DEUTZ Aktiengesellschaft (DEZ) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. I'm Hailey, your chorus call operator. Welcome, and thank you for joining the DEUTZ AG First Quarter 2020 Results Conference Call. [Operator Instructions] Now I would now like to turn the conference over to Leslie Iltgen, Head of Investor Relations and Corporate Communications. Please go ahead.

Welcome, and good morning. Welcome to our conference call on the first quarter 2020 results. My name is Leslie Iltgen, Head of Investor Relations and Corporate Communications at DEUTZ. With us today is our CEO, Dr. Frank Hiller; and our CFO, Dr. Andreas Strecker. Mr. Hiller will give a short update, as always, on the business and point you to the key highlights of our first quarter results, whilst Mr. Strecker will then cover the financials in depth. As always, both will be happy to answer any questions you may have in our Q&A session at the end of this call. Also, let me remind you that this call will be recorded. A replay will be available on our Investor Relations website after this call. Before I hand over, please also pay attention to our usual disclaimer that you will find in the presentation. It is now my pleasure to hand over to our CEO, Mr. Hiller. Please go ahead.

Yes, ladies and gentlemen, a warm welcome to our conference call on the results for first quarter of 2020. Overall, we can say that DEUTZ is facing a challenging situation by the coronavirus crisis. For sure, we have also some effects by the new emission regulation and prebuy effect. But the major topic here is the coronavirus, and we have a double-digit percentage decrease in new orders and unit sales and revenue. Also, the EBIT margin falls to a minus 3.5%. So we have a significant drag on our operative activities in the first quarter, but also now in the second quarter in April. Beginning of April, we had to stop our production more or less completely for around 2.5 weeks. Already in the first quarter, we had a lot of implications by the coronavirus in China. We had to stop our production in Spain for some time and also a lower efficiency in our factories in Germany by the demand of keeping the distance of the workers. So on the other side, very positively is that we have a profitable service business, which is still growing, also under these conditions. And the increase was by 2.9%, and we reached a turnover of EUR 92.4 million on our service business. Also, our China strategy is good on the way. So we are processing according to plan even if the first quarter was quite challenging in China. So a lot of the work for the project has to be done out of home offices, but the team between DEUTZ and SANY is really working very closely together, and we are on time plan. We have started an efficiency program 2 months ago, Transform for Growth. So this is now in the detailed work on the measures, so a catalog of different measures is now put together aiming on further improvement on efficiency over the whole value chain, including reduction of operating costs, shared services, automation and digitalization are the big topics. Also optimization on production on further global production network will be done. I think we can start with the implementation of the first activities in 2 months, and we will keep you updated on the effects and the opportunities we are following with this program. Together with the management team, we have defined a Vision of Success 2020 in an outstanding pandemic year. Besides performance targets and strategic targets which we have every year and which are defined also for the year 2020, we think it's important to add also additional targets for these year to grow in a smooth way through the crisis. And therefore, we have defined this Vision of Success 2020, which works towards our different stakeholders. So this means for customers and dealers, for example, to keep up our performance, especially on the service side. It's also in the direction of our employees. For sure, the most important thing is safety and health here also clear communication. Another stakeholder here, which is important for us is the supplier, the supplier base. We will see in the future, I think, really challenges on the supplier base because our suppliers are normally also suppliers to the automotive industry. And so it's our clear intention to treat them fair also in the crisis to have a robust supplier base also in the future. On the shareholder side, for sure, so having a closer look on EBIT and especially on our cash situation. And also to go on with the most critical elements for long-term company success on the product process and technology side, for example, things like our China strategy electrification. So this will be -- there will be no change. Clear focus also during this crisis time. And for sure, also on the society, to support the society with our equipment to build up the necessary infrastructure. And also to support on the health side, we did quite a lot on this by sending masks to hospitals and things like that. So I think besides performance and strategic target, that's also an important topic for our company in the year 2020. On the guidance side. So this -- for 2020 remains still under review. It's too early to say anything on this. I think, especially quarter 2 will be very important for that topic. I'm changing now to Page 5. Sales figures. You see here the sales figure for new orders, a decline of nearly 31%. On the unit sales, a decline of minus 16%. This is positively influenced by the products of Torqeedo. Here we produced and shipped 8,000 -- more than 8,500 motors to our customers. So this is an increase by more or less 5x by a new product line. But for sure, this product is on the revenue side not contributing to the average, so this gives a negative product mix effect. And this is also the explanation why revenue dropped down much more than unit sales, so drop of minus 25% and means an overall revenue amount of nearly EUR 340 million. Orders on hand on March 31 was on a level of nearly EUR 270 million, a clear drop from last year coming from around EUR 500 million. Looking into the regions on Page 6, revenue by region. You see that we are mainly affected by Asia Pacific region and Americas. Asia Pacific, for sure, was very heavily affected by the corona crisis in Q1. In Americas, this effect was not on the customer -- on our direct customer side. So far, it's more on the end customer side. So end customers in the U.S. are mainly rental companies and they react very quickly. So when they recognized the implications of the corona crisis, they more or less stopped their orders. So therefore, we have a very sharp drop down in Americas. Under the conditions of this crisis, more or less, Germany is, I would say, more stable and Europe. But we'll have a closer look on Q2 in the next weeks. For sure, there will be some more implications because a lot of customers have had also shut down their production in April. Revenue by application segments on Page 7. First of all, here, you see the nice development on the service side. So it means that all our measures we are taking on the service side are paying off. On the Material Handling side, we have the sharpest drop down, and this is also very much related to the American business, rental companies behind that's the reason for that. Agricultural Machinery, a drop-down of nearly 36%. This is also affected because a lot of our customers, they are sitting in crisis areas of the coronavirus, for example, Italy. And so we had here some really tremendous impact. So Construction Equipment, minus 26%. That's it so far from my side, and I will hand over now to Andreas Strecker for the key financials in detail.

Good morning from my side as well. We continue on Page 9 with operating profit and net income. We've seen a negative EBIT of EUR 11.8 million in Q1 2020, which is a drop from previous year numbers, driven mainly by this sharp fall in revenue caused by the coronavirus crisis and also the customer selling the inventories of prebuy engines from last year. And with reduced volume, also we've seen diseconomies of scale in our factories. There also were some continuation agreements with the suppliers that go through insolvency proceedings. We see the tail end of that. Good news is, we continue to receive materials from these suppliers. Reduction in net income resulting from a decrease in EBIT, we've seen a positive income tax situation through deferred tax income. If we go to Page 10, with the 2 segments, Compact Engines and Customized Solutions. We've seen that in new orders, we're more affected on the Compact Engines side through situation in U.S. as an example, whereas Customized Solutions was much more stable with minus 4.5% order intake. On the EBIT side, driven by volume reductions and the insolvency proceedings, the segment Compact Engines was significantly affected with an EBIT margin of minus 6.5% as opposed to a profit in the first quarter 2019. On the Customized Solutions, we still have a very solid EBIT margin of 11.1%. If you go to Page 11, the segment Other comprises of Torqeedo and then Futavis mainly. There, we've seen that new orders were increasing by 5.4%. Very good development on the Torqeedo unit sales to 8,500 units. Big increase in revenue and improvement in EBIT, but also positively influenced by the deconsolidation of DAMSA that we had in Q1 2019 that caused a loss in that period. But overall, Torqeedo had quite a good development in Q1 of 2020. If you look at Page 12, the R&D spending, slight increase was expected and planned as we work on E-DEUTZ products China for developments and the further extension of the product programs. On the capital expenditure, here, we've seen that we had the extension of leases and replacement of expired leases. We have a strong look at all expenditures as we speak. On Page 13, working capital was increasing compared to December 31, 2019, which is no surprise because at DEUTZ usually working capital ratio is quite favorable. The increase to 18.3% is lower than we anticipated. Also, we have a very strong eye in conserving cash and reduce working capital as much as possible. The cash flow from operating activities is negative, mainly driven by the reduction in operating profit. If you look at Page 14, there, you see the free cash flow at minus EUR 35 million. And comes driven by the cash flow of operating activities. The net financial position were same reason also there and increase in these liabilities that we've seen here. Page 15. We see the equity ratio and funding is still very healthy at plus -- of over 50%. On the funding side, we continue to have our syn loan EUR 160 million. As in the past, that runs over a long period of time. Nevertheless, we are in discussions with our banks to receive an additional credit line in the low single -- triple-digit euro, discussions are ongoing. Just to be on the safe side that we continue to do what we need to be doing to secure also further funding of future activities. With that said, I would hand back to Frank Hiller for the outlook for 2020.

Yes, ladies and gentlemen, as already mentioned several times, so there isn't a clear impact of the coronavirus crisis on DEUTZ. For the timing of our guidance for 2020, there is no time line right now because it's too early and very difficult to predict. Together with the Supervisory Board, we took the decision to propose in the annual shareholder meeting to suspend the dividend payment for 2019 to keep financial stability. And on the other side, as Andreas Strecker mentioned, we are currently in an advanced stage of negotiations about obtaining a further credit line for low triple-digit million euro amount. Despite the coronavirus crisis, growth projects are to continue being implemented as planned. So these are, I would say, the big levers after the crisis, our China strategy electrification and all the activities, which goes towards increasing our profitable service business. Maybe so far from our side, and we are open now for your questions.

[Operator Instructions] And the first question comes from the line of Charlotte Friedrichs of Berenberg.

Three, if I may. The first one would be if you could give us a bit of color on current trading? I know the visibility is low, but what are you seeing right now also in terms of order intake, commentary from your customers, et cetera? Second question would be around potential for cost reductions. Do you already have an idea of what magnitude of cost savings you could generate with your cost-cutting program or round about where is your fixed cost base, breakeven number of engines, et cetera? And then thirdly, on the customer -- sorry, on the supply situation, could you give more detail on the continuation agreements that you have with some of your suppliers?

Okay. Maybe I'll start with the current trading. So to be honest, this is very volatile. And a lot of our customers had shut down their factories for several weeks now. This is more or less recovering now in Europe. We see quite a good situation in China. China, more or less, I would say, is back on 70% to 80% before the crisis. But Europe is -- we have to see the next 2 weeks. It's too early to predict. And U.S. is, I would say, very low right now.

Cost reductions, breakeven point. We had in 2019, our breakeven was roughly in the neighborhood of 150,000 engines. We are working strongly now to bring that more in direction of 140,000 engines. We've reduced apples-to-apples, 250 people since the beginning of the year. And then also we have strict expense controls, every invoice or any planned expenditure above EUR 5,000 goes over my desk at the moment. So we are working hard on it. The program Transform for Growth, I think in next couple of months, we will be able to bring more detail to that. And supply continuation agreements we have Gusswerke in Leipzig and Saarbrücken, they run until June 30, then they are finished. And the same with the supplier, [ of VW ], runs until the end of May, and that would be the end of our continuation agreements in insolvency proceedings. As I said earlier, we receive a very, very steady supply of parts from these suppliers, which is positive.

Next question is from Frederik Bitter of Hauck & Aufhäuser.

So I would be very interested to hear a bit about the inventory. What do you think or what you hear, what you see are sort of the inventory levels are to key customers, including, I think, very crucial to prebuy engines, if you could share any light on this one it will be very appreciated.

On the inventory side by the prebuy engine, so this was an effect overall of around -- it goes over 2 years and it was around 35,000 engines, and over 2 years around EUR 200 million. And what we had out of the year 2019, this will be more or less finished. This first EUR 100 million will be finished at the mid of this year. And for the year -- sorry, for the year '18 -- 2018, this will be finished at the mid of this year. And the prebuy engines out of 2019 will be finished mid of next year. So we think it will be around, maybe half of this 200,000, means 100,000 is still on stock on our customers. That's what we predict.

Well, obviously, if you say mid next year 2019, prebuy engines, that obviously is not what sort of the whole market demand obviously would be. But it's rather, it's been phased until next year, I assume. It will be slowly reduced.

Yes, it will be slowly reduced for sure. This is now the regulation, and we hope that there will be no postponement in the regulations. So some of our customers are working on having some new regulations so that this could be also suspended for some months. But this is now the regulation, it goes 18 months. And so mid of next year, it will be finished.

Okay, sure. And then another I have as well is, do you still expect the cash-in from the property sale of about EUR 60 million or so, if I have it correctly in my mind, this year? And if so, do you -- what quarter do you think you will receive the cash-in?

Yes. We plan to receive it this year, will be in the fourth quarter of 2020.

Okay. Good. And the last one I have for now and I have some others, but I know you'd like to extend your time to other questions, could you tell us roughly where your covenants are, financial covenant?

The covenants from the credit agreements we have right now, it's EUR 2.5 billion. EBITDA, we are way below that, yes. So there is, as we speak, headroom sufficiently. Nevertheless, it's a measure of precaution. We are discussing with the banks to increase the line to EUR 60 million.

Now obviously, it is financially accretive clearly. Just wondering, do you need to take any -- into account any adjustments on the net debt to EBITDA side, say net debt, for instance, adjusted for IFRS 16 or the EBITDA. Are there certain factors we should exclude as regards to covenants definition?

I mean when the -- I mean there's a clear understanding with all banks at the moment and all clients that in the current environment with corona when companies have reduced results, and they would not hold it against anybody in the next months and look you have a covenant issue now. So that is, I think for 2020 that is not an issue if companies in general would come closer to those covenants because the results go down. So that is a clear understanding between companies and all banks that 2020 is at the moment, is a clear exception.

Okay. Net debt, is it excluding IFRS 16 effect? Or it's including?

It's including. It's including.

Okay. Okay. And as opposed to EBITDA, it's on a rolling 4-quarter basis for the last 12 months, if you will?

Yes, yes.

It makes a lot of sense, okay. So it's not moving as fast. That's a -- the last one, actually, on this one, the 2.5x, is that a half covenant or is it something you would have an upcharge on the interest rates should you cross 2.5x? And if maybe, I don't know, there may be an early termination clause, maybe, I don't know, at obviously higher rate?

Yes. Frederik, Mr. Bitter, there's a grid. When you are at 0.5 and then 1 and 2, so there's a slightly increase depending on which bracket you are in. But there is interest rates [indiscernible].

[Operator Instructions] The next question comes from the line of Richard Schramm of HSBC.

Yes. I have a follow-up on this supply chain issue with Gusswerke Saarbrücken and Leipzig. I'm not sure if I understood you correctly, but the deliveries are running until mid of the year and then you will change to another supplier? Or how will it work with the current insolvency of these 2 suppliers here?

Yes. We received a part from Gusswerke qualifications until June 30. In parallel, we have built up a second source already with the corona crisis. Then the new second source in Turkey and Spain were also shut down due to corona. We elected to extend Saarbrücken for one other quarter just to be sure that we get parts because, again, the new source was shut down by governments, and that's why the extension came into effect for Saarbrücken. But the second source built up is running completely as planned.

But right now, Mr. Schramm, I think that the biggest challenge is on the customer side, there is no risk on the supply chain by our suppliers. It's more on the customer side, low number of demands and also what comes to a problem is now a lot of shifting orders on the customer side because they have some -- also some shortage with some other materials. And so they are shifting also the engine types on our side. So it's more on the outbound and less difficult on the inbound.

Okay. But just let me summarize. So this Gusswerke Saarbrücken and Leipzig will be replaced by mid of the year by your 2 new suppliers in Spain and Turkey, right?

Among others, yes. I mean, we spread it to more suppliers because there were many parts, but as an example, as 2 of these selected suppliers were shut down, we elected to continue with the Gusswerke for another quarter.

And maybe I have missed this, but did you mention how much of extra cost this costs in Q1 and what to expect for the full year on additional cost from this side until this change is now completed?

Yes. We had north of EUR 6 million in Q1, will be a little bit less in Q2.

Okay. And then I have 1 another follow-up on this prebuy engines you mentioned. Did I understood you correctly, you mentioned 100,000 units in costs?

No. EUR 100 million.

EUR 100 million in revenue. Yes.

So in unit terms, it's, of course, then I thought approximately 15,000 to 20,000.

15,000 to 20,000.

Sorry?

. Yes. Correct.

15,000 to 20,000. Okay. And the last point, I have concerning your investments. You mentioned that it is pushed up by new leasing agreements. This then net figure or are all leasing -- new leasing equipments going into investments on a gross basis here?

We have to show all the future liabilities that we have out of the leasing contract, yes, in that number.

So this includes the early quarterly issue and level off over the year? Or should we expect for the full year in general?

Yes. I think as we go forward, and we are reducing overall spending, we will not see that increase over the whole year. I think in -- what we've seen in the first quarter is also an overflow of things that we didn't fully pay in 2019 when the money outflow was in 2020 in the first -- in the early months of 2020. But that isn't -- that's not anything you should take time for. So it will come down in the next quarters, the difference to previous year.

And there are no more questions at this time. I hand back to Leslie Iltgen for closing comments.

All right. Then yes, thank you, everybody, for joining the call today. Should there be any follow-up questions after this call, don't hesitate to contact us. As always, we're happy to answer any questions you may still have. Other than that, I wish you a great remainder of the day. Cheers, and goodbye.

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.