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

Ladies and gentlemen, welcome to the Oerlikon Q1 2024 Results Conference Call and Live Webcast. I am Sandra, the Chorus Call operator. [Operator Instructions] And the conference is being recorded. At this time, it's my pleasure to hand over to Stephan Gick, Head of Investor Relations. Please go ahead, sir.

Good morning, ladies and gentlemen, and welcome to Oerlikon's Q1 results call. With me in the call, I have Philipp Muller, CFO of Oerlikon. Philipp will start the call with a presentation providing an update on our end markets financials and outlook. We will then follow up with a Q&A. With that, I would like to open our presentation and hand over to Philipp. The floor is yours.

Thank you, Stephan. Good morning, everyone, and welcome to our first quarter results presentation. In Q1, we continue to execute on our strategic priorities of driving efficiency and innovation. We are doing this in a difficult economic environment as industrial production and consumer spending continue to be subdued and currency headwinds persist. In addition, we're driving forward the separation of the Polymer Processing Solutions division, and we're on track with our plans. I will start the presentation today with an overview of the group results, followed by an update on our end markets, the divisional results, and I'll conclude with the outlook. At the group level, orders were CHF 642 million. Q1 represents the first quarter where we see a sequential improvement in our Polymer Processing Solutions orders after a period of 5 quarters where we saw our customers delaying their investment decisions. Group sales decreased 20% at constant FX to CHF 550 million. This is in line with our expectation and driven by lower filament orders in the previous quarters. Surface Solutions achieved stable organic sales year-over-year despite soft PMIs. Operational EBITDA margin was 15.7% in Q1. This is about 80 basis points lower than last year. In the context of reported sales being down 25% and the majority of our end markets being in a difficult spot, this is an excellent result. It's a clear proof that we're managing costs to extremely diligently and we will continue to do so. We achieved a double-digit EBITDA margin in Polymer Processing Solutions and improved margins in Surface Solutions by 122 basis points. We will continue to execute a clear set of cost and pricing actions throughout this year. With that, let me provide you an update on our end markets. In Surface Solutions, we are operating across the tooling, automotive, luxury, aviation and general industries end markets, particularly the general and tooling industries show close correlation to industrial production. Both the Euro area and U.S. PMIs are showing sequentially improving momentum compared to Q4. Remained, however, in overall subdued conditions for the moment. The sluggish industrial activity had an impact on our general industries and tooling sales in Q1. Despite that, we made a very significant step in our innovation pipeline by successfully launching our ALCRONA EVO. After 14 years, this is the successor to our extremely successful ALCRONA PRO product. ALCRONA EVO features a 30% performance increase and will position us at the top of the market for years to come. In automotive, global light vehicle production declined in the first quarter. We expect this to balance out during the remainder of the year with industry agencies forecasting a slight growth for the full year. We continue to drive innovation to make future mobility more efficient and sustainable, be it in the vehicle body or in the battery hybrid or combustion powertrain technology. In Luxury, our integration of Riri is on track. After Q4 having been impacted by destocking of our customers, we saw our sales improving in Q1. For the time being, the market momentum remains relatively low, with customers acting in a wait-and-see mode. This is related to the weakness in the Chinese end market, rising gold prices, inflation and some geopolitical uncertainties. Certain leading indicators like Swiss watch experts underscore this, while other indicators like tax-free shopping remain strong. Mid-term growth drivers for the luxury segment remain well intact. In Aviation, we saw a 19% passenger growth in the first 2 months with industry agencies expecting 10% growth in 2024, rising flying hours and certain quality issues in the industry are driving MRO activity and demand for our solutions. Oerlikon's products are supporting a more efficient and more sustainable aircraft engine technology. In our Polymer Processing Solutions division, the last 18 months have been impacted by large customers delaying their investment decisions. Meanwhile, we are confident that we have seen the trough of activity in the market. Q1 was improving sequentially, which represents a first improvement after 5 declining quarters. We see some initial signs of revitalization in small and mid-sized orders and continue to note that all of the midterm growth drivers are well intact. Our more positive market view is backed by increasing governmental stimulus for the machinery industry in China. We also note that the price cost spreads of our customers further improved in 2024. This means our customers earn a positive cash margin on every ton of product they sell, which is a precondition for them to invest into our equipment. For the moment, we're focusing on profitability and innovation to be ready to drive the next up cycle. In our nonfilament business, where our end markets and geographies are more broadly diversified, we saw the impact from globally soft PMIs. The nonwoven staple fiber and industrial yarn businesses are seeing some customers delay investment decisions. Typically, orders are smaller with lower financing needs and return faster when consumer demand picks back up. In Flow Control, where performance is closely related to car model launches, we saw positive impacts from a reacceleration of car launches towards the end of the quarter. We expect positive momentum to continue throughout 2024. Summing up, in Surface Solutions, we see a continued subdued industrial environment. However, PMIs indicate early signs of improving growth momentum. In Polymer Processing Solutions, last year's difficult order environment will impact 2024 sales in line with our guidance. The sequential order improvement we saw in Q1 is the first positive sign from the market. We are confident that we have seen the trough of activity in the market. With that, let's move to Page 4, where we discuss the financials for our Surface Solutions division. In the first quarter, we achieved orders of CHF 391 million and sales of CHF 371 million, representing a book-to-bill ratio of 1.05. Despite soft PMIs, we achieved a stable sales development year-over-year in organic constant FX terms. In addition, we saw a positive contribution from 2 additional months of Riri consolidation, which was, to a large extent, offset by negative impact from foreign exchange. Operational EBITDA in the first quarter improved 8% to CHF 65 million. This includes an operational EBITDA margin increase of close to 130 basis points to 17.6%. The improvement was driven by strong pricing and continued cost discipline. 17.6% in Q1, which is usually a slow quarter, and in a continued difficult environment, is a clear sign that our focus and actions on Surface Solutions margins are gaining traction. Our management team continues to be laser-focused on this critical topic. I want to provide some more context around the margin development on the next page and show clear action areas, which we will tackle to get to 20%-plus margins. Let me move to the next slide. It shows the EBITDA margin development for Surface Solutions since 2019 and how we aim to reach 20% plus EBITDA margins in the midterm. In 2019, we achieved 16.9% EBITDA. During COVID, we executed certain very aggressive structural cost-out actions and achieved 18.3% EBITDA margins in 2021. So, 140 basis points improvement despite 14% lower sales in 2021 versus 2019 due to COVID. In 2022 and 2023, like many other companies, we have been exposed to an unprecedented hyperinflation, especially on the labor side and significant strengthening of the Swiss Franc. The input cost increases in labor and energy kicked in mainly in 2022. In terms of labor, which is by far the biggest cost driver of our services businesses. We saw dramatic increases in countries such as Germany and the U.S. Working with our customers, we had to take a wide-ranging set of pricing measures, which started to have an impact from the second half of 2023. And since then, we had to increase the frequency of these actions. Meanwhile, we have established dedicated pricing teams and corresponding technology, and we will continue to focus on pricing in order to reach our 20% plus EBITDA margin targets. Pricing will also be enabled by our accelerated innovation. Our R&D efforts now have a much stronger focus on commercialization. This allows us to price upcoming innovation at a significantly higher gross margin than our existing portfolio. In parallel, we are digitizing all of our business processes. We finished our global SAP rollout at the end of last year, and we are rolling out a digital twin for our coating operations throughout 2024 and 2025. In addition to that, we will continue to manage structural and operating costs very tightly. Overall, we are very confident in our actions to drive Surface Solutions profitability in the midterm. We fundamentally believe this business will yield a margin above 20%. With that, let's move on to Polymer Processing Solutions. Orders in Polymer Processing Solutions were CHF 251 million. This is down 16% year-over-year, but up 38% sequentially. Improving momentum was supported by filament, where we saw some initial signs of revitalization in small and midsized orders. Government stimulus and improving price cost spreads of our customers make us confident that we have seen the trough in the market. First quarter sales of CHF 179 million were down 47% at constant FX. This was mainly impacted by last year's difficult order environment. Furthermore, the division saw delayed shipments due to tensions in the Red Sea. This will shift some sales into the second half and the remainder of 2024. In terms of profitability, we achieved a 10.5% operational EBITDA margin. Considering the downturn and basically the having of our sales, this is an excellent achievement. It was supported by our proactive cost actions, which we implemented last year, and we will continue to manage costs very tightly. With that, let's conclude our first quarter results on the next slide. Our first quarter results reflect strong operational execution as well as early signs of improving end markets. Surface Solutions achieved a stable top line in a difficult environment. The integration of Riri is well on track, and the EBITDA margin has been significantly improved year-over-year. The division is in good shape to reach the targeted 20% plus margin in the midterm. In Polymer Processing Solutions, we saw Q1 orders improving 38% sequentially. Improved momentum was supported by Filament where we saw some initial signs of revitalization in small and midsized orders. We also note recovering consumption in our customers and encouraging signs for governmental stimulus in the Chinese machinery industry. Furthermore, as you see in the diagram in the middle, the price/cost spreads of our customers significantly improved since 2022. This means our customers earn a positive cash margin on every ton of product they sell, which is a precondition for them to invest into our equipment. Overall, we are confident that we have seen the trough of activity in the market. In terms of profitability, the division achieved a robust double-digit EBITDA margin despite cyclically lower sales. This means our proactive cost measures are bearing fruits. Last but not least, we are on track with our Pure-Play transformation announced in February. We are evaluating options for the separation of Polymer Processing Solutions. This includes the trade sale, an IPO or a spinoff. We clearly want to ensure that the separation creates value for all stakeholders, given that this is a unique asset. Polymer Processing Solutions is a market leader in a niche market that has been growing over the cycle at a 4% CAGR in the last 20 years. The business' capital returns are outstanding. The execution time frame for the separation continues to be 2024 to 2026. While we prefer sooner rather than later, timing will also depend on the separation mechanism and on their recovery speed of the filament end market. Overall, we have made solid progress on our operational and strategy execution in the first quarter. After a strong start to the year, we confirm our 2024 financial guidance. With that, let me open it up for Q&A.

[Operator Instructions] The first question comes from Michael Foeth from Vontobel.

First, 2 questions. The first one on Polymer Processing. You said it's the order improvement mostly driven by small and midsized orders. So, I guess we're still waiting for the larger projects to kick in. What are your customers saying? What is your visibility there? And how fast can that come back? That would be the first question. And the second one is, when you say that the separation process of the businesses is on track, what does it really mean? I mean, what has happened in the 2 past sort of months? And how will you decide on the separation mechanism? I mean, what are the decision triggers there? How dependent are they on the performance development of the business?

Good morning, Michael. The first one is, I think, around the globe and not just in China. The new project discussions have just taken a different dynamic on again. I think the investment environment is a lot more positive. I think it's driven by what we've shown a number of times now, the improved economics for our customers. But certainly, also specifically in China is driven by the new actions of the Chinese government. So, the stimulus actions that were specifically announced on February 24th are helping in this. I don't think it creates any artificial demand for us. I think it just helps our customers to make new investment decisions and specifically to upgrade existing equipment, which will be helpful for us. There is a variety of discussions. When we highlight specifically what was driving the first quarter, we were driving the first and second, the medium-size and the small orders, but I think also the large-scale orders are on track. But Michael, I just want to make sure, do you still hear us?

Yes. There was just a very short cut, but it's fine.

Okay. And then your second question, Michael, is on the separation process. So, I would describe it as, internally, we are preparing the company for the separation. And you know that the 2 divisions are operationally very independent already. So, I think there are a few things to be done from a customer segmentation standpoint or from an operational point almost nothing. But as it pertains to certain back-end functions, finance, HR, IT. And so, we want to make sure that the 2 divisions are fully prepared for a separation. And then, timing of the separation will depend a little bit on the market environment. I think to an extent maybe where we are exactly on the filament cycle, how fast it's going to recover now. I think that'll drive this decision a little bit overall market environment. And then we wanted to give ourselves a little bit more time in order not to box us in too much. But like I said in my prepared remarks, clearly, the preference is to move faster rather than slower.

The next question comes from Alessandro Foletti from Octavian.

I'd like to start with the margin path towards 20% in Surface Solutions. So, if I take your Slide #5, basically. Can you please give a little bit more detail on what will be the contribution of the different levers that you mentioned there from, so to speak, the level we are now around about 18% to the 20%.

Yes. I think about kind of maybe half driven by price and half really the cost side of things and to really to get to 20%. Alessandro, I think, specifically on the services side, it's all about keeping total costs kind of flattish, maybe only slightly up as revenue grows. And I think that volume leverage in that very high gross margin service business allows us to get to the margins. And then I think on an ongoing basis to stay at the 20%-plus margin level, pricing will play a key role. I think we're hopefully not going to face sort of a shock hyperinflation environment again, but we will continue to see a cost inflation environment for years to come. And so, our pricing mechanisms that we've really completely revamped on the services side and on the material side will help us to stay ahead of the curve on this.

So, it means also, when you speak about price, the 50% price driven that it is also sort of a mix component? You may be more about in percentage of sales or something or not?

I just think that the pricing mechanism kicks in mostly on the services side, Alessandro. I think on the equipment side to measure it is hard. On the materials side, as you know, we're doing a lot in terms of it, but there's also the material surcharges that we have, specifically on services. We have completely revamped our pricing mechanisms. We've actually implemented a brand-new pricing module in SAP for this and established a team around that. So, I think we're going to be a lot more thoughtful in terms of how we drive that in the future together with our customers.

And to finish off with this question on the timing. Can you say something more specific on the timing?