Ferronordic AB (publ) (FNM) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Ferronordic Q4 report 2019. Today, I am pleased to present CEO, Lars Corneliusson; and CFO, Erik Danemar. [Operator Instructions] Speakers, please begin.

All right. Hello, and welcome to this fourth quarter 2019 presentation of Ferronordic, which was a quarter that ended our best year ever with an overall revenue of SEK 3.7 billion, which was up 16% and an operating profit up 31% to a total of SEK 358 million. And if we go and look more on the Q4 on Slide 2, we saw aftermarket and contracting services driving earnings in the quarter. We had a growth -- strong growth in the aftermarket but lower equipment sales. We had continued growth in contracting services. We were recently awarded dealer of the year by Volvo CE. During fourth quarter, the expansion to Germany was completed, and we took over the operations as planned in January 1, and the board will propose a dividend of SEK 4.24 (sic) [ SEK 4.25 ] per share. If we turn to Slide 3, again, the best Q4 operating result to-date. Revenue down 6% year-on-year on lower equipment sales. Compensated by a strong aftermarket, which was up 23% and also other revenue, which was up 106%, and this is then mainly contracting services. So all in all, this meant that we had an operating profit, which increased 13% to SEK 95 million and a net income, which decreased 10%. So again, this was the best operating profit in Q4 that we've had. We saw selling and general admin expenses to revenue, which was up to 11.1% versus 8.8% in Q4 '18. And all in all, this resulted in an operating margin of 9.9%. Again, we move to Slide 4, and obviously, growing aftermarket and contracting services. The aftermarket growth is continuing nicely. And we're continuing to refine and develop our digital sales support, which is giving good traction in the aftermarket sales and we see good performance and growth in Russia on Volvo and Renault Trucks aftermarket sales. And we continue to grow contracting services, again, more than doubled sales year-on-year. And obviously, if you remember, we ramped up our biggest project during the first half of 2019, and that is now delivering -- continuing to deliver results for us. And I'm very happy again and to say that we were awarded dealer of the year for Volvo CE in EMEA, Europe, Middle East and Africa. And with motivation of our investments to develop staff, our staff, digitize our services and developing new business models. So I'm -- we're very proud to have receive that award. Moving on to Slide 5, and we talk about business development. Our roll-out in Kazakhstan is continuing as planned. If you remember, we opened up business in Kazakhstan in Q1 2019, and during the year, we established 8 locations. We continue the expansion of our local sales force, and obviously, building up service organization. Also, our component rebuild center opened in late Q4 2019. The aim is here to rebuild engines and gearboxes. And we have first component -- first components, I should say, we have produced in Q1 2020. And obviously, we're continuing to develop and grow our contracting services business. If we move on to Slide 6, we -- as I mentioned then, we took over operations in Germany, for Volvo and Renault Trucks. The area which we're covering is approximately 20% of the German market for heavy trucks and the German market is the biggest in Europe. The area, which we're covering includes big metropolitan cities like Hannover and Frankfurt Rhine-Main. And also a big part of Eastern Germany, where we're seeing the fast-growing cities, for instance, like Leipzig and Dresden. And the intention is to grow and improve the network in this area, and obviously, to apply our business model with the aim to increase the aftermarket sales for the most improved customer satisfaction and through that increase both Volvo and Renault market shares in our area in Germany. Now I hand over to our CFO, Erik Danemar, to explain a little more about the number for Germany.

Thank you very much, Lars. So if we turn to Slide 7 of the presentation. A few words on the financials of the expansions to Germany, as we have communicated the expansions was made up of 2 transactions, one with Volvo, which was an asset deal and then an acquisition of a local dealer called Auto-Haas, structured as a company -- company acquisition. Looking first at the Volvo part of it. The purchase price ultimately for the Volvo assets was SEK 96 million. These assets were transferred in January 2020, which means that they were treated as prepayments, the payments were made in 2019. SEK 71 million of the total SEK 96 million related to real estate and improvements and equipment to that real estate. And that will sit in Property Plant & Equipment in the consolidated accounts. The residual was mostly spare parts inventory. And that's, I would say, in prepayments in the consolidated accounts. No trucks inventory or receivables were included. In our initial press release communication that was the plan, but as the deal was concluded, the trucks inventory and receivables were not part of the deal and hence, the transaction amount there was smaller than initially communicated. When it comes to the purchase price of Auto-Haas shares, so the company acquisition that was SEK 40 million, and that was consolidated from the 20th of December on income statement, and then on the 31st of December to our group balance sheet. The transactions were funded by a credit facility from Nordea, and the incremental net debt contribution or increase driven by the German transactions was SEK 195 million, of which SEK 64 million related to net debt assumed from the acquisition of the local dealer Auto-Haas. We see a headcount increase from the expansion to Germany of about 230 people, most of whom are mechanics and sales representatives. If we move onwards to Slide 8 and look a bit at the macro situation as it has been and looking forward as well. Then we see that the Russian economy continued to recover in 2019, albeit at a modest pace. The preliminary GDP numbers for 2019 now points to 1.3% GDP growth. And looking into 2020 consensus forecasts are ranging from 1.6% to 1.9% of GDP growth. The average annual inflation increased to 4.5% in 2019 from 2.9% in 2018, but was trending down in the end of 2019 and is expected to come to lower levels in 2020. As a result of that, partly, Central Bank cut its key rate in 2019 from 7.75% to 7.20 -- sorry, 6.25%, so that's 1.5 percentage point cut through the year. And on the 7th of February, the Central Bank made another 25 basis point cut to the key rate, which now stands at 6%. Growth in 2020 will partly depend on the execution of the National Projects in Russia. So that explains part of the range we see in guidance or forecast for GDP growth in 2020. Looking at Kazakhstan, the economy continued to grow there, 4% recorded in 2019 and around 4%, 3.9% forecasted for next year 2020. The ruble when we look year-on-year strengthened 6% versus the Swedish krona, and 2% against the euro, these are again, annual average numbers. Turning to Slide 9, and looking at the profit and loss statement. So we did see a revenue decline year-on-year in the fourth quarter of 6%. Equipment sales was down 22%, but that was offset by a strong aftermarket growth of 23% year-on-year. And other revenue growing at 106%, and that is very much driven by our contracting services business. Looking at the equipment sales, we saw new units down 24% and an average price decline, driven by the product mix much of minus 7%, against a market that we estimate being about flat, so largely unchanged. The gross margin was supported by growth in the aftermarket and contracting services, where margins are higher. Looking at SG&A, we did see an increase as a percent of revenue. So G&A expenses moved to 11.1% in Q4 versus 8.8% in the fourth quarter 2018, and that was partly driven by one-off expenses related to the expansion to Germany, which we have put up around SEK 7 million. Another important factor is the strengthening of the ruble over the year, about 10%, with most of our G&A expenses being ruble-based. Even at that, our operating profit increased 13% year-on-year to SEK 95 million, our best fourth quarter results ever. We did have higher interest costs in the quarter, which together with an FX loss had a negative impact on net income. So net income declined 10% to SEK 57 million. And we also -- as Lars mentioned have brought to you that there will be a dividend proposed over SEK 4.25 per share. Turning to the next slide, Slide 10, and looking at the market. We do see a slight increase still in -- coming in 2019. And yes, the markets remains only at 63% of the 2011 level and 56% of the 2012 level. Our revenue, however, is 55% higher than it was in 2011 and 126% higher than in 2016. Operating profit is 281% higher than in 2011. And we see strong growth in aftermarket and other revenue share. And these factors are impacting the operating margin for us. And contracting services is, again, the biggest part of other revenue, so driving that part of the revenue stream. If we look at revenue and margin development on Slide 11. We see, again, the revenue being down 6% year-on-year, and this is the first decline in last 12 months rolling revenue over the 14 consecutive quarters and that has to be excluded from the last 12 months, the fourth quarter of 2018, which indeed was strong on new equipment sales. The fourth quarter gross margin increased driven by aftermarket and contracting services and the operating margin grew to 9.9%, which was the highest margin seen in the fourth quarter and also in terms of operating profit, the best fourth quarter we've had so far. Moving to Slide 12. Looking at last 12 months SG&A, we also see an increase and as noted, an important factor there is the stronger ruble, but also some of the one-off expenses that we have seen related to the expansion to Germany. Our return on capital employed stood at 27% in the fourth quarter of 2019, a decline versus previous -- the previous period is partly related to the growth in working capital. But also the effect of IFRS 16 and also the addition of assets from the expansion to Germany. Moving onwards to Slide 13 and cash flows. We see that cash flow from operations before changes in working capital improved on the higher margins. We posted in the quarter, but then change in working capital had a negative effect on cash flows, and that is due to the fact that inventories and prepayments increased more than we saw an increase in payables. Inventories and prepayments partly increased as a result of the expansion to Germany. At the same time, with regards to payables, we did settle a meaningful payment to Volvo as a last step of transferring importation. So this was a payment related to the residual spare parts inventory that was transferred to us, and that reduced payables in the quarter for us. There was also a negative effect of tax and interest and especially interest payments were higher than last year. They stood at SEK 19 million in the fourth quarter. CapEx increased mainly due in the quarter to the acquisition of the assets and the business in Germany. Then with regards to cash flow from financing activities, also, the increase was very much driven by the loan we got to finance the acquisition of the assets and the business in Germany. Moving to the balance sheet on Slide 14, and looking first, year-on-year, we see that we have an increase in PP&E year-on-year to SEK 700 million, and this is driven mainly by machines for contracting services, which is on our balance sheet in Property, Plant & Equipment but also IFRS 16, and, of course, also the expansion to Germany, which is included in the year-end. Net debt increased year-on-year, mainly as a result of higher working capital, partly also due to capital expenditures and IFRS 16 and the dividend payment we had. And of course, the expansion to Germany, which contributed SEK 195 million of net debt. The cash position we had was partly driven also by the draw we did on the facility for Germany, which also left the cash position at year-end. There were also meaningful cash receipts closer to the year-end from the sales activity in the core business. Working capital grew mainly on inventories, and that's partly related to the taking over importation from Volvo, as mentioned. With regards to Germany, that contributed SEK 27 million in terms of net working capital to the consolidated balance sheet. In terms of increasing lease liabilities that includes SEK 95 million related to IFRS 16 from the 1st of January 2019. Working capital thus stood at 20% of revenue looking over 2019. And with regards to our leverage ratio, we had net debt and EBITDA, which stood at 1.2x. Turning to Slide 15, and our financial objectives and dividend policy. We will see here that with regards to the revenue target, the target there to triple our 2016 revenue in Russia and CIS by 2021, and we are currently more than twice the 2016 revenue more twice the 2016 revenue, more precisely 226% stand-off or best. With regards to operating margin, we have a target of 6% to 8% and in 2019, overall, we stand at 9.5%, so above that target. But I remind you that the target was adjusted following the announcement of the acquisition of this expansion to Germany. Net debt to EBITDA, our target range is 0 to 2x, and we currently stand at 1.2x. And I mentioned that a dividend will be proposed of SEK 4.25 per share in terms of -- which is in line with our dividend policy. So with that, I hand over back to Lars to comment on the outlook.

Yes, thank you. Looking into 2020, we believe that the market will continue to grow more or less in the same pace as 2019. However, should the so-called National Projects pick up speed during the year, there is a potential for additional growth. The existing fleet in the market, the population of machines is not really capable of handling potential National Projects, which then our infrastructure investments that are planned, and should they be realized during the year and for sure, there will be new equipment needed to do these projects. And also in the longer perspective, we are optimistic as the fundamentals in the machine markets in Russia and Kazakhstan are strong. As we've talked about many times, the market is still at 60% of what it was 6, 7, 8 years ago. The existing fleet is being depleted, and the replacement speed is not up there. So for sure, there is still a pent-up demand in the market. So we believe in the market going forward also long term. As for Germany, we believe that the demand for new trucks will remain high, although lower than in 2019, 2019 was a record year for the German market. But as we're right, we believe it will continue to remain high. And to summarize again then, we saw good growth in the aftermarket. Lower equipment sales compared to a very strong Q4 in 2018. We more than doubled the growth -- the business in contracting services. We were awarded dealer of the year for 2019 by Volvo CE. We completed the expansion to Germany. And we increased the ordinary dividend from SEK 3.75 to SEK 4.25 per share. So that summarizes the presentation. And I believe we'll open up for questions.

[Operator Instructions] The first question comes from Carl Ragnerstam from Nordea.

It's Carl here from Nordea. A couple of questions from my side. First of all, your 2020 guidance for Russia, does it include any of the National Projects? Or do you just see it as upside options?

We believe that the fundamental market will continue to grow, should the National Projects be initiated, which I haven't been yet for the infrastructures. That would be an add-on, yes, that's what we do.

Okay, perfect. And in terms of contracting services, I mean, it was quite a rather significant sequential decline, was that due to seasonal variation? Or I mean, due to weather or such worse? Or is it more project-related somehow, can you explain that?

And was with contracting services increased 100%, Carl.

Not sequentially, right?

Right. That is quarter-on-quarter, not year-on-year. And I think -- I mean, you would look at like, other service -- sort of other revenue overall. And I would say, Carl, that contracting services was quite stable compared to the third quarter. So if you look sort of on a project basis, we're unchanged there. So you will have some deviations quarter-on-quarter. But again, the project activity that we've been involved is the same. So yes, it's more or less stable performance there.

Okay, perfect. And you also talk about unusually high inflow of Chinese machines in the quarter. Can you say any specific reason behind that? And are you worried that it might be here to, I mean say, mid-term, long-term? And I guess, it will lead to price pressure if they will try to enter Russia, is that correct?

Well, first of all, I don't think we can speculate in what our Chinese colleagues are doing. In reality, we're not competing against them in this segment of small wheel loaders. We should also mention that in the statistics that we receive, the western manufacturers, including Volvo, are reporting retail sales, whereas the Chinese manufacturers are reporting deliveries from factories. So it's actually import of these Chinese machines, not necessarily retail sales. And we do not really see this as a -- it's an one-off effect, we believe, we don't see this as a trend.

I would also just add to that, Carl, that again, price pressure, I mean, maybe, but this is not a segment that we really are competing in. And that's why we present the numbers in the report, we make this qualification. These are not sort of machines that we're competing with.

Next question from Kenneth Toll from Carnegie.

So a few questions. The -- in Kazakhstan, do you feel that you're more or less done with the locations you have now? Or is it still a lot of work to do in establishing yourself in Kazakhstan?

I think we have been doing a good job in establishing ourselves this year in strategic locations. It will continue like we've done in Russia, where if big projects comes along or when big project comes along, we will put up on-site locations to support the customers there. But strategically, I think we're more or less done, maybe a few more locations out in the country. But so far, so good.

Yes. So not much more need for working capital or spare parts on inventory in Kazakhstan then?

Well, I mean, obviously, we're hoping to grow the business, and we will grow the business in Kazakhstan, which will obviously drive inventories but is also driving sales. So we're far from done in our expansion in Kazakhstan, but we're doing fine, we are on target, and it's a very, very potential and prospective markets.

And then I got a bit excited when I read the Volvo AB's quarterly report. When I read about construction equipment in the Volvo report, they were pretty optimistic about the Russian market saying that orders were up and deliveries were up year-over-year and they were very optimistic. And then in your report, you report lower shipment on new machines. So have there been any large sort of inventory swings? Or have you geared up your inventory for Q1? Or what could explain the difference between the Volvo optimistic view for Russia and your lower deliveries year-over-year?

Well, I mean, we have increased inventory also in Russia for 2020 orders. Again, coming back to the overall market, the one-off Chinese importation is included in the total market, which probably was depicted in Volvo's Q4 report. As we write in the report, this is exclusively importation of small Chinese wheel loaders to the market. So in the -- our market, so to speak, the fundamental market for our main product is -- we estimate as being more or less flat in Q4, but with a slightly higher order intake going into 2020.

Okay. And then -- sorry, the working capital as share of revenues jumped up in the fourth quarter. And one reason was that you started to take the German operations on your books, but also then that you became the importer in Russia, which you didn't -- yes, that you weren't before. But if we look at it a little bit longer term, I mean, in a year or 2, where do you think that the working capital as share of revenues could end up for Russia -- sorry, for Ferronordic in its sort of current structure?

Yes. Thank you, Kenneth. I'll take that one. I think -- I mean, you're right in terms of where we end up the year, it's partly driven by Germany, and we try to provide you with sort of the incremental contribution from there. It's partly driven by the transfer of importation to Ferronordic. And there we have concretely, as we also given the report a large settlement of spare parts inventory that was transferred to us. Actually, in the third quarter, the payment came through in the fourth quarter, so that reduced payables there. And then there were, again, order intake also in terms of positioning ourselves for the next year. Looking forward, Kenneth, we're cautious on giving guidance. But I think the transfer importation is something that will -- should be working capital neutral for us and cash flow neutral for us, but there is a transition period. So we do expect things to normalize, but it does take some time. That's the guidance I would give there.

Okay. So -- yes. So in the longer-term perspective, if you have a working capital share of sales of 6%, 7%, 8%, but that would be sort of a normal level where you feel that you could have enough equipment to serve customers, but still not too much. So it becomes expensive, would that be -- still be a fair level?

I think it will always depends on where the market is headed. If we're growing, there is a certain level there. And if the market, for some reason, is moving another way, and that will also have an impact on working capital. But I think somewhere between what you've seen historically and where we are now is where you should orient yourself against. We do expect as we work through this importation for working capital to come down to more normal levels.

Okay. And then finally, on Germany, you've had your hands on this organization for 2 months or so now. What are your initial feelings? Have you gotten any feedback from larger customers, employees? Or do you still feel that the plans you set up before you made the acquisitions that they are really doable in the pace that you've thought from the beginning?

I think, Kenneth, if anything I think that we feel more, what we should say, which we do believe having that the plans that we made up are doable and that we can grow the business and work according to the plan, and it's been a very positive experience so far. The takeover went very well, and we have gotten very good response and very good feedback from all stakeholders in this process.

Next question from Julien Batteau from Pascal Advisers.

Hello, can you hear me?

Yes, sure.

Yes, Julien.