Sika AG (SIKA) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Sika 9 Months 2022 Results Conference Call and Live Webcast. I am George, the Chorus Call operator. [Operator Instructions] The conference is being recorded. The presentation will be followed by Q&A session. [Operator Instructions] The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Dominik Slappnig, Head of Corporate Communications and Investor Relations. Please go ahead, sir.

Thank you, George, and good afternoon, and welcome to our 9 months' results conference call. Present on the call with me today is Thomas Hasler, our CEO; Adrian Widmer, our CFO; and Christine Kukan, our Senior IR Manager. We published our 9 months figures this morning at 5:00. The presentation to the results is as well published on our website. As this is a call only, we will not be presenting the slides. They are mainly a basis for our discussion. With this, I hand over to Thomas to start with the highlights of the 9 months.

Thank you, Dominik, and good afternoon to everybody. It's a great pleasure for me to update you on the 9-month performance of the company. It has been a quarter very much in line with the first 2 quarters we have a very diverse picture overall. But in combination, a strong growth, organic growth, has been achieved with over 15% in all the region, double-digit organic growth. But the underlying markets are very different and remain very different where we still have in 3 of the 4 regions a good healthy volume growth. Underlining the overall growth we have still in -- especially in Europe, Central Europe, South and North and negative volume trend that continues also in the foreseeable future, whereas the other regions and main countries still have a solid underlying volume growth. The overall picture is diverse, as I mentioned, but the universal aspect and the universal performance of our companies that independent of the market situation, we outperformed the market. So in declining volume markets like we see in the distribution, for instance, in Europe, we outperformed the market trends clearly. In growing areas, like Global Business where the car production is picking up, again, we are outperforming the underlying market significantly. This is a universal Sika DNA to adapt and compensate market trends by offsetting that through our resilient strategies, through our strong portfolio of activities, but also through the segments that we are active in, which are more resilient to the general trends of the market. Also, our bottom line evolution is in line with our expectation, which is overall an overproportion of EBIT growth. The first 9 months has delivered in this regard, an over proportional growth, and this is also our expectation that for the fourth quarter, we will continue on that path and deliver the results as we have outlined in previous statements. I would also like to provide an update on the MBCC acquisition, where we are confident to close the transaction as targeted in the first half of next year. We went into the details at the Capital Market Day in regards where we stand. And here, since then, we are moving in the right direction, and we are confident to close the transaction as outlined. We are also confident for the remainder of the year that the trends will be, in a certain way, instable, but our stability will offset and we'll deliver the results as we have outlined also at the Capital Markets Day, which will be clearly above 15% growth in local currency and also an overproportion of EBIT growth in line with our strategic targets outlined in our 2023 strategy. With this, I would hand over to Adrian, who is going into more of the details on how our performance is built up and also giving you some flavors on margins, evolution and expectations.

Thank you, Thomas, for the highlights and the introduction. And good afternoon, good morning to all of you. I will now give you further color on the financial results. Starting with the top line. We have continued to deliver solid sales growth also in Q3, which resulted in double-digit growth in all regions in the first 9 months of the year and a local currency growth of 18.5%. Organic growth was 15.1%, whereas in Q3, organically, the growth was actually slightly higher than in Q2. Acquisitions, overall, in the first 9 months added 3.4% of growth. This represents the net impact of the bolt-on acquisitions we have consummated in 2021 as well as in early 2022, and also the divestment of the corrosion protection business in Germany at the end of Q1. Currency effects year-to-date are minus 1.9 percentage points negative and FX headwinds have increased in Q3, and this negative currency development is primarily related to the weak euro and the British pound, while the U.S. dollar strengthened over the course of the year. Sales growth in Swiss franc as a result was a solid 16.6% in the first 9 months. Moving to the regions. Region EMEA grew 10.5% at constant currencies. Organic growth was slightly higher, 11.3%, while the divestment of the Corrosion Protection business had a negative scope impact of 0.8%. After a strong growth of the distribution business in 2021, which includes sales via home improvement, stores, builders merchants but also online platforms, the last 2 quarters saw a clear volume decline in Europe, while the project business driven by economic support programs and new investments in energy infrastructure was more robust and so only a small volume decline. By contrast, growth in Africa and the Middle East was dynamic at double-digit rates. Foreign exchange effects also in this region were quite negative with minus 6.5% year-to-date. Region Americas recorded a very strong growth of 31.9%. Key revenue generators were infrastructure projects, and high demand also came from investments in commercial construction, such as stadiums, warehouses and data centers as well as near-shoring activities. In Latin America, growth was particularly pronounced in Colombia and Mexico. Acquisition growth, driven by several bolt-on acquisitions in the last 18 months, contributed a further 6.8 percentage points of growth, and foreign exchange effects here were positive with a positive impact of 4.9 percentage points. Sales in Asia/Pacific increased by 17.6%. In China, it was particularly the distribution business, which saw ongoing strong growth momentum, recording double-digit growth rates, while the project business was impacted by additional COVID-19 lockdowns. Nevertheless, in totality, Sika continues to record double-digit growth in China. Business in India also grew dynamically whereas growth in the Southeast Asia picked up notably in Q3 and marked a double-digit growth in the first 9 months. Acquisition contributed 7.1 percentage points of growth, while foreign exchange impacts were virtually flat or slightly negative at 0.3%. Finally, growth in Global Business accelerated further in Q3 and posted in the first 9 months a growth of 22%, supported by solid demand for new vehicles and a normalization of the supply chain. And once again, Sika's growth was clearly above [indiscernible] rate growth. Acquisitions also contributed here with 5.9 percentage points of growth, while foreign exchange impacts remain negative at 1.8 percentage points. On gross result level, material margins contracted by 330 basis points to 49.3%. This is down from the previous year of 52.6%, but with a used GAAP of 210 basis points in Q3 and Q3 material margin in isolation with 49.1% was slightly higher than in Q2 where we recorded 48.9%. Pricing impact in the first 9 months was about 15% and is now clearly overcompensating absolute year-to-date raw material cost increases, while relative material margin in percent still decreased year-to-date due to the base effect related to the strong pricing component. Dilution from acquisitions accounted for 30 basis points on a material level, while ongoing formulation and other efficiency initiatives contributed positively. Operating costs, which include both personnel costs as well as other operating expenses, developed strongly on the proportionally on the personnel cost side, an increase of 7.1% compared to a top line growth of 16.6% was under-proportional due to a solid operating leverage and contained personnel cost increases. Other operating expenses increased by 5%, supported by a gain resulting from the divestment of the corrosion protection business that was negatively affected by expenses in connection with the acquisition of MBCC Group, with a positive net impact of CHF 129 million. This effect in the first half year was a positive CHF 140 million. Contribution of the many operational efficiency project continues to be in line with the target of 50 basis points of profit improvement acquired logistics and travel costs, particularly as well as initial impact from the recently consummated bolt-on acquisitions weighed negatively. Overall, EBITDA growth in the first 9 months was 14.6% and an EBITDA ratio of 19%. This compares to 19.3% in the first 9 months of the previous year period. With CapEx modestly above the depreciation rate and the higher intangible amortization due to acquisitions, depreciation and amortization expenses increased by about CHF [ 16 million ] in absolute terms to CHF 290 million, but under proportionally to sales growth, providing further leverage. As a result, EBIT increased slightly over-proportionately by 16.8% to CHF 1,231.5 billion and an EBIT ratio of 15.4% of net sales. If we look at EBIT development on a like-for-like basis, EBIT in percent of net sales is 80 basis points below previous year in the first 9 months, but this gap reduced notably in Q3, where it came down to 30 basis points only. In looking below the EBIT line, net interest expense increased by 8.5% compared to the same period of last year. The increase is related to the bridge facility for the MBCC acquisition. Other financial expenses increased by about CHF 40 million to roughly CHF [ 21 million ] in the first 9 months of 2022, primarily due to higher hedging costs and hyperinflation accounting impacts. Group tax rate in the first 9 months of 2022 remained flat versus previous year at 24.6%. And on net profit level, the increase was 15.8% to CHF 885.9 million or 11.1% of net sales, also at par with the previous year ratio. In addition, cash generation in Q3 stepped up significantly, due to focused net working capital management with Q3 operating free cash flow CHF [ 90 million ] previous year and the year-to-date operating free cash flow totaling CHF 422 million. This reducing reported net debt to EBITDA ratio to about 1.2x on a 12-month rolling basis. With this, I conclude my remarks and hand back to Thomas for the outlook.

Thank you. Adrian -- maybe I already provided the outlook in my introduction. So I repeat myself, we see a strong finish to the year, in line with what we have communicated at the Capital Markets Day, providing a growth level of about 15% in local currency for the full year and an over-proportional EBITDA result for the full year, in line with our strategic targets of the strategy '23. In addition, as also mentioned before, we are confident to achieve the targeted closing of the MBCC transaction in the first half of 2023, and we will report more on that once we have the verifications from the authorities.

We're good. I think we are now ready to take your questions. We are opening the line, please.

[Operator Instructions] The first question comes from Roger Paul from BNB Paribas. .

It's actually Paul Roger from Exane. I'll start with 2, if I may. The first question is on pricing. I mean I appreciate the advantage that prices never go down in the industry. But I guess we've never really seen them go up 15% in the year before. So my question is how confident are you that you can keep any tailwind from lower raw materials costs next year and that pricing will still be sticky, even in places like EMEA if demand gets a bit weaker? My second question is, Adrian, you mentioned a strong working capital performance in Q3. I wonder to what extent there was some destocking that could have affected your gross margin if you're pulling through any expense of inventory? And if that is the case, do you expect a similar dynamic to get in Q4?

Okay. I'm going to answer your first question on the pricing. The 15%, as you mentioned, this is clearly quite remarkable and hasn't been, let's say, a topic in the last 10 or 20 years, but it has had been mandatory by the evolution of the input costs. And it's correct. Some of the input costs may see some relaxation in the future. But at the same time, we have still a lot of uncertainty in the markets, which are also quite valuable to our customers. I mean the supply chain disruptions, the same source that we provide our global footprint that is leveraging, let's say, challenges in the market are valuable topics, which makes us confident that in the pricing discipline, we can stay strong and avoid that there is a linearity between certain input costs and the overall pricing that we apply. . So here, it's clearly visible that there is no normalization overall. We have inflationary components. We have energy, labor, inflation costs, so there will be multiple elements. And at the same time, our customers value our products, not just for the product itself, but also for the robustness of our supply innovation and also the possibility to leverage our position in the market.

And Paul, here on the second question, on working capital, there is a very sort of limited negative impact here on, let's say, the P&L through these measures. On the one hand, it's really maintaining here the discipline, and obviously, in an environment with, let's say, increasing input cost and also strong top line there is obviously an absolute buildup of working capital. We're very much focused on containing and reducing this. And on the inventory side, it's really sort of regaining efficiency, which has been impacted by, let's say, the supply chain disruptions during the last 12 months and leading to longer lead times leading to a bit more safety stock and also sometimes having not the right material on stock. So this is being worked through and being focused on specifically with a positive impact here on net working capital development, but less so and probably to the contrary on the P&L side.

The next question comes from Rall Elodie from JPMorgan.

So my 2 question will be, first of all, on gross margin, if I may ask. So we've seen an improvement indeed in Q3 at 49.1% versus Q2 at 48.9%. But I think expectations are for gross margin to reach around 52% in Q4. Do you think that's achievable? Or where do you think you could land in Q4 gross margin, please? And my second question is a follow-up on margin as well with regards to the time to the trading margin at 14.2% in Q3. What would you expect for Q4? And when should we expect to get back to the 15% lower end of the target range?

Yes. Thanks, Elodie, for the questions. And clearly, and I think what is important is having sort of reached its inflection point in terms of material margin trend. And I think what I believe were actually here on quite a good track now on the pricing side and with, let's say, input cost just about having plateaued towards the end here of the quarter. I mean we must not forget that with, let's say, a 15% pricing the mathematical impact on the material margin would be around 750 basis points if we were just passing on input cost increases in absolute terms. So here, we have made quite some good progress and the expectation is that we will now continue to improve material margin sequentially. Will we be reaching 52% in Q4, I don't think so, but the target is clearly to get above previous year and further and further up. Also, when you look at, let's say, the EBIT margin, you have mentioned the 14.2% I mean on EBIT level, we have clearly, here reduced the gap to previous year quarter-on-quarter, also in terms of like-for-like, comparison as I have mentioned that before. And here, the target, and here, we feel quite confident that in Q4 the isolated EBIT margin will be above the 14.2% we achieved last year or 14.1% or beyond, actually.

The next question comes from Matthias Pfeifenberger from Deutsche Bank. .

Maybe on the volumes, could you share some light on European volumes in the third quarter? Is it like down 3% to 5%? And can you remind us of the pricing base in Q3 and Q4. Did you already raised prices in Q3 and Q4 last year? And then also on 2023, can you confirm the margin flow at 15%? And while you strip out the integration cost of something like CHF 80 million next year? Or will that be digested in the operating figures?

Yes. On pricing, year-to-date, the 15% in the first half year was around 14%. So we have increased that further against here, clearly, an increasing pricing trend in the previous year. So as I mentioned, I made very good progress here on that front, and we also continue to increase prices in some of the areas, particularly where we continue to see increasing raw material cost. I mean there is clearly still areas where we see this. On European volumes, here, we have to make or on the volumes, we have to make a distinction here clearly in the Middle East and Africa continued strong growth in Europe itself, we have particularly a volume decline in the distribution channel, whereas, as mentioned, the direct in size, the project business is much less affected. But in Europe, itself and volume declines in Q3 have been high single digit. But here that the situation has not been very different to, let's say, the majority of Q2.

Okay. And then just a follow-up on the guidance. You said basically you're better than 14.1% in Q4 last year in the fourth quarter. But that obviously is a bit contradicts a bit with your guidance of disproportionate EBIT growth. So what do you regard as over-proportional EBIT growth? Is it 16% when top line is 15%. I mean in our ball park it's over-proportionate means, may be, I don't know, more than plus 5% in terms of growth outperformance versus the top line.

Well, in our clearly over-proportional means over-proportional. For last year, we had a 15.0% EBIT. So anything above that. And I think it is a bit speculation at this point by how much this is going to be. But this is and remains our guidance, and we remain also confident that we will achieve this.

The next question comes from Priyal Woolf from Jefferies.

I've just got 2. The first one is -- with regards to the distribution channel, obviously, you've been increasing your exposure to this since you acquired Parex in 2019. Do you get a sense that within that channel, there is a buildup of inventory at all? And therefore, do you see any risk of destocking impacting your volumes going forward in any particular regions or products? And then the second question is just a quick follow-up on the gross margin. If there aren't any huge surprises to raw materials going forward and you put through the price increases you plan on putting through. When do you think it's reasonable to get back into that usual 54% to 55% range?

Well, thanks, Priyal for these questions. On the distribution channel, I mean, there is no, let's say, significant destocking typically just given also the, let's say, the sheer volumes. Also when you look at, let's say, distribution in itself and with the various sub channels, there is quite different developments. I mean we have here the volume topic clearly in Europe, whereas in other areas, it is the opposite or a lot less pronounced. It is clear that particularly due to COVID, there has been a very strong growth of let's say, products typically going to these channels or applications where obviously, now there's sort of a partial normalization taking place. But here, the destocking effects on our business, on our volumes if anything is very small or temporary. Now obviously, the question regarding, let's say, long term or what I'd say, midterm relative gross margins over here, that is a difficult question to answer. It will certainly not happen next year. But due to this effect, due to this mathematical effect now having basically lifted the base quite strongly, and obviously, there can be sort of a longer time until we move back depending on also how, let's say, overall prices and input costs move. But I think it is clearly more important that's how we steer the business to basically continue to increase again material margin and particularly then on the bottom line, drive over-proportional EBIT growth.

The next question comes from Manish Beria from Societe Generale. .

So yes. So my question is like, so what is the outlook? I mean, on the volume for next year. So could Sika be very resilient like having like flattish sort of volume? Or you see, I mean, sort of a decline like low single digit, mid-single digit?

Thank you for the question. And this is, of course, a bit speculative. We don't expect that next year will be back to normal. So we have many elements that will drag on into next year, that's very clear. But at the same time, there are let's say, upside and downside potentials everywhere. I think China, for instance, is a very important market. I would be slightly positive that after this difficult COVID times that there will be a relaxation and also some recovery of that market. The Americas has a strong momentum. We don't see any good reason why that would stop [ approval ], but it could soften eventually. And so there are elements in Europe with the war that is unpredictable how it will further move. So here, there are many, many elements that may play a role in how it goes. But I would say refraining from providing any specific guidance. The guidance that I would clearly make is whatever the conditions are, our aspiration and our performance shall be measured against the local environment and the local mode of operation. And if there is a negative volume, we want to be better than that, equalizing, flattening that. We have a resilient strategy. We have a strong portfolio. We have all these countries that are doing extremely well, and we have companies that have challenges or countries that have challenges, so to say. So it is too early to provide a guidance. But whatever comes our aspiration is to outperform and stay within our long-term performance goals that the 2023 is outlining.

And I have a follow-up also here, the second question. If you look at the other OpEx line, just removing the personnel, just the other OpEx line that you report, I mean. So if you look at it, I mean, Q3 level also the first half if you exclude all the exceptionals, it was growing like double digit, I mean. So just trying to understand like because you have a strategy of, I mean, some synergies plus also, I mean, underperforming -- under-proportional growth like getting 30 basis point expansion each year by cost cutting or operational synergies and things like that. But that's not working out here in the exact sense, I mean, so it's a double digit, I mean, 10%. So what's the reason for that? And also, what is the outlook, like next year also could be a good inflation year for this other OpEx line? .

Yes. On the other OpEx line, whilst it is double digit, it is clearly below top line. But it is also clear that some of the inflationary areas when we think about, let's say, logistics costs when you also think about the energy costs, although this is a relatively small item in our case, but also, let's say, travel cost, having come back to normal levels. This is an element of, let's say, cost inflation there, which at least partially will be on, let's say, the right basis again at year-end. And this is also an area where we put some pricing elements in form of surcharges out. So this has also to be seen in that context. And clearly, going forward, there will be a continuation of this improvement, particularly driven through these operational efficiency projects, which will continue to keep other OpEx development below the top line development. .

Okay. And the last one, like the gross margins in Q4 will be flat Y-o-Y or not?

You mean Q4 compared to previous year or now compared to Q3?

Previous year.

To previous year. Here, clearly, the ambition is to move that above previous year level. .

The next question comes from Martin Flueckiger from Kepler Cheuvreux. .

Yes. First one is coming back to the EMEA volume issue as you've named it. My understanding from your elaborations, I can't remember now whether it was Adrian or Thomas, to be honest, but was that project business was also slightly down. Was that a misunderstanding on my part? Or was that the case? And particularly, I'm wondering about changes in momentum versus Q2 on the project business side, leaving distribution aside for a minute. What are we seeing there? Are we seeing further slowdown, stable growth project business. What's happening there? That's my first question. I'll come back to the second one in a minute. .

Yes. On the project business, yes, there was a slight volume decline. Obviously, there is very different market here within Europe, for example, one being affected is the U.K. In terms of, let's say, sequential development, there is on the project side, probably a small negative development compared to Q2, but not in a major way. .

Okay. And what does your project pipeline look like for EMEA over the next 6 to 9 months? What does that tell you? Is it a further slowdown or what's on the cards here? .

Well, the pipeline actually looks quite solid. And we also have to see that, obviously, many of, let's say, the sort of the [ same ] measures, particularly also related to sustainability aspects have not really taken a strong foothold yet. But on the, let's say, infrastructure side, there is many good projects coming. So the pipeline doesn't look worrying. .

Okay. And just on the pricing -- okay. The way I understood it is that you had about 14% of H1, about 15% for the 9-month period. Now we've got an increasingly challenging comparison base, right, in Q4, if I remember correctly from last year. Do you expect that number, that 15% number for the 9-month period to be lower in Q4? Or do we -- numerically, are we going to see further acceleration? .

Yes. I don't think we will see an acceleration. And you're right, particularly Q4 last year, there was clearly also more pricing impact than in the part before that of last year. So whilst the overall prices will continue to go up at least slightly, and on a year-on-year basis, there is more of a flattening or possibly even a small negative effect. But there is clearly -- well, unrealistically going to be an acceleration on the pricing side. .

Okay. When you say negative effect, you mean slightly lower than Q3?

Just, let's say, for the full year and obviously, the curve was much steeper last year in Q4.

Okay. That's helpful. Just my final one, please. The tax rate is a bit volatile as we go into Q4, at least, historically. It's actually been the case in 2020 and '21. Just wondering what we need to -- what we should pencil in, in terms of tax rate assumption for Q4 and for the full year? .

Yes. I mean you're, of course, right that the tax rate, per se, in particularly Q4, there is a certain volatility typically. I would say the full year tax rate should be, let's say, at the similar level of the previous year, obviously, give or take, some base points. But I don't foresee sort of a meaningfully different development. .

Right. So 21.5.

That was the last year's rate. So yes, around there.

Next question comes from Cedar Ekblom from Morgan Stanley. .

Just one question on the global business. That business has seen a lot of margin compression over the last couple of years. And it was clearly a strong improver in the third quarter. Can you talk about how we see the margin in that business developing over the next 18 months or so? And if there's any reason why we shouldn't be able to get back up to the sort of 16%, 17% EBIT margins that we saw in that business a couple of years ago. .