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

Ladies and gentlemen, welcome to the Ferronordic Q3 Report 2020. Today, I am pleased to present CEO, Lars Corneliusson; and CFO, Erik Danema. [Operator Instructions] Speakers, please begin.

All right. Hello. This is Lars Corneliusson here, and welcome to this presentation of our Q3 results. And as you can see on the Slide 2, we had a record result and strong cash flow. In Russia and CIS, we saw strong unit sales growth despite lower markets. And overall, we had an organic sales growth that was partly hidden by a weaker ruble. Solid operating profit due to revenue mix and cost control, continued control. In Germany, unit sales was flat compared to Q2 as the market remained weak. As we have strong cash flow at SEK 100 million and lower net debt, and AGM approved a dividend payout of SEK 4.25 per share. Real numbers, it's 17% revenue increase, 1% operating profit decline, 9.5% operating margin but a 9% increase in EPS and our highest net profit ever in our 10 years' history. But if we move to Slide 3, some highlights for the group, where revenue then was up 17% to SEK 1.129 billion. Due to headwind on the ruble, Russia decreased 7%, but then adding consolidating German operations added 24%. As you can see, again, Russia total revenue -- Russia/CIS, I should say, total revenue, minus 7% in Swedish kroner but 15% in ruble. Equipment and after -- equipment, down 7%, but plus 15%; and aftermarket, minus 8% in SEK but 14% in ruble. Contract and services revenue were largely flat in kroner, but more than 20% growth in rubles. German revenue, minus 6% quarter-on-quarter to SEK 229 million. And the mix is that 59% was from truck sales, 31% aftermarket and 10% other. Operating profit was on par more or less with last year at SEK 107 million and in Russia/CIS, we had a record-high operating profit, which grew 14% year-on-year. Again, this is revenue mix and good cost control. Obviously, the group operating profit decreased due to a negative contribution from Germany, and we had an operating margin of 9.5%, which is above financial targets. Our net profit was SEK 81 million, which is a 9% increase, and we have lower working capital and net debt. We turn the slide to Slide 4, some operational highlights from Russia and CIS. The market for our main product groups declined 12% year-on-year. This is a decline, but it's a much smaller decline than it was in quarter 2. We saw some market recovery Q-on-Q as operational restriction eased, uncertainty decreased and due to pent-up demand. At the same time, our new construction equipment unit sales grew 21% to 292 machines year-on-year, and we saw again that our customer base continued to demonstrate resilience in their operations and maintaining their investment programs. As we increase the share of sales for escalators and backhoe loaders and decrease the share of articulated haulers in our portfolio, that resulted in a 27%, 10% in ruble, year-on-year lower average sale price. Aftermarket revenue share at 24%, which was more or less unchanged, while contracting services increased the share in our sales to 13%. If we go to Slide 5. Germany, operational highlights. In Q3, German market for heavy trucks declined by 15% year-on-year. This decline is also much less than it was in Q2. We should, however, remember that last year, there was a pre-buy effect in Q2 and the market dropped in the second half of the year. And therefore, the number is more or less flat compared to Q2. We saw, however, a late quarter recovery quarter-on-quarter, which was driven mainly by the tractor segment. Our sales area is approximately 20% of Germany and moved in line with the total market. So we sold roughly the same amount in Q3 as we did in Q2, 151 units. Aftermarket sales more stable and grew 4% as truck utilization showed signs of recovery and started to come in a bit more often in our workshops. We saw better gross margin but lower operating results, partly then due to restructuring costs. We are restructuring. We are building up our organization and business in Germany as we have planned. Obviously, overall, we keep focus on customer, employee health and safety, while continuing to deliver great customer service. Moving to Slide 6. A bit more on business development in Germany. We are -- as I said, we are restructuring the sales organization, the processes, the systems. Network review underway. We are intending to increase our share of the aftermarket business in our region. And I think we are on good track to do the restructuring in Germany. For Russia/CIS, we had -- talking about contracted services, we performed well in very challenging conditions, continuous lockdowns on sites and problems obviously with COVID. We then announced that we are going in as general contractor for palladium future mine site in Norilsk, in northern parts in Russia, where we then are now a general contractor. That includes road construction, drilling and lasting, overburn removal and site preparation for a future palladium mine site where we are preparing the site and we're preparing for the building of a processing plant on the site. And this is also interesting because we are subcontracting a number of players to perform these services. One also exciting news is that we are actually expanding our machine and component rebuild center in Ekaterinburg. You might remember that we opened it late last year, early this year. And we see good demand, and therefore, we are expanding our capacity in the center, where we are rebuilding and basically recycling machines and components, gearboxes, engines, for reuse and back into the market again. Another thing that we saw during the quarter was that there was increased activities and tendering for the national projects. The much-talked about national projects in Russia, we now see activities actually going on and tenders being awarded to contractors. That would logically give effect going forward in next year on machine sales as well. So that's -- by that, I hand over to Erik for economic development.

Thank you very much, Lars. Yes. Moving then to Slide 7 to get an overview of what the macroeconomic conditions and situation look like. It should come as no surprise that the economies where we are operating, our markets have been affected significantly by the COVID crisis, and in terms of Russia/CIS, also by the reaction to that in terms of the oil price, given, still, a meaningful part of these economies, depending on oil price. If we look 9 months of 2020, at Russia, we can see that we're down 3.5%. Looking at the full year, IMF believes that we'll see a decline of 4.1. Russian Ministry of Economics, slightly more positive, 3.9. Looking at next year, however, there is a consensus that we will see a recovery. So I am at there at 2.8, the Russian Ministry of Economy (sic) [Russian Ministry of Economics], at 3.3% If we look at monetary conditions, we have seen inflation easing. We were at 3.7% in September and are looking for a full year somewhere in the range, 3.7% to 4.2%, versus a slightly higher level in 2019. So a slight decline in inflation is expected. And that partly is reflected in the interest rate environment, but more so, of course, at the lower interest rates, a measure in Russia, as in other markets, to ease monetary conditions for companies in the light of the strains that comes with the COVID crisis or COVID situation. Russian Central Bank has lowered key rates by 300 basis points year-on-year to 4.25%. In this quarter, however, there was one move in the beginning of the quarter, down 25 basis points. The ruble has moved significantly, and that is partly reflected in our results, which I will get to shortly. Year-to-date, we see a 32% decline if we look at 31st of December to 30th of September, so 9 months, and that is driven by this economic uncertainty. There is a risk of. And then, again, the oil price reacting to the macroeconomic situation and the uncertainties surrounding the macroeconomic outlook. Kazakhstan, a similar situation, down to 0.8% in 9 months, 2.7% expected decline for the full year and then a recovery next year. And Germany in 3Q, lower than was expected. That's a preliminary estimate, but a decline of 3.1%. Still, IMF is looking for minus 6% in full year '20 and then a bigger recovery still next year as we hopefully emerge from the pandemic situation. If we turn to Slide 8 to look at the longer-term market situation and how we have performed in it, you will see, for those who follow our company, a familiar slide there with 3 lines, the lower black line being the market, the black line at the bottom. And what we can see is still a market that, in our view, has a lot of potential. We are still around half of where we were in 2011, '12. So we believe that there is not only a higher normal market in Russia/CIS, but also a series of years where there has been underinvestment in the machine part, and therefore, a lingering up demand. And as Lars mentioned, we have also seen an additional impetus from the national projects starting to be implemented, more slowly than maybe was expected at first, but now seeing some actual tendering going on there. So we do believe that, longer term, there is a lot of potential in this market. But even where we are now with a market that, again, around half the level of where we were in 2011, '12 our revenue is around 50% higher, 51%, and our operating profit even more so, 3x higher or 325%, as we have really leveraged both our business and our position in this market that we still believe has a lot of room to grow. With that, I will turn into the financials to give you an overview of that. So I turn to next slide, #9. And I think it's important again here to put in context the movement in the currency. The average rate is used over 3Q to convert the income statement from the Russia and CIS. There is the Kazakhstan here but it moved in a similar way. And then we had a 23% depreciation on the average rate year-on-year. When we turn to the balance sheet, even more so, there is 33% if you would look year-on-year. But there, we should also look quarter-on-quarter, which was 16% decline. Looking overview on the income statement, a total revenue of a bit more than SEK 1.1 billion. That's again an increase of 17%. But then Russia is showing a slight decline in Swedish krona, an increase in organic in rubles. And with the addition of Germany, so 20% of the revenue made up of Germany in the third quarter. Looking at the revenue mix, we had 62%, so equipment and trucks. So that's new. And used machines in Russia and Germany -- Russia/CIS and Germany, 26% coming from the aftermarket. That's the higher by about 2 percentage points, both on the second quarter and last year. And then 11% coming from contracting services. That's on a group level. In the Russia mix, contracting services was up at 13%, 1-3%. We saw a slight decline in gross margin, mainly based on the consolidation of Germany. As you can see to your left there, meaningfully lower gross profit there, about half of what we have in Russia. So that obviously fits into a lower consolidated gross margin. SG&A in Russia declined meaningfully year-on-year, almost 20%, 19%, and slightly quarter-on-quarter. Of course, the ruble is an important factor there. But I remind you here also that the revenue in ruble terms were up 15%, and you would expect some of that G&A to follow that up. So it's still good cost control as we see it as we hold on to some of the cost savings we implemented in the second quarter. On a group level, we are slightly higher, and that's again as a result of consolidating Germany. Operating margin at 9.5%, that's above our financial objectives, and that, despite the negative contribution from Germany of minus 7.3% in the third quarter. Operating profit, more or less flat year-on-year. And that's, again, the balance of a record result of SEK 124 million in Russia and a minus SEK 17 million in Germany. We did pay down loans. As you may recall, we did consciously build a liquidity buffer end of 1Q and through second quarter. And we did reverse that, and that is partly reflected in lower interest costs. And that helped us from them being flat on an operating profit level to reach a record net income at SEK 81 million, which is up 9% versus last year. If we turn and look at longer-term trends on Slide 10. What we can see is, starting looking at revenue is that we have a slight decline in Russia/CIS when we look at last 12 months rolling. And that is, of course, much driven by that 23% depreciation in this quarter average of the ruble. Otherwise, again, the ruble revenue was up 15% in the quarter. On the other hand, then we have the contribution of revenue from the German operations at SEK 229 million in the third quarter and about SEK 750 million in 9 months, which is, of course, still lower than expected due to the COVID situation that has impacted all our markets, but the German market in some ways more than Russia/CIS. When it comes to margins, we can see that we are about back at our more historical levels. If we look at the graphs, you see to your right, the trend. And that's then a combination of a higher-margin in Russia/CIS and then consolidating that lower margin from Germany. Similar when it comes to operating margin, also at historical levels on a group basis, which is the combination of a strong operating margin in Russia of SEK 13.8 million but offset by a negative margin from the German business at this point as we continue to implement new processes and organization in Germany. We did have a restructuring cost that impacted the margin in Germany in the third quarter of SEK 4.7 million, as you'll see in the report. If we move to Slide 11. We have there the longer-term cost trends and return on capital. Starting on the cost situation, slight increase again when we look on a group basis. That's why Russia and CIS has declined. But then seeing a higher contribution from Germany, 16.8% in the third quarter, as mentioned, partly an effect of the restructuring. That is a natural effect of the changes that we are implementing to improve the networking organization in Germany. When we look at return on capital employed, also an improvement, and that's then a high profitability in Russia and CIS that is driving that. When we compare year-on-year, of course, the capital tied up and the negative operating profit that we see coming from Germany at this point drags down the consolidated level somewhat. If we move on to Slide 12 and look at cash flows. There we can see a slight increase when we look year-on-year in cash growth from 95% to 100%. That's a result of the operating profit growth that we saw in Russia. We also had lower interest and tax expenses in Germany. We also had lower operating -- net operating capital, which contributed to the positive cash flows that we see. And across the group, again, lower interest, as I mentioned, financing costs and tax expenses. CapEx decreased year-on-year when we look at the CapEx line. I make a footnote there that we disclosed that, partly, this is an effect of machines that have been in inventory being transferred to a contracting services from inventory to PPE. And this is a noncash movement. So this is, you could argue, a cash flow that should be reflected in CapEx rather than in -- then sit in as a decrease of inventory noncash. So that was SEK 20 million in the third quarter, as you will see in the report as well. In financing activities, you can see effect of us paying down debt, as I mentioned. And then, as Lars said, we have approved the dividend payment by the AGM, and that's something that will come through quite shortly. That's not a Q3 event, but we paid out currently. As a matter of fact, today is the expected payment date on that dividend. Quickly on the balance sheet overview. Next slide, 13. Bring your attention again to the fact of the Russian ruble, year-to-date, a 32% decline; quarter-on-quarter, 16%, which is also a significant movement. And that has had an effect. Clearly, when we look at property, plant and equipment, there is not only a depreciation effect that we have. A big part of the PPE is now machines in the Oracle contracting services, and those are being depreciated. But here, we also have a meaningful foreign exchange effect, whether you compare year-on-year, year-to-date or quarter-on-quarter. Similarly, when we look at working capital, there is a big decline in Russia. That is partly a decrease in inventory that we're seeing, but there is also there a foreign exchange effect. And we did see positive cash flow in Russia, and that's reflected also in the net debt that we attribute to Russia/CIS. As you see, we have a net cash position that has gone from SEK 47 million to SEK 205 million at the end of the third quarter. Germany, also some decline there in working capital. A slight increase in net debt as we had a negative operating result. We did carry interest costs, and there was actually quarter-on-quarter a slight strengthening of the euro when you look at the end-of-period rates. Working capital now for the group, standing at 8% of last 12-month revenue. And that's annualized then for Germany. And that has released, of course, cash for us in the 9 months of this year. Last year, same period, we were at 18%, and we were as high as 20% net working capital to revenue at the end of last year on the December 31. The increase in working capital was driven partly by us taking over importation from Volvo. So rather than buying equipment and parts in Russia, we started last year, buying them from the sites of production. And that was part of the reason why working capital grew, and that situation has now normalized. As a result, partly of that working capital release and the strong cash flows that we've seen, net debt has declined further to SEK 83 million and net debt-to-EBITDA at 0.2x, which is well within our financial targets. If we turn then, on that note, to the financial targets. On Slide 14, then we currently, when it comes to our revenue target, tripling our Russia and CIS revenue from 2016. By 2021, we're at 2.2x. So somewhere still to go as we enter next year. When it comes to operating margin, we have an objective of 6% to 8%, where last 12 months at 8.1%. But I remind you then that, that's one quarter, the fourth quarter of last year, so that is excluding Germany. If we look at 9 months of this year, that's maybe more indicative, we're at 7.6%, so in that range and again, net debt-to-EBITDA at the moment at 0.2, which is -- well, of course, at the lower end of the objectives that we set ourselves. And with that, I hand back to you, Lars, to say something about the outlook and before we open up for questions.

Yes. Thank you. Well, obviously, the COVID situation and the measures to contain the spread of it has caused, as we all know, uncertainties across our markets. And we might face for the rest or 2020 and 2021, again, various degrees of disruption in supply/demand and customer interfacing. What we've seen in October is that the business trends from Q3 have continued. I think our business have adapted very well to the challenges related to COVID-19. But as cases are again picking up, restrictions are reintroduced. We fully recognize that the future is uncertain and visibility is low. However, currently, we expect the markets in Russia/CIS and Germany to start to recover next year. And obviously, in a longer perspective, we are positive as we believe the underlying fundamentals and business opportunities in our markets are strong. We're building on a great team. We have strong brands. And we see long term, very strong and good opportunities for market growth in our markets. So that's about the outlook. And then maybe we should summarize just again. It was a record net result and strong cash flow. Strong unit sales growth despite the lower market in Russia and CIS. Organic sales growth, partly hidden by a weaker ruble. Solid operating profit, our highest operating profit ever in Russia due to revenue mix and cost control. Unit sales in Germany, flat quarter-on-quarter. Market remained weak. Strong cash flow and lower net debt and approval of SEK 4.25 dividend per share being paid today, actually. So I suppose then we open up for question and answers.

[Operator Instructions] Our first question is from Karl Bokvist of ABG.

Yes. So 3 questions, I think, to begin with. The -- first of all, is when it comes to, as you say, the visibility is low. But have you seen any indications from the Russian government when it comes to these larger infrastructure programs or spending that things are moving?

Yes, we have. And in Q3, we actually saw contracts being awarded for road construction. And it is starting. It is not in the magnitude that was initially planned. But we do see contracts being awarded for the national projects, which is a positive sign, obviously, and which should then result in equipment sales in next year.

And just a follow-up on that, when you mentioned not in the same magnitude, is there any particular area of the bigger program where you see a little less spending than initially expected, perhaps if we look at affordable housing or infrastructure or those kind of there?

I think it's -- the national project, in general, are being implemented slower than was anticipated in the beginning. And it has been changed, the time schedule for it, not really the magnitude of it, but the time schedule has been prolonged, which I think is a reasonable and realistic time schedule rather than having them all finished by 2024, it has now moved up to 2028. And for instance, one of the roads now that have been tendered is a new highway between Moscow and Kazan, which is 700 kilometers. And it's not realistic to build such a road in 3 years. So we -- but in general, there is no break being predominant more than speed, if I put it that way. So this is positive, and we've been obviously waiting for a more broader scale implementation, which we see happening now, actually.

And my second question has to do with working capital. This has been -- it's been a topic over the past quarters. And you're making very, very steady progress, and you're now down at the kind of high single-digit percentage in relation to sales numbers that you guided for might be a realistic long-term level. So do you think that -- let's say that markets start to recover from next year and onwards, could we see a bit of -- perhaps a short-term inventory buildup again? But overall, you're confident that you can now maintain this level and keep it in line with your long-term ambitions?

You want to take that, Erik?

Sure. I can take it. I think, I mean, we're now back at a situation that we would qualify as more normal. I think if we see a pickup in markets, a recovery following this crisis, then we would need to build up inventory and take on more. But that said, Karl, I mean we would expect that to be accompanied by increased sales. So I wouldn't expect that per se to lead to a higher, as a percentage of sales, working capital. It's a lot about how quickly we can turn the inventory we carry. And I remind you obviously of the different dynamics there with Germany, to a greater extent, being customer-driven. But therefore -- partly, therefore, also us having a shorter payment terms there. Whereas in Russia, we need to carry bigger inventory to meet customer needs. And then it's a bit more looking forward and taking cautious steps to build inventory to capture the market as we see it developing. And then it depends again on how that market pans out. So I think it is a natural part of our business that we will have some variability in the total working capital. But again, the kind of things that we had before, that was at least partly related to this structural change in us taking over importation. So in a business-as-usual and growth situation, I would not expect that to reoccur.

Understood. And third question is more of a long-term one. And I think maybe it's up to you to say if it's more on the -- up to the Board or of to management here. But I mean, you continue to have a very, very strong return on capital. And just -- it would be interesting to hear your thoughts over the coming 3 to 5 years in terms of how you view your capital allocation strategy when it comes to continued growth expansion, dividends -- of course, you have a dividend target, but share buybacks and things like that, given that you -- well, just hearing your thoughts in terms of how you would like to allocate capital going forward, given that you have already undertaken quite a lot of expansion activities in the last year or so.

Yes. Let me --

Do you want to start, Lars? Or -- Lars, you start right.

Well, I mean, from a strategic point of view, if we start with that, we have an intention to continue to grow, and we want to grow in related areas of business in adding products to our portfolio. We want to continue to grow geographically. These strategic objectives have not changed. Obviously, we have a lot of things to do still in Russia. We are investing more into contracting services. We're building up our rebuild center. We have Kazakhstan that is in the initial phase of its expansion, and obviously, we have Germany, which is under-invested and needs improved network to be able to increase customer satisfaction and market share. So from a strategic point of view, that's what we're doing now. But clearly, we want to grow further. But I think for the time being, we need to deliver on the commitments to ourselves and to our shareholders and to Volvo, what we have taken on, and then take the next step later on. So that's from a strategic point of view. From the capital allocation, I leave you -- I hand it over to you, Erik.

Yes. So just maybe building on that because, obviously, the capital allocation will follow the strategy of the business. Well, I mean, we have growth ambitions in the markets where we're currently at. We're developing in Kazakhstan. Russia, as we've stated, I mean, we see much potential to grow further, and that's across our business areas. So there is a potential there to invest more capital, the contracting services and the core business as well. There will be need for that. At the same time, we are in a situation we're developing in Germany. There is a need to invest in the network there as we have communicated. So those are priorities to us, and we think they will deliver good returns to shareholders. And that's the current trajectory we're on. And then in addition to that, we are continuously looking for new markets, as you know, and potential new business areas as well there are related -- closely related to what we're currently doing. And that's maybe then not on the current trajectory, but something for the future. And besides that, Carl, I mean, the dividend policy is at least 25%. That's how we put it. So to the extent we generate good cash flows and have a strong balance sheet, and we don't see high-return opportunities that we believe will deliver more value to investors, then there is room for making higher dividend payouts. But we put this guidance and we communicate our targets for the market to know what we're aiming for, basically. So yes, that's what I would say. I hope that answers your question to some extent.

Our next question is from Kenneth Toll of Carnegie.

A couple of questions. First, you grew the aftermarket sales by very high numbers. What happened there? How did you manage to grow so much? And do you think those growth rates are sustainable?

Well, I think if you look on our aftermarket sales for a number of years, it doesn't stick out. Particularly this quarter, we have good traction in the aftermarket. We're getting closer and closer to our customers. We're making sure that they purchase our services and parts in the market. And we believe that we can -- there is still room to grow the market share, as we call it, and penetration in our own fleet in the market. So that is in the core of our business now. we're basing it on aftermarket. Of course, it gets more difficult for every year to grow your market share, but we still see opportunities to grow that, Kenneth.