Intercos S.p.A. (ICOS) Earnings Call Transcript & Summary

Good afternoon. This is the Chorus Call conference operator. Welcome, and thank you for joining the Intercos Group First Half 2022 Financial Results Conference Call. As a reminder, all participants are in listen-only mode. After the presentation, there will be an opportunity to ask questions. [Operator Instructions] At this time, I would like to turn the conference over to Mr. Renato Semerari, Chief Executive Officer of Intercos Group. Please go ahead, sir.

Thank you very much. Good afternoon or good morning, everybody. As you know, the first semester of this year has been marked once more by abnormal headwinds, just to quote the 3 main ones, supply chain disruption that gives no signs of improvement, the second inflation which has got worse due to the energy cost spike due to the Russia-Ukraine conflict, and third, the China lockdowns due to the COVID-zero -- Zero COVID policy, which has been outing the growth of the main engine of growth of this market for the past years. Despite all these headwinds, Intercos achieved very strong results in the first semester of this year, actually, from a top line standpoint, the best ever semester that the company has achieved. And I want to thank the teams for their efforts. I want to thank the capabilities of this company in continuously innovating. And also, I have to thank the measures we put in place to minimize the impact of the inflation. Turning page, you will see a summary of the first semester results. First of all, net sales ended at a plus 17% growth, helped also by currencies as we grew double digit at plus 13%, also on a constant currency level. All the business units, the regions and the customer clusters were in positive growing year-on-year. Second, from an adjusted EBITDA standpoint, we also -- we are also posting double-digit growth, despite the inflation impact and the inefficiencies in production due to the supply chain disruption. Third, our adjusted net income was up by 54%, so a fantastic growth. And this was thanks to the EBITDA growth and also the currency effect that more than offset debt interest cost. Fourth, from an ESG standpoint, we have reached a new milestone in the semester with the first Intercos plan, CRB, being becoming carbon neutral, and this is something, again, that mark our efforts and our commitment to ESG matters. Fifth, our net debt reduced once more by EUR 49 million versus the same period of the year ago, taking our leverage down to 1.18x EBITDA. I will now pass to Pietro, who will give you more details on our results.

Thank you, Renato, for the really extensive introduction. Now let's have a closer look of our performances. As said already, we have realized sales of EUR 368 million. We have achieved a growth of 17% on prior year, which means 13% at constant currency. Main currency effect came from U.S. dollars, but also RMB, the Chinese currency, gave us a positive effect. In the second quarter, we have achieved EUR 193 million of sales, growing 13% on prior year, with an EBITDA of EUR 29.5 million at 15.3% on sales. This has been the highest second quarter ever of the group of Intercos. In gross margin, if you turn to Page 6, in gross margin, we grew 14.5%. This has been overall in line with prior year on net sales, just slightly decreasing, mainly affected by the performances that we had in the business unit Hair & Body. Our adjusted EBITDA is at EUR 48.7 million, growing at 10% on prior year on the first half in 2021. This has been driven by the positive sales performance along with a stable profitability of Make-up and also Skincare. EBITDA on sales is at 13.2%, slightly down versus prior year. Basically, this is due to the lower profitability of Hair & Body. We will touch it in a few minutes the view that has been more affected by the supply chain disruption and the higher energy costs that we have incurred in. I have to say that we really had an excellent performance also in terms of net income. Our adjusted net profit was equal to 28 -- EUR 20.8 million, growing 54% on prior year. And this important growth is due obviously to the increased EBITDA but also to our financial items. We continue to benefit from our low level of the cost of debt but -- and also this was more than compensated by favorable exchange gains. Net debt was at EUR 125 million, improving by EUR 49 million versus prior year. This is in line with the result that we have achieved at the end of fiscal 2021, slightly better, EUR 1.5 million better. And this has allowed us to have a record low leverage ratio at 1.18x and net debt without IFRS 16 below EUR 100 million. So an excellent result and a record-high low level of net debt. Now Renato will comment the results achieved by the different segments and customer type regions.

Thank you, Pietro. If you turn to Page 7, I will start by giving you a look by business unit. As you can see, Make-up has been the engine of growth. Its weight on the total business has progressively increased to go to 66% in the second quarter of this year. All in all, Make-up has an excellent performance with a steady plus 24% growth year-on-year in both quarters. Right now, in the first semester, we are now at plus 6% versus 2019, which has been the best ever year of Make-up for Intercos. And in the second quarter, the growth versus 2019 has been plus 10%. So extremely strong performance of Make-up. Skincare, overall, confirmed its weight on our total business. A good quarter 1 has been partially offset by a negative Q2. In comparison with the quarter 2 a year ago, that was the highest ever quarter for this business unit. So a record quarter as a base. Obviously, the China lockdowns and difficulties played the key role in these results. Third, Hair & Body confirmed a mid-single-digit trend in terms of growth, pretty even by quarter, at plus 4% in the semester, plus 5% in the second quarter. To note that the impact in the base of the hand sanitizer business in the Q1 has lowered -- artificially lowered, I would say, the result of this business unit. Without the hand sanitizer of the first quarter of last year, in the semester, we would have had a double-digit growth also for Hair & Body. If you now turn the page, I'm going to give you the look by region. As you can see, Americas confirmed to be the main growth driver for Intercos in the semester, gaining up to 35% of our total business in this semester. The growth has been very solid, both in the semester, plus 29% and in the second quarter, plus 27%. So a very steady growth in this region. As for EMEA is concerned, in the semester, we were up 12%, with quarter 2 decelerating a bit the pace growth at plus 5%, which -- this was mostly driven by the supply chain issues, especially in Hair & Body, with also key projects delayed in this business unit that affected the overall European performance. Asia was up double digit in the semester, plus 10%, and also in the second quarter, plus 13%. And this was thanks to the fantastic performance of Korea that more than offset the difficulties we've been facing in China. Going to the next page, Page 9, you can see the results by customer type. As we said during our last earnings call, Emerging Brands confirmed to be the key growth driver, also in this case, reaching 35% of our total business. Emerging Brands have grown 31% in the semester, with a very strong plus 23% also in quarter 2. This was mostly driven by European and U.S. prestige Emerging Brands. As for Multinationals, they also achieved double-digit growth both in the semester and in the quarter, respectively, plus 12% and plus 10%. This was driven by prestige Make-up, mostly in U.S. and in Korea. Last but not least, Retailers had a high single-digit growth both in the semester and in the quarter, plus 8% and plus 7%, so a very even growth pace, mostly thanks to European mass players. If we now go to Page 10, you will see the EBITDA results by business unit. So you've seen a growth of plus 10% in total, as Pietro just explained. And this was clearly driven by Make-up, with a plus 24%, both in top line and in EBITDA, so with a very steady EBITDA margin at 14.1%. Skincare grew also proportionally to the top line growth, plus 9%, so stable EBITDA margin plus 13.3%, while Hair & Body was the business unit that suffered from an EBITDA standpoint, losing about 400 basis points of EBITDA margin. This was driven by a combination of 3 factors. The first one is the mix of clients and projects. We had the unfortunate coincidence of 3 major projects, which were delayed from quarter 2 to quarter 3. These are projects at higher margin than the average for Intercos prestige clients. The second was driven by the energy cost increases that are particularly affecting these business unit due to the use of energy that is required for this production. So mix, inflation. And the third is the supply chain disruption that led to a lot of cost inefficiencies, production inefficiencies in our planning of this business unit that is characterized by higher volumes per production shift. So the 3 factors had a negative even impact of about 1 million each that created the issue you're seeing in terms of EBITDA margin. I must say that we are expecting a significant improvement as of next quarter, driven by the move of the projects I was mentioning before, from Q2 to Q3 as well as starting to profit from the energy surcharge that we are -- have started to pass to clients at the end of last quarter.

Okay. So now we move to the cash flow and the debt. In the first half of the current fiscal year, we have generated EUR 1.5 million. In cash flow, we are down versus prior year by EUR 18 million. And this basically, this lower cash has been generated entirely at the operating level. Operating cash flow is reflecting the increase that we had in the inventory that we have done in the first 6 months of the current fiscal year. We have increased our inventories by EUR 43 million. And this has been done in order to cope with the really high level of orders in this context of supply chain disruption. Additionally, what we have done, and this was expected and foreseen, we have increased our CapEx spending to EUR 21 million in the first half of the fiscal year. Very important is the cash that we have been able to generate in the second quarter of the current fiscal year. We have generated EUR 29 million of cash. That means that we had a cash conversion on EBITDA at 1 -- of 1, basically 1. Net debt is at EUR 125 million. As already said, it is important to note the really low level of leverage that we have. We are now at 1.18x. This is a record, never done by the group. And again, our net debt, without accounting the effect of the IFRS 16, is below the threshold of EUR 100 million, low ever level of debt for the group. Moving to Page 12, you will find our outlook and guidance. Overall, we are confirming the guidance that we gave since the beginning of the year of net sales increasing in a range between plus 10% and plus 15%. As you know, looking at the coming semester, we still see significant headwinds. The main 4 that I want to comment on because we believe that Intercos is place better than competition to cope with those. The first one is the longer-than-expected supply chain crisis. I must say that in the past 12 months, we have worked through our global network to diversify our supply sources. And also, we have built inventory to be in a better position to cope with shortages and delay in components arrivals. And as a matter of fact, I'm very happy to say that the feasibility of production at the beginning of each May -- month, which is to say the percentage of orders to be executed and complete where we have all the materials in our end at beginning of the month has been increasing since June of this year. So in June, July and now in August, we are seeing an improvement of the percentage of production orders that can be executed as of the beginning of the month. And this allows us to plan in a more effective way our productions in the course of the month. The second is the inflationary environment. We've been speaking many times on the fact that the ownership of 80% of our sales being with formulas we own and we have the IP for, gives us more pricing power than normal [ ultra ] manufacturers. And as a matter of fact, in the second semester of the year, we will start cashing in the benefit of the energy surcharge that we are passing to clients to temporarily offset the energy cost that skyrocketed. The third is the Chinese COVID-Zero policy that is still impacting the Chinese consumption overall. As we said last time, our exposure to China is much lower than many of our clients and listed companies in our sector. And the proof is that the growth of Korea has been offsetting already in the first semester the negative popping up in China. Also emerging -- Western emerging brands are now getting into the market -- into the Chinese market, and this will help smoothen the impact of lower consumptions and possible lockdowns in China in the next 6 months. Fourth, the possible recession that may hit U.S. and Europe. And on this one, I must say that I'm pretty confident that the resilience that the beauty market has always shown in the past will still be valid. There may be trade down of consumption from prestige to mass market, but this should have virtually no impact on our business because we have basically a 50-50 split between prestige clients and mass clients. So we are well protected in case this happen. All in all -- moving to the following page. All in all, we keep having, I must say, a better-than-expected order entry inflow in Make-up and Skincare. The pace, yes, has decelerated a bit in total, still remaining very solid. You can see May, June, we collected order for EUR 106 million. We have no signs of slowdown in Make-up, which continues to be very solid. While we had -- we start witnessing a bit of slowdown in Skincare, and again, the China situation is clearly not helping this business unit this year. Moving to the next page, you see that our order book continue to be extremely strong. All in all, for Make-up and Skincare, our order book is plus 38% over 2021, plus 54% versus 2019. So this puts us in a very comfortable position that we have the order to execute a very good year, especially on Make-up that is driving the growth as we've seen happening already in the first semester. The Make-up order book is plus 48% versus 2021, and plus 57% versus 2019. So we have the means to go even beyond our guidance if everything goes well and if we can execute all these orders despite the supply chain crisis. So that's all on our side. We are ready to take on your questions.

[Operator Instructions] The first question is from Anna Frontani of Berenberg.

Actually, two questions from my side. So the first one on China. If you can maybe provide some more color on what you're seeing now in terms of both demand, supply chain? And more importantly, what you're seeing -- what you're expecting for the next month? And in particular, do you see new customers coming through despite the situation, despite the lockdowns? So that's the first question. And the second one, given the inflationary pressures that you're seeing, can you give us an update on the pricing actions that you're taking? And also maybe as you touched on it, on the energy debt note, are the customers accepting that? Or do you see a little bit of struggle there?

Thank you, Anna. First of all, China, well, China is not in a good shape overall. There is clearly these lockdowns risks. Consumption, overall, is quite shy, and we are seeing some measures taken by important brands to try and control costs in a more difficult situation. Just to quote one, Maybelline has announced that it's closing its retail stores in China and remaining [ wholesale ] and e-commerce as an example. So all in all, the situation is not very, very positive. We've seen the Chinese brand not performing particularly well during the June promotion weeks. So again, not very good signs for the time being. Now everything is now pointing to the [ 11/11 ] event. We always talk about China as if it was a market where you have steady consumption, is not the case. Consumption is very much concentrated in this big promotional event. So we are seeing conservatism from the Chinese brands for the [ 11/11 ], relying more on their star products rather than new launches and new initiatives. I think that the year will be marked by this uncertainty. And I'm confident that the market is going to grow overall in the year, but nowhere near what we were used to and especially Chinese brands are being a lot more concerned about the results than in the past. Shouldn't quote specific brands or clients, but I think that what is happening to Perfect Diary is a very good example of the attention and the shift of focus from growth to protecting bottom line. So that is a bit the situation. Yes, there are some new customers coming in, but it's not the usual pace in China, very different from what we are seeing happening in Korea, at least for what we are concerned, where we are getting extremely positive results not only driven by Korean customers, but especially by Western clients wanting to be more performing with specific assortment for the Asian countries and sourcing them out of Korea. So Korea is going beyond our expectations, to be honest, and this is offsetting China that clearly we were not estimating at the beginning of the year in the shape it is today. Coming to your second question, pricing. So you know that we have increased our prices at the end of last year. We announced to our clients an extraordinary measure, which is a temporary energy surcharge that is based on the productions run for them in any given month. We had quite tough discussions with clients because normally, when you increase prices, you increase your [ lease ] prices, which means that the price increase applies to the new orders they are placing but not on the orders they have placed in the past. Our measure touches the whole order book. So no matter when the order was placed by the customer, it is increased, thanks to this measure. So the discussion took a bit longer. Right now, we have had the agreement of all -- virtually all the clients with the exception of a couple of them. I'm obviously thinking about the top 20, 25 clients, so those who really count. So we are now getting in motion to apply it to virtually everybody. So as of July, we will start cashing the benefit of this action. So you see nothing of it basically in the first semester or in quarter 2, you will start seeing the impact of it in Q3. I hope I've answered your questions, Anna.

Yes. The next question is from Kate Rusanova of UBS.

I have three. So first of all, would you be able to provide any indication on the adjusted EBITDA margin development for the rest of the year? At the Q1 results stage, you were quite confident about the relatively stable level of profitability this year. So can you reiterate that? Or do you feel it is now looking a bit of a stretch or the visibility has deteriorated? Second question is on the order intake for Make-up. You mentioned there has been no slowdown in the demand. So is the EUR 90 million or EUR 90 million, EUR 95 million order intake for the category is a normalized level, going forward? And finally, it would be very interesting to hear any insight you can give on the performance of the outsourced beauty markets during previous recessions. Did the outsourced beauty market underperform the underlying beauty market back in 2008, 2009? In other words, were brand owners less inclined to outsource production? And if I go in to see softer consumer purchasing power, do you think there could be a shift away from emerging brands and prestige brands towards more mass products and potentially retail products? And if it is the case, what mix impact do you expect to have on your margin?

Kate, I'll try to answer all your questions, but then you can come back if I missed anything. First of all, you asked a question about what is our guidance about EBITDA margin. The guidance, I would feel confident to give you now is to reiterate the guidance we've given since the beginning of the year. So basically stability of EBITDA margin in the year. This would mean that in the second semester, we should be running at about 20 basis points of EBITDA margin higher than last year, which I think is feasible, given the order book we have, given the prospects we have in Hair & Body, which should be a significantly better second semester versus the first semester, especially because of the big projects that were shifted from Q2 to Q3. And obviously, because of the impact of this energy extra charge that we are going to benefit in the second semester. So gaining 20 basis points in the second semester versus last year is absolutely possible, and we think it's realistic to still assume that will happen. So our guidance doesn't change neither in top line nor in EBITDA margin guidance. So I hope I've answered your first question. Second question was about order intake in Make-up. The order intake in Make-up kept being very, very strong. I can tell you that even July remained very strong, so on par with previous months. I must be honest, I will keep telling it, sooner or later, it should slow down or it's reasonable to expect to slow down. So far, it didn't happen. But I think that we should expect to see a bit of a [ value ] after the peak, then go back up again for the future. Again, this is not happening so far. We are sitting on an order book on Make-up, which is extraordinary to the point that our operations team is desperate of the many orders that they need to execute, and it keeps flowing in at a very strong pace. So I hope I keep being wrong and that the pace is going to stay, although logic says it's bound to slow down for a moment in the coming months. The third question is the most difficult one. First of all, because neither of us was in Intercos at the time but also because, as you know, there is no panel that tell you what is the outsourcing market and doesn't track it on a regular basis. The first study that was commissioned by Intercos to see what was the trend and which were the market shares in the outsourcing market was commissioned in 2014. So way after the economic recession you're referring to. At the time, the outsourcing market was a lot smaller than what it is today. I don't think there are any fundamental reason why it should change because of a recession because what brands are trying to avoid and escape from is the complexity of -- especially in Make-up, the complexity of producing certain production in-house. And no matter what you have right now, as we speak right now, 55% of our sales are done with emerging brands and private labels, and they have no way out than maintaining the outsourcing. So I honestly do not expect any big change in fundamental trends because of a recession. What can happen is what you mentioned about possible trade down between prestige and mass market. And this is something that historically happened during recessions. So it is very possible this happens. But we need to bear in mind that since the last recession, the emerging brands phenomenon has developed in a major way. And a lot of emerging brands have positioned themselves in what we call mass-tige segment, which is either the entry point to prestige or the top of the mass market price points, which I think will be as with spot, I think, in a recessionary environment because someone who buys a very expensive prestige brand is more likely to trade down one step rather than going all the way down to mass market. Again, we have a 50-50 business between prestige and mass. So from a top line standpoint, there shouldn't be a major shift. There might be if there is a massive shift in -- towards mass market, there might be a bit of a mix impact on the EBITDA margin. But again, I think that the emerging brands will play the cushion here and provide us with a tempering minimizing factor into that. To be honest, what we are seeing until today, and you know that better than me, is -- especially in U.S., is that prestige market is not giving any particularly worrying sign of slowdown, actually is probably better the performance in prestige and mass market so far. That is also true that we're not yet in a truly recessionary environment. So we will see, but we are not very worried about that. Kate, I hope I answered your questions. Otherwise, I'm more than happy to...

The next question is from Martin Deboo of Jefferies.

I've got three. I'll try and keep them brief. Renato, just building on what you've just been saying about recovery in Make-up, good to see it now back above 2019 levels. Getting away from the numbers, what is going on out there, just trend-wise? Are we seeing Lips coming back, sort of what sort of level of innovation are we seeing out there? Just sort of bring it to life a bit for us what the shape of the Make-up recoveries looking like. We can see what the numbers are, but I just want to go behind the numbers. Second question is more about the guidance and the laydown in the year. You kicked off the year at something about 18% LFL. You're an 8% LFL in Q2. You need double-digit LFL in H2 to get in the middle of the guidance. Did you always see the second semester as the [ third ] semester? Just how is the year panning out? And do you see something of a rebound happening in H2? And the third question is for Pietro. Pietro, are you doing a sensible thing, I think, in optimizing service level and just building the inventory that delivers that. So should we expect a similar net working capital outflow in H2 to what we've seen in H1? Those are the questions.

Martin, let me try to give you a bit what's happening behind the scenes in Make-up. To be honest, we are seeing growth in all the segments of Make-up. Lips are certainly growing in an important way. But Powders are growing even more. Now this may be driven by the fact that we've always been known to be the undisputed #1 in formulations for Powders. But Powders are extremely strong. Pencils are going very well as well. So all segments are performing well for us this year in Make-up. What we are seeing is after -- if you want a more qualitative point of view, what we're seeing is the comeback of color, which is what we've always thought it was going to happen after COVID. I still remember everybody saying, everybody is moving to natural, no make-up, no color, everything is going to be more minimalist and all that. This is typically something that happens when our clients, our consumers are in a down period, allow me to say, which COVID obviously brought that. As soon as the restrictions went away, there was the revenge of color, I would say. So bright colors coming back again, [ socialization ], opening up occasions, boosting the usage of make-up. And we've been fortunate or clever, I don't know, in getting some new clients, emerging brands doing particularly well, and this was clearly what brought us above and beyond the general Make-up market trend. So it was a mix of Make-up coming back, consumers willing to go back to color and to smile again, allow me to say so. And the fact that we've gained during the pandemic years, we've been developing new emerging brands that have come to the market doing extremely well as well as some more established either Emerging Brands or Multinationals doing initiative with us, with our innovation, doing extremely well in the market. So those are the reasons behind our performance in Make-up. The second question is the question about like-for-like in H2. Frankly speaking, if I look at the order book we have in our hands, our worry is to execute all these order books. If we convert to production and therefore, invoicing all the order book we have already on end, we're going to be doing double digit in the second semester. So again, it's not -- my worry is not what we can potentially do. My worry is how much we will be able to convert, given the difficulties in supply chain. We have never had such a rich order book. And honestly, we could deliver that. We would be able to deliver a fantastic second semester.

Net working capital. Okay. So net working capital in -- we have done an extensive job in the second quarter in order to absorb part of the increase that we had in -- basically in receivables and the lower payables that we had. So we have been able to absorb all of that. And today, we are still seeing quite a high level of inventories. I already said why we do have this high level of inventories, we do have this high level of inventory because the -- on one side, the supply chain disruption does not allow us to finalize completely all of the production that we have. That means that we have leftovers in terms of semifinished products or different components. So we are not able to finalize completely everything. And also, we did increase the level of safety stocks in order to cope with the difficulties in availability of certain raw materials. Said that, if I look at to the days of inventories, and I compare the days of inventories on -- versus prior year, and the days of inventories looking to the amount of open orders that we do have for the next -- for the upcoming months, we are exactly at the same level of prior year. So in reality, we have been able to maintain, in terms of days, the same levels that we had in 2021. Said that, going back also to what Renato was saying, we are seeing now the feasibility of our orders, which is increasing, especially in the last couple of months. That means that if we continue to have the same level of -- the increased level of feasibility, we should see our inventory is going down as we are able to ship, produce and ship all of the goods that we have. So we will still have a high level of inventories at the year-end, so we will have an absorption coming from inventories, but not at the same level that we have today.