DSM-Firmenich AG (DSFIR) Earnings Call Transcript & Summary

Good afternoon, and thank you for joining us today for our half year 2022 results webcast. I'm tempted to say welcome back, with the merger announcement end of May, the Capital Markets Day in Paris mid-June, we've demanded a lot of your time already. Today, we can keep it light as there is no news on the merger, and that means for legal compliance reasons that we won't talk about it today, nor take questions about it. Once we have published the offering circular together with Firmenich, which is foreseen for the fourth quarter, we have something to talk about again. So today, it's all about the first half results. Geraldine and Dimitri will give a short introduction by running you through a few slides of the presentation to investors, which we published this morning together with the half year press release, which you both can find on the website as usual. Here, you will also find the disclaimers about forward-looking statements made in this webcast. After these introductions, we will open the line for questions as usual. And we have planned today an hour for this webcast. So with that, let me give the floor to Geraldine.

Thank you, Dave, and hello, everyone, from me as well. I have to say it was really nice to see so many of you in person recently, given all of our transformational announcement. But indeed, today, it's all about the half year results. So I will start by running through a few slides with the key financials and the performance highlights. Then I'll hand over to Dimitri. He will run through our core ESG performance, and then we'll open for the Q&A. So let's get started. And if we go to Slide 2 of the presentation, which is our quote. Now, of course, in this quote, we do make reference to the important moments on our transformation journey that took place during the last 6 months, not only, of course, the announcement of the intended merger with Firmenich, but also the divestment of DSM Engineering Materials and Protective Materials that took place during the first half. Now I'm mentioning this because as we've announced these divestments, they are now reported entirely as asset held for sale in the balance sheet. So a word of warning, the balance sheet is not easy to read because the year-end comparators include everything, and the June balance sheet actually bundles that into asset held for sales. And also when it comes to the income statement, this is all reported under discontinued operations. So our comments on the call will be predominantly focusing on Health, Nutrition & Bioscience, the core of DSM continuing activities. But I would just like to say, nonetheless, right now, that our Materials businesses did have a good half of the year with double-digit organic growth and with a step-up in EBITDA versus a high performance last year. So all is good on Materials as well. Now going to the next slide. Here is the slide that summarizes the performance for the first half and Q2 of our Health, Nutrition & Bioscience activities. Now HNB delivered a good half year with, as you can see, a top line growth, organic growth of 10% and an EBITDA up 7%. Now this was on the back of resilient demand throughout the market, throughout the 6 months, and as well strong pricing showing that we are able to counter inflation albeit sometimes with a bit of a time delay. Now looking at Q2, we have seen broadly similar conditions in Q2 versus Q1. And you see there a double-digit organic sales growth, also with strong pricing offset and inflation. Now when it comes to volume developments in the first half, what we are seeing is a good market demand, resilient demand throughout the 6 months. Although in Q2, Animal Nutrition volumes did suffer somewhat from the COVID lockdowns in China, and I'll come back to that in a second. And we also saw some supply chain constraints resulting in order backlogs for HNC and for F&B. Having said that, the conditions during the quarter actually got better. We saw an acceleration in Q2 with June having stronger volume and pricing momentum going into Q3. Now let me pause for a second as well on the step-up in EBITDA for the second quarter. You see an adjusted EBITDA up 5%. That includes 1% from M&A, from acquisitions, and 6% from foreign exchange. But please also note that, that 5% does reflect shortfalls related to these items I just mentioned. So if you think of the COVID lockdowns in China for Animal Nutrition, that's about a 3% impact. The order backlog in HNC and F&B, probably about 1%. And the time lag between costs rising and our ability to get the full impact of pricing adjustments through, probably about 3% to 4% for the quarter. Now lastly, looking at this slide, the margins. So you see that we closed H1 at 19.5%. Adjusted EBITDA margin, 19.3% in Q2, so quite similar. Now in both cases, these margins reflect the dilutive mathematical effect of the inflationary environment with the top line, of course, reflecting a lot of pricing adjustment to offset the rising costs, and we've calculated that dilutive effect at about 160 basis points for Q2 and for H1, which means if you back that out, we're actually pretty close to the 21% that you're used to seeing for these businesses. So that is the aggregate financial highlights. Now if we go to Slide 4. As you know, from the 1st of January, we've started reporting our businesses in this format with the 3 business units, Animal Nutrition & Health; Health, Nutrition & Care and Food & Beverage. Now as you can see on this slide, all 3 business growths actually contributed very nicely to the organic top line growth, whether it be double-digit or high single digit in H1 and in Q2. Now if we go to Animal Nutrition, let me give you a little bit more color on the performance for the first 6 months. So maybe first comment here, a good half year, as you can see, with double-digit organic growth. And what we have seen in terms of pricing is that the strong pricing that we had in Q1 continued in Q2, showing our ability to counter the rise in costs and -- through our pricing actions. Now when we look at volumes, we saw consumer demand for animal protein remaining good. Now having said that, of course, China did have an impact with the COVID-19 lockdowns, and we've quantified that at about 3%. So where you see a 0% volume for Q2, that would have been 3%, if we just normalize for effectively the fact that there was very little out-of-home consumption and that did have quite an impact on the quarter. We also saw some impact from destocking. You may remember that it began in Q1. It was lesser in Q2, and we saw that destocking fade throughout the quarter towards the end. Now a couple of comments on species. We saw the demand for poultry, which, as you know, is a stronghold for us, and be very strong, actually across all regions. We also saw good performance in beef in agriculture during the half year. Now when it comes to pork on the other hand, of course, the demand was a bit lower, also linked to this out-of-home consumption in China. Now we also saw, during the half year, that there was actually a very resilient demand for meats, which also meant a good demand for our products with the inclusion rates of our essential ingredients being very robust because they're actually essential for the life of the animals. And we also saw continued good demand for our performance solutions and especially the feed enzymes. Now at the bottom there, you have a few logos, and I'd like to say a few words about the progress on our innovations. Now firstly, of course, Bovaer, a lot of positive news. Firstly, the approvals. As you know, we had the very important approval in the EU for Bovaer, but also in other geographies like Argentina and Switzerland. So that is going very well. It has led to the launch of a number of large-scale pilots with many farms such as in the Netherlands with FrieslandCampina with about 200 farms and with other customers, such as Arla, et cetera. We also signed during this period, an agreement with Elanco, the world's largest animal health company, a licensing agreement that will enable Elanco to develop, manufacture and commercialize Bovaer in the U.S. market, effectively accelerating the reach of Bovaer to as many animals as possible as quickly as possible, which is pretty critical as well from a climate change point of view. Now when it comes to Veramaris, we are seeing a continued demand for sustainable fully produced salmon on high-end omega-3. We also saw a growing interest for the new areas of pet food and human nutrition. And when it comes to Sustell, our environmental measuring platform, Sustell has been extended to aquaculture, which is very good. And you may have noticed as well that we closed an acquisition in Brazil that will support our precision animal feed business in Brazil, combining a data-driven business model to the animal business in Brazil. So these were a few highlights on Animal Nutrition. Now if we go to HNC on the next slide. So as you see here, also a good half year with 9% organic growth. And we saw the business conditions in Q1 basically continue into Q2. So quite similar with good demand across all segments. We have seen the pricing initiatives that began in Q1 accelerate in Q2, as you can see there, and the pricing supporting the 7% organic growth in Q2. Now volumes were a bit impacted in the second quarter by some reduced availability of some raw materials, which has created some order backlogs but we have seen that actually easing towards the end of Q2 and into Q3. So we have a better momentum into Q3 on that. Now regarding a few of the subsegments of HNC. When it comes to dietary supplements, we saw a good performance, especially considering the high performance, the high level last year related to immunity optimizing products on the back of COVID-19, and this was, amongst others, supported by very strong performance by health. When it comes to early life nutrition performance, it continues to progress actually in line with improving market conditions, especially in Europe, where we had some additional demand linked to the North America market. We've also seen that with these improving market conditions, we are seeing more interest in the launch of innovative products that include HMO. And importantly, we've made great progress actually on the regulatory journey to get HMOs approved for China. And we have a good hope that we could obtain this actually maybe as quickly as by the end of this year. As for the remaining segments, they all performed well, being pharma and medical nutrition, PCA and biomedical. So good performances across the board. As for innovation, well, actually, it was a rich 6 months, and we have here a few examples of that. We, for example, have obtained approval for ampli-D in Brazil. If you remember, that's the metabolite of vitamin D that accelerates the immunity enhancement. And there's a lot of customer interest for ampli-D in Brazil on the back of this approval. We also saw Culturelle launched quite a few products, including actually a line of gummies for children that include some health ingredients like Lutein for i-Health, which has been a great success. We've also introduced during the half year, the world's first ever fully bio-based vitamin A, which is a very big technical achievement, and this fully bio-based vitamin A will go at first for PCA, but will have a broader application over time. And last but not least, in our examples, Hologram Sciences is doing well. It is -- it has launched a new brand called Phenology. It is about menopause management and it includes at-home diagnostics, it includes hormone tracking and also wellness programs that combine all of that. So we're seeing a nice development of that entity that we created to accelerate personalized nutrition at DSM. So those were the highlights for HNC. And if we go now to Food & Beverage on this next slide, indeed, here, actually, quite a similar picture to HNC in the sense that we saw continuing good conditions from Q1 into Q2. And as you can see, 10% organic growth across the period. Now we've also seen an acceleration of the pricing actions going from Q1 to Q2, which was good to see. Now when it comes to the segments, good demand pretty much across all segments with, of course, a continued strong demand on plant-based alternatives, plant-based proteins and on pet food, while we've seen, so far, limited down-trading on packaged foods. Now when it comes to the volumes in Q2, they're a little bit low, and that is also to do with availability of sourced materials that has created as in HNC, a bit of an order backlog but we have seen here as well some easing towards the end of the quarter and into Q3. Now as to the innovations, here, we're making very nice progress. We would like to highlight, in particular, that combining Vestkorn and CanolaPRO has enabled us to develop nice capabilities that is so key to this very growth segments of plant-based alternatives, and we're seeing progressively increased interest in the fermented stevia, EverSweet, that is within the JV Avansya. So those were the key highlights when it comes to the business performance. Now a couple of quick comments on the financials, so down one slide. I just want to comment to the fact that the working capital is on the high side. There is no doubt about that. Now this is basically, in part, by design. As you will have heard everywhere, supply chains are still a challenge, and therefore, we are prioritizing being able to deliver to customers rather than inventory levels. But we also see that the balance sheet has become a bit heavier because of foreign exchange, because of inflation into -- built into the balance sheet and that is reflected in the figures here. And if we drop down to the next slide, this has resulted in effect in a very limited cash generation in the first half, which is a reflection of the strong balance sheet, but also actually a bit higher CapEx in line with our level of prepandemic. So nothing out of whack, but a bit higher than we have seen during 2020 and 2021 when, of course, some of the projects were a bit delayed and postponed. Also, we're flagging here, confirming that an interim dividend is confirmed at EUR 0.93 as the interim amount, which is broadly in line with what we normally do as an interim dividend. So to wrap up on this section before I hand over to Dimitri. I think we can summarize that the first half for HNB has been a good half and that we've been able to deliver a good performance despite what are, of course, challenging macroeconomic environments. We have managed to have effective pricing to counter the rising costs, and we have seen underlying demand remained nicely resilient. And the softness in volumes is really only related to what are effectively temporary factors that have eased by the end of Q2 and into Q3. So on that basis, we have retained our outlook as being unchanged, and that is a high single-digit EBITDA growth for the year for HNB, supported by the resilient market demand, supported by the positive pricing momentum and foreign exchange. And with that, over to you, Dimitri.

Yes. Thank you, Geraldine, and also a warm welcome from my side. Literally, a warm welcome if you are at the European continent in terms of temperature. But after a lot of profit information, you know that we are a people, planet, profit company just to complete the dimensions of our company. A little bit around the planet dimensions, also there, I think, an incredible news to tell. First of all, we have launched several initiatives from improving our own sites to introducing greenhouse gas emission reduction, not only from ourselves, but also with suppliers, and I'll come back to that in a minute. We also have committed ourselves to a new renewable energy target of 100% in 2030. Remember that we started the journey in 2018, and I still remember that. We were at 3%, and we were preparing a road map to improve our renewable energy timing. In the current environment where energy is somewhere at risk, I think, could you imagine that we have started already in 2018 with 3%. Today, we are at 77%, and we have a road map all clarified per site per machine per equipment to move that into renewable energy with the full 100%. And I think that is something where we feel really proud about. Then we've also looked at our Scope 1 and 2 emissions, also something which was a journey, a journey going forward, which was based on the science-based targets initiative. So these are not just numbers. Those are validated numbers. We have had a road map, which initially started with 30%. We found ways in implementation execution towards 50%. And we made so much progress that we now feel that we can move it up to 59%, which is nicely in line with the 1.5-degree commitment as the -- at the COP 21 in Paris. We should see official validation results later this year because this will also be validated by the science-based target initiative. So these are not only our numbers in our plan, but we also ask external companies to validate that. Finally, we are working to move from a relatively Scope 3 intense target towards an absolute reduction target. That creates more transparency, is easier to follow, and that is what we're currently working on and more of that to become available in 2023. So that is in terms of planet, then let's move to the slide on people, people, planet, profit also here. Our employee engagement, 76%. We also do pulse surveys throughout the year. And I can tell you that our people are as much engaged as we've ever seen, although I think the difficult environment would expect, people maybe to drop off, but certainly not in DSM. I think we'll see during the pulse survey that we are still having huge engagement within our company, something to be proud of. Then on safety and also on diversity, I think we're making progress. I think the target on safety is below 0.20. That will be absolutely leading in our industry. And we have the first half of 0.27, but we have all the road maps there and behavior sessions there to bring it into a really leading 0.20 frequency index. And then on diversity, it's always high. We're basically looking at female executives, one of our targets. Obviously, we look at diversity in a far more broader lens. But this is something which we made very transparent with you. And we are making progress on that target as well. So overall, on planet and also on people, being a people, planet, profit company, we are making progress, and we're also willing to make progress and be very transparent on our ambitions and targets on that. With that, maybe let's move to Dave to open the Q&A.

Yes. Thank you very much, Dimitri. Indeed, time for Q&A. [Operator Instructions] As I said at the introduction, we can't take today any questions on the merger. And I think when I see a signal, yes, I think we already can start. So operator, I think we can go for the first question.

Our first question will come from the line of Matthew Yates from Bank of America.

A couple of questions then, please. You referenced some of the supply chain challenges that constrained your growth and left some unfilled backlog on the human side. Can you just elaborate a little bit what those raw materials were that you were missing and how that's been resolved? And then maybe particularly for Geraldine, just on the guidance. Your guidance is in reported currency rather than constant currency. Just trying to get a sense of how incrementally favorable the move we've had in exchange rates this year has been for you? And if you wouldn't mind just reminding me the difference between translation and transaction exposure across the business?

Dimitri, do you want to start with the raw materials and then I'll do the FX.

Yes, let's do that. Thanks for that question. So indeed, first of all, it was not only raw material elements. It's a continuous battle to get product and customers being delivered and also having our suppliers delivering to us. I think we have been so far pretty successful in doing that. In Q2, what we have seen in COVID in China is that a few of our sites were only allowed to run at half capacity or maybe at reduced capacity. We have people camping on site because of the travel restriction because of COVID. It shows a little bit about the engagement in itself. By the way, we've now seen throughout Q2 and into Q3, that there is a bit of relief there. I think China is opening up. But hey, I mean, it's very difficult to forecast how that will look like for the second half of the year. But that has relieved a little bit. Just to give you an example, I'm not going to go through all of them, but an important example has been our vitamin C production in Dalry in Scotland, where we are depending on raw materials to supply and to produce the vitamin C. We have operated at rates even below 50% for a certain amount of time. That has been resolved because, obviously, we're working on supply chains on several fronts. So we are back at 100% capacity production rates at Dalry. But just as an example, what has hit quarter 2 for us.

Thank you, Dimitri. Let me come to the foreign exchange. So indeed, we do not report at constant currency. We include it all. So when you look at the first half, let me start there, maybe from an FX point of view. You may remember that for H1, we had about a EUR 10 million benefit from foreign exchange. In the second quarter, we had about EUR 23 million, and that's about 6%. So if I average out, it's about 4% on H1. Now when we are looking at our outlook, so it does include the foreign exchange. And really, if you look at the different moving parts, what we're seeing going into H2 is a somewhat smaller contribution from M&A. It was 1% in the first half. It will probably be 0.5% simply because of the timing of First Choice that was already in from -- for 1 quarter last year. We also would expect the FX to be a little bit lower going forward. And then we are seeing this normalization of volumes that we talked about in Q2, the lockdowns, what Dimitri was just referring to. So that's the buildup for the outlook. And then when it comes to translation and transaction, so what we give as a rule of thumb for exposure is an exposure in Swiss franc of about EUR 700 million. And now on continuing operations, we have to be a bit careful here. It's about EUR 1 billion on the U.S. dollar. Now we hedge transactional exposure, not translation. And it doesn't really economically make a lot of sense to hedge translation. And there are some currencies that we don't hedge like the Brazilian real, which has had at times some impact as well. So what we are seeing is, of course, that overall, the euro is somewhat weak versus probably the basket of currencies for us at present.

And the next question is from Martin Roediger.

Firstly, on the cash flow. I remember that in Q1, you still had a cash flow guidance of adjusted net operating free cash flow to increase. I guess this is not anymore the case after the first half with zero net operating free cash flow. Can you talk about your expectation now for the free cash flow and primary -- well, the continuing operations there? And secondly, on the gas availability in Europe, I know you are not an energy-intense company, but can you talk about, a, the direct risk about not getting sufficient gas for your own production and the indirect risk, i.e., from your suppliers not being supplied in total with raw materials?

Thanks for your question. So let me start with the cash, and then I'll hand to Dimitri for the gas. So cash flow, yes, indeed. So we had a guidance that was for total company. We did not segregate Materials with Nutrition, et cetera. So we were anyway not going to -- it was difficult to have a comparable start of the year. So we decided to focus on EBITDA growth for the guidance on HNB. Now as you have seen, of course, the first half of the year has been challenging when it comes to the cash flow. I think we are not alone in that situation. Now when it comes to the second half of the year, we would -- we will strive to have some positive cash generation. Whether it's enough to offset this difficult start of the year, we will have to see. It has, of course, a lot to do with also the supply chain and the stability that we can see there. So when we're looking at the level of inventory, and in fact, maybe that's worth giving you a little more color here. When you look at operating working capital, when -- receivables are fine. We're not seeing any increase in bad debt, et cetera. We're seeing a level of about 70 days receivables, so nothing unusual versus prior year. Payables are actually a little bit higher, but nothing very unusual either. But we are seeing clearly that we have being higher levels of inventory, both in terms of raw materials, some inventory in transit and also some -- because of in-transit some end products as well. And that one is a little harder to call because we will always make the choice of prioritizing customers over working capital. But the intention is, of course, to try and reverse this trend in the second half as we go there. But difficult to give you a clear guidance on that. And Dimitri, gas?

Yes, gas, indeed, a hot topic. Indeed, I like how you introduced it. We are not, maybe between brackets, no longer an energy-intensive company. I think we're about 3% to 3.5% of total sales, which is linked to energy. Just to clarify also for everybody, we don't use gas as a feedstock. We only use it for generation of electricity and steam at our larger manufacturing locations. So I think that prepares a little bit from a risk perspective. We have mitigation plans in place for these sites who are using gas to make energy and steam. Remember that in Sisseln in Switzerland, we moved to biomass a couple of years ago. And I think that was even before we had these issues, which we've seen today. We've also, I just explained a little bit, our journey on to renewable energy where we're moving our renewable energy percentage up. So also, that's helping us. And we have sites where we have mitigation plan, where we could switch to oil if needed, to generate steam or electricity for some of the sites, we have prepared safety stocks. So in case, we'll be ready to act. Overall, our total spend on energy is about EUR 300 million, of which EUR 200 million is gas and EUR 100 million is others. From the EUR 200 million, we have hedged between 60% and 17% -- 60% to 70% and we have mitigations in place. So from a direct perspective, to the first part of your question, I think we're well prepared, and I have less of a concern. The indirect question, I think, is more important. And what we have done is we have screened our suppliers from a gas risk perspective. And I think it's always good for companies and certainly also ours to have multiple sources of suppliers for key products. And we have reviewed that, and I think we're in a good space. But like everybody is doing that, I think we need to see how resilient the industry will be, but I think we have -- we are well prepared from a direct perspective as well from an indirect perspective. The last point, be aware that we have a very global infrastructure with sites across the globe with more than 200 sites, including premix sites. And if it's needed, we could switch production from one continent to another, if it's needed to supply our customers. So I think we are well prepared, although you never can say that you're fully prepared because yes, the unknown is unknown. I hope that gives a bit of color.

Thanks, Dimitri. And actually, you reminded me of a point that I should have mentioned on the working capital, and that is the shutdowns. So in the second half of the year because you talked about safety stock, we also built up some inventory to handle a number of shutdowns. They're all scheduled, so there's nothing unusual, except there's a couple of somewhat lengthier ones that will take place in the second half. And that will also obviously help reduce somewhat the inventory that we have built up in anticipation of them.

[Operator Instructions] Our next question comes from Chetan Udeshi with JPMorgan.

Two questions. First, I'm just referring to your comment about improved exit rate into third quarter. I was wondering if you can give us any more color on how much improvement have you seen in Q3? And I'm more interested on organic EBITDA because if my calculations are correct, in the second quarter, it was -- your EBITDA was down about 2% year-on-year on an organic basis. Are you expecting an improvement on organic growth on EBITDA in Q3 based on the exit rate that you see at this point? The second question was more on Animal Nutrition. We've seen a lot of data points from across the supply chain, talking about more challenging situation in the livestock industry, especially in Europe because of high crop prices, down trading, farmers going out of business. But there's no mention -- clearly, we've not seen any of that in your numbers, but there is also no recognition of that in your commentary. So maybe can you address that point why is it that we've not see that impact on DSM's numbers so far? Is there a mix issue? Is there a geographical issue? Or is there a risk that you might see with a lag? And last question just on P&L. I noticed there was a big restructuring charge, it's pretty sizable in Q -- sorry, in first half of EUR 50 million or so on EBITDA line. Can you maybe give us more color on what is driving that?

Yes, sure. Let me start with the first and the third, and then I'll hand over to Dimitri on the Animal Nutrition dynamics. So maybe when it comes to the underlying EBITDA, indeed, if you take Q2, you end up with minus 2%. But remember that, that also factors in this impact of the China lockdowns of about 3%, the backlogs of about 1%. And then we do see that in this environment of continued inflation, we always have -- we still have a bit of a time lag when it comes to pricing versus the inflation of the cost base. So when we're looking forward, we believe that broadly this order backlog will unwind over H2, so that should be fine. We do not expect the COVID lockdowns in China to be -- to continue to be as severe. Of course, that is to be seen, but we hope that, that is the case. So what we do expect is that we will be iterative -- in positive territory when it comes to EBITDA growth underlying in the second half of the year. So that should hopefully help you on that bridge. And then when it comes to the APMs, if you remember, last year, we had launched quite a lot of restructuring to get our Health, Nutrition & Bioscience organization ready and tilted to how we are now running the company. And this was -- and I know we shouldn't talk about the merger, but this was actually very important for our future, particularly when it comes to Food & Beverage knowing that we wanted to build on that and that will be the pillar for Food & Beverage/Taste & Beyond. Now this did come with some programs. And what you're seeing is basically the unfolding of those programs, and we had given the guidance at the time that in 2022, we would probably have still about EUR 40 million, EUR 50 million related to that. So that's one part. And the other part that you're seeing coming through in the first half, of course, the costs relating to the portfolio changes. So some to do with the preparation regarding the deal, but also the carve-outs, et cetera. So that's the buildup of the EUR 52 million. Now Dimitri, Animal Nutrition.