Schneider Electric S.E. (SU) Earnings Call Transcript & Summary

Welcome to the Schneider Electric's Third Quarter 2022 revenues. Thank you for standing by. [Operator Instructions] I would like to inform all parties that today's conference is being recorded. If you have any objections, you may disconnect at this time. I will now hand you over to Amit Bhalla, Head of Investor Relations.

Well, hello, everyone. Very happy to have you join us this morning as we talk about our third quarter revenues. I'm joined by our CFO, Hilary Maxson. We're going to get started. The slides are on our web page, and you can refer to them if you're not following on the webcast. Just a very quick reminder of the disclaimer on Slide 2. I'm going to hand it over to Hilary, and then we'll make sure to keep enough time for your questions. Hilary, over to you.

Thanks, Amit, and good morning, everyone. I'm also happy to be here with you today to comment on our Q3 2022 revenue numbers and to update you on our outstanding offer for the remaining minority shares of AVEVA as well as other portfolio actions. Starting on Slide 3 with some highlights on the top line for the quarter. Q3 continues with strong growth with third quarter revenues of EUR 8.8 billion, up 12.1% organic versus a strong Q3 2021 and despite continued impacts from supply chain and impacts from Russia, where we completed our exit from our Russian operations at the end of the quarter. Both businesses contributed with Energy Management finishing the quarter at EUR 6.8 billion, an organic growth of 12.1%; and Industrial Automation finishing the quarter at EUR 2 billion, an organic growth of 12%. Moving to the detail of our strategic growth pillars. More products continued to progress strongly, up 11% for the quarter, driven by both businesses and with strength in nonresidential building and OEMs. Software was up 14% for the quarter, supported by Energy Management Software and Digital Services, both up more than 20%, with our agnostic software companies in electrical design and build plus our EcoStruxure Advisors all performing strongly. AVEVA is focusing on its transition to subscription and drove double-digit ARR growth. This has a negative impact on its sales and profitability, which we expect to last for some time. Field Services were up 8% for the quarter with relatively higher performance in Energy Management services and with an uptick expected in Industrial Automation services in coming quarters, driven by the recovery we see in our long-cycle business. And our Assets under Management, where we're particularly focusing on our monitored and advised assets, which drive recurring revenue, continued to progress strongly, up 29% to 6.8 million. We continued to see strong double-digit growth in our Sustainability business, up more than 20% this quarter with a continued ramp-up in Sustainability consulting. And I'll call out an exciting update we have here on the prior announced Gigaton PPA project we're collaborating on with Walmart to provide increased access to renewable energy for Walmart's U.S.-based suppliers. Last week, we announced the first set of suppliers to enter into an aggregated purchase of renewable energy from a wind farm in Kansas. Combined, this purchase is equal to 62 megawatts of new wind power capacity, so it's a great start to the program. Turning now to our own sustainability journey. And what we do here for our customers and for our own operations is more important than ever, particularly as we see customers continuing to focus on their sustainability goals even with the current macroeconomic backdrop, so this continues to be a great opportunity for us. We achieved a score of 4.54 on our Schneider Sustainability Impact index as of Q3, tracking well towards our 2022 target of 4.7 and our 5-year target of 10. Key drivers of our performance in Q3 were our SSI #2, where we've now helped our customers save or avoid 407 million tonnes of carbon emissions, and where one of our key products for delivering this result, our Altivar variable speed drives, were named the Most Climate-positive Carbon Handprint Product by the Vancouver Economic Commission and Climate Leadership Coalition. Our SSI #5, where we achieved 41% of our packaging transformation goal to eliminate single-use plastic and shift to recycled cardboard; and our SSI #9, where we've now provided access to green electricity to 37.4 million people, well on track towards our 5-year target of 50 million people. I'll also mention that during the Q3, we became one of the first companies in the world to have its net zero commitment road map validated by SBTi, in line with the new corporate net zero standard. And the full detail of our sustainability performance is available in our press release and in the appendix to this presentation. Turning now to the details of our Q3 revenues. As mentioned prior, we finished the quarter at EUR 8.8 billion in revenues, up 12% organic year-over-year. Sales were adversely impacted by around 2 points from Russia where we completed the sale of our Russian operations at the end of the quarter. And with the closing of that sale, we'll deconsolidate Russia going forward. Excluding Russia, volumes contributed around 2.5 points to growth in our top line with a step-up in industrial volumes quarter-over-quarter due to continued easing of supply chain constraints. All of our regions contributed to our strong organic growth with Rest of World adversely impacted by Russia. Excluding Russia, Rest of World would be at 12% organic growth. Scope impacts are now immaterial due to the shift of OSI into organic results as of Q2, and FX continued to impact strongly our reported revenue growth. Based on current rates, which remain volatile, we'd expect positive impact to top line for the full year of EUR 1.7 billion to EUR 1.8 billion and around plus 20 basis points to adjusted EBITA margin. Turning now to some highlights by our end markets. On this slide, we speak to the combined end markets of Energy Management and Industrial Automation, and although we don't report on orders, we've incorporated some comments on the demand environment. Starting with buildings. We continued to see a strong sales and strong demand in nonresidential buildings with customers continuing to focus on energy transition and energy efficiency, digitization and sustainability. Residential building sales remained positive with particular strength in the U.S. where demand continued to stay strong and with some as-anticipated slowdown in demand, particularly in Western Europe and China. Demand for residential was also impacted by some distributor destocking, although sellout trends remained good and accelerated throughout the quarter. Data center and networks also remained strong with strong double-digit sales growth and continued acceleration in demand for data center in the Q3. Sales in distributed IT remained positive despite supply chain constraints and with some softness in consumer-led categories amplified by distributor destocking. In infrastructure and industry, demand trends continued to be strong across most sectors and geographies. So overall, for the quarter, broad-based strong demand continued to support a buildup in our backlog despite the as-anticipated slowdown in residential markets and some distributor destocking, so we continue to be in a primarily supply-constrained environment. Turning now to Q3 results by business and geography. Energy Management grew by 12.1% organic despite some continued supply chain constraints and impact from Russia. North America was up 18% with double-digit growth in U.S. and Canada and mid-single-digit growth in Mexico driven by broad-based demand across our end markets, including residential building and supported by some easing and supply chain constraints. Matching the growth trends of the group, growth in Field Services was high single digit and growth in Sustainability was strong double digit. Western Europe was up 14% organic with double-digit growth in all key geographies, excluding Germany, where we were up high single digits. Sales were driven by strong demand across our end markets with some deceleration in residential building and consumer-led distributed IT also impacted by distributor destocking. And Energy Management Software saw high single-digit growth. Asia Pacific was up 9%, with China at mid-single digits with growth across all its end markets with the exception of residential building, supported by both demand and backlog execution with an easing of supply constraints after the Q2 lockdown. Outside of China, the rest of Asia Pacific was up double digits, driven by strong performance in all key geographies, particularly Eastern Asia, and supported by growth in nonresidential building and data center. India was up mid-single digit with strong growth in buildings, including residential buildings and in data centers, with some decline in sales in consumer-led distributed IT versus a strong baseline. Rest of World was up 2%, impacted by Russia with double-digit growth in most other key geographies, including Middle East, South America and Central and Eastern Europe and with broad-based growth across the portfolio of Energy Management offers. Turning now to Industrial Automation. Revenues were at EUR 2 billion, up 12% organic despite continued impacts from global electronic component shortages in Russia. North America was up 9% for the quarter with double-digit growth in both discrete and Process & Hybrid supported by a project in Mexico, but with Process Automation now positive in all 3 countries due to a translation of the demand momentum in our longer-cycle business now into sales. Western Europe was up 15%, supported by some easing in supply chain and with double-digit growth in all key geographies with the exception of the U.K., where we were up mid-single digit, driven by continued strength in OEM as well as momentum in Process & Hybrid now translating into sales. Asia Pacific was up 18% with China up double digit and rest of Asia Pacific up more than 20%. In China, we saw continued strong sales growth in discrete automation driven by OEM demand and strong backlog execution and good momentum in Process & Hybrid. India was up strong double digit against a strong base of comparison from 2021 with strong growth in discrete, particularly with OEMs. The growth in rest of Asia Pacific was also driven by strength in OEM and Process & Hybrid. Rest of World was down 2% impacted by Russia, but with double-digit growth in most other key geographies, including Middle East, Central and Eastern Europe and Africa driven by discrete automation as well as Process & Hybrid, particularly in Middle East and Africa. South America grew mid-single digit supported by Process & Hybrid with some deceleration in discrete. I now move to Slide 10 to give you an update on our portfolio disposal program and evolution of our share buyback program. If you recall, we set up our current portfolio disposal program in 2019 with an ambition to sell businesses with revenues totaling between EUR 1.5 billion to EUR 2 billion by end of 2022. And with 1 quarter remaining, I'm happy to share with you that we've now reached this target range. The main disposal we're announcing today is Telemecanique Sensors, our legacy industrial sensors business, which generated revenues of EUR 280 million last year. This transaction values the business at EUR 723 million and is expected to close in H1 2023. And as you can see on the slide, we also disposed of some smaller businesses, including our Eberle Controls business and ASCO load banks during the quarter. Including these transactions, we've now disposed of businesses with cumulative revenues of EUR 1.5 billion since we announced the program in 2019. In Q3, we also closed the previously announced sale of our Russia operation, which will subsequently be deconsolidated from our accounts. Just a small note that under the accounting for this transaction, there won't be a restatement of historic periods. So the year-over-year impact of the deconsolidation will be treated as scope starting in Q4. And the financial impacts of this transaction are in line with our previously communicated expectations with an expected write-off of net book value of up to EUR 300 million and a noncash reversal of the currency translation reserve associated with these activities now fixed at EUR 19 million loss. On the buyback, I reiterate we remain committed to the completion of our current program of EUR 1.5 billion to EUR 2 billion. In light of the AVEVA transaction, we've been restricted on further progress on the buyback in Q3, but we do expect to complete the current program in the coming months. Moving now to Slide 11 and to provide you with an update on the AVEVA transaction, which we announced in September. We're moving ahead under the rules of a U.K. scheme of arrangement for this proposed transaction. What this means is that the completion is conditional upon, among other things, a shareholder vote of all minority shareholders expected on November 17. For this transaction to be approved under this scheme of arrangement, it requires the support of a majority in number and 75% of the minority shareholders to participate in the vote. As things stand, this is our preferred transaction structure, although the U.K. rules do allow alternatives. As explained on the call we held with you in September and reflected in the transaction documents agreed with the AVEVA Board, with this transaction we'll be in a position to accelerate the execution of our software growth strategy and to ensure the acceleration of AVEVA's transition to a hybrid cloud-based subscription model. Of course, like any acquisition, while the underlying strategic rationale must be strong, the transaction also needs to be done on terms that make sense from a financial perspective. Our offer price delivers a very significant premium in cash to the minority shareholders in an increasingly challenging environment. And as you know, this transaction is recommended by the Independent Committee of the Board of AVEVA. We think there's opportunity here to more rapidly deliver a unique proposition for our customers combining energy and process data. However, this is not an absolute must-do deal for us, and we could also maintain our 59% ownership. We look forward to updating you as to the progress of this proposed transaction and on our plans for the business in either case and in more detail in due course. I'll finish with an update on our market dynamics since our half year results. First, we continue to see a strong demand environment across most segments and geographies, driven by accelerating energy transition trends, continued acceleration in digital and further recovery in late-cycle segments. And this strong demand continues to support a good environment for pricing going forward despite our expectation that certain inflationary pressures may ease. We do start to see some slowdown in demand in residential buildings, as expected, particularly in Western Europe and China and in the consumer-led piece of our distributed IP offer. However, backlogs remain high globally even in consumer-led segments with no signs of cancellation, so we expect a partial offset as supply chain constraints continue to ease. And demand across the rest of our end markets remain strong. So overall, we primarily remain in a supply-constrained environment with continued strong momentum in demand. So we'll continue to leverage our unique global supply chain setup to execute in the near term and to focus on redesign and our supplier strategy to ensure continued success in the medium term. With this backdrop, we're confirming our full year 2022 target of organic growth in adjusted EBITA of plus 11% to 15%, supported by organic growth in revenues of 9% to 11% and expansion in our adjusted EBITA margins of 30 to 60 basis points. Although I'll note that due to the inflationary environment, we currently expect to finish towards the lower end of that adjusted EBITA margin expansion range. With that, I'll turn the call back to Amit for the Q&A.

All right. Thank you very much, Hilary. We'll move now to the Q&A. I think we do have sufficient time to try to take questions from all the analysts. [Operator Instructions] So with that, I'll turn it over to the operator for the first question.

The first question, sir, is from Alasdair Leslie of Societe Generale.

Just maybe a few questions, I suppose, on the digital flywheel businesses. You saw very strong growth in EM software. That's now, I think, 40% of your software business. Just kind of thinking how sustainable is that growth more than 20%, was there something one-off in the quarter? And then maybe if I can just pick up on the comment you made about strong progress in monetizing sort of digital Assets under Management. I just wonder if you can elaborate on that a little. Are you seeing kind of an uptick in interest in the assets -- sort of asset management and predictive maintenance services, those kind of things, due to the energy crisis? And how much is that already reflected in your growth? Do we see the benefits now? Are they going to flow through in the coming quarters?

Sure. So indeed, we were quite happy to see the continued acceleration of the growth in Energy Management software. I think that's something that we've been working on with our agnostic software companies over the past quarters and past years. And so I think that, that's not something associated with one-offs with this quarter and we're quite pleased to see it. Now that said, we would expect that all of our agnostic software businesses will, at some pace in over some time frame, start to make a shift to subscription. So similar to AVEVA, we may have some differing growth rates among various of the Energy Management software in the future, but that'd be included in the Capital Markets Day guidance that we gave. In terms of the Assets under Management, I think we've talked a few times in the past that we have basically a couple of major categories of Assets under Management. We have the monitored and advised assets under management, where we're driving recurring revenue, and we continue to see great progress there, including similar rates of growth that we see at the overall Assets under Management. Part of the Assets under Management we're also including -- and those include -- those are more than 60% of the Assets under Management that we have today. The rest is going to be logged assets, so we're not yet driving recurring revenue, but important from a Field Services standpoint, identifying our assets in the field and opportunity to shift those to driving recurring revenues becoming monitored and advised in the future. So great momentum there as well. And again, that's something -- that progress and that strategy is something we've taken into account into our Capital Markets Day.

The next question is from Phil Buller of Berenberg.

I know you scale things like [ resi ] by geography and also product versus service and software. But I was hoping you could help us scale some of the other buckets which you're referring to when it comes to the outlook. Can you talk about a continuation of the accelerating energy transition trends? And you talk about a deceleration in consumer-linked segment, which still makes sense intuitively, but I'm trying to get my head around those buckets. So I was wondering if you could help us scale as a percentage of sales, let's say, as to how much is consumer-linked segments. Or how big as a percentage of revenue would you say the accelerating segments towards energy efficiency are, please?

Sure. Of course, it's not perfect. But what I would say here is so sales growth in residential remained good overall. However, like we called out, we did see a deceleration in demand in Q3, mostly in Western Europe and in China and a few other countries. You can see them in the press release. Demand in the U.S., parts of Asia Pacific and Rest of World remains robust. Our overall exposure to residential globally, we've talked about in the past being around 1/3 of our overall building end markets, so we'd estimate the total exposure globally, including all markets that are both in good demand trends as well as those that are a bit weaker today, probably around 10% to 15% with relatively lower exposure in China. So our best estimate in terms of overall consumer-linked exposure in entirety, we would put at 15% to 20%. So really, we consider that the majority of our end markets remain in very strong demand, driven by the mega trends that we've discussed.

The next question is from Andre Kukhnin of Credit Suisse.

Can I focus on the guidance construct? You obviously chose not to move it this time around and we've got a range there, and just looking simply at what you've printed for Q3 and that the run rate kind of for Q4 staying at the same pace, it kind of clearly points to the top end of that 9% to 11% organic. So I just wanted to check whether that makes sense to you and whether there is maybe some notion of moving within the range without moving the range itself. And is there anything kind of beyond what you've already put out to us on expectations for Q4 trends that we need to look out for in Q4 that might catch us out in this math?

Sure. So as you know, the formal guidance that we gave is the adjusted EBITA growth of 11% to 15%. Underneath that, what I would say is that just in the H1 call, we already upgraded our top line guidance to 9% to 11% and then we've stuck with the same margin guidance throughout. So what I would say there is that we do still remain in a dynamic and uncertain environment from a supply chain standpoint. So that's probably the key point that I would say that we see a bit of uncertainty that would -- that I would point to. Other than that, you're right that, as of the Q3, we've continued quarter-over-quarter to track well in terms of supply chain and we hope that's the case for the Q4 as well.

The next question is from Gael de-Bray of Deutsche Bank.

Maybe just to follow up on this, but more on the margin side of the guidance. Because in your comments for Q4 you mentioned gradual easing in supply chain challenges, some deceleration of inflationary pressures, a positive price/cost equation and continued good volumes. So all of this bodes pretty well for margins in the second half, at least in theory, right? So is it fair to say that you're now perhaps leaning more towards the upper end of the margin range rather than the lower end? Or is there something I'm missing here?

No, I think -- maybe I went over it quickly. But I did confirm in the script that we currently expect to finish towards the lower end of the adjusted EBITA margin expansion range. We do expect to see continued supply chain easing. We do expect to start to see some lower inflationary pressure, particularly in raw materials. We are hedged, however, if you recall, on a quarter-to-quarter basis over 12 months. So that easing in raw materials will impact us more in 2023. So indeed, between pricing, where we certainly expect to remain net price positive for the full year versus raw materials as well as a couple of those inflationary elements that we've pulled out in productivity, we still expect, because of timing there, to finish towards the lower end of the range.

The next question is from Jonathan Mounsey of BNP Paribas Exane.

I wonder just thinking about actually you don't disclose orders, but you have talked about book-to-bill. The fact early on in the year that revenue growth was lagging because of the -- but you did have a very strong order intake, obviously, supply chains away. I guess you're starting to hit tough comps now for orders. I'm just thinking about both year-on-year and sequentially, are orders still up on that basis year-on-year and sequentially? And also, what's the book-to-bill like now? Is it still above 1 or is it below 1? And could -- as the comps get increasingly tough, are we expecting the book to bill to fall below 1, say, in Q4 or through into the early part of next year? And if it does, I think you mentioned at the end of your script the backlogs remain high. How long before that backlog becomes exhausted and revenues would come under pressure?

Indeed. So I did mention that, in fact, we continued to see record backlogs in Q3, so we continue to see positive evolution from a backlog standpoint. We don't report on our orders, but I think that gives you a good sense. Also, I talked about demand sort of as a proxy for what we're seeing on the ground order. So in general, strong demand across the board, aside from those few points that I called out that aren't enough to make a difference in the overall demand equation. So at the moment, we still remain in that strong order environment with backlogs increasing. Now I think what you're asking about is, look, some of that backlog increase is probably associated with an increase in delivery times because we have supply chain constraints and some of that is associated with demand from the market and we agree that that's the case. In the supply chain-constrained areas, we would anticipate at some point to see some normalization from an order standpoint. You might see in your orders technically they fall into negative range. But at the moment, we continue to see a strong demand environment. So we don't see a scenario where, on a whole, we would expect to have a loss of momentum in overall sales on a going-forward basis.

The next question is from Simon Toennessen of Jefferies.

Hilary, I just wonder if you could talk a bit about trends in discrete a bit more. I think you mentioned on the IA slide that you're seeing it slowing in some parts. You obviously mentioned the late cycle recovery continuing in your Q4 outlook. But maybe a bit more color on discrete trends also by end market would be helpful.

Sure. So probably the couple of areas that I might cover there, maybe there are probably -- the one that I would point to is the demand dynamic that we're seeing in China. So in China, we saw a good turnaround in sales after the Q2, supported by both demand and supply chain recovery. In demand, we continued to see momentum across many segments with the exception of construction type. So that includes residential, but also some OEM segments correlated to construction like HVAC, hoisting elevators. And then our equity investment -- equity method investment, Delixi, is also impacted. Good news, despite those weaknesses, we're now positive year-to-date in respect of both orders sales, and we expect to finish the year positively and with good momentum in 2023. But that's the one area that I would probably point to a deceleration from an OEM standpoint in demand. The other one, I think, that we called out was one of the countries in South America. But in general, we continue with good demand trend.

The next question is from James Moore of Redburn.

Can I please follow up on Mr. Mounsey's last question, please. I mean if we have an industrial downturn globally next year, I'd just like to understand a little bit how you think you might behave this time compared to previous cycles. Schneider's always seen a downturn in the past when we had the cycle, but I guess you've increased your percentage of revenues that are growing more secularly. I wondered if you could give us a flavor for what percentage of revenues you think are growing above underlying end markets like green, and how much that's changed really over the last 5 or 10 years? I'm really trying to decouple the secular versus the cyclical.

Yes. Understood. So for us, I think that -- we think and obviously we run many scenarios, right, so there's lots and lots of different scenarios that everyone can talk through. But we believe that most of our markets remain with good momentum even in that scenario based on the mega trends that we've talked about. It only accelerated really with the issues with Russia and Ukraine with countries more focused on energy costs, on energy securitization. So I called out the level of portfolio that we expect is more consumer-linked, that 15% to 20%. As you know, we -- like you mentioned, we've also shifted our revenue mix over time to more recurring revenue, more software. Much of that digital flywheel we think is more resilient than just purely cyclical than it is in the past. So I won't give a particular breakdown of numbers, but it's really that 15% to 20% we think is probably more cyclical with the mix in the rest where we would expect to continue to see a good amount of momentum based on the mega trends that we've talked about.

The next question is from Ben Uglow of Morgan Stanley.

I was hoping you could elaborate just a little bit on some of the comments around the AVEVA transaction. Hilary, I think you sort of said that this is our preferred transaction structure, but under U.K. regulation there are alternatives. So I guess what I want to know is what are you sort of implying there? What could be the alternatives? And then in terms of this being a sort of "not a must-do deal," it is a major capital commitment. It's a EUR 4 billion sort of cash outflow from Schneider. If you weren't to do this deal for whatever reason, do you have other M&A opportunities in the pipeline that you could simply switch to? So if it's not a must-do deal, what else could you be thinking about?