DEUTZ Aktiengesellschaft (DEZ) Earnings Call Transcript & Summary

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, and our new Head of Controlling, Mr. Oliver Nord. As usual, Mr. Hiller will walk you through the highlights of our 9-month results. And then Mr. Schulte will say a couple of words on our numbers before we hand over to a Q&A session. Please be aware of the disclosures at the beginning of the presentation, and I also want to point out that the call will be recorded. An audio replay, including your name and your questions will be available for a few months on our IR website. After that time period, it will be deleted due to data protection rules. Without much further ado, I now hand over to Mr. Frank Hiller.

Yes. Ladies and gentlemen, good morning, and a warm welcome to our 9 months figures. I would like to start with an overview of our operational and strategic highlights. First of all, the market is good, willingness to invest remains high from our customer side. This is relevant for all regions and all segments. So, we have double-digit percentage increases in new orders, in unit sales and revenue. Orders on hand have more or less doubled on a level of EUR 0.6 billion. The limitation is not the market. The limitation is the supply chain. I think that goes along with the whole industry. So we have a sharp rise in the EBIT margin before exceptional items. Our restructuring program Transform for Growth, which we have started 18 months ago is paying off and leads also to free cash flow in a positive territory. So we confirm our guidance for 2021 despite the supply chain challenges. We achieved further milestones in our green or less green activities of highway drive solutions. And this is also the next point. We'd like to speak a little bit about hydrogen in this case, especially about our hydrogen engine TCG-7.8 H2. We presented that 2 months ago. And the engine will find its first application in the stationary equipment for power generation, together with the utility -- regional utility company, RheinEnergie And we are really happy because this is a real highlight, and we received very good feedback from the market. And as you can follow other companies are now also following the way of the hydrogen engine. I think this has really a big potential. And the hydrogen engine compliance with the CO2 threshold set by the EU for zero emission. So it's a zero emission engine. We are working hard on this topic in development and preparing production for that. So that we can reach full production in 2024. Also in this circumstances with hydrogen, we are going in a cooperation with the German Aerospace Center, DLR. So the focus here is on making more or less environmental-friendly construction side, means having all the equipment around with CO2 digital approach and also having the relevant infrastructure for this. So this is on the hydrogen engine side. Hydrogen, on the other side, the fuel cell technology is interesting for us. And we went into a strategic partnership with Blue World Technology, a Danish company and developer of fuel cell components and systems, including for stationary applications for the gensets and the automotive sector. the technology of Blue World Technology is based on the reformation of methanol, which is a renewable liquid fuel. And the key aspect of this alliance is, on the one side, and I think that's the most important, to have an exclusive distribution and service agreement, with Blue World Technology for stationary fuel cell generators gives us the opportunity to sell also this technology in the future, and this is combined with a 10% stake in Blue World. This will be completed in quarter 4 this year, so -- after the dilution has taken place. We expect also the fuel cell technology to be important in the off-highway segment for mobile applications in the future. So also this is a step towards CO2 neutral future of the company. Looking at our service business. Service business, as you know, is relevant for us to keep our customers happy, but also on the other side, to increase our profit. And we have defined, already years ago, a clear path to a stronger service business and this really pays off. Here, we have a revenue increase more than 16%; new orders on hand, nearly 19%; new order intake, sorry, more than 18% and orders on hand also a plus of nearly 54%. So we have substantial growth, especially from our parts business. And the target for this year is to reach a turnover of EUR 400 million, which was defined early in last year, and I think we are on a very good way to fulfill this. Coming to China right now is, I would say, all the construction companies. We see a market weakness in China. So far, looking at our JV with SANY, which is the most important activities. Activities are running well. Unit sales is on a level of more than 18,000 engines so far. Revenue, nearly EUR 160 million and also positive EBIT contribution to our results of EUR 1.5 million. But for sure, as you know it also from the newspapers, there are some effects, which more or less cools the market down also by political reasons, temporary power outages is one big topic. The other thing is coronavirus. They still have challenges on that and take quite serious measures with lockdowns -- regional lockdowns. So also, this is influencing activity property market, as you know. And right now, we have also the effects by the new emission legislation in China, China 6, which was introduced mid of the year. And for sure, there is still some stock level on old trucks, which more or less reduce the demand so far. So we see this as a, I would say, a temporary effect normally in China, downturns and upturns are quite sharp. We estimate that this might go on for 6 months, maybe 12 months, but we are also prepared for a market increase in China. And what I would like to point out is that there is no effect on our guidance for this year. [indiscernible] and we see also no effect on the midterm guidance on our top line to reach more than EUR 2 billion turnover '23, '24 and to reach our EBIT margin of 7% to 8%. Maybe so far from my side, and I would like now to hand over to Sebastian Schulte.

Thank you, Frank, and good morning, good day also from my side to our 9 months results call '21. If we start with the top line, looking at the top line results, the first 3 quarters. We see, as already stated before, a significant increase in new orders from EUR 933 million in the previous year 9 months to 1.5%, slightly over 1.5%, so increasing by more than 60%. All aspect to mention here is that we do have -- or we did read to record some positive effects, particularly September and June, more than EUR 100 million coming from certain customers, bringing forward their orders almost for a year, mainly in the U.S. as it responds to longer lead times, in particular and some price adjustments. We see also on the unit sales, an increase by 34%, including Torqeedo engines. So if we take out the Torqeedo engines, the increase is even slightly higher, 38%. So our unit sales in the first 3 quarters saw some 145,000 units. And on the revenue side were increased by 26% to EUR 1.17 billion. What you see is then, first of all, book-to-bill is 1.3, still a very high ratio. And looking at our regional distribution, this is even higher in APAC and Americas. So in some of these regions, we do see that the order backlog covers more than 30, sometimes even 40 weeks of business going forward. What you also see is a slightly higher rise in unit sales than in revenue. That is due to the fact that we do observe a shift in the product mix towards smaller engines, the engines with a capacity of less than 4 liters. That explains the slight deviation in the growth path here, and orders on hand or the backlog more than doubled now. If we compare it with the previous period, we're now on a level of EUR 660 million, which is significant number of order backlog and gives, again, a certainty of the business volume going forward, explaining then the high order of backlog coverage. To move on, still continuing with the top line. Looking, first of all, on the left-hand side, the breakdown revenue by region. So we see significant increase pretty much in all regions led by Germany, 32%; followed by Americas, 30%; and then on par, Europe without Germany as well as Asia Pacific and lagging a little bit behind the relatively small market, Africa and Middle East. But as stated before, particularly with Americas and Asia Pacific without the supply chain challenges and shortages, we would have grown more in revenue in those regions because a lot of that is going toward backlog. On the right side, we'll see the revenue breakdown by our application segments. And this is clearly led here the increase by the material handling business, 71% increase compared to previous period, but also in other construction equipment, 32%, agricultural, 21%; and services mentioned by Frank Hiller earlier growing by 16%, but we have to keep in mind that the drop in service revenue in the last year also wasn't nearly as high as in the new engine. So in total, we can see here that we have a significant increase, mostly double digit across all regions and across all application segments we serve. Moving on to the bottom line. We do see a continued improvement in our earnings structure here in our earnings. If you compare it with the previous period, we are now after 3 quarters by some EUR 31 million EBIT -- well, we recorded the same period last year, a high loss of [ EUR 66 million ] due to the situation we had in '20. And what contributed to this increase, well, obviously, the increased volume of business, as just stated, we were benefiting here from economies of scale, but also it goes hand-in-hand with the cost savings as a result of our implementation of the program -- the efficiency program Transform for Growth. And last but not least, last year, 2020 was also negatively impacted by suppliers, particularly in the casting business, where we had to support them in order to secure our contributions from them. So summing up. Now we are -- we have achieved 2.6% after 9 months. You see on the left side that Q2 and Q3 was in the range of 3.7%, 3.5%. So Q3 was slightly lagging behind Q2, that's also due to a slight decrease in revenue because in Q3, perhaps the summer months, which proved to be some -- a little bit of a seasonal effect due to holiday on our holidays and not only on our side but also on the customer side. Net income before exceptional items was EUR 26.8 million, leading to an EPS before exceptional items of EUR 0.22. Moving on to some selected key figures. We see here on R&D slight decrease in R&D expenditure, EUR 66 million to EUR 59 million on the percentage of sales. The decrease is obviously higher because of sales have gone up significantly in this period compared to the previous one. Also on CapEx, we've gone down a little bit, but we had quite a high level still in '22, which, at that point, had been boosted up by the extension of leases and replacement of expired leases. So the whole subject of IFRS 16 looking on the -- if you take that out, we're like some EUR 3 million lower than on the previous year. And just I think a very good news is working capital. Well, it decreased by 11%. However, we increased business significantly. So we were seeing here that the ratio has gone down from 80% of December 31, now to 78% and the ratio is decrease is influenced significantly due to quite a rigorous management on the working capital side, mainly on in receivables and payables where we are implementing a much, much stronger global management on that. And we'll see later that helped us both in terms of cash flow. Cash conversion cycle has been reduced significantly over the past 9 months. Bringing me to cash flow and net financial position, we do see here a sharp rise in cash flow, starting with cash flow from operating activities, plus EUR 87 billion, now at EUR 68 billion in the first 3 quarters, well, obviously driven by the earnings performance improvement and the earlier mentioned net working capital management across the group. We'll now look at free cash flow. We see also a significant increase because by what I just said or have you reflected the slight reduction in CapEx as well. So we are now positive after the first 3 quarters by EUR 15 million, which again is positive news. And in that sense, net financial position stayed more or less constant particular as lease liabilities have gone up a little bit if we take them out, we managed to further reduce net financial position by some [ EUR 75 million ]. Finally, moving on from the balance sheet structure as well as the financing overview. And first of all, equity, equity ratio remains at a very comfortable level. We are above 45%, and that's what we currently have defined as our target numbers. So we were well on track. On the credit financing side, we informed earlier this year, that we had managed to early retire the credit line, KfW, that is the German state support facility. So we managed to return that credit line of EUR 150 million, which was gone up to us as a support during the covid crisis. So we retired that ahead of schedule and secured with other banks, bilateral lines of showing up to EUR 75 million. This means now we are -- we will remain to have unused facilities totaling EUR 200 million are available summing up from the EUR 75 million bilateral lines as well as the existing EUR 160 million from them, which has still term until June 24. And you see here on the chart in the middle that currently out of that, some $235 million available lines we are utilizing only EUR 35 million. On a long-term bank loans, minor numbers, what -- in terms of repayment profile, EUR 10 million within 12 months, EUR 6 million within 5 years on top. So summing up, we are well positioned here. We have a very solid and healthy structure on both balance sheet and financing situation. In that sense, thanks for your attention. I would hand back to Frank Hiller for the outlook going forward.

Yes, ladies and gentlemen, coming to our guidance for the year 2021 and also midterm target 2023 and 2024. In September 13, we raised our guidance to unit sales of 155 million to 170 million [ Indiscernible ] engine revenue of EUR 1.6 billion to EUR 1.7 billion EBIT margin, 2% to 3% and free cash flow breakeven. We are confirming this, and we are also confirming our midterm targets for '23 and '24. And this despite of difficulties in supply chain, which we will see and we are convinced which you will see the challenges also next year, especially in the first half of next year and the temporary downturn in China. Maybe so far from our side, and we are open for your questions. Thank you.

Already, yes, would you please open the line for questions.

[Operator Instructions] The first question is from the line of Jorge González Sadornil from Hauck & Aufhäuser.

I first would like to ask about the joint venture with SANY. The production target for the inventory that was published in the Q4 was 80,000 in 2022, if I remember well. Can you please update on us on this estimate, taking into account the current new environment? And my second question will be also related to this. I have the impression that you have slightly adjusted the way you have given the EBIT contribution for this unit. Can you give us a reference for the adjusted EBIT that you expect coming from China this year? And maybe from next year? And finally, I think that at this time, you are producing mostly engines for trucks, the production -- the growth of production expected for next year was also coming from truck engine production? Or you were also going to deploy lines for other type of engines?

Yes. Thank you very much. Maybe I'll start China. The situation right now is that we have reached this -- in the GB, 18,300 engines. And so far, our joint venture activities with SANY is very much related to truck engines. Now, since -- especially since October, we have really a sharp downturn because of the outages of power and also the stock level of old trucks with the old emission legislation. So I think this will take maybe 6 months to come back on a demand level, and we are right now in the phase of reviewing what this means on volume next year. So the intention in the past with a stable market was to reach 80,000 next year, all with our activities. This will not happen right now, and we are reviewing the numbers. The EBIT effect will be limited and also the performance, the EBIT performance so far of the JV is above our expectations.

I mean if I may continue, and if I understood your question correctly, you also wanted to understand if -- what is the EBIT contribution we have. And if we changed our method of accounting for that. So to the latter, the answer is no. We account for the SANY joint venture or joint venture with SANY according to the equity method. So what we show in our accounts, and you saw it earlier on the presentation when Frank Hiller showed his outlook in China, the first 3 quarters, the share of this joint venture, of this profit, of this equity accounted investment was EUR 1.5 million. And it comes from the net income from the joint venture. Say earnings after tax and then reduced by PPA effect in our accounting. So 1.5% is the results we've seen in the last 9 months.

Sebastian, sorry. So for the previous quarter, you commented that the contribution was EUR 3 million and now it's EUR 1 million. This is because of the PPA then. Can you give them as a guidance of the PPA for the full year, please?

Yes, the PPA is in the range of EUR 0.3 million per quarter, so full year roughly EUR 1 million, a little more, a little more, but on the range. So a small effect.

Next question is from the line of Charlotte Friedrichs from Berenberg.

Three, if I may, also starting with your China joint venture. So is it correct to look at it this way that you have maybe a run rate of 3,000 to 4,000 engines per quarter now for the next 6, 12 months and then an improvement thereafter, but you're not quite sure about how big that improvement will be at the moment? The second question would be around the supply chain. Can you give us an update where you are now in terms of cumulative price increases and when you think that you will basically balance out with raw material price increases here? And then thirdly, on cost savings, can you not give us an update on where you are now as of 9 months 2021, what the expectation is for the full year this year and then the years after?

Maybe I'll start with SANY, the activities. Right now, you have to assume that the factory in planning, the truck production is completely shut down by these power outages. And this is more or less the situation which you find in the whole industry. In some cases, they really have reduced the power distribution by 100%, yes. They completely shut down the activities. So it's -- right now, it's difficult to say how long this will last and what will be the impact on the figures. So we are right now in the phase of reevaluating this. In an overall view, we are absolutely convinced that this will come back then later on even stronger because our addressable market with our products is 40% of this is China. And also the second topic you raised, supply chain. I think also here, China helps us because this gives us the opportunity for a second source. And for sure, we have increases on the cost side, on the supply chain. But right now, it's also the time to pass this to our customers. And for sure, nobody wants to have higher prices and higher costs, but there is a clear understanding also of our customers that additional raw material prices and other effects have to be passed through.

And following up with your third question regarding the progress of the efficiency program, Charlotte, you know that in 2020, we had the range EUR 12 million to EUR 15 million bucket of cost savings. And in '21, in the total of full year, we're pitching somewhere between EUR 35 million and EUR 40 million right now. And after 9 months, we are in the high 20s of what we have achieved. The majority of that effect relates to staff costs on the one hand, that was the reduction in particular, overhead due to this redundancy -- voluntary redundancy program, where we reported in the past on that we have achieved our target numbers. But this also includes financial effects across the operations across the company in Germany, at least, due to the agreements we had reached between company the Works Council and the unions regarding the collective bargaining agreement. There were some voluntary contributions by the employees, which we're utilizing and obviously, which is contributing to the numbers. So we are on track towards that EUR 35 million to EUR 40 million for the full year in the high 20s what we achieved so far.

Understood. One follow-up on the supply chain and pricing situation. If you add together all of the price increases that you've passed so far, where are you now? And are you planning any additional ones?

Yes. We are in permanent discussions. And for sure, looking at our contracts. There are some regulations inside if there are extraordinary effects, we have to discuss it and so we are in permanent discussion with our customer. And this is not only a discussion of price increases by higher costs, this is also a discussion of the volume they need for sure. The whole industry is short and also there, I would say, is a good lever for us. We can only serve our customers in a good way if we have prices on a level which cover the additional costs on the supply chain side. So the ongoing discussion, and I can tell you, sales colleagues, they are really very busy with customers about supply situation about price situation. So this goes hand-in-hand.

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

So I'm -- I have to come back to this last topic of the increasing prices to compensate higher costs you have. So if I understood you correctly, there is no automatism in your contracts that you can pass on at least a certain portion of material prices to your customers as some other companies can do obviously is a kind of price escalation gross, so you have to negotiate, obviously, your contracts one by one. Is that correct? And -- or do you have a certain kind of list price increase, which apply for, let's say, next quarter or so, which is then generally valid for all customers. Can you explain a bit how this process runs?

It's not really that there is no automatism at all. It's a mixed picture. We do have certain contracts which do have price escalation formulas, but there are other contracts which are not completely modeled, too. In the end, it's -- as Frank said, it's a combination of, on the one hand, applying these formulas where they exist, but on the other hand, also taking account for extraordinary effects coming from supply chain at the moment. And that's why it's really not an automatism for the entire portfolio but a combination of automatic application of formulas as well as discussions and negotiations on top.

Okay. So this suggests that there is quite obviously then a time lag. You have to bear to -- until you have a compensation by higher prices from your customers, right? So can you give us an idea how big this gap is you have to bridge for the current year?

It's correct. There is a gap. There is a gap on the customer side. There's also a gap on the supply side because we have similar structures in place with our suppliers. And so if you remember our statements on the book-to-bill and on the order coverage, you obviously see also different gaps in different -- with different customers in different regions. So what we can see, what we can certainly see is, we did a major initiative around the first half of the year. and we're beginning to see the effects now on both sides, supply as well as on the customer side in our P&L. But it's not -- it's not the same, let's say, 3 months or 5 months across the board, you'll have some going earlier and you have some going later.

And Mr. Schramm, we know, I think this circumstances quite well out of the past. And we are starting discussions with our customers also in times when prices on the supply chain side are still on the same level. But we see that price increases are upcoming. So we do quite of front loading on this also in the discussion with our customers. So the time lag in between, I think, will not be that significant. Maybe to make it clear, the discussions about cost and price increases have already started at the beginning of this year.

Okay. And just a quick follow-up on the order side. I think we discussed this already last time, the visibility there, if there are double bookings in orders or not because customers might fear that there is a shortage of supplies, and they might order in excess of what they actually need. Do you think there is some activity like this going on there? Or can you rule that out?

Yes, good point, and we use are very cautious here. So the orders on hand could be much higher than what we are showing right now, taking all possible orders in. But the limitation right now is more or less our capacity. So we don't think that there are double bookings inside so far. We'll see how this goes on. Right now, we are convinced that the whole next year will be a year where the market will not be a problem, where more or less limitation on the capacity side, especially on the supplier side will be the challenge. So we don't see really restrictions also for next year, not from the market side, challenges on the supply chain side.

We have a follow-up question from Jorge González Sadornil.

I would like to ask again -- I'm sorry about that, the joint venture with SANY. Can you give us an indication of the -- that you expect to -- the EBIT contribution that you expect from the joint venture taking into account the production, you are now estimated for this year, the 22,000. And regarding next year, although you have already commented that you are evaluating the situation. Can you confirm if you still plan to deploy new lines for the -- for producing engines for off-highway type of machinery? Or if you are also thinking about this and evaluating the plan also in this sense?

We are doing in this plant, engines for on as well as for off-highway. And I can tell you that the collaboration with SANY is very strong, and they are putting more and more orders to the joint venture, also more which was planned in the past. Talking about the EBIT development. So for this year, more or less, it was planned to -- in the original business planning. -- to have a neutral EBIT margin more or less a breakeven result. This is so far still better. And also last year, we performed much better. In the long run, the EBIT margin for China is also planned on this level of our company target of 7% to 8%. This -- the target is to -- or the original planning was to reach this in 2003 -- '23, '24, and we are still convinced that will work because the -- now the downturn, we see this really just for limited time. And this is such a sharp downturn that there -- we are convinced that they will be within some months, also, a sharp upturn.

We have a follow-up question from Charlotte Friedrichs.

Thank you. Two questions. The first one on the supply chain. Are you seeing any indications that the supply situation is starting to get better already? Or is it rather the case that it is still hard to tell no clear signs in any particular direction?

September was a very, very challenging month for us. Now October, went much, much better. But it's -- I would say, it's still not really stable. And the biggest impact comes from semiconductors, for sure. And we are here convinced that this would be also a shortage going into the next half year or first half year of 2022. But what we have seen now in October is that it has become much more better. But it's too early to say if this will go in this direction because it's still a little bit unstable. We are with a lot of suppliers, especially on the electronic side, in daily discussions and about the logistic chain and so on. It's still not really stable.

Understood. The second question is a bit more general. So if you look at your non-dealer portfolio, with the current setup that you had, where would you like to strengthen that, for instance, through further M&A or partnerships? Are you happy with what you have at the moment? Or are there still perhaps some white spots that you want to fill?

I think the general development will go very much into CO2-neutral application. So what we really focus on is our hydrogen activities. You have seen that the minority share acquisition of Blue World Technology and also electrification. We have next week, our Capital Market Day. I hope to see you all there. And you will see that there will be a real focus on, I would say, green technology, because we are convinced that this will even more speed up in the future and that we are really in a leading role there. So looking charts at the hydrogen engine, I think the feedback from the market was enormous. And I'm really happy to see that also other companies are taking now this direction. This helps us to also generate a good supply base for hydrogen engines. The good thing is for this hydrogen engine, we have already capacities here, but there have to be some new development on the supplier side for injection systems and so on. And it's much more interesting for the supply base. It's not only one company is following this way if other companies are also going in this direction. So talking about acquisition and where we spend our money on R&D in the future is more or less all goes into the direction of sustainable drives. For sure, we have also to make the existing classical, I would say, classical drivetrains and combustion engines also in the future clean up. This will be also a topic but -- It's very much related to technology.

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

Well, thank you very much for your participation and your questions. If there should be any questions left open, please contact myself or the IR department. And as Mr. Hiller said, we hope to see as many sales people at our Capital Market Days. And if we don't see you there, we'll talk to you at the latest with our full year results in March next year. Thank you so much, and goodbye.