Vesuvius plc (VSVS) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Vesuvius Sales and Trading update. [Operator Instructions] I would like to remind all participants of this call is being recorded. I will now hand over to the CEO of Vesuvius Plc, Patrick Andre to open the presentation. Please go ahead.

Good morning, everyone. My name is Patrick Andre. I'm the CEO of Vesuvius and with me this morning on the line is Guy Young, our Chief Financial Officer. So I will start by giving you the highlights of our trading performance since the start of the second half. And after that, as always, we will be happy to open the floor for questions. The first message is that we have -- it's quite a resilient trading performance which we have over the past format, which now leads us to plan for our 2022 results to be somewhat above expectations of the market. You may know that the range of analyst consensus for 2022 was between GBP 194 million and GBP 209 million. We now expect to be somewhat above that for the year. So what are the reasons for this quite resilient trading update not that much the market, unfortunately. The markets have been weaker more or less as we have planned it would be when we had our latest update. There have been some regional differences from one region to the next, the trading, the market environment in Europe has been even a bit weaker than what we saw. Conversely, the market environment in other regions than Europe has been a little bit better than what we saw. But overall, when you take all the work together of trading environment or market environment have been more or less as weak as we have planned, it will be. So the reason why our resilient results performance as many quarters, we have continued to make market share gains in all of our divisions and in particular, in Flow Control in all regions of the world. The second reason is that we have continued to have an efficient pricing management, and we have been able to continue to increase prices to continue to offset all cost increase energy, labor raw materials that we were confronted with. At the same time, we have engaged into an important cost-cutting program, as we always do when markets start to weaken and they are. So we have been able to start reducing our cost base, and we will continue to do so as much as necessary in the coming months in case markets will continue to weaken. Two other points. We have also benefited from a bit better-than-expected tailwind from ForEx exchange over 2 million and Guy will give detail to you during which in person. And also even if our inventory have been declining. We have been able to reduce our inventory, but we have reduced our inventory a little bit less than what we planned at the time of our latest trading update midyear. So the negative fixed cost absorption impact, even if it has been significant, as negative bit less than what we planned in our last order. And all these reasons together are combined to help us achieve better results than what we initially planned. And this is what is supporting now our forecast of results somewhat above expectations. Our cash performance has also been quite good so far since the end of July, we have started to reduce of inventory, even a little bit less than what we would like. But clearly, our inventory has started to reduce. And as a consequence, we continue to generate good free cash flow, and we expect our leverage ratio, our net debt-to-EBITDA ratio to be significantly down end of the year as compared with mid-year we have 1.3 middle of the year, we expect to be on or around 1 at the end of the year. At the same time, even if our markets have been weakening, the fundamentals of the market are not turned. And we continue to be absolutely convinced that market, both steel and foundry are growing long term. And for these reasons, even if we are cutting short-term costs, we are actively continuing at the same pace all of our investment for the future. It makes first investment in R&D. We are continuing to increase our R&D spend, which is fully expensed in the way we are accounting for it. It's not capitalized. We are increasing our R&D spend because we believe that is what will continue -- help us to continue to gain market share going forward. And our expansion or investment in capacity expansion, in particular, in Flow Control to help us continue to grow and gain market share in the fast-growing region of Asia, Southeast Asia, Turkey, Middle East, Africa, Latin America. Our investments are continuing at it and our new investment in new capacity in Flow Control will lead the market progressively between the end of this year and the end of 2023, beginning of 2024, we believe just in time to enable us to fully benefit from the market recovery when it will be there. We have also finalized a small acquisition. It's a small thing that's important for us on a strategic point of view, a small company in China called BMT, which is a producer of basic monolithic factory material, it has been a partner of business for many years, it's a small company, GBP 14 million turnover, but important for us strategically because it will enable us to expand or present in basic monolithic, not only in China, but also in North Asia and in Southeast Asia. Now that we are fully 100% owner of this company we will be able to introduce or latest CCP, which we could not do before IP protection reasons and this will support our growth and market share gains in all these China, North Asia and Southeast Asia region going forward. From a sustainability point of view, we are continuing to make our progress. We will be in 2022, our CO2 footprint, our CO2 emissions will be 20% lower in 2022 than they were in 2019. So we are very -- on the right track to reduce our CO2 emissions and all the efforts that we have been making in terms of sustainability over the past few years are now clearly recognized also by external agency because MSCI has been upgrading a few days ago or rating AA, which is the second highest rating label for all companies worldwide. We are very pleased with these results. Looking at the -- looking forward, we expect that market will continue to return in the coming months, I think we should have no revision on that, both steel and foundry market are basically in front. So we expect the next few months to continue on that front, especially in EMEA, there is nothing new there. It's more or less as we have planned, it will be. I would say, a typical downturn, we are fully prepared for that. The year 2023 for this season is uncertain and will be refined from giving guidance at this stage because there is a high level of uncertainty about when market will go the other way, when will be the inflection point and when market will start to recover. What is clear today, we may have seen the ArcelorMittal selling a bit a few days ago is that a significant part, especially in EMEA of the weakness that we see on the steel market is due to these depot. And so apparent consumption, which is what is important first for us is relatively down, but see consumption is much probably not down as much on apparent consumption. And at some point, there will be a rebound. But this rebound is very difficult today to know it will take place in Q2 next year or end of next year. This explains a very wide ramp of consensus for the results of the business in 2023. The range of consensus today is anywhere between GBP 167 million and GBP 218 million. We are relatively comfortable with the trend because we got the crystal ball ourselves, so we will refrain from giving guidance. But most probably the upper end of the trends correspond to a very optimistic probably too optimistic assumptions regarding when market will recover. It's very soon that markets will recover already Q1, Q2 next year, which we do not see as the most likely scenario out of cautiousness for the time being and the lower end of that trend, will assume that market did not recover until the end of 2023. So for the time being, it's too early to do our own opinion about where we feel in that trend. But we believe not further 2 months and at least probably during the course of H1, we will be confronted with which end market, both steel and foundry, with that at some point in time after that the -- our market will recover and will review their long-term growth. So I will end there and I propose to open the floor for questions, and Guy and I will be very happy to answer.

[Operator Instructions] And we will take our first question from George Featherstone from Bank of America Merrill Lynch.

First one would just be kind of a little bit of a follow-up on your last comments there, Patrick, around normalization of inventory. So maybe starting with Vesuvius itself. Where do you see your working capital percentage of sales ending this year? And then where do you expect it to trend in the first half of 2023. And then how much as the wider channel inventory do you expect to normalize and kind of when by how much destocking have you be able to quantify that sales destocking you expect to see in the first half of next year?

Thank you. I will then hand over to Guy to give you some figures. But as far as our own inventories are concerned, we are clearly -- we have already clearly started to decrease because logistics and supply chain also are improving, not only because markets are declining. Also logistic and supply chain are improving. So we don't need to keep as much buffer on safety margin as we have been over the past 12, 18 months due to the disturbances in the trade market in particular. So since I'm clearly getting better. It opens new possibilities for us to reduce. So we have started to reduce we have initial plans to completely reduce what we believe a normal level by year end. I don't think we'll be able to do that. So we will significantly reduce but not as much as we wanted to initially. We will still have some unwind of inventory during the first half of 2023. But already this year, and this is the reason why we are already generating good cash flow. We are starting to unwind our inventories. So that's for us. And I will hand over to Guy to give you some more figures. But regarding the steel inventory, it's clear that if you remember, during the half year results. I have the indicated that we have the ranges for that steel inventories were too high, clearly July. They have clearly started to unwind and we have the perception that they are reducing relatively rapidly. It doesn't mean that the reduction is over, not yet. But especially in Europe, there has been significant solution in production of steel in Europe and also in other places. And we believe that steel inventories are now relatively rapidly reducing it will probably take a few more months for them to reach the level at which the reverse trend will start. But we are on a good track to reduce excess to inventories also. So somewhere in H1, we will have simultaneously both the reduction in excess steel -- refactoring inventory all in excess steel inventory will have been achieved sometime in H1 next year. Guy, maybe you can give some more -- some bond numbers regarding the working capital intensity?

Sure. Thanks, Patrick. George, I think the trade working capital to sales for 2022 is probably more likely to be between 23.5% and 24%. We should see about half of our expected under recovery, under absorption rather of fixed costs flowing through to next year. But our trade working capital overall should be declining back towards its trend of around 21% as soon as supply chains end markets have normalized, which I would expect to be happening through '23 and '24. So up to 24% before coming back down to '21, George.

Okay. That's really useful. And now I try to touch on the cost base reduction. I just wonder if you could give a bit of color on where that's been targeted and also in that context. You mentioned good pricing traction covering the cost inflation that you've seen on labor. But on labor, what are you seeing as the cost inflation potential for next year? Is that part of the cost base reduction that you're targeting and can you raise prices again to offset that in the context of the volume declines you're expecting?

It's a very good question. We are trying to reduce costs everywhere. What we are already doing is, of course, travel, external professional team, everything is being reduced, but we are also, we have already started to put some of our people on furlough. So as we are reducing production in many of our plants we have started furlough in several places to reduce our fixed cost base, and this is already helping us in our results, and we will continue this as we've done during the pandemic. This is in fact, we are applying exactly the same methodology of what we've done during the pandemic to conform the drop in volume. We are doing that now, and this is contributing to maintaining a part of mitigating the negative impact of declining markets. Report costs are increasing, or will increase. We are in inflationary context. First, we are being extremely reasonable in our labor negotiation at the same time, we are facing our people normally well, but we are also reasonable in the way we are doing so. We have a lot of discussions with our people to agree together and the other was being able to agree so far on reasonable or labor cost increase. And to a second, yes, for us, labor is a good cost, as energy, as is raw material and our pricing management is adapted to cover all of our costs -- all the cost components of our cost structure, meaning, of course, raw material, freight, energy and labor, which are the 4 most important labor is taken into account in our pricing strategy.

The next question is coming from Andrew Douglas from Jefferies.

I'm rather forgetting your technology to work. Can I ask a couple of questions, please. Firstly, going back to George's question on cost out. Is there anything different in this cycle compared to prior cycles in terms of the levers that you have to pull if you do need to take additional cost out. And in terms of what needs to happen from your end markets for us to take those decisions? Or is it similar to prior cycles? Secondly, I just want to touch on the small acquisition in China. I know it's small, but I just wonder in understand your thought process going into next year with a healthy balance sheet, just regarding M&A, whether there are kind of more targets out there that are coming lose. And third, a slightly laser question, but one for Guy. Do you guys have any refinancing to do next year? It looks like there's only a small -- I think it's $30 million to refinance? And if so, would you just kind of roll into your RCF? Or do you have any other options?

Thank you, Andrew. I will let Guy answer on the refinancing. But clearly, we have a very solid balance sheet and a very digital refinancing in the years to come, but Guy will give you more flavor on that. Andrew, on your 2 first questions, cost out, see very similar. We are, I would say, battle harden now. And as you can imagine, so cost -- taking costs we are weathering, it's very similar to what we have been doing regularly over the past few years, each time we had a downturn. This downturn is obviously a top for everyone. I don't know how long it will last. If it will be 6 months, 1 year or 18 months, but it's not 5 years. So we are now well equipped to make the distinction between those costs, which we can and could costs to adapt to this temporary downturn without negatively impacting our long-term strategy. And conversely, those all costs which are actively key to our long-term strategy and which we never touched during the downturn, including a nonclassical downturn like the pandemic. I'm thinking mostly about R&D. R&D, not only we are not cutting R&D, but we are counting to increase our R&D expenses because we have a very good project, we have plenty of ideas of new products that we can put on the market in the coming years, and we don't want to slow that down because this is the key for us to continue to gain market share. But all the cost, there is no secret code, all the other costs, which can be reduced short term without impacting our long-term strategy we are doing and a very decisive and proactive way because it is the only way to do. Regarding DMC, we -- it's small, but it's very important for us strategically because it will really help us accelerate our development in China and North Asia and Southeast Asia, which are very important areas for us. And yes, we have an appetite because we have a strong balance sheet. We have an appetite for other similar bolt-on acquisitions. We are currently looking at other opportunities, midsized opportunity. Other opportunity was CCPI, Universal, DMC or slightly some order alternatives. We have the balance sheet to do it to absorb it and relive them because they are generally a high level of synergy integration risk is low, there are not stretching management teams. And so we have an appetite. So there is no guarantee that any of those will happen, but we are proactively looking for other opportunities going forward. Now Guy, if I may hand over to you to give some information about refinancing.

Thanks, Patrick. Andy, yes, you absolutely right. But very little in terms of refinancing requirements. We've got a small USPP notes that's due for redemption at the end of '23 of around $30 million. And yes, again, you're right, our intention is to utilize either internal cash resources or some of the RCF in order to do that prevention. So no major refinancing requirements during.

The next question is coming from Bruno Gjani from BNP Paribas Exane.

I was just wondering if you could go back to the underproduction in H2 and if you could isolate and quantify the impact that you expect underproduction to have on H2 profitability. And further, if you could expand on that and touch upon production expectations for next year, are you reducing production in H1 '23 to a level that is below the Q4 level. So is it not a sequential cut or you are simply holding production at a lower Q4 level for longer.

I will pass it back to Guy to complement with some numbers. But qualitatively, first, we are producing less than what we sell that's how we reduce inventory. So we are closing less than what we sell during H2 this year. And we will continue to produce less than what we sell in H1 next year. But what we sell in H1 next year, I don't believe it will be lower than Q4. Q4 is a very low quarter. I think it's more or less everywhere the same. And so I don't see us -- again, I have no crystal ball, unfortunately. But I consider it unlikely that production on sales of Q4 be higher than H1 because the Q4 is very low in terms of production and sales, lower than Q3. It's normal always like that as a cycle -- in such a cycle. And I would, at this stage, expect H1 to be a bit lower than H2, but higher -- lower than H2, but higher than Q4. Now if I may hand over to you Guy to put more flesh around this.

Sure. Bruno, we spoke about a potential range of impact with regards to the under-absorption of pick a cost at H1. And we estimated it to be impacting us by between GBP 8 million and GBP 10 million in the second half. My expectation at the moment, although we've obviously still got 2 months to run, and we are still looking to continue to reduce inventory. But my expectation is that about half of that under recovery -- or sorry, under absorption will flow into next year. So between GBP 4 million and GBP 5 million.

Okay. That's helpful. I was just wondering if you could talk about perhaps why you're getting that larger production cut in H2? Is it perhaps because it has positively in markets -- market share gains more pronounced? Or is it to do with more favorable cost dynamics, they perhaps contracted energy costs being lower this year for you? Or did it just make sense to spread some of that burden, that underproduction presents on your margin over several periods and actually coincide that with the cost savings that might flow through. So just some color around why not a large cut in H2 and get it out of the way.

I say it's a very good question. I'm believing if we could reduce production even more in H2, we would do it, but sometimes, first of all, when we do just officially follow, you need to negotiate with your people. You don't announce them from Monday to Tuesday that you will put 80% of people in the plant, it's all over. So we need to negotiate with them to do that in, I would say, a responsible way because we want to give our people. I insist on that. It's not like we are shutting the operation and since that we never restarted. We want to keep our people. We are very qualified blue-collar in particular, also white-collar, but we have very including blue-collar, which as we want absolutely to keep because they are key the quality of our production, the quality of our operations. So when we reduce production in the plant, we don't do this in a dumpy way. We discussed, we explained why we are doing it, we take the time to -- I would never dare to say convinced because people are never happy position on furlough. But at least, I think it's important to take the time to explain because in a few months from now, we will start again, and we will need to have those people fully motivated, fully ready to ramp up production again with the best level of quality for our customers. So the way we do the ramp down is very important for the quality of the ramp up later on, quality and speed of ramp-up later on. So we are doing as much as we can. We are reducing as much as we can but considering the decline in the market, especially in EMEA, it has not been as quick as we would have liked it to be. That's the reason why our ramp down of inventory would be very serious signifier, but not as much as we wanted to be during the second half this year.

Got it. That's very helpful. And just the last one on pricing. I was wondering how pricing has developed sequentially, so Q3 over Q2, are prices stable? Or have they started to moderate lower already?

It has moderated, obviously, if you compare the quarter-over-quarter evolution it has been moderated because of cost base are moderated but our prices are still increasing because of COVID have still been increasing over the past few months. It may well start to decline sometime in the course of next year. When it does, as we have always said, we would -- we will pass through all this through to our customers for raw material, in particular, the pass-through. But for the time being, our pricing has been between stable and slightly increasing depending on the region and because our cost base has not started to decline yet.

Okay. Just so -- just to follow up on that, so next year, so this year, you would have seen very significant price increases to the tune of I'd say, what, 16%, 17%. As you look forward to next year, how much of that do you expect to get back to customers or any indication? Or do you expect to hold it all? Or what are your thoughts on this?

It's too early to predict that because it will depend on what will happen on the cost base. So I don't believe labor will decrease next year. I am tactical about the fact that energy will be. There are several school of sales. And as you can imagine, I don't have fixed goal all about the cost of energy but I don't consider it seen from today, that it would stand 1 month or 2 months from now. Same from today, I don't consider it as a most likely scenario that energy prices will decrease on average significantly next year as compared with what they are today not as compared with what they were more to do but as compared with what we are today. And freight may is declining as we speak. Freight is continuing to decline. So this is a positive factor in terms of cost base decline. And raw materials are not declining that much raw material excluding freight today are not defining that much. At least the raw material we are losing in those filling the holes. They are not declining excluding freight for the time being. So it's a mixed bag and it's very difficult at this stage and will be different from being so to predict by how much the -- it could decline next year. All in all, I hope it will decline a little bit, but it's too soon to tell you by this percentage. And we will follow. This is something we are revising literally every month, we are following that every month if not several times a month. And we will adjust our pricing if and when we observe a real factual cost decline in the market. But again, it's not the case for the time being.

And we will take our first -- the next question from Dominic Convey from Numis.

Just a couple, if I may. Just following up on Bruno's point really around the inflation expectations for next year. To foray, what wage inflation next year? How would you characterize your expectations? Would you say sort of mid single digit or perhaps mid- to high single digits next year. And looking at it another way, as things stand, what level of price increases do you expect you will be required to put through next year to fully recover that weighted average cost increase. I'm just conscious that to date, we focus very much on our pricing models for 2022. Now it's sort of a good time to review and just get our revenue line in shape for next year? And then third question, just in terms of shape, implied within the new guidance for this year, what is your expectation in terms of the performance of the last 2 months of the year relative to what you've already booked in the 4 months to October.

Regarding your first one, we do not have, as you can imagine, a single wage expectation for all countries anywhere in the world. And it's interesting because we see relatively large valuation. So there are some countries where wage -- we forecast wage inflation to be low double digits. And there are some countries where we are forecasting wage inflation to be low to single -- low to mid-single digits. So it's a wide range. And we are looking country by country at the specific situation, the evolution of the currency, the specific level of inflation in such a sub developed country and we are very significant valuation. You still have considered you know, where inflation is still on the rise. You have other countries where infection may have already picked, so this also creates a difference in the dynamics of negotiations of discussions we have with our employees. So we expect a relatively wide range of outcome from low to mid-single digits to low double digits next year in terms of wage inflation, it's really a case-by-case basis, and we are looking at it on a case-by-case basis with our local managers being empowered to adapt their decision based on local circumstances. It's not something we are running from the headquarter, and we trust our leaders locally. In terms of price increase, our price increase -- our price evolution. Again, it's too soon to answer this question because even if wagers is relatively, I would not dare to say creditable, but you can make some forecast in terms of wage. Wage is only one of many elements of our cost base, raw material, freight and energy are also important ones. And this is changing literally by the day, by the week. And we are adapting our pricing earlier demand. So will other elements and wages more than compensate with the decline of other elements more than compensate the decline in wages, the decreasing wages, we see possible, it was handled. We will monitor this. We are monitoring this on a regular basis and we will adjust our pricing strategy accordingly. But again, unfortunately, because I don't have the crystal ball, I cannot tell you what will be the resulting evolution of our price we will see that when it's done going forward. And to answer your question, we do not have and we are not planning to have a lower unit margin in the later half of -- in the end of this year than what we have so far. Volumes will be -- are lower. So you have a fixed cost absorption impact. But in terms of unit margin permits, we are not planning to have a lower profitability than what we have so far.

There are no further questions on the conference line. I will now hand over to the management for closing remarks.

Thank you very much to all of you for attending the call today. I wish you a nice day, and we are looking forward to seeing you when we announce our full year results at the beginning of March next year. Thank very much.

Thank you, everyone. That concludes your conference call for today. You may now disconnect. Thank you for joining, and enjoy the rest of your day.