LEM Holding SA (LEHN) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. Good morning, and welcome to the LEM Holding S.A. Half Year Results '23/'24 Conference Call. [Operator Instructions] The floor will be open for questions following the presentation. Let me now turn the floor over to your host, Frank Rehfeld, CEO of LEM.

Good morning, ladies and gentlemen. Thank you for joining us here on the webcast at the telephone call. Today, we would like to introduce LEM's half year results of our financial year '23/'24. My name is Frank Rehfeld. I'm the CEO of LEM, and I'm here together with Andrea Borla, our CFO. For those who are not yet familiar with LEM, LEM is providing senses for measuring electrical parameters, namely current, voltage, and energy, and with those help our customers and society to transition to a sustainable future. You see the agenda for today's presentation. After my opening remarks, I will give you more detail on the business performance of LEM. Andrea Borla, our CFO, will then introduce the financial results, and I'm going to outline what we expect in the future afterwards. After a pleasing first 6 months, we can report almost 13% top line growth in Swiss francs that are equivalent to 22% of growth at constant currencies. Supply chain shortages are over, and we can fully satisfy cash demand demands. In order to put the numbers into perspective, it is important to notice that the base in '22/'23, with which we compare has been impacted by the COVID lockdowns in China, in particular, in Shanghai in April and May 2022. Deliveries that could not be made in the previous financial year due to component shortages helped to go in track, renewable energy and energy distribution. The business situation in China was challenging during the first 6 months and is going to remain like that also in the second semester. Important stocks were built during the shortage times that are now getting reduced while investments are done cautiously. In the other Asian markets around China, however, there was strong growth and the same applies to EMEA and to a bit lesser extent also to the Americas. We managed to maintain a strong EBIT level at 23.1% and see the bookings further normalizing. We operate at the moment in a rather challenging economic environment, geopolitical tensions and fragmentation, inflation, energy crisis, wars. Nevertheless, we believe that all those short and midterm challenges are not questioning the megatrend of sustainability with the ultimate goal to move to a carbon-neutral world in between 2040 and 2050. Therefore, we continue investing in R&D and drive forward innovation. We opened at the beginning of the financial year, a new R&D center in Sofia that will allow us to enlarge our software development skills and also has signed a cooperation agreement with TDK on next-generation measurement technology. Both steps are well aligned with the market development and our strategy to increase functionality in our products as well as the miniaturization and integration in Power Electronics. That goes along with higher switching frequencies and therefore, requires different measurement technologies. Also, our footprint extension makes good progress. Our plant in Penang Malaysia has been finished ahead of time. The first production line has arrived and a highly motivated Malaysian team is hungry to ramp up the new facility. Exports will start latest in the beginning of 2024. To reiterate the reasoning why we've been deciding to set up this plant in Penang, it was first in order to give LEM sufficient space for the next growth steps; second, to balance our manufacturing footprint in the world; and third, to tap basically the talent pool of Penang with respect to semiconductor competencies, in particular, for back-end posts. With that, now let's move to the business performance in a bit more detail. Following our business structure, you see here the development of the 5 businesses in comparison to the same period in '22/'23. Important to mention is that all businesses have been growing at constant currencies and have been differently impacted by the strong negative currency impact, depending on their exposure to the different geographies. The growth rates are also impacted by backlog effects in comparison to the first 6 months of the previous financial year, in particular, in the long cyclical businesses like track and a part of our high-precision business. The distribution of our businesses relative to each other, you see on this page. In comparison to the full year picture '22/'23, there have been some changes in the business sizes relative to each other. Since the automation business grew slower than other businesses, mainly impacted by cautious investments in uncertain times and strongly impacted by negative exchange effects, its share in the total business reduced from 33% for full year '22/'23 to now 30%. Automotive lost 1 percentage point, while renewable and track were gaining 2 percentage points. These were the 2 businesses that were particularly strongly impacted by supply chain shortages in the last year. Now let's go through the businesses one by one and start with our biggest business, automation, that represents 30% of our global business. You see here the turnover plotted for the last 5 years. Our automation business grew 7% in constant currencies however, Franc in CHF due to the already mentioned currency effects. Exports from China have been shrinking globally and also LEM has been affected. This has been overcompensated by a very strong performance, in particular, in Europe. Our automotive business was nicely growing by more than 17% in constant currencies. However, in particular, the weakening renminbi has had a strong impact on the growth rate in Swiss Franc. While the trend in the European market and rest of Asia is positive, we've been losing momentum in China. The supply chain constraints and aggressive competition led to a decline in turnover in a still growing market. Our Chinese team is fully committed to gain back market share. We're investing both in front and capacity as well as R&D competency to respond to the situation while short-term winning back market share through price initiatives. Renewable energy, now 18% of our business is including the solar and wind power generation market. The business was growing by more than 34% in constant currencies or 22.2% in CHF. The strong demand from our non-Chinese markets was overcompensating the slowdown in China. Chinese export declined as a result of the geopolitical tensions impacted the global position of the traditionally strong Chinese inverter manufacturers. Nevertheless, we see the market for renewable energy deterioration continuing to grow, and this also applies for the local renewable energy market in China. Energy distribution and high precision, continuing to represent 15% of our global business contains our high-precision business, with Smart Grid Solutions and UP,S uninterrupted power supplies, as well as DC Meter for fast charging stations. This was the third fastest-growing business after renewable and track with 23.5% in constant currencies. The main growth drivers were the strong demand for our DC Meter as well as also the pickup in the high-precision business. The charging infrastructure as a key enabler of the battery electric vehicle growth is going to get further rolled out while our customers work on innovation and increasingly cost-efficient solutions across the world. Consequently, we work with them on next-generation products. Let's take this into account. Our smallest business, Track, contains all solutions lab has to offer for trains, metros and trims for both rolling stock as well as track side. It grew to a 13% share of our global business and had an exceptional growth rate with 63% in constant currencies or more than 54% in CHF. We eventually could deliver outstanding orders from the previous reporting period and profited from the update in our energy meters in locomotives as well as from a strong demand in China. This very strong growth rate has to be understood in comparison to a rather low base in the first semester in '22/'23. Projecting this business now from a regional perspective, we see important changes in comparison to full year '22/'23. What is most apparent is that EMEA and China changed their positions. For a long time, China has been dominating our business geography with shares of around 40% and has now become second after EMEA that moved up from 31% of full year '22/'23 to 38% in these half-year results. The drop of the Chinese share for 39% at full year to now 31% is the result of multiple factors. On the one hand, the strong depreciation of the Chinese currency, the sluggish economic growth, including also the negative export development but also the loss of market share in e-mobility. As already indicated, the situation has been analyzed and understood and our regional head, John McLuskie, works day and night on the remedy. Nevertheless, the markets outside China developed nicely, as I already said, in particular in rest of Asia as well as in EMEA. The Americas showed a solid performance in light of depreciation of the Swiss Franc, and we've decided to further invest into the team to accelerate growth sales. With this, I would like to hand over to Andrea who will introduce the financial results in greater detail.

As the Group CFO, I'm pleased to present attractive financial results for the first 6 months of the year. Let me summarize the financial highlights in 3 points. First of all, sales continued to grow nicely. At constant currencies, we experienced a 22% growth compared to previous year. This sales growth was the main driver for the profitability improvements. Second, LEM holds a continued strong balance sheet, reflected in a healthy equity level, and this despite a record high dividend payout early July 2023. And third highlight, the operating cash flow ended slightly higher than last year's level. The overly negative point is the low order intake, which is the consequence of changing ordering patterns by our customers and slow markets, especially in China. The gross margin in absolute value increased by CHF 11 million from CHF 93.8 million to CHF 104.7 million. In respect of the gross margin in percentage, we have reduced by 0.5 percent points. What are the main causes for this development. We experienced higher material costs, especially for electronic components, whereas sales price increases have become more limited. However, in Q2, gross margin increased to 47.7% due to a favorable mix impact. Our 2 low-cost locations situated in China and Bulgaria cover 80% of all sensors produced by LEM. The construction of our Malaysian site is now completed, and we will start production before year-end 2023. The percentage of our low-cost location is, therefore, expected to increase in the coming years. The SG&A increased by CHF 3.7 million, which are mainly related to ongoing investments in digitalization projects and buildup costs for our new production facility in Malaysia. The personnel costs remained basically at the same level as last year. We are working on several automation and process improvement initiatives, which will allow LEM to grow the SG&As under proportionally during the coming years. The R&D expenses increased by CHF 1.3 million, confirming the willingness of not jeopardizing LEM's future growth by optimizing its short-term profits through R&D costs. Those cost increases are due to increased hirings of R&D engineers. We focus not only on renewing our current product portfolio but as well on developing new product families, addressing new markets and applications in the future. Going forward, R&D expenses are expected to remain in the 8% to 10% corridor. During the first 6 months of the year, LEM suffered mainly from the Swiss Franc appreciation against major currencies, which resulted in a CHF 1.9 million exchange loss. The gains from hedges compensated only marginally those losses. In respect of the financial expenses, the main elements related to interest expenses due to the increased interest rate levels and expenses on lease liabilities. Income taxes. So the first half year effective tax rate is at 10.6% only, and this is mainly due to a one-off event, which is due to the increase in deferred tax assets as a result of the tax rate increase in the Canton of Geneva from 1st of January 2024 onwards. Excluding this one-off effect and one-off event, the tax rate would be at 15.6%. We as well continued to benefit from the HNT, tax status in China, which results in a reduced tax rate in China of 15% instead of 25%. And here, you find the full P&L for both the half year '23/'24, which is on the seen in the left side of the table and the Q2 on the right side of this table. In Q2, LEM achieved quarterly sales of CHF 111 million, which represents a growth of 3% compared with last year's Q2 sales. During Q2, as well, both EBIT at CHF 25 million, CHF 25.5 million and net profit at CHF 23 million reached very good levels, reflecting the very good momentum experienced during the recent summer months. Moving on to the balance sheet. What are the key points per September 30, 2023. The equity ratio, first of all, the equity ratio dropped by 9 points from 53% to 44%, and this is a consequence of the dividends payout in July. Second point I want to underline is the net working capital, which increased by CHF 9 million, in line with the business activity increase. And third point, for end of September 2023, the net debt of CHF 64 million consists of CHF 25 million cash and CHF 89 million current financial liabilities. And LEM plans to reduce a large part of those net debt before end of March 2024, thanks to the free cash flow to be generated during the second half of the year. Talking about free cash flow, here you'll find the cash flow statement. The cash flow from operating activities increased slightly, whereas the free cash flow dropped due to net working capital increase and higher investment expenses -- investments in our factory in Malaysia. In summary, we are pleased with LEM's first half year performance, reflected in continuous sales, profitability, balance sheet, and cash flow improvements. There has been one disappointing element, which is the drop of the order intake experienced in the first 6 months. You may now wonder what the future will bring to LEM. For that, I'm very happy to hand back to Frank.

Thank you very much, Andrea. Now let me elaborate about the outlook for our business. For those who attended our Capital Markets Day, 1 year ago, this slide might look familiar. However, I wanted to share with you again how important the business transformation is that we are driving and that is yielding results. You see here the share of the 2 business types that we call heritage business and also what it comprises automation, track, HIP, and UPS and megatrend business and how this is developing relative to each other. The shift towards more and more megatrend business gets driven by substantial R&D investments we are doing while upgrading our processes and also work on our corporate culture. Alongside with that, we see that the megatrend markets are growing faster than the heritage markets. Now what do we expect for the whole financial year after a strong first semester. I'm sure when you hear the global use and, in the forecast, the number of bullish news is rather limited. Also, we have a rather cautious view on the second half of the year since this is also traditionally weaker than the first half. This leads us to a forecast of sales in between CHF 420 million to CHF 440 million and an EBIT margin of above 20%. We continue to invest into R&D as well as also increasing our manufacturing capacity since we are confident that the megatrend of sustainability is going to further drive our growth. With this, I would like to close and thank you very much for your attention. Already today, I would like to invite you to join our full year review on May 28, 2024. And now I would like to open the floor for questions.

[Operator Instructions]. And the first question comes from Arben Hasanaj from Vontobel.

So I would have 2 questions. The first one would be around if you could explain a bit the trends that you see in the subsegments and especially also, yes, where is the weakest or where this weakness in demand is coming from, especially, but in general, what trends do you see in the subsegments? And then my second question would be around this partnership that you announced with TDK. I was just wondering, what does this bring to you that you were maybe not or that was not accessible to you before? So I'm trying to see what you will get out of this? Yes, if you could elaborate a bit. Thank you.

Yes. Thank you very much for the question. Maybe I'll start to answer and Andrea will then fill in accordingly. Now in the different businesses, we see overall, let's say, minimum long-term and positive trends. There is no doubt this is the reason why we are investing in all those areas. And what we see probably in the automation business, and I've been probably alluding to that is that here, at the moment, there is a bit of a cautious investment in particular also in China. And this is basically radiating to the whole world. And therefore, we don't really see here a sharp growth momentum, but rather sort of a stable situation. We see automotive with focus to the battery electrical vehicles and without any doubt further growing, but further growing means for sure also that how electronics get miniaturized, power electronics, get more compact and this leads to a lower value per component that is going to materialize step by step further and further. So that means then to measure current in an automotive application needs to get cheaper and cheaper in order to be able to have basically a competitive bill of material of an electric vehicle in comparison to combustion in the vehicle. And renewable energy, we clearly expect for this year further growth. At the moment, also there, we see the local Chinese market developing and we see also the markets around China and developing probably a little bit slower than what was the case before. What we saw, let's say, 50%, 60% increases. This probably will get a bit more tamed down, but besides this, we see here nice developments. Then talking about probably the energy distribution and high precision market also here for us, this is mainly an infrastructure business, both in the AC area with Rogowski coils and in the DC Metering area with our DC Meter also here, we expect midterm growth. But also here, the growth might have impacts that supply chains are changing. So the cost pressure also here for charging infrastructure leads to the fact that charging stations get increasingly manufactured in China, and this will eventually also drive a change in the way we are delivering our products. They will then get exported from China to specifically the world. Track is all in all, not a fast-growing business. When you look at the overall infrastructure here, therefore, I've been explaining, this is a bit a special situation that we have because of backlogs, because of also functional changes and that are happening with the metering. But also here, we expect quite some growth also in the future. And the second part of your question was referring to TDK. Now what do we see in the overall and measuring environment. At the moment, most of our sensors are based on whole effect. So we basically measure the magnet field of the current, and that is typically going through our product. The fall has a lot of advantages, it's very cost competitive. It's proven over 30, 40 years, but has limits in terms of switching frequencies. When you see the future, in particular driven of this market by automotive and I've been mentioning miniaturization and miniaturization goes along with higher switching frequencies and there, the whole sensors will not be sufficient anymore. So we need a new technology. TDK is the unrivaled market leader in producing TMR sensors since basically hard disks were invented because this is basically the fundamental technology. So for us, the partnership with the market leader in this area was an important step to basically get this technology accessible for us, for our applications and win together. Hopefully, I was not getting too technical, but to explain a bit the strategic reasoning also.

The next question comes from Tort Barniol Ferran of Kepler Cheuvreux.

On the order book. I was wondering like what's the status of your order third book by now? And what percentage of sales it covers for the next year? And if you have seen like a decrease in the lead times? And then also, if you could comment a little bit more on the end markets. I mean, especially probably or particularly in the automotive bank renewable energy, what -- in the automotive side, what's actually driving -- or what has changed in the competitive environment in China? And is the increasing competition basically coming from local Chinese players? And how are you dealing with that? And then on the renewal energy, I mean, we've heard recently all these profit warnings coming from the solar inverter. So I was wondering like how do you see this split between wind and solar for or into demand, at least in the short term? And then my last one would be on the TDK development agreement that you signed, and it was more like on the growth prospects that we could expect in terms of sales and proportion of sales? And if the margins of these products are going to be brought in line with what you are reporting now. Thank you very much.

Maybe I start with the order book. So I think it's important to see the development of the order book over time. And before supply chain crisis and COVID, we basically had typically a visibility in our order book from 3 to 6 months. COVID and the supply chain crisis were extending our order book, not in the high but in the length, so just imagine the order book based on the months in which the order should be delivered and sudden is up over time. The length was extending to 12, even up to 18 months. And this is now with supply chain crisis over normalizing, and like in Harmonica, basically getting squeezed together to the pre-COVID levels. And this is not surprising development that we also expected. So therefore, we don't see yet at the moment really concerning signals. And second question was on end markets. Now let's start with automotive. I've think this year, 4x in China, and then when you are in China, different from what you see in Europe, you see basically in particular, on the east of China, almost every second or every third vehicle being an electric vehicle. So the capacities that have been built up in the OEMs and also in the -- basically supply chains are huge, huge overcapacities. And the competition is a cutthroat competition. So basically, everybody tries to now increase their volume and this obviously has affects and throughout all supply chains because obviously, the cost pressure is ended. We clearly saw that in the last 2, 3 years, where we could probably less well trouble that competition has been getting more fierce, that capacities were built up that now needs to also get filled. So we see basically here and rather hard cost competition. Is this a situation that is concerning us? Yes. very clear. Is it a situation that makes us desperate? Clear no. Because there are further developments ongoing in this market. And we are building up capacity, we are ramping up competencies in order to be sure that in the next design and the next design in slots, we will be present. So therefore, we see here for sure, a short-term dip for ourselves, but are very confident that we have everything in the pipe to compensate it. And you talked about renewable energy. And when I understood your question correctly, the question was gearing towards how do we see wind versus solar. Now wind always has been traditionally a bit the weaker part or smaller part, not the weaker but the smaller part in our business. And this remains valid. I think the stronger and more important part is the solar part, and we basically see this continuing. I can only agree that for sure, the overall commercial situation that our customers don't make us confident that there will now be offshore developments in the wind markets that will change this situation quickly. Whereas the solar business has been scaling very, very nicely in the past with very dominant Chinese inverter suppliers that our direct customers, 9 out of 10 of those inverter suppliers come from China. And they are basically very successful underway despite the fact that also they see some, let's say, resistance because of the geopolitical tensions at the moment with their exports. Last question was on TDK. TDK is not a short term, let's say, effect. So we're talking basically about this new measurement principles. We don't see effects, let's say, before '26, '27, really impacting, let's say, in volumes, our business. But again, it's an important step that is yes, mission critical for the future to be at the technology edge and the technology front to basically be ready to satisfy future demand. Hope that helps with answering all the questions and perhaps I just add one point on the order book. Order book is a figure we do not present. But it's important to note that today, for end of September, let's say, our duration is still substantially above the 3 to 6 months. So this means, in other words, that we expect -- our hypothesis is that we will find again 1 day, this 3 to 6 months average order age and means that over the next coming quarters, we still will see weak order intake.

Okay. Perfect. Thank you. May I have one follow-up question on the automotive side. Is the Chinese competition actually -- because you mentioned in the Capital Markets Day that the LEM was above average in terms of accuracy and reliability. So I was wondering if the Chinese players, have they been able to get to your level? Or they are still below in terms of accuracy, reliability, and basic technology capacities?

This business in automotive is to a large extent, also an innovation business. We came from times where typically the product life cycle of a design in with lasting 8 years, sometimes even longer when the product was still carried over into the next platform. We see this substantially shrinking towards 3, 4 years because, again, the costs need to go down and then the cost is to go down to a level or at a level at a rate that you cannot do with annual price issues. We see for sure at the moment that solutions we've been introducing a couple of years ago now getting scaled and basically done in a very similar way now at the moment. But again, we foresee already new measurement technologies, new principles, in particular for state of health, but also for the inverter business, we intensively work on the onboard chargers. And there, you see new requirements because this is safety critical. So there are a lot of important developments. And in particular, the fact that the Chinese automotive industry is gearing towards export to Europe and with rather stringent safety requirements, we are very much convinced that we have here extra order future trends. But again, it needs stamina, it needs R&D investment. It needs also further improvement on the front-end side. So we have been triggering this in short term, we do work with basically price but this is not sustainable. For sure, we want to remain at let's say, a decent sort of margin business.

As there are no further questions, I'm turning the floor over to the host to answer the questions submitted in written.

There is one question from Ronald Wildmann from Serafin Asset Management who is asking which effect is more predominant with order intake, the short-term lead times or the becoming demand situation.

Yes. Of course, this is more based on anecdotal evidence and our judgment because, of course, we don't have each order intake, the reason. But I would say there is a majority is to the shorting lead times, a slight majority. And this is the, let's say, the major cause of this substantial order intake drop.

Thank you. There are no more questions from the webcast. Operator, do you have more questions in the telephone conference.

Actually, last minute, a question from Daniel Koenig from Mirabaud Securities. [Operator Instructions]

Yes, I have a question on automation. I'm a little bit puzzled by this development, the wonderful development in EMEA, while in China is not so great. I'm wondering when have you seen this that EMEA is suddenly a trend towards sustainable and customer-oriented solutions because when I look at all the subsegments, they're all somewhat affected by the industrial downtrend and sluggish growth. I'm a little bit puzzled that EMEA is running very well. And then I have a follow-up. I was also wondering in Europe, at least in Switzerland, there is a boom in heating pumps and was wondering have you seen anything which would point to a revival of heating pumps in EMEA? That's it. Thanks.

Thank you, Mr. Koenig. So automation, we've been talking about negative developments in Chinese exports. And we see that basically quite some equipment that we report under automation has been slowing down as exports from China and -- that's again an interpretation. We assume that here rather European solutions have been taken rather than the solutions from China. So we interpret this as probably a mindset change from this U.S. Chinese sort of attention that basically more and more buyers rather go for solutions from Europe than from China. The second question on heat pumps. Yes, heat pump is an interesting business also for us. However, one needs to be a bit careful the numbers are not in the multimillions, so we're talking about 200,000, 300,000, 400,000 heat pumps that are getting built and probably leading to a demand of sort of 1.5 million to 2 million current sensors. So that's probably not a game changer. But for sure, the heat pump business, by the way, more on Asian business than the European business is something that we expect to grow in the future with basically the regulations coming.

Thank you. So now there are no more questions submitted, and I'm handing the floor over to the host again.

There are also no more questions on the webcast.

And then I would like to thank you very much for your attention again. Please bear with us for our full year results in May next year. And until then, I wish you all the best and hope to see everybody back then. Thank you very much.