Gränges AB (publ) (GRNG) Earnings Call Transcript & Summary

Welcome to Gränges conference call for the second quarter of 2020. As usual, here in Stockholm, it's me, Johan Menckel, CEO of Gränges; and with me, I have CFO, Oskar Hellstrom. We will start this presentation with an update of the general market situation and Gränges' performance during the last quarter. After that, Oskar will take you through the financial results, and then we will conclude the presentation with a short summary and the Q&A session. When we now have the second quarter of 2020 behind us, we can conclude that this turned out to be the most challenging quarter in the modern history of Gränges. As we're all aware of, the world is currently severely impacted by the outbreak of COVID-19. The extraordinary measures that have been taken to reduce the spread of the virus have significantly affected market conditions for Gränges in the second quarter. We started to see the impact on demand already in the first quarter when the car producers in Asia and Europe close their production facilities. The same thing followed in North America in the second quarter, resulting in that the end market demand on the automotive side declined with 50%. The demand for our HVAC products, however, held up slightly better, mainly explained by the increased market share in 2020. In total, our sales volume declined by 24% year-over-year, and the adjusted operating profit declined to SEK 42 million in the second quarter. On a positive note, the cash generation continued to be very strong, and the adjusted cash flow before financing amounted to SEK 238 million in quarter 2. Our top priority during the quarter has been to work in accordance with our contingency plans to secure the health and well-being of our employees and take measures to mitigate the negative impact on Gränges business from COVID-19. Gränges Annual General Meeting was also held in the second quarter. At the meeting, Gränges' new Chairman, Fredrik Arp, was elected. The AGM also authorized the Board to issue new shares of total SEK 2 billion to finance the acquisition of Aluminium Konin and Gränges' growth strategy. The difficult market conditions became very evident when looking at some statistics over the recent market development. For the automotive market, the research from IHS currently estimates a global decline in light vehicle production of 47% in the second quarter. If we look at estimates by region, we can see that the decline in the light vehicle production was largest in Americas and Europe, with 73% and 65%, respectively. Asia is holding up somewhat better, being down only 25% year-over-year. This is largely due to that China that was first severely impacted by COVID-19 in the first quarter, but now has partly recovered. IHS estimate that there was a slight year-over-year growth in the Chinese light vehicle production in the second quarter. Although the production stops at many car producers now seem to have come to an end, the uncertainty about the real customer demand remains very high as we go into the second half of the year. Currently, IHS expects a gradual recovery of the automotive production and a smaller year-over-year decline of 12% compared to the 47% in quarter 2. If we look at Americas HVAC market, this is typically a more stable market than automotive and, to a large extent, driven by replacements. It doesn't mean that it has been unaffected by COVID-19 and the unit production is expected to have a decline by 19% in quarter 2. Given the current market uncertainty, it is very difficult to predict how the HVAC market will develop in the third quarter. To a large extent, this will depend on how the general economy in the U.S. develops, considering the COVID-19 outbreak. When looking at Gränges sales volume development during the second quarter, we can clearly see the impact of the lower automotive demand in all regions. In total, our sales of automotive materials declined by 41%. In Asia, sales volume was down 28%; in Europe, 47%; and in Americas, we experienced a 60% (sic) [ 16% ] decline. This largely follows the pattern of the development of light vehicle production in the quarter. But we see a slightly lower decline for Gränges. The key reason for this is that the uncertainty in the market and the difficulty in predicting the market demand has resulted in customers building up additional inventory, which will be reduced over time. If I should mention something on the positive side for automotive, it is the development in China, where we see a higher activity in the second than in the first quarter. Given the current situation, this can likely continue going into the quarter 3. For HVAC & Other business in Americas, we see a volume decline of only 7%. There are 2 main reasons for this: first, we have contracted a market share increase as of 2020, as we communicated in our first quarter report; secondly, the demand for specialty packaging materials for food and pharmaceutical has increased as a consequence of the COVID-19 outbreak, especially the demand for materials for food containers for home deliveries and takeaway has increased as a result of the lockdown in many U.S. states. As we communicated in our quarter 1 presentation, we have activated contingency plans focusing on 3 primary areas: continuity; cash; and cost, to mitigate the impact of COVID-19. In the second quarter, we have continued to work in accordance with these plans to secure business continuity, protect cash flow and reduce costs. Safety always come first in Gränges. Our highest priority is to ensure the health and safety of our employees while maintaining continuity and developing the business. During the quarter, we have continued to adapt the operations to the new market situation, and we have managed to avoid COVID-19-related operational disturbances in our own facilities. While maintaining continuity and developing the business, it is of great importance to secure cash flow. As part of this, we have increased the focus on working capital control and receivables collection. This is an area where we continue to see positive effects in the second quarter. To preserve cash, we have further reviewed our CapEx spending, and we have revisited the ongoing expansion programs. It is equally important to ensure good liquidity. On 30th of June, Gränges had available cash and unutilized committed credit facilities of about SEK 2.1 billion, well above the need for the coming 12 months. Finally, we have addressed the cost base to adjust it to expected market demand in the short to medium term. This means reductions of capacity and manning primarily through temporary plant closures and layoffs. We have also reinforced our general saving program and limited spend to allow only business-critical expenses for the time being. Considering the weak sales and earnings performance in the second quarter, I'm, however, satisfied with the way we have addressed and proactively responded to the challenging situation, especially with the speed of the actions taken. On this slide, I want to give you an indication of what the current status of operation and expansion initiatives in Gränges looks like. The production plants in Huntingdon, in Newport in the U.S. and the Shanghai plant in China are currently operating as normal. In Europe, we have closed part of the plant in Finspång by end of March, and the parts that remain in operation have been reduced to about 40% of normal capacity. As an adjustment to the market demand decline, during the quarter, we have gradually scaled up the capacity to meet the actual market demand. All employees have been temporary laid off up to 60% of the time and we have reached an agreement with the Workers Union, which gives us flexibility to scale up or down the manning level at short notice. In the U.S., we have 2 plants with the same capabilities, which gives us an even greater flexibility to adjust capacity to market demand. The Salisbury plant was temporary closed in early April, and all production has been transferred to the larger and more cost-efficient plant in Huntingdon. As in the Finspång plant, employees in Salisbury were temporarily laid off during the second quarter. As the expansion investment in Huntington continues to deliver very well, and soon is fully ramped up, we have made the decision to extend the temporary closure of the Salisbury plant until year-end. As a consequence of this, more than 100 employees were terminated at the end of June. Depending on how demands develop going forward, we may do further capacity adjustments. As I mentioned earlier, one of the actions we have taken to mitigate the effects of COVID-19 is to postpone our capital expenditure. This goes for the maintenance investment as well as for the 2 ongoing expansion projects in Newport and Finspång. In the fourth quarter of 2019, we announced the acquisition of Aluminium Konin. The acquisition will strengthen the product offering and presence in Europe and contribute with the strong positions in new attractive niche markets. Aluminium Konin will also add new capabilities and capacity to expand the offering for future transportation solutions, such as electrical vehicles. The completion of the transaction is subject to customary approval from the competition authorities. Due to the COVID-19 outbreak, the process to receive clearance will take a longer time than originally anticipated. Therefore, the closing of the transaction is expected to take place in the second half of 2020. With that, I hand over to Oskar for the financials.

Thank you, Johan. As Johan has talked about, COVID-19 has been the main theme for Gränges in the first half of 2020 and for natural reasons, even more so in the second than in the first quarter. The drop in sales volume in quarter 2 led to a significant reduction in operating profit and operating profit per tonne, as you can see on this slide. The primary driver behind the decrease in profits is the low capacity utilization, resulting from the low volume in the quarter. If we compare with Gränges' theoretical maximum capacity, the utilization was, on average, around 60% in Q2, around 70% on the HVAC side and only about 50% on the automotive side. Given that a large part of our cost base is fixed or semi fixed, this had a significant negative impact on the operational leverage in the quarter, and this is especially true for the automotive business. And you can see on this page that the operating profit per tonne is declining for automotive whereas it is more stable for HVAC. One important reason for this, in addition to the fact that we have a lower volume induction on the HVAC side, is that we have successfully taken out capacity for HVAC by temporary closing the Salisbury location, as Johan mentioned. If we adjust for the capacity taken out in Salisbury, the utilization on the HVAC side was above 85% in the quarter. Another thing that I think is worth to highlight is the mix shift with more HVAC and less automotive products in the quarter. If we compare from a year-over-year perspective, this mix shift means an unfavorable profitability effect for Gränges due to the historically higher margins for automotive products. Still, if we look at the second quarter in isolation and at the current volume levels, we have presently higher earnings in absolute terms on HVAC than on automotive products. If we look at the second quarter financials and compare with the same quarter last year, we can see that sales volume decreased by 24% to 70,800 tonnes and that the net sales decreased by 30% to SEK 2.2 billion. The main reason for the net sales decreasing more than the sales volume is lower metal prices than last year. Changes in foreign exchange rates did not have a material impact compared with the second quarter of 2019. Looking at the earnings. The adjusted operating profit amounted to SEK 42 million in Q2. That's a decrease of SEK 215 million or 84% on prior year. The main driver behind the reduced operating profit is the low sales volume leading to the low capacity utilization. In addition to this, we saw some effects of less optimal metal management in the quarter. And the primary reason for this is that it's difficult to optimize the raw material mix in our cast houses when we have large changes in volume and product mix. Over time, this will be adjusted for and optimized based on the new volume level. Similar to the first quarter, we see increased depreciation of in total SEK 27 million primarily related to the completed expansion project in Huntington. A slightly higher average conversion price contributed positively, and net changes in foreign exchange rates was positive SEK 4 million in the quarter. The second quarter operating profit further includes SEK 14 million of government grants related to financial support in connection with COVID-19. The majority of this is related to temporary layoffs in Sweden. Including the SEK 14 million of government grants, the total cost savings from the COVID-19 actions amount to about SEK 50 million in the second quarter. Looking at the profit margin, the adjusted operating profit per tonne declined from SEK 2,800 to SEK 600 in the quarter. Items affecting comparability amounted to in total SEK 5 million quarter. These are related to the ongoing acquisition of Aluminium Konin. Including the items affecting comparability, the operating profit amounted to SEK 37 million in the second quarter. The profit for the period was SEK 1 million, and this is not a level that we are satisfied with, but it may be considered acceptable under the circumstances. During the second quarter, the net debt decreased by SEK 312 million to SEK 3.2 billion or 2.9x adjusted EBITDA. We continue to see a strong underlying cash generation in the quarter, and the cash flow before financing adjusted for the expansion investments amounted to SEK 238 million. And as Johan mentioned earlier, while the areas that we have increased our focus on, as a response to COVID-19, is working capital management. Here, we continue to see a positive development in the second quarter. And in total, we released SEK 108 million of working capital. Part of the release is enabled by the sequential business downturn from Q1 to Q2, but it's also a lot of active work behind this in terms of supplier management, inventory management and, not the least, receivables collection. Despite the very challenging market situation for many of our customers, especially on the automotive side, we have managed to keep the level of overdue receivables stable during the first half of the year. We have also continued to invest in total SEK 40 million in our expansion programs. Of this, SEK 27 million are related to Sweden and SEK 13 million to the U.S. As you know, we put the expansion programs on hold, but due to the contracts with the suppliers, spend does not come down to SEK 0 immediately. Still for the second half of the year, we expect very limited expansion in CapEx, unless we make a decision to restart any of the projects. With the planned reduction in maintenance CapEx and provided that the expansion investments are not restarted before year-end, we currently expect the full year CapEx for 2020 to be about SEK 450 million. The FX and other component on this slide is primarily not cash related, but it's the result of currency translation effects on U.S. dollar-denominated debt as the SEK appreciated against the dollar in the quarter. In terms of access to liquidity, we currently have cash of close to SEK 1 billion and committed available credit facilities of about SEK 1.1 billion. This does not include the financing arrangement for Aluminium Konin, which is a separate facility. Excluding commercial papers, which are backed by our revolving credit facility, and a small working capital loan in China, we have no loans or bonds that are due until the third quarter of 2021. We believe that the financing that we have in place gives Gränges the strength to meet both the downturn as well as the expected recovery. With that, I'll hand over back to Johan Menckel, who will provide an outlook and a summary of the second quarter.

Thank you, Oskar. Given the rapid development of the spread of COVID-19 and the higher level of uncertainty in the market, it is currently very difficult to provide an accurate forecast even for the short term. That said, the research from IHS currently assumes a gradual recovery of the global light vehicle production with a sequential growth and the lower year-over-year decline in the third than in the second quarter. As commented earlier, the inventory levels are high at many of our customers, and we expect that these will start to come down in the third quarter. This will have a slowing effect on the demand for the Gränges products in the third quarter. Our belief at this point is, however, that we will see a lower year-over-year decline in our sales volume in the third than in the second quarter. Our current best guess is that the sales volume in the third quarter will be around the same level as in the second quarter. That goes for the group as well as for the individual regions. Keeping the seasonality of our business in mind, this is, however, an improvement since quarter 3 is typically a weaker quarter than quarter 2. Further, we expect to see increasing positive effects in the third quarter from the cost reduction measures that we have taken as part of the actions to mitigate the impact of COVID-19. Although the short-term implications of COVID-19 should not be underestimated, we believe that for Gränges, the medium to long-term fundamental is still positive. Our focus on supporting sustainability, light-weighting and electrification is likely to keep us in a favorable position also in the post-COVID-19 environment. It may even be so that the current crisis will speed up development in other areas and create additional opportunities for Gränges. With a strong commitment to constantly improve and develop, Gränges is well positioned to continue to deliver sustainable and profitable growth throughout economic cycles. To conclude the 2020 second quarter report. The COVID-19 and measures taken to reduce the spread of the virus affected the markets in which Gränges operates. And the demand for our automotive materials declined by over 40% in the quarter. This was, however, partly balanced by increased market shares on the HVAC side, leading to that, our sales volume declined by 24% in the quarter. The adjusted operating profit was reduced to SEK 42 million, but the cash generation remained strong with an adjusted cash flow before financing of SEK 238 million. The profit for the quarter is not at the level that we are pleased with. Considering the weak sales and earnings performance in the second quarter, I'm, however, satisfied with the way we have addressed and proactively responded to the challenging situation, especially with the speed of actions taken. Although the market conditions are expected to continue to be very challenging in the coming quarter, we continue to be positive about the medium to long-term outlook and are determined to continue to grow and strengthen our presence and position globally. Thank you for listening, and now we open up for questions.

[Operator Instructions] Now I would like to invite Mr. Rusta from [indiscernible] from [indiscernible] to ask your questions. Okay. I would like to invite the next person, Mr. Karl from ABG Sundal to ask your questions.

So first question from my side, I think relating to the ramp-up contribution. Is it possible to get an indication of how many kilotonnes we're talking about here approximately?

I guess you referred to the ramp-up of the Huntington expansion program.

Yes, exactly. And how much it has perhaps contributed on -- this quarter sort of incrementally.

No, but I think that, as you recall, we had a plan to reach 75% of the 40,000 tonnes annual capacity there by midyear, basically after the second quarter, but we indicated already in Q1 that we are ahead of that plan, which was, of course, very positive. As we now exit the second quarter, we have almost reached the full sort of available capacity at this stage of this investment. So we are very close to finalizing the ramp-up there. This means that basically, we have close to the 40,000 tonnes annual capacity available. And of course, in terms of utilization, we have more or less utilized all of this in the second quarter because this is now the sort of most efficient equipment we have in North America, and we try to fill that first. And that's also when Johan speaks about the temporary closure of the Salisbury facility, the volume that was previously produced in Salisbury has been reallocated to this new investment, basically. So it has a very high utilization in the second quarter.

All right. And if I'm not mistaken, I think in the past quarterly reports, you mentioned that you saw a positive contribution from Huntington and Newport. So it's just interesting hearing, given the fact that you mentioned that you put a Newport upgrade on hold. I was just wondering if you could perhaps provide a bit of clarity on how much extra volumes that is coming from Newport.

Yes. No, that's a good question, Karl. No, what we do see -- I mean Newport is the facility where we have the capabilities to produce this super-thin aluminum foil, and that goes into packaging and pharmaceuticals and so forth. We have seen an increased demand for that type of products in the second quarter. And so we are gradually ramping up that production facility and qualifying customers. There has been sort of fairly limited production volume but increasing. The reason why we put the investment on hold in Newport was not necessarily sort of from the CapEx perspective, it was more related to the fact that the equipment supplier couldn't travel to Newport and sort of finalize the upgrade of the last mill there. Because it's an Italian equipment supplier and they couldn't travel to the U.S. for COVID-19 reasons. But we are now discussing to try to restart this investment again because we do see that the capacity that we can get from the upgraded third mill is going to be sold in the market in a very short future. So that's a decision that we have on the table to make at an appropriate point in time.

Understood. And just final one for me on the CapEx side before -- just another question is, when you now target a reduction in expansion CapEx, how do you believe that one should think about the planned Finspång expansion? So for example, if or when things would normalize, when would you make the decision to start expansion projects there? And when, if so, could one expect volumes from the facility? I think you previously targeted contributions in the second half of 2021 before COVID-19.

Absolutely. I mean, at this point in time, we have decided to stop that project. We haven't made a decision yet on when to restart. But if we assume now, for a second, that we will keep the project sort of temporarily on hold for the rest of the year, it means basically that we see 6 to 9 months delay. So you're absolutely right. We expected to see the benefits to start to materialize in second half of 2021. Everything else is the same. That means we are into the late first half of 2022, I guess when you start to see these benefits. But we also need to keep in mind that, I mean, there is a twofold benefits coming out from this project, right? One part is the additional capacity, that's 20,000 tonnes. Depending on the market development, that capacity may or may not be needed within this time frame. And in that perspective, the delay may not have that much of an impact. But the other part, of course, is that this is going to be a quite substantial cost saving for the Finspång facility. And that impact, of course, is something that we want to sort of try to get as soon as possible, of course. So from that perspective, the 6 months to 9 months delay is unfavorable, I would say.

All right. And final question. You mentioned or highlighted that you received government support this quarter. And do you expect to receive anything in Q3 or Q4 as well? And my follow-up also, when it comes to volume and you say sales volume is fairly in line. When you say fairly in line, if I may, does that mean somewhere around plus/minus 5% versus Q2? Or how do you think one should think about it?

Yes. Oskar, here, I can answer maybe the first question there on the government grants, and then Johan can give some more flavor around the sales volume. But if we start then with the government grants, of course, a large part of these grants are related to the temporary layoffs that the Swedish government has sort of made available to companies operating in Sweden. That scheme will continue in the third quarter and provided that we have sort of the same or similar volume outlook, I foresee that we will continue to receive those grants. I mean it's basically a balance between using the temporary layoffs and getting the grants and doing more permanent layoffs. And that's, of course, something that we are always evaluating as well. But sort of with the current outlook, I do foresee that we will receive grants also in the third quarter. For the fourth quarter, it very much depends on what sort of the business activity will look like, and that's a little bit early to comment on, I think.

Then, yes, you had a question regarding the outlook for quarter 3. Johan here. And I think the question was if you can assume the volume in quarter 3 to be in line, plus/minus 5% with the volume we had for quarter 2? And then that's a correct statement as we can see it right now. I mean just to give some more comments about that. For the automotive market, we saw that China was, of course, coming in first in this COVID-19 crisis. And there was an inventory buildup in quarter 1 that impacted the sales in China in the quarter 2 negatively. And we have the same, so to say, pattern in the rest of Asia and Europe and Americas for quarter 3, where there was an inventory buildup in quarter 2, which will have to be reduced over in quarter 3. So China is, in a way, we have a more positive view in quarter 3 in terms of demand for automotive. But your assumption there, Karl, is fair and correct.

So I would like to invite the next participant Oskar from Danske Bank.

This is Oskar Lindstrom from Danske Bank. Two questions from my side. One, I guess, just following up a little bit on Karl's question there about the government grants. I mean you mentioned here that you had some SEK 50 million in cost savings and government grants in the second quarter. You mentioned in the report that you expect the cost savings to increase in the third quarter. What size of cost savings should we expect in the third quarter?

Yes. It's a good question, Oskar. We haven't sort of provided a specific guidelines on -- or guidance on exactly how large additional cost savings will be. It will be also dependent on the volume development here. Because basically, what we are doing with our cost savings is trying to take out as much as of the fixed cost and as of the semi-variable cost as possible, basically trying to convert that into variable cost. But that's, of course, actions behind that. So from that perspective, I would say that we have taken a lot of actions during Q1 and Q2. We have not yet sort of received the full quarterly run rate impact from that, if you wish. And as Johan indicated earlier, we are also reducing, now making a permanent reduction of the workforce in the Salisbury plant by the end of June. That's expected to have additional positive contributions in -- going into the third quarter. But that said, we haven't given an exact amount for what additional savings that will be expected. The government grants, I think, it's fair to assume that they will be on a similar level in Q3, provided that the market activity is similar.

Right. And could you say maybe what the run rate is in terms of personnel reduction now compared to at the beginning of -- or the average of Q2? Or...

No. I think the way to think about it is we have some comments in the report there on sort of the number of personnel on the average during the quarter. But I think the key sort of difference here that you can think is that we have 128 blue-collar employees that have been on temporary layoff in -- for a large part of the second quarter. And those have now been permanently laid off by the end of the second quarter. So that will mean some additional savings coming out of that. That's between, I would say, between SEK 3 million and SEK 5 million from that specific action, but then there are other actions as well, of course.

Right. Okay. My second question is more general. I mean very clearly, I mean demand from your customers for existing business has slowed dramatically and hopefully, will sort of recover now as more factories open. I'm thinking a little bit about sort of the new business acquisition. And has that completely stopped during this past quarter? Or are you -- do you continue to sort of plan for new models and supplying new products to customers? Or is it merely sort of them calling and focusing on volumes?

No, I mean, all this -- Johan here, good question. All these kind of long-term activities is, of course, still very active. And I mean, just to give you an example, I mean, in the European Union, there's been an investment of EUR 60 billion for the electrification of the automotive industry. And I mean, the market for flat-rolled products for battery, which is a nonexisting market for Gränges today, has equal global size as the whole heat exchanger market for combustion engines. So there is a lot of activities ongoing and on Gränges side with new products. But of course, due to the slowdown in the general market due to COVID-19, a lot of tests and customer interaction has been stopped, of course, for -- just for practical reasons. But I mean, the interest and the demand for this kind of long-term business development is still very valid. And for sure, having a more of a medium- to long-term view, we are very confident that our products and offerings will well serve kind of the need in the future. So nothing has changed on that side. It's more like short-term practical, very difficult to work with new business development since we have not been able to meet customers basically.

We have a question from [ Julian Bates ] from [indiscernible]. [Operator Instructions]

Yes, sorry, I was on mute. It's regarding the EBIT per tonne. In Q2, it was obviously very low. And usually, in Q3, it's lower seasonally over the past 4, 5 years. So my question is how exceptionally low Q2 was basically?

Sorry, [ Julian ], I didn't catch your question there at the end.