Nokian Renkaat Oyj (TYRES) Earnings Call Transcript & Summary

Welcome to the Nokian Tyres' Q1 (sic) [ Q2 ] 2022 Interim Report. [Operator Instructions]. I'll now hand the floor to Head of IR, Paivi Antola. Please go ahead.

Thank you. Good afternoon from Helsinki, and welcome to Nokian Tyres' Q2 results conference call. My name is Paivi Antola, and I am the Head of Investor Relations in Nokian Tyres. And together with me in the call, I have Jukka Moisio, the President and CEO of the company; and Teemu Kangas-Karki, the CFO of Nokian Tyres. In this call, we will go through Q2 results and an update on the progress with the exit from Russia, with the new capacity and our focus in the coming quarters. And this all will be presented by and Jukka and Teemu and followed by Q&A. So Jukka, please go ahead.

Thank you, Paivi, and welcome on my behalf as well. I would like to go through prepared notes in the presentation and the heading is War in Ukraine overshadowed H1. And I move to Page 2, some quick reflections before I go into the highlights of the numbers. Exit from Russia initiated, so the board decided to initiate a controlled exit from Russia as it's no longer feasible or -- nor sustainable to continue operations. Right now, at this moment, we are evaluating different options. We've hired external advisers, and we are in discussions with possible candidates as we speak. A part of the process, impairment and write-down of about EUR 300 million were recorded in quarter 2 results. Actions to increase the capacity outside Russia are ongoing. So we are increasing capacity at the Finnish and U.S. factories for passenger car tires. These programs were initiated already in 2021, and they have continued throughout 2022, and we still include investments and equipment in the latter part of this year so that they will be both readiness for 2023. And also, as mentioned about the U.S. factory readiness for 2024, and we are now ready to achieve 4 million tires capacity in the U.S. and between 5 million and 6 million in Finland. Investment in new factory in Europe is proceeding. We have obviously the possible locations in place. We are doing the evaluation, engineering has been done, and we are finalizing the steps to make the decision to start investment. Outsourcing options are also being developed. So we look to have alternative suppliers to help us during the time when the capacity is being built in Europe and these off-take options are being developed currently as well. I move to Page 3. I have a highlight of the numbers of quarter 2. Net sales increased by 7.4% in constant currencies. So we recorded EUR 482 million in net sales versus EUR 416 million in 2021 in the same quarter. Tire demand continued good and volumes were down due to supply constraints in our company. Operating environment was increasingly more challenging due to war and tightening sanctions. Segment operating profit at EUR 86 million versus EUR 89.6 million in quarter 2 2021. We increased prices to combat cost inflation, and that led to higher net average selling price. Our team performed extremely well. It was a demanding quarter in terms of sanctions having an impact as well as the logistics becoming increasingly more difficult to take raw materials to Russia and also ship tires from Russia to other markets. And under these circumstances, I want to thank our team and also congratulate them because it has been a very demanding environment, and we did well in that environment. I move to Page 4. We have a strong balance sheet. Cash flow was impacted by higher working capital. I call out some key numbers in the financials, net sales up by 7.4%, as mentioned. And year-to-date, we are about 14% in constant currency, ahead of prior year. So at about almost EUR 900 million in the first 9 months -- for first 6 months versus EUR 758 million in 2021. Operating profit percentage in the quarter was about 80% versus 21.5% a year ago. And year-to-date, we had 17% versus 18.5% in 2021 and 19% in full year '21. Segments earnings per share. So before the write-off and so on, EUR 0.55 versus EUR 0.51 a year ago and in the first 6 months, EUR 0.93 versus EUR 0.80 in 2021. Return on capital employed at 15.2% before the write-offs. Our equity ratio, including write-offs, is 64%. So that shows that we have a strong balance sheet, and this time the write-offs continues to be strong. Obviously the currencies and various other matters are impacting that, but nevertheless, so 64% equity ratio. Cash flow was weaker, and we incurred higher working capital, both the inventories were high because of the more expensive raw materials. Also the receivables were higher because of the good net sales and also the currencies impacted in our working capital by increasing the absolute euro amounts of working capital. Gearing at 14.8% and interest-bearing net debt at the end of June at EUR 243 million versus EUR 140 million a year ago. Capital expenditures are EUR 18.7 million in the quarter and EUR 33 million year-to-date, both below last year numbers. However, as we've said, we will start incurring more capital expenditures towards the new factory in the latter part of the year. And with that, I hand over to Teemu to talk about financials and segment profitability. Teemu, please.

Thank you, Jukka. Let's go through some key figures by business unit starting with passenger car tires. In the second quarter, our net sales was on a level of EUR 335 million. Net sales increased and tire demand continued on a good level. However, the segment operating profit declined partly because of lack of tire supply impacting especially our business in Central Europe. We are happy how our average sales price has been developing. We have been able to increase prices in all our markets strongly. And therefore we have been able to offset higher raw material and other cost inflation in the second quarter and the first half. Our inventories in the passenger car tire business are on a higher level than in the comparison period in order to save that better supply in the second half. As we all know, now we cannot get any tires from Russia. Then moving to look at our net sales development by quarters, and let's focus on the price mix. Here you can see how it has been developing in the first quarter and in the second quarter. And if we exclude the Russia, you can see during the callout post that the price increases without Russia has been on a level of some 9% in the first quarter and around 20% in the second quarter, meaning that the price increases in Russia, Asia has been exceptionally high in the first half, impacting also our absolute profit for the second quarter. Then if you look on bridges and focusing to the segment operating profit part here, if we look at the price mix component, we see that we have had a positive development of EUR 87 million versus the material headwind of EUR 58 million. So we have been able to offset that one. And then the supply chain bucket, a negative development of EUR 20 million. And the majority of that is coming from increased logistic costs because we have been taking extraordinary measures to get the tires out of Russia. We have leased ships and full trains. So therefore, on top of the cost inflation, the cost level has been on an extraordinary high level, which then should benefit us a little bit in the second half in order to sell the volumes. Then moving to the Heavy Tyres performance in the second quarter. There you can see that our net sales for the Q2 was on a level of EUR 74 million and our segment operating profit close to EUR 16 million. And if you then also look at relative profitability, that was on a level of 21%, clear increase from the comparison period. This is -- the performance is a result of a strong demand in all product segments. And we have been also been able to improve our production efficiency. And therefore the profit development was according to the numbers that I highlighted earlier. In Heavy Tyres, the inventory levels are on a low level, unlike in Passenger Car Tyres business. And this is the indication that the demand has continued to be on a good level, and we haven't been able to increase the inventory levels in the Heavy Tyres. Lastly, the Vianor business unit, the second quarter had a good season sales, which lasted longer than normally. Therefore the net sales was on a level of EUR 99 million, and the segment operating profit a little bit below EUR 10 million. Because of the longer season, it also increased some of our cost, and therefore it has an impact on our profit and profitability. Moving to the assumptions for this year. As we have been communicating already earlier, the controlled exit from Russia will have an adverse effect on our supply capacity, impacting especially our Central European business and the raw materials and logistics costs are estimated to have an adverse negative impact also in the second half. Nevertheless the demand for Passenger Car Tyres and Heavy Tyres is estimated to continue strong. Our guidance for this year is unchanged, meaning that our net sales are expected to decrease or to be at previous year's level and segment's operating profit is expected to decrease significantly compared to 2021. And back to you, Jukka.

Thank you, Teemu. And moving on. It's important that we continue building the new Nokian Tyres, so something old, something new. The old and important thing is that we have a strong innovation pipeline for the future. Look at some of the key products on Page 12 that we've launched; Hakka Blue for summer in Nordics, Nokian Tyres Outpost AT, also introduced R5 Hakkapeliitta friction tire and new Nokian Tyres Hakka Truck Coach and these are following the succession of product launches last year, like Nokian Tyres Hakkapeliitta 10 season proof, et cetera, et cetera. This is something important, something old and this will continue to renew our product offer and product pipeline. This coming season, coming autumn, so we will have Hakkapeliitta R5. It's a new flagship for Nordic non-studded winter tires that will be launched and will be available to consumers in this autumn. It includes 1/3 of the track compound of renewable and recycled materials. It also has Hakkapeliitta R5 SUV with Aramid strong sidewalls and Hakkapeliitta R5 EV with ultra-low sound levels silent drive with SilentDrive technology. This product will come with over 160 SKUs and available to consumers as of fall 2022 and the main markets are the Nordic and North America, and this product will be made in Nokian. Priorities for the coming quarters, something new, we will put new capacity. So we are working on the final site selection, final engineering, and also preparing ourselves for starting the project and starting the actual building. We will continue to exiting Russia, so the process will continue with our external advisers and potential candidates. We will also keep cost in strict control after getting our cash flow temporarily, especially in quarter 2 because of the extraordinary measures we took and also that we built inventories of ready-made products. We have a high working capital. We expect that we release money from the working capital. Business units and areas will implement specific plans in Nordics, North America, Central Europe and Heavy Tyres. And we will keep on providing customers with world-class products and services, and we will keep our innovation pipeline up and running, and we will be looking forward to introducing R5 in the autumn. We are highly confident that this will be a very, very successful product. So going forward, we will focus on building the new Nokian Tyres. These were the prepared notes for the presentation. Paivi, over to you.

Thank you, Jukka. Thank you, Teemu. And now operator, we would be ready for the questions from the audience, please.

Our first question comes from the line of Giulio Pescatore of BNPP Exane.

The first one on your profitability in -- for the car segment. Can you give us any indication of how much of the segment operating profit was linked to your operations in Russia? And I guess that's key as we move into H2 because of the lack of supply because it looks like the majority of your operating profit in cars did come from Russia. So any color you can give us on that would be great. And then moving to free cash flow, the cash burn in H1 was quite significant, also considering that the CapEx are yet to increase. I understand the product movement. But can you help us maybe bridge maybe what we should expect for the full year to a working capital reverse or how we -- should we anticipate in H2? And how much would the increase in CapEx be? Any color on that would be super helpful.

If I start with the cash flow. And there we need to bear in mind, at least 2 topics. First of all, it's the normal seasonality, which means that we are burning cash in the first 9 months and then the cash is coming in, in the fourth quarter, and we don't expect any major changes to this normal seasonality. Then in the second quarter, we took some extraordinary measures in order to secure the supply and the logistics out of Russia. And therefore part of that is already visible in our profit. And the second part is that which is visible in our cash flow and balance sheet due to the fact that we have now higher inventory, as mentioned in my prepared notes, not only for finished goods, but also for raw materials. And the raw material part, we will consume that in the coming quarters being on a normal level than after the year-end. Then your question regarding the Russia and profit and profitability. As I showed in the net sales, bridge by quarters, there it was visible that, especially in Russia we were able to increase prices significantly, even though in other markets, we also increased prices strongly. That also indicates that we had a strong profit generation in Russia. And then these extraordinary logistic measures that we took, those costs are visible outside Russia. So those are maybe few comments to give you some color.

Our next question comes from the line of Thomas Besson of Kepler Cheuvreux.

I have a few questions, please. If that's okay, I'd like to go one by one. First, could you help us understanding the timeline for the board decision and the communication of your strategy ahead?

Okay. So timeline of the strategy and the decisions will be such that we are working right now on these initiatives, and we expect that the third quarter results -- immediately after the third quarter results, we will have -- we will find some targets that we will -- we can talk about most likely. And then by that time, we have a plan and decision to invest. And also we will then see how this exit from Russia will continue because, obviously, this is not totally in our hands. It also takes into account that there are other parties involved in that process. But basically, our plan is that by the end of this year, we have new financial targets in place, and we've updated our expected financial performance in '23, '24 and beyond.

You had record inventories at the end of Q2. It's been discussed in the prepared remarks and in answers to the previous question. But in the extent of the increase, it is such that I wanted to ask whether you have eventually overproduced in Russia in the second quarter where you could still use that asset to secure potential revenues in H2? Or it's not the case, and you effectively fully rely in H2 on your capacities outside Russia?

It's our capacities outside Russia, mainly serve the markets in Western Europe, North America and so on, also offtake and so on will then help in 2023. So the Russian capacity can operate and reduce for Russia.

But so in the second quarter, you have not overproduced in Russia for sales that will take place in Q3. You have already put point that you can use for sales outside Russia?

Yes, we have brought ready-made goods outside Russia to European and North American inventories.

Can you give us an idea of the magnitude of the number of stores that have been effectively already taken out of Russia for being sold in H2?

Now to be precise, but to give you some color, we have increased the inventories with -- in a way that it will give us some benefit in the second -- in the third quarter. But it doesn't change the overall picture that we lack tires in the second half.

Understood.

Yes, if you look at the volume development quarter-by-quarter, you see that especially in the second quarter, year-on-year volumes were down. But if you look at the -- end of the announcement, the production volumes were up in the first half.

Yes. That's what I understood. When we -- until you take the decision, can you help us understanding what you're going to privilege between Passenger Tyres and Heavy Tyres because you -- it's going to be difficult for you to make both in sufficient numbers. So are you going to continue to make Heavy Tyres because right now they are 20% plus margins? Or are you going to privilege studded winter tires? How do you effectively assess the priorities?

Well, we have an ongoing growth plan in Heavy Tyres. So that will, of course, continue. And then the most important priority at this point of time is to ensure that the Passenger Car Tyres will get new capacity both in those plants that are already ongoing, but also the new factory and then complemented by offtake in coming years.

Okay. I have a last question. I mean you -- well, I mean, you have seen some operations in Russia, receivables in Russia. How do you effectively pay your operator in Russia on one side? And how do you get paid for your tires in Russia, given the sanctions?

So now the Russia business needs to operate in itself. So we cannot do any payments or receive money from Russia and then how to get the money out of Russia, it's part of the controlled exit process, how we structure the possible deal to get the money out of Russia.

Our next question comes from the line of Artem Beletski of SEB.

Actually, we will ask one by one. And one element, of course, the exit in Russia, maybe you could provide us with some, so say, color relating your cost structure. How it has been distributed between Russia and basically other countries just thinking about, for example, SG&A levels last year, administration costs and depreciation. So all the color would be most appreciated.

So as you know, the cost level. And now if you talk about excluding the production cost of the SG&A breakdown, if you were asking that one. So majority of our costs are outside Russia. So the Russia SG&A level is clearly on a different level than outside Russia. So a majority of the costs are in the west.

And maybe the other question is really you spoke about inventories and growth on that side. Could you also maybe comment on trade receivables. I think growth there was some 40% year-over-year. Do you see some, so say, elevated level of uncertainty relating to this kind of receivables? Or do you see the situation is as normalized during previous years.

How to put it in a way that -- with the information we have at hand, I would say that there is no elevated risk with the comment that situation might be different tomorrow as we have been seeing this year that what we say today might be totally different tomorrow.

That's clear. And then maybe the last one from my side. And just thinking about your guidance for this year, I think last quarter, you provided some sort of additional color in terms of segment EBIT decline for this year and making some comparison towards sort of the levels what you made in 2020. Could you, so to say, provide color around sort of the full year earnings outlook also at this stage?

I don't think that beyond this guidance we have, it's difficult to give many moving elements and so on. So say that this is going to be a similar year to COVID year.

Our next question comes from the line of Christoph Laskawi of Deutsche Bank.

I'd like to start with the process from exiting Russia, essentially. So the first one there would be, could you potentially recover machinery and move it to Finland to increase the capacity? I guess this is part of the negotiations. But I'm wondering if you would like to share any comment how likely that will be. And in case all the negotiations fail, could you consider running the plant as local for local. And as you just elaborated on how difficult it is to repatriate cash from Russia to Europe and you still have, I think in the release, you said around EUR 400 million in net assets that you have in Russia and Belarus. What's the confidence in that you really get the cash in from that? They're also part of the negotiations? Or is there a way to channel it to you? And then I appreciate that you will provide financial targets post Q3 for '23 and '24. But is there any comments you could currently give on what the potential size after the exit might look like on the Passenger Car side? Would it be fair to assume about 30% of the capacity and how big could outsourcing, which you mentioned on the slide really be given that there's not that much available capacity, I think, to outsource to. And lastly, even though I appreciate you might not comment just the margin profile of the Passenger Car plants in the U.S. and Finland to give us a rough proxy.

Maybe if I start with the equipment that clearly, today, carrying equipment out of Russia is not possible. One day, it may be. And therefore, obviously, when we go through the process, then that could be one and might be one parameter that we factor into the deal, including also as Teemu mentioned about cash repatriation, and all that. So obviously, there are multiple ways of working on the deal, and we will see how -- then what the final outcome is. In any case, what has to happen is that Russia, the country localized, so it operates locally and that would be the only way going forward and then make it possible for any transaction to happen. So that is ongoing right now. And then the financial targets, I appreciate your quick -- asking and so on, but many moving elements at this point of time, we would love to come back when we are -- have more clarity about the site selection, the outlook, and long-term plans of our volumes. And then we have all that available, then we would love to come out and talk to all the investors about that. And as I said, by the end of the year, hopefully, after quarter 3 ASAP, so we will be ready to do that. But at this point of time, it would be too early to talk about that because too many moving elements at this point of time. Teemu, any additional comments you have.

Now, with the repatriation of the cash, I think that's one of the fundamental element in structuring the possible transaction. And so far, what we have been seeing and hearing, it should be possible.

Just one follow-up, if I may, on suppliers of yours. And I mean in general, you have been sourcing for your footprint in Russia as well, partially from Europe. Did suppliers already approach you and have been asking for changing conditions, how they supply you given that your footprint will likely be smaller? And could there be any cost associated to that as well? Or so far or as it was before, and no major changes?

So far, no major changes. Things continue quite normal with the exception of Russia, of course, which is not normalized, maybe unnecessary to say here.

Our next question comes from the line of Panu Laitinmaki of Danske Bank.

I have 2 questions related to your plans on the new capacity. So firstly, can you give any color on the sorts of options that you have. I understand you haven't made the decision, but any color on kind of whether you would think if it's a greenfield or an acquisition? Or what size are -- should we be looking at, that would be very helpful. And the second is, what do you think this will cost? Should we kind of use the U.S. factory as a kind of guide of what would it cost? And do you think this can be done without new equity. So those are my questions.

First, let me comment about the options and Teemu will talk about the cost and expected investment and all. So options we've been through already because, obviously, this process started quite some time ago. So we've been through multiple countries and options and we've been into few and out of those few we are doing deeper digging now. And we have, as I said, strong candidates on that and it's going to be greenfield. So it's not going to be brownfield or joint venture. It's going to be greenfield. Teemu?

Then in terms of financing the investment, my current view is that we can do the investment with -- without the new equity. And then the U.S. factory is a good proxy for the total investment amount. And in the U.S., how we are doing it is 2 plus 2 million cases in the new CE factory. We are currently planning to do it in 3 million plus 3 million tire bases.

That's very clear. Can I just ask one follow-up? So can we use the U.S. kind of building up the factory as a proxy of how long will it take from decision to getting cars out from the factory?

Yes. The concept is slightly different because we go with the ambition that we start producing as quickly as possible. So therefore, we changed the order of equipment and we start with -- without the mix in department. And so we actually built the entire building, and we started that in so that we get tires faster to market and then we bring mixes from Nokian, then build the mixing department concurrently when we are running the factory. So that gives us a fast time to market from the factory.

And that is the playbook that we used in Russia. So we made the mixes in Finland and then moved into Russia site.

America is too far away from doing that but Europe is close enough that we can take mixes for Nokian originally and then have a faster time to market.

Our next question comes from the line of Michael Jacks at Bank of America.

The first one, if you can please just go back on the inventories balance again. Can you please give us a sense for how much of the increase is contributed by higher raw materials and logistics costs versus the finished goods build-up, obviously, because one will benefit revenues in the second half. The other one would have an impact on margins. That's the first question. Perhaps I just stop there, and I'll ask my follow-up after that.

Maybe I start to answer this slightly different. I think that one big portion is the higher cost level that is visible in our balance sheet. And as you can read in our release that the year-on-year increase is over 40%, which is significant impact on our balance sheet inventories. Then the split between finished goods and raw materials there, I would say that a good proxy is somewhere between 50/50.