Karnell Group AB (publ) (KARNELB) Earnings Call Transcript & Summary

Welcome to the Karnell Group Conference Call Q2 2024. [Operator Instructions] Now I will hand the conference over to the CEO, Petter Moldenius; and CFO, Lars Neret. Please go ahead.

Good morning, everyone, and welcome to Karnell's Q2 report for 2024. And I'm Petter Moldenius, CEO of Karnell. And with me today, I have my CFO, Lars Neret. And we will be walking you through our financial performance for the quarter and we will be discussing our strategic initiatives and providing insights into our recent acquisitions. And as you can see on the screen, what we have lined up for you today, we'll start with a brief introduction to Karnell, again, as this is our second public report, just to give you an introduction for those of you who are new, listening in. Lars will then give you the highlights of our financial performance in Q2, including the acquisitions that we've done and organic growth. And after that, I'll dive into the specific results of the last acquisition in Ojop and in NE Engineering. And at the end, we'll reserve some time for a Q&A session, where you'll have the opportunity to ask questions and both through the phone and through the chat. To the introduction. Karnell is an active long-term owner of industrial technology companies, and our strategy is built around the clear thematic approach, focusing on acquiring small- to medium-sized companies that hold strong position in their respective niche markets. We structured the group into 2 distinct business units, each tailored to leverage their unique strengths. The first one being product-owning companies and they hold their own intellectual properties or IPs often in the form of patents or what we refer to as technical height, some advantage that provides value to their customers but keep our competitors at bay. The focus is developing innovative products that can deliver customers value and ensuring that they, in turn, also maintain their competitive edge in their market. The second one is niche manufacturing and our niche manufacturing companies specialize in specific areas of manufacturing subsets and being able to provide exceptional value to their customers. And our success criteria for this unit is clear. We constantly want to achieve a 20% EBIT margin for all of our companies as that is a quality stamp in terms of the value they deliver to their customers. At Karnell, we have a disciplined acquisition strategy, targeting around 2 platform companies per year. We are highly selective, prioritizing industrial leaders in their niches and often opting out, to pass on opportunities rather than to compromise on quality. As of now, Karnell compromises of 14 company based in Finland, Sweden and the U.K. And collectively, we're now employing about 700 people. And financially, as you can see on the screen, we have our pro forma figures for '23, and they reflect solid performance with net sales reaching SEK 1.3 billion and an EBITA of SEK 183 million. So moving on to Q2. And as a reminder, as I mentioned on the last call, we strive to be very transparent. And that means sharing detailed numbers that may sometimes see in the short term. However, we firmly believe this as a commitment to transparency that will benefit us as a group and our shareholders in the long run. And on that note, it is important to highlight that we have chosen not to adjust our financial figures for the IPO costs or external advisers' fee in the report or in the chart that you can see on the screen. At Karnell, we believe in presenting the numbers as they are without resorting to adjusted figures that may obscure the true financial picture. So moving on to Q2. It's been a stable financial development for Karnell despite the challenges in the markets. We have achieved a 20% growth in net sales, which is a testament to our robust business model and strategic execution. What is particularly noteworthy is that we managed to achieve a small yet positive organic growth, even though it's been a softer market environment. But our growth this quarter wasn't just organic. It also reflects our ongoing commitment to the strategy we've outlined during the IPO. We have continued to identify and acquire niche industrial players, companies that not only exhibit high profitability but also generate stable cash flows. These acquisitions have been made at reasonable multiples, ensuring that we not only are growing, but also doing so in a financial responsible manner. The quarter's performance is a clear indicator that our strategy is working. We remain focused on executing our growth plan, finding opportunities in niche markets and delivering on our promise that we've made to our shareholders. Despite these broader market challenges, our disciplined approach to the acquisitions and our emphasis on sustainable long-term growth continue to drive Karnell forward. I would also like to mention that we have a low leverage even exiting Q2 and have a very healthy M&A pipeline going forward. And with that, Lars will go through the financials in detail.

Thank you, Petter. So first, an overview of the development of sales and EBITA. And we have added some more quarters here, so you get a feel for the historical growth in the second quarter. And looking to the left here on our net sales, we've had a CAGR of 47% from Q2 in '21 to Q2 in '24. And the reported increase from the second quarter last year to this year was 23%, and we ended at SEK 357 million. For EBITA, the CAGR from 21% has been 42%. And from last year, EBITA increased by 14% to SEK 41 million. If we look at the breakdown of net sales on the left here, we had an organic growth of SEK 2 million or 1% which we are very happy with considering the current market conditions. Acquisitions represented 22% of the increase and just a very small currency effect. EBITA increased by 14%, and most of that came from acquisitions. And organically, we had a decline of 21% or SEK 8 million. Most of this is related to unusually high central costs in the quarter, and this was mostly due to timing effects, where some costs have previously had not been fully accrued for, including Board fees and bonuses. And then we had transaction costs relating to the acquisition of Ojop of around SEK 1 million in the second quarter. And some of the increase is also due to a higher cost base in general since we are now a listed company. And if we only account for our operating companies throughout our 2 business segments, the organic decline in EBITA was 5%. If we look at another breakdown of EBITA, we had reported EBITA for our operating companies totaling SEK 52 million for the quarter. And then we had the acquisition costs of SEK 1 million for Ojop and then other central costs of SEK 10 million. Now looking at our business segments and starting with our Product-owning companies. We had a good quarter with an increase in sales of 45% to SEK 179 million. Most of that came from acquisitions, but we also had an organic growth of 4%. EBITA increased by 102% to SEK 24 million, and most of that also came from acquisitions, but we also had a strong organic growth of 16%. EBITA margin improved from 9.7% last year to 13.5% this year. And Q2 continued the recovery from a weaker year last year, and several of our companies performed better with higher sales and higher margins. And as we've previously talked about, we have some companies that operate in the construction sector in Finland, and that is still very cautious. But during the quarter, we have seen some stability here and hopefully a beginning of a recovery. For our Niched Manufacturers, sales increased by 6% to SEK 178 million. The increase came from acquisitions, and we had a slightly negative organic growth of 1%. EBITA decreased by 6% to SEK 28 million. And here, we had an organic decline of 13%. EBITA margin decreased from 17.5% last year to 15.6% this year. Our Niched Manufacturers had a very strong quarter and year last year, and this year shows a little lower activity in general, but still with good profitability across our businesses. We still see a little lower activity from some of our larger industrial customers and also a little weaker demand in the Chinese markets. Moving on to cash flow and then we talk about cash flow from operating activities. We had a stable cash flow level in the quarter as well as for the last 12 months, but due to a little higher activity at the end of the quarter, the working capital is a bit higher than previous year. Especially accounts receivable are higher. And here, we have some variations in cash flow between the quarters, which is why we usually view cash flow on a 12-month rolling basis. On to our capital structure and net debt, and we still have a very strong capital structure. And during the quarter, we increased the net debt with the acquisition of Ojop, but then we also received the remaining part of the cash from the IPO, the overallotment option. And as of June, we had a net debt of SEK 93 million, excluding IFRS leasing, and a leverage of 0.6x. And apart from leasing, we also exclude the earn-outs and the liability for our put call options in our calculations. You can see them here on the table to the right, if you want to make your own calculations. Back to you, Petter.

Thank you. Moving on to acquisitions. And during Q2, we acquired Ojop. A well-established product-owning company with strong market position in the niche of eccentric locks and battery connectors. Ojop was founded back in 1922. So it has a long history of innovation and quality, making it actually the second companies within Karnell's portfolio that has over a 100-years track record. This rich heritage aligns perfectly well with Karnell's investment criteria as we seek out companies with strong and enduring market positions. Ojop offers around 300 different eccentric locks, but under 4 brand names, catering to OEMs and end users across 50 countries, with Sweden being the largest market. This acquisition is a prime example of what we are looking for and that we are executing on our strategy to acquire niche industrial companies that not only has a strong market presence but also exhibit high profits with stable cash flows. And with Ojop, we're not just adding another company to our portfolio, we are enhancing our group's overall capabilities and market reach in Product-owning segment. And we expect this acquisition to contribute positively to our overall growth and profitability moving forward. Just after the close of Q2, we completed the acquisition of NE Engineering and further expanding Karnell's presence in the precision engineering sector. NE Engineering is a British precision engineering company that specializes in CNC turning and milling and it serves demanding industries such as subsea telecom, niche automotive, energy and food processing. This acquisition is significant as it marks our second entry into the U.K. market, and we see great collaborations, opportunities between NE engineering and Plalite, the precision engineering manufacturer that we acquired in 2023. While their offering are complementary, both companies stand to benefit significantly from sharing best practice and leveraging each other's customer base. This cross-pollination will not only enhance the operational efficiency, but it also open up new growth opportunities for both businesses. And as you can see here, NE Engineering has shown consistent organic growth, driven by its ability to attract and retain high-quality customers. The acquisition aligns perfectly with our strategy of acquiring niche industrial companies that deliver stable cash flow and high profitability. Also during Q2, as part of the goal to grow and further strengthen our presence in the U.K., we have recruited an investment director and he's going to start at the end of September. And by experience, we know that it's of great importance to have local presence, and we will look forward to continuing our expansion in the U.K. Good. To sum up before we open up for questions, we are pleased with the results of Q2. Despite continued challenges in the market, we have successfully maintained our growth trajectory and executed on our strategic objectives. The IPO process that we navigated earlier this year, continues to serve as a quality stamp for our group's vision and future. It has provided Karnell with a solid foundation of long-term thinking and home, perfectly aligning with our commitment to providing stable ownership to the companies that we acquire. The milestone has also equipped us with resources needed to pursue further successful acquisition of small- and medium-sized industrial technology companies, each a market leader within its niche. And importantly, as I said earlier, our lower leverage has positioned us well and to take care of the advantages when we see opportunities in the market and that we can ensure our continued growth without compromising our financial stability. We are excited about the path ahead. And together with our new and existing shareholders, we are eagerly anticipating continuing on our growth journey and further solidifying Karnell's position as a leading industrial technology group. And with that, we open up for questions.

[Operator Instructions] The next question comes from Max Bacco from SEB.

This is Max Bacco from SEB. First off, well done. Nice to see that you are within positive territory in terms of organic sales growth during the quarter. A couple of questions from me. I'll take them one by one. Starting with the most recent acquisition of NE Engineering, quite steep improvement in both sales and profitability here in 2024. I guess that's rolling 12 months or something like that. What would you say is a reasonable level to assume ahead, both in terms of sales and profitability for that company?

As you rightfully state, Max, it's -- they have had a tremendous organic growth and speaks well of their ability to attract customers in an organic manner. However, you can't grow these type of companies that fast, so I think we have to see that the last financial year, which ended end of March this year is a bit of an exception, especially in terms of profitability. So when we look at these type of companies, you know the average assumption we have or what we're looking for is 20% EBIT margin. I think a smaller company like this with the strong presence they have in the market, one would think that long term, they can be between 20% and 25% on a more normalized level.

Okay. Perfect. Understood. And then I noticed that I think it was in the report, you mentioned that overall, the niche manufacturers are indeed having a bit slower demand, at least compared to last year, but that you have noticed or sensed a bit more positive tones, if I understood it correctly. Could you elaborate a bit on that more in detail what you're hearing and what you're seeing here for the coming quarters?

Absolutely. So as you said, I think first half and even now Q2, it has been somewhat softer out there in the market in general. It's no single company within the Niched Manufacturing that stands out. They all more or less felt a bit softer markets. Especially also when we entered into H1, it was a bit of a lower demand and the order books were actually going down. Now we, as you know, don't really comment or giving any guidance. But what we can say is that we see that the sentiment overall is picking up, and it is a bit more of a positive attitude entering into H2 versus what we had when we entered H1.

Okay. Understood. That sounds promising. And then on M&A, I mean, you have done 3 platform acquisitions year-to-date. And as you mentioned during the presentation, your outspoken target has been to do around 2 acquisitions annually. And it sounds like your -- I mean, your M&A pipeline is -- continues to be strong and so on. But in terms of capacity within the organization to take care of additional companies, basically, do you have the capacity internally to do more M&A this year and then more focusing on -- not on the financial side, more on how much you can manage yourself, let's say?

That's a good question. And I think also that is, as you said, that we have spent time and effort and also invested there and in recruiting a person on the ground in the U.K., that will now also start then at the end of September. In addition to that, we're also looking to strengthen the team in Stockholm. So we've also been looking for adding an investment director here. But with that said, we are driving a very decentralized model and the companies themselves are driving their business, and that's very important for us. So we still have capacity to continue on the growth journey as we've committed to during the IPO and to our shareholders.

Okay. Understood. And then perhaps a question for Lars. I mean, as you mentioned yourself, quite negative net working capital effect here during the quarter on the cash flow, minus SEK 18 million. I think it was plus SEK 12 million here in Q1. I guess it's seasonality and so on. If you have any thoughts on the net working capital development here during the second half, is it possible for you to actually release some working capital and, in that way, support the cash flow instead?

Yes, also a good question. Absolutely. And as we see, so we have had seasonality in our cash flows as well. And if we look at the big items in working capital, it's inventory and accounts receivable. And inventory is pretty stable and follows pretty much the seasonality of the earnings of the company. Accounts receivables are a little bit more flexible or fluctuating. And so we had a little bit higher activity at the end of the quarter here, which is why the accounts receivables are a little bit higher than they were last year. And yes, we expect those to release in Q3. So we expect, of course, that Q3, especially for accounts receivable, will be a little better, at least for working capital. And we have -- it's I wouldn't say normal to have these high accounts receivables, but it is fluctuating in some companies, and we don't have any problems with old accounts receivable and such. So yes, we expect them to release and working capital to be a little bit lower in Q3 at least.

Okay. Perfect. Very clear. And then on the topic of seasonality, could you just perhaps remind us of your -- I mean, looking at sales and earnings, the seasonality here during Q3 and Q4? I mean I think Q2 is usually your strongest quarter during the year, but how should we think about Q3 and Q4?

Well, Q2 and Q4 are our best quarters, seasonality, and Q1 is probably the lowest, and Q3 is also very low. Q4 is usually a little bit better actually than Q2. Q3 is usually low, but it might be good to keep in mind that actually last year, we had a very good Q3, especially for the niche producing companies.

Okay. Understood. So a bit tough comps here in Q3 then. And on the central costs, which were minus SEK 11 million here in the quarter, and you mentioned that they were a bit unusually high. And historically, I think it's been around SEK 6 million on a quarterly basis. But now we have added another or a new investment director in the U.K., and of course, you are now a listed company. So what would you say is a normalized level to assume going forward?

Yes. It's obviously then a little bit higher now. And both with the new hires and, of course, with some added costs for us now being a listed company. So I would say, around SEK 7 billion to SEK 8 million per quarter would be a reasonable level.

Great. Understood. All right. Understood. And then the final question, you mentioned in relation to the working capital that the end to Q2 were quite -- or was quite strong. And I mean, we are halfway through Q3 now as we speak. So if you could give any comments on the development here during Q3. Has it continued to be stable and perform as we have seen during the first half of the year?

Again, I think we're not really giving any real guidance but more than what I said earlier on, that we are entering in H2 with more confidence than we did when we entered H1.

There are no more questions at this time. So I hand the conference back to the speakers for any written questions.

Yes. So we have a couple of questions here from Martin at Central Invest. I think a couple of them have already been answered, the development in NE and high central costs. There's another one from the footnote, [indiscernible] rebounded due to seasonality to 22% margin in Q2 after a loss in Q1. Do you still see around 20% margin for 2024?

Again, we're not sort of giving guidance on specific companies within the group. But in general, they are doing very stable performance and we expect them to be more or less on the same level as they have in the past.

Okay. No more questions that I can see. Good. Then thank you, all, for joining and listening in and we wish you a great day. Thank you.

Thank you.