Rheinmetall AG (RHM) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to Rheinmetall's First Quarter 2023 Conference Call. Before I start on Page 3, I would kindly raise your attention to our legal disclaimer on the following page. So now let's start with Page #3. First quarter was in line with our expectations. Operational sales performance benefited from the overall positive trend in our security businesses, and we reported the best operating free cash flow ever in a starting quarter. We are, again, expecting a very pronounced seasonality in the year 2023, largely driven by the growing sales share of the Weapon and Ammunition business. Equity contributions made the difference in both starting quarters. While the operating result in the first quarter 2022 included a positive at-equity effect, the first quarter 2023 was quite the opposite. Summarized, a negative deviation of minus EUR 29 million, and in addition, the burden of the inflation compensation payment. We reported an IT incident at the end of April, with an isolated effect on our civil businesses. There was at no time any danger that the incident was transmitted to the defense network, and we are currently in the process of bringing all systems back to normal. Last but not least, we confirm our full year guidance. And once we have closed the Expal Systems deal, we will provide an updated guidance. So please turn to Page #4 for an overview on the market. The new Minister of Defense, Boris Pistorius, had a strong start. He is clearly trying to make change happen in his domain. And things in Germany start to happen. After the Puma issue was finally resolved by mid-January, we have booked the Puma upgrade contract in the first quarter. And we are awaiting a decision on the second lot in the course of the second half. We have made really good progress with the ammunition framework contracts for tank and artillery and some vehicle programs, like the airborne platform, Caracal. In addition, the government-to-government deal with Australia for the Heavy Weapon Carrier is now taking shape. Lockheed and Rheinmetall have recently signed an MoU regarding the cooperation on Rocket Artillery Systems for the German forces. This opens a completely new field for Rheinmetall. Please move on to Page 5 for the presentation of our Ukraine business. The support of the Ukrainian people remains a top priority for the European Union and the German government. And as you can see on this slide, Rheinmetall is trying to support with all available resources. Order intake for Ukraine reached year-to-date, around EUR 700 million. This includes delivery of the first 20 Marder from our own inventories until the end of March, and more demand for tactical vehicles is expected. Ammunition is clearly in focus, and we have signed contracts for medium-caliber tank and artillery rounds, together with additional service components, such as field hospitals and automated surveillance systems. We are expecting to receive further orders because a financial funding from Germany and the European Union to further support Ukraine, has already been committed. Please continue on Page 7. Sales grew operationally by 7.7 (sic) [ 7.6 ]% to almost EUR 1.4 billion. Currency and mergers and acquisitions did not have any material effect in the first quarter. All divisions but Weapon and Ammunition were able to improve year-over-year. The decline of the operating result by EUR 19 million to EUR 73 million was mostly attributable to negative at-equity contributions from our Chinese joint ventures and the Hungarian joint venture for IG. Our German employees received an inflation compensation payment in the first quarter. This was an additional burden to the P&L, and we are expecting a similar payment for the first quarter 2024. Special items have a supportive effect and result from positive mark-to-market valuation effects of our liquidity reserve. Basic earnings per share for the continued business rose from EUR 1.08 to EUR 1.15. In accordance with IAS 33, we reported diluted earnings per share of as well EUR 1.15 due to anti-dilutive effects. Please turn to Page 8 for a more detailed analysis of Rheinmetall's seasonality. Quarter 4 is a quarter with the highest business impact for Rheinmetall. We realized on average, over the last 3 years, 1/3 of our sales and more than 50% of our operating result in the last quarter. The second half is representing more than 50% of sales and almost 3/4 of the total operating result. We are expecting that Weapon and Ammunition will continue to be a growth driver for the group. And combined with the spending behavior of our governmental customers, the trend to expense at the end of the budget year will most likely continue. Therefore, we recommend to anticipate this back-end-loaded pattern again for the year 2023. Let me move on to Page 9, for the details of the at-equity results. If we compare the operating performance of the group, excluding the at-equity results, we would report an improvement of more than 12% to EUR 85 million year-over-year. The first quarter 2022 reported a positive contribution from at-equity in the amount of EUR 17 million, including a high single-digit positive effect in the division Weapon and Ammunition, as well as positive contributions from the China joint venture. China flipped from positive into negative territory in the first quarter 2023. And we had a negative at-equity contribution from our 25% stake in 4iG in Hungary. 4iG reported a net loss for 2022 and the first quarter 2023, driven by noncash write-offs, which in total accounted for around EUR 12 million. We are assuming that the 2022 business development of 4iG will basically continue in the year 2023. Metalworkers' Union negotiated an inflation compensation bonus, and this first impact in the first quarter 2023 accounted for a high single-digit amount. Please turn to Page # 10. First quarter 2023 was, in fact, the best operating free cash flow ever of a starting quarter, and came in at minus EUR 105 million, after minus EUR 463 (sic) [ 462 ] million in the previous year quarter. Due to a delay into April of one payment, we missed the targeted breakeven. We were able to collect a lot of receivables [Technical Difficulty] [ reserved ] in the fourth quarter 2022 and received as well first prepayments from our international customers. Inventory buildup continued, but at a much lower level than in the previous year. Moving on to Page 11. The successful placement of the EUR 1 billion convertible bond had a structural effect on our balance sheet. It is still liquidity neutral in the first quarter, but the accounting treatment of the convertible has an impact on the equity and debt positions. We book the option value of the convertible in equity, and treat the difference to the received cash as debt. This explains why equity increases to EUR 3.2 billion, and the equity ratio drops to 34.7%. Now let's have a look at the divisional performance on Page 12. Vehicle Systems reported a strong quarter, with sales improvement of more than 15% to EUR 462 million. Higher leverage and the strong performance of tactical vehicles drove the operating result to EUR 42 million after EUR 29 million in the previous year's quarter. As a result, margin improved to 9.1%. Operating free cash flow rose by EUR 31 million to minus EUR 94 million, mainly on prepayments, which were partly offset by inventory buildup. Weapon and Ammunition sales declined from EUR 258 million to EUR 238 million, as increasing orders from the German customers were not sizable enough to compensate the effect of missing export licenses in South Africa. The previous year included a favorable at-equity contribution, as already mentioned. Adjusted for this effect, margin would have improved and reached an excellent result improvement of 10%. Cash collection and carefully managed working capital led to the best operating free cash flow in the first quarter ever. The operating free cash flow was clearly a highlight and the result of the high cash collection of Q4 receivables. Electronic Solutions reported a 20% sales growth to EUR 201 million and more than doubled the operating result to EUR 10 million. This generated an operating margin of 5%. Very positive development was largely driven by the ramp up of the Hungarian Lynx and high volumes for personnel equipment. The division successfully reduced their receivables and improved operating free cash flow by EUR 36 million to minus EUR 71 million. Sensors and Actuators grew sales by 4.5% to EUR 363 million, but suffered a decline in operating results of 50% to EUR 13 million. Sales growth stayed behind comparable overall global production growth of 8.3%. The operating result was hit by additional raw material cost increases that have not yet been passed on to customers. Materials and trade increased sales by 4% to EUR 198 million. This sales increase was mostly volume driven. The drop of the at-equity contribution from our Chinese joint venture was a major driver behind the decline of the operating result from EUR 16 million to EUR 12 million. The currently sluggish light vehicle demand in China is mainly affecting higher-priced luxury cars of Western origin, which happen to be our main customers. The [ 4iG ] at-equity contribution is reported in the line non-divisional and consolidation, and is the reason for the decline of EUR 13 million. Please move on to Page 13. Rheinmetall nomination declined by 8% to EUR 3.1 billion, and booked business and frame nominations remained on previous year's level, but the order intake was EUR 278 million below last year. Please bear in mind that we reported the single biggest ammunition order for Hungary, with a volume of around EUR 850 million in the first quarter 2022. So compared to an adjusted 2022, the order intake looks much better and is composed of quite a few orders across the division. Rheinmetall order backlog has crossed the EUR 28 billion level, and we are expecting to see further growth. This takes me to my last presentation slide, number Page 15. [ They ] have presented the above guidance only 7 weeks ago. At this stage, we don't see anything that poses a threat to our guidance. And once we have closed the EXPAL, we will have a closer look at the guidance and provide you with an update. Thank you for your attention. And now I'm available for your questions.

[Operator Instructions] And the first questioner is Mr. Christoph Laskawi of Deutsche Bank.

The first one, before I continue with others, would be very publicly, the German MoD was making statements to speed up procurement, has implemented changes, safeguard that as well. Do you actually already see the benefits of that? And as a result, could we expect sizable order intake from Germany before the summer break? Or is it more likely that we'll get the press announcements after the summer break?

Well, thank you for your question, Mr. Laskawi. We expect for the full year 2023 a high order intake. And of course, we are working on getting orders in the second quarter. And compared with the previous year's quarter, it should be -- it would be significantly more.

And the second question is on the at-equity result, thinking how that should turn into Q2. Should we expect another negative as we've seen it in Q1 from your 4iG contribution? Or is that basically done now and it should be more normalized going forward?

Well, in the first quarter 2023, we have an impact of 4iG from the fourth quarter 2022 and the first quarter 2023. So in the coming quarters, the at-equity result, which we expect to stay negative, is a lower single-digit number.

And the last question would be on the autos business. Sensors and Actuators clearly dropped in earnings year-over-year because of, as you highlighted, inflationary pressure. Do you see any improvement in the negotiations with the OEMs, do you have pass-throughs already in Q2? Or should we expect that largely being back-end loaded?

I would expect that largely more back-end loaded due to the fact, of course, that we had our IT incident in April -- end of April. And of course, that affects somehow the whole organization. And therefore, we see it more in the second half of the year.

The next questioner is Mr. Sven Weier of UBS.

The first one is -- would be a follow-up on Christoph's question on order intake. And you just kindly said it will be substantially higher than Q2 last year. Now my question really is, given that you differentiate between frame nominations and order intake, I think in Q2, there's a lot of ammunition framework agreements coming from Germany, in particular, a couple of billion. What about the core order intake, so outside the frame nominations? What are you expecting there?

Well, regarding my question to the order intake in Q2 compared with previous year's level, of course, the significant increase, that includes these bigger ammunition orders, which we expect to come in, in the second quarter, but some, of course, as well in the second half of the year. Overall, the order intake should be -- of the rest of the orders should remain on a high level.

Understood. And maybe if I may, can you just help me understand the booking of the order intake regarding the Leopard tanks for Ukraine? Because I guess that was not yet booked in the first quarter. Is that all coming in Q2? Or how should we think about that?

It's not yet booked. That's right. And we are expecting it in the months to come.

Because that was a fairly significant number as well, right?

Right.

Understood. And then I was just wondering, as a quick follow-up to the IT issues that you've mentioned, is the incident only affecting the sensors and actuators business? And what's the kind of cost you would expect it to relate to that incident?

The IT incident affected our whole civil business. So that includes not only sensors and actuators as well as material and trade. Of course, we will have some additional cost to set it all up again. But if you think back, in 2019, we had an attack as well on our civil business. And overall, the additional cost which we had to spend, was a middle single-digit number. And therefore, we are very confident that this IT incident will not substantially affect our [Technical Difficulty] [ core ] performance.

Understood. And then the final one from me, is just on the pushouts you had in Q4. I remember you had around, I think, 300 million pushouts from Q4 that we were normally expecting in Q1. Is that revenue level related to South Africa? Were you still missing the export's approvals, or -- am I right, or it's something else?

No. It has been several, yes, orders or sales, and it's not related with these South African ones.

But those delays have not been booked in Q1 yet?

South Africa, No, there is no export.

But the other delays that we were expecting for Q1, the 300 million, is that still to come, or...

Well, partly, it came in, in the first quarter. And some of them are expected to come during the rest of the year. For instance, the tactical vehicles.

We have one more questioner. It's Ms. Virginia Montorsi of Bank of America.

Two for me. The first one would be, you've kind of touched on this. But on weapon and ammunition, could you give us a little bit more color on exactly what drove the lower or weaker operating performance? And anything you can tell us in terms of how to think about the phasing for the full year?

Well, overall, operational, we have better performance in the first quarter because -- it's all linked to at-equity contributions, which are negative in the first quarter 2023, plus these higher single-digit number of inflation compensation, which we had to pay in the first quarter due to the agreement of the unions. Therefore, within our fully consolidated businesses, the operational performance is much better compared with previous year's quarter.

Okay. That's really clear. And maybe last question for me. We've seen Australia publishing their defense spending review, and they've significantly lowered the number of vehicles for the Lynx contract that I think you mentioned a few times you were confident you could sign. How should we think about order intake for this year given that, I guess, Australia's numbers of tanks are changing a little bit?

Well, the number of tanks in Australia, yes, it is reduced. And about the timing of the order, I'm not going to mention any quarter or any month, because it took us already a long time where we expected the order income. And as you know, we didn't got it so far.

The next questioner is Mr. Christian Cohrs of Warburg Research.

First, on the Ukraine, you mentioned the support and the business you've made with Ukraine. A couple of weeks ago, CEO Papperger was in the press stating negotiations with the Ukraine government about a potential manufacturing site for the Panther. So can you maybe elaborate how this potential project or idea has developed in the meantime?

Well, there is no decision as of today. But of course, we are in negotiations and talks with the government. And Mr. Papperger mentioned 7 weeks ago that he expects a decision within the next like 2 months or 10 weeks. So therefore, we hopefully have an update within the next month.

Okay. And second question relates to your group minorities. These were actually positive, plus EUR 3 million versus minus EUR 30 million 1 year ago. Despite the fact that if you strip out the at-equity earnings, that the fully consolidated businesses have achieved higher earnings this year, and especially this is also true for vehicle systems. So maybe can you shed some light on the minority side, which -- what are the -- actually, what are the moving parts to explain this massive deviation versus last year?

Well, of course, if you look at the minorities, it's the number of minorities, which are part of our fully consolidated companies. And one company, for instance, is a South African company, Denel Munition, where you see a difference in performance. And then we have, of course, our -- it's the -- hold on, let me just look it up. We see truck business, where we have a swing -- a little bit swing in the performance. And then there are several other smaller companies, and that all ends up in the reported numbers.

Okay. So it's a mixture of a broad mixture? Because I'm surprised, to be honest, by the magnitude of the swing.

But it's -- I just would like to remind you on the seasonality of our business, and it's just the first quarter. So don't put too much effort on the first quarter.

I have one more questioner. It's Sash Tusa of Agency Partners.

I just wanted to check whether there had been any change to your expectations for the closing date for EXPAL, or indeed the antitrust issues or financial issues associated with that transaction?

Well, we expect to close this acquisition in the beginning of July. And we are quite confident that it will take place there -- or then.

There are no questions at the moment, therefore I will repeat [Operator Instructions] There seems to be no further questions in the queue.

So if there are no more questions, I would like to thank you very much for your kind interest. And I would like to close the call with a brief summary. The first quarter was absolutely within our expectations. Our operational performance improved further in the first quarter, and operating free cash flow made a significant move in the right direction. And finally, we confirm the current guidance with an outlook that we will provide an update once we close the [ expired ] year. Looking forward to meet you on the road. Goodbye, and thank you from my side.