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

Welcome to the Ferronordic's Quarter 2 Report 2022. [Operator Instructions] Today I'm pleased to present CEO, Lars Corneliusson; and CFO, Erik Danemar. Please begin, management.

All right. Good morning, everybody. This is Lars Corneliusson here, and welcome to this conference on the second quarter '22 for Ferronordic. And if we move to Slide 2, we have as a headline for this, Evaluating Strategic Options. Obviously -- for the group concerning our business in Russia, it's obviously heavily impacted by the conflict in Ukraine, and as we wrote in the first quarter report, troubled times, and they have continued and they have become increasingly worse, and environment is difficult to operate in. Despite that, we saw during the quarter revenue growth of 6% for the group to almost SEK 1.7 billion, and this was partly due to currency effects. We will come back to those effects later. And as you can see Russia/CIS, our equipment sales in units actually decreased by 64%. And revenue in local currency decreased by 20%. But, again, thanks to currency and strong ruble, it's increased 5% in SEK. In Germany, truck sales in units decreased by 4% in a market that declined 6%. Revenue increased 12%, again, partly due to FX, but also strong used truck sales and growth in aftermarket sales. And we are further promoting and investing into electric trucks. So, if we go to Slide #3, please, as I said, evaluating our strategic options. The conditions for our business in Russia have continued to deteriorate. Further sanctions have been introduced, and Volvo and other of our key partners keep sales to Russia suspended. Obviously, we take all measures to ensure that our operations in Russia comply with applicable laws. However, where permitted, we have continued to service our customers. However, going forward, it is actually questionable whether at Ferronordic, we are able to continue meaningful operations in Russia. And taking this into mind, we're obviously evaluating all strategic options for the Russian business, and that includes partial or full divestment, or downsizing and continuing on a more limited scale. We've worked hard during the quarter to ensure that any negative effects from the Russian business will not spill over on our businesses elsewhere. And it's good to see though that our businesses in Kazakhstan and Germany are developing well, and we continue to strengthen our positions in these markets. And in Germany, we are indeed marketing electric trucks from both Volvo and Renault trucks, and we're about to launch rental business for electric trucks in Germany. And obviously, in this situation, we continue to look for both product service and market opportunities to grow the business, obviously outside of Russia. Taking on Slide 4 a bit more deep dive into the financials. As I said, group revenue, SEK 1.7 billion. Russia revenue down 20% local currency, but 5% up in SEK to 1.3 billion. Equipment sales down 32% in SEK, actually 48% in rubles, and you'll see here what the currency this is giving us. Aftermarket sales up 43%, plus 10% in rubles, and contracting services was very strong at -- with a growth of 98% SEK, and 52% rubles. And obviously, this is related to that last year's comparison numbers. We were ramping up some projects during the last year, and now we see these comparables. German revenue plus 12% to SEK 375 million, and equipment sales was flat more or less. Aftermarket sales up 28%. And the group operating profit increased by 2% to SEK 147 million, and over SEK 157 million came from Russia/CIS, and German operating profit also increased to minus SEK 10 million from minus SEK 13 million last year. Operating margin down 8.7%. Erik will talk about the reason for the 63% decrease in earnings per share. Net debt higher on higher working capital and currency effects, and the net debt of around SEK 712 million or 0.9x EBITDA. If we can move to Slide #5. And what has happened in Russia from an operational standpoint in the quarter is that the market -- overall market for construction equipment declined by 37%. What we saw after 24th of February and into April in Q2, we saw strong demand and prices remaining firm, obviously, partly supported by customers' efforts to manage risks from ruble volatility, inflation and supply constraints. Since then, however, the markets have declined due to restricted supply and lower demand. And that you can then see in our new machine sales in units, which decreased by 64%. And we expect sales to continue to decline, as our sellable inventories decline and new restrictions take effect. Again, we take all measures to ensure that our business complies with applicable sanction laws and regulations. And aftermarket activity was stable as we could see a slight growth there. And production continued in contracting services, as I've said, compared to last year. It's mainly due to growth of business in the second half of last year and also, of course, currency effects. Moving to Slide 6. Germany. As I said, market for heavy trucks declined by 6%, Rigids grew by 16% and tractors grew by 3%. Supply remains constrained, which hold back market growth. But obviously, rising inflation and energy prices, higher interest rates and weaker business indicators, are obviously also affecting the business sentiment in Germany. The manufacturing PMI declined through the quarter as order levels decreased. If we talk about our own area, new trucks registered decreased by 9% and then represent 18% of the total German market, whereas we then decreased by 4% to 206 units and obviously, we continue then to take market shares for Volvo trucks in the quarter. Aftermarket sales increased by 28%, of which 11% was organic growth and the rest from acquisitions made. And gross margin increased to 9.7%. Take Slide 7, more on business development. In Germany, as I said, marketing electric trucks from both Volvo and Renault Trucks. We are in the midst of launching a rental business for electric trucks with a vision to offer sustainable transport services to our customers. We think that this is a very good way to go to market for e-mobility and show what electric trucks can do. We are continuing to invest into our network and organization. We started operations in a new workshop for us in Bad Hersfeld. And on the next Slide #8, you can see the map where we are today in Germany and how we have expanded the network since we took it over then from Volvo in the beginning of 2020, 10 outlets, and we are now at 16 outlets. The last one then, which we opened in March and sales started in Q2 is about Bad Hersfeld. And we have then added Fulda, Limburg, Nordhausen and Bergstrasse and Bingen and Bad Hersfeld, and we are -- hopefully then we should open in Q3 our new greenfield service and sales hub in August. So, all in all, we have 6 as we speak, 16 Ferronordic outlets in Germany. And with that, I hand over to Erik to continue on Slide #9 with economic developments. Please go ahead, Erik.

Thank you very much, Lars. Yes. I will start with the macroeconomic context in which we're working, when we are making these strategic considerations, that Lars has mentioned, for the business overall and for our activities in Russia. So, in Q2, we see GDP down 4%. That's according to the industry of the economy, probably less down than expected. IMF expects the full year to be down 6%, and we have an expectation for the next year of a decline of 3.5%. Inflation has abated somewhat. It was up 20% in the first quarter, now down to just below 16%, which still is almost 10 percentage points above where it was last year. The Central Bank has reacted to that. If you recall, there was an aggressive rising of rates to 20% in Q1, and since then the rates had come down in the second quarter, 9.5%, and then after the reporting period, another 1.5% to 8%. And the ruble has moved significantly. We saw it weakened sharply in the first quarter, beginning of the second quarter, but then strengthen. And this is important to how the numbers look in both income statement, but even more so on the balance sheet where there really was a strong point on the ruble on the 30th of June. So, as you can see, we mentioned here a 44% strengthening of the ruble quarter-on-quarter, so between the 31st of March and the 30th of June, 41% year-on-year. And then, if we look at the average rate which is applied to the translation of the income statement, that's also 24% stronger. So, a very meaningful effect there as well. The markets where our business is growing and developing well, as Lars mentioned, we see support also from the economy in Kazakhstan, 3.4% reported in the first half of this year, 2.3% expected for the full year, and further growth in the year to come expected at 4.4%. So that creates some good backdrop for the growth that we have in mind for the business there. In Germany, 1.5% in second quarter. The growth forecasts have been revised lower there, but we are still in growth territory and 1.2% expected in the full year, and then a lower 0.8% in the year to follow in 2023. If we move on to the next Slide #11, give you an overview in our standard format of the income statement. Again, a revenue slight short of SEK 1.7 billion. That's plus 6%. But again, a meaningful foreign exchange translation effect there. The Russian business actually down 20% in local currency, but then up 5% in SEK. Revenue mix between the segments still remain roughly where it has been, partly driven by lower sales of trucks in Germany. We will see that shift towards Germany going forward. As we said, we expect lower sales from Russia, of course, going forward as a result of inventories and restrictions at that [ pie ]. Mix of revenue reflects a different picture also in the segment, but above all Russia, where, again, the new and used equipment sales have declined. So, on a group basis, we see about half -- 46%. In the first quarter, that was 65% from equipment and trucks and 28% aftermarket. So that coming up, that was 23%. And then contracting services making up 24% versus 10% in the first quarter. Again, FX, important factors there. And then, as Lars mentioned also, when it comes to contracting services, we did ramp up in the second half of last year, so there is a low base number there as well. So, as a result of that shift in mix, is an important driver, we see a slightly higher gross margin. SG&A as a percent of revenue is also slightly higher there. Again, there are important currency effect translation. And then in Germany, as we know, we have integrated new businesses as we expanded in 2021, which also has at least temporary effect during the integration phase there. Operating margin declined. We did take additional provisions in Russia of almost SEK 100 million -- SEK 99 million, and that's mostly relating to receivables -- doubtful receivables and to some extent to inventory as well. Operating profit largely flat on last year. We had a significant foreign exchange loss in the quarter, SEK 81 million, and that is a result of the stronger ruble. We have discussed before our currency exposure, our matching of payables with receivables and inventory in Russia, as it were. We have had payables from our Kazakh entity in rubles. Not anymore any new orders after February were invoiced in U.S. dollars, or to a lesser extent, euros. But outstanding payables were in rubles, and the correlation, which was very strong between the Kazakh tenge and the ruble, did break down in this quarter, and we saw the ruble strengthening against the tenge, causing this -- big part of this loss in the second quarter. We note that in the subsequent event that the ruble has since lost some ground, about 20% from the closing date, 30th of June, up until this reporting date. So, some of that would be reversed. But again, that's what's really the key driver of that FX loss that we see. If we move on to cash flows on Slide #15, we see a decrease in cash flows to SEK 39 million, that's operating cash flows for the group, partly driven by an increase in working capital, that in turn is driven by a reduction in payables that outpaced reduction in inventory, and we also saw an increase in receivables. We have, as Lars mentioned, made efforts to isolate Russia from the rest of the group, so that there is no spillover effect, and part of that has been settled payables as [ strictly ] as practical for us. And again, that is one part of the driver of the increase in working capital, which in turn impact the free cash flow, of course. If we look at the investments in the quarter, it relates to trucks in Germany, and then also 2 machines in contracting services. Here, I note also that the machines to contracting services are shown as investment flows there as when they're paid for to the supplier, so, not actually when they're delivered. So, meaning that the payment that went through as these payables as we settled, are for machines that were ordered some time ago for delivering on projects that were agreed upon again, previous year. If we move onward to next slide, briefly on balance sheet. Again, I want to stress here that you will see the currency effect. Some of the increases in the group balances are really driven by that 44%. If we're looking quarter-on-quarter increase in -- or strengthening of the Russian ruble against the Swedish krona, 41% year-on-year as well. That explains really most of the PP&E increase, to some extent, net working capital as well. But as we discussed, that's also the effect that I just noted, that we paid down payables more quickly than inventories decreased, and also, we saw some increase in receivables. In Germany, also a less significant, but also an increase in net working capital, which balances to the group level there of 14% of LTM revenue versus 3% where we were, and in net debt then at SEK 712 million or 0.9x of EBITDA last 12 months. With that, we can move to next slide, which is really an extract from the report where we make additional disclosure, so, what we bring to the market there, given the turbulent situation and big uncertainty that's around the Russian business. Here, we show a balance sheet standalone Russia, so without Kazakhstan or any allocation, for the first quarter, second quarter and also for the preliminary balance sheet for the 31st of July. This is preliminary and subject to change, but this is what we see. And you know here also the 20% change in the exchange rate from the 5.04 to the 6.03 since the end of the quarter. So that's one of the determinants of the balance sheet positions here. But you will see a general trend of especially machine inventory decreasing and reaching in the quite low levels, parts staying up a bit higher in the inventory situation here. And you will also see the movement in PP&E partly driven by the exchange rate. There is also a preliminary sales for July. And again, it drives on the decline in unit sales as well as the sales overall in the business, and as fact, we do expect this trend to continue. On the next slide, you will really see the Q2 table that we just saw on the previous slide, in a latter presentation, just to show you an illustration of the NAV as we have it at the moment, with the cash and equivalent receivables that we have at the moment, and then new and used machine inventory being a smaller part, and then the parts and other inventory, which includes attachments, being a bigger part, and then you have PP&E and any contracting services, which is really mainly the machines in contracting services, but also to some extent, the car pool and some of the equipment and facilities they use there. And then on the other side of this balance sheet, you will see the matching tables that we had outstanding at that point. And again, this is in Swedish krona, so bearing in mind that there is a meaningful FX effect in these numbers. And then the borrowings that support the contracting services business and as well as other borrowings, and also leases at the end there. If we move to the next slide, we keep our slide on our financial objectives and dividend policy. We say that this is subject to potential review. We mentioned this in the first quarter report already that, given the big changes in our operating and strategic environment, these are likely to change when we have more visibility on where we're going in the Russian business. As it were in -- at the end of this quarter, we were at 1.5x 2020 revenue and still above our operating margin targets, and also and within our leverage target. And with that, Lars, I give the word back to you for something on the outlook.

Yes. If we can turn the slide to the outlook then. Obviously, there are prospects for our operations in Russia, they continue to deteriorate. Business conditions are becoming increasingly difficult. And as we have mentioned, we are exploring all strategic options. Operations in Kazakhstan may continue, but they are so far a smaller part of the sales. And in Germany, we believe that the recovery from the pandemic may lead to increased demand for trucks and service. However, the geopolitical situation and higher energy prices may also affect the German economy. In a longer perspective, we believe that the underlying conditions and business opportunities in the Kazakh and German markets remain strong. So, by that, I'm handing over to questions, please?

[Operator Instructions] And our first question comes from Adrian Gilani, ABG.

It's Adrian here at ABG. I'd like to start off by asking, when you say that it's becoming more difficult to conduct operations in Russia, does that also include it being more difficult to make payments within the country as well as to and from the country?

Maybe I'll start, then Lars. Within the country, I would say, it's still not a big problem. We can make payments within the country. As you know, Adrian, there are a lot of banks that are restricted and fully blocked. And with those banks, we can have nothing to do. So, there are limitations there. But there are still several other banks that are operating in a normal fashion like UniCredit and Raiffeisen and Bank Saint Petersburg, et cetera. So, there are channels to facility payments in Russia. International payments are more restricted and more procedural.

Okay. So, as a follow-up to that, there's a fairly significant increase in receivables in Russia. Should we take that to believe that, that's not a result of your customers not being able to make payments?

No. It's not sort of effect of them not being able in the financial system to make payments. I think -- I mean, except for the currency effect that you will have there as well, of course, we have a growth in receivables. We have made sort of additional provisions for receivables. But in general, if one would sort of look back, then, so far, customers are still paying, and we do collect receivables. So, it's not driven by the system that I would say.

Also on the contracting services side, that -- I mean, productivity seems to be holding up fairly well so far there, but you have flagged that this could deteriorate over time. Is this something we're going to see already in Q3, the sort of decreased efficiency? Or will it take longer?

Well, it will decrease over time, most likely. I don't believe we will see something short-term, but over time, it will happen.

And also a fairly specific question. You used the phrasing sellable inventory as opposed to just inventory in the report and in the presentation. Should we assume that not all of the remaining inventory in Russia is sellable due to sanctions? And if so, how much of the inventory is not sellable?

Well, you're correct in the word sellable that we do have certain inventory that are not sellable. How much that is? We don't disclose it. It's not a majority for sure.

I mean, where -- Adrian, where we concretely know that there are things that are restricted, then that's provided for. So that wouldn't be a part. I think a challenge is -- for you as for us is that the rules are changing very rapidly. So, it's quite uncertain how the future will look. But if we look at the moment, then we provide for what we know we cannot -- we are restricted on.

But it is fair to assume that it's a relatively small percentage, that's not sellable?

At the moment, yes.

And looking at Germany, if new unit sales were to slow down, which is looking like it might happen, are you sort of nearing a point with your current workshop network where you're able to absorb those lost equipment sales with higher aftermarket sales, as you have been able to do in Russia previously? Or do you still have to sort of build out that workshop network before you reach good absorption rates?

No, we're on a good track, Adrian. We can't really see what level we are at, but we -- of course, the more we build it out, the higher that level becomes. And we also do have some capacity within those workshops to take on several more service hours and parts. So that is -- and we also then have a good used business and the rental business on top of that, which is working fine. So, we're getting closer to breakeven in Germany, even if the truck sales would go down, which we -- so far is restricted by supply. Not -- we haven't yet seen any demand issues, but the supply is really the -- continuous.

And just a final one from my end. You might have mentioned this during the presentation, and I might have missed it, but, is the profitability timeline for Germany is still the same regarding wanting to be profitable this year in Germany?

Yes. We're hoping to break even during second half to reach a point -- breakeven point when we break even in Germany, yes, in the second half.

Our next question comes from Kenneth Toll, Carnegie.

So, if I understand it correctly, you took this write-down of SEK 99 million. And if we correct for that and look at the adjusted earnings, they were very strong, actually. So where does this strength come from in Russia? Is it very good profitability on spare parts?

You'll take that Erik or...