Carel Industries S.p.A. (CRL) Earnings Call Transcript & Summary

Good morning. This is the Chorus Call conference operator. Welcome, and thank you for joining the Carel First Half 2020 Results Conference Call. [Operator Instructions] At this time, I would like to turn the conference over to Mr. Francesco Nalini, CEO of Carel. Please go ahead, sir.

Thank you. Good morning. Thanks for joining this call for presentation of the first half 2020 results. I'm on Page 2 with the main highlights, and we are proud to report that, in spite of the unprecedented situation that took place in the first half of this year with the temporary lockdown in China in February as well as the extended lockdown of the Italian plant in March and April with, of course, a sharp economic downturn globally, we were able to achieve operating results not far from what we had reported in the first half '19, thanks to the resilience of our business model and thanks to the resilience of our operating model that allowed us to promptly react to this fast-changing adverse scenario. Revenues were down 3.6% compared to the first half of '19 or 3.1% net of the foreign exchange, so in the high end of the expectation range that we had at the end of Q1. This performance is particularly positive if we take into account that we faced the shutdown of more than 60% of our production capacity and that thanks to our strategy of technological mirroring in production and the resiliency of our supply chain that we increased over the last few years with the footprint expansion program and that we are also investing to increase even more and speak. This has always been a key pillar of our strategy and has been particularly important during this period. EBITDA at 19.2%, in terms of profitability, is substantially in line with the full year '19 and is 1 percentage point higher than the Q1 result. And that's thanks to the quick and effective implementation of a number of initiatives to contain operating expenses, offsetting the absence of operating leverage as well as higher logistic expenses that we face to effectively continue serving our customers as we will see. We had a strong cash generation with a free cash flow to equity of approximately EUR 10 million and a net financial position, which is in line with the first quarter and with the end of last year even after the dividend payout. I'm now moving to Page 3 with some more economic details. So revenues at EUR 161 million were 3.6% lower than last year or 3.1% net of the foreign exchange, this is in the high end of the guidance that we provided, and we were able to recover most of the backlog that we had during June with a residual sale in July, thanks again to the resiliency of our production footprint. EBITDA was down 8.4% to EUR 30.9 million with a profitability of 19.2%, down 1 percentage point from the first half of '19, but in line with the full year '19 when it was 19.3% and 1 percentage point more than the first quarter. If you look at the bridge, we start from EUR 33.7 million in the first half of '19, we lose EUR 5.1 million due to the operating deleverage, basically. Then we have EUR 1.2 million of additional logistics costs that we faced voluntarily because we gave priority to the service level to our customers and the defense of our market position in this period. And that's related to more usage of airfreight to compensate higher lead times and disruptions from our supply base as well as more expensive airfreight because of the shortage of available flights and also a greater inbound volume due to the fact that we also increased the inventory. Of course, we forecast an improvement in this cost item in the second half of the year. We then have EUR 3.4 million of discretionary OpEx reduction that offset this mainly in terms of travel, consulting and marketing expenses. And so we'll end at an EBITDA of EUR 30.9 million. Net profit was down 14% to EUR 16.3 million due to the operating results and higher D&A related to the footprint expansion and CapEx were $5 million with a strong reduction from the $11.2 million of the first half '19 mainly due to the end of the footprint expansion program, while we maintained our long-term investment in R&D, and we also invested in making our supply chain even more resilient by deploying additional production lines in Croatia, the United States and China to make our supply chain more resilient, and that was not foreseen before this pandemic situation. I'm now moving to Page 4 with the revenue breakdowns. To the left, we can see the breakdown by region. EMEA was down 0.5% net of foreign exchange, so essentially in line with last year. Here we have a very good performance from Eastern Europe, thanks to the investments we made over the last few years to increase our presence in the region and a good performance in some applications like heat pumps in Northern Europe that's thanks to market share increase because these are projects -- new projects related to market share increase that we achieved in the last period as well as help by government incentives related to the sustainability programs, for example, in Germany. This offset some weaker applications like wellness or automotive. In Asia Pacific, sales net of foreign exchange were down 6.8% which is a strong improvement over the minus 17% of the first quarter. This is thanks to a good recovery in China. China accounts for approximately 50% of sales in the region. In China, we had a good performance from data centers, from food retail and also from new opportunities related to investment in indoor air quality, like hospitals and luxury condominiums. On the other hand, the rest of Asia was weak because of extended lockdowns and the corresponding economic downturns. North America had sales of minus 12.7% net of foreign exchange, more or less in line with the first quarter. Latin America at minus 6.2% net of foreign exchange. Here we had a strong impact of the foreign exchange. We had a positive result in Brazil in local currency. However, a pretty soft result in the rest of Latin America. In general, the American regions were the latest to be hit by the pandemic, and so they still represent the most uncertain area. To the right, we can see the breakdown by sector. HVAC was down 4.9% net of foreign exchange. Again, we had a positive result in data centers, in heat pumps, in some indoor air quality applications, offsetting poor results in automotive as well as the wellness application. Refrigeration was up 1.1% net of foreign exchange with a good performance in food retail in China and Europe, offsetting a slowdown in the Horeca and food service application. Here concerning food retail, I would like to mention that the market, in general, was not so positive because retailers have been pretty cautious with investments. We believe that we start to invest again when the situation improves, but so far, they have been pretty cautious. However, this positive result is mainly due to market share increase because of our strategy of market share increase in food retail. And it's it provided positive results, especially in Europe and China during this first half. The noncore was down 14.7%, net of foreign exchange. I would like to highlight that the core business net of foreign exchange was down 2.9%. I now leave the word to Nicola Biondo for commenting the items below the EBITDA on Page 5.

Thank you, Francesco. The Slide #5 details the group results from the EBITDA to the net profit. The first half of 2020 was impacted by higher G&A cost mainly related to the [indiscernible] CapEx level of 2019. In the period under review, the financial charges were higher compared to last year due to an increased amount of loans available for the group. It should be noted that such growth was more than compensated by the better result of forex and of the company consolidated with the equity method. The tax rate of the period was 23.1%, pretty in line with the first half of 2019. The increase compared to the first quarter of 2020 is mainly related to a different country mix and to the fact that it is expired tax subsidy in Croatia. The group net profit of the first half 2020 was equal to EUR 16.3 million compared to EUR 19.9 million of the same period of 2019. Slide #6 shows the net financial position evolution of the first half of 2020. The net financial position was pretty stable compared to December 2019 level. The fund from operation was equal to EUR 25.5 million and around EUR 10 million higher than the CapEx and the increase of net working capital of the period. The increase in net working capital was mainly driven by seasonal effect. It should be noted that the DSO at the end of the period improved compared with the period -- with the same period of last year. In June, the group paid dividend of around EUR 12 million. At the end of June 2020, the group has an amount of cash, cash equivalents and available credit lines of about EUR 100 million. The financing activity performed during the period made even stronger the good financial situation of the group. I leave the floor to Francesco to go on with the presentation.

Thanks, Nicola. So I'm on Page 7, in the closing remarks. So to summarize, we managed to mitigate the impact of the lockdown of more than 60% of our capacity thanks to the resiliency of our production footprint that has always been a key pillar of our strategy and that was increased over the last 2 years with the expansion program. In the last few months, we launched a number of initiatives to increase this resiliency even more in terms of additional production lines as well as extensive work on our supply base to increase the redundancy also in terms of geographies. The backlog accumulated during the lockdown was absorbed mainly in June with the residual sale in July. On the demand side, also the resiliency of our business model mitigated the economic slowdown, thanks to the diversity of applications and geographies. In HVAC, we had a good performance in high-efficiency heat pumps as well as data centers and a poor performance in automotive and wellness. In refrigeration, we had a positive performance in food retail and a negative one in Horeca and food service. We launched a number of initiatives to reduce discretionary OpEx that took full effect in the second quarter of 2020, enabling us to maintain the EBITDA margin in line with the full year '19 and improve it compared to the first quarter. So to conclude, we saw a positive sales result in July. Also the preliminary figures for August are positive. So we expect the third quarter of 2020 in terms of sales at least in line with the same period of 2019, and we have a favorable view on the full year, even if it's still too early to provide the precise guidance for the fourth quarter considering the uncertainty that remains pretty high and the short visibility that we have in terms of portfolio. For 2021 in the medium term, we maintain all our strategic drivers of growth because they are still there, and there could be the rebounds of the applications that were softer this year as well as the geographies that were weaker in 2020 plus additional opportunities like indoor air quality as well as those coming from investments on the Green Deal by the European Union. Thank you so much for your attention. We are now more than happy to answer to all of your questions.

[Operator Instructions] The first question is from Alessandro Tortora with Mediobanca.

I have, let's say, four questions, if I may. The first one is on the description you made by region. I would like to understand if you can share with us some, let's say, more details on the performance in the U.S., which, let's say, was negative. And the -- on the other side, if you can, let's say, give us, probably I didn't catch, sorry, during the presentation, the performance, okay, of China in this first half? The second question is on the heat pump. I understood that this is an application that is gaining faction. Can you give us an idea if this is an application so far probably concentrated in Nordics, Northern Europe? And overall, what is, let's say, considering all the components and software, the -- let's say, the weight of this application for you as of today compared to your total sales? The third question is on the backlog. I understood that you still have tail end of the, let's say, backlog pre-COVID situation. Looking at, let's say, your backlog today, is, let's say, how can I say, stable year-on-year, it's up compared to the last year? Just an idea considering, let's say, your guidance, okay, for the second part. And the last question was on the tax rate. I understood that there was this expiry in Croatia subsidy. I thought that you were trying to get some renewal, okay, of this from Russia in terms of, let's say, lower tax rate or is it something, let's say, structure and so tax rate will be, I don't know, 23% going forward?

Okay. Thanks, Alessandro, for the questions. So starting from the regions. In the U.S., the performance has been -- okay, first of all, let's start from reminding that we had a very good performance last year because we had approximately 20% growth in North America last year. In general, the market in North America has been deteriorating very fast when the pandemic evolution started to deteriorate in the beginning of 2020. The performance is not bad in HVAC. So HVAC has a performance, which is not so bad, whereas on the other hand, the performance is poorer in refrigeration, especially in the food service application. Because in the U.S., in refrigeration, we are growing in food retail, but we are still pretty exposed to the food service application, and that has been performing very poorly in North America for obvious reasons. In terms of food retail, as I was mentioning, in general, in the market, the investments are very cautious and so in Europe and China, we managed to get a significant market share in this period. In North America, we are getting market share over the medium term. But over these 6 months, the cautiousness of the retailers in terms of investment prevailed. On the other hand, HVAC had a positive performance. We expect probably a slight improvement in North America in the future. In terms of China, so China had a positive performance in this first half. So China grew with a good recovery after the slump in the first quarter. Here we are having a good performance pretty across the board, I would say. But in general, we had a good performance in data centers in -- as well as in some applications related to indoor quality like hospitals as well as luxury condominiums, where we're seeing a number of projects. All of these projects for indirect quality but also data centers. They involve also humidification, the humidification business, because modification is very important for indoor quality and also increasingly important for data centers. We also had a good -- a positive performance in food retail in China because we are growing with some big retail chains that are having a good performance in China because they're opening stores, whereas, in general, on the food retail market in China, again, the market is cautious. But we are following some big retail chains that are opening stores. In terms of data centers, we are now -- since probably you remember that we started an activity of direct promotion to end users in data centers in China, we're now specified by 2 of the 3 biggest technology companies in China for their data centers. Going to the second questions. So for the heat pumps. Let's say that overall, heat pumps for us weight approximately 10% of the total turnover, approximately. The growth in this moment is -- yes, is mainly in Northern Europe because that's the region or the part of the world that historically has been more advanced in terms of the shift on technology. So we have several new projects there that are the results of the work done in the last few quarters with our customers, and these customers are probably benefiting from also the favorable regulatory environment for heat pumps that is present all over Europe, but especially in Northern Europe. We also have to mention that heat pump tends to be kind of seasonal because in the first half typically of the year, it's when they they create the stock for distribution base. So in general, we are very positive about the heat pump application, but it could have some seasonal fluctuations, but that has always been the case. Talking about the backlog. So the backlog was recovered almost entirely in June. In July, we recovered the last tail. Now the backlog related to the pandemic is over. So there's no more additional backlog related. Since the beginning of July, there's no additional backlog. And our order portfolio is the normal structural levels that we have. The performance that we have seen in terms of sales in July and August was positive regardless of the fact that the backlog was fully recovered. Concerning the tax rate, I leave it to Nicola.

Okay. Thank you, Francesco. And the tax holiday in Croatia was linked to the amount of investment that was done in the past in that factory. And due to the fact that, for the pandemic, we used more than expected capacity of this facility there, we use all the benefits that we had from the government in the past. At the moment, we are not foreseeing so big investment to have a tax holiday for the future in Croatia. The way to the country mix that we are expecting for the future, we foresee that the tax rate for the future will be around 21%, 22%.

[Operator Instructions] The next question is from Will Turner with Goldman Sachs.

I don't have too many questions, but just some kind of rather tactical ones. So the first being, the lower discretionary spend that you had relating to travel expenses and marketing, do you expect that -- those lower costs to stick going into 2021 or do you consider them temporary reductions? The second question is on the higher working capital consumption. You've outlined on why that is the case to give some more resilience in these kind of unprecedented times. But if we assume that we've -- people are adapting a little bit better to credit, supply chains are coming a bit better online, can we expect that working capital outflow to reverse in the second half or at some point in 2021? And then my final question is that given that you intend in the future to do further bolt-on M&A. Could you give us an update on how the performance of Hygromatik and Recuperator were in the second quarter? I think in the first quarter, you said that they both grew or at least one of them grew 10% organically. Did they manage to maintain growth in the second quarter? And are you still happy with their performances?