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

Welcome to Gränges Conference Call for the third quarter of 2020. As usual, here in Stockholm, it's me, Johan Menckel, CEO of Gränges; and with me, I have our 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 presented the second quarter results in July, we looked back on the most challenging quarter in the modern history of Gränges. Although we, at that point, expected the situation would improve in the second half of the year, the third quarter turned out to be significantly better. During the quarter, we have experienced sequentially improved market conditions in all regions, with HVAC in Americas representing the strongest development. During the quarter, we have continued 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, and we continue to do so. Following the improved market conditions in the third quarter, the sales volume increased by 1% year-over-year, and the adjusted operating profit increased to SEK 203 million. The cash generation continued to be very strong, and the adjusted cash flow before financing amounted to SEK 380 million in quarter 3. During the quarter, we also established a new business unit Gränges Powder Metallurgy, this new business unit is focusing on spray forming technology and advanced aluminum powder for additive manufacturing. I will come back and explain more about this business in today's presentation. The improved market conditions become evident when we look at the market statistics. The year-over-year decline in the market activity in quarter three is nowhere near the drop we saw in the second quarter. For the automotive market, the research firm IHS currently estimates a global decline in light vehicle production of 3% in the third quarter. This can be compared with a 43% decline in the second quarter and it means a sequential growth in vehicle production of 61% from the second to the third quarter. If we look at estimates by region, we can see that Asia and Americas are almost back at last year's level, with a year-over-year decline of 1% and 3%, respectively. An important driver behind the positive development in Asia is the development in the Chinese market that was hit by COVID-19 in the end of the first quarter, but has since then recovered. IHS estimates that the Chinese light vehicle production increased year-over-year by 11% in the third quarter. Other markets in Asia, like, for instance, India remain more challenging with weaker production rates still far below last year's level. Europe is a little bit behind the market development in Asia and Americas with an 8% LVP reduction in the third quarter. Even though production rates are increasing, the uncertainty about the real customer demand remains high. Currently, IHS expect a continued recovery of the automotive market and a similar year-over-year decline as in quarter three. The most positive development in the third quarter is the Americas HVAC market that is expected to have grown by 16% compared with the same quarter last year. There are 2 primary drivers behind this. First, the summer season in the U.S. has been unusually long and warm this year, which has a positive impact on sales of air conditioning units. Secondly, as many people are now working from home because of COVID-19, there is an increased need for better indoor climate, which has increased the demand further. When we're looking at Gränges sales volume development during the third quarter, we can clearly see the impact of the strong HVAC market and the start of the recovery of the automotive market. In total, our sales grew by 1% year-over-year and with 23% quarter-over-quarter. If we look at the sales volume of automotive materials, we see a year-over-year decline by 14%. In Asia, sales volume was down 5%, in Americas 12%, and in Europe, we experienced a 27% decline. This largely follows the pattern of the development of light vehicle production in the quarter, but we see a slightly higher decline for Gränges. This is the reverse situation of what we saw in the second quarter when Gränges sales volume declined less than the light vehicle production. The key reason for this is that the uncertainty in the market during quarter two and the difficulty in predicting the market demand resulted in customers building additional inventory in quarter two. These inventories have started to reduce in quarter three. For the HVAC and other business in Americas, we see a volume increase of 15%. There are 3 main reasons for this. First, we have contracted a market share increase as of 2020, as we have commented on earlier. Secondly, the HVAC market was very strong in the quarter, and thirdly, 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 and for home delivery and takeaway has increased as a result of the heavy restrictions in many U.S. states. As we have communicated earlier, we have activated contingency plans focusing on 3 primary areas: continuity cash cost to mitigate the impact of COVID-19. In the third quarter, we have continued to work in accordance with these plans to secure business continuity, protect cash flow and reduce costs while continuously readjusting our production capacity to meet the increased customer demand. In this slide, I want to give an indication of what the current status of operation and expansion activities initiatives in Gränges looks like. In September, we restarted the Salisbury facility in the U.S. that was temporarily closed in April to reduce capacity following the COVID-19 outbreak. As of October, we are back to what we -- can be considered to be a more normal situation in our Finspång facility in Sweden. We have reduced the number of employees on temporary layoff and have instead, given notice of permanent reduction of 75 employees. The purpose of this measure is to improve the efficiency and to enable a shift of competence in order to improve the competitiveness in our Swedish operation. This means that as of October, all Gränges facilities are back to what can be considered as normal operations. As we have communicated earlier, we put the 2 remaining expansion investments in Newport and Finspång on hold as a consequence of COVID-19, partly to preserve cash and partly due to travel restrictions. Considering the improved situation, we have now decided to complete the upgrade of the Newport facility and continue and complete parts of the planned investment in Finspång to realize certain production efficiencies. Those of you who listened in on our first quarter presentation this year remembers that we did our best quarter so far in Americas in quarter 1. Following a slower second quarter, we have now again made a new record quarter in Americas. This is a combination of the strong HVAC business, the recovery of the automotive market. And last but not least, the successful ramp-up of production volumes in our Newport, Arkansas facility. We have run an investment program in Newport over the last 2 years to upgrade the plant and the 3 existing rolling mills to target the U.S. market for light gauge foil. With the key applications within specialty packaging for primarily food, health care and pharmaceutical products, as you may recall, we stopped the upgrade of the third and final rolling mill earlier this year, but we have spent significant time and effort in the first half of this year to qualify supplier from the 2 finalized mills. This has started to pay off in the third quarter. We know that the light gauge foil market was undersupplied in U.S. already to start with. Due to COVID-19 and related changes in consumer behavior demand has increased further as purchase of ready-made food, pharmaceutical have increased. This had a positive impact on the ramp-up of the commercial production in Newport in the third quarter. In total, we delivered some 2,700 tonnes of products from Newport in the quarter in relation to the planned capacity ones fully completed of around 20,000 tonnes per year, this means utilization of about 50% in quarter 3. The fact that we already had this low utilization made an operating profit per tonne above the group average is a very good sign of the potential in this business. As I commented earlier, we have restarted the upgrade of the final rolling mill and aim to have that completed by the end of quarter one next year. A core element of Gränges strategy is to explore structural growth opportunities in adjacent markets where our existing knowledge and strength can be further leveraged. One such area is aluminum powder for additive manufacturing, where we now are entering through the establishment of Gränges Powder Metallurgy. Additive manufacturing is a production technology that is now starting to be utilized at industrial scale, which means that the need of raw material will increase significantly in the years to come. So far, aluminum has not been used for additive manufacturing to a very large extent, but this is now changing, and the projected growth for this market is 25% plus year-over-year, the coming 5 years. Now is a good time for Gränges to enter this market. We have worked with aluminum powder for several years as this is a key input to our TRILLIUM product, and we have a large in-house knowledge of this field. Until now, we have, however, not sold an aluminum powder externally. Our production assets for aluminum powder are located in our former joint venture, Getek, that we have now acquired to secure full control of the powder production. As part of the transaction, we're also acquiring disposed portfolio of high-performance aluminum alloys that can be used to produce advanced additive manufacturing powder. Applications for the spall alloys are today found in high-tech industries such as aerospace, industrial robots as well as in general industries. The production base for Gränges Powder Metallurgy will be our plants in Saint-Avold and Velbert that have an initial capacity of about 3,000 tonnes per year. The Powder Metallurgy business will be a good complement to our existing business, and we aim to serve both existing and new customers with advanced aluminum powder materials going forward. In November last year, we announced the acquisition of the Polish aluminum rolling company, Aluminium Konin. We originally expected to close the transaction in the first quarter this year, but due to COVID-19, the process to receive competition clearance took longer time than expected. The EU Commission gave their final approval of the transaction in September, and we expect to close the transaction in quarter 4. We have also agreed with the seller of Aluminium Konin, Boryszew Group that part of the purchase price will be paid in Gränges share, approximately 10% of the SEK 2.2 billion enterprise value will be a noncash issue of shares to the seller. I'm very positive to that the seller becomes a shareholder in Gränges since it makes sure that our interests are aligned also after the transaction is completed. This will help to ensure that we can achieve a successful integration of Aluminium Konin into Gränges. As part of this agreement, Boryszew Group will hold the Gränges share for at least 6 months and commit to take the share of our planned right issue. As for the right issue, this has previously been indicated at a size of SEK 2 billion. This amount will be reduced with the size of the non-cash issue to the seller, securing additional value for our shareholders. The final size in terms of the right issue will be decided by Gränges Board of Directors and will be communicated when such decisions are made. I would like to take this opportunity to revisit the strategic rationale for Gränges to acquire Aluminium Konin. First, getting access to additional capabilities and capacity is 1 of the 3 primary reasons for making this acquisition. Aluminium Konin has a modern and cost competitive production facility with a broad range of capabilities with the location close to key customers. With Konin, Gränges will get capacity for growth and additional production capabilities that may be used, for instance, to broaden the offer of solutions for electrical vehicles. Secondly, Aluminium Konin has a strong position in several attractive niche markets with good underlying growth potential. For example, specialty packaging, electronics and automotive structures that are markets that Gränges is not serving in Europe today. This will diversify Gränges business portfolio and further strengthen our platform for future growth. The diversified portfolio is also something that has proven to be a great asset for Konin during the COVID-19 pandemic. Since the company is less dependent on certain end markets and therefore, so far, has been able to maintain a good sales volume during the crisis. Thirdly, Aluminium Konin is primarily serving the European market and complement Gränges geographical footprint in a very good way. Through the acquisition, Gränges will get a stronger presence in Europe, and we'll be able to leverage our know-how and capabilities of the European organization to realize synergies. To put the acquisition of Aluminium Konin in a little bit into perspective. Gränges has a strong track record of growth in earnings improvement. Since early 2012, we have more than doubled the group's production capacity and increased EBITDA almost 4x. This development has been supported by select acquisitions and investments to expand the existing facilities. In 2016, we acquired Noranda, followed by an investment program to increase capacity and capabilities. In its nature, the acquisition of Aluminium Konin is relatively similar to the acquisition of Noranda. And with the ongoing investment program completed, it will be secure that we will have capabilities and capacity required to continue our growth journey. With that, I hand over to Oskar for the financials.

Yes. Thank you, Johan. As Johan has talked about, we saw a positive development of the sales volume in the third quarter, both have we compared with last year, but especially compared with the second quarter, where the sequential growth was 23%. When we look at this chart, it's also easy to see the connection between the sales volume and the operating profit per tonne. And I think that there are a couple of things that are worth to highlight in this context. As we discussed earlier, since we have a last -- a large fixed cost base, capacity utilization in our production plants is an important driver of earnings. In Q3, we managed to increase the capacity utilization on the automotive side of our business to close to 65% from about 50% in Q2. This is not quiet at the 70% where we were at in the first quarter this year. But as you can see, we still managed to reach a slightly higher operating profit per tonne than in the first quarter. And this is to a large extent, driven by successful reduction of fixed and semi-fixed costs throughout our production footprint. For HVAC, Q3 was a new record quarter, and we had capacity utilization of about 85% and a record operating profit per tonne of SEK 2,700. On the group level, we're back at the same operating profit per tonne in Q3 of SEK 2,300 as we had in Q1 this year. Before we leave this slide, I think it's also worth to comment on the seasonality and the mix shift. Whereas 2019 was a quite typical year from a seasonal perspective with a strong first half and a less strong second half, 2020 is clearly different. The effect of COVID-19 has wiped out the traditional seasonality. And the second quarter that's typically the strongest one, now seems to become the weakest quarter in 2020. As for mix, the automotive business has historically been the highest margin business for Gränges due to the higher technical content of the product. This is, however, not the case for 2020 due to the low capacity utilization following the drop in light vehicle production. Instead, we see the higher-margin in the HVAC business, where we made significant improvements over the last couple of years and now also started to see the benefits from the expansion investments. Even though we're not happy with the margin development in the automotive business in 2020, I think this clearly illustrates the margin potential in Gränges in a scenario where the improvement within HVAC is sustained and the automotive demand is restored to historical levels. If we leave the sequential perspective and look at the third quarter compared with the same quarter last year, we can see that the sales volume increased by 1% to 86,700 tonnes and that the net sales decreased by 14% to SEK 2.6 billion. The main reason for the net sales decreasing when the sales volume is increasing is lower metal prices than in last year in combination with the net impact of changes in foreign exchange rates that was negative SEK 232 million in the quarter. Looking at the earnings, the adjusted operating profit amounted to SEK 203 million in Q3, an increase of SEK 13 million or 7% on prior year. The negative impact from the lower volume and capacity utilization on the automotive side and less optimal metal management was offset by volume growth in HVAC, a slightly higher average conversion price and effects from cost reduction initiatives. Depreciation increased within total SEK 14 million, primarily related to the completed expansion projects in the U.S. Net changes in foreign exchange rates was negative SEK 5 million in the quarter. The third quarter operating profit further includes SEK 10 million of government grants related to financial support in connection with COVID-19. The majority of this is related to temporary layoffs and reorientation support in Sweden. Looking at the profit margin, the adjusted operating profit per tonne increased by SEK 100 to SEK 2,300 in the quarter. Items affecting comparability amounted to in total SEK 26 million in the quarter. Of these, SEK 25 million are related to efficiency improvements and organizational changes in Sweden and SEK 1 million to the ongoing acquisition of Aluminium Konin. Including the items affecting comparability, the operating profit amounted to SEK 177 million in the third quarter. The profit for the period was SEK 124 million compared with SEK 198 million in the same quarter last year. The reason for the higher profit in 2019 is that we then released a provision and made a retroactive tax adjustment for income tax in China. Earnings per share amounted to SEK 1.64 in the third quarter. During the third quarter, the net debt was reduced by SEK 435 million to SEK 2.8 billion or 2.5x adjusted EBITDA. We continue to see a strong underlying cash generation in the third quarter, and the cash flow before financing adjusted for the expansion investments and acquisitions amounted to SEK 380 million. As we talked about in our second quarter report, one of the areas where we have increased our focus on as a response to COVID-19 is working capital management. Despite the sequential pickup in business activity, we continue to see a positive development in working capital in Q3. And in total, we released SEK 105 million in the quarter. I would like to say I'm very happy with how the Gränges team has continued to work with supplier management, inventory management and not the least AR collection. Despite the very challenging market situation for many of our customers, especially on the automotive side, we have managed to reduce the level of overdue receivables in the third quarter. We also continued to invest in total SEK 15 million in our expansion programs. Of this, SEK 14 million are related to Sweden and SEK 1 million to the U.S. As you know, we put the expansion programs on hold earlier in the year, but due to the contracts with the suppliers, some spend remained in the third quarter. As we've now taken a decision to complete the project in Newport and parts of the project in Finspång, we expect to see expansion CapEx of about SEK 50 million in the fourth quarter. We currently expect the full year CapEx for 2020 to be about SEK 470 million. The FX and other component on this slide is primarily not cash related, but is the result of a currency translation effect on the U.S. dollar-denominated debt as the SEK continued to appreciate against the dollar in the quarter. I believe that the continued strong cash generation is good evidence of the efforts made by the Gränges team when it comes to cost savings and capital management, and this also shows the strength of the Gränges business model. With that, I'll hand over back to Johan Menckel, who will provide an outlook for the fourth quarter and the summary of the third quarter.

Thank you, Oskar. Given the spread of the COVID-19 and still fairly high level of uncertainty in the market, it remains very difficult to provide an accurate forecast even for the short term. And that said, the research firm IHS currently assumes a continued recovery of the global light vehicle production, with a similar year-over-year decline in the fourth as in the third quarter. Even if highly uncertain, our current view is that we expect to see an organic year-over-year growth with low single digits in the fourth quarter. Sales of automotive materials is expected to be flat compared with last year, whereas HVAC and other is expected to increase with mid-single digits. This does not include any impact from the Aluminium Konin acquisition. Although the short-term implications of COVID-19 should not be underestimated, we believe that for Gränges, the medium to long-term fundamental still is 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 through the economic cycles. To conclude the 2020 third quarter report, the third quarter turned out to be fairly good for Gränges, we have experienced a sequentially improved market conditions in all regions with HVAC in Americas, representing the strongest demand. Following the improved market condition, the sales volume increased by 1% year-over-year, and the adjusted operating profit increased to SEK 203 million in the third quarter, and we made our best quarter so far in Americas. The cash generation continued to be very strong and the adjusted cash flow before financing amounted to SEK 380 million in quarter three. During the quarter, we have also established Gränges Powder Metallurgy focusing on spray forming technology and advanced aluminum powder for additive manufacturing, a very good complement to our existing business. The acquisition of Aluminium Konin is expected to be closed in quarter 4. Although the market conditions are expected to continue to be a bit uncertain in the coming quarter, we continue to be positive about the medium to long-term outlook. Now we open up for questions.

Our first question comes from the line of Gustaf Schwerin from Handelsbanken.

Johan and Oskar, Gustaf from Handelsbanken here. Firstly, a few questions on your guidance for Q4. I had a bit of problems hearing during the call. So sorry if this has been answered already. Firstly, on the automotive business, the inventory reductions that you were talking about for the Q3, are those largely over now? The reason I'm asking is when I look at your guidance for Q4 seeing stable volumes year-over-year. Is that implying some restocking in Q4? Or is that stable volumes in Q4 versus the negative growth in IHS forecast just related to the fact that you lost more volumes last year than the -- then versus what the IHS numbers suggested? That's my first question.

Oskar here. I think it's a fair question. It's certainly something we can clarify. When we say stable volumes expected, we refer to Gränges Q4 volumes last year. So for the automotive business, we are expecting the volumes to be ballpark the same as last year. And obviously, that means a general strengthening compared to Q3 and Q2, where the volumes were down compared to last year. This is a combination of things. Of course, the automotive production is gradually growing stronger. We have seen a lot of inventory cleared in the third quarter, although some remains at customer level. But we also need to keep in mind that we had a fairly weak quarter, relatively speaking, in Q4 last year on the automotive side. So it's a little bit of meeting easier comparables there as well. So it's a combination of things. But when we say flat, we refer to our own sales for last year.

And then on the HVAC growth in Q4, is that mainly on easy comps last year as well? Or I mean, you've talked about this longer effect is seen going into Q4 a bit, but has something fundamentally changed?

Yes, Johan here, I mean, HVAC in Americas, 3 primary drivers there. One is, of course, that the season has been extended. So the demand has continue even continue even in quarter 4. And then, of course, we have already contracted higher market shares. And I mean, these are the -- yes, the primary drivers behind the strong, I would say, demand from HVAC in Americas.

Great. And then just to be very clear on how we should view the volume guidance in total for Q4. So when you're saying organic growth, is that then excluding the Huntington ramp up in June 2020?

No. Organic growth refers to that it excludes the acquisition of Aluminium Konin as that is expected to close in the fourth quarter. Organic would include any sort of expansion investments we make to our current footprint.

Okay. Understood. Understood. And then lastly, from my side. When could we expect to hear some more about the pro forma numbers for the acquisition and your view on synergies, et cetera?

Yes . I think that -- I mean, we are hoping now that we can complete the Konin acquisition in the fourth quarter. And I mean, as soon as this is our company, we are also in a position, of course, to comment more around that. So at this point, we are awaiting closing. And after that, we are in a position to sort of make further comments on Aluminium Konin.

[Operator Instructions] Next question comes from the line of Mats Liss from Kepler Cheuvreux.

Yes. Coming back to automotive then and I guess the mix change there towards more electrified vehicles and so on. Previously, you have been talking about the content of your supply will increase in the electrified world. Could you confirm that? Or is it sort of -- well, could you say something about it?

Yes, Johan here. Good question, Mat. No. But we are -- as we have said earlier, very active. And for instance, we are delivering test material to the, for instance, Volkswagen MQB platform, and we have also in Asia, being awarded the business to Daimler Benz. So we are absolutely both in the EV structure and are very active in in delivering test material for several new businesses. So I mean, this will be more clear, yes, beginning of next year when many of these test period will be ended. So then we can come back to have a better answer. But absolutely, we are very active, and there's a lot of things happening in that -- on that side.

And the supply value for you in the sort of normal electrified car? Is it sort of higher than in combustion engine car? Or Is it more the same?

In terms of content for traditional type to heat exchange material, we expect to see that for a sort of comparable size, electric car versus a comparable size. Combustion engine car, it's around 40% more of typical heat exchanger material. And then, of course, the type of material is, to a large extent, very similar, indicating, of course, a similar value for Gränges.

As a side comment, Mats, I'm Johan here. I mean what we also are trying to do, we are also delivering test material for parts in the battery, like the casing and the battery foil to battery producers. And these are, of course, new business to Gränges and new customer groups.

So I guess typically we will sort of gradually see an increase of the world of electrified vehicles, you will, all things equal, your supply value is likely to increase that?

Yes. That's correct.

And as there are no further questions, I'll hand it back to the speakers for closing remarks.

Thank you, everyone, for participating in today's call. Good questions and interesting questions. Of course, you had the earlier communication about the results, I guess, a bit less question this time. We look forward to our next call on January 28 when we present our year-end report for 2020. Thank you, and goodbye.