Kendrion N.V. (KENDR) Earnings Call Transcript & Summary

Good day, and welcome to the Kendrion's Third Quarter Results 2020 Analyst Call. [Operator Instructions] Today's conference is being recorded. Joep van Beurden, Kendrion's CEO, will start today's call with a short statement, after which there will be time for questions. At this time, I would like to turn the conference over to Joep van Beurden. Please go ahead, sir.

Thank you very much. Good morning, and welcome to Kendrion's Q3 2020 Results Teleconference. My name is Joep van Beurden, Kendrion's CEO. And with me on the call is Jeroen Hemmen, our CFO. I will start the meeting with some remarks regarding our Q3 results, after which we'll have time for Q&A. We will post a recording of this call and of the Q&A on Kendrion's website as soon as is practicable. I would like to draw your attention to the fact that certain statements contained in my remarks and in the answers to your questions constitute forward-looking statements. These forward-looking statements rely on several assumptions concerning future events and are subject to uncertainties and other factors, many of which are outside the company's control that could cause actual results to differ materially from such statements. Before reviewing our Q3 2020 results, let me start with giving an update on the impact of COVID-19 on the way we operate at Kendrion. Our priority in dealing with the pandemic is the health and safety of our employees, their families, customers and suppliers. We continue to apply strict operating procedures in all our factories to protect all of our stakeholders, and we will keep these measures in place for as long as required. This includes working from home for all employees for whom this is possible, strict separation between production shifts, keeping enough distance between colleagues, professional cleaning and disinfecting between shifts, temperature screening and the use of face masks in all of our factories and offices around the world. And although our employees have, of course, been affected by COVID, we continue to deliver to our customers around the world. We are also working closely with our suppliers, and I am pleased to say that currently, our supply chain continues to be fully operational. At the same time, we are closely monitoring our inventory and are committed to reducing our cash contained in working capital during periods of reduced revenue levels. Let's talk about the Q3 results. As you have seen from our press release of this morning, we've had a solid third quarter and are reporting a 6% increase in Q3 EBITDA compared to Q3 last year and a 42% increase in cash flow despite the COVID-19 impact on our top line. I am proud of our employees who have delivered these results amidst the COVID-19 pandemic, which is putting pressure on all aspects of our business and our lives. We operate in 3 business groups: The Automotive group, Industrial Brakes and Industrial Actuators and Controls. Despite the challenging market circumstances, the medium to longer-term growth prospects for Kendrion are favorable, and we continue to invest in that. Within Automotive, we are evaluating our European manufacturing footprint and have decided to close our facility in Eibiswald, Austria for mid-2022. Eibiswald currently employs 93 full-time equivalent personnel, of which around half in production. All production lines will be transferred to other Kendrion facilities over the next 1.5 years. For the medium to long term, our Automotive product and project pipeline is healthy. In Industrial Brakes, we expect to fully realize the targeted EUR 2 million run rate for cost synergies in the fourth quarter of this year, and we continue to see good growth opportunities. We intend to increase our manufacturing footprint in China by building a new 28,000 square meter facility in Suzhou. We will be able to accommodate the strong growth that we anticipate. And talking about China, its economy has recovered and the contribution of former INTORQ, part of our Industrial Brakes business unit, is well ahead of expectations. Next, let me review our financials. Revenue in the third quarter of 2020 came in at EUR 98.6 million, a decrease of 4% compared with the third quarter of 2019. Excluding the revenue contribution of INTORQ, revenue decreased by 16% as the pandemic continued to affect our end markets. This is a step-up from the organic revenue decrease of 34% that we experienced in the second quarter. In Automotive, the upward trend that started in June 2020 continued in the third quarter with year-over-year revenue decreasing by 17%, a significant improvement over the 44% revenue decrease in the second quarter. Several automotive niche markets, such as the global bus and coach market remained weak, while the passenger car segment in Europe showed a steeper than expected recovery. Automotive in China continued its strong performance with revenue exceeding pre-COVID-19 levels. Industrial revenue increased by 17% compared with Q3 2019. Excluding the contribution of INTORQ, revenue in the industrial activities decreased by 18%, 1-8, year-over-year comparable to the year-over-year drop in the second quarter of 2020. Organic revenue in Industrial Brakes decreased by 18%, 1-8, year-over-year. Here, the COVID-19 impact was a bit higher in Q3 than in Q2, while orders in the wind power segment in China continued to be strong. Revenue from the former INTORQ activities was robust. Industrial Actuators and Controls experienced an organic revenue decline at the same rate as Industrial Brakes, so again, 18%. Certain segments such as medical and food processing equipment performed well while aerospace and textile machinery continue to be weak. China had a strong third quarter as the economy experienced a V-shaped recovery. China revenue increased 85% year-over-year, including INTORQ and 7% organically, with all business units contributing to the higher revenue. Our normalized operating results before depreciation and amortization increased by 6% to EUR 11.4 million from EUR 10.1 million, which means our EBITDA margin rose to 11.6%. Our added value margin increased by 1.6%, largely as the result of a higher revenue share of the industrial activities. Total personnel costs and other operating expenses decreased on an organic basis by EUR 5.2 million or 14% of the total cost base as a result of strict cost control, structural cost measures taken in the previous quarters and the use of short-term work arrangements. Together, this more than offset the organic revenue decline. Profitability in both the Industrial and Automotive activities developed favorably compared to the second quarter. In Industrial, profitability also improved year-over-year. The effective tax rate in Q3 2020 was 27.8% compared to 26.5% in Q3 of last year. Net finance charges increased by EUR 200,000 due to the funding costs of the INTORQ transaction. Normalized net profit before amortization and acquisition-related intangibles was EUR 3 million, unchanged from Q3 2019. Over the first 9 months of 2020, normalized EBITDA decreased to EUR 33.2 million from EUR 36.2 million over the first 9 months of 2019. Our normalized EBITDA margin remained stable at 11.3% as a larger added value margin and organic cost reductions of EUR 17.3 million partly offset the profitability impact of EUR 67.8 million in lower organic revenue. Normalized net finance costs in the first 9 months of 2020 amounted to EUR 2.5 million, EUR 600,000 higher than the first 9 months of 2019, mostly as the result of the additional debt taken on to fund the acquisition of INTORQ. Normalized income tax expenses for the first 9 months of 2020 came out at EUR 2 million, well below the EUR 3.8 million in the first 9 months of 2019, reflecting the lower profit before tax. The normalized effective tax rate in the first 9 months of 2020 was 23.8% compared to 25.8% over the first 9 months of 2019. All in all, this resulted in normalized net profit for the first 9 months of 2020 before amortization of intangibles arising on acquisitions of EUR 8.8 million compared to EUR 12.1 million a year ago. Kendrion's financial position is robust. Total net debt, including IFRS 16 lease liabilities, decreased from EUR 130.5 million at the end of Q2 2020 with EUR 7.9 million to EUR 122.6 million at the end of Q3 2020. The lower net debt was the result of a positive free cash flow of EUR 8.8 million in the third quarter, which was more than 40% higher than in the third quarter of 2019. Our leverage ratio was 2.9 and 2.5 excluding lease liabilities, which means Kendrion was operating well within the financial covenant level of 4.5 agreed with its banks as per 30th of September 2020. We invested EUR 11.2 million in the first 9 months of 2020, well below the depreciation of EUR 19.1 million. Investments in the third quarter were particularly low as we suspended nonessential investments in response to the COVID-19 crisis. And while we expect investments to increase in the fourth quarter, we anticipate investments for the full year to end somewhat below the level of last year. Kendrion's solvency ratio was 45.7% at the end of September 2020 compared with 47.3% at the same time last year. Let me talk a bit about the outlook. In the short term, we expect the global economy and the increasing COVID-19 infections worldwide to continue to negatively affect the markets we are operating in. And as the longer-term impact of the pandemic remains highly uncertain, we will continue to focus on our costs and protect our liquidity. Despite this dynamic and the unprecedented economic situation, we see ample growth opportunities in our focus areas for Automotive, Industrial Brakes in China for the medium to longer term. Kendrion has transformed in a global, more centralized group with a clear unified strategy and a matching collaborative culture. And with the successful addition of INTORQ, our Automotive and Industrial activities each represent approximately 50% of our revenue and growth potential. The balance between these 2 will provide a natural hedge against cyclicality going forward. We remain positive about our business fundamentals, with our main objective being to deliver sustainable, profitable growth and are working hard with our teams across the world to ensure that beyond COVID-19, our prospects are better than ever. I now open the line for your questions.

[Operator Instructions] We will now take our first question from Frank Claassen from Degroof Petercam.

Three questions, please. First of all, on your Chinese plant, your new Chinese plant, could you indicate how much CapEx is roughly involved and what the timing of this CapEx is? Then secondly, on your plan to shut down the Austrian plant, can we expect restructuring charges? And what are roughly the savings you envisage on this action? And then thirdly, on the short-term work at Kurzarbeit, how much benefit did you have from this roughly in Q3? And what do you expect going forward for Kurzarbeit?

Okay, Frank. Thank you very much. Let me talk a bit about our intention to build the Chinese plant and then maybe Jeroen, you can talk about Eibiswald and the impact of Kurzarbeit. So as you said, we intend to build a 28,000 square meter Chinese plant in Suzhou, China. This will act as the headquarters of our Chinese operations. It's -- when completed, will be the largest factory that the Kendrion Group has. And the reason we do this is because, as you know, over the past years, when we started to look into China about 4 or 5 years ago, it was 3% of group revenue, and we're now well over 10%, and we see ample opportunity for more growth. So that's the goal. The choice that was in front of us, as always, is either we lease something for the longer term or we build it. And the analysis of that yielded that building our own facility is both financially and also strategically, in our view, the preferred option. So that's what we're planning to do. In terms of the CapEx, we do not disclose that, but the alternative is leasing, so you get a bit of a sense that, that would be significantly more expensive than building our own. So maybe you can gauge a little bit from that. Timing-wise, we still have a lot of work to do in order to get ready for groundbreaking, but we expect that in around 2 years, we'll be able to produce the first products in that facility. Jeroen?

Yes. So on the Eibiswald closing, which is planned, so that project is planned to be finalized in the mid of 2022. We do anticipate restructuring costs, so partly severance, moving cost, validation, because we will move the production lines to other manufacturing plants. So those need to be validated. We expect those costs to end between EUR 2.5 million and EUR 3 million spread out over the next, yes, 1.5 years. And ongoing savings will be roughly around EUR 2 million per year, mainly because of a better use of utilization of overhead. And then on the short-time work in the second quarter, in total, we had a contribution of around EUR 4.5 million. And in the third, that has been reduced to around EUR 2.5 million due to the higher activity level in our businesses.

And then Frank, to your question as what we expect going forward on Kurzarbeit, I mean it's a highly flexible tool. It's there because that's -- the flexibility is exactly what we and, of course, other companies like us need. So it's hard to know. It very much depends on activity level. So if we stay at the level here, then you can -- we will probably continue in a similar fashion. Activity level up means less Kurzarbeit. Activity level down would mean a little bit more. It is highly flexible, and we're trying to make as good use of it as is possible.

We will now take our next question from Tijs Hollestelle from ING Bank.

Yes, I've got a question about the weakness in the Industrial division and your comments that the COVID-19-related effects were more visible in the third quarter than in the second. What is exactly driving this? Is this the specific end markets' industries customers? And how do you see the developing going into the fourth quarter and possibly next year? And Joep, also a question, what is your feeling about the potential German factory closings during the Christmas holidays? Are you already picking up anything on that from conversations with customers? Final question for Jeroen. Are you anticipating any material trade working capital effects on the fourth quarter cash flow towards the end of the year?

Yes. Thank you very much. First, a little bit on industrial. So I take you back to Q2. Of course, then as you will remember, in April and May, automotive market was really badly affected with many of the large plants, automotive plants in Germany like Volkswagen and Daimler closing altogether. As a result, you saw this 44% year-over-year decline. Towards the end of that quarter, automotive came back to and stayed with us in Q3. So clearly, that has a positive effect, if you look at the year-over-year numbers, as we had indicated. The interesting thing was that Industrial and specifically in Industrial Brakes in Q2 was down but not as steep as automotive. So effectively, the activity level in Industrial with a bit of a marginal difference in IB, but not really all that much, roughly stayed at similar levels, so Q2, Q3. So about just a bit better than 20% down, while Automotive just basically came up to the same level. So if you now look at the 2 segments, their -- in terms of the overall activity level, as we call it, related to the economy, if you like, it's roughly on par. Within Industrial then, there is certainly, when you look at actuators and control, some segments, like as you know, we have certain actuators in airplanes that is clearly affected because far less airplanes are being sold and produced. Other segments do really well. When you look at Industrial Brakes, when you go into, for instance, things like industrial robots, that's directly related to investment activities. And the investment activity is not -- I mean it's clearly negatively affected by the pandemic as well. So I would say Industrial down around, in activity level, 20% across the board, fairly stable. And Automotive, this is bit of a tick-shaped recovery. Maybe one more remark to make on the Automotive side. So as we -- you heard -- you could read in the press release and also I said it in my prepared remarks, so the passenger car markets came back towards the end of Q2 and actually in Q3 was probably even a bit better than that. But if you look at the more niche applications such as long-range buses and trucks, that is still quite difficult and certainly long-range buses, which you can compare in a way with planes. People don't travel, and that really affected the industry and therefore, also the investment level in these types of capital goods equipment. So that gives you a bit of a flavor of what has happened in the segments. Then the annual question on Q4. It's always -- December has usually not a lot of visibility because, as you know, that is the month in which most of our customers, specifically in Germany, but also in other parts of the world, close down for the holiday. We expect that to happen now as well. Whether it's going to be worse or slightly better is difficult for us to know. What we are planning or we expect is that when you look at October and November, the activity levels is -- are comparable to what we've seen in Q3. December is a bit of a wildcard. But we -- for planning purposes, we assume it's going to be similar as what we've seen in other years, so that effectively you're going to have a half a month. Jeroen?

Okay. Yes. And then on the working capital in the fourth quarter also basically highly depends on this month of December, because that drives particularly the accounts payables and accounts receivables. So obviously, last year, we had an extremely good fourth quarter related to the cash flow with a decrease in working capital of more than EUR 20 million that I do not anticipate this year. So it will be lower than that inventory. I think it will move in line with the activity level. And the only particular thing which is different than other years is the fact that we have to pay around EUR 2 million in VAT, which we have postponed in the second and the third quarter, which we now need to pay in the fourth. That's the only item which is different than in other years.

But rest assured, and as we've done in Q2 and also in Q3, that the attention that we have on costs, investments, cash flow, working capital and everything related to that is -- we're not going to let up. So that will be certainly very much at the forefront of what we will be doing as we have in Q2 and Q3 but certainly also in Q4.

[Operator Instructions] We will now take our next question from Johan van den Hooven from Edison.

A few questions from my side. During the Capital Markets Day presentation, you sort of made a split between smart actuators and the more traditional ones. Perhaps a bit short after the presentation, but can you give us some more information about the trends in smart actuators and the traditional ones? Especially also, are there any delays due to COVID of course in introductions, well, development projects? Second question is about Austria. Half of the staff is in production. Question is what will happen with the other staff? And perhaps a silly question, but why the decision now? I do understand that over the past few years, you have lowered the number of plants overall within Kendrion. And why was this plant not part of that process and happens now? Just from a curiosity. And well, that's it for now.

Okay, Johan. Thank you very much. So first, in Automotive, indeed, as you rightfully point out, the smart actuator sometimes we refer to internally, and also we've mentioned that at the Capital Markets Day as our lighthouse projects and the more traditional actuators. So if you look at our pipeline and our R&D activity, I would say that the activities at customers and also at Kendrion, when it comes to the smart actuator, the lighthouse project is as strong as ever. Maybe the investment level there also on behalf of our customers, maybe is actually even a bit higher than what it was before. That is at the expense of developments for the more traditional actuators. Now that is 2 -- there's 2 elements to that. One is that when you look at sort of the investment in incrementally better classical actuators, there's certainly some slowing down there and less investment. At the same time, this -- the effect of that is also that some of the projects that we have running today that typically last, as you know, for 7 to 8 years, are actually running a bit longer. So it's not necessarily all that bad in a way, because it just simply means that our existing revenue streams continue. What is very important, I think, also, and if you think back to the Capital Markets Day is that where we do see the growth opportunities going forward for the medium to long term, it's all in the actuators that are fueling the ACES, the car of the future. And that is -- that continues undiminished. So that is, I think, gives us as part of the reason why we are so positive on the medium to long-term prospects of our company. Now as to Austria, we are looking at our manufacturing footprint, specifically within Europe. As you can probably imagine, that is quite a strategic initiative that we have taken a while to really understand and to make sure that we're doing the right thing. And at the end of that fairly detailed analysis, our conclusion was that the manufacturing footprint -- it's a simplification initiative really to say, look, this is not because we feel that there is less growth opportunity in Europe or anything. Not at all. But it is simply to have 6 manufacturing facilities relatively close together in countries that with similar cost levels and similar capabilities is -- we feel we can optimize on that. And that's why we have taken then in itself painful decision to close the Austria plant over the next 1.5 years. Please note that all the lines will be moved to other factories around Europe. So there is -- this is not related to any downdraft in revenue, any nominations or anything. And as to the personnel, we, of course, work very closely together with local authorities with the [ Vitebsk ] in Austria, but the vast majority of the 93 FTEs will be leaving the company in the course of the next 1.5 years in a managed and respectful way.

We will now take our next question from Maarten Verbeek from The Idea.

It's Maarten of The Idea. Firstly, at your Capital Markets Day, you launched a financial KPI, ROIC excluding acquisitions-related intangibles to start monitoring that KPI. Could you also provide the acquisition-related intangibles on your balance sheet?

I don't know. But I will give you the answer. I'm looking it up. I think it's around EUR 26 million, but I want to be precise.