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

Welcome to the Ferronordic audio cast teleconference first quarter 2022. Today I am pleased to present CEO, Lars Corneliusson; and CFO Erik Danemar. [Operator Instructions] Speakers, please begin.

All right. Good morning, everybody. This is Lars Corneliusson and welcome to this presentation of our first quarter 2022. And if we move on to Slide 2, obviously, we are in troubled times, and the business has been affected by the conflict in Ukraine from end of February. In Q1, we had a 38% revenue growth to SEK 1.746 million as demand remained strong. So all in all in Russia/CIS revenue increased 32%, partly due to machine product mix and growth in aftermarket. And we saw a 9% operating margin, which was affected by SEK 45 million in provisions. In Germany, we saw the truck sales increasing by 66% in units in a flat market, so we took obviously market share. Revenue increased 62% due to new strong new and used truck sales and growth in aftermarket sales. So all in all, 38% revenue increase, 36% operating profit increase, 6.3% operating margin and an earnings per share increase of 12%. And obviously, on Page 3 then, after 24th of February, the EU and other countries have imposed far-reaching sanctions and restrictions on Russia, some of which affect our products. And some of our key partners, including the Volvo Group, have suspended sales and deliveries to Russia. Logistics and transportation to and within Russia is very difficult. Monetary and currency conditions have been volatile. The payment system works locally, but international transfers have some limitations. Obviously, we're working to adapt our organization to the new circumstances. And we're not restricted by sanctions. We continue to service our customers and sell products from inventory and from partners that continue to deliver. Demand in the market has so far remained high and market strong. However, if this is protracting further, the situation poses significant risk to our business in Russia. And we are indeed considering contingencies and our options for the future. And we may need to review our financial objectives. Our businesses in Kazakhstan and Germany are not directly impacted by the situation, and we continue to develop these markets. So if we move one slide to Slide #4. Again, some group highlights. Revenue up 38% to close to SEK 1.8 billion. CIS revenue up 32% in SEK with equipment sales strong at 37%, aftermarket sales up 33% and contracting services 11%. Even more growth in Germany with revenue up 62% to SEK 420 million and where the equipment sales then was up 80% and good growth also in aftermarket and other sales. So that meant that our operating profit increased by 36% to SEK 108 million. Operating profit from Russia was SEK 119 million, whereas the German operating results increased to minus SEK 10 million from a loss last year of SEK 14 million. We had negative cash flows on high working capital and investments made in January, and we ended the quarter with a net debt at SEK 255 million or 0.3x EBITDA. On Slide #4, more on Russia, Q1 operational highlights. The market for construction equipment grew by 25%. And before February 24, we saw strong demand due to pent-up demand, strong commodity prices and continued spending on big infrastructure projects. And actually after February 24, the markets and the prices continued to grow, partly driven by concerns of ruble depreciation, inflation and upcoming supply issues. As we said, key partners, including the Volvo Group, have suspended sales to Russia, so in March, our sales were made from existing inventories. Unit sales, construction equipment increased by 17% and average sales price increased by 18% in local currency and 14% in SEK and very strong growth in aftermarket sales by 32%. In contracting services, we had challenging operating conditions due to a very severe winter conditions and that affected production and it actually declined slightly quarter-on-quarter. And we have 5 machines and 84 components that were processed in our rebuild center. If we go to Slide 5 and look at Germany, as we said, based on registrations the total German market for heavy trucks was flat. Rigids declined a little and tractors were unchanged. We saw a continued recovery in economic activity and pent-up need for fleet replacement that boost the demand. But the market growth is held back and is continuously held back by supply constraints. In our area, in Germany, new truck registration increased by 4%. And then our part of Germany is -- German market is 18% of the total. But as we then ourselves increased our unit sales by 66%, obviously, we took quite some market share for Volvo Trucks further in the quarter. And as I said, good development in the aftermarket sales. We'll continue to Slide #6, we started operations at a new workshop in Bad Hersfeld which was -- we're filling an important gap in our growing network. We continue to market and demo electric trucks to our customers. In Q1 '22, we signed the first orders for heavy, fully electric Volvo FM truck that will start to be produced towards the end of the year. And we installed first wall-boxes for equipping our network for electrification and we received state subsidies for promoting electric transport. And we are very excited about working with our partners and customers to further develop e-mobility in Germany. So a summary of our network expansion on Slide 8. We then added -- as we can see, we have -- since we took over the German network or Germany in early 2020, we started our expansion when we're closing transactions in January '21, April '21, June '21. And we are in -- as we speak, building a greenfield state-of-the-art service and sales hub in Hanover, which we expect to be ready by Q3, Q4 this year. We took over Bergstrasse in October '21, Bingen in December '21, and then we started operations in Bad Hersfeld in the end of the quarter, and we now have 16 operational outlets in Germany as of March 2022. So by that, I hand over to our CFO, Erik Danemar, to continue.

Yes. Thank you, Lars. I will then continue on the next slide. First, with the big picture, economic development macro as we typically do. And starting -- looking at Russia, our local authorities reported GDP as up in the first quarter, 3.7%. But looking forward, using IMF forecasts, we're looking for a decline in the market of 8.5%. That is their forecast. And then in 2023, a negative 2.3% GDP development. Monetary conditions were volatile in the quarter, of course, especially in the latter part of it, after February 24. Inflation in March increased to 16.7% that compares to 5.8% in the same period last year. In response to this, the Central Bank raised key rates to 20%, that is from 9.5%, so a very significant increase. After the reporting period, rates were lowered, 300 basis points in 2 occasions, down to 14%, and that's where we are at this point. The ruble was also very volatile, depreciated very sharply and then appreciated. If we look at the reporting period, we see an average depreciation of 4% that is affecting the translation of our income statement. And if we look here on the balance sheet, that is the end of the period, 10% compared to the previous quarter at the end of 2021 that is. Kazakhstan saw a strong growth in the first quarter, partly driven by strong commodity prices, supporting the economy there. And growth is expected also in the full year 2022. It's expected to slow down and average 2.3% and then increase next year 2023 to 4.4%. Germany, also strong growth in the first quarter and 2.1% expected in the full year and 2.7% in 2023. If we then move on to look at the financials of the period. Moving to the next slide, we'll see, as Lars mentioned, the total revenue of close to SEK 1.8 billion. The revenue share of Germany increased up to 24%, so almost 1/4, and that was driven by strong new truck sales, as Lars mentioned, in units up 66% and more so in revenue. But also a strong growth in our aftermarket, partly driven by acquisitions and partly by organic growth. The revenue mix was more or less as we typically have. So around 2/3 of equipment in truck sales, 65% -- 23% aftermarket and 10% contracting services, and then you have 1% other, which is mostly trucks rental in Germany. Gross margin was stable at 17.2%. SG&A as a percent of revenue stayed below 10% down versus the same period last year, mainly driven by Russia with a lower rate at 8.6% and strong revenue in both segments. Operating margin declined and that was partly due to additional provisions in Russia/CIS. We took SEK 45.3 million in the quarter. Those were related, amongst other, 2 contracts that may not be completed due to the suspended supplies, but also to our stock inventory in Russia and also potential credit losses. Operating profit then increased 36% to SEK 108 million, and the net income increased 12%. We did have significant FX losses in the quarter. So that explains the drop from the operating profits to the net income. Also slightly higher taxes in the period. If we move to the next slide to our EBIT bridge, which really just encapsulates what I said about the income statement here. We see a strong top line-driven growth picture in the EBIT, some increase in SG&A, although not as a percentage of revenue, but rather in absolute terms. And then the provisions that I mentioned, all of them relating to our business in Russia. German gross profit increased, but so did also SG&A, as we increased our network as a part of that is again driven by the acquisitions that we did through 2021, but also some sales-related costs that increased with the higher sales levels. If we move to the next slide, briefly on cash flows. We had a negative total cash flow from operations. That was partly driven by an increase in working capital for the group, which in turn was on the German side. We did also pay a higher income taxes and interests in the quarter and taxes were partly related to withholding tax. Russia working capital was -- sorry, Russia/CIS, so including Kazakhstan, was more or less stable, slightly down, mostly driven by lower inventories. And that's again, mostly on the Russian side of Russia/CIS, so Russia and Kazakhstan. In Germany, cash flows from operations were negative partly due to the operating results but also an increase in working capital there, which was driven both by higher inventories and a coincidence of lower payables in the period. Investing activities in the first quarter related to acquisitions of trucks for the rental fleet in Germany and also additions of machines to contracting services that were made in January of the period. If we look at the balance sheet on the next slide. We can see a decrease in property, plant and equipment, so our fixed assets partly driven by depreciation and partly by ruble depreciation. Note the foreign exchange rates used for the translations they are included in this slide. Again, Russia, working capital largely unchanged at 1% of all the last 12 months revenue. As did were in Russia, we did sell down inventory in this situation and used it to pay down our payables, which then reduced the overall scale of the balance sheet. In Germany, we had the increase, as mentioned, in -- and if we speak about working capital as a percentage of revenue, then a increase from 6% to 12%. Net debt, a small increase from year-end to SEK 255 million, which then equals 0.3x EBITDA over the last 12 months. If we move one slide forward. In this quarter, we released some additional financial information. We disclosed Russia standalone financial statements. So this is taking the Russia results separated from the Russia/CIS part and disclosed that for -- the end of last year, so the fourth quarter. If we look at the balance sheet, also the end of the first quarter, so 31st of March, and then preliminary for April of this year, so April 2022. And this is, of course, to give the market some insight into both the most recent position of the balance sheet, but also the movement in the balance sheet between these periods. I stress that these -- the April numbers are still preliminary. I would also point to the FX rates, which we have included, which has been applied to translate the balance sheet from Russian rubles to Swedish krona, which explains part of movements in the balance sheet. And you will also have a preliminary April sales results disclosed here. Again, they are preliminary, I stress, and you also have the FX rate used there for the translation. If we move on to the next slide, Lars mentioned that due to the current situation, we may need to revise, review our financial objectives. We do need more visibility on how the current situation develops before we engage in that. At the moment versus our stated financial objectives, we stand over the last 12 months at 1.4x 2020 revenue, 7.6% on an operating margin basis and 0.3x EBITDA, so -- within those financial objectives that we currently have. And with that, I pass the word back to you, Lars.

Yes. And obviously, if we try to look a bit forward, obviously as a result of the military conflict in Ukraine, the subsequent sanctions, counter-sanctions and suspended deliveries from some of our main partners, the prospects for operations in Russia have deteriorated significantly. In addition, the impact of the sanctions on the Russian economy could also be very significant. And if the situation continues, it poses risks to our business in Russia. Our operations in Kazakhstan continue but are a smaller part of sales and may also be adversely affected by a worsening economic situation in Russia. In Germany, we believe that a continued recovery from the pandemic will lead to increased demand for trucks and service. The geopolitical situation may, however, also affect the German economy and markets in the longer perspective. We nevertheless believe that the underlying commissions and business opportunities in the German market remain strong. So by that, I'm handing over to the operator for questions and answers, please.

Thank you. [Operator Instructions]. The first question comes from Adrian Gilani from ABG.

It's Adrian here from ABG. I'd like to start off just with a few questions from the preliminary April figures that you released. So starting off you had SEK 900 million roughly in inventories in Russia. Is the strategy here to sell off the current inventory as quickly as possible? Or are you looking to sort of spread out these sales to make the inventory last longer?

Thanks for the question, Adrian. I think we continue to work as we are allowed to comply with sanctions and provide products and sell products and services as needed in the market. So I think we will pace it as we see reasonable in the market.

And just regarding the PP&E of roughly SEK 650 million. I assume that a fairly significant portion of these are the contracting services machines. And so we expect that these machines would have any significant reselling value as well if the Norilsk or Irkutsk contracts were to be run out and you can't renew those contracts.

Yes. I mean we -- again, here also we continue in line with what's allowed in contracting services. And yes, we believe that there is a secondary market for machines as well. But again, we use them in the current operations now.

And do you have some sort of indication of how much of the PPE and Russia roughly are the contracting services, machines?

No. We don't provide further breakdown than we have here. But you're right to point out, Adrian, that most of the fixed assets in Russia relates to contracting services. There is, as you're aware, also some real estate and some parts of the network that through IFRS 16 would come in there as well, but the bigger part relates to contracting services.

And just on the sort of current status of the operations obviously contracting services -- the current contracts are still running. But -- and at the moment, you're saying that this could be renewed as well. Do you have some sort of indication on when the 2 main contracts here expire.

Well, they're continuing to operate, and we don't disclose that contract trends, but they are continuing to work.

I think, I mean, generally, Adrian, if you remember that those contracts tend to be relatively long-term, so they're between 3 and 5 years typically.

Okay.

And as also we don't disclose when they mature.

Okay. And also regarding the smaller suppliers that are still active, is it possible at all to sort of scale up the partnerships with the smaller suppliers to make up for some of the lost sales if Volvo doesn't return or takes time to return.

Yes. We do expect that part of the business to grow for sure.

Okay. And also just one final question on Germany. Just to clarify the wording here. When you say that Germany is expected to reach a positive operating profit in 2022, just to clarify, does that mean for the full year 2022 or that it will reach a positive result during the year, sort of?

We expect it to reach positive result for the full year.

Okay. I just wanted to clarify.

Thank you.

The next question comes from Victor Hansen from Nordea.

First, a question on the Russian operations related to equipment and the aftermarket. So if you could give an update on how the adoptions you mentioned of the Russian business is going, perhaps what the current OpEx run rate is? And also, if you have materially reduced headcount or outlets.

Yes. Thank you much, Victor. I mean we don't here provide numbers. What we say is that we have adapted the organization and we've continued after the reporting period to make adjustments to changing and very volatile operating conditions. We have not reduced the network footprint, but we have made cuts in the organization, and we will continue, Victor, to be responsive to how the situation develops and changes. I think that's what we can say at this point.

Understood. And then on contracting services, perhaps to follow up on Adrian here. Are you able to continue with contracting services, as I believe your efficiency could suffer without any new equipment or spare parts from Volvo Group. Would it be possible to perhaps exit your current contracts, which are going well into 2023, as you mentioned, and beyond? Or what's happening here? And then finally, on this topic, are you mainly using Volvo machinery or are you using a lot of other equipment as well perhaps if you haven't, speak.

Yes, I mean the -- it's very difficult to answer how we can see the future in these conditions that we're operating in. At the moment, yes, we can continue contracting services. Clearly, as time goes, you're right that if we can't replace all the machines, it will become -- it will have an effect on productivity. And of course, contracting services main -- so big business concept is to have a higher productivity. The vast majority of the machinery that we have in contracting services or Volvo machines. There are some other auxiliary equipment, for instance, and products that Volvo might not produce from other brands. But as it stands now, the majority -- vast majority are Volvo machines.

That's helpful, Lars. And then on Germany here. I believe you currently have a long-term target of a 5% operating margin. And I'm wondering how much further outlet expansion would you say is needed to reach this target? And then I assume that there are efficiency and volume components to this -- to reach this target as well. Would it be possible to get a rough bridge or some sort of walk-through on how you are planning to reach this 5% target?

I think, Victor, first thing, I don't think we actually gave ever a specific EBIT target. I think it's been backed out from our financial objectives when we changed those when we entered into Germany. But of course, we do expect to move higher on the EBIT. Now to get there, when it comes to the strategy, the core of that is really to take a bigger share of the aftermarket in the area where we operate. And to do that, in turn, we need to further build out the network. I understand you would like sort of a number of outlets, but it depends a bit on how we build the network. And it may be that we can provide more transparency on that at some point. But at this time now, I would say that -- what we can say is that if you look at the map, there are points where we're not, and we need to be and we need to have presence there. How many workshops there would be, it depends a bit on the format of those workshops. You can work in different -- how do we say, strategies there. You can have bigger hubs serving a bigger area or more -- a bigger number of smaller workshops. So I think that depends. And I think you may be driving towards CapEx as well over time. And that is also the reason why we have never specified that as we want to help the market understand, but it depends also if we do greenfield or if we acquire or if we lease something existing. And maybe there, what we could indicate is that I think when it comes to acquisitions, we probably, over these past 2 years, found sort of the locations that we thought we had to purchase because they were in very strategic locations, and we needed those. So probably what's more left is more of greenfield/ least current stations. And I think that's what I can say now, Victor. Of course, we expect there to be meaningful scale benefits of growing the top line. And that's both in terms of new truck sales, of course, to build the population and build that aftermarket, but then maybe more so from growing the aftermarket where the margins are also better.

And let me add there also, I mean, one very important part of the strategy to capture more aftermarket is actually to apply mobile service that is very, very common within the construction equipment also to trucks and basing in bigger hubs and actually going out to customers, serving customers on site, which is, of course, a very good offer, particularly for instance, construction customers that are used to us for many years from working with construction equipment. And we are entering into doing that in Germany to additionally reach a better coverage for our customers.

That's very helpful. And a follow-up on Germany here. Would you say that sales leasebacks of your real estate that you acquired is an option here to improve the balance sheet is needed to?

Victor, I mean I would say it is an option. We always look at opportunity to optimize our funding costs. So yes, it is one of many options that we would consider.

And then just a final question. Perhaps if you could remind us on what leverage level your loan covenants are based on.

I don't think we have disclosed that, Victor. So I think maybe for you, maybe more to look at the current financial objectives. I think it's reasonable for you to assume that they would be in line with our financial objectives.

Thank you. The next question comes from Kenneth Toll from Carnegie.

Yes. Thank you. A lot of questions have been asked. But what are the possibilities to bring on the new brands in Russia? I mean, there are producers of construction equipment that are based in countries that are not sanctioning Russia such as China, for example. I know that those products coming out of China are very, very different from the Volvo products that you are used to work with. But would that be a possibility if the sanctions drag on for a very, very long time.

Well, first of all, Kenneth, as an EU company, we must abide by the EU rules and regulations and by the undertakings entailed by our agreements and with our suppliers. And with regards to products that are not sanctioned by EU, we were in close dialogue, obviously, with our existing partners on potential changes to the portfolio. That's probably what I can say.

And then also the Kazakhstan operations, when you moved in there, you said that this is like adding another region to Russia because there were trade agreements and same language and everything. But if it becomes harder and harder to operate in Russia, could you -- would it be possible to operate the Kazakhstan operations as standalone apart from Russia? And would it be possible to get such operations profitable in such a case?

Yes. I mean we see a good traction on our business in Kazakhstan. We're developing now. We're expanding that. We're taking market shares. We're getting the brand known, both Volvo brand, but also the Ferronordic brand. And yes, it can operate standalone. And yes, it can -- standalone be a profitable market. And I think we've more or less built the platform in Kazakhstan, but it's going in a good direction. So yes, the answer is yes.

[Operator Instructions] The next question comes from [indiscernible]

I just wanted a little bit clarification. It's still a bit unclear for me so, because the sales in April were still quite good. Are these sales then mostly coming just from your inventory?

The sales are coming from the inventories and from suppliers that continue to deliver to Russia. Most of the sales are from inventories, yes.

And I don't know if you can clarify on that because Volvo is your largest supplier. They are not -- they don't want to supply to Russia anymore. Are there -- are they the only ones or do you have other suppliers who also don't want to supply Russia anymore?

We have other suppliers as well that have suspended deliveries, yes.

So is it correct to assume that if the current situation stays like this for a long time because sales are now still quite good concerning the -- how bad the situation actually is, is that in couple of quarters that there will be -- we can assume there will be like a sales cliff or a steep drop in sales once all inventories are depleted?

I mean, I think we say in the report that we do expect in the current operating environment that we expect sales to decline as the inventory decline, that's the environment we're currently working on. To some extent, they're compensated by the suppliers we have. Suppliers that continue to suppliers to Russia maybe some increase there. But again, the current inventory, yes, the sales will decrease as the inventory declines.

And can you share with us the percentage of revenue that comes from suppliers, which have suspended deliveries to Russia?

No, I don't think that's something we disclose here. I think what I could maybe -- I mean, point towards would be for you to have a look at the Annual Report where we saw sales that would be in 2021, so it wouldn't be directly applicable but you would get a sense -- a good sense, I think of the product and supplier mix that we have, and then you may be able to form an opinion.

And concerning the limitations on payments, is it still possible for you to transfer money to Sweden or outside of Russia or are you also limited there?

So when it comes to payments, maybe to start in Russia, the payment system is restricted in various ways. When it comes to Russia, we can make payments, receive payments, et cetera. Some banks have been restricted by the regulations. In that case, we had fund works -- ways to work with our client base in -- through different channels. When it comes to international transfers, the current account is open, so to say to pay for services and products, that's still possible. So we can make international payments in all currencies there. When it comes to the capital account, so meaning debt and dividends, there are restrictions and they are complex, and it comes down to case-by-case reviewing. So that's more complex.

That then more limitations imposed by Russia itself then?

Correct. Those are -- yes, from -- inside Russia. I mean it -- when it comes to restrictions in Russia, that's more driven by EU regulations. Yes.

Those were -- and because I did not fully understand I think the question was asked before, my apologies. I had a bit of a difficult line then. Do you expect the German market or your German business to be EBIT positive for the entire 2022?

That's correct, yes.

Thank you. There are no further questions at this time. Dear speakers, back to you.

Okay. So thank you very much for listening in to this presentation. I would certainly hope that we would have this conference under other circumstances than we see. Again, a summary, we're working with all contingencies and looking at all options for our business in Russia. And let's hope everything will work out. So thank you very much.