Azelis Group NV (AZE) Earnings Call Transcript & Summary

Good morning. Welcome to Azelis Group's 9 Months 2022 Trading Update. I'm Pam, Investor Relations, and I'm joined this morning by Dr. Joachim Müller, CEO; and Thijs Bakker, CFO. As usual, Joachim will start with the operational highlights of the period, followed by Thijs, who will give a financial update. Joachim will then wrap up with an outlook for the remainder of the year and open the floor for Q&A. We remind everyone that this presentation may contain forward-looking statements that are subject to risks and uncertainty [Operator Instructions]. We will make the recording of this presentation available on our website later today. With that, I'll turn you over to Joachim.

Thank you, Pam. Hello, everyone, and thank you for joining us on this update call. 2022 has been an excellent year so far. In the first 9 months, revenue has grown 53% and 26% of that was organic. All our three regions delivered strong performance in both revenue growth and profit improvements. In terms of profitability, in the first 9 months, our conversion margin expanded by 598 basis points to 48.9% despite the volatility in the supply chain and the increasing macroeconomic pressures in most markets. Free cash flow was 81% higher than the prior year and even with higher investments in our working capital to support the revenue growth. Our ability to improve our profits and generate cash have helped us to continue on our deleveraging path with a net debt EBITA of 2.3x at the end of September well within our objective to stay below 3x leverage. Operationally, we continue full steam with our initiatives to drive future growth. Our [ labs ] are as busy as ever and some of you will get to see how we try to drive innovation for both our customers and principles and our labs here in Paris later on today. We also continue to advance our sustainability agenda and have recently achieved the top industry ranking from Sustainalytics. Overall, we remain focused on strengthening our lateral value chain, making sure we are the best partner for our customers and principles across any economic cycle. So let's move on to the next page. Let's look at our Q3 performance in more detail. As I said earlier, of the 53% revenue growth in the first 9 months, 26% was generated organically. 21% was revenue growth contribution from acquisitions. We also had a 5.5% uplift from currency effects. Across our end markets, we saw strong demand in life science in all three regions, especially in Food and Nutrition, Personal Care and Pharma. Life Science had a further boost from Agri and Environmental Services as a drought in Europe drove a formulation requests in Q3. In Industrial Chemicals, we continue to see strong performance in CASE, especially in Europe and the U.S. with price increase still supporting the growth that we have been seeing since 2021. In terms of industry consolidation, we completed eight acquisitions in the first 9 months. In EMEA, we acquired Umongo, South Africa, Whitfield in the U.K. and Tunçkaya in Turkey. In Asia Pacific, we acquired Catalite in Thailand, Chemo India and ChemSol in Malaysia. We also acquired Ashapura in India, which completes our global network for flavors and fragrances, to complement Vigon in the U.S. and Quimdis in Europe, some acquisitions we did over the last 24 months. In the Americas, we acquired Rocsa in Colombia, which serves as a strategic platform for expansion in South America. These eight businesses had combined annual revenue of EUR 361 million. We have signed four more acquisitions with total combined annual revenues of EUR 140 million. Well, in fact, three of those have already closed in October. Now I will hand over the floor to Thijs, who will talk about our financial performance during the quarter, starting with the next slide. Thijs, to you.

Yes. Thank you, Joachim. Good morning, everyone. I will now provide you a brief summary of the group's financial performance for the first 9 months. So let me start on Slide 8, where you'll find a summary of the 9 months P&L and also the third quarter performance of Azelis Group. As we can see, Azelis delivered a very strong performance in the first 9 months. With a strong growth trajectory, resulting in revenue for the first 9 months of EUR 3.1 billion. This represents a year-on-year growth of 52.5% increase in revenue. The growth comprises of a combination of strong organic growth of 25.8% and 21.3% revenue growth contribution from the first time inclusion of acquisitions. Revenue was furthermore supported by 5.5% from FX translation. For the third quarter, revenue came in at EUR 1.09 billion, representing 49.5% growth versus 2021, with organic revenue growth remaining strong at 22.5% despite the tougher comparables as 2021 ramped up towards the second half of that year. Growth remained very strong in both Life Sciences and Industrial Chemicals, with higher year-on-year growth in Industrial Chemicals, partly due to the acquisitions we have made in this segment in the last 12 months in addition to our organic growth. The strong organic growth and addition of acquisitions resulted in elevated working capital levels to support this growth, mainly in the inventory side. But our ratios are improving, however, I will come back to this later. The group's gross profit for the first 9 months increased with 57.6% to EUR 736 million. The majority of this growth comprised of 32.1% organic growth and 20.2% from the first time inclusion of acquisitions. Gross profit in percentage of revenue ended at 23.7%, implying a 77 basis point expansion of margins. This expansion is the outcome of mix effect, first-time inclusion of M&A at lower gross profit margin levels and disciplined margin management to pass through price increases that were incurred from our partners. To give some insight into our M&A margins and underlying organic margin performance, gross profit in percentage of revenue for the organic business improved from 22.9% to 24%, implying a step up 108 basis points. For the first 9 months of 2022, the group generated an adjusted EBITDA of EUR 379.8 million and an adjusted EBITA of EUR 360.1 million. Adjusted EBITA increased 79.6% or measured in constant currency by 73.9%. Adjusted EBITDA as a percentage of revenue increased to 11.6%, reflecting a margin expansion improvement of 175 basis points. This improvement is a reflection of the strong organic growth and benefits growing our skill, despite our accelerated growth investments in digital and commercial initiatives as well as additional bonus accruals in line with result development. All of this resulted in a significant improvement in our conversion margin. Conversion margin calculated as adjusted EBITDA in percentage of gross profit improved from 42.9% to 48.9%. On the next slide, on Page 9, I would like to provide a quick overview of the growth breakdown of our revenue and gross profit by region. On this page, we have broken down 52.5% reported revenue growth and 57.6% reported gross profit growth between organic growth and growth coming from the first-time inclusion of acquisitions and FX effects. The first-time inclusion of acquisitions generated 21.3% of our revenue growth for the first 9 months as we are executing quite well on our M&A pipeline. In addition to what Joachim was saying, please note that we completed 12 transactions in the course of last year with four in the last quarter and eight acquisitions in the first 9 months of this year. Out of these acquisitions, still a significant portion is not part of our organic growth calculation yet. The group performed well on one of the key pillars of our growth strategy: Organic revenue growth. The group achieved an organic growth level to 25.8% for the first 9 months, with all of our regions delivering high double-digit organic growth even on a more challenging comparable basis. In addition, this slide demonstrates clearly our ability to be able to pass through price inflation as well as the hard work in executing our margin management initiative programs, which is reflected in the 32.1% organic growth in our gross profit line. Let's have a look at the regional financial performance in terms of revenue, adjusted EBITA margin and conversion margin on Page 10. Let's start with EMEA, which makes up 44% of the group's revenue. Revenue increased 53.3% to EUR 1.37 billion. The majority was driven by organic revenue growth of 32.3%, driven by strong performance in the more resilient Life Science segment. EMEA's gross profit increased by 54.9% out of which 38% was organic, mainly driven by mix and execution of margin management initiatives. The region generated an EBITA of EUR 170.9 million, translating to a 12.5% EBITDA margin. This drove 731 basis points expansion in the conversion margin, 51.7% in the first 9 months versus 44.4% in the previous year. Also, the order book remains solid in EMEA. In Americas, revenue increased by 40.1% year-on-year to EUR 1.2 billion. Out of this growth, 17.3% was organic. Revenue growth in the Americas contributed furthermore from FX translation effects of 11.8%. The region delivered 235 basis points gross profit margin expansion, mostly driven by the top line growth and effective pass-through policy, but also by the first-time inclusion of M&A, where South America is contributing at a lower gross profit margin percentage. The region generated an EBITA of EUR 168.5 million, translating to a 14.1% EBITA margin, an excellent expansion of 229 basis points driving up a 427 basis point step-up in conversion margin to 56% versus 51.8% in the previous year. Last one, Asia. Asia Pacific continues to be the fastest-growing region for the group. The region now accounts for 17.3% of group revenue versus 14% in the first 9 months of 2021. Revenue increased 88% to EUR 537.8 million. This growth was supported by strong organic growth, 31.1%. The gross margin contraction in the region was mostly due to the slower demand growth in China, which continues to be impacted by COVID measures as well as negative mix effect from recent acquisitions, which we are performing at a lower gross profit margin levels. That was offset by strong growth initiatives and activities elsewhere in the region, especially in Southeast Asia, as well as increasing skills efficiencies across the region. The region doubled EBITA to EUR 43 million and expanded its EBITDA margin by 48 basis points to 8%, resulting in 455 basis point expansion of the conversion margin for the first month of the year. So let's move on to the main cash flow driver, working capital on the next slide. The bar chart here on the left provides you the details on the underlying working capital components in absolute terms as well as in days and the chart on the right gives an overview of the seasonal comparisons over the years of our working capital development. Net working capital to revenue normalized for acquisitions was 15.9% at the end of September compared to 15.4% at the end of June, at 15.3% at the end of December 2021. Working capital represented 58 days of revenue at the end of September compared to 56 days in June, as we have intense focus on this topic. The higher working capital investments during the period is due mostly to higher inventory to support the strong demand growth. But also, please note that EUR 134 million, the working capital additions for the period came from our recent acquisitions. These acquisitions are not yet at Azelis standards, but roughly double the working capital ratios as the organic business as we are still in the process of integrating them and bringing them in line with group policies. Despite continued elevated working capital, the group generated a free cash flow of EUR 275 million, which is an increase of 81.4% year-on-year. And this translates to a cash conversion of 75.7% compared to 56.9% cash conversion in June and 67.1% at the end of December 2021. So overall, we are very pleased with the group's financial performance for the first 9 months. There's still much work to do, especially in improving our working capital performance for the acquired platforms but we are making progress, and we are confident we will get there. I will now hand back the presentation to Joachim for some closing remarks.

Thank you, Thijs. And as you said, yes, we are confident. We have had a good year so far as shown by our results. Although we are mindful of the increasing macroeconomic uncertainty around the world, we still see the positive momentum going into Q4, albeit at a slower pace at the beginning as compared to the beginning of the year. In addition, we have a sufficiently diversified business, and we are defensively positioned in terms of our end markets. So we remain confident that we'll do well regardless of economic cycles. We've shown that in the past and it's becoming tougher. We will show that going forward. We have a resilient business model with many levers to protect margins. We are asset-light and we have demonstrated in the past that we can generate cash through the cycle. Therefore, as I said before, we are confident that we will be able to deliver on expectations for 2022 and this is more important that we will deliver on our medium-term guidance that we will be the leading innovation service provider of the industry. Thank you. With that, let's open the floor for Q&A.

[Operator Instructions] We take our first question from Suhasini Varanasi from Goldman Sachs.

Follow on to the specific verticals or specific geographic areas that are a bit slower than expected, please?

Can you repeat your question? It was very far away.

Yes, sure. So I was saying -- sorry. So you mentioned that the growth has been good going into Q4, albeit at a slower pace compared to Q3. So I just wanted to get some more color on maybe the growth by vertical or geography, maybe where you're seeing slowdown in maybe specific areas by vertical or geography?

Yes, we have -- as you remember, if we move back into Q4 2021, the industry was picking up across the board. And on these industrial segments, there are some headwinds we are seeing, for example, in the Americas on the industrial side, not significant. We're still growing, but not as strong as we did in Q4 2021. We're having in China, really, as Thijs mentioned, not an easy sale because the economic growth is just very sluggish. The regular shutdowns of certain parts of the country really don't help to deliver strong growth there, we're still growing, but not as to the level we like to. We see a very strong growth in Southeast Asia, also India. That's an area where things are good and now moving into Europe, Western Europe. There are the pictures mix, I should say. Even on the industrial side, we have some segments which are really going strong. Some other elements where we see a little bit more headwinds. As it was indicated on AES, so agriculture and environmental services, well, business is flying still very hard driven by the drought we had over the summer with regard to reformulation requests, but also as regard to actual business. So that's all good. We have a very strong performance of the business still in Africa, which for us is becoming more and more also of an important region. We do not have a significant amount of revenues there. So all in all, good picture still, but compared to the comps we had in Q4 last year, the growth is not as strong as it was last year, same time around. Is that fair? Clear?

Just one more, please, if that's okay. I just wanted to get some sense on how you're thinking about pricing and margins generally for next year, given the inflation, I think that the first half results, you were indicating that you're still comfortable targeting margin expansion in '23. Just given that wage inflation in Europe is pretty high. And given the growth is slowing going into Q4, I just wanted to get your thoughts on whether anything has changed on that front going into '23?

Thijs was talking about pricing policy that this was an instrumental piece of how we run our business. And then yes, true. Obviously, inflation continues to remain very high, and we're on our [ forefront ] to make sure that price increases we are seeing in the markets that these are given into our end customers. More importantly, the drive and expanding the lateral value channel, we spoke about that earlier, which means that embedding more products into an offering to individual customers allows us to drive prices up going forward. So we remain confident, as I said with my last sentence that we will deliver on the margin expansion we promised to the markets to you in the years to come with on-site being alert and on the other side, expanding our service offerings to customers.

And the next question is coming from Luuk Van Beek from Degroof Petercam.

First of all, on the gross margin, the increase was -- there was some increase in Q3, but it was less than the previous quarters. And obviously, you mentioned acquisitions with a lower margin, but that should not be a huge difference versus previous quarter. So can you say if there's a mix change or anything else that is driving that difference? And my second question is on the pricing trends. Can you give a breakdown between volume and price? And also indicate if you see any prices going down driven by the macro environment? So what will be the pricing environment going forward?

Thijs, you want to take?

So Luke, thanks for your question. Our gross margins, as I mentioned before, I opened up actually quite well. So our pass-through pricing policy is very effective, and we're showing growth on growth. Main comment when you see margin contraction coming in is mainly mix and also a little bit seasonality. And also, please note, if you look at growth comparables, and that's what I mentioned first on the gross margin in absolute terms, 2021 was obviously a very strong year, especially in the third and fourth quarter. As Joachim just alluded, we expect a normal fourth quarter in line with seasonality. So look also at the working capital charge, for instance, compared to previous years, but still significant growth. On the GM1 percentages, there is, of course, quite a significant impact from the M&A that we are doing. So what we normally do, we buy these companies at a margin that sometimes is diluting our overall gross margin -- gross profit margin profile. But with the lateral value chain, and the principles and our partners that we will add to their portfolios. We are very confident that in the future, we will get this up. We have an excellent track record there. But yes, it has been active, and we're stepping into new territories like South America and in certain segments where the margin profile is just a little bit lower. That's why I also made a comment on the organic gross profit as a revenue percentage is much higher when you look at the organic side of things. On the volumes and pricing side, we don't want to make too many formats on volumes due to the fact you cannot compare [ Ramsey ] in Pharma and [ Tonset ] in coatings .So you make really -- yes, you can get really like strange effects when you try to make a variance analysis. Overall, we see in the industrial segment and Joachim, maybe can say a little bit more about that. We see obviously in the industrial segment, that segment is more prone to economic volatility versus the more resilient Life Science segment where there's much more formulation going on. So that's basically what we're seeing in the marketplace.

On the Industrial segment, as I said before, in the U.S., industrial activities have eased a bit, especially over the summer, but it's also fair to say that recent readings are a little bit more positive. So direction of travel there on the industrial side is not so as negative as one might have thought about 2 or 3 months ago. And in Europe, it's really -- when you look into different markets, we still have some markets doing well and some others face more headwinds, particularly in Dutch, we had over the summer. We had some really remarkable headwinds, but some of that also has eased recently, right, the best.

So orders is looking really good.

Yes. It's really a mixed bag. But that, again, speaks also to the strength of the firm. We have so many market segments and countries we are serving. So you will always have some things which are looking really not so great. But as long as we drive all the segments together still up, we're in good shape.

And the next question is coming from the line of [ Hank Berman ] from [ Kempen ].

The first one on acquisition activity in the market. So last week, Brenntag actually increased its targeted acquisition spend to EUR 400 million to EUR 500 million per annum, which is roughly double -- more than double, actually, what they spent in the past and also doubled with yourself and [ ICD ] spent in the past. So do you expect this will change the dynamics in the consolidation, let's say, in the acquisition market a little bit in the upcoming years? That's the first question. Second question is on your cost base. Can you give us an indication how much variable compensation is in your cost base this year also to give us an idea, let's say, how much OpEx reduction we can expect if and when markets do cool down and you see slow down growth a little bit going quarters?

Thank you. Thijs you will take number two, and I'll take the first one. Obviously, we have heard what Brenntag has announced, but we stay focused on how we explore and to develop our own lateral value chain. On the specialty side of things, we have a certain set of principles we're working with, and these principles still have numerous hundreds of different distributors in different markets. So we will approach them. And as I said in earlier discussions we had with you, we will approach them on one-on-one discussions. We're engaged on one-on-one. Most of the process we're driving on the M&A side are really not processes -- competitive processes, but their process we initiated by approaching targets where we think their portfolio is fitting well to our lateral value chain offerings. So we stay focused, we remain focused on what we have been doing, building relationship with existing -- with targets, representing our principles and then get closer to them at one point and tap them into all of that. That increase of Brenntag or the focus of Brenntag on M&A, will that increase competition on what I just said? You can hear not really. There's still this 20,000-plus, according to BCG, companies out there -- distributors there. So I really don't expect this will change dramatically dynamic for us doing M&A going forward for the next couple of years.

Yes. On the bonus, obviously, we are a sales-driven marketing and sales organization. So variable compensation is a large part of our overall compensation strategy. So you need -- these numbers also referred to in our year-end report. It's quite high compared to other companies. If we take the effect there, you can roughly say on a yearly basis that we have around EUR 55 million to EUR 60 million in variable payroll costs. This year, obviously, the performance is very good. And most of the jurisdictions already maxed out on the maximum bonus potential. So the effect over prior year is that there is around EUR 12 million to EUR 15 million more in variable compensation than previous year. So obviously, we have to accrue in line with this performance, but our growth, of course, also in the third quarter was very good. And also in the fourth quarter, we do not expect a significant slowdown.

The next question is coming from the line of Laurent Favre from BNP.

Two questions, please. The first one regarding 2023. I just wanted to clarify walked about the medium-term margin target. Are you specifically referring to 2023 margins being up in 2022? Or is it more the multiyear statements? It wasn't here from your comments, at least for me. And then the second question was more about the competitive landscape. We've seen over the last year, I guess, with Celtic and Barents, two regional players becoming a bit bigger, more global in [ Ag ], I was wondering if you started to see an impact or if you're expecting an impact in terms of consolidation of authorizations and supply chains from some key customers, is that correct?

Thijs, you go for the first, and I go to the second.

Yes. So our medium-term guidance is 8% to 10% revenue growth, half M&A, half organic and 10 to 15 basis points margin expansion. This is driven by scale, mix effects, but also, take for instance, the M&A that we have included in here, we see a lot of opportunity and a lot of runway for margin expansion there. So I see this as an opportunity. So this is on top of our 2022 figure.

Okay. On your second question, competitive landscape, yes, quite some activities at that end, a combination of Celtic and Cornell, and you were asking whether there's a threat for us and or the industry possibly. I do see that as actually a good thing because this will continue to professionalize our industry. We will move from over the years, more away from being seen as a distributor, but again, as innovation service providers because we are the only ones we're able to combine the different chemistries, the different offerings from principles in a formulation, and that's something we're well -- there needs to be a good understanding of the industry that this has to be the role of the industry. So for us, no, it's not a threat. I see that as a good thing on the avenue to professionalize the industry further.

And then Thijs, sorry to insist, but I guess, consensus right now is assuming that margins are down in 2023. Is your message today that we are all a bit too conservative?

Yes, I think you're correct. In Q3, I already -- and maybe a little bit to react also to [indiscernible] comment. If we -- we said in Q3 that we do not want to give every time an outlook or an update on the outlook. The consensus is currently at EUR 436 million EBITA. We have to give basically a correction on the outlook if we go over a threshold of 10%, but we stay within that range, but it will be on the upper hand. And yes, your comment that the consensus is a little bit too conservative, is correct.

Next question is coming from Jayanth Challapalli from JPMorgan.

So could you remind us on how fourth quarter usually performs from a seasonality perspective versus the third quarter dip in earnings?

And thank you for that question. Normally, the fourth quarter at the end of November and December, it tapers down. I refer also in the presentation, you can see a couple of years back basically the working capital development that gives you a little bit of a pattern on seasonality. Now what happened in 2021, as Joachim already said, Q4 is exceptionally high. It was an exception. You can also see that in the line that all of a sudden popped up. We do not predict a similar shape of the curve in the fourth quarter. But obviously, our order book is still very positive. We expect to have a good quarter, but we do not expect an exceptional fourth quarter like in 2021.

And I mean, third quarter was very strong. Could you help us understand why the guidance for this year was not changed or updated?

Yes. I think I just answered that in the previous question. I think the guidance if you look on a revenue level and on an EBITA level, it's a little bit on the low end, but we do not expect that our EBITA will go over 10% over the consensus of EUR 436 million.

Understood. And just my last one. Could you help us with the incremental contribution from acquisitions on fourth quarter's earnings and next year's earnings? From just if you could give us a sense of how much you expect them to contribute?

Can you repeat your question again? Sorry.

I was hoping you could help us with the incremental contribution year-on-year from acquisitions on EBITA in fourth quarter and next year? Any sense that you could give us?

Now we do make statements on that. We put in the report, we put a take share we split out by reaching organic and M&A contribution. And then also on the first part of the presentation, Joachim indicated how much M&A we acquired. So I think that's where you can do the math with. Again, we're very positive on the runway of our M&A pipeline, but also on the future synergies that we will get out of there.

[Operator Instructions] There are no further audio questions and no written questions. So we have come to the end of this call. I will now hand over to Chief Executive Officer, Dr. Joachim Müller for his closing remarks.

Well, thank you. Thank you, everybody, for listening in. The world is in an interesting state. We have numerous challenges around the globe. I hope Thijs and I and with that, the entire Azelis team, and remember it's a team delivering this result has shown you that we are on a good track. We will deliver to what we have promised, and we will live up to what I always say, under-promised and over-delivered. We have had good months till now and whatever lies ahead, we will manage it well. Thank you for the trust, your interest and looking forward to talking to you next year on our full year results. Thank you.