ElringKlinger AG (ZIL2) Earnings Call Transcript & Summary

Dear ladies and gentlemen, welcome to the conference call of ElringKlinger Group. At our customer's request, this conference will be recorded. [Operator Instructions] May I now hand you over to Dr. Stefan Wolf, CEO, who will lead you through this conference. Please go ahead, sir.

Yes. Thank you very much. Ladies and gentlemen, a very warm welcome to all of you to our conference call on the preliminary and, as of today, unaudited figures for the fiscal year 2020. Just to give you a short overview on our agenda for today. I will start with the most important headlines for the reporting year 2020. And then I hand over to my colleague, our CFO, Thomas Jessulat, and he will then walk you through the preliminary figures. And afterwards, I will close the presentation with a few words on the current fiscal year 2021. And then, of course, as always, after our presentation, you have the possibility to ask questions. Yes. Well, for the fiscal year 2020, we saw the following headlines with respect to ElringKlinger. I don't have to tell you that it's not any news for you that the fiscal year 2020 was heavily impacted by the COVID-19 pandemic, operationally as well as financially. We are not the only company that was suffering from that, but everybody in our industry and in the economy was suffering like that. In view of the challenges, 2020 was certainly not an easy year. But given the underlying conditions, I think we can indeed be satisfied with our results and the results of the ElringKlinger Group. We saw a top line decrease of minus 14.3% to EUR 1.480 billion. And organically, sales were down by minus 11.7%. This represents an outperformance of the global automotive production, which declined by 16.2% in the same period, that means in 2020. Our EBIT came in at EUR 27.2 million, and the EBIT margin was at 1.8%. In the fourth quarter, the margin was at 5.5% even though we had to recognize several factors, including the proceeds by a fuel cell partnership; different noncash impairments related to the business; and, last but not least, the success of our global efficiency program, which led to an improvement of earnings and optimization of cash situation and the reduction of the net debt level. Hence, operating free cash flow stood at a strong level of EUR 165 million due to our continued disciplined CapEx spendings as well as our consistent working capital management. The consistently strong operating free cash flow enabled us to further reduce net debt to now EUR 459 million. The trend that -- this translates into a net debt ratio of 2.5. Twelve months earlier, the figure has stood at 3.3, so quite good improvement here. Apart from the mentioned challenges due to the COVID-19 pandemic and the continuation of our global efficiency program, we have set 2 important courses for the fuel cell business. Well, COVID-19 had a firm grip on the world last year. The fiscal year 2020 was, as I mentioned already, not an easy year. Let me take another brief look back. After the outbreak in China, the New Year holidays there were extended, and strict containment measures were put in place. Then at the end of the first quarter, the pandemic wave built over into Europe and a little bit later into North America. Governments took lockdown measures sometimes to varying degrees. Alongside other sectors, the automotive industry was hit very hard. At ElringKlinger, we took precautions at a very early stage, such as restricting travel, introducing distance rules and separating production areas. Despite production disruptions as a result of the lockdown, we were able to maintain our supply chains. This helped us when to recover -- when the recoveries started at the end of April. China was already approaching a normalized level. In North America, demand recovered quite dramatically -- dynamically, while the recovery in Europe was rather sluggish. In the fourth quarter, infection figures rose again, particularly in Europe and North America, but also in other regions of the world. There was talk of a second wave and governments resumed countermeasures. Irrespective of the pandemic, we set an important strategic course for the fuel cell business of the group in the third quarter. In a chronological order, we first entered into an agreement with Airbus for a long-term partnership within the area of fuel cell technology. ElringKlinger will provide the newly established company with access to technology relevant to hydrogen-powered fuel cells. Airbus conducted an extensive analysis of the fuel cell stack market prior to the agreement. As part of the international selection process, ElringKlinger's best-in-class performance proved decisive. The high-power density of our stack and its extensive expertise with regards to industrialization processes proved key differentiators. ElringKlinger will hold a noncontrolling interest in the newly established company, while the majority stake will be held by Airbus. The closing of the transaction took place in December 2020. The second important event that we had last year in October, we have signed a strategic partnership with Plastic Omnium, French supplier which includes the 60-40 joint venture, named EKPO Fuel Cell Technologies to develop, produce and commercialize the fuel cell stack and components market. We will have an annual production capacity of initially up to 10,000 units. And additionally, we will transfer our Austrian subsidiary, ElringKlinger Austria, for integrating hydrogen systems to our French partner, and we are going to receive an amount of EUR 15 million for that. The closing of the agreements with Plastic Omnium is scheduled still for Q1 2021. Yes. So much from my side. I will now handing over to my colleague on the Board, our CFO, Thomas Jessulat, and he will explain the financial figures, preliminary figures for 2020.

Yes. Thank you, Dr. Wolf. Also a warm welcome from my side. I will now present you the preliminary and unaudited figures for fiscal year 2020. Regarding the global auto production growth, ElringKlinger has again outperformed the market in 2020, even though we saw a tough year for the market. Sales declined by 14.3%. We noticed a headwind from the FX market of EUR 40.7 million and an M&A impact of EUR 4.1 million. Considering these 2 impacts, we recognized an organic decline of minus 11.7%. The global market -- global markets, meanwhile, declined by 16.2%. We now come to Slide #6. As Dr. Wolf mentioned before, we have implemented a comprehensive efficiency program to optimize group's cash flow figures in the short and medium term, which is based on the 3 building blocks: earnings, net working capital and CapEx. The program includes measures to improve earnings, for example, the group-wide cost reduction program as well as the optimization of the performance in Switzerland and North America. In addition, we have clearly defined effective measures to reduce net working capital, and this includes an extension of payment terms, a reduced level of trade [ with 0% percent ], the optimization of inventories. And regarding CapEx, we continue a disciplined approach. On Slide #7, you see the earnings development of the EBITDA and the EBIT level on a year-to-year basis. Despite the pandemic-induced downturn in revenue, EBITDA totaling EUR 180.9 million were largely unchanged on the prior year figure of EUR 181 million. This also is reflected in a higher EBITDA margin. EBIT came in at EUR 27.2 million, which corresponds to a margin of 1.8%. In terms of both revenue and earnings, the group therefore remained within the guidance range. It had adjusted in May 2020 in response to the first COVID-19 lockdown. Revenue had been expected to decline by a slightly smaller percentage than the market as a whole. As for EBIT, excluding proceeds from the fuel cell partnership, the outlook has been for margin that was noticeably lower than the prior year figure of 3.5%. For explaining the elements of the EBIT, we now come to Slide #8. Comparing to the EBITDA last year, we have to consider the proceeds of the real estate sales in 2019. As the agreement with Airbus has been closed, we received proceeds of EUR 25 million in Q4 2020, attributable to this partnership. On an operational level, the impact of the pandemic resulted in an earnings shortfall of around EUR 42 million. This figure factors in the positive effects of instruments utilized by the company, such as short-term work in Germany. At the same time, earnings improved by around EUR 47 million due to the global efficiency program of the group. It includes comparatively short-term effects such as the reduction in travel and non-personnel costs as well as structural elements such as a cut in material costs or the adjustment of sales prices to current levels. Additionally, the group recognized an impairment loss relating to noncurrent assets of EUR 24 million in columns with IAS 36 resulting from regular within the process of setting up the annual financial statements. In this context, we also had to consider impairment on development costs and other parts of the current assets which sold around EUR 19 million. And last but not least, provisions of around EUR 12 million have been made to cover various business operations in the wake of the COVID-19 pandemic. Another pillar of the efficiency program is CapEx spending. The investments in property, plant and equipment, an investment property amounted to EUR 57.3 million. And this translates into a CapEx ratio of 3.9% in terms of total sales. One year ago, these figures stood at EUR 92.2 million or 5.3%. As we have finished our investment cycle with new plans, larger factories and extension of the global footprint, we're able to introduce a disciplined CapEx approach. We weigh things up carefully and only provide funds for the classical business on an order-oriented basis. At the same time, we focus strongly on the new technologies. For example, we're installing a fuel cell stack assembly line in Dettingen. We have also ordered a battery assembly line for our German location in Thale, and we have invested in new machinery equipment for the Lightweighting/Elastomer Technology business units. Now we come to Slide #10. Another part of the efficiency program is the optimization of the net working capital position, which has been reduced to 27.2% of sales coming from 33.4% by year-end 2018. The level has been reduced from EUR 568 million by year-end 2018 to EUR 433 million by year-end 2019 to now EUR 403 million. The main impact results from the optimization of inventories while trade receivables remained at an almost constant level compared with the previous year. We have not changed the framework of the instruments with regard to receivables and are on the same level, approximately than 1 year ago. With the help of the global efficiency program and its elements, we managed to generate operating free cash flow of EUR 164.7 million. Now we come to Slide #11. Not at least as a result of these factors mentioned before, net financial liabilities reduced by a further EUR 136.5 million to EUR 458.8 million in 2020. And this translates into a net debt ratio, which is the net debt in relation to EBITDA of 2.5. Twelve months earlier, the figure had stood at 3.3. Having said this, I now turn back to Dr. Wolf.

Thank you very much, Mr. Jessulat, for explaining the figures. By looking at the last slide, #12, let me give you some insight on the current quarter. Generally, the IHS experts see a stable market in North America and a slightly decreasing market in Europe. As particularly Asia has suffered from the COVID-19 pandemic in Q1 2020, we expect tailwind from the Asian markets. They have basically completely recovered, which is kind of ironic that where everything started, they are back to normal now. There's still some uncertainty in place in our industry. You all know that we have a semiconductor shortage. This will have an impact on the automotive industry. As of today, we do not see a lack of demand, but we can also not rule out any effect in the upcoming weeks. The visibility of the changes in schedule is low, leaving us exposed to short-term changes. We also see some shortage in steel that might also create a problem. Regarding the COVID-19 pandemic, we currently do not know whether there will be a more severe third wave of infections. If so, there is a risk of serious economic consequences, and the automotive industry is supposed to be hit as well. All in all, the impact depends on the length and the degree of the potential wave. We all hope that global vaccination will end the epidemic at best in summer 2021, and we will specifically support the path to resolve it. Let me briefly summarize. The volatility of the economic markets still exist, and the influencing factors are numerous. Therefore, we will consider the development of our business in January and February 2021 and will include it in our assessment for the fiscal year 2021. Thus, a detailed outlook for the current year will be provided not today but on the day of the release of the annual report, and that is on March 30. So that's so far from me with regard to the current situation. And now Mr. Jessulat and myself are more than happy to take your questions. Please go ahead.

[Operator Instructions] And the first question received is from Akshat Kacker of JPMorgan.

Akshat from JPMorgan. Three, please. The first one on Page 8, where you show the EBIT bridge. Can we get into the details for impairments and provisions? How much of this was booked in Q4? And how much of it affected your reported EBIT of EUR 25 million in the fourth quarter? That's the first one. The second one is on raw materials. The last time we saw an uptick in the commodity cycle, it eroded a significant chunk of your earnings and cash flow. How much of this has now been negotiated with customers for a pass-through, especially on steel and plastics? The third one is on the building blocks for free cash flow in 2021. Would be interested in understanding what are you using for CapEx in your budget planning for 2021. Should we think about a number that's close to 5% of sales? And also on working capital, you have already made a lot of effort in reducing inventory, and you mentioned that receivables are at the same level with no change in instruments. But how should we think about 2021? Can you offset the headwinds from higher volumes and raw materials by increasing factoring? Would be interested in your thoughts there.

Yes. Thanks for your questions. Let's start with question number one. The largest number when we talk about impairments is certainly the impairment related to IAS 36. Most of it has been booked in Q4, and that is the amount of the EUR 24 million. It's different levels of tests that we applied here, but most of it has been recorded in Q4. When we look at to the number here in regard to impairments and other factors, this is the EUR 19 million, then we have here an impairment of development costs for certain capitalized R&D expenses in the high single-digit amount. We have 2 customer-related topics here with a mid-single-digit amount, essentially the receivables, impairments and on inventory items, we have a high single-digit amount here. When we look at provisions, then we have booked 2 items here related to customers, customer disputes essentially. The one is a single digit amount and the other one is a lower -- it's a mid-single-digit amount, the other one is a lower single-digit amount plus some other items here. Again, some entries were made in Q3, but the majority of entries were done in Q4. Now when we come to the next question of yours on the raw material side. As per the end of the year, when we walk through our main commodities, which are aluminum, steel and plastics, then to give approximately an overview what hedge we have with the customer contracts and what net amounts are. So on aluminum, roughly 60% are covered in customer agreements in terms of price clauses. We have done within the last 2 to 3 years, a high effort in terms of modifying customer contracts here so that we get an improvement here on that end. And on aluminum, I'd say, taking into account supply agreements, we have a high single-digit exposure on aluminum. On steel, we have a lower percentage. It is not so common here in regard to steel. It's a lower single percentage, low to mid-single percentage amount on the customer side. We have done some metal hedging that also has impact in 2021. Not only in 2020, but the hedges go into 2021. And also on the steel side, we have pretty good coverage on the base prices for materials. But on the LME side, it's a sort of shorter-range coverage. At the end, we have high single-digit exposure as per December 31. On the plastic side, we have roughly 25% in terms of price clauses here with the customers. We have some coverage here on the supply side. And I'd say we are high single-digit amount as well on plastics in terms of exposure. Yes. So on the third question of yours, this is the free cash flow outlook for 2021. In terms of number, I think we are at a high double-digit amount for CapEx in absolute terms for 2021 as for today. And on the working capital side, I see the situation in the first half as not so much transparent. Because from the customers, customers report interruptions of vehicle production. However, the visibility of changes in the releases is fairly low. So we are exposed here, I would say, to short-term changes if they come through. On the supplier side, we have seen shortages of some raw materials in 2020, mainly in plastics. And going into 2021, we see on the one side, certain price developments. And we see also more shortages as part of the run-up, in particular, also on steel and aluminum. So the impact is difficult to say in the first half. I would say the first half, we are not going to be so efficient eventually in terms of working capital because we have to cover ourselves with material for what the customers also communicated here that they want to catch up with lost volumes throughout the year. And we'll try to manage in the second half an optimization program again so that we run eventually increased inventory levels down in the second half. This would be my tactical view on things.

Let me add one thing as I'm in charge of sales, OE sales. Of course, we have consequently, since about 1.5 years, we only entered into contracts with material price adjustment clauses. And as Mr. Jessulat said, we are pretty well covered already from the past with regard to aluminum. Not that good with regard to steel. And we have, of course, a lot of those old contracts that are still in place and that are still running. Because normally with our traditional product portfolio, we get so-called lifetime contracts. And today, an engine model runs 5, 6, 7, 8, sometimes 10 years. If we talk about heavy-duty truck engines, they run 12 to 15 years, yes? So of course, we tried to adjust things here, but we are still in a lot of contracts where we are faced with the risk of price increases in materials, especially in steel, but also, of course, we benefit when the prices are going down, that has been in that way all the time. But new contracts, we insist on that -- their material price changes that the risk is taken by the customers.

The next question received is from Christoph Laskawi of Deutsche Bank.

I'd like to go back to the bridge piece. The first question will be on the IAS impairments that you took. Are those entirely volume-related because we have seen several other companies taking those in Q2, essentially? Or is this, to some degree, also a business line where you might see that the OEM is canceling it or any other impact in the overall market volume? And then on the efficiency program, you already stated that some of the items will not be sustainable, which is absolutely normal when it comes to travel expenses and parts like that. Is there a rough share that you could give with regards to what you would see as recurring in 2021 and what might fall away? That's the first question.

Okay. Thank you for your questions. On the bridge, IAS 36, it is COVID-related impairments. Because when we experienced the situation last year in the second quarter 2020, we started with our sales planning subsequently. And all related impairments are based on our planning assumptions here, and it's purely related to that. So it is a very strong or so COVID relation here. And on the efficiency program, I would say that the low reference is first quarter 2020 in terms of EBIT margin. This is -- I mentioned that before, 4% to 5% is the flow. Now we have made certain assumptions. We had a good start into the year. So when we look at the profitability here of the fourth quarter, sort of adjusted EBIT, then I come up with roughly EUR 40 million, a little bit more than EUR 40 million on EUR 450 million in sales. So that's 9-point something percent. So that's including those effects. It is including no travel, it is including short-term work, it's including also some variable items here in our cost structure. So having said that, 4 to 5 is a floor for ElringKlinger at certain levels. We have started pretty well, and we are a little bit ahead on what we have planned. So that is the way I would want to answer the question on the efficiency, which would give us some margin improvement for 2021 relative to what we have seen in first quarter 2020.

One thing we also have stated, of course, some money in the sales I've mentioned, trial expenses, but I'll just give you an example. For other issues, now we normally have a big boost on the Automechanika, which is the world's largest spare part fair in Frankfurt every other year in September. And of course, we are also represented on the International Auto Show for heavy-duty trucks in Hannover. That was also scheduled for October last year. So that's around about EUR 1 million, a little bit more than EUR 1 million that we just saved not going to those fairs because they didn't happen. They didn't take place. So -- and that is not only at ElringKlinger's. In a lot of companies that you see, where you see the results now from 2020, you have to consider that there have been a special effect because we saved some money because a lot of things just didn't happen.

Yes. That is well understood. We just got comments from other suppliers, for example, Heller, saying that they face, say, EUR 10 million cost at wood per month in Q1 versus the very low cost base in Q3 and Q4 because they are revamping the activities. Is this a comment like that, that you could make as well? Or not at this point because it's still too uncertain?

What do you mean in terms of the cost structure or?

No. Essentially, costs that you have been able -- like the travel expenses, like marketing expenses that you have been able to ramp down and which will reoccur whenever the whole of the activities is restarted, might be R&D on some projects as well.

On the first point, it is certainly the level of short work that then applies. And on a monthly basis, this is a low single-digit figure. And at some point, certainly, if volumes remain like they are, then we are going to be going out of short-term work. And in that case, we are talking on a monthly basis a low single-digit figure in terms of that. Now the other, for some time, travel is going to be restricted. Who knows what's happening on the fair and the exhibition side? For now, I would say, uncertain, but that's the key driver. And that gives you a little bit of feeling in terms of on a quarterly basis, how much that could be.

And one thing is clear, we have -- we all have learned from this COVID pandemic. Some of the costs will come back, but some of the costs will not come back because we found out that not only we as ElringKlinger, but our whole industry, we found out that a lot of things can be done worsely as you not do have to travel around the world all the time. That it is not necessary that sometimes 2, 3, 4 people travel together to some event or to see customers or whatever. So we will have a sustainable reduction of cost based on the experience that we made. And also, as Mr. Jessulat said, I'm pretty sure that we will not see every fair and every event that we had in the past that this will come back in the future. If you only look at, let's say, auto shows, yes, we have around the world. We have around 6 to 7 auto shows per year around the world, starting with Tokyo and then Geneva and Frankfurt and Detroit and whatever. If that will come back, I doubt it. I don't think that we need all of that. And also, we will have a pretty close view from the Board here on travel expenses. We made the experience. Mr. Jessulat and myself, we had our Board meetings with our subsidiaries. We don't have to travel 4 times a year to China. We can do 2 of our Board meetings in China to see the people. I think it's important that you see each other and you have physical contact from time to time, but 2 of the Board meetings per year can be done virtually by a video conference. So the world will change after this pandemic. I tell you, our industry will change a lot. And this, of course, it showed us that there are still cost optimization possibilities that we have not thought of before this pandemic.

Agreed. Another question on hydrogen and potential order intake. We -- yesterday, we got a statement from Faurecia that they target for hydrogen order intake around EUR 500 million in 2021. Is that something that you are communicating on as well in the future, that you will have a specific order intake target before revenues kick in a couple of years from now? And should we expect any news though in the coming months?

Well, we have -- when we founded EKPO Fuel Cell Technologies, when we had our press conference, we announced our expectations, and that is that we are going to have 10% to 15% of the market in 2030, which means around about EUR 1 billion sales. And that, of course, if I look at our classical business, it's pretty clear when there is an engine under construction, we know that they started in 2025. And then we know that we sell x amount of cylinder gaskets and special gaskets and all of that. This is more unsecured in the fuel cell business. Once you have the order, things might be postponed. So you get the order, but it's not clear if series of production starts in 2022 or '23 or '24. Sometimes we have postponements here that are quite long. Nevertheless, we are happy with the situation that we have, with the orders that we have on hand, that, of course, has been transferred in this new company.

And last one is a housekeeping question more than anything else. If I understood it correctly, the factoring volumes that you have at year-end are essentially unchanged versus 2019?

Yes. Approximately similar.