H+H International A/S (HH) Earnings Call Transcript & Summary

Welcome to the H+H International A/S Financial Report for the Q2 2020. [Operator Instructions] Speakers, please begin.

Good morning, and welcome to the conference call for H+H interim financial report for second -- first half of 2020. My name is Peter Klovgaard-Jørgensen, and I'm the CFO of H+H. With me is CEO, Michael Andersen; and unfortunately, our relations -- Investor Relations manager, Cristina Rønde Hefting, could not be with us today. We will take you through the presentation, which is also available on our website. The webcast is recorded and will also be available after the call on our website. On Slide 2, there is the agenda for today's call, a short summary about H+H, and I ask you to pay attention to the disclaimer on the forward-looking statements. Now Michael will give highlights to the quarter, a more detailed walk-through of the quarterly market development in the U.K. and a strategy update.

Thank you, Peter. Moving to Slide 3. I will quickly address key highlights for the second quarter of 2020 as well as current market outlook. We will go into details on the following slides. Q2 2020 was a mixed quarter. Most of our markets had good performance in the quarter despite the outbreak of COVID-19. On the other hand, the U.K. market was severely hit in Q2 from the lockdown at the end of March. End of the quarter, we have seen a recovery of the U.K. market and more clarity. Yet overall, visibility for second half of 2020 remains limited. Due to the recovery and better clarity, we have reintroduced a financial outlook for 2020, which we will go more into details with. But firstly, we will address the market situation in the U.K. and the effects of COVID-19. Moving to Slide 4. We came out of Q1 with very limited impact from the COVID-19 pandemic on all our markets. For Q2, however, our U.K. market was severely affected by the governmental measures taken on the 23rd of March as distribution centers and building sites consequently closed down. The lockdown continued through April. And first, in the beginning of May, a phased reopening was initiated of building sites and distribution centers. And from start of June, the housebuilders, sales centers and merchants opened again. As of July, most building construction sites are open and productivity level has increased as distancing rules are softening. Going from 2 meters to 1 meter of distance has increased productivity on the sites, however, still not at pre-closedown level. The lockdown in the U.K. meant that H+H U.K. halted production in April due to the high inventory levels and very limited demand. As demand increased in May and June, though from a low level, H+H U.K. started production up again in the end of June. In early August, all 3 U.K. factories were running, and we do see a recovery of the market. However, visibility is still low. Moving to Slide 5, where we will give you a brief strategy update. What the current market situation has shown us is the strength in the more diversified footprint we have obtained over the last years through acquisitions in Continental Europe and Poland. The consequences of the pandemic with a lockdown in the U.K. would undoubtedly have hit us much harder 3 years back. In 2015, our revenue share in the U.K. was approximately half of the group's revenue and the share of earnings even higher. Looking 1 year back into 2019, we saw a much more balanced platform with a U.K. revenue share of approximately 1/3 of group revenue. For the revenue share in Q2 2020, we see a U.K. market severely hit by the lockdown, whereas our other markets performed well despite of COVID-19 and supported by strict pricing strategies, as pricing strategy we believe we could not have executed on without the increased market share in our core regions. H+H is today in a good position to meet current challenges due to the improved diversified footprint, consisting of 3 core markets and 2 product lines targeting different building types. Also to note, we are pleased that we in Q4 2019, reduced our risk exposure by divesting our Russian business. We still believe that the German market has further consolidation potential and are continuing M&A activities also in current market situation. There are still good opportunities in the market. And with our strong financial position, we are able to pursue these opportunities. Now I will pass the word back to Peter.

Thank you, Michael. Moving to Slide 6. We will take you through the market development in our other markets. Overall, we had good performance in our other markets despite COVID-19. Looking at the German market, the lockdown did not impact building sites or distribution centers, and in fact, Q2 performance came out better than initially expected and above last year. We see a high order backlog to support midterm demand and the trading levels have continued in July. Also, the strict pricing strategy, of which we've seen the effect in recent quarters, are continuing as planned. In Poland, the lockdown did not impact the construction sector either. Trading were at expected levels and only slightly below an extraordinary high level in 2019. We do see increased competition in CSU, which I'll get back to. Trading levels continued in July. For our other markets, current trading is also at expected levels with no significant impact from lockdowns. Moving to Slide 7. In relation to the outbreak of COVID-19, we had taken several actions, which we also presented in connection with the Q1 report. Firstly, we are focused on securing health and safety of our employees as well as customers and visitors. We have enhanced safety precautions across all sites in order to reduce contamination risk. Our production impact has not been directly linked to contamination, but only to external factors, such as the previously mentioned U.K. lockdown. As an international company, we're used to working virtually and the transition to fully virtual meetings have been relatively easy. In Q1, we also presented our contingency planning. I'll just briefly update on current actions taken. The contingency plan entails adjusting production according to demand and reduction of shifts in the U.K. as well as Poland, which have been effectuated. In addition, a reorganization of the Nordics have been initiated and expected to be completed by end of 2020. The reorganization aims at a continued high customer focus in our current geographies while strengthening the cross-border synergies in back-office functions. On the CapEx side, we've been able to reduce planned investments significantly, which currently includes a postponement of the new CSU factory in Poland. For now, it is postponed to 2021. Other investments are kept to minimum investments for the time being, and we will assess the level according to the market development. In the meantime, we have taken further actions to optimize cash flow and also increased our committed credit facilities. After the brief update on the market development and our COVID-19 response, I will go through the key figures for the period on Slide 8. Revenue for the quarter totaled DKK 596 million, a negative growth of 23% compared to last year. Adjusted for the divestment -- the divested business in Russia, which had strong growth last year, the negative growth would amount to 19%. And organic growth was negative with 22%. The high negative growth was due to the U.K. lockdown, which we have touched upon. Excluding the U.K. market, organic growth grew 2%, showing the overall positive performance in the remaining markets. Despite the severe negative impact from the U.K. market, we kept a 2-digit EBIT margin at 10%, corresponding to an EBIT of DKK 57 million for the quarter. Free cash flow totaled positive DKK 108 million, showing a strong operating cash flow and cash management. Year-to-date, our revenue amounted to DKK 1.3 billion, corresponding to a negative growth of 11% compared to 2019. Investments were kept at a low level, totaling DKK 43 million at the end of June. ROIC amounted to 18%, exceeding last year's level. This is due to special item in second half of 2019 affecting the 2019 level. Financial gearing was at 0.8x EBITDA before special items, demonstrating a low level and well below our long-term target of 1 to 2x EBITDA. Excluding leasing, net interest-bearing debt was DKK 297 million, corresponding to the financial gearing of 0.6x EBITDA before special items. Moving to Slide 9. We'll take a closer look at revenue for the period. As mentioned, revenue was impacted by the U.K. market with a total of negative 23% development. Excluding U.K., the group organic growth was positive 2%, showing good market development despite COVID-19. Germany had organic growth of 6%, strong development with higher prices and stable volumes. Poland had organic growth of negative 3% against an extraordinary high activity level in 2019. Higher prices in aircrete was offset by lower volumes and flat prices in CSU. Other markets grew 5% adjusted for Russia, which we divested in Q4 2019. The Nordics, Benelux and Switzerland contributed to the organic growth in both pricing and volume. Moving to Slide 10. I will go further into details on the gross margin. Despite pressure on the top line, we maintained a gross margin of 30% for the quarter, just 1 percentage point lower than Q2 2019. The quarter was negatively affected by lower volumes produced and sold in the U.K., offset by efficiency improvements as well as higher sale prices. Government grants from the U.K. contributed positively with DKK 10 million, equivalent to 2 percentage points. Further, we saw the increased pressure on raw materials was partly offset by lower transportation costs due to lower oil prices. Compared to first half of 2019, our gross margin increased 2 percentage points, totaling 31% for the year-to-date. This was overall mainly due to efficiency improvements, higher sales prices and government grants. Moving to Slide 11, we go into details with our EBIT margin. Despite market challenges, we maintained a 2-digit EBIT margin totaling 10% for the quarter. We are pleased to report that we can maintain that level of margin in a challenging quarter. The key drivers for the margin level in the quarter was the negative impact by halted production in the U.K. and limited demand. The group's other markets contributed positively with strong operational excellence across markets, including continuous improvements, purchasing initiatives and synergies from the acquired companies. The extraordinary high level in Q2 2019 was impacted overall by higher prices and a strong quarter for the divested business in Russia. As we move to Slide 12, we see a net interest-bearing debt and financial gearing at continued low levels. The net interest-bearing debt decreased DKK 9 million since the end of 2019, totaling DKK 398 million. Looking at the first half of 2020, the net interest-bearing debt development was mainly driven by operating cash flow, partly offset by the payment of the acquired German aircrete factory in January as well as the last preferred deferred payment for Grupa Silikaty in Poland, both totaling DKK 74 million. The CapEx level, excluding IFRS 16 impact, amounted to DKK 43 million, which was related to maintenance and essential upgrade products. By end of June, financial gearing was 0.8x EBITDA. Adjusted for the IFRS impact, the net interest-bearing debt totaled DKK 297 million, corresponding to a financial gearing of 0.6x EBITDA. Compared to Q2 last year, we see a decrease of DKK 204 million primarily driven by a strong operational cash flow. Finally, it's worth mentioning that we, in the beginning of 2020, have utilized an extension option to extend the finance agreement by 1 year to 2023. Further, we have increased our committed facility with additional DKK 0.1 billion coming from the available -- sorry, off the available credit facility that was utilized during the quarter. With a credit facility of DKK 1.1 billion, we currently have unused committed bank facility of DKK 0.8 billion at 30th of June, which corresponds to an increase of DKK 100 million in the quarter. On Slide 13, we have gathered the key financial figures for the quarter and first half. A few items to highlight is that the year-to-date, we see a pressure on the top line impact from COVID-19, and despite that, we have increased gross margin and EBIT kept at the decent level of 11%. Investments were capped at a low level of DKK 43 million at the end of June. For the year, we expect CapEx in the range of DKK 100 million to DKK 130 million, which I'll get back to you when get to the outlook. Total equity increased by DKK 299 million compared to Q2 2019. And as per 30th of June, equity amounted to DKK 1.5 billion, equaling a solvency ratio of 48%. Free cash flow amounted to DKK 108 million and was predominantly impacted by strong operating cash flow in the period. With that, I will continue to the market outlook for the second half of 2020. Moving to Slide 14. As mentioned, we still see low visibility for the second half of 2020, yet some clarity has shown in the U.K. market, and therefore, we introduced financial outlook for 2020. Before I get to that, I would like to walk you through our assumptions for the outlook. We see volumes have partly returned in the U.K. market, yet the visibility in relation to volumes for the second half remains low. In regard to the other markets, we still see a softening of the markets, as initially expected. In our outlook, we do expect that any resurgence of COVID-19 is not expected to have nationwide impact on our markets. More specifically, in the U.K. market, we have listed the drivers, which have and can further support the recovery of the market. Regarding government stimulus, it was announced in the beginning of July that the threshold for stamp duty is temporarily increased from GBP 125,000 to GBP 500,000. This will continue until the end of March 2021. This will have a further -- this would have a rather large impact as it covers 9 out of 10 house sales in the U.K., which will now be exempt from stamp duty. Further, the requirement of housing should be finalized by end of year in order to utilize the Help to Buy program have now been extended to the end of February 2021. And additionally, we've seen that the softening distancing rules have improved productivity at the construction sites, reaching 80% compared to last year. A further softening of distancing rules could be required in order to improve productivity further. In the long term, we also stress that fundamentals remain attractive. Specifically, for Poland, we have seen a slowdown in permits. We expect that this is driven by close public offices and that they will recover, but is currently uncertain. Also based on GDP and PMI data, together with continued competition, we expect lower volume as we defend pricing levels. In the Nordics, we expect continued high level of volumes partly offset by price pressure. For Germany, we expect stable development as higher prices are offset by a slight volume decline. A high order backlog is expected to keep the rest of 2020 fairly stable. This leads us to the financial outlook for 2020 on Slide 15. We have presented our view on the market -- the current market situation and view on second half of 2020. With that in mind, we reinstate our financial outlook. Due to the low visibility that persists, we note that the range for expected revenue is wider than under normal circumstances. Revenue growth before acquisitions and measured in local currencies are expected to be in the range negative 16% to negative 8%. EBIT before special items is expected to be in the range DKK 250 million to DKK 300 million. Investments, excluding acquisitions, divestments and IFRS 16 effects, are expected to be in the range DKK 100 million to DKK 130 million. Looking at the realized figures for first half of 2020, we overall expect negative organic growth in the second half of 2020, while we focus on defending our margins. The CapEx level is kept at a low level to maneuver -- with maneuver to adjust according to the market development. This finalizes our presentation for the second quarter of 2020, and we'll go now to Q&A. Operator, will you take it from here?

[Operator Instructions] Our first question comes from the line of Laurits Kjaergaard of ABG Sundal Collier.

A couple of questions for me. The first one, in Q2, you realized some tailwind in your gross margin from the U.K. government of about DKK 10 million. Could you talk about it? Is there any restructuring cost in this quarter from the Nordics you mentioned specifically, Peter? Or any one-offs that we should be aware of for the remaining second half in terms of restructuring or perhaps any sort of compensation from any of the governments where the -- in the markets that you operate in?

Yes, I'll answer to that, Laurits. So overall, the restructuring of the Nordic at this time does not expect to carry a significant cost or worth mentioning, and there is no one-offs in the quarter. Within our other COVID-19 measurements, there are also no other one-offs than the government grants that we have mentioned.

And not for the second half, either?

No, you can say, when you look at our production, predominantly came up and running during the last part of June, and the last factory came online in August. So there is a limited government grant coming in. But I would say that from now on, there will be a limited government grant in the U.K.

That's fair. In terms of the reopening of the U.K., you mentioned specifically the stamp duty holiday and also the extension of the Help to Buy programs. Can you talk about specifically, what does this mean for, let's say, the underlying trends in the market? Because I mean the housebuilders obviously have a fixed amount of contracts that they're working on at the moment. Do you think that your customers will get a spike in the number of houses they would be building? Or what does these regulations specifically mean for your customers do you think?

I think what we should go back and look is the market activity, for instance, the housing market in the U.K. and what we have seen from official sources is that the number of transactions and the number of houses put up for sales has come back to pre-COVID levels. And we think that one of the drivers for that are also these initiatives where, for instance, a stamp duty holiday has a quite significant impact on the total cost for a house. And then if that runs out at the end of the first quarter next year, it is a closing window. I think that the effect on the extension of Help to Buy, we have to understand that, that is more a technicality that will enable the housebuilders to complete already agreed sales contracts so that the house buyer can be included in the Help to Buy program. And that has an effect, but not as big, I think, as the stamp duty holiday.

But isn't this more due the number of transactions, not necessarily new builds, which you are more exposed to?

Yes, when you look at the total transaction, that is correct, but we see a similar pattern reported from the housebuilders in terms of sales contracts for new housing. It follows the overall market trend. And the stamp duty also goes for new houses.

Okay. That's very clear. Moving a little now to Poland, you reported a negative 3% organic growth in the quarter despite sort of still -- entrance to the market with the new production lines there. And you also mentioned that the public offices for permits have been closed throughout the period. I mean you're reporting negative 3% organic growth, which is not really dramatically low. Are you saying that these effects maybe has an effect into the second half? What are you sort of projecting there? Or is this even maybe a 2021 effect that maybe some of the houses, which should be built in Q2 next year, are then not being -- the permits are not being sort of applied for now? Or what are you saying here in the Polish market?

So I think when you look at the negative organic growth of 3%, that is -- that really should be seen in the light of a last year that had a very high activity level. So you can say it has maybe more balanced out maybe. And that -- I think that you should see that as the key driver of the negative growth. When we mentioned the permits and the decline in those, this is predominantly within the CSU area. And what we see there is, it clearly is the result of the closure of the public offices administrating these permits. And basically, what we're looking for now is what is the recovery of those permits, but that is still unknown. So of course, for us, it's getting important to know whether that will recover through new permits coming through or whether this decline will not necessarily continue but more flatten out, you could say, and thereby not recovering. Overall, for second half of the year, we do see the increased competition in the CSU. And that is also what is reflected within our guidance. You could say that, overall, as we also say before, we are defending our price, and that could mean some volume growth.

Could you remind us sort of what is the, let's say, the lag time for when a permit is issued in -- for CSU type of production sites in Poland versus when do you actually receive, let's say, orders on building blocks from the housebuilder? What's sort of the lag time?

When we talk about these larger projects in the CSU, those are often larger apartment projects. Of course, there will be some time. And I think you're also hinting at it, you said, do we think that the drop in permits is going to impact us so much this year? Or is it more if it doesn't recover, a longer-term effect? And I tend to agree with you that a decline in permits in the high-rise segment, now here in the second quarter, will probably, if it doesn't recover, have more effect next year. But it does introduce a certain level of unclarity on the market in the second half.

Okay. Maybe one last question for me. You guide CapEx of DKK 100 million to DKK 130 million for 2020. And you have previously announced that the Reda plant in Gdansk will be postponed until next year. Could you talk a little bit about sort of what's the underlying, let's say, CapEx that we should be looking at? Is there any -- is there a wish list for you in terms of which factories besides Reda need some sort of refurbishment to get up to, let's say, the margins of your overall business? What sort of a wish list that we could look at?

So of course, as you mentioned, Reda, for us, is a strategic investment adding CSU capacity in the northern part of Poland. So for us, that is still important and are still one that we want to carry through. But given the circumstances, earlier in the year, we decided to postpone it to 2022. Besides that, there are certain capacity and efficiency projects that we would like to do, in particular, in the German market, which is currently also now moved into 2021. But I think, overall, the range of the DKK 100 million to DKK 130 million should be seen in light of a typical maintenance level at around DKK 70 million to DKK 80 million, and then we do, of course, additional efficiency and capacity investments on top of that. And with the guidance of DKK 100 million and DKK 130 million, it allows us some maneuverability depending on the market development. So if we should see a change in our operational cash flow for the year, we can do adjustments in our CapEx as needed. But at the same time, we also reiterate that we maintain focus on our strategy. And of course, that also includes investing in our factories. And I think you should see it in that light. So if market development continues being strong, then we can be closer to the DKK 130 million level.

Did you say that Reda was postponed to 2022?

No, sorry, 2021.

Our next question comes from the line of Kristian Johansen of Danske Bank.

So first question is on the U.K., where the government has proposed a reform to the planning system. Just curious on your thoughts around that and what potential impact it could see and when for you?

I think that, of course, there has been discussions as to whether the very bureaucratic planning system that they have in the U.K. has an impact on volumes in the U.K. And to some extent, it may have, at least when you talk about the original overall goals from the English government to get the number of added dwellings up to 300,000. I think that has had an impact. But when we look at last year's added dwellings at 240,000 dwellings, which was the highest for many years, I think that, that impact is, I think, more welcomed by the housebuilders in their quest to make more land available, but it's not going to be something that has a short-term impact on our business. It's more long-term impact.

Okay. Understood. Then secondly, on the U.K., just what have you seen on the imports? To what extent have they disappeared during this complete market slowdown? And are they coming back? Or have they been directed to the markets with high demand?

We do not have no -- we don't have any specific data in terms -- for now in terms of what happened to the volume of the imports in the second quarter. But we must say that we cannot see that they are withdrawing from the market, and we have seen that they have -- they are still in the spot market, and they're also trying to get in and fill voids for some of our competitors. But it's not something that we are feeling ourselves, and it is still difficult for the imports to get long-term contracts with large customers. So they are more targeting retail merchants and the spot market. But they are not withdrawing from the market.

Okay. Then my -- sorry, my last question is just on Germany and competition. So you expect the softening of this market, what impact on competition and pricing do you expect that could have?

We are talking about a slight softening of the market? I think when we look at Germany and look at it from an overall point of view, I think that it is a quite stable market this year, also at current levels. We do not see increased volumes, but we still think that we can maintain our pricing levels. And that means that demand is good in the market, and we do not see any significant price pressure in Germany currently.

And I think also, in particular, in the CSU, we see a very strong order backlog, which has actually only increased during COVID-19 due to lack of labor force to execute these orders. So when you look at the public information around the construction order backlog, again, it has only increased during the quarter. And you can say that, that sort of helps safeguard the activity on the medium-term or midterm level.

Our next question comes from the line of Laurits Kjaergaard of ABG.

Again, just one follow-up question to my good friend, Kristian's, question there on Germany. We've seen the EU trillion-euro Green Deal package with a high focus on energy efficiency and housing. And there's particularly been a focus on this bottleneck issue, which you also mentioned in your report. Could you talk a little bit about what can we expect in Germany in terms of these bottlenecks for the past couple of -- for the next couple of years? Because if there's going to be a spike in renovation rates and sort of a big demand for people renovating, and on the other side, you already have bottleneck issues with sort of building of new houses. How do you think that this EU package could potentially impact the market in Germany?

I think to start off with -- of course, this deal will, of course, impact the overall market to some extent. But it doesn't, as such, change the fact that there is an underlying demand for new houses. And the government is also very aware of this underlying demand. And you say the U.K., of course, are very monetary in their approach to assisting with this undersupply of housing. The German government doing it slightly different, where they're actually more looking into a possibility of making more land available. So the German government are doing initiatives to increase available land and thereby also support new housing being built. So I think with that, there's still a quest or a search for more housing. I think that, that need will continue. It could be that the Green Deal will enforce also more energy improving initiatives. But as such, whether it will directly impact the new housing, I personally do not believe so. In terms of the labor force, I think, to some extent, it will balance out. We know that there have been issues, but we are also hearing that the labor force is coming back again. This is more, of course, not publicly supported or any, but that is what we hear. So I believe that in the short term, it will even out. In the longer-term, we will, as we mentioned before, we will try to see if we can do something in helping productivity on the construction sites. And that is continuously within our focus. Because on the longer term, you will also see labor shortage in the U.K. and in Germany, as mentioned. So I, think that there is some longer-term possibilities there.

If I may add, Laurits, already now, we are introducing products in Germany that are focusing on increasing productivity. And in general, if you look at the penetration of aircrete over the past 10, 15 years, that has also been driven by both the, of course, performance of the product, but also that the product has proven to help productivity improvements in general. In the midterm, as Peter's saying, is that, that I think the challenge for us, when we look at innovation, and let's say, we put it in a context of 2, 3 years from now, it is going to determine who are the winners and who are the losers in this market, who can come up with solutions that further aids on reducing CO2 emissions in new buildings and in the building process as well as also solutions for improving already existing buildings and the suppliers who can come up with solutions that are significantly helping builders to improve their productivity. So that is going to be a focus area for us.

Specifically on sort of installation or sort of the green attributes of aircretes, calcium silicate, other product competitors, do you see an advantage here, specifically on the product itself?

Yes, that's what we have seen. If you really go in and look at penetration patterns for our product lines, you can see that we have consistently increased the penetration. Now aircrete is particularly focused on 1-, 2-family houses. But in all the markets we are in, we have just, over the past 20 years, seen an increased penetration. And that is driven both by the properties of the product in terms of being maybe a more CO2-friendly product, for instance, when you -- if you compare that with clay, but also that methodologies on the building sites are improved and therefore, productivity going up. If you take CSU as a product as well, you can go to Poland, and you will see over the past 10 years, I think penetration has doubled. And that's because it's seen as a quite effective product to use in -- especially in apartment buildings. And that penetration pattern you can also see in Germany.

[Operator Instructions] And there are no further questions at this time. Please go ahead, speakers.

Okay. With that, I would like to finish the call here. Thank you very much, and have a good day.