products continues to be very good and we saw a growth of 3% in the quarter. But as you have seen during Q1 and Q2, the picture between the segments are very different. The bakery segment continued to be challenging, I would say particularly in the European market, but also rather tough in both North Latin America and U. S. But there are also some lights in the tunnel and we see good growth in Asia, South Latin America and Nordics. And then the dairy segment continued to grow really nicely with a high double digit growth. And it's more or less all around the globe we see this good growth. And that's both with our traditional products, but we also see good growth with the plant based products. And then regarding Special Nutrition, I had to take my hat off and they had another fantastic quarter. We saw double digit growth for our Aconino product range. We saw also double digit volume growth for the product range, Infat, which is sold through Advanced Lipids, a joint venture between AK and Simotech. And then finally, Foodservice reported declining volumes in the quarter. But as I said, I start to see some light in the tunnel regarding the market condition in the Nordics. So if we then move to Page 12 and look at the volume evolution, and I think the important part here is to focus on the plus 3% for the specialty, sema specialty. And I will say we have to go back quite a lot of years to find plus 3% organic growth in food ingredients for the specialty in sema specialty. The 4% growth in commodity should be more be seen in the light of minus 9% in Q3 last year. So let's move to Page 13 and looking at the trends. And then you can see that we had an all time high operating profit for Food Ingredients. This is the best quarter ever from an operating profit point of view. And then if you look at operating profit per kilo, we have seen a more stable evolution over the last 18 months. The product mix continued to improve in Food Ingredients, but we have also had some extra costs related to the ramp up of both Brazil and China that have impacted EBIT per kilo negatively and also the acquisition of Cal Oil where we got in 110,000 ton without any profit. So if you look at the growth in the quarter, it was up 6%, but at fixed FX, it was actually up 9%. So let's move to Page 14, and chocolate and confectionery fats. Continued good volume growth, plus 9%, so we are gaining market share again in this business area. And we saw strong growth, both for the high end specialty products and the semi specialty products. And it was good growth, both in more mature markets, but also in more emerging markets. Operating profit increased by 4%. And I will say we have faced some challenges during this quarter for chocolate and confectionery fats. We have seen continued strong demand, but we have faced some production disruptions in orders, which have resulted in increased production and supply chain costs. And this will gradually improve towards the end of Q4. So I feel really comfortable here that when we leave the Q4, we are back on track here, but there will be some extra cost as well in the Q4. Looking at Page 15 and the trends for chocolate and confectionery fats, you can see another good quarter despite the challenges. And then looking at operating profit per kilo, we have the ramp up cost and then also some extra cost for production and supply chain in the quarter, which have impacted EBITPA kilo negatively. So let's look at Page 16 and the cocoa butter price. As you can see, the cocoa butter price has decreased, but it's still in the sweet spot between $5,000 $6,500 So I don't think there's so much more to say that the cocoa butter price remain in the sweet spot. So let's move to Page 17 and Technical Products and Feed. We have had some challenging this quarter, that's for sure. Both Q1 and Q2 was rather challenging, particularly for our fatty acid business. But I will say now with the Q3, we are back to almost historical levels again. And that's partly due to that our fatty acid business has now started to see normal raw material prices. But it's also related to that our feed business continued to improve nicely. So let's move to Page 18. Our new company program is developing according to plan, but I would also like to highlight we have a few areas which is a little bit ahead of plan and that's Special Attrition and Dairy Plus. And we will at the Capital Market Day make a deep dive in some of our projects in the AK way. If we then look at Page 19, I would also like to share some nice photos from the official inauguration in our new factory in Changi Yang. We had that in the beginning of September. We have more than 200 customers and distributors participating, but also the Board of Directors participated as well. And I must say, it looks really promising from the new factory. And then on Page 20, I would just like to inform that we still have some tickets available for our Capital Market Day in Stockholm, November 28. So you can go to our web page and sign up for the Capital Market Day. And then if we look on Page 21 and have some concluding remarks, I think you will not be too surprised because looking at the future, we continue to remain prudently optimistic. I think that was all from my side today, and I'm ready for questions. Thank And we have our first question from the line of Casper Blum from ABG Sundal Collier. My side, please. First, regarding chocolate and confectionery fats. Can you just confirm that the disruption you've seen here in the quarter is a temporary one? And that when we look into 2018 Q3 and Q4, we would see a normalization and a bit of, how can I say, rebound in the profitability in CCF? And then my second question is regarding Food Ingredients. I don't know if it's possible, but can you give some sort of guidance to what EBIT per kilo would have been had it not been for your structural initiatives, I. E. The greenfields and your the acquisitions that you did last year? So I can say an organic EBIT per kilo, so to say. Thank you. Thank you, Casper. Yes, the situation we have with disruption in Orest is of a temporal in nature and it will be solved by the 4th quarter. So when you're going into 2018, that will be solved. That I can confirm. And regarding so coming back also maybe a fair comment to CCF, I will say without those costs, I will say that CCF has been able to show a double digit year over year improvement in the quarter. And looking at Food Ingredients, I will say the same. You have 9% if you add back the FX. And then the cost is more or less in the same magnitude as I commented upon in Q1 and Q2 related to Brazil and China. So you have also seen a double digit improvement year over year in for Food Ingredients if you have normalized it. But I suppose there must be a dilutive effect from the factories that are not running with full utilization. Do we have any guidance to the profitability levels for your, how can you say, legacy business? No. But what you can we can look upon it is, if you look at the ramp up costs we have had in the quarter, it's in the range of €10,000,000 to €50,000,000 in the quarter for the group. Okay. Thank you. Your next question comes from the line of Karl Melendy from Nordea. Please go ahead. Your line is now open. Yes. Hi. Thank you for taking my questions. I was wondering if you could specify what kind of contribution on earnings you had from Calloys in Q3 this year. And also in regards to financial net, up sequentially but down significantly year over year. Should we regard this as a new normalized level? Thank you. Regarding Cal Oil, it's a small positive contribution. So we are still far below any 8 ks average, but that is a small EBIT contribution in the quarter and you will see a gradually improvement here over some time. But I think that's what I can say about the Cal Oil. Regarding the financial net, I think this is more close to what you should expect going forward, what you saw in the Q3. Okay. Thank you. The next question comes from the line of Oskar Lindstrom from Danske Bank. I have one question remaining. And that's in the foodservice business, you said that, if I understood you correctly, you forecast an improvement starting in Q1. And what sort of gives you confidence in this? What gives me confidence is when I start to look what we have in our contract portfolio for 2018. And is that sort of a material or significant improvement? And was it only referring to Western Europe or globally? It's only referring to the Nordics. And Nordics, sorry. Yes. And this is a rather small part of the total AK, but I clearly see an improvement in the Nordics, which has been the challenge in 2017. All right. Thank you very much. Thank you. The next question comes from Heidi Vesterinen from Exane BNP Paribas. Please go ahead. Your line is now open. Hi. So I have a few. So on Foodservice, is the business primarily in the Nordics? Do you have exposure elsewhere? Because it sounds like other markets like U. S. And Asia, the underlying demand has been quite good. So how are you doing there? Or do you have plans to expand in those areas? And then back to the production disruption, are you able to quantify what the impact was in Q3 and the expectation for Q4? I'll start with those 2. Thank you. Looking at Foodservice, we have a quite significant business in the U. K. And we have also quite significant business in the States. And they are doing really well. So the issue we have seen in foodservice during 2017 has been insulated to the Nordics. And regarding the impact in chocolate confectionery fats, I commented that without the disturbance, we have seen a double digit EBIT improvement year over year, and now we have 4% in the quarter. And I think you should expect some similar cost into the next quarter. Thank you. The next question comes from the line of James Targett from Berenberg. Please go ahead. Your line is now open. Just on looking at sort of organic growth in Specialty and Semi Specialty and Food Ingredients, as you said, one of the best performances for a while. How confident are you in that level of growth continuing? I mean, you talk obviously strong growth in Special Nutrition and you got hopefully an improvement in Foodservice and the new capacity continues to ramp up in emerging markets. So just sort of where do you do you think that is sustainable at 3%? Or could we see some upside from here? Thanks. No, I hope we should be able to continue to grow from this level because we see a strong momentum in our Special Nutrition business and that's, of course, small from a volume point of view. Dairy, we also expect continue really nicely. And then of course, the challenge has been the bakery, which is a big chunk from a volume point of view. And when they are not performing that well, the rest need to grow faster to be able to get to the 3%. So I am a little bit optimistic that we should be able to at least keep this level and maybe with a small upside. We have a follow-up question from the line of Heidi Vesterinen from Exane BNP Paribas. Please go ahead. Your line is now open. Hi, again. Is there an update on Tropicao at all? I think we were meant to hear about this one at the end of the year. And second question, we've seen the deal with Bunge and your competitor, I OI. Does that change anything in terms of the competitive environment? And they've been talking about benefits of back integration. What is your view on that? Thank you. Coming back to let me just start with the Tropicao, we will come back to that at the Capital Market Day, but we are still optimistic that we will close the first contract here during 2017. And regarding Bang and Lotus, I think I should not comment upon competitors, but we feel comfortable with our multi raw material strategy where we work with different kind of raw materials. And we will secure our need of raw materials even if we are not backward integrated. As there appears to be no further questions, I'll hand back to Frederic for closing comments. I would like to thank everybody for attending this call. And thank you very much. And I'm looking forward to see you soon.