Welcome to the Alfa Laval Q2 earnings call. At this time, all participants are in a listen-only mode. There'll be a presentation followed by a question answer session, at which time if you wish to ask a question, you'll need to press star and one on your telephone keypad. I must advise you this conference is being recorded today, Thursday the 18th of July, 2013. I would now like to hand the conference over to your speaker today, Lars Renström. Please go ahead.
Thank you. Good morning, most welcome to the presentation. I will start by giving you my three highlights. The order intake improved sequentially and was up 5% organically, we came in somewhat higher than we anticipated. We expect the third quarter to be on about the same level, which means somewhat higher than the corresponding quarter a year ago. The second highlight is that order intake for the Marine & Diesel Division grew 11% sequentially, mainly due to large orders for exhaust gas cleaning. This means that the first half of 2013 is up 21% compared to the second half of 2012. Official statistics show that the increased contracting to the shipyards that started in the first quarter continued in the second, triggered by low yard prices and increased fuel efficiency of modern ships.
Finally, after a series of stable quarters in China, we achieved a broad-based double-digit growth sequentially since the wait-and-see mode seemed to ease somewhat. Let's take a look at the key figures now. Orders received declined 4% to SEK 7.6 billion, net sales dropped 3% to SEK 7.5 billion. Adjusted EBITA declined 4% to SEK 1.2 billion, the adjusted EBITA margin reached 16.4% versus 16.5% a year ago. For the first six months, orders received declined 7% to SEK 14.7 billion. Net sales dropped 4% to SEK 14.1 billion, adjusted EBITA declined 5% to SEK 2.3 billion. The adjusted EBITA margin reached 16.4% versus 16.5% a year ago. Now we move over to orders received and margins. There you see that the orders received on rolling 12 months reached SEK 29.3 billion, the increase was 1% year-on-year at constant exchange rates.
After three consecutive quarters with a secular order intake, we achieved growth. Moving over to the next slide. You see from the order analysis that year-on-year acquisitions contributed with 2.2 percentage units, organic growth was -1.4%. We had negative currency effects of 5.2%, giving a total of -4.0%. Sequentially, acquisitions contributed with 0.1%, the organic growth was 4.6%. The positive currency effect was 0.9%, it gives a total of +5.6%. Moving over to the next slide. The EBITA margin reached 16.4%, the operating result was SEK 1.2 billion. We can see that we have now had six consecutive quarters around 16.5%. Moving over to highlights in the quarter. Process Technology booked a large order for heat exchangers to a petrochemical plant in the Middle East. The U.S.-based Niagara Blower Company was acquired.
The company adds about SEK 400 million in annualized sales with a profitability well above group average. The company supplies air-cooled heat exchangers, especially suited for the oil and gas processing industries. The Marine & Diesel Division booked two large orders for exhaust gas cleaning. One for two new cruise ships with a value of SEK 55 million, and the other for retrofit installation worth SEK 170 million. We expect more orders for exhaust gas cleaning during the second half of 2013. Now we move over to the development per segment. We see that year-on-year in the quarter, six segments grew or were unchanged, whereas five declined. Let's take a closer look at the divisions, and please note that all comments are sequential. We start with the Equipment Division, where order intake was up 10%. Sanitary saw good demand from beverage and dairy applications.
Both industrial equipment and OEM had significant growth due to seasonal demand. Also, successful introduction of new products contributed to the growth of OEM. Moving over to the Process Technology Division, we see that food reported growth for base business and large contracts alike. Energy and environment was down due to non-repeats. Partly as a very high activity level in the oil and gas resulted in lack of industry resources, leading to projects being postponed. For process industry segment, base business supported growth. Moving over to the Marine & Diesel Division, which grew 13% on top of the 20% growth in the first quarter. Marine & Diesel equipment saw a base business growth reflecting an increase in yard contracting. Marine offshore systems was lifted by a strong base business as well as large exhaust gas cleaning contracts.
Demand for parts and service declined as large repair orders were not repeated. On the next slide, we see that for the half year, that marine and offshore systems is the only segment up, supported by exhaust gas cleaning. Process industry and energy environment are down due to non-repeat large orders. We, however, maintain our positive view on demand from refinery and oil and gas industry as the activity level is high. Now we move over to the geographical developments. There we see that for order intake in the quarter year-on-year, North America grew 11%, followed by Latin America with 10% and Nordic at 7%. Central and Eastern Europe declined 12% due to non-repeat large orders. Let's take a closer look at Asia, and now all comments are sequential. The region grew 5% and base business was strong in all three divisions.
As a whole, Marine & Diesel and Equipment Division grew, while process technology declined somewhat due to non-repeats. Marine saw a positive impact from new ship contracting in general and for oil and gas transportation vessels in particular. After a series of stable quarters in China, we reported broad-based double-digit growth for base business and large orders alike as the wait-and-see mode seemed to ease somewhat. Next slide. Western Europe and Nordic increased 4% and 29% respectively. There was a positive development for both base business and large orders. The large exhaust gas cleaning order boosted the growth in Nordic. We saw growth in most countries and sales regions. The 10% growth in Central and Eastern Europe was explained by a very good base business development. Russia was unchanged as the decline in large orders was compensated by growth in base business.
Next slide, we see that North America declined 10% due to non-repeat large contracts as base business and parts and service was unchanged. We see that in oil and gas, customers are delaying projects due to lack of resources. Latin America grew 10% since we received large orders in the food and oil and gas sectors. The base business also reported growth. On the next slide, we see that for the first six months Latin America delivered 5% growth year-on-year, while North America and Western Europe, including Nordic, were unchanged. Central and Eastern Europe and Asia declined due to non-repeat large orders. Moving over to the next slide. Here we have a top 10 ranking in 2012, and the yellow bars show the LTM development after the second quarter. The U.S. continued to strengthen to the number 1 position.
All other markets declined except Mid Europe and Adriatic, since we had very strong first six months last year. By that, we move over to the financials, and Thomas.
Thank you, Lars. Good morning, all of you. Let's take a look a bit more into the details of the financials. Let's move on to the next slide. Lars has covered the orders in a good amount of detail, let's move on to sales. In the quarter, we realized sales of SEK 7.55 billion. Let me confirm that this was in line with our own expectations, including that the delays commented after quarter 1 were largely recovered. Sales was down 2% organically compared to last year. Acquisitions added 3.7% in the quarter. Please note that we had as much as 5.1% adverse translation effect. However, given that the weakening of the Swedish krona remains, we expect translation effects to be less significant in relative terms on a full-year basis. In absolute terms, sales was down 3.4% year-on-year.
Sequentially, we enjoyed a like-for-like increase in sales of 14.3%, mainly explained by a combination of seasonality and delays from quarter 1. Looking at parts and service, it represented 27.4% of total revenues in the quarter against 26% in quarter 2 of 2012. Parts and service represented 27.7% during the first six months, an increase from 26.8% last year. With that, let's move on to gross profit margin. Gross profit margin for the quarter was 37.9%. This represents an increase of 0.9% year-on-year and a reduction of 0.3% sequentially. Remember, with the first quarter report, I said, in the near term, we expect a negative mix effect as capital sales is expected to increase and FX transaction effects will be turning to the negative.
I also said we do not foresee any material changes to load or any material effects from gross margin in the backlog compared to the just reported. The slight positive price effect is expected to continue year-on-year. I would argue that the actual for Q2 was just reported, came out as we predicted three months ago. We were then benefiting from better factory results, which is then mainly a combination of load and lower metal prices. We were then suffering from worse mix, FX, and still some accounting adjustments to Alfa Laval standards at Aalborg Industries. Year-on-year, we were mainly enjoying a better mix, factory results, and a limited positive price effect, partly reduced by a slight negative FX effect. Let's come to the first forward-looking statement. In the near term, we expect a slight negative mix effect.
FX transaction effects are expected to be limited, but negative. We do not foresee any material changes to load or factory results as a whole. Finally, gross margin in the backlog is not expected to present any material change to the just reported. With that, let's move on to look at overhead costs and other items in the P&L. Starting with R&D. R&D ended at SEK 191 million in the quarter, which is an increase year-on-year, like for like of 6.4%. R&D spend, looking at the first six months, represented 2.6% of sales, and that is, of course, in line with our guidance for R&D in relation to sales. Moving on to sales and admin. Sales and admin amounted to SEK 1.27 billion in the quarter, representing an increase like for like of 0.9% year-on-year.
This effectively means continued effects from the savings program initiated late 2011, taking salary inflation and selective revenue investments in presence into consideration. We had, as I'm sure you've noted, adverse FX effects totally impacting EBITA of SEK 63 million in the quarter, giving us an EBITA margin of 16.4% and in absolute terms SEK 1.24 billion. Moving on to profit before tax, we ended with a profit before tax of SEK 969 million in the quarter, a decline of 12% over last year. This included exchange differences in the financial net of SEK 103 million and total FX effect, including the effects in EBITA of SEK 166 million. Actually, profit before tax was some SEK 28 million higher, excluding FX in a year-on-year comparison. Of course, this has a lot to do with the weakening of the Swedish krona as far as the exchange effects in the financial net is concerned.
Before leaving the P&L, taxes ended with a charge of SEK 325 million. The higher-than-guidance tax charge is coming from a few non-deductible items. Our long-term guidance remains 28% taxes based on profit before tax. EPS for the quarter SEK 153 and SEK 181, excluding amortization on step-up. This is a slight decline compared to Q2 of 2012. Broadly explained by FX effects. With regard to return on capital employed, we reached just over 26%, an increase sequentially of 1% and a decline of just over 2.5% year-on-year. Return on equity 22%, against 22.9% last year, but then an increase of 0.6% from Q1. Let's move on to look at the cash flow statement. We can summarize the cash flow statement in the following way. We enjoyed a substantial increase in cash flow from operation.
This was reported thanks to a reduction in working capital to compare with a fairly substantial increase in the second quarter of 2012. This reduction is to quite some extent coming from an increase in customer advances in our Process Technology contract business. Acquisitions of SEK 441 million is largely coming from the acquisition that Lars commented just before of Niagara Blowers in the U.S. Free cash flow reached SEK 876 million. This is to be compared with SEK 450 million a year ago. I think it's fair to say that we had another really good quarter in terms of cash generation. Let's take a look at the FX. As mentioned earlier, FX effects in EBITA were SEK 63 million negative, coming from a translation of SEK 56 negative and a SEK seven transaction negative.
We have, of course, updated our forecast for the full year on the back of, among other, the weaker SEK. With the assumed rates as specified on the slide, we expect a net FX effect of a negative SEK 125 million in EBITA for the full year, mainly coming from translation as specified. This is an improvement of SEK 17 million compared to the projection as presented with the Q1 report. Applying the same rates into 2014, we estimate an adverse transaction effect of a mere SEK 15 million to be compared with a negative SEK 100, three months ago. Let's move on and look a bit at the order backlog. We had a total order backlog as per end of June of almost SEK 14.9 billion, representing approximately six months of LTM sales.
Looking at the backlog by division, you find an increase in new Process Technology and Equipment and reduction in Marine & Diesel year-on-year. However, it's worthy to note that sequentially, Marine & Diesel backlog grew for the first time in a very long while in Q2. Looking at the order backlog to be shipped during 2013, this amounted to SEK 9.79 billion. Let's move on to the bridge of full-year sales 2012 to 2013. Looking at the known and the unknown parameters for full-year sales We had a like-for-like backlog as per January 1, that will cause reduced sales with SEK 100 million for 2013. Based on the closing exchange rates as per June 30, we expect negative translation effects to sales of some SEK 0.9 billion. A reduction of this effect with some SEK 300 million compared to the last report on the back of, again, this weaker SEK.
The acquisitions in 2012 and 2013, we estimate will give additional sales of SEK 700 million in 2013. This might be lower than you expected. The reason being that acquisitions exposed to oil and gas are also expected to be influenced by the delays among customers commented earlier by Lars. This gives a subtotal for the known parameters of SEK 29.5 billion, an increase from the situation after Q1 of SEK 300 million, due to less of translation effects. As far as the unknowns are concerned, it's always up to you to form an opinion about demand. Please consider our outlook and the order trends over 2012 and through quarter two of 2013. To provide you with a reference point, en-route orders amounted to SEK 5.1 billion in the second half of 2012 at current exchange rates.
With regard to prices, we made small adjustments to prices for standard products at the beginning of the year, giving limited effect to the total. Net metal prices are expected to have somewhat of an adverse effect on particularly the OEM segment. With that, I give the word back to Lars for the outlook and the closing remarks.
The outlook is as follows. We expect that demand during the third quarter will be on about the same level as in the second quarter, which means that it's somewhat higher than the same quarter the previous year. For each division, our demand expectations for the third quarter is as follows. Marine and diesel, somewhat lower since the large exhaust gas cleaning orders are not likely to repeat in the third quarter. Equipment on about the same level, since the positive seasonal effect remains. Finally, process industry somewhat higher due to large orders expected. That completes our presentation, now we hand it over to the operator for the Q&A session.
Thank you. As a reminder, if you'd like to ask a question, please press star and one on your telephone keypad and wait for your name to be announced. If you wish to cancel your request, please press the hash key. Your first question comes from Ben Maslen from Merrill Lynch. Please ask your question.
Thank you. Morning, Lars. Morning, Thomas. I wonder if maybe you could give us a little bit more color on your comments on the oil and gas market in the U.S. You obviously say there are some delays there. Just is that in upstream or downstream segments, onshore, offshore? Just a bit of color there. Have you seen cancellations? Then maybe how long do you think it'll take the industry to work through this capacity issue, I guess, that they have? Thank you.
You can see it among end customers and also among contractors. It is a shortage of human resources competence. That means that they delay some of the investments. It's hard for us to judge how long it will take. The activity level is high, but we can see that for the large contracts, there are delays. We cannot give an assessment how long it will take.
Okay. From your perspective, it's more that you stay at an elevated level as opposed to these markets come down in terms of your business?
Absolutely. We stay on an elevated level. It's the large contracts that we see are being delayed.
Great, thank you. Then a follow-up question on the exhaust gas systems. Can you say how many scrubbers you actually sold in the quarter? Just give us an update on tendering, whether there's any change in your expectations for that market now relative to earlier in the year. Thank you.
We are in discussions with several ship owners, we made a couple of 100 quotations. Quite a few of the quotations are with customers that are getting close to making a decision. The number of scrubbers is
I'm sorry, Ben, we can't give you the exact number at this juncture. Obviously the two large orders that we landed in the quarter represents several individual systems. I'm sorry, we can't provide the exact number at this juncture.
Got it. Okay. Thanks, Lars. Thanks, Thomas.
Your next question comes from Peder Frölén from Handelsbanken Capital Markets. Please ask your question.
Yes, good morning to both of you. Firstly, you mentioned in a lot of places about the seasonality helping, especially equipment, and maintaining that high seasonal activity into Q3. On a broader level basis, are we normally seeing a weaker season in Q3? Is it normal to see the service being slightly lower in the second quarter over the first on seasonality reasons? That's my first question.
When it comes to seasonality, what this refers to is really that during quarters two and three, typically, you have an exchange of systems for heating as well as air conditioning in the northern hemisphere. It's really relating to the Equipment Division business. As far as service is concerned, this has nothing to do with seasonality. It's merely a question of when customers actually place orders for, as Lars stated, major overhaul contracts, service contracts for power plants or other installations.
That's very clear. Thank you. To follow up on Ben's questions on ballast water systems, maybe you could try to accumulate number of systems in the backlog and also about the activity there. On the gross margin, 37.9%, to me, a rather strong figure despite the negative mix sequentially. You mentioned that it was in line with your expectations on a net basis, so to speak, but could you please quantify the positive effect of load and raw material more in detail? On the other side, I guess the negative mix, which I think you will hold for yourself.
Well, if we start with ballast water treatment, we see a good activity level. For the first six months this year compared to last year, we are up more than 90%. We are having an order intake around SEK 200 million for the first six months. Good activity level.
Clear. Thank you.
As far as gross margin development is concerned, I have to make you disappointed, Peter, though, you will not get the details in terms of % units when it comes to a bridge between last year or sequentially. What I can say is that there's a fairly substantial mix effect year on year. We were enjoying not only a good load, a somewhat better load than we anticipated also sequentially, but of course, we were also enjoying some positive effects from the lower metal prices. That's really the bulk. Then sequentially, of course, we did have, as we predicted, somewhat of a negative mix effect.
Yeah, that's very clear. Thank you.
Your next question comes from Andre Kukhnin from Credit Suisse. Please ask your question.
Good morning, it's Andre from Credit Suisse. Thanks for taking my questions. Firstly, on China, on your commentary, could you tell us whether you believe you're taking share in China, or is this the broader market development that you're seeing, the improvement?
We saw now that we had a double digits uptake in order intake, and it was broad-based for Alfa Laval. The wait-and-see mode that has been prevailing for quite a while seemed to ease somewhat. To draw any further conclusions from that, we don't want to do. We read the same newspapers as you do about the macro statistics in China.
Maybe just to add to your comment, Lars, when it comes to the breadth of the uptake in China, one conclusion that I think we can draw is that the investments that we have made during the last 12, 15 months in going west and further increasing our presence is paying off, because it's not really coming from the very large contracts. We have it across pretty much all segments, and then also local component business.
Great. Thank you. Just another question on the acquisitions pipeline. How is it looking right now? Could we expect another few deals like you've announced with Niagara?
Well, our target is to add 3%-4% annual sales growth both on acquisitions. We continue to believe that we will deliver that, and we have a number of discussions ongoing.
Okay, thank you.
If I may add, to come back to Ben's question about the EGC or exhaust gas cleaning orders, I can provide the following detail, including the order that we announced in December. We have landed 18 systems for 13 ships. That is a combination of new ships as well as retrofit orders. 13 ships, 18 systems.
Your next question comes from Sven Weier from UBS, Frankfurt.
Yes, good morning.
Please ask your question.
Good morning. A couple of questions from my side, please. First one is on the shipyard order recovery. It seems that this has already arrived at your order book. Does that mean that the kind of 6 to 9 months period has now shortened a bit? I guess Wärtsilä was also just making that comment that they're now seeing this period shortened. Second question would be just on the project pipeline. I guess in the pre-close conference call, Thomas, you said that the pipeline for big tickets was a bit smaller going into Q2, but the midsize projects below the radar screen of the SEK 5 million was actually developing quite fine. I was just wondering if you could give us an updated picture on that. Just finally, on the raw materials, you already mentioned you had a small positive impact.
When I look at the raw material development, we've already had quite a significant decline. Is it that you have to pass on most of the benefit to your clients? Thank you.
The marine orders, yes, we see that the lead time has decreased. The orders are coming in faster than historically. We saw base business picking up in the second quarter. When it comes to the pipeline of small, medium, and large contracts, you could see that in the second quarter, we had a good order intake of small and medium size since we delivered growth despite fairly few large contracts. When it comes to the pipeline going forward with large contracts, we have commented that we see some large contracts coming in in the Process Technology Division, and that will generate growth for them in the third quarter.
Finally, Sven, on raw materials. If we look at the alloys, and also the copper and the aluminum prices, let me start off by saying that this most recent reduction in prices only started, say, 8 weeks ago or so, 8 to 10 weeks ago. Of course, there is a bit of a lag before this has an effect without any hedging. On top of that, of course, we have some of our next 12-month exposure hedged, which means that we are pushing the effects forward and are getting less, say, instantly or with the limited non-hedged lag. I would not agree with you that we are passing on the bulk to customer. It's merely a matter of the hedging and the fact that there is a bit of a lag before it really kicks in.
As I commented for the sales bridge, of course, we will see some adverse impact, particularly in the OEM segment, where we do have raw materials clauses pretty much in all of the OEM contracts.
Can I just ask you one follow-up question on the marine business? Obviously, we've seen quite a strong development in the environment area and new equipment orders. How should we think about profitability of the marine division going forward? I guess especially on ballast water, you share the profit with Wallenius. scrubber is a relatively new product, should we assume that to have somewhat of a depressing effect on margins, or what's your guidance there?
Well, Sven, I appreciate that you're trying to get a forecast for profit in the Marine & Diesel Division, we are not, as you know, providing any forecast on the profit line. To give you a bit of a sense, we do not see any drama in either direction. I think you should recall as well, if we go back, I think it's now almost two years, we have seen what we then called a normalization of price levels in the marine area. The situation that we were used to before boom, say going back to 2003 and 2004. Of course, that has kicked into our P&L as well at this juncture.
Thank you.
Thank you. Your next question comes from Colin Gibson from HSBC London. Please ask your question.
Hi. Good morning, gentlemen. A couple of questions, please. First of all, I just wanted to go back to your discussion of the food business within PTD. Just wondering generally how sustainable you see the growth that you saw there in Q2, whether we should expect more good momentum for the rest of the year, and just generally how you feel about that business. Second question, I wanted to ask you how you feel about GEA's slightly surprising decision to put the whole of their heat exchangers division up for sale. What I'm thinking particularly is the risk to Alfa Laval in terms of a new owner of that business, either adopting different pricing strategies or, depending on who it might be, being able to bundle products in a way that you can't bundle products.
How should we feel about either of those risks when we think about GEA's exit from heat exchangers? Thank you.
First of all, when it comes to the food segment, we have generally a positive view on the food segment, and with applications like vegetable oil and so on. However, between the quarters, the business comes, it's often fairly big contracts, and they come in a little bit lumpy. Therefore, between the quarters, it's hard to tell how it will develop. Overall, we have a positive view on the food segment. Then we have, when it comes to GEA and the risk of a new owner, well, let's say short-term, it, of course, opens opportunities for Alfa Laval, since uncertainty among customers and among GEA's organization will, for sure, open opportunities for us. In the longer perspective, a new owner. Well, we have great respect for GEA as a company, and they have been a very tough competitor.
We are prepared, whoever will be the new owner at the end, we are prepared to take them on. When it comes to bundling, I would say that GEA has had good opportunities to bundle. We don't see any threat there.
Okay. Thank you very much.
Thank you.
Your next question comes from Peter Reilley from Deutsche Bank, London.
Good morning. I just wanted to come back to the marine exhaust gas scrubber business. If I understood it right, you said that you aren't expecting any large orders in the third quarter, but you are expecting more orders in the second half of the year. Does that mean you're expecting a strong fourth quarter? Are you changing your outlook on the market, or is it just the timing of some of the larger orders coming through?
It's timing of large orders. You have drawn a correct conclusion.
Okay. Secondly, just on the larger picture, you've obviously had several years now of the 2 years of the margin coming down on a year-on-year basis. As you said, it seems to have stabilized in around about 16.5%. Is that now, you think, a sustainable level going forward, or is it really dependent on volume developments? Can you get the margin back up to where it used to be if you have a more positive volume environment?
Well, to begin with, I don't think we've commented on the margin as such. Of course, it's a fair conclusion that we've reported half a dozen quarters consecutively on about the same level. Going forward, the only thing I can say is that I have to remind you of our target of being above 15% operating margin as often as ever possible. We will do our best to overshoot our target as often as possible.
Thank you.
As a reminder, if you'd like to ask a question, please press star and one on your telephone keypad and wait for your name to be announced. If you wish to cancel your request, please press the hash key. If there are no further questions, please continue. Oh, apologies. There's a question from Peder Frölén from Handelsbanken Capital Markets. Please ask your question.
Yes. Thank you. Sorry for that. Coming back to the outlook, Lars and Thomas, I totally hear what you're saying about year-on-year and also sequentially. Given this sort of higher activity in, call it, investment willingness, it seems that a slight growth year-on-year with the effects that we are flattening out on translation, at least in orders, feels a bit cautious. Is there something I have missed here? Is it something else that is expected to maybe come down a bit, or that you are more uncertain about the direction than what's typically given about your very detailed outlook?
Peder, we have commented on each of the division, and we say that as we do not expect a repeat in the very short term of large contracts in marine, we expect marine to be somewhat down.
We expect equipment to be on about the same level, high level due to seasonality. Finally, process technology, as we believe we will land some large contracts, will be up somewhat. One down, one flat, and one up. I think the average of those is pretty much the same, and that's really what we're saying.
Yeah. For you, about the same level as sort of plus or minus 3%, yeah. That's in your mindset, right?
Well, Peder, again, we are dependent on individual customers' decisions for contracts and also component orders. We're in the hands of our customers to that extent. We cannot predict whether they take the decisions on September 30 or October 2.
Yeah. That's clear.
We can't do it any better than this.
Thank you.
All right. Thank you, Peder.
There are no further questions then.
That completes the Q&A session. Thank you all of you that have attended, and we are wishing you a nice, warm, and relaxing summer wherever you are. Thank you and goodbye.
Thanks, guys. Bye.
That does conclude our conference today. Thank you for participating. You may disconnect.