OC Oerlikon Corporation AG (OERL.SW) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Oerlikon Q1 2020 Results Conference Call and Live Webcast. I am Alice, the Chorus Call operator. [Operator Instructions]. The conference is being recorded. [Operator Instructions]. At this time, it's my pleasure to hand over to Mr. Andreas Schwarzwälder, Head of Investor Relations at Oerlikon. Please go ahead, sir.

Thank you very much. And good afternoon, ladies and gentlemen, and welcome to Oerlikon's conference call on the 2020 first quarter results. Particularly in light of the current circumstances, I do hope you are all well and staying safe. My name is Andreas Schwarzwälder, I'm Head of Investor Relations. With me today is our CEO, Roland Fischer; and our CFO, Philipp Müller. As a reminder, all related documents, including the following presentation, are available for download on our website. In light of the wide-reaching impact of the COVID-19 pandemic, we have changed the structure of today's call. We have the following agenda for you. Roland Fischer will talk about Oerlikon's response to COVID-19, how it has affected Oerlikon, what actions we have taken and how we have positioned the company for the future. Phil Müller will then give you an overview of the financial performance during the first quarter. After their presentations, we will host the Q&A session, as usual, to answer your questions. Today's conference, as mentioned, is being recorded, and a replay will be available on our website later today. And now handing over to Roland.

Yes. Thanks a lot, Andreas, and welcome to all of you from my side as well. No one could imagine 6 months ago that a global pandemic would deeply affect all of us. And I hope you and your families are all well and staying safe during these difficult days. The evolving fallout from the COVID-19 pandemic has impacted all of our daily lives, brought the global economy to a standstill and also our Oerlikon business cannot avoid the effects. First of all, the safety of our people is top of our minds, and we have taken appropriate actions to protect them and all of us. Secondly, we do have acted decisively to protect the liquidity of our business and to ensure business continuity, working closely with the customers and suppliers. And finally, we have adapted to the new environment to emerge from the pandemic at the end as a strong [ organization ]. And so let's go into more details. Since the initial outbreak, we have been monitoring the dynamically evolving conditions resulting from the COVID-19 pandemic, and we have taken action to protect our employees. We have fully adhered to guidance of local governments and health authorities. And additionally, we have enabled working from home wherever possible and ensured a safe working environment at our locations. We have implemented measures to ensure employees distancing and personal protection. And as an example, Oerlikon is providing 2 facial masks for every employee. And beside of that, Oerlikon entered the current environment with a strong balance sheet and we have acted swiftly to preserve our strong liquidity. We have fully drawn our credit facilities, resulting in over CHF 1 billion cash available at the end of March. We have capital investment and discretionary spending wherever possible. We are prepared for the future, and we are able to act when attractive opportunities such as value-enhancing M&A opportunities are showing up. And we face a diverse global picture from business continuity, operational and supply chain perspective. Some countries, such as Spain, Italy, India, Malaysia and Mexico, just to mention a few, have enforced a total lockdown. This has indeed affected our businesses in different ways. The Manmade Fiber business felt major impacts in China during January and February as part of the extended Chinese New Year, where we have substantial operations and customers. Operations started up gradually in March and have returned to full capacity since the end of that month. Despite the shutdown in Europe, the segment operated at full speed in Germany, achieving even a record production of winders in March in our German facility in Remscheid. The key challenge here in Europe has been to secure the supply chain in the COVID-19 environment. The segment has succeeded in balancing the situation, and we are confident of being able to fulfill the planned delivery schedules for 2020. In our Surface Solutions business, situation is different. The operations of the global coating center network have been subject to local governmental regulations and industry exposures. In China, all 13 sites were closed in February. During March, the majority of our sites were operational again, and all sites in China have been back in operations since the end of March. Globally, a total of about 25 out of 166 Surface Solutions sites had to be closed temporarily upon requests by the relevant local governments. Depending on the industry exposure and volatility, affected sites, we are operating at 50% up to 100% capacity. And needless to say, we are striving hard to ensure our business continuity, to work closely with suppliers and to serve our customers wherever possible. And last but not least, during March, we outlined our productivity improvement program and our commitment to build a stronger Surface Solutions Segment. Oerlikon as a group is not in a fight for survival, but we are cognizant of the need to strengthen our business and emerge from the aftermath of the pandemic as a stronger and more agile business. It is with this in mind that we have accelerated the program and have identified additional cost-out initiatives. It is also with great personal sadness that we today announced a headcount reduction of around 10% in our Surface Solutions Segment. Oerlikon is expecting to spend CHF 25 million to CHF 35 million in the implementation of the entire program as communicated already earlier in March. The future proofing of the business under these programs gives us the confidence to maintain our midterm commitment to group EBITDA margins of 16% to 18%. And furthermore, these programs will not limit the ability of the Surface Solutions business to grow structurally once markets return again to a kind of growth mode. Due to the multi-facets of the impact of COVID-19, we see a diverse picture in market dynamics. The strength of Manmade Fibers' market position, customer proximity and order book provides a stable base in this economic environment. We received contract awards from 3 of the world's leading Manmade Fibers manufacturers in China with a combined value of over CHF 600 million and the delivery schedule reaching out to 2023. Furthermore, due to the COVID-19 dynamic, a strong global demand for Oerlikon's meltblown nonwoven technology, used to produce surgical face masks, has been noted. This demand is expected to grow in the upcoming quarters, driven by the government regulations and the need for greater supply security and reduced dependence on imports for critical medical items. Following the impact from the COVID-19 challenges in China in the first quarter, the segment succeeded in balancing the situation, and we are on track to fulfill the planned delivery schedules for 2020, and a similar pattern is expected for the order intake. In Surface Solutions, the short-cycle nature of our business and the structural changes impacting the end markets are challenging. In tooling and general industry, we are closely correlated to industrial production, which is expected to take a substantial hit in 2020. We anticipated some recovery with the easing of the lockdown restrictions across regions and industries. In automotive, pre-existing headwinds have been compounded by shutdowns in production and the closure of the global dealership network. While we have seen announcements last week from automotive OEMs like Volkswagen of the reopening of plants, the scale and speed of ramp-up is unclear. Even in China which is spearheads the recovery, sales and production of cars may not return to prior year's level before July 2020. And in the aerospace industry, challenges have been compounded by the sudden and substantial reduction of commercial air travel. Airlines are in a fight for their very survival, and we see the cascading impact from new aircrafts down to MRO activities. Airbus already announced a reduction in production of over 1/3. Overall, assuming the current pace of lockdown easing and assuming a second wave is not forthcoming, Q2 is expected to be the bottom. However, the shape of the recovery has plenty of facets across the different industries and is very difficult to predict. Oerlikon's stability and strength as a group and the structural long-term market dynamics, combined with the decisive actions we are taking, will position us well for the recovery when it comes. And while we are navigating the immediate impacts from the global crisis, we also have a key focus on positioning our company strategically for the future. We continue to invest selectively to further expand our technology and innovation leadership in Surface Solutions. We are very well positioned to weather the COVID-19 pandemic and benefit from the eventual market recovery. Together, with our cost measures, we can emerge as an even stronger company. We have taken some very tough decisions during the first quarter, but we are convinced and we believe it is necessary in these difficult times. Manmade Fiber has evolved as a company and is a stabilizing force for the group during this time. It continues to deliver strong returns. Our healthy balance sheet positions us well for the future, and we will be ready to execute with the right growth, and M&A opportunities are coming up in good time. And after this overview, which is unusual, yes, as Andreas indicated, I would like to hand over to Philipp for additional comments on the group's financials. Philipp, it's yours.

Thank you, Roland. Good afternoon, and welcome to today's presentation from my side as well. I will go through the first quarter results. Let me start with the group financial review. Group orders for the first quarter decreased by 29.9% to CHF 477 million. This was driven by a couple of factors. In Manmade Fibers, we saw a significant amount of orders in China being delayed due to the lockdown. It is very important to note that we see this as a temporary item, and we continue to see our full year on track. For the first half of 2020, we expect Manmade Fibers order intake to be around CHF 500 million. In Surface Solutions, orders were mainly impacted by the slowdown of the various end markets and due to the COVID-19 pandemic. Group sales were 15.2% lower at CHF 529 million. In addition to the previously described slowdown across markets, we had a 5 percentage point negative impact from FX as the Swiss franc continued to strengthen. At constant exchange rates, group sales were CHF 558 million, down 10.6%. Group EBITDA was at CHF 58 million, a margin of 11%. Before I go into the segments, a quick note on the restructuring program we have previously disclosed. We initiated the program to improve capital, operational and administrative efficiency and boost profitability. These goals are unchanged. We're aiming to reduce our structural cost base on a sustainable basis. Across geographies and through a number of initiatives, we are reducing total headcount in our Surface Solutions business by approximately 800 employees or around 10% of the segment's headcount. Due to the COVID-19 situation, we are accelerating these measures as much as possible. We are expecting to recognize a material part of the CHF 25 million to CHF 35 million of restructuring costs in the second quarter 2020. And we expect to see some of the cost savings to come through in the second half of the year already. I'll continue with the segments. First, on Surface Solutions. We saw a slowdown in all of our end markets and across a number of regions. Order intake declined by 13.5% year-over-year to CHF 333 million, and sales decreased by 12.4% to CHF 325 million. The decline in orders and sales was most noticeable in the tooling, automotive and general industries, particularly in March. Excluding the impact from FX, sales were down 8% in the quarter. The EBITDA margin for the first quarter was 12%, mainly attributable to lower sales and some negative geographical mix. As Roland highlighted earlier, we expect Q2 to be the trough of the economic impact of the pandemic. This is based on the assessment that the pattern of lockdown easing we currently see continues and assuming no secondary wave [indiscernible]. Next, on Manmade Fibers. We saw a significant amount of orders in China being delayed, resulting in order intake of CHF 144 million. We expect Manmade Fibers order intake to be around CHF 500 million for the first half of 2020, and our full year expectation remains unchanged. Sales for the segment decreased by 19.3% to CHF 205 million, mainly attributable to the lockdown in China and negative FX. Given the sudden nature of the decrease in sales, and in light of the fact that our total year delivery schedules remain intact, our ability to adjust cost in the business in Q1 was limited. Accordingly, the EBITDA margin declined to 8.9%. We expect that trend to reverse in the next few quarters as we catch up on the delayed revenue from the first quarter. While Manmade Fibers in the first quarter was impacted by the shutdown in China, our business remains very stable. Our full year outlook for orders, sales and margins in the segment remains unchanged from what we told you at our annual outlook meeting in March. Before opening for Q&A, let me summarize the key messages of today's first quarter presentation. First of all, the impact of the current crisis and the shape of the recovery are extremely difficult to predict. The group guidance we provided you at the beginning of March is no longer valid. And at the moment, we can't provide you an updated outlook with a reasonable degree of certainty. Second, we have taken decisive and proactive actions to protect our employees, maintain business continuity and to take advantage of new business opportunities, especially in our nonwoven business. Third, we have a strong balance sheet, and we have secured our group liquidity. Fourth, the productivity program and cost-out initiatives will structurally adjust our cost base in Surface Solutions and allow us to emerge as a stronger and more agile company when markets which we serve recover. And finally, we are committed to our mid-term target for group EBITDA margins of 16% to 18%, and to returning to our structural growth trajectory once the market stabilizes. With that, I'll hand it back to Andreas.

Thanks, gentlemen. This closes our comments for the first quarter of 2020, and we are happy to open the lines now for questions. Operator, please go ahead.

[Operator Instructions] The first question comes from the line of Fabian Haecki from UBS.

The first one is regarding the restructuring of Surface Solutions. I try to understand by how much you have stepped up your restructuring efforts. So you are saying that you expect the CHF 25 million to CHF 35 million in implementation costs in Q2. Actually, that is roughly the same number you said with full year results pre corona outbreak in Europe and in the U.S. So why is it not -- why don't you have higher costs? And the 100 employees you're sparing in Surface Solutions, already before that was a focal point for -- on the restructuring side, but has this really been kind of expanded? Or is it the same restructuring program just kind of highlighted again.

Yes. Fabian, I think at the end of the day, it's the same restructuring program that we talked about. In the material aspect it is similar, I would say. Where we've probably taken a couple of steps forward is in those industries that we have described that we expect are not going to recover as quickly, specifically in aero. So I think that's sort of a change. And we had obviously given you a range, CHF 25 million to CHF 35 million because we wanted to leave a little bit of room in there. We're probably now closer to the higher end of that range because we have added some mass to that. And so -- but it's basically the same program, and we're just aiming to execute it a lot faster given the current situation.

Okay. My second question will be on the -- the famous question on the additive manufacturing activities. With the full year results, you were still having quite some hope that the aviation industry will pick up some projects. I guess that has now become extremely unlikely that aircraft manufacturers have any spare money for 3D printing projects. Has your view changed? What are you going to do with this? And what saving can we expect, considering that in the past that was diluting your margin by 300 basis points in Surface?

So actually you are, Fabian, partially right. On the civil aviation business, we will see a slowdown, and this is what we take into account. But fortunately or -- no, I don't want to give an evaluation, but on the military, on the defense application side, the business is quite stable. And what is the case in the U.S., in our U.S. site and here in our European, [ and valid in ] our European side, is not heavily depending on the aerospace business. This is more prototyping and more general industry and automotive from that perspective. Yes. On the civil side, we will see an impact. We expect an impact to be erected already on it. We adjusted the headcount also in the additive application business. And this is, from my perspective, under control, yes.

So what can we expect in terms of dilution going forward? Will this continue to create costs as you did? Or will you cut deeper into that business?

We have -- as I said, we did already cuts in terms of structure and in terms of people. And for the time being, we stick to our plans. We do not see major shifts here.

And Fabian, what we said is that the expectation is for the business to be less dilutive in 2020 than it was in 2019. That's true in the first quarter, and that's -- as far as we can see right now, that also remains true for the remainder. So I think there are some green shoots, still a lot more work to be done. And then the only thing I would add to that is that we've obviously also curtailed sort of incremental CapEx investment in that business to an absolute minimum.

Okay. Then the last one on Manmade Fibers. Can you give a bit flavor on pricing, backlog mix side, particularly into Q2? Will pricing improve? Is pricing generally improving? Has this been the case for the CHF 600 million large order you gained from China? But particularly now in the short term, is this anything we can expect to see an upward trend here?

I think we are still on our path to be back on the price level, but this is not a jump start. It was not a jump start in the past as well. That means, yes, we do see a slight improvement in pricing as well also for the latest big contract.

The next question comes from the line of Sebastian Kuenne, RBC.

Three questions. For the CHF 600 million Manmade order that you announced but that hasn't been booked, it seems like it hasn't been booked as orders because it was linked to the shutdown in China. But then I wonder why you plan to book it in 2021 and not earlier. So maybe you can explain why -- if there's a condition to it being booked or what the background is of that?

Yes. Sebastian, I'll just -- if you want me to take that one or you want to go through all the [indiscernible]. So that's an easy one. I mean we typically book those orders sort of as we receive the down payments from our customers. Very standard. So we get the contract award, and they're part of the larger project. And when we get closer to those delivery dates, we actually also book the orders into our system. So nothing unusual. That delay actually had nothing to do with the administrative challenges. These orders are for delivery in 2021, 2022 and also in 2023. So naturally, we would book those orders in any given circumstance next year and the year after.

So when the down payment comes, you book the order?

Yes. That's --

And again, no, there are more criterias of contract. The down payment, secured finance, LC or whatever and then also approvals on the customer side in terms of certification. And then, finally, depending on when the delivery slots are required, we don't book orders to be delivered in 3 years ahead. This is nothing what we do.

And the CHF 600 million, is that now an unusual item or do you have in every quarter kind of a CHF 600 million order sitting around that you have not [indiscernible]

Unfortunately not. I think this is -- again, this is a compound of 3 -- consists of 3 contracts. 3 out of the 5, 6 big Chinese filament producers. That means there are some smaller one and 2 bigger ones here. That means this -- a single individual contract runs in the range of CHF 100 million, CHF 150 million, up to CHF 200 million. And this is not very special. We have it from time to time. But of course, we don't have...

Not every day.

Not every day, right?

But I think it confirms, Sebastian, and we talked about this a couple of times, it confirms the trend to larger individual installations, right? We -- I think over the past couple of years, as we've seen some consolidation amongst our customer base in China, the orders tend to get a little bit larger and chunkier. But it's certainly not uncommon that we see these larger orders that are for delivery a couple of years out.

Understand. In Surface Solutions, I have a question. Organic growth, minus 8%. It looks actually much better than what Sandvik, for example, has shown in their tooling division. Do you think there's some restocking effects, especially in China or in other regions, where dealers that are open are saying, okay, now we have the COVID crisis, I better -- deliveries are not secured, I better stock up a little bit? Or do you think this is natural demand that you actually saw, the minus 8%?

No. I think it's a twofold answer. On the one hand side, we do have a very comprehensive portfolio when we talk about OSS. We saw first signs of a slowdown. It's a significant area, what is short cyclical by nature, whilst the aerospace business was more stable. And our January, February business has been not -- almost normal, let's say, that way. And just in March, we saw the crisis effect, mainly in China, where we had to lock down our 13 sites. Unfortunately, China is a high-margin country, whilst in Europe and in U.S., March was still okay-ish, right? So that means stocking, destocking, restocking effect, difficult to say. I would say no one. I didn't sense it.

Probably not yet. Yes.

Since you mentioned aerospace, that would be my last question. You indicated that the segment was still growing within Surface Solutions, but you also mentioned that the maintenance of turbines is coming down. What scale of impact do you guys expect for the coming quarters? I mean are we talking that the surface business will halve and aerospace business will drop by 1/3 for the new turbines? I mean what's the scale here?

So my logic is a very simple one. Due to the sheer fact that the commercial aviation or air travel is close to, I don't know, 0%, 5%, 10%, something like that, this will have a major impact on MRO volume, what is a smaller part of our business or a certain -- a smaller part, not a minor one, but a smaller part. And the new engines, deliveries, schedules are also dramatically cut down. The Airbus indication, 1/3, and we do see and have similar indications and forecasts from Safran for the LEAP engine, and we have a similar pattern on the geared turbo fan from Pratt & Whitney and MTU. That means we do see and expect a substantial decline in aerospace business. Fortunately, aerospace is not 100%, doesn't represent 100% of our [indiscernible] business. It's about, I don't know, 1/3 max, something like that. And from that perspective, it will heavily depend on how other more short-cycle industry types will behave.

Understood. And final question, if I may. You drew your credit facility even though you still have nearly, I think, CHF 300 million of net cash. What is the reason there? Because I think you don't have so much inventory or working capital requirements for the year and you cut your CapEx. So what's the logic behind drawing the entire credit facility?

No. It was really more of it -- you're absolutely right. There wasn't an immediate necessity for it. It was more of a precautionary measure. It comes at a very limited cost to us. And so it's sort of more in the way now that we obviously have a lot of flexibility to reduce that again when we choose to do so. So we're sort of in the light of that at the end of March.

The next question comes from the line of [ Michael First ] with [indiscernible].