KONE Oyj (KNEBV) Earnings Call Transcript & Summary

Good morning, and welcome to KONE's second quarter results call. My name is Natalia Valtasaari. I'm Head of Investor Relations here at KONE, and I'm very pleased to be joined here today by Philippe Delorme, our President and CEO; and by Ilkka Hara, our CFO. As usual, Philippe will start by talking through the highlights of the quarter in terms of financials, but especially our strategy execution. Ilkka will then follow up with some more details on markets and financials, and then Philippe will wrap up before we head into the Q&A session. And just as a reminder, already at this point, please in the Q&A, try to limit yourselves to 1 question, 1 follow-up. And of course, you can rejoin the queue if you have anything further to ask. But with that, Philippe, please?

Thank you, Natalia, and good morning, everyone. I'm very pleased to be here today to discuss our second quarter results, which reflect continued progress across our business and good momentum in our strategic priorities. Looking at the number other growth stands out. I was especially encouraged by the acceleration in modernization, which grew by well over 15% this shows our success in capturing the opportunities created by aging building stock around the world. We also delivered further margin expansion and strong cash generation highlighting the quality of our business mix and the benefits of disciplined execution. Beyond the financials, we continue to advance our strategy. An excellent example is the increasing connectivity of our maintenance portfolio now at 44%, strengthening both customer value and our service capabilities. And finally, there is a good momentum in the planned combination with TKE. I'll provide a more detailed update on this later in the presentation. But first, let's take a closer look at our financial performance. Let's start with orders. Orders grew by almost 11% in the quarter. What I find particularly encouraging is both the breadth and the quality of that growth. Three of our four regions delivered double-digit growth, while modernization grew strongly across all regions. The new sales, we grew 3.4% in comparable currencies, putting year-to-date sales growth at a respectable 5%. Our adjusted EBIT margin expanded by 40 basis points thanks to a richer sales mix and improved operating leverage. Cash generation was also very robust, resulting in healthy cash conversion and further strengthening our financial position. So overall, this was a good quarter for KONE with growth across all our key financial metrics and performance very much in line with our expectation. Let me share a few practical examples of the progress we are making in executing our right strategy. In digital first, we continue to make good progress, both in connecting more maintenance equipment and rolling out productivity tool for our field technicians. Together, we make an even more reliable responsive and efficient service partner for our customers. In modernization, our modular approach significantly reduces downtime, 1 of the biggest concerns for customers undertaking upgrade projects. I'm confident that this is a key factor behind the consistently strong modernization growth we've delivered since the launch of [ rice. ] I also believe it is behind the improvement in our modernization, customer satisfaction scores within during the year. In residential newbuildings, our focus on affordability without compromising quality has strengthened our competitiveness in this important segment. Our offering developments are supporting growth in new equipment today while also creating a valuable installed base for future service business. Turning to cut carbon. 75% of our equipment deliveries are now equipped with regenerative drives, helping customers reduce energy consumption and meet increasingly demanding sustainability requirements. And finally, our core processes and culture. Our ambition is to be the #1 choice for both customers and employees. We track our progress through annual customer loyalty and employee engagement surveys. Customer loyalty has developed positively in 3 of our 4 areas, but feedback also highlights opportunities for further improvement. And at the same time, employee engagement remains above the global benchmark, reflecting the strength of our culture and the commitment of our people. I'm proud of what the onetime as a completion. I'm also happy to see our strategy translating into tangible value for our customers. And let me share a few examples from the quarter. Starting in China. We have a great example from the hotel industry where minimizing downtime is absolutely critical. Our fast-track delivery capabilities not only helped secure a modernization contract but also regain the customer maintenance business. This clearly demonstrate the value of combining speed, reliability and strong customer relationships. Next, an excellent example of how digitization creates value for customers. The Meca-clocktowers is an iconic landmark and a customer with whom we've built a long-lasting relationship. Last year, we connected the equipment to our 24/7 connected service platform. The true proof of our predictive maintenance capabilities came during the Haj pilgrimage in May, when more than 5 million people travel through Mecca. We completed the season with record high customer satisfaction underlining the reliability of our solution. And then moving closer to home, -- we recently secured an order to deliver MonoSpace for vators to rapidly growing residential area in track. This is a great example of how our effort to improve competitiveness of our residential offering are translating into commercial success in an important market segment. Let's move on to sustainability. One of the key sustainability milestone this quarter was the validation of our updated near-term science-based targets. The impact and supports our long-term ambitions. We now target a 46% reduction in Scope 1 and 2 emissions and a 40% reduction in Scope 3 emission from our 2022 baseline by 2030, and we are committed to achieving net 0 emissions by 2050. We were also again included on CDP supplier engagement assessment leader board with an scoring, a great achievement for the team, showing consistent engagement on an important topic. Turning finally to our planned combination with Teekay. We've discussed the strategic rationale extensively over the past few months. So let me simply reiterate how excited we are about this opportunity by bringing together the strength of both company, we can accelerate innovation, improve responsiveness and create even greater value for our customers and stakeholders. With regards to required approval, we reached an important milestone at the Extraordinary General Meeting in June. Shareholder support was remarkably strong with nearly 100% of vote cast in favor of our proposals. The regulatory review process is also progressive as planned with filings submitted or underway across all key jurisdictions. At the same time, we've begun integration planning so that we are well prepared to move quickly once all necessary approvals are in place. The collaboration between our team has been open, constructive and highly productive, which reinforce my confidence in our targeted EUR 700 million cost synergies. As a reminder, this target reflects our expectation after any divestments that may be required as part of the regulatory approval process. Now let me hand over to Ilkka will take you through the market developments and our financial performance in more detail.

Thank you, Philippe, and a warm welcome also on my behalf to this second quarter results webcast. Let's start by taking a look at market activity over the past few months. Overall, the demand picture remains very similar to what we've seen over the last few quarters. Growth continues to be led by service and modernization, but demand for new building solutions has also been active across most markets, while China remaining a clear exception. In the Americas, Unit growth was affected by last year's comparison point, which was strongly impacted by tariff-related demand recovery. In value, the market is growing clearly. What stands out in particular is the Middle East. Despite a challenging backdrop, demand stayed strong and helped drive growth in the broader Asia Pacific, Middle East and Africa region. It is really a remarkable demonstration of the market's resilience. . Let's next look at our financial performance, starting as usual with orders received. Orders grew by 10.9% at the comparable FX reflecting our ability to capture market opportunities across business and regions. Growth was broad-based geographically with double-digit increases in 3 of our 4 areas. This is true also for modernization as order acceleration -- accelerated in all areas. It was particularly encouraging to see this driven primarily by the volume business, although major projects also contributed positively. New building solutions performed well, too, which is important as it supports the future expansion of our service base. Our orders margins declined slightly year-on-year as a result of the inflatory pressure we've seen. That said, we have taken clear actions to address this. These actions include pricing measures already implemented across the portfolio, combined with a disciplined cost management. Then turning to sales, which increased by 3.4% at the comparable rates in the quarter. Growth in service and modernization compensated for the slight decline in new building solutions increasing by 5.6% and 6.7%, respectively. Service growth was impacted by high comparison point in China, as highlighted already earlier. In addition, less contribution from M&A resulted in slower maintenance-based growth in Europe. Even so, year-to-date sales grew -- growth of 5% for the group means that we continue to be well on track against our full year guidance. Moving then to adjusted EBIT and profitability. Margin expansion in the quarter was 40 basis points year-on-year. This took adjusted EBIT to EUR 370 million. Adjusted EBIT excludes items affecting comparability, which amounted to roughly EUR 50 million in the quarter around EUR 25 million of this was related to a planned TKE transaction. And we currently estimate additional EUR 40 million or so one of time cost -- onetime cost in the second half mainly transaction-related. From a profitability perspective, business mix remained favorable, and we benefited again from a good leverage on fixed cost. These factors more than offset margin pressure in China and inflation-related cost increases elsewhere. Overall, it's encouraging to see yet another quarter of profitability improvement. And we have actions in place to support continued progress going forward. Then finally to cash flow. Good progress to report also on this front, as year-to-date cash flow rose to EUR 937 million. Working capital was the main driver of the improvement. Order growth resulted in higher advances and timing of payables also contributed positively. Let's next look at how we're thinking about '26 as a full year. Starting with the market environment. Our outlook for the year is unchanged and consistent with what we have seen so far this year. In new building solutions, we expect the market in China to decline around 10%. Elsewhere we expect growth, slight in Europe and North America and stronger growth in Asia Pacific, the Middle East and Africa. Both modernization and service markets are expected to remain active across all regions offering excellent growth opportunities. Naturally, geopolitical developments remain a risk. But so far, our markets have demonstrated solid resilience. Then to our business outlook, which we have left unchanged. This means we continue to expect comparable sales growth of 3% to 6%, an improvement in adjusted EBIT margin to the range 12.3% to 13%. Looking at the factors affecting the performance, challenging market conditions in China and the wage inflation continue to create headwinds. We also see inflationary pressure linked to geopolitical tensions, including elevated logistics costs. On the positive side, growth in service and modernization supports a favorable business mix and our performance initiatives continue to contribute to margin improvement. With that, I will hand back to Philippe for some closing remarks before we move to Q&A.

Thank you, Ilkka. So to wrap up, a strong Q2 in many ways with order growth being the highlights and great to see growth in modernization across all areas. More broadly, we remain diligently focused on execution that is clearly visible in our quarter-by-quarter profitability improvement and our continued progress against our strategic targets. A big thank you to all KONE teams for the outstanding commitment once again. And finally, although still early days, our plan to combine KONE and TKE are progressing as planned in a very good carbides period. Thank you all for your attention, and I suggest we now move to your questions. .

[Operator Instructions] The next question comes from John Kim from Deutsche Bank.

It's John from Deutsche. I'm wondering if we could start with modernization. I'm trying to kind of calibrate revenue growth for the rest of this year. We did see a bit of deceleration Q1 into Q2 on those growth rates. I'm wondering, is that kind of time and place event? Or are we just starting to get base effects, and we should consider that when you think about growth rates for the rest of the year?

Maybe I'll start, and thanks, John, for the question. Well, first, I'm very happy with a very strong double-digit growth in modernization orders. And the revenue growth is more reflecting some of the slower growth rates we saw in earlier quarters in orders. And we continue to see very good opportunities to grow the modernization business going forward on a double-digit rate also on the revenue. So I think I would more look at our guidance and for the strategy and ambition of the strategy when we look at the growth rate. And with this order growth, I think we have a great opportunity to continue growing the revenue going forward. .

So we are very confident on modernization.

Okay. Quick follow-up. Can you give us any color on the bond program and how we should think about that incrementally?

On the 1 what?

The chinese bond program..

I guess we still see -- I mean, we keep talking about China and some negative trends China is actually a great market when it comes to modernization. There are 2 legs to that. One is a program called Goji, which is more government-led which really works by cities in which we've taken a pretty good share of that market. And then there is the more volume based, which is more customer by customer. which is also very dynamic. But I would say on both, we are running on both cylinders, and we are growing very well in China on the modernization side, and we are pretty happy with where we are. .

China actually has been the fastest-growing modernization markets for some time.

The next question comes from Daniela Costa from Goldman Sachs. .

I will stick to 1 end of follow-up but I'll ask them at a time. Can you give us some color on -- in terms of the order margin decline and sort of what drove it this quarter compared to last quarter. I guess you were seeing some stabilization there. Is it more pricing? And is it just China? Or there is a mix impact, just to give us a color where this -- where has the deterioration been?

So first, we've actually had quite a stable development in margins for a number of quarters. And in this quarter, we had a slight decline in the margins. And it is not driven by pricing more the increased costs that we saw due to the inventory pressure driven by the geopolitics. At the same time, we've also now taking action on the pricing and the impact in Q2 was mainly because of the tender to order lag to see that also coming through in the booked orders. .

Got it. And then just in general, you've been growing quite strongly on the orders for a while ahead of what you grow on the sales. I know the definition of what's going in orders and sales of slightly different. But are you seeing lead times extending? Can you talk a little bit through that? Are you sort of maybe somewhat fact constrained just interested on your view there?

Well, first, very happy on your recognition. So we have -- we want to grow in a profitable manner, and we've been actually doing both very well for now in the first 3 years of the strategy. And we have not seen order book rotation delaying actually opportunities to accelerate that particular modernization. So how to be able to fulfill the customer need faster. So no big changes, but opportunities clearly on order cycle times. .

I would say the impact on how an order translate into sales is also related to how much major -- how many major projects we have versus volume business. Major projects with typically a quite some time to materialize in sales were actually the volume business and the more you go to modernization, the order book rotation would accelerate .

Yes, that's a good clarification. .

The next question comes from Delphine Brault from ODDO BHF.

We'll go 1 by one. starting with a follow-up on your order margin decline. You mentioned some measures to offset the inflationary effect, including price increases -- can you provide us a little bit more color on which regions, which segments we are targeting? And by how much did you raise prices? .

We've actually increased prices in all of the businesses in all the regions to reflect the increased costs. So very broad and see that actually progressing well. .

Including China? .

In China, it's been more stable now as a result of the measures. And of course, the market continues to be very competitive there. At the same time, in China, what we've seen is our product cost reduction efforts in redesigning and working with our suppliers actually having quite a good progress. .

Second question, you highlighted a favorable impact from business mix in your margin bridge. Can you quantify how much this contributed to margin expansion?

It has a positive impact, and it's been steadily contributing positively. Now of course, we don't do segment reporting. So it's hard for me to give very detailed number on that one. But it is 1 of the key drivers of improvement in profitability. .

And I would add to this one, 1 driver that start to ramp up, and we are happy with that, which is the leverage, meaning better control on our fixed costs and growing our fixed costs less than the sales. And you have probably seen that it's, I think, the second quarter where we start to report that, that. And this is also the impact of the profit improvement initial performance improvement initiatives we've put in place, which is balancing the engines that will support the growth of our EBIT level.

The next question comes from Vladimir Sergievskii from Barclays. .

I'll start with service growth, a little less than 6% this quarter. Can you give us some color what's dragging the growth for now? Is it only China or potentially other factors as well? Do you see growth in service returning to the 10% strategic target that you have? And do you see close to 10% growth over '25 to '27 strategic period still achievable? .

So first of all, we are very confident on our growth potential, let's say, high single-digit growth in service. And I think we've always said it and are going to be very consistent here. On the point to be on the slightly lower side in Q2, there are a few things that are explaining that. First, we had a high base of reference, especially in China, but not only. Second, we are slowing down some targeted M&A initiatives for, let's say, small bolt-on for reason you will understand pretty clearly. And last point, we had a few execution hiccups, especially in our repair business in a few targeted geographies that we fixed over the quarter, but that are explaining a slightly lower performance. But midterm and over the cycle period, we are very confident in our potential to grow high single-digit our service business. .

That's extremely helpful. Also, could I quickly check if you have already looked at potential preliminary impact of IFRS 18 accounting change on your operating profit line from 2027. Obviously, 1 of your competitors mentioned some changes in recognizing financing costs and moving them into operating line. I'm keen to hear if you have already an early take on this. .

Yes. So it has very minor impact to our P&L and in cash flow, it will have some impact below the operating -- cash flow before financing costs. So not a major impact on P&L.

The next question comes from Andre Kukhnin from UBS.

Maybe just 1 on modernization. Could you comment on where the profitability level is for this business now for you. I remember you mentioned it was around group level at the Capital Markets Day a couple of years ago. I just wanted to check if that's progressed from there and whether the order book is pointing to progression in this level in this area?

So first, on the monetization. So what we said was that the target for us is that it's not dilutive to the group average and over the strategy cycle, that means that it continues to improve its profitability along the lines of the whole company. And then you're talking about orders. So actually, what -- given the faster rotation of the orders in modernization, so -- in the second quarter, especially the biggest markets were quite quick to reflect the increased costs to also then prices. And we saw less impact on order margins in modernization. And then lastly, the more we drive this partial modernization that Philippe was mentioning already earlier in the presentation that has a positive impact on profitability. So we see good opportunities to continue to drive profitability improvement in the modernization business. .

Great. And if I may follow up on the comment on TKE progressing to plan. Could you comment on where you are in the U.S. process at the moment? And is there an anticipation of a potential time line on when would it be normal to hear back from the authorities there specifically?

I guess, predicting what happens with regulatories and arts that we're not going to go into today. And you'll understand easily that we cannot comment. We are very well engaged in our major jurisdiction. And I think we've always said that we are confident in going through the process, including the U.S. So -- that's what I can say at this point. And we don't want to speculate on anything. We are very focused on engaging in a very transparent and positive manner with those regulators. And the work that has to be done is done, and we are making progress.

And that level of confidence has not changed since you announced the deal?

No. We are moving as per the plan and we are following the plan and we are executing the plan. I would just say that I would just stress a very collaborative spirit that's happening between the team which to me is very, very important to make sure that we make progress as a team.

The next question comes from [indiscernible] from AlphaValue.

So 2 questions. First 1 on the fixed cost leverage that you highlighted. I wanted to understand, I think there was an implication that this would ramp up in the coming quarters. Is that the case? And then could we get more benefits to the margin from this leverage in -- and secondly, the app market. So basically wanted to understand was all of the auto grow in this market structural? Or was there an element of catch-up maybe due to the war or -- and what were the key markets where the demand came from? And that's it.

I guess my answer to the fixed cost is simple. Yes, yes. So there's clearly an opportunity to continue to drive more leverage through fixed cost. And yes, it is a contributor positively in '27 as well. .

And on the second question on orders. I mean, the order growth is real. It's structural. It's broad-based. It's clearly driven by modernization, but not only and we see it across the board. And we are very happy with it. Not surprised, but happy. .

The next question comes from Alexander Virgo from Evercore ISI.