Azelis Group NV (AZE) Earnings Call Transcript & Summary

Hello, and welcome to the Azelis Half Year 2023 Earnings Call. As usual, we are joined by Dr. Joachim Müller, who will present the highlights of the first half of the year; and Thijs Bakker, who will take us through the numbers. We will take questions after the presentation. [Operator Instructions] We will make a recording of this webcast available for replay on our website later today. As a reminder, this presentation may include forward-looking statements that may be subject to risk and uncertainties. With that, let's start. Over to you, Joachim.

Thank you, Pam. Good day, everyone. Thanks for tuning in and joining us for the presentation of our first half 2023 -- first half year 2023 results. We appreciate, especially, as we know some of you are just coming back from or about to go to or maybe even in the middle of your summer holiday. As usual, I will start with an overview of the performance in H1 on to the next slide. In the first 6 months, our revenues increased by 6% to EUR 2.1 billion, and adjusted EBITA increased by almost 9% to EUR 263 million. The challenges we experienced in some of our markets have put pressure on organic revenue, which declined by 5%. While the industry faces some headwinds, namely weaker demand in Americas in industrial chemicals, it's also worth reminding that H1 last year reported revenue growth of 54% of which 28% was organic. So there's still an element of tough comps in the results for H1 2023. Nevertheless to -- we faced varying degree challenges in some of the them all markets. Overall, the diversity of our portfolio allows us to mitigate the impact of the current challenges on our business. In addition, we continue to expand our footprint and invest in future growth drivers. Since the beginning of the year, we have acquired 6 companies across 3 regions. These acquisitions further strengthened our business by enforcing our lateral value chain. Worthwhile noting that these companies have combined annual revenues of over EUR 370 million in 2022. We continue to see excellent opportunities, and we intend to pursue those opportunities with the same rigor and diligence as before. A proof point of the resilience of our business model is our gross profit margin remaining stable at 24.1% despite the volatility in some of our markets. Furthermore, the adjusted EBITA margin expanded by 29 basis points, driving -- 129 basis point expansion in conversion margin to 50.9%. Reflecting the benefits of our asset-light cash-generated business, we achieved a 92% cash conversion ratio. Operationally, we are progressing on our innovation, digital and sustainability agenda. We just won another innovation award for Personal Care, have rolled out [ 118 ] portals and had our industry-leading ESG rank can confirm the most recent Sustainalytics and assessment cycle. Let's go through some of the highlights of our growth drivers on the next slide. Across the 3 regions where we operate, the normalization from the exceptional growth in 2022 is ongoing. Our diversified footprint and the general defensiveness of our business model allowed us to mitigate the impact of the current volatility in many of our markets. And is holding up better in life science, cushioning the impact of the weak demand in industrial chemicals. In EMEA, organic growth declined 2% in H1, driven by and large by the acceleration of demand slowdown in industrial chemicals in Q2. Organic revenues in the Americas declined by 13% as our performance remains under pressure from continuous weakness in CASE and in Latin America. Although we have started to see an easing in flavors and fragrances, which was impacted by destocking since Q3 last year, the growth momentum is still stable. In APAC, we achieved 7% organic revenue growth despite a much slower-than-expected recovery in China, thanks mainly to continued strong performance in Southeast Asia and India. In terms of industry consolidation, we completed 6 acquisitions in H1. In EMEA, Smoky Light and Sirius, and hence our lateral value chain in the Benelux market. Lidorr gives us a strong foothold in Israel especially in the very attractive ag market in the region. In the Americas, we acquired the well-established Brazilian Food & Nutrition distributor of Ookla, significant step in our growth expansion strategy in Latin America. And the acquisition of Gillco gives us a formidable entry platform in the U.S., Food & Nutrition market. And eventually in APAC, the acquisition of Chemiplas significantly strengthens our footprint in Australia and New Zealand. Now the following 2 slides will give you some idea about the type of formulations we recently developed with our customers. To stress it again, our formulation work showcases our expertise and most importantly, the value we bring to our principals and customers as an innovation service provider. In this example on this slide, we feature work we did for a customer in the construction sector. Given the rising cost of lithium carbonate, they needs help to reformulate the existing motor product to reduce lithium carbonate contact. Our lab team helped this customer by creating a formulation that not only reduces the lithium carbonate content significantly, and therefore, reduces the cost base. But the customer also got a product with significantly improved sustainability characteristics. Now on the next slide, the following example you see is more tangible for consumers and hence, easier to relate to. Our lab colleagues develop the formulation to address the lactose sensitivity of an increasing number of consumers, choosing specific enzymes on combining ingredients from specific principals, our colleagues formulated a dairy product that even lactose-intolerant consumers can enjoy. This example and the one in the previous slide demonstrates how we create value for our principals and customers valeting up to our corporate tagline, innovations and formulation. Our efforts to contribute do not stop with our principals and customers. As you know, sustainability is utterly important to us. So, we continue to make strides towards our action 2025 agenda, noteworthy. We are already ahead of schedule in one of our key objectives. We already have nearly 32% of senior management positions filled out well. Well, obviously, there's still work left to do on our sustainability agenda, but it's encouraging to be recognized for our ongoing efforts. In the latest assessment cycle of Sustainalytics, we further improved our score and reconfirmed our top industry rating. That's a great motivator for all of us to continue on our journey of relentless improvement. With this, I will hand over to you, Thijs.

Thank you, Joachim. Good morning, everyone. As Joachim has taken you through the business update, I would like to focus on the group's financial performance in those of our regions for the first half of 2023. Let's start with my level overview of the P&L and the drivers of our performance for the second quarter of 2023 on Page 11. Group revenue for the first half year of 2023 was over EUR 2.1 billion, representing a year-on-year growth of 6.1% or at constant FX rate 8%. This growth reflects the performance of our resilient Life Science business, which grew 9% or at constant FX 10.8%; and industrial chemicals business, which grew 1.7% year-on-year or at constant FX 3.7%. For second quarter revenue came in at EUR 1 billion, representing a flat year-on-year performance. Without the impact of the acquisitions, sales decreased with 8.1% versus an organic growth of 23.3% in the same quarter last year. Therefore, this performance is not only in the context of a more challenging environment, but also against a very comparable. The revenue trends reflect ongoing softness in the Americas as well as efforts in balancing mix and gross profit margins levels -- similar levels like last year. We have been successful in executing our M&A strategy. On a pro forma basis, accounting for the full 6 months revenue of closed M&A in 2023, half year revenue would have been EUR 2.22 billion. Gross profit for the first half year came in at EUR 517 million, representing a year-on-year growth of 5.8% or at constant FX rate 7.6%. Gross profit as a percentage of revenue ended at 24.1%, which is basically stable versus prior year. This stability reflects the outcome excellent margin management and a favorable mix shift towards life sciences. In the same period last year, we expanded gross margin by 157 basis points, so we are pleased to hold ground despite the less favorable market environment, as Joachim alluded. Furthermore, we have kept our gross profit margin stable despite the first-time inclusion of some M&A in emerging markets, which is performing at lower gross profit levels. To illustrate this, gross profit as a percentage of revenue for the organic business improved from 24.2% to 24.7%, implying a step-up of 49 basis points predominantly mix-driven. For the first half year of 2023, the group generated an adjusted EBITDA of EUR 279.2 million and an adjusted EBITA of EUR 263.4 million. The adjusted EBITA margin remained strong at 12.3%, translating to a 29 basis point margin expansion resulted in excellent 129 basis points expansion in conversion margin. This improvement is a reflection of all the items that we can control. We are executing on the M&A pipeline. We're executing balanced margin management, and we are controlling our cost base by executing on integration and operational excellence. So controlling our cost. In the second quarter, EBITA margin ended at 12.3%, which is a 22 basis point step-up from the previous year period. Our net profit for the first half year was EUR 109.2 million. I will discuss the drivers of net profit in detail in a later slide. On the slide on Page #12, I would like to provide a breakdown of growth by region for revenue, gross profit and EBITA. In this table, we have broken down the 6.1% reported revenue growth and the 5.8% reported gross profit growth between organic growth and growth coming from the first-time inclusion of acquisitions and fixed effects. Following a record performance in 2022, organic revenue levels in the first half of 2023 decreased by 4.8%. This was largely driven by lower revenue levels in the Americas where the group has a higher mix towards industrial chemicals, which saw lower demand, slow recovery in the FNF segment as well as softer performance in South America. The strong organic gross margin performance I mentioned earlier together with the execution of cost initiatives means that despite lower organic revenue, there is no change in organic EBITA relative to the first half of 2022. This clearly shows the resilience of our business and our ability to leverage scale and cost initiatives in all environments, while continuing to invest for the future. The first-time inclusion of acquisitions generated 12.8% of our revenue growth for the first 6 months as we are executing well on our M&A pipeline with 6 acquisitions closed, out of which 2 are platform acquisitions. Please note, we completed 12 transactions in the course of last year with 7 in the second half of the year, which are not part of the organic definition yet. Now the impact from exchange rate was a negative effect of 1.9% on revenue growth. And comparing the FX rate in the first half of 2023 versus the same period in 2022, the euro has continued to strengthen against most of the major currencies in which the group operates. Let's have a look at our regional financial performance. So please turn to Slide #13. Starting on the left, with EMEA, which makes up 44% of group revenue. Revenue increased by 33.1% or with 6.1% at constant FX rate to EUR 944 million. On an organic basis, revenue was 2.2% lower, predominantly driven by softer industrial chemicals demand outweighing good performance in the Middle East and Africa and our Food & Nutrition and Pharma segment. But please put this performance also in context of growth, organic growth over 30% in the first half of 2022. EMEA's gross profit increased by 12.4%, out of which 5.7% was organic, mainly driven by a shift towards life science. And execution and balancing of our commercial excellence program to optimize our lateral value chain at the customer base. EMEA successfully executed on operational improvement programs and cost control actions, such in H1, which led to an improvement in conversion margin from 53.4% to 55.5%. Turning to the Americas, which makes up 34% of the group revenue. Revenue decreased by 3.7% to EUR 735 million, out of which 13% was organic. Trends in Q2 were broadly similar to Q1 in the Americas, where the region's sales development was impacted by the higher mix in favor of industrial chemicals, slower-than-anticipated FNF as well as softer performance in South America. Adjusted EBITA margin for the half year ended at 13.6%, a decrease of 53 basis points. Despite the challenges in the Americas, prudent cost control and mitigating actions translated to 195 basis step up in conversion margin to 56.7%, an excellent performance. Let's move to Asia Pacific. This region makes up 22% of group revenue versus 17% in 2022 as we are executing on our strategy. Revenue increased by 36% to EUR 462 million, including solid organic growth of 7%. Organic growth was seen across the board, but particularly in Southeast Asia, which more than offset continued weakness in the Chinese market. Asia Pacific nearly doubled EBITA to EUR 41 million and expanded its adjusted EBITA margin with 50 basis points to 8.9%, translating into a 399 basis points improvement in conversion margin to 46.7%. Continued execution of our M&A strategy, both in terms of new acquisitions and excellent progress on M&A integration will continue to drive margin improvement in subsequent periods. Now let's please turn to Slide #14, which shows the net profit of the group. Net profit after tax came in at EUR 109.2 million, a decrease of 23%. This is driven predominantly by the higher interest costs increasing due to higher debt levels and higher interest rates. Secondly, the group incurred a negative impact from 2 noncash related drivers, first being hyperinflation accounting in Turkey, or both balance sheet items and P&L are adjusted for inflation, and there was a negative impact from FX volatility, mainly on intercompany loans. This all led to a higher-than-desired effective tax rate despite good progress on completing our structure [ post-IPO ]. Please move to Slide #15 for the cash flow performance of the group. During the first 6 months 2023, Azelis delivered excellent free cash flow, with free cash flow of EUR 245.2 million versus EUR 139.2 million in 2022, an increase of 76%. Our cash conversion came in at 92.2%, in line with historical trends and in line with our target range of 85% to 95%. Now given that working capital is one of our key drivers of our cash flow, let me take you through our working capital development in the next slide, #16. Net working capital to revenue normalized for acquisitions remained flat at 15.4%. But in my view, this does not give credit to the underlying improved performance. Since Q2 2022, the businesses we have acquired have added EUR 170 million of working capital. Over the same period, the group's net working capital increased by EUR 53 million. So on an organic basis, it has decreased significantly. This demonstrates the working capital improvement we have delivered in the organic business and the opportunity we have to optimize the working capital for the acquired companies. This improvement has been broad based. If both, DSO and DPO, normalizing closer to historical trends. You still see that whilst DIO has improved slightly compared to last year, it's still on the higher end, in my view and reflects more work required here to unlock the full opportunity. Overall, we're pleased with the progress we are making and our programs are working, as our cash flows are also help us to manage our net debt levels. So please turn to Slide 17 to look at the debt profile of Azelis. Change in net debt during the first half year reflects strong operating cash flow of EUR 250 million. The EUR 200 million capital increase completed in May and an M&A spent approximately EUR 558 million, which includes deferred payment to acquisitions in previous years of approximately EUR 50 million. We ended the first half of 2023 with a leverage of 2.6x at the lower end of our stated leverage policy between 2.5x and 3x. Now at the end of June 2023, we have a strong liquidity position of EUR 766 million, both in cash and unused credit facilities. And the strength of our balance sheet, both in terms of leverage and liquidity provides us an excellent run rate to continue to execute our strategy. So in summary, we continue to make great progress on our strategic and financial objectives in the first half of 2023. This is a more difficult operating environment than we have seen in recent years. But we believe Azelis is stronger than ever and is ready to perform for our principal customers and shareholders through the rest of 2023 and beyond. Now let me give it back to Joachim for some closing remarks and the outlook.

Thank you, Thijs. Well said. We are clearly in a volatile territory. As our industry is normalizing after 2 years of exceptional growth. It needs to be stressed. The long-term fundamental drivers of the industry remains intact. While the current volatility in our markets has raised the risk of our outlook at present, the group remains on track to achieve its medium and annual revenue growth guidance of 8% to 10%, subject to current suite of operations and is confident of delivering 10 to 15 bps adjusted EBITA margin expansion for the full year. With that, we are ready to take your questions. Operator, please open the line for Q&A.

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

A few from me, please. In Americas, the gross margin fell more than 350 basis points in Q2. And you indicated time lag in pricing as one of the reasons for the decline. Can you maybe give us some more color on that? And whether this is a one-off effect that is going to reverse in second half or whether it will continue in the second half? That's my first question, please. I take it one by one, if that's okay.

Well, the gross margin decrease in the Americas was pronounced, especially so as we need for -- on the CASE side, right, where last year with markets US being in turbulent waters in short, also prices were extremely high. So we had to adjust to market environment in our formulations by giving in some of higher prices of last year, give that back. Margin then -- obviously, also came down some, but we do feel, especially for the Americas that we have reached a plateau or even slightly are moving up. That's currently the rate of the market, especially on the industrial side.

Yes. And there are 2 mix elements in that number, which you've seen. One is, of course, the inclusion of Rocsa in the M&A in South America, which is performing at a gross profit level. So you see that becoming more dominant. So they're performing at a gross margin level of around 13% to 17%. Second, Vigon, which are FNF platform, which basically was performing last year quite high and basically has declined. So you see that effect in the mix as well in addition to the comment that Joachim was making.

My second question is on the outlook, please. You highlighted the higher risk this year. I appreciate that FX swings is something that nobody can predict. But on an underlying basis, it's clear that Q2 growth has maybe worsened compared to 1Q, with maybe some stabilization in Americas. But can you give us your sense on what are the key parameters or factors that would result in, let's say, going slightly below the lower end of your guidance for the year.

As said, we are confident to stay in between the 8% to 10% of revenue growth. That's also a result of having some of the M&A coming in. We indicated that we acquired 2 businesses in the Americas generating on an annualized basis 2022 of EUR 150 million. We closed that business in June. So that will help certainly also uplift our revenues for the second half, which again gives us the confidence on the 8% to 10% revenue guidance we gave. The second point, I'm now looking more into the markets. We do see that Asia is still a mixed bag. But for -- if we see some slight recovery coming up in China, which gives us some hope that this will gain momentum. Southeast Asia, we have some -- really some bright spots in the region there was -- in Vietnam doing very well, but also in Thailand because we see some good performance. So this will also give us some momentum. As I indicated earlier when we spoke about our results, Americas, we think we're at the end of the third. We are seeing even some minor movement, not huge, but I think we have not only bottomed out, but we were kind of moving up, where we do have challenges is in EMEA, where we will leave aside that the comps in Q3 of last year, but organic growth, Thijs, where it stood?

32% in organic.

32% in Q3 last year. So where beating the comps will be extremely difficult, especially as we see that the markets here are scattered. We have some which are really doing well and some over there not doing so well. Obviously, then, Middle East and Africa, standing out, still doing very nicely. But here in Western Europe, it's -- in some countries, it's challenging. And we see it softening compared to Q1 and Q2. So in a nutshell, Asia moving up slightly. Americas moving up slightly and EMEA is a little bit weaker. That's I think what I would say.

The next question is from Laurent Favre of BNP.

Two questions, please. The first one is on agri horticulture. It's an area where we have seen several warnings from suppliers. You haven't mentioned it as a point of weakness. What are you seeing there? And is that an area that will weaken into H2? And then the second question on the guidance. You've had a 30 basis points improvement in the first half against very tough comps. What are the reasons why you wouldn't be able to grow margins at the same pace in the second half, bearing in mind weaker comps?

On the first -- you can take the second.

I'll have a second. Okay. On Horti, it's a mixed bag. Our Horti business in U.S. is doing okay. Actually, so far, in the year is not performing in EMEA. It's soft. It's a soft season.

It's still doing well in Asia.

Asia is okay. U.S. is okay. EMEA is soft, which is the largest region we see signs of uptick in summer and the weather conditions in Q3...

Usually for Agri here in Europe when Q3 and Q4 are the stronger in all seasons. So we expect this to improve in the second half of the year.

And on the guidance?

You're referring to gross profit, I assume?

No. The -- EBIT margin. So straight EBIT margin.

Okay. It's very simple. Basically, you see a shift towards life sciences, yes. So our mix is shifting towards the life science side. Second, there is, of course, a volume component from a distribution cost with paper pallet basically. So that also gives us a protection there. This is a very resilient business. And then lastly, obviously, we're executing also operational improvement like M&A integration. We made great progress with 20 companies on the platform integrated. So that helps with working capital, but also operating cost leverage and integration of legal entities, those kind of things. And then lastly, we're also operating efficiency programs to align basically our cost base with the top line. And as I said, we have a very variable P&L, and we're basically adjusting towards the current environment.

So in that respect, in that respect -- go ahead, sorry, I didn't hear that.

My question was more -- my question was more, what are the reasons why that improvement wouldn't reoccur in the second half? Are there reasons why? -- not to -- be smaller than in the first half?

Now we expect to continue to grow our EBITDA margin in the second half.