Earnings Call: Q3 2020

Oct 22, 2020

And welcome to everyone to this earnings call for quarter 3 for AK. With me today, I have Fredrik Nielsen, our CFO, and together we will guide you through the highlights of Q3. If you go to Page 2, we have the agenda for today. A short update from myself, a bit of business area updates, as well as an update from Fredrik, a bit more on the details of the financials and then some concluding remarks and as usual, a question and answer session in the end. With that, we're heading into Page 3. A few highlights of the quarter. We have seen a good continued sequential pickup in volumes compared to quarter 2. As you might recall, we had quite a drop in April, May and then saw a starting of a rebound in the end of quarter 2 That came into quarter 3 with a good bounce back in the beginning of quarter 3 and then continued sequential pickup of volumes. Volumes in total are still not at last year's level, but again a good recovery compared to Q2. We have been able to deliver a strong operating profit, a year on year growth of 6%, And that is really linked to a few drivers, which is, 1, the rebound of the volume, of course, but also the quickly adapting to the situation. So as you know, the foodservice segment selling into restaurants, hotels and airline catering and so forth in those segments, we have really adapted to the new situation and reduced our cost as well as launching our optimization program that we have started to implement, will reach full effect by mid next year and forward. And then also a good sales development for our high value added specialty solutions. So that in total really has led to a strong operating profit and a record high operating profit per kilo hour margin is now at 1.07% and that is up 7% year on year. With that, continuing into Page 4, a few more comments to the quarter. With regards to COVID-nineteen, we all know it's still here. It's still impacting people, societies, business operations across the globe. We have had from the get go a strong focus on business continuity, on acting safe, being able to operate since we are an important part also of the food supply chain. That has been working extremely well, and we have been able to operate all our facilities through COVID. We are in the middle of COVID. At the moment, we are living with COVID-nineteen and dealing with that additional risk. That puts a challenge also to the way we operate. We are a co development company. We are used to sitting face to face with customers in our innovation centers looking at new solutions. I'm so proud of the way we have also adapted our way of working, trying to find ways to interact in a virtual setting and making things happen in our innovation centers together with customers, but in a more virtual setting. Also coming back to the optimization program. We launched in the end of Q2 a optimization program that is expected to give us savings of around SEK 150,000,000 on an annualized basis, expecting to reach a full run rate by the second half in 2021, so next year. That has started well. We have started to see that being implemented. So that in combination with short term cost reduction measures adapting to the situation and also more mid- to long term actions, that in total has been working well for us through the quarter. We have also announced this morning that we continue to strengthen our position in the Indian market. We are acquiring the last bit, the 31% remaining shares of AK Kamani, our joint venture with Kamani Oil. And now AAK is 100 percent owner of that business. If we move on to Page 5, a few comments to some key events. We continue to push forward in sustainability in many areas. One example is a partnership with Zaha Global, where we really try to make a difference in this case in Northern Ghana, where we're helping women to find and implement the cost efficient way to get water treatment going and with that get clean and safe drinking water. We've also signed I've signed up to a renewed commitment, you can call it, to the UN Global Compact, and that's super important for us. It is for many of my colleagues in the world. Also happy to see that we continue to launch our AquaPlanet range, which is targeting solutions for plant based foods. And now we have launched that also in China, an important step forward in that. With that, we head into a few more comments on our business areas, the industries that we serve. 1st, at Page 6, Food Ingredients. A good quarter for Food Ingredients. Quarter 3 was a pickup in operating profit of plus 5% versus last year. We continue to strengthen our operating margin. So that's really good to see that the combination of cost improvements as well as focusing on our high value added solutions really give the results that we want. And now we have reached a milestone. We are above SEK 1 per kilo in operating profit per kilo. The main drivers here is really a continued strong development for Special Nutrition and then specifically for infant formulas, high end solutions or super premiums into that sector. Also a good recovery within bakery and a continued good development for plant based foods and in this quarter specifically into plant based dairy solutions or dairy alternatives. We still see a pressure on our foodservice business where we sell to restaurants, hotel chains, airline catering, those volumes are still significantly lower than last year, but we have seen a pickup during the quarter from a very low level in quarter 2. With that, we're heading into Page 7 and comments to chocolate and confectionery fats. In this segment, we continue to strengthen again our operating profit. We had that in a negative direction, call it, some years ago. But really since last year, we started to see a return to profit per kilo growth. And that is a combination of, if you recall, our improvement in the supply chain with better we now have better yielding sheet kernels. We have installed our capacity improvements in our crushing facility in Aarhus. And that, with a volume recovery, gives us a strong result in quarter 3. Organic volume growth is up 2% year on year, and our operating profit is up 7% year on year. So all in all, a good development. And in this sector also like for the Total 8 ks, it's also a good sales mix where we keep on selling more of the high value added solutions, our specialty fats, oils and fats for this industry. Then Page 8 and a few comments on technical products and feed. Quarter 3 is another solid quarter for technical products and feed. We have a slight improvement year on year in spite of the COVID impact, and that is specifically due to a strong performance in our feed business as well as a strong execution in our crushing operations. We then turn to Page 9. Just to give you some more light to what are we doing, call it short term and long term. We have, as I mentioned earlier, focus number 1 was the focus on our business continuity. As an organization, we also really came together in a successful way to adapt to the new situation, specifically a strong execution in our foodservice business where volumes dropped almost overnight, a quick adaption to the new situation, cost reductions and rightsizing has led to that. We are now managing that business in a good way. Also an overall cost reduction and call it short term measures adapting to the new situation across AK. But more importantly, also launching the optimization program that we talked about in quarter 2, which is really targeting us having the right structure, the right cost base, an optimized cost base for the different industries that we serve and the products that we launch into these industries. And that has started well. So the combination we're seeing in Q3, more of the short term savings in Q3 and a bit less of the long term, and the long term savings are then expected to take over as we come into the second half of next year. But all in all, a good execution that has led us to see production cost being down 4% and SG and A being down 9%. Part of the SG and A reduction is, of course, some of the, call it, short term, almost by design savings in travel and entertainment. That will, of course, come back to some extent as we start acting more and more normal. But some of that will also be permanent savings because I do believe we will manage our business. We and other colleagues in our industries and other industries, we've learned a lot through COVID and some of those improvements and new ways of working will stay. But certainly, to some extent, the temporary savings will come back later on when we act more normal. All right. With those comments, I'd like to hand it over to our CFO, Fredrik Nielsen, for some further comments. Thank you, Johan. Let's move to Page 10 and look into the cash flow. If we look at the EBITDA, it increased by $53,000,000 in the quarter or 7% due to the improvement we saw in the operating profit that Johan just mentioned. Looking into cash flow from working capital, negative $73,000,000 in the quarter. If we are looking into the more details behind the minus $73,000,000 we have seen increased accounts receivables due to the sequential improvement in sales during the quarter, but also that we are selling more specialty solutions to customers with longer payment terms. Inventory has increased as well due to normal seasonality. But the good thing here is that the inventory increase has been fully offset by increased accounts payables, which had a positive impact from a cash flow point of view. Looking into the raw material prices, they have increased during the summer that will impact working capital negatively in the beginning of 2021. As always, there is a 6 to 9 months time lag until we will see the cash flow impact from the change in raw material prices. Looking into paid interest and tax, up versus last year, but I think I would like to highlight here that an average tax rate of 24% is actually a real reduction versus last year where we had 25%, since you have the timing where you see an increased tax payment in the Q3. Looking into CapEx, amounted to $226,000,000 in the quarter, where our $53,000,000 was linked to our acquisitions. And then that was, of course, linked to the Russian acquisition that we paid during the Q3. For the rest, the capital expenditure was related to regular maintenance investment and capacity increases. Looking into return on capital employed on Page 11, we saw a little bit of a pickup here in the quarter. So it was 13.7% on a rolling 12 month basis, And that was due, of course, to the sequential improvement we see from the Q2. Looking into Page 12, the net debt. 8 ks has a really strong balance sheet. We have an equity asset ratio of 48% by end of September. Looking into our net debt end of September, we have 2,900,000,000 dollars And if you look at the debt ratio, net debt or EBITDA, it was 1.04, so a very good position here as well. Let's move to Page 13 and looking at the loan and duration profile. Almost 70% of our loans have a duration more than 12 months, which is, of course, is a strength in this volatile world. We have total credit facilities of €8,200,000,000 where almost €6,900,000,000 is committed credit facilities. Let's move then to Page 14 and looking at the FX exposure. I think it's also important to highlight here that we have negative character translation impact in the quarter of $43,000,000 $20,000,000 of those was related to food ingredients, $23,000,000 was related to chocolate and confectionery effects. And based on the spot rate end of September, we should expect to see continued negative translation impact in the Q4 as well. Then I would like to hand back the microphone to Johan. Thank you so much, Frederic. We are at Page 15. So almost needless to say, but still so important, uncertainty and volatility will it is high, but it will remain high. So we have seen a clear sequential pickup from Q2 into Q3. But we also know looking around us that the COVID-nineteen is there. It's going to stay for a while. We clearly do not have a clear picture on when there will be a vaccine, when we will return to something more normal or the new normal. So clearly, the uncertainty is there and it is high. At the same time, as a company, AK, we have shown that we are resilient. We can handle the situation that we're in. But of course, when looking at volumes and certain segments, of course, we're still impacted in the foodservice business where we are not in the world eating at restaurants, we are not flying like we used to do. We're not using hotels like we used to do. But on the other hand, we also see other segments where we perform strong. So the main message here is uncertainty will remain high. And COVID is there impacting us the way we act, the way consumers act and the consumer patterns as of today. This will continue as long as restrictions are there and we will continue to see uncertainty and volatility until consumer patterns return to more normal. Having said that, with our stable position, we are very confident in our position and that we stand strong in this context. And with that, just as a concluding remark on Page 16. We do offer our plant based healthy high value adding oils and fat solutions based on our co development approach. And in spite of these short- to mid term effects that we talked about, the impact of COVID-nineteen, we see no reason to adjust our view on the more long term strong favorable underlying trends in our markets. The short to midterm is still a high uncertainty, but we do remain prudently optimistic about the future and we see those underlying trends being there also post COVID. With that, thank you very much for listening to the comments to quarter 3. We're happy to take any questions. Thank you. And the first question is from Alexander Jones from Bank of America. Three questions, if I may, please. The first is on the Indian JV, where you've taken the full 100% stake now. Could you talk a little bit about what owning that full stake would allow you to do and how that helps kind of the acceleration of AK's growth in India? Then the second question would be following on from that more broadly on M and A, would appreciate a comment on kind of how you see the pipeline now. Is travel restrictions still kind of delaying due diligence? Or is that getting a little bit easier? And then the final question would be on infant formula. So clearly, a very strong result today, but some of the multinational customers in the past couple of days have talked about a tough outlook in next year with perhaps birth rates continuing to fall. So could you give your outlook into next year and whether you think you could offset any end market weakness through winning new customers amongst the kind of local Chinese players? That would be great. Thank you. Thank you, Alexander. And starting with the first question there on our, we call it, former JV, us now taking the final piece of the shares. In this case, it's a successful JV. We entered in. It has been a good journey together with our partner. So see this more as a natural step, a confirmed strong execution in India and a strong expectations for us being able to continue that journey. So the last piece of ownership is not necessarily changing the game us. I would rather say we are now continuing on, on a very good journey. That has been a good journey since we entered into this joint venture. With regards to our M and A pipeline and the question you had more on how are we possible and are able to do due diligence. Of course, COVID-nineteen puts things in a bit of different perspective. We are still geared towards, 1, having a strong balance sheet, so we are able to do M and A. We are certainly focused at doing M and A with regards to our strategic direction, meaning accelerating our strategy with the help of M and A. That has not slowed down at all. We are really trying to map out and to nurture that pipeline of opportunities. Having said that, yes, it's a bit more difficult because the M and A we look at are typically M and As with operations, with assets and physical assets that we would like to walk the floor and have a bit of touch and feel kicking the tires. That is, of course, more difficult, but we are finding ways to do that as well. But of course, that has a bit of an impact and it makes it a bit more difficult. But I wouldn't say it would lead us to not doing an M and A, but it certainly forces us to think a bit differently and to find pragmatic ways to get there and slows down a little bit the processes, I would say, on a general perspective. Then with regards to the infant formula outlook, we have seen and this is the positive. Yes, we've seen we are certainly a part of the total markets, meaning that birth rates going up and down has an indirect, of course, impact to AEK because we sell to these customers that in turn sell to the consumers. What we have seen here, which is positive, is that we are successful with our higher value added solutions, with our premium solutions into this market. We have seen an increased demand for those. So within this industry, we have seen an increased demand on the super premiums as well as seeing more engagement from local customers in China. So there is a bit of shift there. And within that, we have been successful, and that's our strategy going forward to be that. So with that partly being able to offset potential volume reduction, but of course, the best players when birth rates are up as well as the demand for super premium. So let's see where birth rates go, but we have had a strong execution within the market given those volumes that are there. Great. Thank you. Next question is from Oscar Lindstrom from Zanske Bank. Please go ahead. Your line is open. Hi. Good morning, gentlemen. Three questions from me. The first one is on the special nutrition segment and you had some problems late last year, beginning of this year despite a COVID sort of it seems to have stabilized. What is the situation in the Special Nutrition segment? And in particular, the baby nutrition in or infants, sorry, in China. Yeah. Thank you and good morning. I wouldn't call it necessarily had problems. To me, that speaks more about operational problems and so forth. Yes, we're part of the industry. So when birth rates were falling, of course, that impacted the overall market. And when volumes are down, it's not from a year on year perspective that becomes more of a challenge to deliver the increase in profit that we want to see. But having said that, we still have had a continuous development towards focusing on high value added solutions. And specifically to this market, important segment like organics, so organic infant formulas and so forth, we have been able to make that happen and to move volumes there and that helps us. And looking forward, it's a focus for AK to maintaining those high value added solutions and then grow with the market when the market will grow. Okay. A second question, if I may. I I mean, we've had some currency weaknesses in a lot of emerging markets, partly related to COVID-nineteen and its effects on raw material markets. What can you say about how this has impacted your business and especially the CCF segment? You're selling less, selling lower sort of value added products? Or what has been the impact? Yes. Thank you. So overall, as you've seen in the report, I mean, still showing organic volume growth in CCF, still showing increased profit in CCF. But yes, as Frederic mentioned, also with negative currency impact. So there is a bit of negative currency there in the result already. But with regards to the business and our customer contracts, I would say overall not really impacted by currency as such, apart from the fact that in a situation like this, call it, more of a downturn triggered by in this call in this case COVID, but we have also seen it in prior downturns that regions like the SIX region or the countries there start looking for, call it, more cheaper solutions or less costly solutions. Those shifts can be there and they could of course be triggered by currency or by downturn. So there is a slight movement there, but all in all, since we also sell this globally, we have been better in some regions and worse in other regions. And total, as you see in the result, it's still been a good development for CCS. Just a little bit to continue on that topic. I mean, you've managed to, as you highlighted, continue to improve your EBIT per kilo despite sort of a downturn in a lot of markets. Is this sort of a development which you expect to be able to continue to drive in your business? Or should we expect this effect to slow down to a more sort of normalized rate? I don't know. Yes, thank you. Let's split them up, I think, also in a bit of a time perspective. It is bullseye in the middle of our strategy. So our strategy is about that, focusing on high value added solutions, having the right cost to serve, optimizing the structure depending on the industry that we serve and selecting the segments where we have the best possibility to serve it with high value added solutions. So yes, in that and implicit and distracted is about moving towards better EBIT per kilo or higher margin products. What you see now is, of course, also an effect of being able to adapt the structure, the cost base quickly. And on top of that, seeing volumes coming back, so call it managing the cost base and at the same time seeing a volume recovery. So that really helped push, of course, the EBIT per kilo. And as I mentioned before, part of the cost saving today like travel and other things will, of course, come back. But at the same time, myself, the management team and the whole organization, we're certainly going to try to make the best out of this and really focus on not allowing cost to come back faster than volume and EBIT growth. Okay. Thank you. Actually one more question. I mean, at the CMD, a year ago, you spoke about focusing more on, I don't know more, but you talked about focusing on sort of technical capabilities, I think you called it. And you talked specifically about the speciality, lesser things, when it came to acquisitions as well. Has this strategy of sort of acquiring more R and D focused businesses taken on greater urgency with COVID-nineteen and some of those challenges? Or is that really sort of independent of what we're seeing with COVID-nineteen? I would probably say it's if you really look at it on an overall perspective, COVID hasn't really changed. It hasn't changed our strategy. It hasn't changed our belief in the strong underlying trend. Part of the underlying trend is a focus on health and nutrition. And that has certainly I don't think COVID has put a less demand on nutrition and health. So in that context, we could say that the COVID might boost the interest for these kind of solutions, but our strategy hasn't really changed with that. All right. Thank you. Those were my questions. Thank you. And there are currently no further questions registered. So I'll hand the call back to the speakers. Please go ahead. Okay. Thank you very much everyone that listened to this and thank you also for questions. And with that, we end the call. Thank you.