Skellerup Holdings Limited (SKL) Earnings Call Transcript & Summary

Okay. Good morning, everyone. Welcome to our presentation on Skellerup's FY '23 results. Before we start, you will note David is absent today. A family member had a reasonably short notice but planned medical procedure yesterday, so David is in the right spot, supporting their recovery. I'm Graham Leaming, I'm the CFO of Skellerup. And in the absence of David, we also have John Strowger, Skellerup's Chairman with me on this call; along with Tim Runnalls, our Group Financial Controller. As per our normal mode, I'll talk to the slides that you'll see on the screen, and then there will be an opportunity for questions. [Operator Instructions] Okay. We'll move to Slide 2, titled 7 years earnings growth. This slide provides a clear visual of our performance over the past 7 years. EBIT and NPAT have both grown at a comp annual growth rate of 14%. The outcome of revenue growth, margin improvement from new products and operational improvements and good management of indirect costs. We do ensure we have the team to support both the current business and future growth. Moving to Slide 3 and the FY '23 highlights. The graphs on the right-hand side, the one at the top shows our impact for the group and at the bottom, the EBIT by division, excluding corporate costs. As reported earlier today, FY '23 impaired of $50.9 million was 7% above prior comparative period and represents our seventh consecutive record result. Notwithstanding the increase in FY '20 was very small. EBIT of $71.7 million was also up 7%, and both divisions achieved record results. I'll touch on the details of those more shortly. Operating cash flow of $54.1 million was up 25% on pcp. You will recall in FY '22, we increased inventory to mitigate the risks caused by the COVID-19 pandemic. It's good not to be talking so much about COVID-19 anymore. Inventory increased again in the first half of this year for the same reasons. However, as planned, we were able to unwind some of this investment in Q4, reflecting the easing of supply chain risks. Our strong cash flow funded CapEx requirements, dividends and the IFRS-16 lease payments, meaning net debt closed at a very similar level to the close of last year. Our final dividend of $0.14 per share has been declared to bring the full year dividend to $0.22 per share, up 7% and consistent with our earnings growth. And dividends continue to be 50% imputed, reflecting the proportion of our domestic and international earnings. Capital investment in FY '23 included a focus on enhancing operational flexibility, ensuring continued market access in the future and broadening technology. I'll discuss this further later in our presentation. We've also invested significant time on assessing the impact of climate change on our business. There is, of course, some mandatory reporting requirement for FY '24, but the broader benefit is to guide our investment decisions in the future. And again, I'll cover this more shortly. Moving to Slide 4 and this provides a little more detail on the key financials. A couple of points to note that I've not already covered are the higher finance costs in FY '23 due to the high level of debt we carried during the period and also, increased interest rates. But tax and a lower effective tax rate due to the deduction for the benefit received by executives on the exercise of the share options under the LTI offset this impact. I'll move to Slide 5, where we provide some granularity on how the various applications we sell products into performed in FY '23 compared to FY '22. The contribution from dairy increase, which may surprise given a generally tougher global market with lower milk prices. That serves to highlight that the demand for our largely essential consumable products has linked more to milk production than milk price. The lower NZ, U.S. dollar cross rate also assisted given 70% of our sales for the dairy application are made into international markets. The contribution from footwear grew strongly, reflecting growth in our key New Zealand and U.S. markets. A better product mix and the availability of inventory to meet demand, you may recall we were constrained with inventory in the preceding couple of years. Potable and wastewater was slightly down on the prior comparative period. Destocking and reduced demand impacted on a potable water related sales in the U.S. and China, but this was largely offset with growth into wastewater applications, particularly in the U.S. Roofing and construction earnings grew most significantly due to increased sales used in solar applications in the U.K. and Europe. We achieved further growth of sales and high-performance marine foam, and that was the key driver for growth in the sports and leisure applications. Corporate costs were lower in FY '23 due to lower employee compensation costs and interest costs were higher, as I noted on the previous slide. The New Zealand dollar against the U.S. dollar, being our key currency peer, was 10% lower on average in FY '23 compared to the prior period, which was generally a boost to our gross margin at a business unit and application level. However, the hedging arrangements we have in place largely offset this benefit, which is what you see with the read value or unfavorable effects on the chart. I'll move to Slide 6 and highlight some key elements of the Industrial Division results. Industrial Division EBIT was up, as shown, by 10% on prior period and a record result for the third consecutive year. Normalizing for constant currency comparison, EBIT was up 7%. Potable and wastewater is the largest application for this division. As I noted on the previous slide, the performance was flat or slightly down in FY '23. Destocking and lower demand for consumer linked products, like Techwear created a headwind that was offset by growth in sales of our vacuum systems used in wastewater applications. David has highlighted previously our customer focus on product improvements to deliver more value, and this approach continues to help us win market share in this market. As I noted on the previous slide, we've achieved growth in sales of U-Dek marine foam and also the products that we sell into roofing and construction applications. Moving to Slide 7 and Agri Division. EBIT was again a record, albeit a modest 1% improvement over the prior period. On a constant currency basis, it was slightly better with EBIT growth at 2%. As noted, dairy increased modestly with increased sales into the U.S.A. There is a trend towards longer life and higher value milking liners, which reduce the frequency of liner changes. The impact for Skellerup is lower volume but higher pricing to sustain revenue mean investing in and achieving productivity improvements has and will continue to be important for our business. Of note, in FY '23, we successfully relocated our Stevens milk filter business from Featherston to Christchurch. It's located in very close proximity to our dairy rubberware facility at Wigram, and it provides us with access to a larger pool of people and more robust transport route. Footwear, as noted previously, performed very strongly in FY '23. In New Zealand, we increased sales through the urban channels. We rationalized our range. And importantly, we're able to build inventory to meet demand. The pretty ordinary weather over the past 12 months will also have contributed. In the U.S., sales of our dielectric footwear, again, grew. And for those that don't recall, the dielectric footwear provides an insulation to protect against the risk of a live electric source. I'll move to Slide 8. To continue to deliver growth, we are investing in people and equipment to develop stronger and [ terminal ] capability and a more agile manufacturing platform for the future. From an Agri perspective, over the past 12 months, we've added engineers to our product development team at Wigram and we are investing in equipment to give greater internal capability to not only design but manufacture our product tolling. This will not only help us build internal expertise, but reduce risk and enable us to respond more quickly to opportunities. We've also invested in modern manufacturing equipment for the manufacture of some of our products. We've immediately realized gains via increased productivity, reduced engineered process waste and reduced energy usage. Importantly, we are developing a platform in a knowledge basis to facilitate an easier transition for end market manufacturing presence in the future, where we determine that is needed. From an Industrial perspective, as reported at the half year, we moved from a minority position to a 100% ownership of Sim Lim, which manufactures liquid silicon rubber products in Wisconsin in the U.S. We are supporting this with investment in our product development team in Auckland to again enable faster development of prototype and production tooling with less reliance on third parties. In addition, as previously noted, we are partnered with a U.S. manufacturer to produce a range of potable water assets for existing customers in the U.S. This delivers 2 benefits: a dual source alongside our existing supply line and providing local U.S.-made product, which is required by some customers. The [indiscernible] are currently being commissioned, and we expect to be manufacturing and selling product by the end of Q2 of FY '24. Investing in capability is obviously important for the future, but we're also pleased we've moved a few projects in the products and revenue. The most notable in FY '23 that David has discussed in prior presentations is for the hygiene market. We've successfully launched production and began to sell this product during Q4, and customer forecasts show strong growth for FY '24. We're also pleased to now be delivering the LSR diaphragm manufactured from our facility in Whitewater in Wisconsin, which is used in HVAC systems. And again, we expect good strong growth from this product in FY '24. The final slide that we'll move to now summarizes our ESG priorities and performance. From an environmental perspective, our priority is climate change. We've briefly -- sorry, we have described our work in progress in quite a bit of detail in the annual report. And to briefly summarize, the approach we're taking is to consider the impact of climate hazards on the key applications that we sell into that we talked about with you at these presentations. We've considered how these climate hazards might impact the inputs to our products, the facilities in which we operate, our customers and markets, and the transport networks that bring these 3 elements and put processing customers together. We've identified the risks and opportunities we consider important and we'll now move to consider transition and mitigation, but also commercial opportunities to capitalize on the opportunities that we do have with the products that we sell and the applications we're in. Ultimately, this work is giving us practical guidance for investment decisions and actions as well as ensuring we meet our reporting obligations in FY '24. Reporting of emissions is another stream of climate work. To date, this year and in prior years, we focused on Scope 1 and Scope 2 emissions, and gross Scope 1 and 2 emissions reduced by 5% in FY '23, reflecting the move to more efficient facilities for a number of our businesses, investment and more efficient equipment and better management of our operations. With the pandemic thankfully passed by and large, FY '23 was more normal, but our mode of work has permanently changed, as it has for others. We have more staff now on part time and hybrid arrangements than, say, 5 years ago. It is good for our business, and it's good for our people as it helps us retain talent and attract new talent. We've also moved a number of our operations to 4 times 10-hour shifts, which provides both our business and those people with more flexibility. From a governance perspective, as you're aware, John replaced Liz Coutts as Chair at the conclusion of last ASM and as noted, John is with us today. So before we move to questions, John will offer some comments on the Board and in the business from his perspective. So over to John?

I think someone else should talk about the Board. But I think we have talked about the result and management's performance. I mean, this has been another year of shifting sands for us, and this is a record result, notwithstanding a number of pretty strong headwinds in the form of expediting costs and inflationary environment. I don't really need to speak to that with any specificity. We're all experiencing that. Freight management continued to be almost a full-time job for some of our executives in Christchurch. Yes, Graham is correct, the pandemic has gone away, but it went away later in China, which is a -- you'll recollect, is say, we have a significant manufacturing site in China. So a fantastic job by the local people there to manage things and really not miss a beat in terms of delivery of product out of the facility, notwithstanding the most demanding of circumstances. And equally in Vietnam, we had people effectively camping at the factory to meet their commitments to us. We experienced some delayed rollouts candidly from some of our -- from some customers on some major purchase orders. Although as Graham has said, they're certainly coming through now. But nevertheless, they [ impacted on ] what we anticipated for the year. And we had a reasonably significant change in customer mix in the agriculture in the ag sector, courtesy of some M&A activity in Europe that is entirely beyond our control, but some customer mix was -- a change is pretty significant there. And like a lot of people experienced, the impact, a variable demand courtesy of customer destocking post the end of the sugarhead, which was the COVID experience for us all. And I appreciate that change is constant and [indiscernible], but that feels like that list I've just been through feels like a pretty significant series of headwinds for us and notwithstanding that to deliver this result. Management can't say it because they are too modest, and they have to stay that way. But the Board is very pleased with this result in the circumstances.

Okay. Thanks, John. So we'll move to question time. As noted, if you can please just put a note in the chat function to alert me of questions, and we'll take them in turn.

Rohan, we'll see if we can unmute you and take your questions first. Rohan, can you hear us?

I can hear you. Can you hear me?

Yes, we can hear you.

Excellent. And congratulations on a solid FY '23 and a big second half. The questions I had were, firstly, just when you look at industrial, I guess the second half growth was a bit of a slowing year-on-year. Can you just give us an indication of how that phased through? Was this mostly in the fourth quarter and kind of some idea of the run -- sort of run rate, so we can kind of think about the year ahead?

Sure. One of the strengths of Skellerup's business is the range of applications we sell into. And in the second half of the year, we had a very strong performance from our vacuum systems group, which is selling products into the wastewater applications. And we had some slower sales into other applications. For example, marine foam and , as I talked about. As we move into the new financial year, we see some cautious increases in demand in the potable water sector. But I think it's too early to read too much into that. We certainly don't expect it to bounce up in any rapid way as it was during the midst of the pandemic. Rohan, you're still there? We had a question from Christian Bell. Rohan has muted again. So perhaps, we should unmute Rohan.

Apologies. On the hedging side, just looking at the accounts, you currently cover at, I guess, $0.62. Going forward, is that -- or how should we think about that rolling off? Is it near term? Is it more weighted to the near term? And I just noticed you had $0.66 for last year. What was kind of the average rate that you went through the year with?

So why don't we answer your first part of your question first. So we -- our cover goes out. I think in the account that goes out as far as 3 years on the U.S., yes. And on the average of it over that period of time is [ $0.62 ]. For the next 12 months, the hedged rate is higher than that, and it's probably near [ $0.65 ], that's right. In terms of what our average hedge rate was during FY '23, Tim, do you have a feel for what average?

Probably closer to [ 67 ], [ 68 ] from the U.S.

Excellent. That's very clear. And then just in dairy, obviously, there's this move to long-life milk liners and potentially a bit of volatility given low payout in New Zealand. Can you just give us a color -- some idea of expectations around impact in New Zealand of the low payout, but also you've got lower volume from these high life milk liners, but also higher prices. Is that net-net kind of even at the earnings line in your view longer term? Or do you get -- is it a headwind? Or do you get some sort of benefit from that mix shift as well?

Yes. Look, I think net-net, it's certainly that's what the FY '23 earnings showed is net-net. It's relatively neutral. It's not a sea change from shorter life liners to longer life liners, but it's a gradual move in that direction. And it's longer life, what we call black rubber liners as well as silicone liners. So we think that's a trend that will continue because what, of course, that means is there's at least frequent requirement to change out liners. So we see that trend continuing. Okay. Christian, we'll come to you.

You can hear me fine?

Yes, we can.

So I guess -- so my first question, just sort of starts. You had top into guidance implying a strong second half exit rate. You're building a trade record of becoming less cyclical. So on that basis, would it be correct to assume that what you've just delivered as a base that you intend to grow from, and you'll give us an indication of the level of growth at the ASM later this year as normal?

Yes. I think absolutely, Christian, that is a base we want to continue to grow from. What we've achieved over the last 7 years as we've tried to set a new base each year that we continue to grow from. And you're right, ASM is typically the time when we've got enough trading under our belt in the year to offer some outlook on the year that we're in.

Awesome. And then I guess you kind of have -- it sounds like you have the benefit -- a little bit of tailwind from currency, maybe some easing in freight costs as well. So those should be tailwinds going into '24, right?

Yes. I think from a freight cost point of view, we probably experienced the benefit or the reduction of freight rates in the latter part of the second half of the year. So in Q4, we had some of that benefit, which obviously should continue through into FY '24. Also the improvement we got was not only some easing in cost, but some faster transit times, which, in part, accounted for the build in inventory you saw in the first half as those transit times are starting to improve. So freight, I think we're not expecting any step changes from what we had in the past quarter of the year. Currently, if it stays at these levels, yes, we are substantially hedged at around sort of 75% of net exposures FY '24. So at the fringes, we benefit a little bit more from the Kiwi dollar being lower.

How much is freight costs? Like how much of an expense is that for you because it's not broken out in the annual report.

Yes. So it's a difficult one for me to say because on -- in some instances, we sell product on a ExWorks or an FOB basis. So I can't, off the top of my head, give you a quantification of a number. And it also depends a little bit on the nature of the product. Some of our products takes up a lot of space in the container. So the value of a product in a box, depending on what the nature of the product is, can be quite different. So the freight cost relative to the product value can be quite different. So I can't give you an easy one-word answer to that one question.

Yes. No worries. Sorry, just a couple of more questions. You sort of called out some destocking behavior from some of your customers, which just sort of looking at some of those being more on fortune innovations sort of added second half of last year. I guess year-to-date -- well from now, are you starting to see a normalization and destocking behavior, what sort of -- how is that sort of tracking?

Yes. Look, I think we spoke a little bit about the destocking EBIT at the half year when we reported in February, and we saw that continue for particularly in the potable water sector in the second half of the year. Also, as John touched on, the restrictions relative to the pandemic in China lasted longer than they did in many other places. So that impacted demand in China still continues to be, I guess, a challenging market. What we've seen over the past couple of months is a slight lift in demand for some of those potable water applications and products. So it's come off the bottom. We're a little bit cautious about the fact that there could be a little bit of restocking going on. But I think in talking to our people in market in the U.S., we're cautiously optimistic that the level of demand we're seeing now, which has lifted slightly, not at the levels it was during the inventory stocking that was going on in the likes of FY '21. But we're cautiously optimistic that a lot of that destocking is clear and we've got some slightly more normal trading balance.

Okay. And so I guess just following on from that. You sort of -- over the last couple of years, you've achieved some pretty strong top line growth, which has required some working capital support and you've been more strategic on given supply chain uncertainty around raw materials and finished goods. Sounds like some of that stuff is easing alongside cautious optimism around destocking kind of through the rest of it. So what are you expecting for your own working capital in FY '24?

We think we still have some opportunity to take some more cash out of inventory. I guess it's important to remember, inventory is up for both the reasons that we talked about, managing that risk. But also we have been an environment of increasing costs. Some of those pressures on some of our key raw materials, have eased, but we believe we still got some opportunity to reduce the level of investment we have in inventory. And a target we are looking at is trying to get it back down there to where we closed FY '22. Okay. Josh, we're moving to you.

Can you hear me okay?

Yes, we can.

Brilliant. Just first question. On a constant currency basis, revenue growth was pretty flat for both divisions. The result was mostly led by margin improvement. Going forward, you obviously want to grow NPAT, but how do you see the bottom-line growth being driven by, I suppose, top line growth and also margin improvement? How do you expect the mix to look like?

It's quite a broad question. I mean, I'll point to a couple of things. We have a track record of bringing new products into the market. And we touched on a couple of examples that we brought in, in Q4. And they're just a couple. So we do have a good pipeline of new products and new revenue opportunities. Part of our job also is to review what we're making and trim out items that perhaps aren't generating the sort of margins we would like them to do. So I'm not going to give you kind of, I guess, a percentage split of where the 2 things will come from, but we do have a good pipeline of revenue growth opportunity. We've highlighted in the past that we see faster growth as being able to be achieved in the Industrial division. But we're not without opportunity in the Agri division as well as we've demonstrated this year. And one example is footwear. We had good growth out of footwear this year, and I touched on what some of those factors were, but we think we can continue to expand the growth of our technical footwear products in the North American market, for example. We think there's other things we can do in these programs and projects we have in place around the dairy division. And then from a continuous improvement point of view, that never stops. I noted the investment we've been making in both manufacturing equipment and in our development teams. So those things all come with an expected payback to being able to improve the margins and combat rising costs to deliver improved earnings. It's a pretty general answer, but I think it's probably the best like to do, Josh.

That's okay. It's just for some time now, it seems like earnings have been really driven by margin improvement rather than top line growth. I guess, perhaps something that might be helpful. To what extent do you actually trim product lines and what is the top line impact of it? Is there sort of a rough guide you can provide? Is it that material?

There's not a rough guide that I can provide. But products mature. And so in some instances, customers make that choice for us. But it's an area that we're giving an increasing priority to as well. Our particular focus over the past 12 months has been in our dairy business, whereby we've done quite a bit of product rationalization and reduce the number of products we make because that reduces complexity. And obviously, we have to work pretty closely with customers because often, we are making these products for OEM customers and they need some encouragement to help discontinue products with very small trading volumes. So it's a constant part of what we do, and it's probably something in the past. We don't think we've done as well as we could have, and it has more emphasis now. Just going back on the revenue comment there. On the first page, we highlighted the 7-year view. And we acknowledged that our earnings growth has been faster than our revenue growth. But nonetheless, over that 7-year period, we have grown revenue at a compound annual growth rate at 7%. So we believe we've demonstrated, and we can continue to drive revenue growth because without that, there's obviously a ceiling on what you can achieve at an earnings level.

We've got opportunities in front of us. We'd be disappointed if we didn't grow revenue this year.

The reality is, as John recapped at the end there for FY '23, we did have a number of customers destocking. So that did impact us at the revenue line. And we were able to offset that with genuine revenue growth and some of the other applications that we talked about into wastewater, into marine foam, into footwear. So we're confident we can continue to grow both revenue and we should always be striving to improve margin to boost [ the earnings ].

Okay. That's helpful. Just referring to the chart on Page 5 of your presentation. The dairy and footwear bars, which encompass the Agri division, look like they collectively drove a, why don't we call it, $2 million to $3 million improvement in NPAT. If you look at Agri EBIT, it only lifted by $400,000. What -- is the explanation for that hedging? Or is there another explanation?.

You're quite right. So in general, our hedging program is related to the Agri business because that's where the largest net exposure on currency is. Our Industrial businesses are generally more international, and our earnings stream is significantly more international. And so therefore, we have a much larger natural hedge of revenue and costs. So our hedging program is primarily couched at the Agri business. And this year, obviously, we covered [ really well ]. We would have been better if we hadn't had [ it ] just like in prior years. The bar has been green. And like you said, that's the outcome of having a prudent policy to manage that risk in FY '23, but offset the spot gains that we got that boosted the revenue and gross margin of those businesses.

Make sense. And last question from me is really around your plant at Wigram. You noticed -- you noted on Slide 7, some capital investment occurring there. There was a media article last week around job cuts at that same plant. Are they both related? Are you cutting jobs and making some roles redundant because you've managed to automate some of the processes down there? Or is it because demand has slowed a bit? Can you just talk to those points, please?

Sure. I mean, the answer is, yes, they are related and making job cuts is always difficult. We have reduced the number of people we employ in our post-molding activity, which is a -- has been a relatively manual activity. It was necessary. We've touched on a couple of the reasons already, but an outcome of continuous improvement, and that's often how we do things, process and introducing more mechanization has eliminated process waste. It's eliminated things that we used to do. It eliminates moving things when you don't necessarily need to move them, all those things. And it has also eliminated some manual activities. So that's a factor. As I noted before, there's been a gradual shift to some longer life liners, which does capture higher value, but it reduces the volume of products that we manufacture. And we've been making these improvements for a number of years, and until very recently, we've been able to manage that impact by reducing the number of temporary employees that we have on our staff. We've largely eliminated temporary employees from our workforce over the past 6 months or so. And so -- unfortunately, an outcome of the improvement we needed to make has meant that we've had to take some jobs out of that price molding process. Okay. I think we've covered all the questions. So if anyone else has got a question, it seems like an easy way to allude to us is to use the raise your hand function. So I'll just give everyone a minute to see if they've got any further questions. And if not, we'll close out the presentation. . Okay. It seems like there's no further questions. Look, thank you very much for joining us, and hope you all have a good day. Thanks.

Cheers.