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

Welcome to the H+H International Interim Financial Report for Q1 to Q3 for 2021. [Operator Instructions] Speakers, please begin.

Good morning, and welcome to H+H's conference call for the third quarter of 2021. My name is Andreas Holkjær, Investor Relations and Treasury Manager. Joining me on this morning's call is our CEO, Michael T. Andersen; and our CFO, Peter Klovgaard-Jørgensen. This morning, the interim financial report and supporting documents, including the presentation for this call were published and uploaded to our Investor Relations website. During today's call, management will present the interim financial report. After which, there will be a Q&A session. Please note that this conference call is being recorded and will be made available on our Investor Relations website after the call. Before handing over the call to Michael and Peter, I would like to direct your attention to the disclaimer on Page 2. During this call, the Executive Board may make certain forward-looking statements regarding various matters related to our business and company that are not historical facts. Such statements are based upon the current expectations and assumptions and are, therefore, subject to certain risks and uncertainties. Many factors could cause actual results to differ materially. For further information about the risk factors, please see the annual report for 2020. And with that, I will now turn the call over to Michael.

Thank you, Andreas, and good morning to everyone participating in this call. The interim financial report released this morning showed the best-ever 9-month result, with strong organic growth and solid earnings margins. This is primarily due to continued high activity and strong demand across all markets. However, in case continued high transport costs and inflationary pressure on certain inputs and raw materials. In combination, these effects are adversely impacting our earnings margins. We will provide more color on this matter a little later in the presentation. First, I will briefly go over a few highlights from the quarter before providing an update on our key markets. Peter will then provide additional color on the financial performance for the quarter as well on our financial expectations for the full year 2021. I will then provide an update on our strategic initiatives and the recent acquisitions before we open for questions at the end of the call. But please turn to Page 3. First, I'm pleased with the continued strong organic growth and the solid earning margins reported for the third quarter and for the 9-month period. Demand remains very strong, and we are selling everything produced to service our customers, which in combination continue price increases drove an organic growth of 13% in the quarter. However, while activity across all markets is high, the combination of continued inflation and input prices and higher transport costs is putting pressure on our earnings wages -- earnings margins. Gross profit for the quarter was DKK 250 million, corresponding to a gross margin of 31%. EBITDA amounted to DKK 171 million, corresponding to a margin of 21%. And EBIT was SEK 125 million, corresponding to a margin of 15%. Return on invested capital remained high at 21% compared to 18% in Q3 2020 and 19% in Q3 2019. Free cash flow declined to DKK 5 million, mainly as a result of the acquisition of the AAC factory in Feuchtwangen in Germany. Despite using a good portion of our cash for the acquisition, debt remains low with financial gearing unchanged at 0.3x EBITDA at the end of the quarter. Next, I will go over our core markets, starting with the Central Western Europe region on Page 4. Generally, and as previously communicated, the European housing market is still expected to continue growing. This is supported by continued structural undersupply of housing, demographic growth and organization. The positive trends seen during Q2 continued into Q3 with strong demand and high activity levels across all geographies. In Germany, a significant lack of housing space, especially in the larger cities from a growing number of smaller households, provides a solid demand outlook for both AAC and CSU. However, due to a continued lack of installation capacity and available land, the number of issued permits has consistently outnumbered completions of new buildings over the recent years. This has caused order backlogs among housebuilders to grow considerably. The German government continues its effort to boost building activity by providing incentives to homeowners and to stimulate programs targeting the availability and development of land. However, the effects of these programs appears insufficient to convince builders to invest in overcoming the labor challenges, and growth in the German construction industry is therefore expected to remain restrained until a viable solution is found. Demand remains highly imbalanced as demand in the Northeastern part of Germany is considerably higher than in the Southeastern part, causing shipment of products over longer distances. In the Nordic region, the number of issued building permits continues to increase, providing a solid demand outlook for H+H. Further, in the Benelux and Swiss markets, the industry continues to follow an overall positive trend as economies are returning to pre-COVID levels. Turning now to the U.K. market on Page 5. Here, the government has recently been vocal around their ambitions to build more homes as the stronger undersupply of housing remains. However, the exact road map back towards targeted 300,000 dwellings annually remains unclear. House sales increased to the highest level in more than 30 years ahead of the stamp duty deadline. And the current outlook supports continued high activity levels beyond the expiry of the program. The U.K. private housing market remains buoyant and third data -- third-party data provides expect -- providers expect double-digit growth in started dwellings in both 2021 and 2022. This is driven by a strong demand for housing, especially outside of the cities as U.K. citizens appears to have changed their preference and lifestyle choices in the COVID-19 pandemic. During Q3 2021, the U.K. experienced a significant lag of both truck and truck drivers as well as diesel fuel. H+H is working closely with its transportation partners to make sure that both trucks and truck drivers are available to meet customer expectations and needs. And finally, in addition to higher transport costs, H+H is experiencing increasing input costs, especially related to cement and limestone driven by CO2 taxes and high demand due to a large number of infrastructure projects. Before turning the call over to Peter, please turn to Page 6 for an update on the Polish market. Underlying demand remains strong with a historical high number of building permits being issued in the period from January to September 2021. This trend has been seen throughout 2021, but it appears to be stabilizing as we approach the end of the year. The issued permits cover construction work for both developers and for individual investors, and therefore, both of H+H product categories. The number of both issued permits and the number of dwelling starters over the past 12 months far exceed the combined annual installation capacity of Polish construction companies, and thus, further support the short- to medium-term demand outlook. The Polish CSU market remains characterized by competition and price pressure due to the addition of capacity in 2020. While price increases had have been observed in certain regions, additional capacity may still be introduced, which caused further pricing pressure in the CSU market. The competitive environment in the AAC market is relatively more moderate than that of the CSU market, which with pricing following a positive trend due to the very strong demand in the third quarter of 2021. To sum up, we continue to see very high demand across all markets, and there are currently few signs of these trends slowing down. However, we remain watchful of the short-term impacts from the increasing inflationary pressure on inputs and raw materials as well as the higher transport costs in the U.K. and Germany. We expect the inflationary pressure to remain in place for at least until the end of the year, but we will aim to offset the negative margin impact to sales price increases. This concludes my prepared remarks, and I'll now turn the call over to Peter for a review of our financial performance.

Thank you, Michael, and welcome from me as well. Please allow me to take you through the financials for Q3 2021, starting with a summary of our financials on Page 7. As Michael mentioned, Q3 showed continued high demand and activity across all markets, driving a strong organic growth of 13%. Further, our continued cost resilience led to solid earnings and -- despite the increase in inflationary pressure and higher transport costs. I will get back to these in a minute. But first, we will take a more detailed look at the revenue in the quarter on Page 8. Total revenue increased by 14% to DKK 811 million, and organic growth was 13% for the quarter. In the Central Western Europe region, revenue increased by 7% to DKK 355 million with organic growth of 6%, mainly driven by higher prices. In the U.K., revenue increased by 17% to DKK 247 million. Organic growth in the region was 11%, mainly due to higher sales volumes on the back of the COVID-19 lockdown last year. In Poland, revenue increased by 24% to DKK 209 million with organic growth of 28%, driven by higher sales volumes for CSU, and both higher sales volumes and higher sales prices for aircrete. Moving now to Page 9 for a review of our quarterly earnings. As mentioned, H+H faces an increase in inflationary pressure and higher transport costs, which is adversely impacting our earnings margins. This effect is primarily driven by three main factors. Firstly, we're seeing the increases of the prices of certain raw materials, mainly cement, limestone timber and classic oil. Second, we are experiencing higher transport costs in the U.K. and Germany caused by continued high demand pressure, leading to shipment from suboptimal locations. And finally, during the third quarter of 2021, H+H had been conducting certain planned upgrades and maintenance of two of our factories in Germany, resulting in a relatively lower production output from the factories in the period. These upgrades have also resulted in increased transport costs as H+H has had to ship products from other production facilities and often over longer distances. Together, these effects are adversely impacting our margins. Gross profit for the third quarter amounted to DKK 250 million, representing an increase of 4% relative to Q3 last year. This corresponds to a gross margin of 31% compared to 34% in Q3 last year. The year-on-year decline was primarily driven by higher production costs and transport costs, but partly offset by the relatively higher revenue. EBITDA amounted to DKK 171 million compared to DKK 172 million in Q3 last year, corresponding to an EBITDA margins of 21% and 23%, respectively. And finally, EBIT amounted to DKK 125 million compared to DKK 116 million in Q3 2020. This corresponds to an EBIT margin of 15% versus 16%. While inflation and higher transport costs are clearly impacting our earnings margins, we remain confident that these are short-term effects, and we maintain our ambition to defending our gross margins through sales price increases. On Page 10, you will see the development in our net debt in Q3. At the end of Q3, net debt totaled DKK 181 million, of which DKK 111 million related to lease liabilities. This compares to a total net debt of DKK 230 million at the end of Q4 last year. The decline since the beginning of the year is mainly a result of continued strong operational cash flow, but partly offset by cash flow related to the acquisition of the aircrete factory in Feuchtwangen in Germany. If we exclude cash flow related to the acquisition, free cash flow amounted to DKK 132 million. Financial gearing was unchanged from the prior quarter at 0.3x EBITDA and remains comfortably below our long-term target of 1 to 2x EBITDA. Now please turn to Page 11 for a brief update on the ongoing share buyback program announced earlier this year. As of 9th of November 2021, a total of 387,000 shares equal to approximately 2.2% of the share capital had been bought back under the program for a total purchase price of DKK 76 million. As a reminder, the total value of the share buyback program is DKK 115 million, and it's expected that the program will be carried out over a 12-month period. Now before handing the call back to Michael for closing remarks, please turn to Page 12 for an update on our full year 2021 financial expectations. Based on current market conditions, we narrow the previously communicated guidance ranges. We now expect organic growth to be around 11% compared to the previous guidance of 8% to 11%. Further, EBIT before special items is now expected to be in the range of DKK 375 million to DKK 400 million compared to the previous guidance of DKK 360 million to DKK 400 million. The increased midpoint of the guidance is mainly driven by improved outlook for Poland. The narrowed guidance is based on the expectation that the COVID-19 pandemic will not have any material impact on construction activity levels or supply chains. Further, we expect foreign exchange rates, primarily the British pound, the euro and the Polish zlotys to remain at end-October levels. Finally, we expect that energy and raw material prices will also remain at end October levels. This concludes my prepared remarks, and I will now turn the call back to Michael for closing statements.

Thank you, Peter. Before opening up for questions, please allow me to provide an update on our strategic initiatives and the two acquisitions announced in the last earnings call. In September, we announced that we had signed an agreement with Greisel factory to acquire it's aircrete factory located in Feuchtwangen in Bavaria, Germany. This acquisition marks an important milestone as it provides two national coverage for H+H German aircrete business. In addition, H+H will be the only supplier of both AAC and CSU products in the Southern part of Germany, and the factory could potentially supply both the Benelux and Czech markets. Based on legacy production figures, the factory has a potential to add approximately 2 to 3 percent points of market share to the German AAC business. At takeover, the factory has been producing significantly below its potential capacity. In addition, H+H is currently performing certain targeted upgrades and changes to the production facilities, and the ramp-up period should therefore be expected before the factory will reach its potential capacity. In addition to the factory in Feuchtwangen, we are very pleased to announce that H+H has signed an agreement to acquire 52.5% of the shares in the German manufacturing of aircrete and calcium silicate blocks, DOMAPOR. With this acquisition, H+H will be a strong regional player with a modern and well-managed factory, which further strengthens our presence in the German black stone market. In combination, the two factories provided an important expansion of H+H German factory network. Upon closing of the acquisition expectedly at the year-end 2021, and following the integration of the two factories, H+H would be on track to more than triple its German white stone business since 2017 when we started this program. The two acquisitions also provide H+H with an opportunity to perform certain upgrades and maintenance at its Wittenborn factory in 2022. I will provide additional details on this on Page 14. As mentioned, the two newly acquired factories expand H+H German production network and strengthen our geographic footprint in the country. H+H will therefore use this opportunity to confirm certain upgrades and maintenance of the production facilities at the Wittenborn factory in the northern part of Germany. This does, however, mean that the Wittenborn factory will be temporarily closed for a period in 2022, during which we will utilize our expanded factory network to maintain production levels. In practice, we plan to utilize the Laussnitz and Hamm factories as well as newly acquired DOMAPOR factory to support the Wittenborn factory. Further, the Laussnitz and Hamm factories will in turn be supported by the recently acquired Feuchtwangen factory. Upon completion of the upgrades, the Wittenborn factory will be a state-of-the-art facility, both from a production perspective as well from an ESG perspective. The upgrades are therefore of strategic importance, and we expect that they will add long-term value for H+H. This concludes my prepared remarks, and we are now ready to take questions. Operator, please go ahead.

[Operator Instructions] The first question is coming from Kristian Johansen of [ SB ].

Congrats on another acquisition in Germany. Before I get to that, just a question on your guidance. So you report 14% organic growth for the first 9 months and are now guiding 11% for the full year. So if my math is correct, you are implicitly guiding for 2% organic growth in Q4. So one is that also what you're seeing in your numbers? And two, if it is, why should growth come down to such a level?

Thank you, Kristian. Your math is right. I think what is worth noticing is that the U.K. market last year came extremely strong in Q4 because of all the holdback during COVID-19. And that also means that in Q4 last year, we were fully maxed out, and we also sold out of our inventory in the U.K. So a lot of it really was driven by the U.K. And then if you compare that to this year, then you can say that we have -- during all the year, we've been producing and selling at maximum levels in U.K., but we also do not have this additional stock that we can sell out from. So basically, more or less our products are growing straight in production on to the customer side. And therefore, the possibilities of growth, in particular in the U.K., is restricted compared to Q4 2020. When you then look at the other markets in the Poland market, there is still potential room for off sites. And as you look within the guidance range is one of the things that could move the guidance upwards was a continued strong higher-than-expected volume and sales pricing, in particular Poland.

Okay. Just a clarification. So what have you assumed in the 11% for the full year on Poland that we will see the same trend as we saw in Q3?

Yes. So we are assuming pretty much the same trend as we have seen so far. But we also know that there is both a risk of continued competition that can impact the guidance towards the lower end of the guidance, and it could also, on the other side, be stronger than anticipated and with a pickup towards the end of the year, which we actually also saw last year where we saw some stock building towards the end of the year, and that could then indicate the higher range.

Understood. That is very helpful. Then moving towards this acquisition of [ Stone Core ]. So first of all, can you help us a bit on some of the financial details. So first of all, what are you paying for this stake? Second of all, what level of revenue and what margin has this company been making?

So we cannot express the actual purchase price according to the agreement with the seller. What I would say from a multiple point of view, we are roughly in the same spot as you previously seen, where we are somewhere between 7 and 8x. So that's what we say. In terms of financial performance as such, also, here, it is a well-run factory. And as also Michael mentioned, it is well managed and well run. And that, of course, also means that the output of the factory is quite satisfactory. They are also actively in the, say, pursuing volumes over price, which will provide some synergies for us in the short to midterm. But that also means that their margins, in combination of those two factors, are in the same range as ours.

Okay. And the size of revenue roughly?

It's approximately 3% to 4%. 3% market share -- 4% market share, sorry, in Germany that they are adding to our network. So what it means is that we are now completing the, you would say, the target we have announced earlier on achieving a 20% market share on the German market, that has been achieved after the implementation of the Feuchtwangen factory, which was, as you can see now -- a good part of 2022 before that's all up. That will be at market shares exceeding 20%.

And obviously, just to put it into perspective of our previous acquisitions, then it's roughly twice the size of the Laussnitz.

Understood. So just the 20% market share, is that both for AAC and CSU?

No. The acquired factory has roughly 2/3 of its output is on aircrete and 1/3 on CSU. So it means that our aircrete is now above the 20% mark, whereas CSU is around the 15% mark.

You said 15%?

Yes, that's maybe a bit higher. I would say, 13%.

Yes. And then on the Wittenborn upgrade, can you maybe help us a bit on the revenue impact as well here because obviously -- you're now adding more revenue -- but I assume we shouldn't necessarily -- there's going to be some sort of revenue dilution from you shutting Wittenborn down too early. Is that the way to think about it? And can you, in any way, help us quantify how that dynamic will be?

Yes. You could say that what it did in essence, will do is that it will give us the opportunity of utilizing a fairly high capacity in Feuchtwangen, which I think in other cases, we could probably have increased our revenue a bit more in 2022. But if you start from a low level as Feuchtwangen was because it was a company in distress that we took over that had lost quite a lot of market share. It is actually for us to reach the market that we have indicated in any event, a 12- to 18-month program. But what we're doing since we have the capacity available in Feuchtwangen is that we're utilizing that capacity for covering, in essence, for the Wittenborn close down based on the graph, we just showed you. I would say that we will, of course, recover all the revenue loss in Wittenborn in this action. So what we are losing out on is the growth that we would -- Laussnitz have had in Feuchtwangen. That is going to be a little bit longer, and we don't believe to be up at full, say, market share and full capacity in Feuchtwangen before in the beginning of 2023. And range-wise, I would say that we're talking about 1% or 2% market share that we are delaying into '23. There will be some transport costs impacting on the transaction of these transport costs, we will guide the market by isolating them as special items. So you can see that because those are -- you could say, the impact of those costs would be a missed guidance of you because it has a margin impact. So we will isolate that. So if you look at the top line predictions, you should expect that the full market share of the 20% will be reached in the beginning of -- on a run rate level in the beginning of '23, and may be calculated with the cost lower during '22, right?

Understood. Great. And then just on the investment need related to the Wittenborn. I mean, can you quantify how much you need to invest to build this up there?

Yes. These -- they are in isolation. They are not huge CapEx. It's not by any means, like the Borough Green factory upgrade. But it is a -- we're doing a few different things, including automation of certain parts of the factory. We are also doing something on the load in [indiscernible]. And finally, we are upgrading our [indiscernible] base, and both making them more energy efficient and more isolated or higher insulation and also upgrading the layout of the place. So therefore, we are touching on various elements of the business, why there will be this shutdown period, but it's not large CapEx.

But you can say that we're going to end up in the higher end of what we have said that we been saying we are running at a level of a couple of hundred million annually. Of course, now we have added a couple of acquisitions. So we may want to restate that when we come up with our guidance next time. But what we talk about is a year where maybe our investment level will be around 10%, 15% higher than normal.

The next question is come from Laurits Kjaergaard at ABG.

A few questions from my side. First of all, on your guidance, congratulations on the upgrade of the midpoint. I was wondering a little bit about weather, which has been an impact on you previously, seems to the Nordics that winter has come a little bit early this year, and there was even snow experiencing in London last Wednesday. Is this a potential impact on the up and down side of your guidance?

I would say if there is -- if there are severe weather impacts, that would not be included. But we must also say, and of course, the weather is tricky. But in the past couple of years, we have not seen hard weather impacts during Q4, right? So -- but if it should happen, then that would not be included in the guidance.

Okay. And then thank you very much for the commentary around special items and isolating the different costs in regards to transportation with the shutdowns. Could you guide us a little bit on the level of special items for Q4 and then also for next year?

I think that is a little bit difficult for us to do right now. We are really -- I know that we have opened up to just give you some indication as to how we're going to handle some issues. But we would really like to have a better view of the year before we give more guidance on 2022 guidance.

Do you expect special items to be larger in Q4 relative to Q3? Or same level?

That's also a little bit premature. What we are doing in Q3 is that we are isolating the acquisition costs, so costs directly related to these acquisitions. And in Q4, we will have special items referring to the restructuring of the Feuchtwangen factory. So therefore, I would -- as such, I would expect a slightly higher special items in Q4 than in Q3.

So the level that you will announce in Q4 is the restructuring. Is that the level we should then expect for the subsequent quarters next year?

No. The Feuchtwangen -- the restructuring of Feuchtwangen is, we say, a one-off as such and is purely related to restructuring the plant to produce products that fits our product catalog and our quality. So I can say that is simply to get the factory up to a normalized level and normalized standards. The special items that we're mentioning for 2022 would be more related to upgrading our Wittenborn, and in particular, transportation of products from the south to the north.

So will you start guiding for next year, and you obviously guided to for special items, will you then be able to give us an indication of how much special items will be included?

I would hope so, but I -- we will need to see as we get closer to be honest.

But it's not something that I would say will have a major, major impact on our cash flow. So of course, have an impact on our margin, and we think that we will display along say, run rate image if we don't guide you on this.

Okay. And previously, you've been very clear on the 30% target on your gross margin. Given the volatility that we've seen during Q3 here, is that still the vision that you wish to hold for next year, also with the headwinds from the different upgrades in transportation costs?

I think that it is definitely a target that we are trying to defend. When we look at what is happening in the market right now, there are different observation points that we have rapid increases on raw materials. We have to observe that at least 2 or 3 different rules. First of almost, there will be projects in the pipeline that we have already fixed the price on going forward. And that again, in some markets and for some products, yes, as much as 2, 3, 4 months ahead. Then we have also in some markets contracts with customers where we have at least have an intention of not breaking too many contracts when we had this. And finally, we have observe what is competitor behavior. How are they reacting to all this. And therefore, there has to be expected some phasing of input cost increases when they hit us. But we have shown historically that we are very good at passing on these costs into the marketplace. But if, again, not speaking too much about next year because we have no guidance for it, I would say that how we present itself next year, but probably our contribution rate in the first half will be lower than in the second half. I think that's how you should be looking at it.

Okay. And is there any reason that the operating costs should be increasing next year significantly?

Yes, there will be some carryover effects on some of the raw materials. And we have expect -- we have seen announcement of price increases that goes over time. So that we have produced a program of price increases. And that's clear that when you have that already fixed, it's easier for us to react when we know and beforehand, what will happen to the input cost. So I say that there will be -- and it looks as if there is an increasing trend right now, but we have no firm view on it. The only thing we can say is that we are determined to pass it on to our customers, that we are one, but there can sometimes be some phasing in it, which is also to some extent what we are seeing right now, even though that I think part of the margin deterioration this year in the quarter is related to transport because of the excessive demand and also having to work to shift margin to long distances to service our customers.

And just perhaps just a really quick question on M&A. Two very solid things -- acquisitions with momentum, which was difficult during the COVID-19 period because you couldn't meet with potential sellers. Is this sort of a little bit unusual that you received two orders in Q3? Or are you experiencing momentum now in terms of being able to meet potential sellers and perhaps reach acquisition deals with them?

I think that these -- we have been quite vocal about having a pipeline, and we have worked fairly long time with these two acquisitions and that they end up materializing almost at the same time is partly due to COVID restrictions lifting, but also partly due to -- that it has been something we've been working with for a very long time. Overall, I would say that when we look at the situation, we have -- when we look at the Whitestone business inside Germany, we have increased our volume post integration of [indiscernible]. We will have increased our volume compared to 2017 with a factor of 3.5. We're getting market shares up to the level where we are starting to reach the targets that we set out in order for us to have a well-functioning setup in Germany. It's not to say that we're not interested in making more acquisitions, but I think that we're probably going to be a little bit more picky and also make sure that these acquisitions are really fitting in. So we are not having the same massive pipeline as we have had. And also, have to admit that we have not had a 100% hit rate on the things that we have done. We have also looked and reached out for other companies inside Germany that simply do not want to get sold. And therefore, it's still a growth pace with M&A, but I think we are getting less opportunities in Germany, and maybe we are increasing a little bit our, say, geographical focus and looking at whether we can make acquisitions in other parts of our footprint. But I think it's most important for us to kind of -- underlying that we, in a way, now strategically have achieved what we set out to do when we announced this journey. So from now, it's more optimization of our network, we're looking for.

There are no more questions at the moment. [Operator Instructions] It seems that all questions have been answered -- for closing remarks.

Sorry.

No, it's just -- please go ahead.

We just want to say thank you for dialing in. And looking forward to coming back to you next time and reporting on our full year results. Wish you a good day. Thank you.