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

Welcome to the Karnell Group Q3 report 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 Q3 report for 2024 earnings call. I'm Petter Moldenius, CEO of Karnell. And with me today, I have Lars Neret, our CFO. And we will be guiding you through the quarter's financial performance, detailing our strategic efforts and also discussing our recent acquisitions. This is, the following, what we planned for you today, that I will begin with a brief overview of Karnell and our strategic direction, for those of you who may be new to us. We'll then move into the key financial highlights of Q3. And with that, Lars will follow up with an in-depth review of our performance within our different business segments. And I will conclude with an introduction to our recent acquisitions, Haco and NE Engineering. And after that, we will wrap up with the Q&A sessions, where you will have the opportunity to ask any questions that you may have. So introduction to Karnell. We are an active and a long-term owner of industrial technology companies. Our strategy is built around a clear thematic approach focusing on acquiring small- to medium-sized companies that hold strong positions in their respective niche markets. We have structured the group into 2 distinct business units, each tailored to leverage their unique strengths. And the first one is product-owning companies. These companies hold their own IP, intellectual property, often in form of a patent or technical height. They focus on developing innovative products that delivers significant value to our customers, ensuring also that they maintain a competitive edge in their respective niche market. The second one is our niched manufacturing companies. And our niched manufacturing companies specializes in specific manufacturing areas, often a subset within manufacturing. And this enable them to deliver exceptional value to their customers. And our expectations in that business unit is clear, and that is constantly achieving a 20% EBIT margin over time. At Karnell, we have a very disciplined acquisition strategy, targeting only a few platform companies per year. And we're highly selective and prioritizing industrial leaders in their respective niche and often [ opting out ] to pass on opportunities rather than to compromise on quality. As of now, Karnell compromises (sic) [ comprises ] of 15 companies based in Finland, Sweden and U.K. And collectively, we approximately employ 700 people. Financially, our pro forma, as you can see on the slide, for 2023 reflects a solid performance, with sales reaching SEK 1.3 billion; and an EBITA of 183 million. And since then, we have acquired 3 platform companies that are not included in those numbers. Turning to Slide 4. We strive to be as transparent as possible. And even though that means sharing detailed numbers that sometimes may sting in the short term, but -- on that note, it's important to highlight that we have chosen not to adjust our financial figures, for example, for the IPO costs or external fees of advisories or others. And in this report, as always then, there are no adjustments made. We believe that -- in presenting the numbers as they are, without resorting to adjusted figures, as that may obscure the true financial picture. So focusing now on Q3. We are pleased to report a strong financial development during the quarter, highlighted by achieving our highest-ever EBITA margin, along with a solid growth and the successful completion of 2 acquisitions in Haco and NE Engineering. I think also what's particularly noteworthy is that we managed to achieve an organic growth both in revenue and EBITA, and that is still in a softer market out there. I would also like to highlight our EBITA margin of 15.4%, which is the highest to date, meeting our short- to medium-term financial goals that we've set out. And that is 15% over a business cycle. It is also somewhat of a shift in our new companies that -- in the portfolio, that the Q3 is a strong quarter where all companies are contributing to the results. Our growth this quarter hasn't just been organic. It also reflects our ongoing commitment to our strategy that we outlined during the IPO. We have continued to identify and acquire niched industrial players, companies that not only exhibit high profitability but also generates very stable cash flows. These acquisitions have been made at reasonable multiples, ensuring that we're not only growing but doing so in a financial responsible manner. And this quarter performance is a clear indicator that our strategy is working. And we remain focused on executing our growth plan, finding opportunities in niche markets and delivering on the promises that we made to our shareholders. I would also like to stress that we continue to have a strong cash flow, low leverage and a healthy M&A pipeline. And with that, Lars will go through the financial details.

Thank you, Petter. So first, an overview of the development of net sales and EBITA for Q3 historically. And looking at our net sales on the left here: We've had a CAGR of 55% from Q3 2021 to Q3 2024. And the reported increase from third quarter last year to this year was 37% -- and amounted to SEK 357 million. For EBITA, the CAGR from 2021 has been 71%. And from last year, EBITA increased by 45% to SEK 55 million. If we look at the breakdown of net sales for the quarter here. We've had an organic growth of 5%, which we continue to be very happy with considering the current market conditions. Acquisitions were 34% then of the increase -- and then a small negative currency effect in this quarter. EBITA increased by 45%. And most of that came from acquisitions, but we also had an organic growth of 6%. This quarter, we had fairly high transaction costs due to the 2 acquisitions we completed, but overall, central costs were otherwise on a more normal level. If we only account for our operating companies throughout the 2 business segments, the organic growth in EBITA was 5%. If we look at another breakdown of EBITA. We had reported EBITA for our operating companies of SEK 68 million for the quarter. And that is excluding any transaction costs that are separated here, and they amounted to SEK 4 million. And then we had other central costs of SEK 8 million. Over to our business segments then and starting with our product-owning companies. We had a strong quarter with an increase in sales of 65% to SEK 171 million. Most of that came from acquisitions, but we also had an organic growth of 14%. EBITA increased by 104% to SEK 28 million. Most of that also came from acquisitions, but at the same time, we had a very strong organic growth of 42%. EBITA margin improved from 13.5% last year to 16.6% this year. And here we see that the Q3 continued the recovery from a weaker last year for the product company segment. And almost all companies performed better with higher sales and higher margins. We've also seen continued stability for our companies within the construction sector in Finland. And hopefully, the recovery will continue within the sector. For our niched manufacturers, sales increased by 19% to SEK 185 million. The increase came from acquisitions. And we had a slightly negative organic growth of minus 1%. EBITA increased by 7% to SEK 35 million. And here we had an organic decline of 12%. The EBITA margin decreased from 20.7% last year to 18.8% this year. Our niched manufacturers had a very strong quarter last year. And this year still shows a little lower activity in general but still with good profitability across the businesses. We also still see a little lower activity from some of our larger industrial customers. Moving on to cash flow from operating activities. And as Petter mentioned, we had a strong cash flow for the quarter as well as for the last 12 months. The cash flow is still a bit volatile between quarters. And as we mentioned on the previous earnings call, we had a little lower cash flow for Q2 this year due to increase in working capital. For Q3, this effect was reversed and the cash flow was very strong. And the increase is due both to the reduced working capital and to higher profits. On to our capital structure and net debt. So we made the 2 acquisitions during the quarter, which caused our net debt to increase, [ but ] we also had a good result and strong cash flow, so the capital structure remains very strong. As of September, we had a net debt of SEK 223 million, excluding IFRS 16 leasing, and a leverage of 1.2x. And here it's important to remember that, due to the acquisitions in the quarter, we'll get the full balance sheet or net debt effect from those, but very little results to the equation. So if we would include the pro forma figures for the acquired companies, the leverage would be even lower. And as previously, we exclude also earnouts and liability for put, call options in our calculations, but you can see these number here in the table on the right, if you want to make your own calculations. Back to you, Petter.

Good. Thank you. So our acquisitions during the quarter. We -- just in the beginning of Q3, we completed the acquisition of NE Engineering. And that further expands our presence in the precision engineering sector. And we already mentioned this during the Q2 Call, but NE Engineering is a British engineering company specialized in CNC turning and milling and serves customers in very demanding industries. Largest customers are to be found within the subsea telecom sector, but they also do niche automotive production and energy and food processing customers. NE Engineering has shown a very consistent organic growth driven by its ability to attract and retain high-quality customers. This acquisition aligns perfectly well with our strategy of acquiring niched industrial companies that deliver stable cash flow, high profitability; and also comes with great growth opportunities. During Q3, as part of our goal to grow and further strengthen our presence in the U.K. market, we have now also an investment director that has started in the U.K. And by experience, we also know that it's of great importance to have local presence. And we look forward to continuing in expanding in the U.K. Now over to Haco, a Swedish company. And in the end of August, we acquired the company. And it's a third-generation family business led by the siblings Ulf and Helen. Haco is a niched supplier specializing mainly within the industrial wheels, as you can see examples of here down in the bottom left corner; as well as wheels and spare parts for wheelchairs. And I have to take a step back because I think it's very special when we are entrusted with companies like Haco, with its deeply rooted family values and legacy. And their decision to partner with us reflects also their confidence in not just for us to buy the company but also to honor the culture and -- that they have been nurturing for generations. So we are very excited about carrying this legacy forward, supporting Haco's growth while ensuring their commitment to quality and customer service remains at the very heart of everything that they do. Haco has approximately SEK 70 million worth of revenue and a very strong profitability. And it will be part of our product company business unit. To wrap up. We are very pleased with the strong financial performance in Q3, highlighted by achieving our highest-ever EBITA margin. And this was achieved through organic and acquired growth and high level of resilience despite the ongoing market challenges. This quarter, we also successfully executed 2 strategic platform acquisition that further bolster our portfolio -- and setting us up for further growth. Looking ahead, the market outlook for our companies remains stable. Lower inflation and gradually decreasing interest rates are helping to boost investments confidence, particularly in sectors sensitive to these changes such as construction. Our low debt levels, strong cash flow, robust M&A pipeline position us exceptionally well to continue advancing our growth strategy. And we remain committed to leveraging our proven acquisition and ownership model to identify and integrate promising small- to medium-sized industrial technology company, each a leader within its niche. And with that, I would like to open the floor to any questions that you may have.

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

Well done here in the quarter. So a couple of questions from my side, if that's all right, perhaps starting on a specific subsidiary, Rotomon, yes, which you mentioned that you have seen here both a stability perhaps in performance but also possibly a beginning of a recovery. Could you elaborate a bit more on what you're seeing? Is it discussion with customers that is becoming a bit more positive? Or is it actually in the order book that you see, start to see a bit better market? If you have any comments on that.

Yes, of course. So Rotomon. And for those of you who don't know: It's a company in Finland, product owning, who are supplying pipes and tanks for different sorts of water solutions, everything from wastewater to sewage water and gray water. Rotomon had a very challenging Q3 last year given the sort of position that they have in the market, as they are very early on in the construction cycle. So if you think about it, what you need when you start building a new house is, first, sort of the things that goes into the ground. So we are very early in the construction cycle there. And that was a very challenging time, not only that it went down very quickly last year but also, naturally, for us to adapt and -- the sort of overall cost structure in the company. We took serious measures during especially Q4 last year for Rotomon, and that has now shown that we are much more stable. And at the same time, the customers are -- also now are a bit more optimistic and -- especially that we also can see a bit more visibility into our customers' demand that has stabilized. And the company is doing better than it did Q3 last year.

Okay, perfect. And then you touched upon this a bit yourself. You stated, with the new companies here in the group, Q3 is actually, from a seasonality point of view, a quite decent or even strong quarter, which it perhaps haven't been really to the same extent historically, yes. So on the same topic, with the existing group of companies that you have, how should we think about seasonality in Q4 and perhaps Q4 versus Q3, yes, all else equal?

No, that's an excellent question. And as I alluded to during the call, we have seen a little bit of a shift. Q3 has become a very strong quarter for us. And that, I think, comes down to the fact that all companies contribute positively, especially this quarter. And as you are well aware, even though all our companies are profit making, they have some seasonality effect. And some are then struggling in some quarters during the year, and much stronger in others. And we have had a tilt towards Q4 as the absolute strongest quarter for us historically. I think now it is still probably a strong quarter for us, but Q3's margins are exceptionally strong, I would say.

Okay, understood. And here in the quarter in Q3, I mean, the margin improvement, despite a very tough comp, was very strong. And it seems both driven by the acquired companies but also on an organic basis, yes, I would say. Is there anything special here in the quarter that stands out that you find particularly strong or maybe a bit too strong? Or is it quite broad-based, would you say?

No. I would say it's quite evenly distributed. I mean, again as we talked about earlier, I think, the product-owning companies' last year's Q3 was, from our view, a bit underperforming. Now they are very much performing in line with expectation, while the niched manufacturing Q3 last year had an exceptionally strong margins. And we still have a very solid Q3 from those companies but not to the exceptional levels that they had last Q3, so I will say, all in all, nothing that really stands out but just that all companies are contributing in a positive manner to the bottom line.

Okay, perfect. And then 2 final questions, 2 detailed questions, perhaps to Lars. If I understand you correctly: Do you include the transaction costs, M&A transaction costs, in the respective segments and not in central costs? Is that correct?

Yes, that is correct. When we show our segments, that includes the transaction costs for each segment...

Okay. Do you happen to -- yes. Do you happen to have -- I mean I think it was SEK 4.4 million here in transaction costs in Q3. Do you know the allocation between the 2 different segments?

It was a little bit more in the niched production since that's where we acquired NE. And as of now, we have a little higher transaction costs in general in the U.K. than in Sweden and Finland...

Okay, understood, yes, yes, yes. And then finally the last question, also quite detail oriented. I mean quite high income tax, if you look at the profit and loss statement, 27.5% in the quarter. And I think it was 35.9% here year-to-date. And if you could elaborate a bit on that; and also, I mean, what we should expect for 2025 perhaps; if you see any possibility to reduce that.

Yes, good -- also a good question, yes. And 27% is actually fairly low, if we look at the historical numbers. So yes. It's we have been working with our -- with the group structure to be able to reduce the tax, and we are getting there. And historically we've had kind of -- we owned below 90% of our company, so we didn't really had any, like, group contribution abilities. And that has changed now, so it's gradually being better. So I would say that the tax rate would gradually be lower and lower but at a pretty slow pace, though.

There are no more phone questions at this time, so I hand the conference back to the speakers for any written questions or closing comments.

Yes. So we have a couple of written questions here. The first one is from [ Johan Skoglund ]. "Very strong EBITA margin development year-over-year, with a large share from M&A. Is this mainly from the acquisitions of Haco, or several acquisitions working together? And how are the acquisitions performing compared to your initial forecasts?"

So Haco has just been with us for 1 month, so that didn't contribute and -- to a large extent. But it's mainly been driven by the acquisitions we've done for the last 12 months. Naturally then, since Q4, that's contributed and -- to the bottom line. And I think they have all been performing very much in line with our internal expectations.

Next one, from [ Marius Therkelsen ]. "Can you elaborate a bit more on the above 40% organic EBITA growth in the product companies division? What companies were the main drivers for this impressive growth?"

Yes. And I think Max asked a similar question during the voiceover, but I think Rotomon was one reason. The other one was Vebe, who also then struggled during last year. Some will remember we went through the details of our IPO numbers. And they are now back to a healthy level. And I think those are the 2 strongest contributors from an organic growth perspective.

And another question from [ Marius ]. "Both NE Engineering and Haco looks like great acquisitions. For both companies, the margins are at high levels compared to already high margins in 2021, 2022. Are those margins sustainable? And how do you as new owners work to develop these companies further over the next 3 to 5 years?"

Good. I mean these numbers that we show is what sort of we've been able to verify during the DD process in each company. And as often, these are not exactly the same cost structure as we will have when they are part of Karnell Group as when this is owned by a family. They can have different [ incentive systems ] which are more based on dividends. But what we always do when we do our own valuations is that we find what we call then a normalized level. That often includes some investments to the team, strengthening the team; adding back full sort of external [ MD ] salaries, if needed, if the entrepreneur is not going to continue. And that's what we use as basis for our sort of multiple valuation. I think, if you take Haco here for an example, their profit margins during the last year, we don't think they are sustainable but driven by a few very profitable projects that they have during the year. So we don't expect them to stay at a 30% EBIT margin. That is just unsustainable, but they will probably, for sure, be able to continue to deliver over 20% EBIT margin. Same goes with NE Engineering, exceptionally high margins at the moment given a few very successful customer projects they have been driving, but we believe that our niched companies should sustainably be over 20% EBIT margin going forward. And that's the basis for that. I think, in NE's case, they can probably be a bit higher than the 20% mark even sustainably going forward.

No more questions in the chat.

Great. Then we -- thank you so much for listening in and to -- and your interest in our Q3 report and hope to talk to you in our Q4 report. Thank you for now, and have a good day.