FLSmidth & Co. A/S (FLS) Earnings Call Transcript & Summary

Welcome to the presentation of FLSmidth quarter 2 first half results. My name is Mikko Keto, I'm the CEO of the FLSmidth, and I'm joined by Roland Andersen, who is the CFO. We're actually today very proud presenters of the result because we can show steady good progress in all our key initiatives and financial performance. Just reminding you of the disclaimers for future-looking statements, what we will do during the presentations. The key takeaway from second quarter is that underlying Mining EBITA margin is 10.5%. Full year last year was 9.9%. And typically, latter part of the year is good. Reported margin is 7.8%, and we have adjusted underlying EBITA with two main items: one being TK integration planning costs, DKK 45 million. Second one is cost related to winding down operations in Russia, which is DKK 50 million. And my opinion is that we've been successful winding down Russia for the cost, which, of course, is unwanted cost, but still limited and not excessive. Second good news is that Cement continues its profitability journey. 2.1% EBITA margin for Cement is good, and we will continue to increase that one. And for that reason, we will also increase Cement EBITA guidance for the full year to 2% to 3%. This quarter was big for us also in other aspects. We managed to get all the merger clearances for TK. So we are now on our way to complete and finalize the acquisition end of the month. Still going back to the Mining order intake. When you look at the Mining order intake, significant growth in service order intake. You, of course, need to bear in mind the impact of the U.S. dollar and Chilean peso and it has a positive impact about 10% for the Mining order intake. But still underlying order intake growth is very significant and especially pleased about service order intake. And with this service order intake, the mix is good, less labor, more spare parts. Then if we think, again, about Mining EBITA. As I said, this is one of the best achievements for quite some time for our organization. Underlying EBITA 10.5%, it means that we have a steady progress in our financial performance. Given also the fact that if you look at the mix of capital versus service this year and last year, service share was higher last year. So mix is more capital than service in the quarter and yet we come up with a good result. TK is a very significant milestone for us. And we got all the approvals from the authorities and there's no remedy requirement. So there's no remedy requirement from anybody, so it's all clear. And therefore, we can complete the acquisition end of the month. And then Roland will talk about when we are sharing the information with all of you about the headline Financials. But end of the month, 31st of August, we are closing. And then myself and Roland can access the clean room data at the midnight, where we can burn some midnight oil to understand the details. We started talking about derisking the portfolio last time. We are using terminology Scope 1 to 5. And we have clear definitions internally for 1 to 5 scope, 5 being highest risk, either in terms of scope or in terms of the product in question. And we systematically are derisking the portfolio and pushing more business into scope 1, 2 and 3, where the risk profile is much less and profitability higher. And we did year-on-year comparison for backlog and it proves that our backlog quality is much better. When I talk about backlog quality, I talk about both profitability and risk. With a poor quality backlog, you tend to erode the margin while you are executing. So we can see already now that we have a steady progress in improving the quality of the backlog and quality of the earnings. Cement. We are creating more stand-alone pure-play Cement as we go forward. We are accelerating journey in Cement for higher profitability and more service centricity in the business. We've been able to increase our order intake volume, but at the same time the order intake quality is better. So we've done the same as for Mining. Margin for service order intake and capital is higher margin and low risk. So we do exactly the same for Cement business. And we believe that we can deliver 2% to 3% EBITA for cement for the year. That is a journey and we are accelerating the journey in Cement. Good result for Cement is also supported by the mix for the quarter. In relative terms, the service portion is quite high in revenues compared to the capital. And that is supporting the profitability. But maybe if you look at the bottom of the page, you can look at last year and this year, and you can see significant jump in the profitability. And our aim is to create sustainable, profitable Cement business, which will be run stand-alone pure-play business owned by FLSmidth. And we know that we can do much more in this area. Then I hand over to Roland.

Thank you for that, Mikko. So adding up the numbers for Q2 this year, a 23% growth in revenue, 17% organic. And we ended an EBITA of DKK 307 million with a 6.1% EBITA margin. And after tax and interest, profit and loss for the group was DKK 134 million. Sitting in the group's margin is the TK Mining acquisition integration cost, as Mikko mentioned, of DKK 45 million, and also wind-down costs of our Russian activities of DKK 50 million, and adjusting for that, our underlying EBITA consolidated would have been 8%. Looking at the revenue growth of 17% on the left-hand side, still a higher capital market share this year than last year. But if you look on the right-hand side, our revenue, first of all, is still growing. But two important things to note is that our order intake remains higher than our revenues, so positive book-to-bill. And also our service revenue is increasing significantly faster than our capital revenue, which is exactly what we want to happen. If you look at our gross margin, we are a notch down in Q2 compared to the same quarter last year. And it's predominantly Mining that suffers a little bit from a higher capital share as we have also indicated in the beginning of the year, and also a little bit of Russia, a little bit of supply chain and logistic costs sits in this margin. Cement, as Mikko said, have continued their positive traction. They have a healthy service share. Last year was a little bit of a bad comp. But they're moving forward on most of the initiatives. And the reshaping initiatives we did last year are starting to show their sustainable impact. If you look at our SG&A ratio, it's down 1 percentage point compared to the same quarter last year. In our SG&A sits currency impact of DKK 31 million. We have acquisition-related costs from TK sitting of DKK 45 million, also Russia wind-down activity sitting in this cost bucket, and also wage inflation starts to be visible, and we are traveling slightly more in this quarter than we did a year ago. If you look at the EBITA margin on a consolidated basis, it has improved from 4.8% to 6.1%. And on the right-hand side, we are trying to outline the most important drivers. So last year we had a 4.8% EBITA margin. We had TK cost last year and also a little bit of other stuff we informed about. So an adjusted EBITA margin last year of 6.8%. And we are now growing predominantly. The revenue impact is increasing margins. The higher capital share in Mining is reducing our gross margin a bit, and adjusted for a few other things, our underlying EBITA margin is 8%. Now adopting the TK Mining integration planning costs and the Russia wind-down cost, we ended up at a reported EBITA margin of 6.1%. Our working capital development grows a percentage point from 8.2% to 9.2% in the second quarter of '22, predominantly. This is driven by a buildup of inventories that we deliberately have done. This has supported our regional sales and our service business line significantly, especially in Mining, but also in Cement. Then our receivables are up driven by higher revenue and also we have started to spend the prepayments that we received on the larger projects in Q4 last year. And that means that our cash flow for the quarter is negative. On the right-hand side, an EBITA adjusted of DKK 395 million and a negative development in working capital brings us to a cash flow from operations from the group of DKK 214 million. Deducting cash flow from investments leaves us with a free cash flow of minus DKK 297 million for the quarter. And that means that our capital structure targets are roughly stable, equity ratio slightly up. Our NIPT position is still a positive cash position. and as the last quarter, we're going to see that for a while as we will pay the acquisitions from TK come first of September here, 12 days from now. And as Mikko indicated, we are quite satisfied with the performance for the first half in Mining, a revenue of DKK 6.8 billion, a lot of this -- or some of this is currency tailwind. And that means that, that leads us to adjust the revenue guidance for the remainder of the year from DKK 12 million to DKK 13 billion up to DKK 13 billion to DKK 14 billion, and this is predominantly driven by currency. And that also means that it's due to currency, and we have a bit more Russia wind-down costs to come. And that means that we are maintaining our EBITA guidance of 8.5% to 9.5% and saying that we expect to end up in the low end of this range. So an unchanged guidance compared to last quarter. For Cement, Cement have done DKK 3 billion in first half and we expect them to do maybe slightly less or similar in second half, and that means we're maintaining our revenue guidance of DKK 5.5 billion to DKK 6.0 billion in turnover, but the traction, the underlying performance of Cement is good. Service sales is healthy and execution has become better and also the reshaping initiatives from last year are kicking in. So we are raising EBITA guidance for the year from 1% to 2% up to 2% to 3% for 2022. On group level, that means that we're raising our revenue guidance for DKK 7.5 billion to DKK 19 billion to a revenue guidance of DKK 18.5 million and up to DKK 20 billion. EBITA margin of 6% to 7% remains unchanged, as the lift in the Cement margin is not enough to push the group's combined EBITA margin further. So we are quite satisfied with that. And then a quick flash. As Mikko mentioned, we expect to get access to TK at midnight of 31st of August. And we will do a quick webcast or conference call at 8:00 1st of September in the morning, where we will inform you guys of what we know. It will not be a lot, but we think we will have information that is interesting. So let's see how much we have access to at that early point in time. And then we will inform the market as we move forward from there no later than Q3 reporting in beginning of November of revised guidance for the combined entity. And then hopefully, we will reserve the day also on 18th of January where we expect to have a Capital Markets Day, where we will lay out more details about our plans strategically for FLSmidth and for Mining business and for the Cement business and also do a bit more on financial target setting and so on. And with that, I'll give it back to Mikko.

Sustainability, ESG remains a cornerstone of the company. And happy to note that safety is at a good level and continue to be focused, especially in operations, we have significant service and manufacturing operations, repair operations, and we want everybody to be safe there. So that is at a good level today. Also improvement in water. At the same time, we are working with many other aspects of ESG, and I know that we can do more about communicating what we've done. We've done living wage corrections in the company, we've done gender break-up corrections in the company. And I know that we should communicate maybe more what we are doing, because we are doing a lot in those areas. And we will update this communication going forward. And then highlight kind of points of emphasis within ESG frame in the coming months and a special emphasis in Capital Markets Day. And now we go to the Q&A part, please.

[Operator Instructions] And our first question comes from Will Turner with Goldman Sachs.

I've got a couple of questions. The first one is on the working capital development. Could you just give a little bit more color on the extra working capital consumption, in particular the higher work-in-progress assets? Are they concentrated in any one particular project? And does this have anything to do with your Russian order deliveries? And then kind of related to this, how would you expect working capital to develop in the second half of the year?

So I might actually start to comment exit from Russia, and then Roland will talk about that and then the financial kind of aspects of that one. So our exit from Russia is progressing well. So we have much less than 50% of the start of the year workforce still in Russia, and we are migrating out fast. Our backlog is down a lot from DKK 2.6 billion to DKK 1.5 billion. And we recognized DKK 260 million revenue from Russia for the quarter. And then the gap actually between reduction in the backlog and then the revenue that recognized has to also a lot to do with that we've been scoping down and we've been scoping out content from our contracts. So basically talking to customers that we have delivered small parts of the contract, I can say that agreed actually with the customer that we would not deliver certain parts of the contract. So that's why the backlog has come down way more than actually the revenues what we recognized. But Roland, maybe you can comment the other aspects of the process.

Thank you for that. And if I understood the question correct, work in progress, is that impacted from Russia? And it is, to a certain extent, as some of the stuff that we have not yet solved in the backlog sits partly in work in progress, and it needs to, of course, be seen of against our prepayments received from the customers. So there are still some things to clear in work in progress in order for that to come somewhat down. And then in terms of net working capital, I think all along we have guided that it should not go much more up than 10% to 11% of revenue, Obviously, the more currency can drive that up a bit more and also to the extent we succeed in pushing our service business line even further up revenue wise, that is good news, and typically that will tie up a bit more inventory and potentially also receivables. But we don't expect that to come much higher than 10% to 11% of revenue. Did I answer the question?

No, that's clear. And then on the aftermarket order intake growth on an organic basis, what's been the driver behind this? And how do you expect the organic aftermarket growth, particularly in Mining, to develop throughout the remainder of the year given the strong order intake in the recent quarters?

So if you take out the impact of the ForEx, let's say, 10%, then you are left for the kind of 30% underlying growth. And if driven actually by spare parts, so the mix inside the service, you have spares, wears, labor and then upgrades. And the biggest growth actually has been in actual spare parts, which, of course, from a profitability point of view is good, and we have not yet seen any slowdown in that one, and we have a weekly reporting that we follow the order intake for the spares, so that we are checking any signs of any slowdown, any softening of the order intake. But so far, not. And then, of course, we can have a discussion about macroeconomics and what's going to happen next year, that's a little bit. But short term, we still expect that service spare parts, order intake continues at a good level than for this quarter. And of course, if we see anything changing there, we would then, in our next call, indicate that one. But in day-to-day operations, no slowdown yet.

And these spares that you're saying, they often will become the holder's inventory from your customers and miners. Do you have any idea of where that kind of inventory level of spares and parts are relative to a normal year?

We don't believe that inventory levels are going up at all for the mining companies. But what we're seeing is that it's less just on time type of orders. So miners have been more relaxed about that if you need a spare part, they are anticipating slightly longer lead times. And if you anticipate slightly longer lead times and you are not financially pressed, it means that you might order it a month before, 2 months before than you otherwise would. So I don't believe that we see stocking of our customers at the sites. But what we've seen is that they are more relaxed kind of because business has been good. They're running operations at full, they do want to have any risk of missing a spare if there is shutdown or kind of a small shutdown, to change a part. So they don't want to be missing any part. So they have been more relaxed ordering those, but we haven't seen really stocking. So they are more relaxed about ordering, and then they anticipate a little bit longer lead times. And therefore, we see really good order intake.

Okay. Great. And then a final question for me. As we kind of look into the second half of the year and beyond, obviously, miners have seen metal prices come down quite significantly since the beginning of the year. At the same time, some production costs have obviously increased a lot and also CapEx costs would have increased just given the inflationary environment. Have you seen any change in kind of decision-making activity. Is there any more hesitation to invest? Or is it still a very strong market?

On the OpEx side, no. As I said, OpEx is still up because they're running the plants at full. Still demand is, in many cases, outstripping supply. So still, on the kind of operations side, it's kind of full capacity, not that they are restricting capacity, that it would be 70% or 80% of the site capacity. So in that sense, that is supporting the service business and part business, but we see maybe some impact in the kind of longer-term smaller kind of capital projects that if you talk about kind of small or mid-sized mining companies, of course, they are more dependent on kind of funding arrangements for a new investment as the main miners, I think, they have access to capital. So maybe slight signs that there's a little bit more concern about capital and cost of capital for funding. Long-term business cases for most of the mining investments are still very good. But of course, if you are a smaller company, medium-sized mining company, then the cost of funding is more of a concern than for the majors.

Our next question will come from Nick Housden with RBC Capital Market.

I have a couple of maybe more strategic wider questions. So the first one, the adjusted EBITA margin in Mining, 10.5%, looking very solid. But if I look at the minerals business as your main finish, the margin there is closer to 15%. And if you look at the 2 businesses, there's quite a lot of technological overlap, the operating models aren't fundamentally that different. So I'm just wondering, if we look out over, say, a 10-year horizon, is there any reason why your Mining margin can't be closer to that 15% mark?

I think, of course, if you look at some of our peers across Finland and Sweden, then you need to look a little bit inside the divisions, what the divisions or business area compare against, but your question about that why shouldn't be at adjusted EBITA level closer to some of our peers. I think we are closing the gap little by little. But strategically, longer term, I think there should not be too much of a difference. Inside the mix, there might be small differences, but we have a view where we can get and what kind of levels we can achieve in our businesses, and we will communicate that more clearly then in Capital Markets Day. But we have a firm view where we can get.

Okay. Great. And then you mentioned a couple of times in the presentation about making Cement a stand-alone business. Can you maybe just explain what the rationale of this is? Because presumably, if Cement is more independent, then the synergies that exist with the Mining business will be a bit more limited in the future?

So the plan is that we have a pure-play Mining business, which is the main part of the company, and then we would have a more pure-play Cement business. And what we are doing now for the Cement is that we are consolidating Cement operations in the second part of the year because it's too spread out for the size of the business. And then making it more service-centric rather than capital centric, where the business is coming from. But strategically, we haven't seen too many synergies when we had a combined management in the regions for Cement and Mining. We saw them still kind of operating quite independently, and we had a management layer there. And of course, our aim is that it is and would be a valuable asset for FLSmidth, we need to get that Cement asset into a level, and I believe that we can achieve that one, because many of you might have done analysis and indicated that it's actually not adding any value for FLSmidth at the moment and it might be actually quite the opposite. But we have firm steps about consolidating and then making it even more independent and then we can address the underlying issue what we have in Cement, which is actually too heavy SG&A structure for the size of the company it is, because it can be a good medium-sized business, but then, of course, the operations need to reflect that one and then do the service transformation. But we see them going even more stand-alone than today. So we started the journey. So end of the journey, you might see the kind of pure-play Cement business even more than today.

Understood. And then just quickly on the ThyssenKrupp assets that you're acquiring, can you remind us what the Russian exposure of those assets are? I think I remember from the presentation slide that it's not that high, but just some color there would be helpful.

Yes. So we are not really privileged to that information. But I hope to hear from you at the 1st of September at 8 o'clock, then we will see if we can disclose this information.

Our next question will come from Tomi Railo with DNB.

It's Tomi from DNB. First question is the currency impact on EBITA. Are you able to provide that?

So the currency impact on EBITA is relatively limited, hence also why we are lifting top line predominantly due to FX. And that's because we have a significant dollar exposure, but we also have a relatively large presence in U.S., similarly in Chile and South Africa and Australia for that matter. So there's sort of a natural hedge, you can say, in terms of currency exposure.

Yes. As you mentioned, the revenue impact, but assumably, it has also been supporting the EBITA, but you are not, in a way, able to comment any numbers?

No. It's limited.

Second question is on Russia. Are you able to provide a guidance of costs winding down the operations for the full year? In other words, second half?

Yes. So our intention is to exit Russia fully. Up until date, we have reduced our organization in Russia to almost half. We continue those efforts. And then we're working hard in finding a solution to the DKK 1.5 billion left in the backlog. So the intention is to exit Russia full and finally by end of the year, and by the same token, also have a solution to the contractual obligations in the backlog. And that will come with some sort of cost. We don't expect that to be excessive, but that's also why we're saying our guidance will be in the lower end of the mining range.

Our next question will come from Kristian Johansen with SEB.

I have 2 questions, please. So first question is on your Slide 8 and the backlog complexity. Obviously, appreciate the detail here. So just looking at your backlog at the end of Q2, it looks like, say, roughly 30% is what you characterize as high complexity. So first of all, could you elaborate on what proportion of the high complexity backlog will be recognized as revenue this year? And also, how much of your first half order intake has been high complexity orders?

So first kind of might be a little bit more strategic note, and then Roland can comment the actual. So we are setting quotas for the revenue for the different categories, so that we have a quota for scope 5, for example, which is riskiest part of the business, and then scope 4. So we always internally look at that you cannot exceed that quota. And so basically, we stop taking orders for that category if we hit the quota. And therefore, it doesn't pollute the backlog to excessive risk at any given point of time. And of course, we anticipate, we are looking at sales funnel, and we encourage sales organization to this scope and derisk because then you can avoid that quota, so we built a kind of in-built incentive for sales organization to avoid coming to this quota and risk review. And I think maybe Roland you can comment on the actual numbers a bit.

Yes. So as you know, we have talked a bit about this separately also, Kristian. We're moving from driving the business with focus on volume and a lot more with focus on quality of earnings. And that means that larger, bigger capital projects with relatively low margin and higher risk, we simply don't want. At least we only want a certain limit of it. So if that has been, I'm just saying these numbers as an example, 20% or 25% of our intake, that will now come considerably lower in our intake. And we have started this decisively, Q4, Q1. And that means that your order intake from that point in time is expected to develop as we are trying to illustrate here. So I'm not going to put numbers on this, and I know there's a danger of showing a graph like this because then you will ask about numbers. What's important here is that we will be truthful to what we internally call value over volume, i.e., quality of earnings. So there will not be large, lumpy, relatively low-margin projects with relatively high risk taken in going forward. And that's what we're illustrating here in a bit more committing way. And reaction from the customers has been quite positive because if you think about [ C part ], if we would do kind of -- we haven't done EPC now for 2 years at all in mining, so nothing at all. But it's not benefit of the customer that we would actually take that scope because then we're subcontracted and add marginal margin, so customers do understand this better that we focus on the kind of process technology and technology part can do the kind of performance guarantee for that. But it's not customers' benefit that we start to went outside that one because we would contract that out, add a marginal margin. So it's nobody's interest that we do it. And customers and EPCMs, who we see as our partners, are actually quite happy about this approach. So of course, maybe losing a little bit of top line. But all in all, the customer response and response from EPCMs, who are typically important in capital business, has been positive.

Understood. Maybe just a follow-up and then ask in a slightly different way. So the proportion of your backlog, which is highlighted as preferred or low risk or low complexity, is that expected to continue to grow then in the coming quarters? When do you think you will be at the right balance in your backlog?

I think we are still executing. And the new backlog is actually starting to be in the kind of right mix, but we still have a challenge of executing all the backlog, which is not that we would like to have. But of course, you need to flash that through the books, and then you have a kind of -- so for the new order intake, recent order intake, we are happy with the quality, but we still have an issue over there because kind of from contract to actual revenue in major capital business, it's after 2 years, basically 1 to 3 years, so it takes time. And of course, then we plug in TK exactly to the same model. The day we get access to the TK numbers, we are resetting. That's why we don't communicate in clear manner what is our target. We have an internal target. But then, of course, we are resetting the targets based on what we get in from TK. So we put all the TK backlog into these 5 categories, see where we are, and then we decide where we want to go.

Understood. Looking forward to hearing more about that. My second question, just reading your commentary on the Cement market. It almost sounds like rising energy prices is a net positive for Cement demand as it forces Cement customers to do productivity improvement. Is that correctly understood? Or how would you, in general, say, the rising energy prices is expected to hit Cement demand?

So I think if I look at the cement market globally, there are not many new plants, there is not much CapEx in the market. But if you still look at our books, almost half is capital. It means that we are more capital oriented in Cement than the Cement market. And of course, we should look like a market. If it's a service market, Cement market, we should look more service. So I think how the market is today is not necessarily how we look like. And that's why I said about transition to be more service-centric, because then we look like a market, we act like a market, because it's really a service market in many respects. There's some capital -- so in relative terms, we want to grow service faster than capital and be very selective in capital. And also then it's quite spread out, as I said earlier, to so many countries, our operations. And the volume of the business is still limited, means like a good medium-sized company. And of course, we need to make it look like a good medium-sized company, which is service and parts centric rather than project and engineering centric. But I believe that the market is -- what we look at the cement market order intake, we're actually getting better margins for new order intake compared to a year ago. So the capital order intake, service order intake both have a higher product margin in order intake than a year ago. So we are able to provide premium service to our customers and the customers are willing to pay premium, which is a good sign for the Cement.

I guess my question was equally focused on demand you have seen in Q3. Now that we are seeing energy prices skyrocket, is cement demand slowing down? Or is that not the case?

We see small signs of that one. But my expectation is that we see a decline next year because if you think about the impact of the inflation to infrastructure build, if the infrastructure build cost goes up a lot, typically, it will dampen the demand. And then, of course, if we go into downturn recession next year, then governments try to boost bit of infrastructure build. But whether that's enough to compensate the kind of slow demand in the other sector, we don't know. But my expectation is that Cement will see slowdown next year. And we are getting ready for that one.

Our next question will come from Claus Almer with Nordea.

Just a clarification question first. When we talked about the FX impact, is the minimum impact on EBITA, is that on the margin or on the absolute EBITA? That will be just for clarification.

On the margin.

I thought so. Okay. Good. Coming back to the underlying 10.5% EBIT margin within Mining. I guess you are still running behind on passing through the cost inflation. How much does this dilute your margin? That will be the first question.

Nothing at all is the answer. So what I've seen actually in the new order intake that we've been able to do inflation plus price increases. So we have some other operational challenges, of course, exiting Russia and that sort of things. But if I put the one-offs aside, integration planning costs and Russia exit costs, and underlying order intake and order intake product margin, which is, of course, the product cost, and then the sale price. So that is going up both in service and capital, means that we've been able to compensate the inflation in the material cost and labor cost base. Of course, it has an impact on our SG&A and other items. But if I look at clean product cost, capital product, service product, there we haven't seen inflation, but it's, of course, overall inflation a bit for the company.