Ladies and gentlemen, good afternoon. Welcome to the Sika Half Year Report 2017 conference call. I'm [Iruna], the Chorus Call operator. I would like to remind you that all participants will be in listen-only mode and the conference is being recorded. After the presentation, there will be a Q&A session. You can register for questions at any time by pressing star and 1 on your telephone. Should you need assistance, please press star and 0 to call an operator. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Dominik Slappnig, Head of Communication and IR of Sika. Please go ahead, sir.
Good afternoon and welcome to the Sika first half results conference call. We published our figures at 5:00 A.M. this morning. Our new CEO, Paul Schuler, and our CFO, Adrian Widmer, will now provide further details on the results. Afterwards, they will be ready to take your questions. With this, I hand over to our CEO to start with the highlights of the first half year. Paul, please.
Good afternoon and thank you for joining the call. I'm happy to inform you about our very motivating half-year closing. We had an excellent sales growth of 8.1% in local currency with record sales of CHF 2,995 million. Yes, we are just short by CHF 5 million to cross the CHF 3 billion line, and probably we should have pushed a little bit harder. All our four regions were able to grow. We post a double-digit growth in Eastern Europe, Africa, U.S., Argentina, Greater China and automotive, and solid growth in our core markets like Germany, France, Italy, and Switzerland. We have clearly grown faster than the market in a number of countries. The pressure from higher input costs, like raw materials, were well managed through many pricing adjustments. Volume growth together with disproportionate low-cost development results in further improvement in margins.
As a result, operating profit and net profit post new record values in the first half year. EBIT improved by +13.7% to CHF 402 million, and net profit went up by +16% to CHF 285 million. In the first six months, we continued to invest in future growth in emerging markets by opening three new factories, one in Kazakhstan, one in Tanzania, and one in Mexico. We opened a new membrane line in Russia for waterproofing systems, and we founded a new subsidiary in Senegal. Sika is now present in 98 countries with its own national subsidiaries. We are here now, which new country will deserve to become number 100 this year? On the acquisition side, we are very pleased that with Rmax and [U.S. Bitbau] in the U.S. and Bitbau Dörr in Austria, we could acquire leading manufacturing of roofing and waterproofing systems.
The integration runs excellent, the synergies are even higher than expected. Overall, we had a great start. I would like to hand over to our CFO, Adrian Widmer. He will guide you through the financial information. Please.
Thank you, Paul, and good afternoon. Following our CEO's business summary and presentation of the highlights, I will now give you further insights into the financials and the drivers of our record results of the first half year. The business showed an excellent growth trajectory, as we have heard, on top of a strong first half year 2016, with sales growth of 8.1% in constant currencies, picking up momentum from a softer second half year 2016. Normalizing Q1 and Q2 growth for the number of working days, organic growth showed a very similar strong growth between the quarters, averaging 5.7% in the first half year. Acquisitions added another 2.4 percentage points to our growth. A continued strong Swiss franc led to a negative foreign exchange effect of minus 1.4% in the first six months, equaling a minus of CHF 39 million and resulting in a growth of 6.7% in Swiss francs.
All regions contributed to our growth in the first half year. In the region EMEA, sales grew at a rate of 7% at constant currencies. The core markets, Germany, France, Switzerland, Italy, as well as the U.K., achieved solid increases. Growth was particularly strong in Eastern Europe as well as on the African continent. Negative currency effects were most pronounced in the EMEA region, with a negative effect of minus 4.2%. The North American region recorded the strongest growth at 17.4% in local currencies, beating strong growth of 12.7% in the same period of last year. We have been able to leverage the robust activity in the construction sector with our targeted investment in recent years in sales force, supply chain close to the metropolitan areas, as well as acquisitions. Foreign exchange effects in North America continue to be positive, resulting in a growth of 19% in Swiss francs.
Sales in Latin America grew by 2.7% in local currencies compared to 5.9% in the previous year period. While Mexico and Argentina developed strongly, Brazil continues to be affected by the difficult political and economic environment. In addition, construction activity in the natural resources base, countries in the region, has been subdued. Translation effects for once have been positive at plus 2.2%, resulting in 4.9% growth in Swiss francs. Growth in Asia Pacific was a solid 4.1%. High growth was achieved in Southeast Asia, with the exception of Indonesia and Singapore, where residential and infrastructure projects remained at a low level. We also saw high growth in the Pacific Rim, as well as in China, where the construction industry continues to stabilize. Business in Japan developed well. Ahead of growth seemingly expected from projects for the 2020 Olympic Games.
Gross result as a percentage of net sales decreased slightly by 50 basis points from 55.6% to 55.1%. Price adjustments, as well as various initiatives on the procurement side, limited the impact of higher raw material costs, while the dilution effect from acquisitions accounted for about half of the material margin contraction, or about 25 basis points. Driven by the strong volume, disciplined cost management, and efficiency improvements, we showed a strong operating leverage with both personnel costs as well as operating expenses growing significantly below sales growth, at below 60% of sales growth. In consequence, EBITDA increased by 11% to CHF 488.2 million. This is up from CHF 439.7 million in the same period of last year.
Depreciation and amortization expenses were flat compared to the previous year period, which resulted in an EBIT growth of 13.7% year-on-year to a record EBIT of more than CHF 400 million for the first time in a first half year. EBIT is up by CHF 48.4 million in absolute terms to CHF 402.1 million, with the biggest increase coming from the region North America. Net profit after tax again improved over proportionally, completing the strong cascade. Net profit increased by 16% to CHF 285.7 million, or 9.5% of sales. Net interest cost decreased further by CHF 1.1 million, largely driven by the residual positive impact of a CHF 250 million bond repayment in March 2016. Net other financial expenses also decreased significantly, driven by lower negative valuation effects. Lastly, tax rate of 25.9% was basically unchanged or flat versus the previous period at 26.0%.
Cash generation with an operating free cash flow of CHF 63 million in the first half of 2017 was very solid, but below previous year. However, the reduction is largely related to timing, with a larger tax prepayment happening in Q2. This payment last year was in Q3, as well as a stronger seasonal networking capital build-up due to the strong business growth and higher inventory value related to the higher cost of raw materials as well as time. Overall, capital efficiency improved further, and together with a strong profitability development, resulted in a significantly improved return on capital of 28.0%. This compares to 25.5% in the previous year. With this, I conclude my remarks and hand back to Paul Schuler for the outlook.
Okay. Thank you, Adrian. Sika's outlook 2017. The strong start to the year supports full-year targets. We have an outstanding pipeline of big new construction projects, many new products and initiatives, as well as several acquisition candidates throughout the world. We are well on track to increase sales by 6%-8% to more than CHF 6 billion for the first time. However, with efficiency improvement and price adaptation, we expect EBIT and net profit to further increase in line with our guidance. Thanks to the commitment of our employees and the strength of Sika's growth model, we can look forward with high confidence to the second half of 2017.
Okay. This takes us now to the Q&A session. Thank you very much, Paul. Thank you very much, Adrian, for these insights.
We're now beginning the question and answer session. Anyone who wishes to ask a question may press star and one on their touch-tone telephone. You will hear a tone to confirm that you have entered the queue. If you wish to remove yourself from the question queue, you may press star and two. Participants are requested to use only handsets while asking a question. Anyone who has a question may press star and one at this time. The first question is from Martin Flueckiger from Kepler Cheuvreux. Please go ahead.
Yes. Good afternoon, gentlemen. Martin Flueckiger here from Kepler Cheuvreux. Three questions, please. Firstly, this morning, I think your main competitor in the U.S. recorded lower volumes in North America. Can you confirm that Sika gained market share in the U.S., and why you think you gained share? In this respect also, did Sika increase selling prices in North America? If yes, could you give us an indication by how much? I'll go one step at a time.
It's Paul. Yeah, I can confirm that we gained market share in the U.S. We invest in the last years in all the megacities concept. We are very active on all the different markets and invest [stock in]. From that side, we are very well prepared, and we are confident we grow much faster than the market. Regarding the prices, yes, we could manage price increases, and we could manage efficiency improvements through more volume. How much? I don't want to say. I understand probably BASF want to follow, and I don't think that's a great idea. Overall, we can confirm we grow in North America by double digits, and we improved our EBIT.
Okay, thanks. My second question, coming back to your EBIT margin was up 80 basis points in H1. Can you elaborate a little bit how much you saw raw material prices being up on average in H1? You were talking about efficiency gains earlier on. Can you quantify how much efficiency gains contributed to the margin in H1?
This is Adrian. Martin, the currency situation is actually, the material price situation is actually quite volatile, so it really depends from raw material to raw material. Also, foreign exchange has an impact. There has been quite a push. We had many initiatives also on the procurement side to push this back. This is quite a constant work every day and together with price increases. I think we have managed quite well across the globe. In terms of operating leverage and efficiency improvement, our target is to increase cost below sales with a target at about two-thirds of sales growth. We have managed quite well, of course. Also here, this is not always that simple, depending on the market and the growth. The cost growth was actually below 60%, so ahead of target adding more than 100 basis points to the margin.
Okay. Very good. Thanks. My last question on Latin America. Latin America, according to my calculations, saw negative growth of around -1%. Can you just, in Q2 that is. Can you just confirm that? Did I understand correctly that Brazil was the only key driver of this negative development in Latin America in Q2? Speaking about Brazil, could you basically talk about your outlook for the country and other key markets like Argentina and Mexico and so on for H2? Thank you very much.
On Latin America, yes. The volume growth is quite subdued in Latin America overall. I was referring to Brazil being very difficult. This is probably the most difficult market, there is a couple of others, particularly ones sort of natural resource-related economies, where growth is clearly lower. Probably looking back to the beginning of the year, this is probably the region where some of the expectations in terms of market growth have not materialized. The situation in Latin America is relatively difficult, we're managing quite well with price increases, with efficiency improvements, and are still able to improve profitability.
Martin, looking at the outlook for Latin America, we feel we are very strong in Mexico, in Argentina, with great growth rate. Brazil will remain very difficult over the next 12 months, in our opinion. We will see how we can manage it. It's a difficult task, we will have to work hard to achieve the results.
The rest of America will stay on the same level, and we expect the growth rate also at least between 3%-6%, depending a little bit on the market.
Okay. Sorry, just to confirm, that's 3%-6% organic, yes?
Yes.
Thank you so much.
The next question is from Martin Hüsler from Zürcher Kantonalbank. Please go ahead, sir.
Yes, good afternoon. I have also several questions, maybe one by one. The first one, coming back to the gross margin question Martin was asking before. You can give us an indication, what's your expectation for the second half of the year? Do you expect a similar pressure on the gross profit margin, or do you think that comparables will be easier, maybe this gap will close a bit? That's the first question.
We feel the headwind of the raw material will remain. We will have to push our prices. On the other side, we still have the efficiency improvement. It will remain the same pressure in the same magnitude. Our guidance, we will stay there between our guidance.
Okay. Thank you. The second question, I'm looking at the regional EBIT margins, it strikes me that in the regions where you had the biggest growth for organic growth, such as Europe and North America, the increase in the EBIT margin was lower than in the emerging markets such as Latin America, Asia-Pacific, where you had a lower volume growth. Maybe you can shed some light why you had such nice profit increases or margin increases in the emerging markets, even though volume-wise it looks a bit shyer than the mature countries.
Yes, I can do that. I mean, particularly in North America, as you said, very strong growth. We also have quite a strong acquisition impact. Typically, in the very beginning, acquisitions typically have a lower margin than we have. This is really the dilution effect coming from the acquisitions. Although Paul mentioned it, integration is well on track, and I think synergies are even higher than originally thought. We're very pleased with it, this is sort of limiting the percentage margin increase. Initially, of course, in absolute term, North America has contributed the most to the EBIT. In the EMEA region, it's more related to actually foreign exchange rates, where there was by far the biggest impact, actually a negative impact, coming from the euro and the pound and some other currencies.
This is essentially one of the reasons that has limited, although also here we have increased percentage-wise and of course, in absolute terms, the EBIT contribution.
Okay. Thank you. That helps. Maybe just one more, if I may add. While you were mentioning acquisitions, if I look at your-- on page 13, you show the acquisition of Airmax, according to my calculation, this company adds a net profit margin of about 8% to Sika. I was just wondering whether this high contribution or profit contribution of about CHF 2.3 million was before or after amortization, which you clearly should have because you show intangible assets of about CHF 45 million.
I think the 8% you have calculated refers to the months where we have not yet owned the company. We started to consolidate it at the end of January. Of course, this does exclude any PPA effects, this is exactly one of the reasons why margins typically initially are lower than the existing business.
The profit contribution that you show since consolidation, the CHF 2.3 million, is this before or after amortization?
This is after.
After.
Yeah.
Okay, thanks a lot.
The next question comes from Thomas Baumann from Mirabaud. Please go ahead.
Yeah, good afternoon, everybody. My first question refers to North America. We thought when we look back to last year, we had a significant slowdown from this first semester to the second for the reasons you mentioned at the time. Now, being at the end of July and you participating in a lot of projects, can you a little bit give us some flavor what the project pipeline looks like and whether we should, probably should not, but just to be sure, what the momentum from H1 into H2 looks like? That would be my first question. The second question is, the sales to the automotive industry, you mentioned in the report from there was growing by 12% or almost 10, 12%, which is a surprisingly strong number given the softening of the car market. What do you expect here?
how do the pull-ups look like into the second half, especially sales to North America, which, in the U.S., where we have to face negative vehicle production growth. Thank you.
Thomas, thanks for the question. We are pretty confident that we will have a great second year in North America. Our pipeline is excellent in new won projects, many projects. Also, as I said before, we are on a good way in The Home Depot with other customers distribution. We are confident we grow by double-digit growth. We are very confident and strong momentum in the U.S. Confident that we bring the double digits. We refer the industry. We also have a lot of new projects, a lot of new additional sales. Also there, we will grow double-digit. Referring to the automotive market in the U.S., we supply all the companies over there.
We have added a lot of new parts in several new cars, we won one or two or three new models in new car systems. Also there, even the market goes down, we will, in automotive, remain and grow, and overall industry will grow also confidently between our 6%-12%.
Six to eight, you mean? 6 to 12?
Six to eight.
Okay.
It's a target, The industry probably overachieves the target.
Okay
my guess would be 10.
Okay. Thank you very much.
All my hope. Let's put it this way.
Okay. Thanks a lot.
The next question is from Patrick Rafaisz from UBS. Please go ahead, sir.
Thank you. Also three questions from my side. First, on cash flow. You explained very well what happened with the operating free cash flow in H1 with the cash tax and the net working capital. How much do you think of that loss versus prior year can you recover as you're selling down inventories or as this effect phase out? As opposed to cash tax was just a timing issue, so that won't matter. Do you think your cash conversion in 2017 can be similar as in 2016? Or will it be lower because some of the net working capital increases-
No.
Is pushing?
I would expect this to be quite similar in terms of the cash conversion rate as in the previous year. As I mentioned, most of it is really timing, and part of it is related to quite the strong growth momentum which we expect to continue. Of course, we are also working hard here to reverse one or the other effect here. I'm quite positive for operating free cash flow in the second half year.
Very clear. Thank you. A follow-up on the gross margin and raw materials. The squeeze was 50% raw materials and 50% dilution from acquisitions. During this second half, do you think you can recover any bit of that within the fifth of these 50 basis points? Either the dilution from acquisitions become smaller or maybe price increases help you to lower the squeeze from raw mats?
On the acquisition side, I think this will be very similar. This is in the first year, we will see a similar effect also reaching into the second half year or to the end of the year. Of course, on the raw material and pricing side, it's still quite a volatile situation, depending also on the region. We're targeting, of course, to maintain this. It's difficult to predict this exactly. As Paul said, the target is really to maintain that.
Okay. Good. The last question. Can you talk a little bit about the EBIT loss in other segments, which is getting smaller and smaller?
At this rate, when would you expect to be break-even, even on that line?
Don't go out and extrapolate it. If you look at, let's say, the reduction of around CHF 12 million, most of it has come through the automotive segment, which is in there performing strong growth and profit improvement. There's also some costs or lower cost in the central area. The lion's share is coming from the automotive business.
If that continues, then you should be able to narrow that loss every year, right?
If this continues, the EBIT will increase in the automotive area, which of course, will mitigate any cost effects there. As I said, don't extrapolate it. This is not necessarily a linear equation. Yes, clearly, there is a segment in there which is performing quite well.
Okay. Thank you.
The next question is from Bernd Pomrehn from Vontobel. Please go ahead, sir.
Good afternoon, gentlemen. Again, on the U.S. construction market. We are now waiting and waiting for an infrastructure package in the U.S. What are your assumptions for your growth in 2018 and beyond, if we don't see a new infrastructure program? Would you be prepared if we actually see a new infrastructure program in the U.S., would you be able to handle this increased demand?
Thank you, Bernd. We're also waiting and waiting and hoping that they will start. The good news is we are really able to handle it. We invest in a lot of new capacity, close to the megacities, close to the infrastructure project. Yes, we can handle it. Our sales force is ready, factory is ready. I can always interpret out of the news what they do in U.S. I think they need infrastructure project. If we travel around, yes, they need it. If they release the money, we are ready to participate.
Okay. Second question, if I may. You already mentioned your different procurement initiatives, but I understand that you are still predominantly buying in Europe. Obviously, we are now seeing substantial capacity additions for some of your raw materials, especially in the Middle East. Could you be a little bit more specific regarding your current opportunities to identify and approve new suppliers, especially in the polyurethane market? Thank you.
Yes, I guess one of our strengths is we really have everywhere purchasing department in all areas, in all the bigger countries. We have excellent organization. They share information, we are able to move products regarding the prices. For example, if the price really goes up in Europe, we go and purchase either in China or in U.S. We move products around. We have a supply chain. We know exactly how far we can go to make the best price for us. We see the development in the Near East. I think there is some interesting new factories coming up. Yes, we are on top. I guess Sika can be proud on the purchasing department to handle these difficult tasks so good. Therefore, also we see it in the margin that we can quantify else on that level.
Confident that we have enough material and confident we will get probably one of the best prices in the industry.
Okay. Thank you, Paul.
Thank you, Bernd.
The next question is from Phil Roseberg from Bernstein. Please go ahead.
Good afternoon, gentlemen. I just had one question left, I think, for Paul. You still have free cash flow well in excess of the outgoings for CapEx acquisition and dividends. I just wanted to get your views. We never actually got a very clear answer to that question from your predecessor. What is going to happen to that free cash flow? What's the intention for it? Does it mean any change in the pace of acquisitions or of development in general, or is it an increase in the pace of returns of cash to shareholders?
Of course, we would also support the shareholders. However, we are very keen on acquisitions in years. We really feel the construction market is now consolidating, therefore we pushing acquisitions. We like acquisitions of CHF 100 million-CHF 500 million. That's the favorite one. Not so easy to get, but we working on wherever we can. On the bolt-on, we always try to see the efficiencies and see their best. One of the major, even increasing speed, we want to have an acquisition. Yes, the cash flow will remain invested in acquisitions.
Just a follow-up. You mentioned that the CHF 100 million-CHF 500 million are your favorite ones. Why do you say that exactly? Because they are the most attractive, because they are different products? Why do you say that they are your favorites?
We have a great history on integrating small to bigger companies between CHF 100 million and CHF 500 million. We can integrate it very simple and see the synergy potential the best. I think it's the fastest for us in the right size from the culture side, but also to acquire the synergies. If we go to the real big ones, like the CHF 1 billion, CHF 2 billion one, that will really cover our organization. Not sure we would focus so much then on the market as we do today on the customer side. That's the favorite one. Never say never. If the right candidate comes, we are ready and we would have the cash.
Very clear. Thank you very much.
Thank you, Phil.
As a reminder, if you wish to register for a question, please press star and one on your telephone. The next question is a follow-up question from Martin Flueckiger from Kepler Cheuvreux. Please go ahead, sir.
Yeah, thanks. My question has already been answered in the meantime. Thanks.
The next question is from Torsten Wyss from BZ Bank. Please go ahead, sir.
Yes. Hello. I've got just one question basically on Latin America. As Martin said before, Latin America was minus 1% organically in Q2, whereas you flagged that Brazil is being difficult, but no other country. Brazil accounts for about 25% of sales. I wonder how badly Brazil is doing in order to bring the LatAm group sale organically down in Q2, or are there other countries that were negative?
Yeah. Thorsten, this is Adrian. As I mentioned, yes, of course, Brazil is the one which is most in the limelight, and actually the share in Latin America is actually even below 25% of sales. As I mentioned, there is a couple of others where the economy is more related to natural resources, where growth is quite slow or to even slightly negative.
Mm-hmm. There are other countries that are negative.
There are.
in Q2, organically speaking.
Yeah.
Yeah. Just another one coming up to my head, which is on the raw mats. I understand you don't give a guidance, so to speak, in H2, please give an indication on the negative raw materials trend in the course of H1, i.e., did the raw mats commodity prices, the impact worsen or ease from Q1 into Q2?
Overall, as I said, it's quite a volatile situation, really, depending on the region, depending on the price. Also, we in Europe had really situations where it was even difficult to get raw material. There's not a clear pattern of development, and I would say the impact is probably the biggest around this time now.
Mm-hmm. Thanks.
The next question is a follow-up question from Martin Flueckiger from Kepler Cheuvreux. Please go ahead, sir.
Yeah, thanks for taking my follow-up. I was just thinking of another one. This is a question for Paul, by the way. Coming back to your explanations regarding the gross margin expectation. If I remember correctly, at the beginning of this year, you were hoping for or targeting a stable gross margin. The way I understood your answer beforehand, it wasn't very clear whether you would stick to that expectation or whether you had actually lowered it to the current level of gross margin at H1.
Current level. I would say it's current level.
Okay, thanks.
There are no more questions at this time.
If there are no more questions, thank you very much for your interest in Sika. This brings us to the end of our call. Goodbye, and have a nice and excellent summer from our side.
Okay, thank you very much.
Thank you.
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