DEUTZ Aktiengesellschaft (DEZ) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. I'm Mohit, your Chorus Call operator. Welcome and thank you for joining DEUTZ First Half 2021 Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Christian Ludwig, Head of IR. Please go ahead.

Thank you very much, and a warm welcome to everybody on the line. Together with me in the room today is our CEO, Dr. Frank Hiller; as well as our CFO, Dr. Sebastian Schulte. Mr. Hiller will walk you through the highlights of our H1, and then Mr. Schulte will say a couple of words on the numbers before we hand over to a Q&A. Please be aware of the disclosures at the beginning of the presentation. And also, I want to point out that the call will be recorded. Thank you so much so far. And now I'll hand over to Mr. Frank Hiller.

Yes, ladies and gentlemen, warm welcome to the results for the first half of 2021. I will start with the operational and strategic highlights. So we had a significant new order growth. Orders on hand are up of around 110% year-on-year. For sure, we have some extraordinary effects by price increases and also by stopping some engine models, which caused a pull-forward effect. But I think the order increase is really a positive -- a very positive sign. Double-digit percentage increase in unit sales and revenue, and this in nearly all segments. Exception is the stationary equipment, which is a small segment. We have a significant improvement in operating profit, for sure based on cost savings through our efficiency program which we started 18 months ago, Transform for Growth. And we are confirming the raised full year guidance for 2021 despite the difficulties in the supply chain. For sure, this will be also a topic for us for the second half. Supply chain issues are really challenging the organization. And for sure, if those topics would not be on the desk, even a higher turnover and margin could be possible. Further on, some strategic highlights after the reporting period. So it's a new strategic partnership with AGCO and ASKO which is very important for us. And also, the -- on the technical side, the hydrogen engine is ready for the market. I will come to that later on. But first, on our global Transform for Growth efficiency program. This is on track, and we are focusing on a saving -- total savings achievement in the year 2021 of nearly EUR 40 million. So the target of our program is to save costs on the staff side and also a reduction in operational costs and warranty costs. We started a voluntary reduction program. Last year, this was taken by 361 employees. Until the end of half -- of the first half 2021, 109 employees have already left the company. Until the end of the year, the number will raise up to 171 people. In total, the workforce is reduced by 275 people compared to the end of 2019. This results out of the Transform for Growth program but also on the fixed-term contracts coming to an end and neutral (sic) [ natural ] attrition. So the program is delivering according to plan and gives a good basis for securing the long-term competitiveness of the company. Having a look at our activities in China, also this is on track in the first half year. The unit sales was around 15,000 engines. Revenue are nearly EUR 125 million, and the EBIT contribution for DEUTZ are around EUR 3 million. So you see, this is in a ramp-up phase and developing very nicely with an EBIT margin in the joint venture of 4% to 5% EBIT ratio. For this year, we have planned unit sales of 35,000 to 40,000 engines. Next year, 2022, the target is 80,000 engines. And the capacity we are installing is 200,000 engines, and we assume that we will reach this number within the next year shortly because demand is very high in China. You see some pictures here from the new location in China. So this is developing very nicely. Another topic is -- which is important for us and for our performance is our service business. And looking back into the last year, 2020, the crisis here, also in this year, service performed very well. So we stayed in the crisis flat on the revenue compared to competitors, which had a reduction of around 10%. You see that our measures in the service business are performing. And now in this year, with a better -- much better market environment, the revenue is raising up nearly to 15% new orders, even higher, nearly 20%, and orders on hand is more than 60% higher than last year. So a lot of measures are taken here. For example, lifetime parts warranty and lifecycle solutions are just some examples. And since Q3 2021, the service business is marketed independently under the S-DEUTZ brand. And then a look on the customer side. A very important relationship also coming out of the past is the relationship with AGCO, especially with the Fendt brand. We are delivering since years our 4.1- and 6.1-liter engine to Fendt. And this supply agreement is now prolonged until the end of the decade. Furthermore, we discussed collaboration on future technologies. Here, especially our E-DEUTZ activities are in focus and sub-150 horsepowers. In the past, AGCO was producing these engines completely by themselves. Here, we are checking the possibility of a closer collaboration. And this is, I would say, a normal trend which you see in the industry because the combustion engine is coming more under pressure. So the players in this field are more open to team up. And this gives us also in the future a good opportunity not only in our segment, in the off-road segment, also discussions are going along in the truck environment. So I can say the industry is very open for collaboration, and this gives us an additional possibility to win additional business. Another topic is the supply agreement with ASKO, ASKO a completely new customer to us. We have a supply agreement delivering engines out of our existing plants to ASKO. ASKO is relevant for all our segments. So they are producing engines in the agricultural environment, also construction equipment and for logistic applications. And in the next years, there is also the opportunity to build up a local [indiscernible] with ASKO. We have to see how this develops, but it's the first step to be a supplier to ASKO. Also, we want to use the ASKO network on the service side to be more present in service in Turkey than before. On the technical side, a real highlight is our hydrogen engine, which is now ready for the market. This is based on the 7.8-liter diesel engine and works completely with 100% hydrogen gas and meets all the criterias which are set by the EU for a zero emission or zero-CO2 emission engine. And yes, it's -- we see here a big potential. Also, in connection with applications for fuel cells, we don't see the hydrogen engine as a substitute for fuel cells. We think both technologies have their opportunity in different environments. We will start with this engine in the stationary equipment. A cooperation or a first pilot application is already planned for the next year together with a regional utility partner here around Cologne, and the engine is scheduled to go into full production in 2024. Maybe so far from my side, and I hand over to my colleague, Sebastian Schulte for the numbers.

Thanks, Frank. And also from my side, good morning to all of you for this -- for today's investors and analyst call for the first half '21. Looking at the top line of what we achieved in the past 6 months, and as Dr. Hiller already said, we have a significant increase in new orders, amounting now roughly more than EUR 1 billion in the first 6 months, up by a sharp 65% from the previous comparable period. And we need to mention one thing. Some EUR 100 million out of that, representing roughly 15,000 engines, are sort of an extraordinary effect coming mainly from June. When some customers brought some orders forward in response to price adjustments, we reacted on the market situation, increased prices on 1st of July, and some customers secured some orders on the old prices, which was expected. But also with a particular one customer, we agreed on a new order procedure with longer lead times. And also, as part of our scanning through the portfolio of engines, we decided to discontinue an old engine series. And as you usually do, then you give the customers the opportunity to place their last order. That's what they did, and that explains that 15,000 engines or EUR 100 million orders -- order intake being brought forward. In terms of unit sales, we sold 93,000 units, including some 18,000 units from our Torqeedo business. So that leaves 75,000 DEUTZ engines, significant increase compared to the previous year's period, translating also then into a book-to-bill ratio of 1.34 for the first half. However, if we were to look at the June numbers, that book-to-bill ratio would even be significantly higher, particular in the regions Americas and Asia, where our order backlog now represents quite a long period of time, more than 6 months. So we are -- we have a solid order pipeline ahead of us. In terms of revenue, we increased from EUR 620 million to EUR 770 million half year over half year, 25% up. That's, again, slightly lagging behind the new orders. If you go look at the revenue in a bit more detail, on the left-hand side, we see the regional breakdown. What we see here is pretty much proportional growth across all regions. Obviously, particular in Europe and in Germany, quite a strong recovery. If we compare to the 2020 numbers, these regions were hit more significant by COVID than, for example, Asia. But also, in Asia Pacific as well as Americas, we grew significantly, as I said, across all regions. If you look at the breakdown by application segment, we have only one exception which didn't grow. That was the stationary equipment segment. In all the other applications, we grew. The biggest relative growth rate was material handling with plus some 50%. Biggest absolute growth was in construction agreement (sic) [ equipment ], and we grew by more than EUR 50 million in terms of revenue. And also quite, I think, solid for us is that in the service business, as Frank Hiller pointed out earlier, we closed the first 6 months with EUR 195 million revenue. It's so far very important because, first of all, service wasn't hit that badly last year due to COVID. So growing 50% is good. And also, we have here particularly attractive margins, which backs up our profitability in the medium and long term. In terms of profitability, what we see here is a significant jump particular from Q1 to Q2. Q1, we closed more or less breakeven, 0.2%. Now after -- in the second quarter, we secured EUR 60 million EBIT, 3.7%. So step by step moving further ahead to our target profitability margins. And if we accumulate that over the first half, we come up to EUR 16.8 million or, in relative terms, a margin of 2.2%, coming significantly higher than the negatively -- or heavily impacted H1 2020 of minus 8%. Main reason for this jump is, on the one hand, obviously, the growth in volume of our business with economies of scales, going back to a more healthy level of production. But also, I think that's even more importantly that we see the cost savings coming from implementation of our Transform for Growth programs -- program, now hitting more and more the bottom line in the P&L. But also, one special effect we had in the half -- in the first half last year, we had a particular one supplier which went through an insolvency proceedings. And in order to secure our supply, we had to back them up with payments, and that was the situation which doesn't affect us this year anymore. So that also contributed to that sharp rise in profitability. If you look at some other key figures here, in terms of R&D, the overall expenditure was slightly lower than the prior year period, EUR 46 million down to now EUR 39 million. R&D ratio, down to 5.1% impacted by, on the one hand, a reduction in spending but also the increase in turnover for that period. In terms of capital expenditure on a first glance, down from EUR 89 million to EUR 33.6 million. But if you see there, we're showing separately the effects from IFRS 16. So we take them out because that was particular special situations last year by the extension of some leases and the replacement of expired leases, which then, under IFRS 16 also, we need to show capital expenditures. We take these situations out, more or less stable in terms of CapEx. Working capital in -- the ratio decreased. We showed you the ratio always considering the last 12 months. So it decreased from 18% to 17%. And we see that in the last 6 months, we build up working capital by EUR 10 million, definitely much, much more underproportional to what we grew in revenue. So we'll come later to the cash flow. That's one of the reasons why cash flow was slightly more positive than what we initially expected. But I'd also like to say that if we consider here the revenue of the last 3 months and annualize that, our ratio would be significantly lower, in the range of 14% to 15%. Now -- so here, our -- as we write on that slide, a much more rigorous management of working capital across the group, particularly when it comes to receivable, payables starts to pay off, working capital ratios as well as free cash flow. That's the key point for the next slide here, cash flow. Net financial position had a sharp increase in cash flow from operations by almost EUR 90 million, now to EUR 45 million in H1. And again, where does it come from? Here, obviously, on the -- from the EBITDA development, operational business, as explained before, and that we are now on a much more favorable level of working capital. This translates then also directly into the free cash flow. We have achieved a positive free cash flow with EUR 9.7 million after 6 months, influenced by, as I said, cash flow from operations but also by the slight reduction in investing activities. And that's certainly a positive news that we can, in a growing business environment here, show that we are well in control of our free cash flow and thus also the net financial position, which increased slightly from December 31 to now June 30 mainly because of a slight increase in lease liabilities. Take them out, we have further reduced our net financial position without leasing now to some EUR 23 million debt. So here also, a solid development when it comes to the liquidity. Coming to the equity and funding numbers. So first of all, we are -- we have grown our equity position with some EUR 20 million. The ratio has gone down slightly by 1% but still to a very, very healthy 44% ratio in the total. The balance sheet some -- grew a little bit simply because net working capital increase on asset and liability side lifted up here the balance sheet a little bit. But again, I think with more than 40%, we are, at least in the current business environment, on a very, very healthy level, above our target figure of 40%. When we talk about the financing situation, there's no update here. As you know, we do have 2 major facilities. On the one hand, the syndicated loan facilities of EUR 160 million. You see here in the right part of the chart EUR 160 million, of which we are utilizing currently EUR 65 million. On the other hand, the rather short-term KFW-backed facility of EUR 150 million which we have not utilized and we also do not intend to utilize in the coming months. Long-term bank loans repayment profile, up to 1 year, EUR 10.3 million; 1- to 5-year, EUR 8.4 million. So you see here also no impact expected on our -- or no major impacts expected on our cash flow position. Yes, to sum up, good development in profitability, promising development in cash flow and still a very, very solid balance sheet and financing ratios. And having said that, I would like to hand over back to Frank Hiller. Thank you.

Yes, thank you. Coming to the group guidance for this year, we are confirming the raised full year guidance for 2021, and this despite the challenging supply situation. Unit sales will be on a level of 140,000 to 155,000 DEUTZ engines. The revenue, in between EUR 1.5 billion to EUR 1.6 billion. And EBIT margin before exceptional items, 1% to 2%. On the free cash flow, we have a change. We increased it to a negative low double-digit million euro amount. Previously, it was a low to mid-double-digit million euro amount. And I think this is a really good message because in the old guidance, there was the sale of the Cologne-Deutz side, the installment of the purchase price was included for this year. Now this will be postponed until next year, and this is a number of around plus/minus EUR 60 million. So we really have a very good improvement on the free cash flow side. Talking about the final installment of the purchase price for this Cologne-Deutz side. Unfortunately, the negotiations between the owner of the site now and the city takes a little bit longer, but there is no risk on this topic. So we will have the benefits out of this payment then in the next year. Good so far. And now going to the midterm targets for 2023 and 2024. So we are on a good way to achieve our targets, see it very positive. Revenue above EUR 2 billion. EBIT margin, 7% to 8%. What are the important topics to be technology neutral on be technology approach side and also expand our high-margin service business? Implementation of the regional growth initiatives is in focus, especially Asia and China. And for sure, the systematic implementation of our efficiency program, Transform for Growth, adjusting costs on the staff side, operating costs and optimizing of the global production network and reducing complexity, especially in the product portfolio. This year, we are focusing on our E-DEUTZ activities in -- on -- the midterm target is 5% to 10%. And as said, we are, I would say, on a very good and promising track. Coming to my last page, and this is an important page. So it's a save the date for our Capital Markets Day, which we are planning in -- at November 17 in Stockstadt am Rhein. This is near to Frankfurt in a location, Coreum. This is, I would say, a technology and experience world for construction equipment. And here you can see our new products and services in live performance. I think that could be very interesting for you. And for sure, we will also provide you with the latest data and business development. And it would be a pleasure to meet you there. November 17, please save the date. Yes, maybe so far from our side on the presentation slide. And now we are open for your questions. Thank you very much.

Yes. Thank you, Frank. Operator, please open the line for questions.

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

I'll do them one by one. Can we talk a little bit about the order intake, please? Do you have an idea of the sort of level of aggressiveness of the orders that you're getting in, for instance, from rental chains at the moment, double orders? And perhaps also a first look at current trading. For instance, is your book-to-bill in the third quarter so far above 1 or rather a touch below maybe?

Yes. Thanks for the question. First of all, in terms of aggressiveness, obviously, and I tried to explain that also in the presentation earlier, I mean, 1.3. And if we look at June number, I said it's even higher number. That's not sustainable in the long run until we begin to double our business. So we do expect a decrease in the book-to-bill. And currently, I wouldn't say we are expecting a number very close -- very, very soon going below 1, but certainly going more towards the 1. In terms of sustainability or aggressiveness, we do not expect double bookings here because whenever we book something as order intake, it's a binding order. And it's our full expectation that everything the customers book from us, we will deliver and they will accept. So in that sense, yes, going on current numbers, we are not able to make statements here, and -- but would obviously continue to report on the development in Q3 then as the time comes.

The second question would be on China and the momentum that you're seeing there. Do you have a feel that perhaps the recovery is slowing down to some extent?

Yes. Especially on the truck market, we see some market decrease because -- out of the China VI legislation. So a lot of trucks with the old emission legislation were produced, and they are on stock. And here, we see right now a little dip, and let's see how long this will take. I think some months. But overall, especially on our off-road segment, order intake is stable and it's according to plan.

Yes. Maybe let me add one thing. Rather towards the short term, we have, particular when it comes to the Asian region, a very high book-to-bill ratio. And our order backlog covers here roughly 6 months. So what we -- if we -- we need to observe for the next months, but we do not see here a short-term impact.

Understood. And then the final question would be on price increases. Can you give us an update on how much you've passed so far in terms of price increases and what your plans are going forward?

Well, we are trying to pass over as much as possible or even more, if possible, some cost increases to the customers. But again, we need to keep in mind here that with a lot of customers, we do also have long-term contracts, which is certainly a good thing in the long run. And most of these long-term contracts do include clauses, contract clauses, which include also an adjustment for price increases. So some of the price increases we do expect will have a slight lag in time. So we will really foresee the first measurable impact on the P&L, I expect, the end of Q3, beginning of Q4. But the full impact we expect rather in '22.

And the next question comes from Richard Schramm from HSBC.

My first question refers to the development in compact engines on the operating side. So how would you estimate your incremental margin in this segment here if we look to the quarterly developments in Q1 and Q2? Hello?

Just a second, please.

Oh, sorry.

No problem. So you're referring to the development in our appendix where we came in compact engines from minus 49% to plus 0.3%, is that correct?

Yes. Well, in fact, I look between Q1 and Q2. In Q1, we had minus 6; in Q2, we had a plus of 6 [indiscernible].

Oh, okay. So yes, got you.

And the delta was some 53. So that's, I think, the close development, which should -- reflects your actual cost position, I assume. And if I calculate correctly, the incremental margin would be about 23%, 24%, but I just wanted to check and what you think about the sustainability of this figure here.

Yes. I mean that is what comes out of the calculation. And obviously, the main reason for that between that period of time, this is why I was asking back, in order to better understand where you come from here. But the main reason here is the further ramp-up in production are mainly scale effects particular between Q1 and Q2. We do need to see impacts or sizable impacts on price increases or on cost increases. So it's mainly due to scale effects. But on first glance, your number which you calculated here makes sense to me.

Okay. So the further development, I mean, if we assume kind of seasonal -- normal seasonal pattern, that Q3 is likely to be weaker again during the summer holidays. Then it's fair to assume that also, the risk is there that you'll slip again below the break-even line in that quarter here on the operating side?

In the -- regarding to the small engine, sure, the risk is there. And this is -- as you said, the summer quarter now is affected due to seasonal reasons on our side. In some of our operations but also our regional companies, we do have outages due to vacation. But the same applies to the customers and, quite frankly, particular to some major customers in that small segment. So there is a slight risk that we go below that current level. And this is also why we are still, as Frank said earlier, remaining on the rather cautious outlook for the rest of the year for exactly that reason.

Okay. And then concerning the Other segment. So I was positively surprised to see here that you have achieved a break-even results here in Q2. So I wanted to check if this is also purely operating driven and should be now a sustainable level here going forward. Or was there some special effect which helped here with the improvement?

In Q2, as you said, we are -- in Q2, as you said, we're pretty much breakeven. Now in the Other segment, as you know, that is from the development in Torqeedo here, where particular the June was quite a good month, also not completely unexpected. Here, the Torqeedo business does have a seasonable factor in that. But in Q2, there was no special effect here in that sense, yes, that's correct.

Okay. A final question concerning your R&D spend, where we -- you've seen an absolute decline. I mean a decline in margin is no wonder, but I would have expected that the level would remain. After all, this is only a temporary issue. Or is there a kind of structural effect behind that?

Mr. Schramm, I think this will -- this is now an effect which we have in first half. This will be on a level of the last years for sure. The focus is completely different so -- when we in the last years invested a lot into combustion engines and in new engines. So this is quite limited. We do only development in combustion engines with -- together with partners or on the basis of existing engines where we do a further development. The main goes into, I would say, alternative solutions, our E-DEUTZ activities and for sure also the hydrogen engine.

Yes. That's what I expect, that there are some fields where you have to spend clearly more than in the past year to drive forward your innovative products then. Okay.

There are no further questions at this time. I hand back to Christian Ludwig for closing comments.

Well, thank you very much for your questions. I wish you a happy day, and I hope very much that we'll not only speak for our Q2 results but also see each other at our Capital Market Day in November. Please save the date. We'll go out to you all, and we'll follow up round about in September with a detailed invitation. Until then, all the best and happy week. Bye.

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