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

Good day, and welcome to the Kendrion First Quarter Results 2022 Analyst Call. This call is being recorded. At this time, I would like to turn the conference to Joep van Beurden, CEO. Please go ahead.

Thank you, and good morning, everybody. Welcome to Kendrion's Q1 2022 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 Q1 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 it's practical. 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 Q1 2022 results, I would like to reflect a little on the current economic and market environment that we are operating in. As we went into 2022, we started the year with a certain degree of optimism. And for good reasons, the COVID pandemic seemed to recede, industrial demand was strong. And on the automotive side, the market was about to pick up. As in 2021, 10 million cars that could have been sold were not produced because of supply shortages, and this was expected to ensure a bit of an upturn in passenger car production despite the ongoing shortage of semiconductors. Reality turned out to be different. The Russia-Ukraine conflict caused significant economic uncertainty, sharply increasing energy prices, continued unpredictability in the automotive supply chain and more pressure on all sorts of input materials like steel and copper. Right after the war started, major German OEMs like Volkswagen had to shut down some production sites because they lack vital components like wire harnesses. As a result, car production was down 18% in Europe compared to Q1 2021. In addition, the COVID pandemic is now disturbing life in China and the Chinese government implements strict lockdowns in Shanghai and other major cities. Inflation is high and the labor market is tight. Is there a positive as well? Most certainly, demand for our products in our industrial groups, both for IB and IAC was strong in Q1. And looking at our order book, this is expected to stay strong as our actuators enabling the transition towards clean energy continue to drive growth. Let's talk about the quarter. We delivered a good first quarter under difficult circumstances. Group revenue grew by 13% compared to a strong Q1 2021, reaching a record level of EUR 129.9 million. On a normalized basis, we grew our EBITDA by 4% and net profit before amortization by 19%. I'm proud of this achievement. In an environment of macroeconomic uncertainty, supply chain volatility, high inflation, we again continue to grow both revenue and normalize profitability. Q1 represents the sixth consecutive quarter where we report revenue growth and the seventh consecutive quarter with normalized EBITDA growth. I'm also happy to report that in Q1 2022, we were well above the prepandemic revenue level, taking INTORQ and 3T acquisitions pro forma into account. In short, our growth potential is good also in difficult economic circumstances. So what is driving this potential? Many of our stakeholders view Kendrion as an automotive Tier 2 company with a bit of industrial site business, and that may have been the case in the past, but today, the reality is different. We're an actuator company focused on products that help enable the global push towards electrification and clean energy, whether it's brakes for wind power, robotics, automated warehouses, sound actuators for electrical vehicles or induction heating technology, helping industrial processes move from oil and gas to electrical solutions in all our business groups and in China, the broad push towards electrification determines our product development decisions, and it has determined these decisions for a couple of years now. They have been amplified by the INTORQ acquisition in 2020 and most recently, by the addition of 3T to our group. It has resulted in a balanced portfolio exposed to the global and accelerating trend towards electrification and clean energy and not overly dependent on any specific vertical or market segment. And as a result, we've been able to deliver significant growth in revenue and profitability over the past 1.5 years. I'm proud of our global team who have delivered this. Now let me talk in a bit more detail about Q1 and some of its highlights. Our industrial businesses continued their strong performance as we benefited from strong demand for products related to the energy transition. Our industrial revenue increased by 28% compared to a year ago and significantly above prepandemic levels, taking our industrial acquisition pro forma into account. Automotive revenue was 1% lower, so largely flat while in Europe passenger production -- car production was 18% lower. Demand for industrial brakes continues to be strong in all segments and across all regions, driven by the accelerating electrification. Revenue for IB in Q1 was 24% higher than a year ago. In Industrial Actuators and Controls, organic growth was 34% compared to last year, as our business development efforts in recent years are beginning to pay off. Demand for new products such as rotary locks for industrial washing machines and inductive heating for industrial baking is increasing. Recently acquired electronics and embedded systems specialist, 3T, is performing well, and we have started recruiting software and electronics engineers for our Automotive Group. To accommodate anticipated FTE growth at 3T, we are opening an office at the High-Tech Campus in Eindhoven per July 1, 2022. In Automotive, the market continues to be difficult, driven by ongoing semiconductor shortages, demand volatility and inflation in raw materials. As mentioned, European car production declined with 18% year-over-year. Despite these challenges, we protected our added-value margin and delivered revenues in line with Q1 2021. The construction of our new 28,000 square meter manufacturing facility in Suzhou's renowned industrial park in China has been delayed due to new COVID outbreaks as we lost around 40 building days due to the pandemic. We now expect to start production in the new facility early in 2023. Now let me review our profitability in a bit more detail. Normalized operating results before depreciation and amortization, or EBITDA, came in at EUR 16.8 million, 4% higher than in the same period last year when it was EUR 16.1 million. You will have seen that our profitability grew in absolute terms, but not as a percentage of revenue, and about half of the lower profitability percentage was caused by passing on of higher raw material prices into the sales price. Depreciation charges dropped by EUR 0.9 million to EUR 5.4 million in the first quarter of 2022, leading to a normalized EBITA of EUR 11.4 million, which is 16% above the EBITA of EUR 9.8 million in Q1 2021. The effective tax rate on normalized income in Q1 2022 was 27.3% compared to 30.7% in Q1 2021. Normalized net profit before amortization charges arising from acquisitions increased to EUR 7.6 million, up 19% compared to last year. We normalized the gain on the sale of our building in the U.K. and expected closure costs of the Automotive manufacturing location in Eibiswald, Austria. The closure was announced in 2020 and is expected to be finalized in 2022. So the combination of the gain and the expected closure costs resulted in a EUR 2.1 million and after tax EUR 1.6 million normalization. Reported net profit came in at EUR 5.1 million. Total net debt, including IFRS 16 lease liabilities, increased to EUR 137 million compared with EUR 130.6 million at the end of 2021. The debt increase was caused by normal seasonal effects on working capital. First quarter free cash flow amounted to EUR 6.0 million negative compared to EUR 5.4 million negative over the same period last year. The leverage ratio based on total net debt divided by 12 months rolling EBITDA was 2.4, well below the financial covenant of 3.25. Kendrion's solvency ratio remained strong at 45.3% at the end of March 2022. We secured a financing arrangement of, in total, EUR 175 million to refinance our existing EUR 162.5 million credit facilities. The refinancing comprises a EUR 72.5 million transaction in the Schuldschein private placement market and a revolving facility agreement of EUR 102.5 million with ING Bank and HSBC. Both instruments are sustainability linked based on Kendrion's sustainability rating by EcoVadis. With the refinancing transaction, we have extended our debt maturity profile at competitive terms, reducing our expected interest payments by around EUR 500,000 per year. Financial covenants remain unchanged with a leverage ratio coverage of 3.25. Before we go to Q&A, let me talk a little bit about our outlook. We expect the economic climate to continue to be unpredictable for the foreseeable future. Despite that, we see substantial opportunity for growth with products that help advance the global transition towards electrification and clean energy. This is reflected in our order books, the outlook for industrial continues to be good. Longer term, we are confident that our strong position in the growth market of Industrial Brakes, selected segments of Industrial Actuators and Controls, Automotive and China will help deliver our medium-term financial targets of on average 5% organic growth per year between 2019 and 2025. An EBITDA of at least 15% in 2025 and return on invested capital of at least 25% also in 2025. We talk about our confidence reaching our targets every quarter and at our Capital Markets Day of September 8, we will give more insight in our growth opportunities and how we expect to reach our ambitious growth and profitability targets. I now open the line for your questions.

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

Two questions, please. First of all, on China. You've indicated that you've seen revenue pressure because of the lockdown. Could you quantify this pressure? And also, yes, could you elaborate on what is the current situation in China? Yes, are you still open, are you still selling or what is the situation there? And then secondly, in Austria, have we now seen all the charges related to the closure of the Austrian plant? And could you remind us of the savings kicking in?

Yes. Thank you, Frank. So on China, so as mentioned, we have seen a bit of an effect, and this is purely related to lockdowns. As you would have read in newspapers, this was particularly an issue in Shanghai. It is getting better now. These -- the lockdown measures are being somewhat released, and we have resumed production there. In terms of quantifying it. In Q1, the impact was relatively limited because it was towards the tail end of the quarter that we saw that. Now we're not going to break it out very specifically, but to give you a bit of help, we have 2 facilities there: one is Suzhou and one in Shanghai. The one in Shanghai has had some -- a couple of weeks of production interruption. So that will certainly affect the second quarter a little bit. Now at the same time, if you also look at the order portfolio and of course, the exposure we have to other parts of the world, I'm not expecting this to be really material, but clearly, it does have an effect. The situation there is -- yes, I mean, as I mentioned, in Shanghai, the situation is more stable, and we have resumed production there. It is fluid because, of course, the pandemic is not yet over. So we're keeping a very close eye on this. I think if you look at China a little bit longer term, you look at our order book and you look at the 50 million that we produce there and the potential that we see that all, as you will understand, is unchanged. The other thing to remark is what we also -- you saw us announcing a bit of a delay, a 1-month delay, in taking control or moving into the new building that we're currently -- that we're building -- constructing in Suzhou, that was also related to COVID. We lost about 40 building days. This has also resumed, but of course, a bit of uncertainty there as well. So we're keeping a very close eye on that, too. And then maybe for your questions on Austria, let me hand over to Jeroen.

Yes. So the costs we incurred Q1 relate to the social plan for the staff. In principle, this should be it. There's one big that we anticipate the final production line to be relocated to Germany in the summer, after which we can also finally close the plant. The main thing still to do is selling the building. So we are confident that we can sell it for more than that is currently in the books, but obviously, we still have to sell it. And on the savings, that also -- it depends a bit, we try to absorb as much of the indirect costs in the existing organizations in Villingen and Romania. We anticipate savings in excess of EUR 3.5 million and roughly EUR 1 million of that has already been realized on an annual basis from the second half of 2021 from people that are leaving the organization.

We'll now take the next question from Axel Stasse from Berenberg.

Congratulations for your seventh consecutive profitability growth. I have 4 questions on my side. Can you please elaborate a bit more on how easy it is for you guys to change pricing strategy and your prices with existing customers given the inflationary environment? My second question is more related to the actions that Kendrion can take right now, given the supply chain disruptions. Are you, for example, working with several key suppliers? What are the key components missing for you guys to deliver the product to your customers? My third question is more related to the organic growth that you guys expect across the 3 business units. Do you have discussions with customers, for example, automotive manufacturers? And do you have, I would say, a visibility that we don't have in terms of supply chain shortages that are expected to ease? Is it in H2 2022? Is it more beginning of 2023? And last, but not least, should we assume that working cap should increase in the coming quarters? Or do you think that from current levels, yes, it should not massively increase?

Well, thank you, Axel. Let me take the first 3 and then on the working capital, hand over to you, Jeroen. So your first question on pricing. So is it easy? The answer is no. It's hard work. At the same time, when you look in certainly in the Automotive segment at the contractual situation is sound. In Industrial as well. And for the smaller customers, this is more on a negotiated basis. But of course, with smaller customers, there's also a little bit -- there's a different pricing power balance, if you like, in that discussion. So it's certainly not easy. The legal position is strong. It's hard work. We spend a lot of time in it. And we've managed to protect the added value margin because that's where you see this quite well. It was 49.0 and I think a year ago, it was 49.1. And if you compare this to Q4, which we haven't highlighted in the release, but you will see that it's actually better than it was in Q4. So spending a lot of time between purchasing and sales, not easy, hard work. But so far, we managed to defend that added value quite well. On the supply chain, so the first thing to note is that one benefit we have is that our supply chains are not global. They are local. We operate according to a strict local-for-local policy. And it means that in the region, so Europe, China and the United States, to a large extent, also in India, where we have a small facility, we source pretty much everything from local sources. So we're not dependent on big shipping lanes or flying stuff across the world. And that helps. Now at the same time, it's tough. It's tough on copper, it's tough on steel. There is an inflationary discussion to be had that, of course, the purchasing guys will need to do. And then the whole situation around semiconductors are -- is still very much an issue, not just in Automotive, but across the globe in more segments. So it's a little bit the same as on the pricing. It's hard work. We're managing this well. There isn't a specific input raw material where we feel particularly exposed other than what you read in the newspapers where everybody, everyone has been dealing with. And the notion that our supply chains are reasonably short, if you like, helps. Then in terms of organic growth, look, if you step back and you look at the underlying long-term trends that you see in Automotive, our products are exposed to electrification, autonomous driving, which is -- you can read any market report on that, and you see the underlying growth and the dynamics there are very favorable. The visibility into how long the current disruption will take that we have is definitely not better than anybody else's. We -- say we all read same newspaper and it is, to some extent, I think, the visibility -- everybody who claims visibility, I would say, is probably overstating it a little bit because it has very much to do with geopolitical situation and everything around that. So on the industrial side, the situation is different. There are, first of all, there are many more segments that we're exposed to. Of course, electrification is not just happening in automotive, but basically everywhere. And you've seen the performance in Q1, you've seen the performance on Industrial last year. We're looking at the order book, that continues to be in a very good shape from our perspective. And barring some unforeseen other events that would impact the supply chain, I expect continued good growth in that segment for the remainder of the year. And again, there, the trends -- the longer-term trends are very favorable there as well. Working capital, Jeroen?

Yes. Sure. So working capital, yes, it's all about inventory on the receivable and on the payable side, payment behavior has not materially changed, and I also don't expect that going forward. Inventory, we have seen some increases in inventory for 2 reasons. First of all, the order volatility. So that makes it more difficult to plan your inventory. And second of all, also where strategically we have to increase some stocks on materials that we think will be in short delivery going forward. I think that on a normal basis, the current stock level in relation to the revenue is appropriate in these times. The only exceptions are the accumulation of some buffer stock, production of some buffer stock for the relocation of the final lines from the Austrian facility towards the summer. And second, towards year-end, the production of some buffer stocks in China because there also we expect that we can relocate the existing facilities in the new facilities that we are currently building in early 2023. And then we are talking about between 2 million and 3 million buffer stocks towards the summer and then again towards year-end. But besides that, I think the current level of inventory should be a sustainable .

[Operator Instructions] We'll now take the next question from Johan van den Hooven from Edison Group.

It's Johan van den Hooven, Edison Group. Three questions from my side. The first one is about the good strong growth in Industrial Actuators and Controls. Can you tell us a bit more about new products, for instance, how many customers are there or length of contract, what are the contribution of these new products? Second question is, you mentioned the decline in car production of 18% in Europe in the first quarter, can you just give a bit more information about the commercial vehicles side of your business and also with link to the order book, commercial vehicles? And the third question is, can you provide us an insight on the CapEx level for the full year and might need a bit more because of the delay in China? Or are you saying 40 days delay, it's only a time delay and not the cost margin.

Yes. Thank you, Johan. So on IAC, you need to -- very strong growth there in the quarter, 34% year-on-year also there. We are above the prepandemic levels. Now there is a couple of new products, and I mentioned 2 that have been developed over the past couple of years. One is specific rotary locks for industrial washing machines and other industrial equipment. I mean as with all IAC segment, quite niche. It's a small market. But if you have, as we do, a very capable new product, then the growth potential of such niche is actually very interesting at good markets because also these are proprietary products, so there is some intellectual property around it, which makes it easier to defend the margin. The other one to mention is this induction product. Now these are products for industrial heating. Now induction is there is a limit to how much energy you can actually create using induction. So for very large furnaces, this is not suitable, maybe in the future. But at this point in time, it is, for instance, used in industrial baking. It's a little bit the same nature, it's a niche. But it's -- I mean it's a very innovative and much cleaner and easier way to heat your product. And therefore, it's the same. We are now currently seeing the ramp, and we expect that ramp to continue. Now you should think of these individual segments in the order of a couple of million over the next couple of years. But it adds up because there are other segments that we've started 3, 4 years ago that are now ramping. And another third example, I want to mention, is we're also producing certain safety valves that are being used in the nuclear power equipment, so nuclear power generators. And that, for a long time, was really only spare parts and not a lot of growth in -- on the back of this energy transition that you see now, of course, everywhere announcements of countries ordering more and more nuclear power generators. And that is another example of a niche where we have a strong position, some propriety products and some good growth opportunities over the next couple of years. And that is the name of the game in Actuators and Controls. Then the second question, you talked about the automotive decline of 18%, right? So, yes, commercial vehicles, by nature, more stable. So I would say they're far less affected in the same way. Of course, I will say that, that 18% is probably also an anomaly in the sense that it was -- there was a couple of weeks where certain large factories were completely shut down. That is now behind us. So I do not expect the same 18% lower level to persist. But of course, we all know the volatility is -- in the passenger car market is substantial. Commercial vehicles are a lot more stable. And the other thing to note is it's not just trucks and buses. We're also in things like farm equipment, which is also the nature there is -- that's a lot more stable than what you see the volatility that you see in automotive. CapEx?

Yes. And then on CapEx, so on the regular CapEx, so excluding the China building, we expect somewhat more than depreciation, so between 10%, 15% more than depreciation for the year. And for China, so we currently still estimate the total building cost of around EUR 20 million, so EUR [ 40 ] million in total to go in 2022, of course, depending on how the situation develops with the building days, but that is the current guidance on CapEx.

Okay. So far with the 40 lost building days that doesn't move the needle a lot related to the EUR [ 40 ] million?

No.

[Operator Instructions] We'll take the next question from Maarten Verbeek from The Idea.

It's Maarten of The Idea. Firstly, you mentioned that part of your growth had to do with the inflation, so price increases, which were some 4% to 5%. Could you break that down into the impact it had for the Industrial Group and what it had for the Automotive Group?

Yes. Yes. So it was actually -- all were around about 4.5%, so in IAC and IB and Automotive.

Okay. What we also have seen is that a lot of parties are strengthening their inventories. Could you say something about the inventory side of your Automotive customers? Have they sourced more to secure their level of inventory?

Not from where we stand, Maarten. But I will immediately add to that, that the visibility we have into the inventory levels of the -- certainly of the big OEMs is very limited. But looking at the order patterns, there is quite a bit of volatility in those patterns, and they were according to our view and our assessment related to volatility in the supply chain, semiconductors, wire harnesses as an example, we, of course, we don't see that late February, early March. And we haven't seen any sign that there is big restocking going on.

Okay. And then lastly, if I understood well, your gross margin was virtually flat. But is that more or less to do with the fact that there was some kind of mix shift more to industrial group with a high gross margin than to Automotive Group. Could you say also something about the individual development of those 2 groups regarding their gross margin?

Yes, just before a couple of points to make. So certainly, the gross margins in the Industrial are superior to those in Automotive, as we all know. So clearly, a shift in mix helps. There is also a mitigating effect on the gross margin that if you -- in an inflationary environment, if you pass through input price into your sales price that also has a negative effect on the gross margins, just mathematically. And that effect is not as small as you may intuitively think. So if you get a 5% input price increase and you reflect that into your sales price, your gross margin goes down by around 2 points at roughly the levels that we're at. So that is material. Now then you want to say something about the difference there. I think it's limited, right?

Yes. It's not material deviating from the levels of last year [ per group ].

Yes. but clearly, if you shift your mix goes into the -- more into the industrial direction. Clearly, that has a positive effect. At the same time, there is the negative effect across the board of basically inflation on your gross margin. So these 2 probably balance out. And so I would say in the mix, if you look at the 49 relative to the 49.1, that is, I think, quite a strong performance defending this gross margin. And if you compare that to Q4, as I mentioned earlier, it's actually up.

As there are no further questions, I would hand the call back over to your host for any additional closing remarks.

Well, I would like to thank all of you for your attention. If you have any follow-up questions, then you know where to find us. Thank you very much.

Thank you. That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.