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

Ladies and gentlemen, welcome to the Ferronordic audiocast with conference Q2, 2021. Today, I am pleased to present CFO, Erik Danemar; and CEO, Lars Corneliusson. [Operator Instructions] Speakers, please begin.

Okay. Thank you. Good morning, everybody. This is Lars Corneliusson here and I'm happy to present our second quarterly results. We see -- if we move on to Slide #2, you can see that overall it was a record operating results for us with Russian sales up 31% in revenue and market is picking up speed. We saw strong performance in our aftermarket and contracting services businesses. In Germany, we had truck sales in units which were up 47% compared to Q2 last year and obviously then gained market shares. We continued our investments in the service network and organization in Germany and for the group a record operating results, despite negative currency effects both in Russia and in Germany. And we had strong operating cash flows as working capital remained low. So if we turn to Slide 3, some more financial highlights. As I said, group revenue up 32% to -- close to SEK 1.6 million. Russia revenue up 31% in SEK and 54% in rubles. Equipment sales up 50% rubles, 28% in SEK; aftermarket sales, 34% in rubles and 14% in SEK. And contracting services actually more than doubled its revenue in rubles and then were up at 82% in Swedish krona. German revenue up 37% to SEK 336 million, where we saw equipment sales up 49%, which is 57% in euro; aftermarket sales up 28%, whereas other sales declined. And group operating profit increased by 37% to as I said before, a record SEK 144 million, where Russia increased 31%, Germany increased profit to 14%, still at a loss of SEK 13 million. And we had operating margin which increased then from 8.7% to 9% and strong cash flows as working capital declines to 3% of revenue. And net debt at SEK 143 million. If we then turn to Slide 4, some operational highlights. The market for construction equipment which we measure it in units, the total market, all product groups included grew by as much as 74%. It was -- the increase in the market was supported by improving business outlook, pent-up demand, strong commodity prices and increased government infrastructure spending. And the so-called national projects will now be implemented and we see strong demand from our customers for these projects. We -- there are still supply chain concerns and there are also potential changes in utilization. The -- at least rumors that we may temporarily boost demand going forward or have in --throughout the quarter, of course, possibly a pre-buy effect on expectation over increased utilization fee. In new construction equipment units grew 26% to 369 units. We grow most notably in sales of our bigger machine articulated haulers, forestry equipments and pavers. We have record sales of road construction equipments and we had an average sales ticket which was plus 25% in local currency and 5% in SEK, and obviously, that is mainly due then to the product mix there. One very positive thing is also that we again this quarter caught up with the ruble devaluation in the aftermarket sales. And then while we increased to 34% in ruble, that resulted in 14% increase in Swedish krona. And in contracting services, we have reached the planned capacity now at our operations in Norilsk. You might remember we have been mobilizing for 2 or 3 quarters. We are now at planned capacity and we have also expanded our operations in Norilsk -- Irkutsk. As we then saw contracting services increases as a percent of revenue, 5 percentage points to 17%, and we saw also good sales of equipment. Obviously, the aftermarket share revenue declined by 3% to -- 3 percentage points to 20%. And if we look into Germany, Germany in Q2 registrations were up by 20% for heavy trucks. And also here, a pent-up demand from last year and also the economic recovery obviously. It was mainly driven by the tractor segments. You can see tractor segments up 41%, whereas rigids are only up 3%. Our area represented around 19% of the German market and our area grew faster at 22% year-on-year, although only 2% quarter-on-quarter. And our new truck sales in units increased by 47%. And obviously, we took market share in the quarter then and may partly this is because some customers actually postponed purchases in Q1 this year, and we were waiting for the new Volvo models to arrive to the markets in Europe, which happened in April. Aftermarket sales increased by 28% SEK, 34% in euro, and this was partly due to the acquisitions of the workshops that we made, and these acquisitions contributed approximately 20% of the total aftermarket sales. And gross margin was at 9.6%, which is up from 6.7% from last year. Some words on business development on the next slide, 6. In Germany, we are expanding our network and we are improving the delivery to customers, so to speak, and we have then completed the acquisitions of workshops in Fulda, Nordhausen and Limburg. We are continuing to expand the network. We're also continuing to change processes and organization, as we speak, ongoing and including incentive structures and the new way of looking at CRM work and the system itself. In Russia/CIS, as I said, contracting services reached planned capacity in Norilsk. Our long-term customer GV Gold, we have further expanded our operations with that company in Irkutsk. And also very positive news for us is that in our rebuild center in Ekaterinburg, we produced our 100 main -- big component was produced during the quarter. And the first rebuilt machines had the warranty expiring during the quarter without any issues whatsoever. And we started our cooperation with some big mobile crushers and screens. In all of Russia, we launched in April and we're very excited about this cooperation going forward. But as you can see, we have just launched it in -- during the quarter. If we then turn to Slide 7, this is a picture of our network now in Germany where we closed transaction with Fulda in January, Limburg in April and Nordhausen in June. And we have also -- we are planning for a service and sales hub, a new one in Hannover, which will be a greenfield investment. The land has been bought and we are investing now in '21-'22, and hopefully, it should be ready by Q3 of '22. And by that, I hand over to you, Erik, for economic developments.

Yes. Thank you, Lars. If we can move to the next slide, please. And you should see there is some of the macroeconomic highlights. Operator, are you moving one slide forward? There we go. Yes. So to give the macroeconomic context, Russia, very strong growth in the second quarter, 10.1%. That is potentially versus the trough of last year. Q2 was when we had more or less of a full lockdown in Russia due to the pandemic last year. So if we look quarter-on-quarter, it's also up but less so. These are data from the Minister of Economy. Expectation for the full year, not as big as again the rebound versus last year that we saw this quarter. But 4.4% is still a strong growth and then an expectation of 3.1% in 2022. Inflation, transitory or not, is a big debate in global markets. But in Russia, it's also picked up as we emerge from the lockdown situation, the restrictions. So we saw 6.5% in June and that compares to 3.2% last year. As a response to that, the Central Bank has hiked rates, 50 basis points in June and then another 100 basis points after the reporting period in July, so now standing at 6.5%. Same period last year, it was 4.5%. So that is a meaningful increase. The ruble depreciated 18% on average and 13% on end-of-period used to translate the balance sheet. The average is for the income statement, so impacting our -- the way our financials look in that way. If we look at Kazakhstan and take there the first half of the year, we also see a rebound over a longer period as we have there the 6 month -- not as strong, but it was also strong in the second quarter. 3.2% expected for the duration of this year and then next year, 4%. And Germany, strong also. Low base effect partly from last year of course but picking up there 11% in the second quarter specifically. 3.6% expected for the full year of '21 and 4.1% the next year. So all markets expected to continue to recover this year and also see strong growth next year. If we move one slide forward, you will see a slide that we come back to and track for the market. And it shows, on the one hand, the market for construction equipment for Russia/CIS since the founding of Ferronordic -- Ferronordic was founded in 2010, but where the market was in 2011. And you can see that we're still only -- even after the healthy pickup that we saw in this quarter and have seen this year -- only 62% looking on a 12 months basis. So those 62% is last 12 months versus where we were in 2011. So we believe there is still quite some way to go for Russia to replenish its fleet and part of machines, and indeed to deliver on the infrastructure ambitions that the country has set itself. Our revenue is up 70%, despite that market being again significantly lower than it was in 2011. And our operating profit, almost 4x, 394% versus 2011 level. So quite a positive development in our financials there. If we move to the financial statements to give you an overview and a summary of what we've seen, we have then a total revenue of SEK 1.6 million. Strong growth there year-on-year of 32%, as Lars mentioned. Split is more or less unchanged of what we saw: 79% Russia; 21% Germany. We have been around that 4 bps of Russia and a bps being Germany. If we look at the revenue by activity also year-on-year, equipment and truck sales as a share is unchanged year-on-year. Aftermarket stand at 21%. That was actually 24% last year, so that's a decrease and that's due to the increase in contracting services. So that's now 13% of the revenue mix. It was 10% last year. And then we have a small part of other there which is mostly related to rental and car business in Germany. Gross margin, positive development to 18% versus 17.2%. That's driven partly by a higher gross margin in Germany, also slightly a higher gross margin in Russia, but a bigger pickup if we look year-on-year in Germany there. SG&A, so our cost overheads stood at 8.9% of revenue, down from 9.4%. So that's a positive development and that's much driven by a lower rate in Russia/CIS of 7.7%. That was 8.4% last year. If we look at the operating margin, achieved a strong result for the group there as a whole, 9%. And that's a result of a greater share of the operating profit coming from Russia/CIS and the margin being high there, 12.5%, same as it were as last year, but also a lower or less negative operating margin in Germany. We had some one-off costs again in Germany. Those are related to the acquisitions mainly that we have completed and engaged in during the quarter, SEK 3.2 million there. And as a result of these effects, we saw an increase of the operating profit by 37% for the group as a whole to SEK 144 million, and that is a record profit for a single quarter operating profit, which is encouraging. We had higher taxes in the quarter. That's partly due to higher operating profits and pre-tax profits rather, but also related to withholding taxes as we paid intercompany dividends from the Russian subsidiaries up to the parent company, partly to fund the dividend payment to shareholders in the quarter in May and that is subject to 5% withholding tax in Russia, and that was realized in the second quarter. We had lower financing costs as we had lower net debt. If you recall, last year during the pandemic, we did draw on working capital facilities in that environment to boost our liquidity situation. And that had some impact, of course, on the interest expense that we faced in that quarter. If we move to the next slide for a visualization of the movement in operating profit between the years second quarter '20 and second quarter of this year, you will see that the gross profit in Russia/CIS is the big mover. That is an effect of both then a higher revenue and a slightly higher gross margin. That growth doesn't come without costs. We have grown the organization, partly in contracting services, partly to support those sales. And then there are some low base effects also, I would say. We had, especially Q2 last year, almost a full stop on travel and marketing expenses and they should return, and they are returning to the business. We have some extraordinaries. We put it here in Q2, 2020. Last year, we had a one-off customs refund in that specific quarter, which also lifted the operating results that year. And then we have Germany, a stronger gross profit. There also big revenue and higher margin there as well, but an increase in cost as well. And those one-off costs that I mentioned related mainly to our acquisition and M&A activity. If we look quickly at long-term trends on the next slide, #12, we can see that we continue to grow our top line and that's both -- in both segments. So both segments contribute to the growth of the group. And this is showing the last 12 months trend. And again you can see there the group result in red and Russia/CIS in the black there, but again both contributing to the growth. If we look at the lower margin trends, that is the graph that you see to your lower left, then also good trends there. Stronger gross profit, but also then higher operating margin, again driven by the bigger contribution from Russia/CIS and a high margin there, but also a less negative margin from Germany. If we move to Slide 13, we can see the long-term trends, again last 12 months here. So rolling 4 quarters, you can say. There also a decline in SG&A expenses to revenue. So for the group, we ended up below 10% at 9.9%, which is something that we're quite happy with and much driven by higher revenue achieved from our cost base in Russia and a lower level there as a percent of revenue, both year-on-year and quarter-on-quarter. To your right, you will see our return on capital employed. Positive trends there also for the group and much driven by the higher operating income in Russia/CIS. But also we have a negative results from Germany, but that's lower than it was last year. So in that sense, also contributing to a better return for the group as a whole. If we move to briefly look at cash flows, we had again strong cash flows in the group as a whole, driven by the strong operating results, but also partly due to the low working capital we had in -- at the end of the quarter. Tax payments, I mentioned, were higher, both higher tax profit before taxation and then to some extent, the withholding taxes that I mentioned. Lower interest payments, again from that lower debt stock outstanding. And then cash flow from investing activity is higher and that's partly due to the acquisitions that we completed in the quarter in Germany, 2 of them mentioned by Lars, but then also investments in the Russia/CIS business. We make a point here, particularly that we had big additions of machines to contracting services as you see here, SEK 96 million. Rental machines -- also to our rental business of SEK 15 million. And those in the quarter are not in the cash flows. They are partly an increase in payables, but partly also a reduction owned inventory moved to PP&E. So that cash flow only will be seen in the cash flow statement when the payables come due. And cash flows from financing activities reflect mainly debt increase that we have taken in Russia/CIS. There is a question of leases for mainly the contracting services business and then debt funding in Germany, and of course, also the dividend payment that we made to investors in May of this year of SEK 109 million. If we move briefly to the balance sheet to summarize that on the next slide, #15, you will see an increase in PP&E versus the last quarter. I mentioned the increase in machines and contracting services. That's captured there. Also, the acquisitions again in Germany increases the property, plant and equipment. Against those factors, you would have of course depreciation, but also some effect from the currency. Remind you there that it was a 13% depreciation of the ruble, if we're looking at the end of the period rather than the average rate. Working capital in Russia decreased further. So we were at 0% over the last 12 months revenue, mainly an effect of higher payables. We continue to order in a strong market and inventory come out very quickly in the demand that we face. We mentioned in the report that these are low levels of working capital. We have typically historically seen between 5% and 15%. In Germany, a slight increase in working capital from 11% to 14%, mainly on higher inventories, but also less payables in Germany. For the group then, we ended up at 3% of trailing 12 months revenue in terms of working capital. And net debt increased, partly driven by the dividend payment that we had and partly by the investments, and that we've taken on to fund that. And we then end up with a net debt-to-EBITDA of 0.3x at this point. I mentioned last quarter, but closed in this quarter was the credit facility with Nordea that we as agreed. If we move onwards to our financial objectives to update where we stand, starting from the top there with revenue, our objective to double revenue by 2025, just set in the beginning of this year and we are moving forward. And when it comes to operating margin staying above 7%, while again 9% in this quarter, but trailing 12 months at 7.7%. So above that target and well below the 3x net debt-to-EBITDA that we set over a business cycle. And with that, Lars, I hand back to you for a few words on the outlook.

Yes. Thank you. And as you have understood from our presentation, obviously customer activity in our markets has improved and we expect our markets to continue to recover as the economies open up and of course again as a result of pent-up demand. As we talked about Russia sales, higher commodity prices, increased activity in the so-called national projects, that again moderated by potential risk of increased utilization fee. In Germany, we expect a broader European economic recovery to boost demand. Clearly, uncertainty remains regarding supply chain constraints, but in the longer perspective -- and also in the longer perspective, we see strong underlying fundamentals and business opportunities in our markets. So to summarize again, on Slide 18, this was our best operating results ever and good performance in all business areas and truck sales in Germany up 47%. So, I suppose that summarizes the business. And by that, I hand over for questions, please.

[Operator Instructions] We have a first question from Victor Hansen from Nordea.

So I'm wondering if you could provide any color on the national projects that you mentioned and that what you are currently seeing in the market? Is activity continuing to ramp up? And if you, in any way, could quantify the market improvement here versus last year, please?

Yes, we see a ramp-up of the national projects and there are roads being built, not only main highways, but also in -- throughout the country in [ parts ] and investments into railways and highways mainly. There is an attempt to accelerate those national projects to put up speed. But as we have mentioned, Q4, there is not enough capacity in the machine fleet, in this machine park and among the contracts to actually ramp up much quicker unless we sell more machines to the market and that is what we see happening right now. Obviously, as you all know, the supply chain is constrained and limited potentially, short term at least, the implementation of these projects. And that we need to use older machines to do that and it will not be as efficient, but the money is coming out to these national projects. I mean, we've been waiting for this for a long time, but now it is actually happening. So it's a good sign. I don't know what you mean with quantifying the market, Victor. Could you like some...

Yes. How much it has improved? How much more -- the project value versus last year, basically?

I can't tell you that exactly, but it was -- there wasn't too much last year. And how much has been spent yet, I can't really tell you. We know that roughly how much has been devoted to be spent, but I -- just totally, I can't give you that number because there are so many different projects in different -- not only from the federal government but also in the regional developments that are supporting these national projects, so to speak.

Okay. Wonderful, Lars. I appreciate the color on that. And a follow-up. To what extent do you believe this helped your sales in Q2 in Russia?

No, clearly, it has helped our sales. And as we said, we have record sales of road construction equipment. We have a very strong market share in road construction equipment sales. So it clearly has helped us. How much in exact percentages is very difficult to say because again the pent-up demand would have been there even without these projects because the machine fleet has been depleted since 2015 when we saw the slide. Here it's shown the margin is not even today big enough to replenish itself. So what is -- what's here, I think is -- the real question is when will the additional capacity be installed into the market to be able to finalize these projects really.

Okay. Great. And regarding working capital in Russia, it declined to 0% in Q2. And could this impact your ability to deliver machines of spare parts and possibly services in the near term?

Maybe I start there. I mean I think, Victor, this is a reflection of a tighter supply situation in a strong market. We order and usually, there is a certain stock turnover time, and that has been -- has shrunk basically. So I think -- I mean, to answer your question, it's a reflection of the fact that, yes, there are supply constraints. But we do believe when -- especially when it comes to service and aftermarket that we can definitely continue to service our clients. Can we capture all equipment opportunities that we would like to? Probably not. But that's a normal market situation as well. So, yes. And I think also as we mentioned in the report and as I said in the presentation, historically we've had a higher working capital. So these are low levels. If the current situation continues, strong market and some constraints in supply, then one could expect the working capital to remain low for some time. But ultimately, I would expect a normalization to occur.

Okay. And regarding your sales price, it improved in Russia and CIS. And I'm wondering if this is driven by price hikes possibly -- made possible from the strong demand or possible to mitigate currency headwinds or perhaps changed sales mix or anything else?

It's a combination of those 3 things. And obviously, when the ruble devaluates, there will be a price increase in the market eventually, and it comes. We also usually in a situation like this, we try to increase prices to the customers obviously in the real currencies to put it that way and also try to focus on selling machines, bigger machines where we have better profitability over time where the aftermarket requirements are very high. And it looks like an investment into the installed base of machines. So that is what we're trying to do in that situation ongoing now, yes.

Okay. Great. And so regarding your financial targets, your current EBIT margin, it's significantly above your group target already, with Germany set to improve. And given that you continue to perform well in Russia, it appears to me that your target is rather prudent. Do you have any comments here?

Maybe I'll start. Lars, you can add.

Go ahead.

I think it's a [ quote ] answer no. We stick to the targets that we set. I mean we set the target as above 7. And the development out over the horizon that we set those targets for will hold some differences I think in how the segment develops. We expect Germany to grow as we roll out the network. And even if the margin comes up there, it will still have, on the total, an effect of lowering. And then when it comes to Russia/CIS, well it is a lot depending on not only how quickly as we say, it is a stated business target to increase contracting services. We believe this segment or activity has a lot of potential for us, but it also depends on how we grow that business, how much we rely on subcontractors as we partly do in real. The more we rely on subcontractors and manage subfleets, the lower the margin will be, margin contribution, but on the other hand, the lower the capital commitment will be as well. So I think that we stick to our targets where we are now. And again it depends a bit on the growth opportunities that we find as we grow the revenue.

Okay. Great. And a final topic. For Germany, do you still target a breakeven results from the end of the year? And would it be possible for you to reach this with your current footprint? Or would you need to add more outlets as you are doing and guided for?

We stick to our targets to have a run rate of breakeven during the year. As you see, we have gotten some additional sales from the new workshops that we have acquired in the aftermarket. And clearly, the key to reach breakeven is to continue to improve and increase our aftermarket sales, and that we will continue to do. But yes, we stick to our target to have a breakeven level on EBIT this year.

Next question from Adrian Gilani from ABG.