Croda International Plc (CRDA) Earnings Call Transcript & Summary

Hello and welcome to the Croda Trading Update. My name is Caroline, and I'll be the coordinator for today's event. Please note, this call is being recorded. [Operator Instructions] I will now hand over the call to your host, Mr. Steve Foots, the CEO, to begin today's conference. Thank you.

Good morning, everyone. Many thanks for joining this call. A few thoughts from me, and then Louisa, and back to me, and then we'll take questions. Hopefully, you've had all the chance to read the trading update we issued the first thing that covers the period of 1st of July '23 to date, our third quarter. Whilst July and August had normally slow months for Croda, our performance in quarter 3 was weaker than anticipated as customers have continued to reduce their ingredient inventories in Consumer Care, Crop and in Industrial markets, depressing our sales volumes. So quite indiscriminate across the all markets. The macro environment is tougher than I've seen in my 30 years in the industry. And as we continue to see the ripple effects from COVID, and the unprecedented stocking and destocking that followed, it's difficult to be precise. But we believe the indiscriminate volume reset that we are seeing has been due to a combination of both destocking, which is the main driver in our crop markets right now, and a weaker demand environment, which is having an impact in some consumer markets, and most obviously in industrial markets. Visibility remains low at about 2 weeks, and with no indications of a significant rebound to come in the fourth quarter, we now expect full year 2023 group adjusted PBT to be between GBP 300 million and GBP 320 million. There are really 3 things that changed for us since our half 1 results in July. And in order, firstly, in Consumer Care, sales volumes in the Beauty Care business were lower than expected in July and August, with North America not recovering from quarter 2. Beauty Care sales volumes have improved in September, and we expect the recovery to continue through the remainder of the year, albeit now from a lower base. Half 2 profit margins in Consumer Care are expected to be lower than half 1 due to the negative leverage impact of lower volumes and adverse business mix. Secondly, in Life Sciences, sales have weakened further in Crop Protection, with improvement now expected to commence in the first half of next year. And thirdly, weak industrial demand globally is continuing to adversely impact Industrial Specialties, both ingredients that we sell direct and via the Cargill supply agreement in particular. So we're not expecting IS to be profitable in the second half of the year. I'll make a couple of further comments about sector trading before handing over to Louisa to run through the self-help measures we've taken to protect profitability. In Consumer Care, the strong price mix is continuing to offset lower volumes in Beauty Actives. F&F sales remained strong. The business is having an excellent year. And Home Care sales are recovering well, led by sales of technologies that are differentiated by sustainability. Sales of our ECO surfactants, for example, are up by around 25% so far this year. In Life Sciences, Seed Enhancement continues to perform well, with the business firmly on the right side of regulation such as EU's recent adoption of measures that will ban the use of microplastics in agriculture in the year -- in the next 5 years. A really great opportunity for our microplastic-free innovation in seed treatment. In Pharma, we expect to deliver lipid systems to our principal COVID-19 vaccine customers as planned, and non-COVID sales to remain resilient as customers' innovation pipelines continue to develop. Our Pharma business continues to make great progress with its industry-leading position in biologics delivery. We're particularly excited to see the continued expansion of our Pharma clinical pipelines for nucleic acid-based drugs, including encouraging results from trials of mRNA vaccines for infectious diseases such as flu. Our recent partnerships and new product launches are helping to further strengthen our pipeline of opportunities. So Pharma pipeline going from strength to strength. Now over to Louisa to cover cost measures and our focus on cash.

Good morning, everyone. Thanks, Steve. So just on the cost point, we've implemented some measures since the second half of this year to protect our short-term profitability. And as we've seen volumes reset downwards, we've been optimizing our production to match that lower demand largely through reduced shift patterns and plant shutdowns, and more recently, make-to-order customers -- contracts with customers, I beg your pardon. That helped us to reduce cost, including energy and freight. But outside of production, our main focus has been budgeted cost avoidance through tight control of head count and other measures such as travel bans. Although some job losses have regrettably been necessary in the U.S. Variable pay is another saving, and these cost measures are incorporated into our guidance for the full year '23. But in addition to that, there are opportunities to drive efficiency savings by simplifying our business processes and ways of working and by consolidating our site footprint. Principally, those sites that serve industrial customers, such as Cikarang in Indonesia, which we have closed. We're working through those plans now, and the changes will result in some annual cost savings in 2024 onwards, and we'll talk to you more about that at our full year results. On cash, we're actively managing the cash position. We're particularly focused on managing down inventory levels with some good progress since we last spoke to you, and we're continuing to strike a balance between investing in future growth opportunities and maintaining our capital discipline. We do have quite a large number of in-flight capital projects, including the farmer expansion for LNP and facilities in India, China and fragrances, but we're challenging the pace of these where we can, as well as all non-committed and non-safety-critical CapEx projects. Back to Steve for some final remarks, and then we're going to open up to questions.

Yes, Thanks Louisa. So as you can see, we're focused on protecting profitability by controlling what we can control. But at the same time, it's driving incremental sales growth by increasing customer sales activity. Our relationship with customers and their demand for innovation are going from strength to strength. And this is what will drive the rebound on our performance. When the supply chains from our core markets have been fully rebase and the macro environment improves. So let's stop there. And Louisa and I are very happy to take your questions from now.

[Operator Instructions] We will take the first question from line, Chetan Udeshi from JPMorgan.

I joined a few minutes late because I was in the queue to get the operator. So apologies if these were already addressed earlier in the call. But I was just doing the math of implied second half EBIT. And I think, you are essentially saying the contract to COVID business is expected to come as expected. So let's say, I think from memory, it was GBP 20 million of earnings in Q4. So the implied second half PBT is about GBP 115 million and you guys did GBP 175 million. So let's say, it's a decline of GBP 60 million, give or take. Can you help us understand what -- like, what is the magnitude of that decline to GBP 60 million in second half versus first half between the 2 divisions and different buckets? The second question was, just looking into now next year, what are the key moving parts besides the macro improvement that we should be sort of thinking about? And sorry, last small question, you said the Pharma business, that's lipid, was resilient. Can you maybe explain a bit or expand a bit on that resilient topic? I mean, are we talking about smaller decline than the rest of the group? Or is that still -- is that business still growing year-on-year?

All right. Louisa, do you want to kick off on EBIT, And I'll come back on '24 and Pharma.

Yes, absolutely. Hi Chetan, we previously guided to GBP 370 million to GBP 400 million PBT. We're now saying GBP 300 million to GBP 320 million. So if you take the midpoint of GBP 310 million from the bottom of the previous range of GBP 370 million, we've got, as you said, about a GBP 60 million drop. Broadly, half of that is Consumer Care. To Steve's point, we had a weak July and August with the Consumer Care run rate going backwards from our exit rate in H2, which we think was influenced by the summer. We are seeing a pickup in September, as Steve said. And the Q4 projection is based on a small pickup that is from a lower base and now a gradient as it were. 1/4 of the GBP 60 million drop is from Crop, and again, reiterating what Steve said, this is because that Q4 pickup that we had assumed in our GBP 370 million guidance is not happening. And then the last quarter is a combination, broadly skewed towards Industrial Specialties. Obviously, destocking in that sector, and then some adverse FX headwinds to make up the final bulk a bit of that quarter. So half quarter-to-quarter is how I would split that GBP 60 million . I'll pass it over to Steve for '24.

Yes. Well, let me kick off with '24 and I'll let you play you in as well. So we're not providing formal guidance for '24 year, as you'd probably expect with the volatility. But particularly, as visibility remains limited to a couple of weeks, I think GBP 420 million looks optimistic at this point from what we can see. But increasingly, positive sentiment coming in Consumer Care customers. We should be fully through the destocking by the end of the year, turn of the year with extra load at the extreme, hopefully ready to place orders again in a normal way at the turn of the year. So we're getting through that. And by the end of the year, Crop will have seen 3 successive pretty negative quarters of destocking. So we should see improvement in the first half of next year there as well. And then the Pharma business is making great progress. We're not expecting the $60 million of COVID lipid sales that we're delivering in quarter 4 to repeat in '24, but that will -- replaced by some good revenue growth from the pipeline that's already coming through. So I think that's it's up for '24. I mean, on the -- and we'll update in February as well. I think one of the big things is the -- as volumes come back, what we see is this margin will come back pretty quickly. But we can't call when that's going to happen. The product margins, as I call them, is still at very robust levels. So when we get good quality revenue growth across the board, we should see some margin improvement coming through at the same time, is my point there. But again, we'll update you more in February on that. In Pharma, it's just less negative, it's resilient so it's doing well. I think the area that's had some exposure there, like in consumers being the consumer health area, as you saw, expect dermatological creams, medicated shampoos and the like. But if you look at the underlying business performance, and if you accept the COVID normalization to one side, which is the lipids, and some reduction in vaccine adjuvants from the COVID, the underlying business is progressing very well. And we're really excited with that. So we're pleased with that. I think in terms of -- so just to go on in terms of the pipeline. In Pharma, particularly Virodex, we launched just recently, as you heard from us in the middle of the year, that's going to generate some mid-single-digit millions of pounds of revenue. Squalene will do well next year, as well [indiscernible] as well. So all of those 3 are recent launches and will generate around GBP 10 million worth of revenue just on those 3 products alone. And then, of course, we've got the flu vaccines, which are coming more broadly. And the clinical research, as you've probably seen with Moderna, Sanofi, Pfizer, and everybody else is developing at pace. And we're watching with interest, well more than interest. And obviously, we've got a number of lipids in some of those formulations as well. So the Pharma pipeline looks really encouraging. 1 or 2 more new launches that you haven't heard from us particularly into this whole bioprocessing area that we're focused on as well, you'll hear more about that probably in February. So seeing Pharma in a good way. I think the other areas, just on the innovation side, just to support when this demand comes back and see, that I talked about that my opening remarks. But this microplastic-free capacity free regulation change is significant. We saw it coming a couple of years ago. It's been formalized in Europe just last week. What that means is an extra revenue stream from '24 for seed treatment for microplastic-free and into '25. So that's great. And we're world leaders in that microplastic-free. So we'd expect that. And just to complete it for Consumer Care. ECO surfactants growing very well, as you'd expect. We took that big decision a few years ago. And then patented biotech surfactant launch is coming later this year in so for our lipids, and we've got a patented biodegradable platform, hair conditioning platform coming out later this year, too. So all of those add to growth. So at the innovation level, we're really pleased. It's -- the customer activity is great. Our -- and the innovation pipelines are healthy. We just need the world to rebase in its supply chain and demand to get back to some sort of level, probably a moderated level from where it was in '19, but at a level that's that is still relatively high. And that's our model. But we're quite naturally cautious for next year where we are today. So hopefully, in a long way, Chetan, that answers that.

We will take the next question from line, Gunther Zechmann from Bernstein.

A couple of questions, please. The Ag recovery that you now guided to be pushed out to H1 2024. Steve, you mentioned that's just 2 weeks order book visibility. So what is the basis, other than what you said in the previous question, that it will affect that business 3 quarters of destocking by year-end. And then, Louisa, if I can ask you on capital discipline, that's the paragraph in the press release. Should we expect some CapEx cuts on that? And in what area? What is the new CapEx guidance, please? And lastly, maybe for Louisa as well, how much should we expect from the cost measures that you've initiated?

Yes. Yes, just on the Ag then, and I'll pass to Louisa. I mean, look, on the Ag side, it's our best guesstimate based on that. When we talked to you in June and then July, it was the same. The mechanisms we use are -- there's a concentration of customers and we know them very well. We have strategic partnerships with most of them. So our intelligence is as accurate as it can be listening to our customers. But of course, as you probably get with everybody else at the moment, the customer's forecasting is about as inaccurate as ours. So they know what they know, but they don't know for sure. So we have to rely a lot on what they tell us. But I think, the message is, look, it's still actually quite buoyant out there on a relative basis with crop prices still high. So the trading environment isn't bad. Their general sense is, just given when they look at their stock levels relative to -- there's about 4 or 5 key products that nobody else can supply in the world apart from Croda. We're registered in thousands of formulations in crop with those. Going back to the ICI days actually with [indiscernible] way back. So we can model that quite well with the demand on that. And that's what we tend to look at. So it's based on more customer conversations. It could change, but we'd rather be cautious on that than not because we don't -- we simply don't see the data points that would encourage us to say that we're going to have a better quarter for them, we think. And the order intake wouldn't suggest at the moment that we're going to see like a hockey stick or some sort of ramp-up. So that's why we've called it the way we have. Louisa, over to you.

Yes, sure. I'll start with capital and then move through cash and cost. We previously guided, Gunther, to GBP 170 million to GBP 180 million on CapEx. I'm expecting that to moderate towards the lower end of that guidance range. The difficulty we've got, as I said in my statements, is that we are -- we've got some of these large in-flight committed projects that's difficult to slow down, and that's in the short term we've got for the rest of the year. So we're doing what we can on that, as I said, trying to challenge the pace, but sometimes it's not helpful to moderate those because they tend to get more expensive. But I'm expecting it to be at the lower end of that capital -- previous capital guidance range. But positively, though, on cash more broadly, the working capital discipline in the business continues to be strengthening. The regions have done really well in getting their stocks down, obviously, with lower sales, the debtors are down. And at the end of the quarter, we're in a really good inflow working capital position. And keeping the guidance for the full year that we will have an outflow just because -- I'm sorry, an outflow on working capital just because of the timing of the lipids gets us, but the working capital discipline is good, and I think that's going to help our cash position. On cost measures, look, we don't have a very significant cost base. If you look at our cost base, we're not known to be -- well, we're kind of known to be [indiscernible], and given the cyclical nature of this volume drop, we're trying to balance that short-term profitability but not damaging our growth for the future because we are innovative and our model is predicated on that local proximity to customers. And whilst I don't want this to sound defensive, a lot of our sites are shared. So it's quite difficult to push through total shutdowns of plants, which is where often you get some of the big savings from. But we are doing what we can. We're controlling what we can across multiple things. And we have done quite a lot of cost avoidance around new head count and travel. And where incremental costs have occurred, like salary inflation in the year, we're going to counter that with clearly no variable pay, which will keep us whole. And I've already mentioned some redundancies in the U.S., which will give us some small annualized cost savings from '24. But look, the big piece that we're working on at the moment is whether we can look more at our ways of working, some of the fragmented ways that we work across the globe and thinking about that for 2024 and beyond. So that's the theme of how we're looking at our cost [ conservation ] and it's this balance of trying not to pull too much cost down when really the issue is not cost, it's needing to, as Steve said, get that revenue back, customer demand. So I'll leave it there.

The next question from the line Nicola Tang from BNP Paribas.

First, actually, they're both on the Consumer Care side. Steve, sorry, I missed the very beginning comment you made. I think you talked about kind of pricing versus volume dynamic? I'm sorry that I missed that. I was wondering if you could repeat and just perhaps talk a bit about how pricing has been developing, and whether you feel like maybe there's areas where you maybe pushed pricing too hard and it's tested elasticity, or whether the volume declines we're seeing is still related to weaker end demand and the destocking side? And then maybe, could you give a bit more of a steer in terms of the margin decline in Consumer Care in the second half versus the first half? Perhaps, with respect to some of the drivers around, I understand less operating leverage, but perhaps some of the initial cost savings or stuff like that coming through combined with mix? And also maybe you could comment on how inputs have trended as well.

Yes. Well, let me do the first question, I'll pass to Louisa on margins. Yes, I'm just looking at the -- if you look at the Consumer Care mix analysis, so quarter 3 versus quarter 2 in 2023, the trend, overall, actually, volumes are up 2%, but the price effect is down 5%, which equates to hardly any 0% mix effect. So that means overall, it's sort of a negative 2% in the price mix. So actually, we're -- yes, it's pretty robust. It's slightly different across the different businesses, but we're not seeing a big volume decline, really. You're saying, actually, you know, 2% up, and that's being driven by Home Care and Fragrance & Flavors up well, and Beauty Actives and Beauty Care down modestly more than anything else. But -- so I think, if you saw that graph that we put up in July, in one of the earlier slides, when we're looking at the recovery of volumes in Consumer Care, it's just -- you can just extrapolate that line along its bottom from June, July. And there's some potential uptick now. September is a little bit better. And order intake for October looks a little bit better. So it is what it is. I think, I would make an overarching comment that -- so we're not worried that volumes are declining significantly further. We're just not seeing that uptick that we would expect to continue. But as I said, June and July -- July and August looks like for us in the industry, it looked like everybody should have shopped early and closed the door effectively. And you found in all markets, from industrial to crop to consumer, that it was lower than we expected. So we're all playing catch-up, and we're playing catch-up as well now. So that's that. I think, just -- well, let me pass to Louisa on the margin side, and I might come back and make another comment.

Yes. Hi Nicola, you know that we finished H1 at 21% in Consumer Care. And obviously, we're going to be lower than that in the second half, principally driven by that July and August performance, which was weak, and that gearing effect we've also got, as you've alluded to. We're really pleased with the F&F performance, which is really strong, and Home Care is also performing well, but it's obviously a very small part of our business and at the lower end of margin. So our margin in H2 is going to be lower than that 21%. And by default, the full year margin in Consumer Care will be lower than the 20% that we've signaled before. So yes, we've got some pressure from that Beauty Care part of the portfolio.

I would just add as well, Nicola, that one thing, a lot of our sites are shared across all markets. So when you look at the big value drop between quarter 2 and quarter 3 in terms of sales, at the top has been a reduction in Industrial Specialties and a reduction in Crop in sales value. They're the 2, so. But they share, in some cases, in quite a lot of cases, they share Consumer Care sites as well. So you have this unusual situation that we don't talk about too often, where you get some margin reduction in consumer because of weakness in other markets. And you've got that running through as well through the second half as well. So that's exacerbating the problem for now. So that's why there's probably an impact to the margin that perhaps you wouldn't have expected from exit rate in quarter 2, if you get my drift.

Just to clarify on that, is it shared, you mean across the 3 -- you're talking about the 3 segments of those headwinds across the 3 segments?

I'm talking about like a factory that's selling into all businesses. If you see a bigger reduction in industrial sales, Industrial Specialties sales or Crop sales like the Mevisa site in Spain or Atlas Point site in America, where they supply in all. If you get a reduction in some businesses, then margin effect -- because the margin could be impacted in the consumer business as well. So there is a bit of weakness in consumer book, but the margin impact is additional to that because of the weakness in other businesses on the same plan, if you get my understanding, so it's the cost absorption across the site.

Just to add to that, Steve, just to finish that up, and maybe to sort of anchor this. We talked about 21% in the first half. I would imagine that there's probably going to be a impact on the full year margin in Consumer Care for the full year, negative obviously.

We will take the next question from line, Matthew Yates from Bank of America.

Appreciate this. This might not be the easiest time, given you're one of the first companies to update on trading over the summer. But in the first half, there was an acknowledgment that some of the weakness was self-inflicted or market share loss, and you are going to respond with some more tactical pricing. Can you share some thoughts as to -- do you -- has that pricing initiative failed to recover any volume? Do you think you need to do more to try and retake some share, or is the weakness you're seeing really not a function of price elasticity at all in terms of just customer buying decisions?

Yes. Yes, I mean, it's targeted, it's working to a degree. But when we thought most of it, or a significant amount would just be becoming each quarter through '23. What we're seeing from our customers is they're just saying, look, we don't need it, we recognize where you are, but we're still sitting on stock levels that are higher than we'd like. So I think it's a fundamental market issue. We're pretty sophisticated at what we need to do. So -- and we can measure it, Matthew. There's about $50 million or $60 million of target business that we wanted to go after. And we're probably in the books through this year. It's probably 20% of that, maybe a little bit more. And we're guiding everything else. We're not losing it. It's just customers actually don't want it yet, and they're saying, they will buy it when stock levels are getting back to normal. So it's a fundamental market issue. I think the other thing I would say is particularly the multinationals. And you find that, not just in consumer but in crop is, we think they're taking their stock levels down to lower levels than they've previously done in the past. So -- and that's more from their organizations, you can imagine the pressure on their cash and balance sheets. So I suspect that we're going to end the year with quite emergency stock levels in some of our customers, or let's just say, lower stock levels than they would normally want to carry. And I think that's a consequence of just the environment that we're trading in as well. So we're obviously watching that closely as well.

Okay. And then just as a follow-up. You referenced that chart that showed potentially a couple of full starts we've had this year on calling a trough and an improvement. And your guidance is certainly not making any heroic assumptions into year-end. That -- your comments around September and October, do you think that's really just volume that was deferred from what may have otherwise been earlier in the summer? Or is there anything about order patterns in terms of frequency or magnitude that does suggest any confidence coming back from the customers thus far?