Sika AG (SIKA) Earnings Call Transcript & Summary

Thank you, Sandra, and good afternoon, and welcome to our 9 months results conference call. Present on the call with me today is Thomas Hasler CEO; Adrian Widmer, CFO; and Christine Kukan, Head of IR. We published our 9 months figures this morning at 5:00. The 9 months presentation is as well published on our website. With this, Thomas Hasler and Adrian Widmer will provide further details on the results and the outlook. Afterwards, we will be ready to take your questions. I hand now over to Thomas to start with the highlights of this 9 months.

Thank you, Dominik, and good afternoon to our 9 months results call from my side. In summary, Sika performed very strong in a very challenging economical environment and geopolitical distress. It is a 9-month result that needs a few explanations as we have the reported numbers and underlying business evolution, which we will present in the coming 45 minutes. We reported an increase in net sales of 5.6% in Swiss francs. The heavy impact from the currency appreciation because our local currency growth is 12.4%. The vast majority of our growth comes from acquisition, 11.1% in local currency. So that leaves 1.3% on the organic side. The organic side has strongly come back from a weak start into the year, and we have momentum going forward. This gives us confidence also going into the Q4 and into next year. On the material margin, which has been and still remains a strong target for us to reestablish our corridor of 54% to 55%, we achieved 53.1% in the first 9 months, a strong recovery considering last year's level of 49.3%. On the reported EBIT margin of 13.5%, which is lower than prior year, we have to consider in there also the onetime effects. So if you take the onetime effects out, our underlying EBIT margin is at 14.8%, which again is 100 basis points higher than prior year. Here, Adrian will go into the details guiding you through this. For me, it's very important that the underlying organic business is going and moving in the right direction. As an indication for this, our Q3 performance is the strongest Q3 or strongest quarter ever on absolute numbers in profitability but it is also one of the strongest ever achieved in Sika's history. It's 24.3% higher than Q3 2022. And it is a quarter where we had little impact from one time. So it is a much more transparent comparison of the going rate of Sika given all the great, let's say, achievements in the first 9 months with MBCC now being closed, but at the same time, of course, also having then onetime effects into our reported EBIT. This leads me also to the biggest highlights of 2023, which is the successful closing of the MBCC transaction in the beginning of May. And since then, the very positive momentum we have seen across the globe, which also reconfirmed our strong positive synergy momentum allowed us also to increase the Capital Market Day, our expectation from the synergies now being at CHF 180 million to CHF 200 million from the former CHF 160 million to CHF 180 million. This clearly is the highlight, and it's also probably the momentum where the company now is gaining traction every day as we advance in the integration. And we will come back to that also from Adrian side in regards to how this momentum will contribute into the future performance. We did also other acquisitions, Thiessen Team in July and Chema in August, important additions to the concrete business in North America or to the local business in Peru, a strong market where we now have more opportunities, almost doubling our presence in the distribution market. Again, one of the typical bolt-on transactions that we stand for and that we are aiming also to continue in the future. Organically, we further invest in India. India is one of the hotspots. We have double-digit growth in India. India, we also foresee in the coming period in the coming years that with all the infrastructure activity, India is the place to be and we added just in time another plant to our footprint in India, which now is up to 12 factories all across the continent. We also reinforced our business in the U.S., the Chattanooga plant, which is producing fibers for the for the concrete business. So all in all, a very eventful 9 months, challenges from the outside which we tackle, which we turn into opportunities. And from the inside, the integration of MBCC and the expansion of our footprint all in line with our strategy which, by the way, we also then reported beginning of October, not exactly within the 9 months, but certainly, another highlight, which is indicating our confidence into the future, into the next 5 years with the elevated growth expectation. And again, with the new EBITDA target range of 20% to 23%, which we aim starting to implement beginning of next year into the new strategy period. With that, I would close the introduction and hand over to Adrian to go and give some more details on the business.

Very good. And well, thank you, Thomas here for the highlights. Good afternoon, good morning to all of you here listening in. I will talk a bit more about the earlier composition of our growth also in the regions and provide further insights into the financial results. We have heard it. We're currently operating in quite a challenging environment. We have been able to deliver local currency growth of 12.4% in the first 9 months of the year, which is strongly driven by the position of MBCC and includes 5 months of the MBCC results. Organic growth was 1.3% for the first 9 months. If you look at Q3 in isolation, these are 2.5% organic growth in spite of 1 working day less. And so clearly here also a notch up in the right direction. Acquisitions almost entirely related to MBCC added 11.1% of additional growth in the period in the first 9 months. Currency effects continue to be very significantly negative and also here, even picked up a notch in Q3 reducing local currency growth by 6.8 percentage points with a corresponding Swiss franc growth of 5.6%. And here, negative currency effects are across the board but primarily driven by the main currencies, the U.S. dollar, the euro, the Japanese yen and also the RMB as well as generally a high inflation environment in many of the emerging markets. When we look at the regional growth, here, all regions delivered double-digit growth in the first 9 months and all with the exception of Global Business benefited from the acquisition of MBCC. Region EMEA grew 10.6% at constant currencies. Here, organic growth was minus 2.2%. Although growth in volume development showed a further improving trend in Q3. And the Middle East posted very strong growth and also Europe sales showed a very solid development in Q3 and a further improvement, while Northern Europe and the dark area remained subdued. MBCC added 12.8% of growth in the EMEA region and the foreign exchange effect was minus 5.8%. Region Americas, Region Americas recorded a growth of 14% also here heavily driven by MBCC. Business in North America was negatively influenced by rising inflation and increasing interest rate environment, but also by destocking in the roofing sector in the first half of the year. Key growth supported were infrastructure projects and ongoing reshoring activities. Most markets in Latin America showed a solid growth and acquisition contributed 13.9% of growth. And here also, foreign exchange effects heavily negative, which reduced Swiss franc growth by [ minus ] 6.2%. Sales in Asia Pacific increased by 13.5% as organic growth in Q3 remained solid, particularly the distribution business in China recorded double-digit growth while project activity saw a slight decline. We have heard about India, double-digit growth, while Japan is showing an improving trend in Q3. MBCC here contributed 8.1 points of growth on top of a solid organic growth of 5.4%. And in the Asia Pacific region, foreign exchange impact is the most negative one with minus 10.2%, particularly due to the weak Japanese yen and the RMB. And finally, global business delivered 13.3% growth in the first 9 months, with underlying car build rate growth being positive on the back of solid demand for e-vehicles, but also supply chain normalization. Sika sales outgrew car build rate growth in spite of continued negative production volumes in the market for white goods, which is also included in the global business. And in addition, the strike in the U.S. automotive sector in September had a negative impact on growth. Also here, a negative FX impact of minus 5.1%. If we move down to P&L, we have heard it. We have delivered a very strong and significant increase of the material margin with a gross result expanding by 380 basis points to 53.1%, up from 49.3% in the first 9 months of the previous year. Also quarter-on-quarter, Q3 marked a further expansion of the material margin. And solid pricing in combination with a continued decline of raw material input cost but also ongoing structural saving initiatives led to this significant expansion. As you can see in the EBIT bridge provided as part of the 9 months presentation, there was a small dilutionary effect coming from short-term PPA effects relating to MBCC, 15 basis points of impact as well as initial procurement synergies included in the synergy bucket in the MBCC. Reported operating costs, which includes both personnel costs as well as other operating expenses, developed over proportionally but include a significant one-off related M&A cost, all reported in the other operating expense line. Also here, I will allude a bit in more detail later on. Just in looking at personnel cost, here an increase by 12.8% versus the top line growth of 5.6% with the acquisition of MBCC as the main contributor while organic headcount development was slightly negative, but wage inflation accounted for about a 5% personnel cost increase on a like-for-like basis, leading to a negative cost leverage. And other operating expenses increased significantly, but as mentioned, were impacted by an extraordinary onetime profit last year, resulting from the divestment of the Corrosion Protection business, while last year's expenses in connection with the MBCC acquisition were relatively moderate, but in combination resulted in a positive net impact of CHF 129 million in the first 9 months of 2022. This will be recorded in other operating expenses. On the other hand, this year, we had onetime costs related to the acquisition and integration of MBCC of CHF 105 million with a similar negative impact. Excluding these items, other operating costs increased by 13.1% driven MBCC but also due to higher energy cost and modestly higher marketing and travel costs as we maintain a high level of customer engagements and market-facing activities. If you look at nonmaterial cost and the negative cost leverage there of minus 210 basis points. This is an improvement of 20 basis points versus the first half year, and is more than 60% inflation-driven. Depreciation and amortization expense increased by CHF 68 million in absolute terms to CHF 358 million or 4.2% of net sales primarily due to MBCC and additional intangible amortization in the first 5 months since closing. This corresponds to an MBCC amortization expense impact of about CHF 100 million on a 12 months basis. As a result, reported EBIT decreased by 7% to CHF 1.145 billion down from CHF 1.232 billion and an EBIT ratio of 13.5%. As mentioned, reported EBIT for Q3 in isolation, however, increased by a strong 24.3% to [CHF 484.4] million. If we exclude the above-mentioned onetime costs related to the acquisition and integration of MBCC as well as the gain last year, year-to-date EBIT margin increased significantly by 100 basis points from 13.8% in the previous year period to 14.8% this year or by CHF 150 million in absolute terms. And on a pure like-for-like basis, basically the organic development here, EBIT as a percentage of net sales increased by 170 basis points to an underlying EBIT margin of 15.5%. Also here, I make reference to the provided bridge. Looking below the EBIT line, net interest expense also increased significantly by [ CHF 53 ] million compared to the same period of last year to CHF [ 87.7 ] million. The increase is largely related to the refinancing of the MBCC acquisition, the 3 bond issuance in November '22 as well as in March and May of this year. On the other financial expense line, also here an increase by CHF 59 million to CHF 80 million in the first 9 months of '23 here primarily due to the impact of an hyperinflation accounting and higher hedging costs, which are driven by the increase in interest differential and higher foreign exchange volatility. Looking at the tax rate. Here, the group tax rate remained at the same level, 24.9%. And was positively impacted by a goodwill amortization benefit resulting from the MBCC transaction in the amount of CHF 90 million. This CHF 90 million was booked in quarter 3. As a result, net profit decreased by 16.9% to CHF 736.5 million. This is down from the previous year level, but a clear improvement versus the first 6 months of the year also on that line. Turning to cash flow. Here, operating free cash flow developed very, very strongly with a significant increase compared to the same period of last year. In the first 9 months, we delivered CHF 877 million in operating free cash flow, which is more than double the amount of the previous year period and here focused working capital management, lower inventory valuations and levels as well as the normalization of the supply chain in general were the main contributors as well as a positive cash effect relating to intercompany financing and hedging activities. This strong cash generation as well as the early conversion of the outstanding convertible bond that was concluded in September led to a strongly reduced net debt to EBITDA ratio of 3.0x on a reported basis. This is down from 4.1x in June this year. And with this, I conclude my remarks and hand back to Thomas for the outlook.

Thank you, Adrian. On the outlook, which is real confirmation of what we also presented at the Capital Markets Day. We expect our sales in local currency to exceed 15%. This is including the MBCC top line aspect as well as an over proportional increase in EBIT, excluding the MBCC acquisition, which I consider the organic performance of the company. In addition to that, the operating free cash flow will be in the range of the midterm target of the strategy, which means above 10%. That's our expectation for the fiscal year '23 going into Q4 and into the finish of the year. With that, we would now open up for questions.

[Operator Instructions] First question comes from Arnaud Lehmann from Bank of America.

I have 2 questions, please. Firstly, on the Q3 organic growth, as you mentioned, was a little bit better to 2.5% on my estimates. We know that the base effect is going to get easier in the fourth quarter because the volume started to slow down in Q4 2022. So I guess, assuming, we keep the same run rate into the fourth quarter, do you expect an acceleration of the organic growth on a year-on-year basis? That's my first question. And within that, what are the moving parts in terms of the volumes and the pricing, that would be helpful. And secondly, we have seen kind of raw materials, in particular, oil prices moving higher. Could you give us an indication of the implications for your material expenses and whether that is driving you to consider new price increase maybe for January next year.

Okay. Thank you, Arnaud. What makes me feel confident also not only in Q4 but going forward is the organic growth. It's -- as you mentioned, it's, of course, a combination of price and volume. And here, when you look into the evolution for -- from Q1 into Q3 and then also a bit in continuation in Q4 and into next year. It's very obvious that the high impact from the price is coming constantly down and is going back into a range, which we would almost say is a normal price adjustment year-over-year. So this is good in a way that it doesn't distort let's say, the volume aspect, which I see as a more relevant factor. And here, when we consider that we started into Q1 with double-digit negative volume in EMEA, in particular, but also the other regions with exception of Global Business had negative volume. This has shaped over the course of the year in the right direction. Still leading to negative overall, but now we are at the level of the volume where we can say that all our reporting regions have a positive trend. And overall, when I look at our largest region, EMEA, we see that here there's a good probability that we will come back into positive volume driven by, especially, let's say, our distribution business in the Europe South, in Spain, in France, in Portugal, in the U.K. So I think, yes, it's also a relatively weak prior year quarter ahead of us. But overall, the progression and the momentum, especially on the volume is giving us confidence also to finish the year and also to start next year strong. On the raw material side, it's correct. It's less maybe dependent on the oil. I think the oil hasn't, let's say, peaked or changed even so the Middle East even were a risk in this regard. But the raw materials overall are having seen and let's say, adjustments downward are now leveling and there's a deep capacitation visible upstream to respond to a weaker demand. Therefore, the price in general are leveling or starting to pick up again. And here then, we have also some outliers that are constantly going up. And cement as a good example is a raw material significant to us that has seen quite strong increases in the past 12 months, and this is going to continue, which, to answer your question, of course, together with other inflationary elements on the nonmaterial side is going to influence our pricing going forward. But as mentioned before, probably more within normal terms of price adjustments and not the huge adjustments we have seen in the past 18 months, which were mandated by the special situation we had on the input cost side.

The next question comes from Cedar Ekblom from Morgan Stanley.

I've got a question on the antitrust inspection that happened earlier this week. I don't know if you'd be willing to comment on that. And also maybe give us a bit of an understanding on the percentage of revenues that might have been inspected. And also if this was just an inspection for European assets or if it included any of your U.S. assets? And then secondly, on the gross margin, I think the recovery has been much faster than expected or at least my expectations. On your comments on sort of raw materials now maybe starting to find a level. Should we assume that most of that gross margin recovery is done and not to expect too much more from here into the end of '23 or is there a potential for a little bit more gross margin recovery to come through?

Okay. Thank you, Cedar. And I take the first question on the antitrust investigation. I can confirm that the antitrust authorities in the EU, in the U.K. as well as in Turkey and in the U.S. have started an investigation into the concrete admixture market. This is an investigation across the whole industry. And we are here with highest, let's say, interest, active to collaborate and to investigate this investigation. This is a lengthy investigation. We just started. We cannot comment on the progression. But I would say it's, for us, very important that this business is acting behaviorally in line and fair with the regulations. And Sika has a strong compliance structure and 0 tolerance policy in place. So here, this is an investigation we fully support. It is an investigation which will take time. And I cannot go further in details, other than, I can confirm that some of our premises in Europe and in Turkey have been visited. And this is an ongoing investigation.

Maybe secondly, here on your question regarding material margin and further evolution maybe a few comments here. Yes, obviously, input raw material cost development has an impact where we see as just commented by Thomas is sort of a flattening curve now. We also had, obviously, the lowest in the Q margin in the third quarter last year. So here in comparison, let's say, the improvement is getting, I would say, smaller. On top of this, we typically have seasonality in Q4 where you cannot just, let's say, extrapolate. In terms of a trend, we would expect or, let's say, in terms of seasonality, we would typically expect lower material margin in Q4. I think the underlying trend, I think it is a continuation where I think it will be relatively similar in Q4 compared to Q3, but obviously, many sort of elements still being a bit volatile in this area. But I would not foresee, let's say, a significant year further increase in Q4 given the, let's say, the time of year.

Just a follow-up, Thomas, on the antitrust issue. I don't know if you can talk about to what period this relates to? And if there is anything to say about the culture at MBCC, which might have been a bit different to Sika's culture on zero tolerance. And if there is any risks that you might have now inherited, which we need to think about, basically ahead of you buying that business as you know -- couple of -- yes, go ahead, sorry.

Yes. I can't go into details, but I can answer your question in regards to MBCC. MBCC, since we have now 5 months behind us, but also has to be expected with the long, let's say, ownership of BASF as a very strong compliance culture and it is very similar to ours. There's zero tolerance policy in place, and this is constantly, let's say, conveyed and trained across the organization, and it is much too early to come to conclusion. The whole industry is checked and revised and the outcome will take some time to have conclusions there, but we have confidence -- confident that our approach to these requirements is strong and good, but the investigations are ongoing. And then maybe just Cedar, to add to this that the MBCC business in Europe has been sold to Cinven as well as the MBCC admixture business in North America. So that's not part of our business today.

The next question comes from Yassine Touahri On Field Investment Research.

Yes. Maybe a question on the -- your scope effect, I think in the previous conference call, you were suggesting like you would expect a scope impact of close to CHF 1.4 billion in 2023. Is it still the case? . And how much would come from MBCC and how much would come from your -- the bolt-on acquisition that you've done over the past 12 months? That would be my first question. And then a second question on the volume development. You talked a little bit about Europe. In the U.S., it looks like the volumes were a little bit weak. Do you see a recovery in the fourth quarter? And in Asia, we are hearing a lot of negative news about the Chinese economy. Do you feel you can continue to outperform? Or do you think that there could be a little bit of a slowdown in our activity in the coming quarter?

And Yassine, I'll take the first one, not quite sure whether I understood it correct. You were referring to, let's say, '23. What is sort of the acquisition impact? Is it entirely MBCC or is there additional acquisition impact, if that's the question.

Yes, that's correct. And I think you gave a number of CHF 1.4 billion last quarter. And I just wanted to know if it's like still the order of magnitude is still the same.

Yes. Broadly, yes. Obviously, here, it is a number which is also impacted by, let's say, foreign exchange. I mean, we consolidated actual rates. So to the extent, currencies move. There may be a certain impact on that overall number. But I can confirm that less the acquisition impact this year will be by and large MBCC. And it -- let's say, the other bolt-ons in terms of impact will be less than 0.5 percentage point.

And next year, the bolt-on that you've done, would you expect also the same order of magnitude like 0.5 percentage points based on what you've done?

Yes, the one that are done, that's roughly the level, yes.

Okay. And then Yassine, to the volumes of the Americas, here, dissimilar to EMEA, we haven't started with, let's say, a double-digit negative volume into the year. But rather with a higher single-digit number. But this number is more constant than in EMEA and remains negative also over the course of the year. And therefore, where we have seen a much, let's say, stronger improvement from double-digit negative into single into low single digit in EMEA, the Americas is more, let's say, Brazilian in the negative midrange volume pattern. And therefore, initially, we have seen especially in the U.S. some destocking elements that were driving this, but we also see here some more, let's say, inflation and interest cost driven elements that faster recovery are probably hindering. So that's a bit the difference between EMEA and the Americas. Asia Pacific actually is constantly getting better with positive volumes from the beginning of the year, being still slightly negative, but moving after Q1 after China came back at least to levels that were providing volume growth and keep this positive volume growth also in Q3, and we expect also in Q4 that we will see nice volume growth in Asia Pacific. And here, it's not only China that is relevant, but India is very relevant. Also Japan has a positive trend. Even so, let's say the economy is stagnating. We have there a nice, I would say, momentum to play on. And then Southeast Asia with the exception of Vietnam, is also very strong on the volume side.

The next question comes from Yves Brian Bromehead from Societe Generale.

I just wanted to come back to a few questions and add a bit of clarity, if you could. Just coming back to the antitrust. Can you confirm that the Concrete technology division is about 15% of sales. And therefore, U.S. and Europe is probably the bulk of it. And also on that point, do you inherit from any wrongdoings of MBCC, or can this be tied back to BASF. That's my first question. Maybe my second question, coming back on the raw materials. You talked about flattening of raw materials. Just wanted to make sure I get this right. But are we talking about a flat curve sequentially from the current levels? Or are we talking year-on-year. Just want to make that clear. And last but not least, maybe last question on wage inflation for next year. What should we have in mind on a like-for-like basis? And can you offset some of that with cost savings?