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

A warm welcome to everyone, and thank you for joining us today for a short trading update call on DSM's first quarter performance. I'm Dave Huizing, Head of Investor Relations, and I'm joined today by our co-CEOs, Geraldine Matchett and Dimitri de Vreeze. We published this morning the first quarter press release, which you can find on our website. You will also find the disclaimers about forward-looking statements made in today's conference call. We did not publish a separate presentation to investors, so don't look for it. As this is only a trading update, we will aim to keep this call to about 45 minutes, which includes a short introduction with Geraldine. And with this, I hand over to Geraldine for that short introduction.

Thank you, Dave. Hello from me as well, and thank you for joining us on this call, especially as it's not our usual rhythm to have a call outside the full year and half year results. However, given that this is our last financial update as DSM N.V. stand-alone following the completion of the tender process and given the market volatility, we thought that it would be helpful to provide as much clarity as possible before we go into the reporting of the DSM-Firmenich combined company. Now this is indeed a trading update, which means that we're providing the business top line development and the group EBITDA. And for that reason, as Dave just said, we haven't prepared a deck, but I'll just give a few introductory comments, and then we will open the lines for the Q&A. Now as context, of course, when you compare Q1 versus Q1, in the first quarter of last year, our performance was not yet impacted by the war in Ukraine. And the extraordinary pace of inflation that followed, that is still very much in effect at present in 2023. For this reason, the year-on-year comparison has been challenging for Health, Nutrition & Bioscience overall, with our sales down 6% (sic) [ 7% ] and the EBITDA down 23%. Now it is probably more useful for us to comment for you on a sequential basis, i.e., the developments in the business conditions from Q4 into Q1 2023. And therefore, my comments will be more on that basis going forward. Now let me start with Animal Nutrition. As we indicated during the full year results call in February, the exceptional conditions that it was experienced by Animal Nutrition & Health during the latter part of 2022 and especially in Q4, actually continued throughout Q1. Whilst we see the consumption of animal-based protein remain resilient, the combination of soft demand, especially in China, the continued high input costs and a decline in vitamin prices has impacted the financial performance of Animal Health & Nutrition. Now within that division, Performance Solutions continued to perform well and actually was strong across the globe with continued strong interest by farmers in optimizing their yields and their efficiency. Now in terms of our human activity, conditions were also broadly similar to Q4, with continued end market demand, good end market demand overall and good business conditions in our key segments. However, during the quarter, we did experience quite a bit of destocking in the value chain, and we also chose to focus and prioritize on profitability over volume. Now this does translate into a lower top line, but a sequential improvement in margins. Now more specifically, for Health Nutrition & Care, we saw continued and good demand for our i-Health products, especially gut health, brain health, women health and the weakness in immunity optimizing dietary supplements in North America. We also saw some destocking through the value chain. As for Food & Beverage, business saw a resilient end user markets, but we also experienced a destocking in the value chain. End user demand in Dairy, Baking, Beverages, Savory, and Pet food markets was solid. And in Hydrocolloids, the demand remains strong. Now from an adjusted EBITDA perspective, it is clear that the lower profitability Q1 versus Q1 is driven by the exceptional conditions in our Animal Health & Nutrition business. Overall, the drop in EBITDA is roughly 50% related to lower vitamin prices, namely vitamin A and the other 50% related to the lower volumes and the continued price cost gap linked to inflation. Now as mentioned in our press release, for the second quarter, we do not expect to see much change in these underlying conditions. But we do expect a better H2 with inflationary pressures receiving a volume recovery, especially in China and vitamin pricing beginning to normalize. Finally, in recent weeks, we have, of course, also marked a number of milestones leading to the completion of our merger with Firmenich. The tender process is now complete, and we gained the support of more than 95% of our shareholders, which means that the contribution of Firmenich into DSM-Firmenich can now happen and that will take place on May 8, so next Monday. We are, of course, extremely excited by the compelling business combination that this merger will bring driving significant opportunities for growth and for value creation for our shareholders and all our stakeholders. And I want to say here that we are very grateful for the support that we have received throughout this process. Now these were our introductory comments. And now Dimitri and I are happy to take your questions through the Q&A. But for that, I need you, Dave, to open the Q&A line, please.

Okay. For sure, Geraldine. Remember that sell-side analysts who want to ask questions in the Q&A session, have to register via an audio conference link, which you can find on our website. I think by now, we all got that. The other participants can continue to listen in this Q&A session via the Zoom meeting, so they don't have to do anything. And as we already have people in that audio-conference room, we can start. So operator, please let us have the first question.

Thank you. [Operator Instructions] The first question is from Andrew Stott with UBS.

Geraldine, Dimitri and Dave. A couple of questions, please. Number one, are you prepared to say what percent of the vitamins portfolio today is profitable? I'm just trying to get a sense of potential further downside, particularly from vitamin E. Number two question, I've read a lot about the China problems in livestock production. It seems like it can get slightly worse before it gets better, i.e., the virus can spread to the south of the country. So I'm wondering whether you would agree with that rather gloomy short-term prognosis? And then question attached to this is, how big is China as a percent with animal nutrition?

Thank you, Andrew, and thanks for joining the call. We heard you a little bit muffled, but I think we got the questions. Dimitri, do you want to comment maybe to the vitamin picture because that, of course, is a topic for today.

Yes, indeed, and Andrew, thanks for that question. And so on my behalf, welcome to have you on this call. Indeed, percentage of vitamins, which are profitable, I would say the majority of the vitamins are profitable. We have indicated that certainly on specific occasions like vitamin A, where there is an unusual circumstance with China opening up but very slowly and therefore, impacting the demand of animal protein in China. Remember, China is the biggest market for animal proteins, and therefore, it has an impact on the demand. And therefore, the 80% of vitamin production, which is produced in China is obviously selling it outside China, and therefore, an overall pressure on vitamin prices that in the context. Vitamin A has a special circumstances with obviously BASF coming back into the market and also selling material, which is close to shelf life. So that is a temporary situation, which will normalize. And as we have said in our press release, we expect vitamin prices to normalize in the second half of this year. Vitamin E is a completely different story. Vitamin E has different dynamics. Supply and demand is relatively in balance. Obviously, also a bit impacted by the soft demand in China, but supply and demand is nicely in balance and is, in that sense, a completely different part. Then in terms of Human Nutrition & Health, which is the Food & Beverage unit and the Health Nutrition & Care unit, we made a deliberate choice to put price over volume. And therefore, we have walked away for some of our vitamins business and predominantly vitamin C. And as you know, our business in animal 2/3 is sold by premix and 1/3 in straits. This lower-priced vitamins are predominantly in straits. We have made a deliberate choice and therefore, we have seen a margin improving, but it had an impact on the volume component. That a bit of color to your broader question.

Yes. And maybe, Andrew, to your question on African swine fever, this is indeed -- well, there's different parts to the China demand. Let me start maybe there. First, if you remember after the hard lockdown of COVID, there was clearly an expectation that the consumption would increase quite rapidly, because consumption of meat is particularly out of home. As it all opened up, there was a view that there would be an increase in consumption per se. Now what we're seeing is that this has been actually quite a slow process as opposed to a bounce back, which is one aspect of what is happening in the market. Now the other aspect is that indeed, there has been another African swine fever scale. And for farmers who have been wiped out in the past, this was very much a trigger to basically accelerate and take the animals to slaughter, but also not to increase the herds. And currently, the herd size are pretty small compared to what we would have been expecting at this point in time. And there is a glut of effectively of meat on the market. So in terms of your question, do we think that it's at the trough? Well, difficult to tell, of course, with these outbreaks. The authorities are increasingly quick at responding, but the risk is there. What we do believe, however, and that's why we're saying the second half should be better is that the consumption will pick up. And what we also see is when that happens, it gets better for farmers and then they start again. So difficult to call out the African swine fever impact, but we really would be expecting to see an improvement when it comes to the dynamics in China for, in particular, swine. Remembering that China represents about 50% of the global swine demand. So yes, this oversupply and the African swine fever is a bit of a combined exceptional position. Dimitri, I see you have...

Yes. I just want to add and also then circle back the last question of Andrew on how much China is in A&H. That's about 15%, Andrew. And you can all see that back in the fact book. And I would like to add on what Geraldine is saying on the ASF. Be aware that we have a very strong business model in Animal Nutrition & Health. So obviously, if there are any ASF in China, the animal protein demand is the main driver. So then other countries will pick it up. And we have a very global reach as DSM. We are basically in every market where it really matters also with our premix facilities. And we also aware that we have our input to all the species. So into ruminants, into pork, into poultry. And that is mitigating a little bit the variations. And we've also seen that during COVID, where people are going more to easier and cheaper proteins like poultry and eggs, and that's also in our basket, in our portfolio. To a certain extent, I would not say we are immune, but we have a solid business model to cover that.

And we'll take our next question from Ranulf Orr with Citigroup.

Just two questions from me, both on vitamins, I'm afraid. The first one is, yeah, actually I appreciate we're in exceptional times within the market. So I guess, we've kind of been here before. But once the Firmenich transaction completes, is there a strategy to further limit your price exposure just beyond vitamins being a smaller part of the mix? And secondly, please, can you give us an update on your view with the vitamin A in the current time line? And really, actually what gives you confidence there will be a recovery? I guess vitamin A prices today are comparable prices to what they were for most of the 2010s, so that would be great.

Yes. Indeed, let me take those. And you should not say it, I'm afraid I have a question of vitamins. I think vitamins are an essential ingredient in many of the solutions we offer to animals and farmers and humans. But there are a few particular situations here which you referred to. Let me start with a bit our journey on vitamins. Remember that in the past, the majority of our portfolio was vitamins. And we always had a path to reduce that exposure and also reduce volatility. Today, we are about 25% at our own produced vitamins. And remember that we also deliberately decided to start sourcing vitamins, certainly in the Animal Nutrition area. And if we complete the merger and as Geraldine has said, that will be next week. Pro rata, that will be close to about 15% at own produce. So this is part of the story line. If you look at the acquisitions we've done, those have been in the areas outside vitamins. It has been in probiotics, it has been in HMOs, it has been in mycotoxin absorbers. So this has been a continuous effort, including our innovation portfolio. So indeed, that is a pathway. Nevertheless, what we have seen on vitamins is that today on vitamin A, nobody is making any money at these prices. And you can refer to, I think, public announcement of many of these players, and you will see that they all cover vitamin A and all other saying that they're not making any money. That is one. Secondly, BASF is close to selling off all their produced stock when they were coming back, which is running out of shelf life, and that will also rollout and fade out throughout 2023. And then thirdly, the moment that China is further opening up, and they are opening up and they come back on track, and it takes a bit longer than maybe we'll expect it. When we are all on track, then the demand protein will improve. And if you then add 1, 2 and 3 together, I think it's very clear, and I'm not saying safe to say, but it's very clear that we expect vitamin prices to normalize throughout the year and into the second half. We don't see that in quarter 2 yet, but we certainly are expecting that for the second half of the year.

And we will go next to Nicola Tang with BNP.

The first question, I wanted to ask a little bit about volumes here. When you look at that 8% volume decline in Q1, how much do you estimate could be from destocking versus stepping away -- proactively just stepping away from volumes to protect your profitability? And how do you kind of, I guess, split an estimate what's what? And then the second question is on price. Just wondering if you could talk a little bit more about price expectations for Q2 and for the rest of the year? Are there still areas where you're implementing further price increases to catch up with cost inflation? Or is it more, at this point, an annualization of past initiatives? And I guess, tied on to that, are there any areas where you would consider giving back price in order to regain lost volume?

Let me give you already some color on the volume movements and then we'll tag in some price comments here. So maybe on volume, let me try actually start with Human Nutrition, because here, maybe it is a development that is maybe not as expected whereas the volume developments, I think, on Animal Nutrition are not a big surprise. Now on -- for HNC, what we have seen broadly, so you saw a minus 7% in volumes for the quarter. You can look at it broadly 1/3, 1/3, 1/3. So 1/3 related to destocking in the value chain, and we have seen that in a number of places, I think, in line with the rest of our peers. And you can -- there's about 1/3 related to end-user demand, that's really more the dietary supplement space that we've pointed out previously. And then about 1/3 where we're making a choice of basically price over volume. So that's how you can broadly step the minus 7%. Then from an F&B point of view, so Food and Beverage. Here, what we're seeing is that actually end-user demand is pretty resilient overall. And it's actually more of a 2-piece, about 1/2, 1/2. 1/2 destocking related to the value chain and about 1/2 where we've really prioritized price over volume. So that's really the split there. And Dimitri, do you want to comment on pricing?

Yes, a bit on pricing. So remember that we have in our human space, these are normally long-term contract pricing. A year, sometimes 1.5 years and they roll over, so they are locked in. You can also see that in the numbers with nice price increases for Q1. On animal, that's more on a quarterly basis with some exceptions here and there. So there, we basically price on a quarterly basis. What we see is that on the vitamins part, like I said earlier, we think that vitamin prices will bottom out and normalize towards the second half. So that creates that momentum also in Animal Nutrition to bring that up. Then in terms of inflation, we expect inflation to ease in the second half. And with the pricing momentum we have, we expect that we could hold on to that. And we also have to do that because as Geraldine already explained, we still have a lag still in the price and the cost. So we expect that to close towards end of '23. But it depends a little bit on how inflation will develop, and it has different elements to it. I think energy, raw materials, transport costs, we see easening. However, we now see labor costs going up. So we need to see how that works. And you need to be careful in seeing the immediate effect because we have about 5 months of stock where it's basically taking 5 months to roll that into our results over time. So therefore, we are more positive about the second half of the year. So overall, we have that pricing momentum in human, it's fixed. Animal, we have it on a quarterly base, and we expect with a normalization in the second half of the year, pricing momentum for us.

I wonder if I could follow up on your last point, Dimitri, on cost inflation. I think before you were talking about 5% overall for the year. Does that still hold? And in terms of what you're talking about there's improvement in the second half, is this more an annual thing? Or are you actually seeing more easing than the original 5% expectation?

Yes. So we basically said indeed about 5%, 5%. I think we still -- I mean, I would almost say we're not economists in the world, but I am. So the economies think it's about 5% and I think that's baked in into our assumptions, but more towards the first half than the second half. But like I said, I mean, lots of people didn't expect labor costs to go up as we've seen today. So I think I've said it earlier in the call, I stop making any forecast or stimulations on the inflation. But certainly, we are working with 5% as a reference number.

And we'll go next to Matthew Yates with Bank of America.

I actually got one. Maybe just to follow up on Dimitri's comment about the 5 months of inventory, is that where the confidence in margin recovery in the second half comes from? Because correct me if I'm wrong, but [indiscernible] we've been talking about this EUR 30 million, EUR 40 million price cost gap now for several quarters, and you haven't actually managed to close it. So is it just a matter of patience or lag to work down that legacy inventory? And then the second question I had, just coming back to animal volumes. My understanding of kind of the premix business or proprietary customers formulate, is that, they've refined those recipes over many, many years to get the best kind of economic paybacks and mortality outcomes for their livestock. Have you seen recently a change in the inclusion rates of the vitamins as farmers are trying to save money? I'm just trying to understand whether the volume decline we've seen could be something perhaps more structural rather than cyclical.

Let me start with the first one, and that is the time lag. So maybe to put numbers onto all of that. So we've been a little bit behind the curve when it is our ability to price versus inflation. If you remember last year, we were at about 7% pricing versus about an 11% inflation in our cost base. And we had, for example, in Q4, a time lag effect of about EUR 20 million. Now if I look at where we are in Q1, we're seeing actually a similar time lag and this really has to do, you're correct, with the inventory. So what you have is you get a carryover of your inflation. So your cost of goods sold that are in the P&L are, of course, coming across at the higher inflated level. Now what we're seeing is on top of that, that you have the energy cost actually has a delayed arrival time when you actually look at raw materials. So what we're seeing is that we do have this natural hangover of inflation in the cost of goods sold, which is clearly still present in Q1 and Q2. So you should not expect that time lag to go in Q2, however, it will start fading in the second half. So that's an important element. And barring, as Dimitri said, we're not economists barring other disruptions but as the way that we're seeing it, that is the time lag effect. So that was on your first point. And then, Dimi, do you want to comment to the Animal Nutrition?

Yes. Indeed. What we've seen is premix, indeed, you jointly develop and formulate. But depending on the circumstances, farmers make different choices. So what we see today where it's relatively soft demand with higher feed costs, they are really trying to optimize their efficiency and yield. And therefore, they change a little bit the ingredients in the premix. And we've seen that in our Performance Solutions business with enzymes, with mycotoxin absorbers, and the likes. So -- and you don't see that as prominent in the figures because the total strait business and the vitamin businesses in ANH is taking that away. But the Performance Solutions business or the specialty part of the Animal Nutrition bit is growing because farmers making a different choice by going more for efficiency and yields, and therefore, they need more sophisticated ingredients. Therefore, in terms of business model, yet again and next to the global approach and the multi-specie approach we have, we also have the ingredient approach. So we are pretty solid and have a very strong business model where if the vitamin prices are in there and they're going to reformulate, they always need to do that by improving yield and efficiency. So it is end-to-end. It's not a structural move. We've seen that, and we have the business model to cope with that.

And we'll go next to Artem Chubarov with Redburn.