Fuchs SE (FPE3) Earnings Call Transcript

Dear ladies and gentlemen, welcome to the Second Quarter 2023 Analyst Conference Call of FUCHS SE. This conference will be recorded. After the presentation, there will be an opportunity for the analysts of FUCHS to ask questions. May I now hand over to Lutz Ackermann, Head of Investor Relations at FUCHS SE, who will start the meeting today. Please go ahead.

Yes. Good afternoon, ladies and gentlemen. This is Lutz Ackermann speaking. On behalf of FUCHS SE, I wish you a very warm welcome to today's conference call on the half year's figures. As always, you can find all the documents at our IR section of our homepage which we have uploaded at 7:00 a.m. this morning. And with me on the call today is Isabelle, our CFO; and Isabelle will run you through the presentation in a second. Afterwards, there will be a Q&A session where you have the opportunity to ask questions. Having said that, I would like to hand over to Isabelle. Isabelle, please go ahead.

Thanks Lutz, and a warm welcome from my side as well to what is the first-ever analyst conference of FUCHS SE. So as you can see we successfully lost the PETROLUB, July third and are now FUCHS SE only. I'd like to guide you through the numbers of what we believe was a very successful first half of the year. So as you can see, all of our KPIs, we always look at are up significantly. Sales as well as EBIT are up by 11%, which means we are already back to profitable growth. So looking at this 1.8 million in terms of sales, this is the best ever half year we've done in the history of FUCHS SE over first half year, up 11%, majorly obviously price driven. So the work our sales team did was amazing, really pays off now. So the strong prices we put into place in 2022, now show their full effect. This is why sales up, EBIT is up significantly as well. Now it's an EBIT margin of already 11 points again, growing equally fast, which means the price increases we put into place to not only cater for the higher raw material costs but for the general inflation we will see later as well. I think we are most proud to announce that the free cash flow in the first half of the year was even beyond our expectations. So we came out at EUR 164 million before acquisition, which is due to the strict working capital management we put into place end of last year. So what we saw in contrast to the years before is that we didn't have -- quite had any working capital built up towards the half year. Usually, this looks very different and this is why our cash conversion is way beyond 1 in the first half of the year. Due to those good numbers and I think in contrast to a lot of other chemical companies, especially in the German-speaking area, we are proud to confirm our outlook for this year, the sales of EUR 3.6 billion, added EUR 390 million as we are above prior year. And due to the good results we saw from our working capital management and the strong cash flow, we would like to increase our guidance for the free cash flow from formerly EUR 250 in to now EUR 300 million for the entire year. I will guide you through the numbers in a little bit more detail and then reiterate our guidance at the end of my presentation. So what we saw in the second quarter was sales of 386 million way beyond what we achieved in prior year was 832 million. In total, for the half year we were up by 11%. Looks like quarter 2 was a little slower compared to quarter 1, but this is not really driven by the volumes but mainly by prices or the price variation clauses starting to come down. As you will see later, prices battery raw material prices now started to come down at least in some of the regions already. And this is obviously the effect we will see from this, let's say 25% of our sales roughly covered by price variation closer. Looking at the EBIT development, we are [indiscernible] that we were more or less able to repeat a very successful quarter 1, so I think what we need to take into account that there is one special effect in quarter 2 due to the closure, due to efficiency reasons and the move of some production at our location in [indiscernible], all of these is catered for in Q2 already, which is a mid-single digit amount. So compared to this quarter 2 would look very similar to what we saw in quarter 1, so yet another quarter above EUR 100 million. And I think this is why we are very, very convinced that we will be able to meet our guidance and expect a second half of the year at a similar rate, what we saw in the first half of the year. Looking at where the growth came from I think it was a very good achievement. All of the growth we saw in terms of top line and then obviously, EBIT as well came from organic growth. So no acquisitions to take into account here but all of that is managed by ourselves. But what we start to see now is, obviously, and as already announced earlier this year, the first impact from the stronger euro. As you might remember, last year in quarter 2, but then especially quarter 3, we had a very weak euro where partially we even had parity to the U.S. dollar, a very strong RMB. And this, we expect to revise during this year and those are the first impacts of those EUR 52 million we lost in the first half of the year already. So having said this, in summary, I think sales EBIT growing at the same rate, improvement in the margins again, our gross profit up by 10%. So we compensated for higher raw material prices in the general cost inflation, most of that as well because what you can see in other functional costs they are obviously up compared to prior year as well due to the higher personnel costs. So most of that really salary increases of existing employees. We are still very cautious in terms of adding additional head count, which you can see in our headcount numbers. But of course, we need to make sure to absorb the extraordinary increase inflation rates we saw last year. We now have the full year impact of higher freight and energy costs as well, although we already see that a slight relief might come here and continue hopefully in the second half of the year. For our CapEx, we still stand for our former guidance of EUR 80 million, so on the level of our depreciation every year. But general pattern we see is that we have slightly slower spending in the first half of the year, but we still expect to come up at EUR 80 million at the end of the year, although we spent a little more in the first half of the year than we did last year. And then I think, definitely, the biggest change compared to last year is the increase in net working capital. If you remember, same time last year when we talked, we had to build up almost EUR 150 million more in working capital due to the increases in raw material pricing. We saw partially after Russia invaded Ukraine. This year, we were able to keep our net working capital more or less on the same level we had at the end of the year and that's despite the fact that our sales grew by 11%. So you can imagine that our receivables are now due to the higher prices we have from the market significantly higher than what we had at year-end. So we did a very good job in managing our inventories, managing our payables to make sure that this stays at a constant level. And this is why we are proud to show you free cash flow before acquisitions of EUR 164 million for the first half of the year. Having said this, I think it's worthwhile to look a little bit into the different regions to give you a flavor of what is happening and where our growth is coming from. EMEA has shown a very strong performance, a surprisingly strong performance in the first half of the year. Almost all countries we are in, we saw double-digit growth rates in our sales. So this does not come from Germany only but from countries such as: Great Britain, Sweden, Poland, France, as well. So across the board we really see a very favorable development in terms of sales as well as, obviously, the effect of the price increases we put into place last year, a very strong increase in EBIT for our own entities but for our at equity companies as well. We have some small currency effects. This is majorly due to the fact that we have countries like Great Britain and Poland in here. But I think the bigger effect we will see later on from the 2 other regions. But I think in total, a major contributor to our growth was the EMEA region again and we can see what a great job our salespeople did last year who's really making sure that the price increases are passed through to our customers. Looking at the Asia Pacific region. This is more of a mixed picture. So we see increase in sales compared to last year although not as high as we would have expected it in the beginning, but at the beginning of the year, but I think this is a very strong signal that the rest of the group is able to compensate for the moderate economic recovery, how we would like to phrase that what we see in China. And even in the APAC region itself, all of the countries we have, maybe Australia, India, the Southeast Asia region or East Asia with Korea and Japan performed convincingly well and had very good results compared to last year. But what we, of course, have to take into account looking at the Asia Pacific region is the effect China has on that region being by far the largest country there for the FUCHS group. And what we see is a good contribution yet not as strong as we would have expected this beginning of the year. Why is that? Well, I mean, if you look at how the economy in China is developing, growth rates are not yet or not there where we used to see them before COVID. The economy is still relatively slow, there's a lot of uncertainty in the market, the demand from the industry is not as strong as it used to be before COVID, and we only see a slow recovery, especially due to the fact that a lot of export business in China is not there yet, and it's only picking up slowly. Which means, especially for our business we already have, so the base business, the volumes are not coming back as fast as we would have anticipated. Although our team in China was very successful in gaining new accounts, getting access to new customers in the market. So we were able to compensate for most of the volume growth that did not come from the existing accounts yet. So I think this is very good news because once the economy starts to pick up again, we have the old base business with Chinese as well as Western customers and we already have the new business and our books with the customers. We now onboarded to make sure that we can at least meet our expectations. We expect that recovery to continue at a similar speed throughout the second half of the year. And last but not least, looking at our Americas business, we saw really nice growth rates compared to last year. So very good growth in sales, a slight effect from currency already but then growth in EBIT compared to last year as well. So think what is extremely important to mention as we saw good growth rates in the U.S. despite the fact that they are at the brink of a recession right now, but our team still has very good access to the customers, volumes are still adequate level, and we see order intake coming back for what is the third quarter as well. We saw really nice developments in Brazil, in countries such as Mexico as well. So I think, in general, a very good, good success story for the region and well above what we saw in prior year. Coming back to our net liquidity again. I think, again, worth mentioning free cash flow above earnings after tax. So cash conversion well above 1.1 for the first half of the year, especially due to the fact that we did not have any build up in net working capital. To put that into perspective, what does that mean? It means that we out earned the dividend payment we did for last year in the first half year alone. We would have expected the net liquidity to be at a much lower level as of June because of the dividend, the share buyback, but we already earned all of this in the first half of the year, which I think is a very good success story and we expect that trend to continue throughout the second half of the year. Major contributors to this development was the net working capital which you can see on the next slide. So you see a nice trend in inventories they are gradually going down compared to quarter 4, 2022. We are now at 24% working capital in terms of sales and will further look in to lower that ratio. But as you can see, compared to quarter 1, inventories are down again, and even receivables net of liabilities are down despite the fact that the revenues are up significantly. And so I think this is a very good success story, and we will put all our assets towards year-end to make sure that this number is lower than again. So to reiterate the guidance, we are very confident that we do not have to lower our guidance compared to a lot of other chemical companies, but we are confident that we can at least repeat the first half of the year in the second half, although the current environment, as I said, in the U.S. but in Asia as well, obviously, it's a little difficult to navigate. We saw varying demand, a lot of other companies issue profit warnings, this is why we decided to stay on the cautious side to make sure to cater for all of those risks. Although, of course, guidance around EUR 390 million does not mean that we will not do all that is in our power to exceed this number and that the number in the ballpark of EUR 400 million could be achievable. For the forecast and for the free cash flow, we are already very certain because this is within our own power that we can exceed the EUR 250 million. This is why we decided to take off the guidance we put for the free cash flow to EUR 300 million because we believe that we can continue on the successful path of getting back part of what we invested into our working capital over the last 2 years. Last but not least, as always, I would like to give you a slight view on how the pricing developed, which somehow ties to the comments I made earlier in terms of the development for our price variation closer. So we saw the Group 1 and Group 2, which behaves very similar to the 3 graphs you see here coming down a little bit again in quarter 2. Although the -- the medium blue line you see in EMEA, we already saw a slight bounce back. So what we see now is more, or say of the normal picture we have before that where usually the prices for Group 1 and Group 2, they're relatively close together across the region. So what we saw -- what was a little unexpected in the second quarter of the year was 0.1%, the uptake or the slight uptake in Germany or Europe in general, again, and the relatively high pricing level we see in China for almost all of the raw materials. What we are happy to observe is that finally, the prices for Group II oils are coming down a little bit. As you might remember, we had what we call a structural tightness in the market namely; the output of Neste not being where it used to be after Cheuvreux took over. So we now see that this is improving and we have 2 players in the market right now who can deliver not at full volumes, albeit, we do not have to rely on SK only anymore but Cheuvreux is back in the game and this is why prices start to come down slightly. The rest of the pricing, additive packages and raw materials, other raw materials, still above long-term average and only coming down slightly. And just to remind you, those costs cater for roughly 60% of the materials we buy to manufacture our products. And this, I think, is our expectations towards Q3 and beyond that -- the pressure on the prices, the raw material prices is anticipated to remain and we will see a slight decrease throughout the end of the year, but no, let's say, full of prices, we still might have expected beginning of the year due to the fact that prices were very inflated when we started into 2023. As on average, our raw material basket grow, just to remind you, from mid-2021 to end of 2022, roughly 70%. And we now see that we are slowly getting back to the level where we were beginning of 2022, which was inflated already. Having said this, thanks for listening to the call. And I would now like to open the floor for any questions from your side.

[Operator Instructions] We will take our first question and the question comes from the line of Markus Mayer from Baader-Helvea.

I have one question actually. And again, on the guidance, what I understood that you want to be cautious and that played out very well. But I do not understand you have achieved over half of the guidance already. Q3 seasonally is the strongest quarter and you have explained that gross margin should improve further. So why only a reiteration of the guidance? Do you see any kind of demand slowdown or expect a significantly worsening that this kind of implicitly earnings decline sequentially from the first to the second half is explained?

Markus, thanks for your question. So I think as I already said, we decided to stay on the conservative side. Why is that? Well, I think generally, we expect the second half of the year as historically to be at least as strong as the first half of the year. But of course, what we saw, not only in China, but in a lot of regions that the current environment is a little difficult to navigate into it. So we do not really see, I would say, the downturn in demand, that would be wrong to say. Our volumes are very stable. But what we see is that our customers are getting a little more cautious in terms of managing their cash obviously as well. So the demand is not as steady as we used to see it but it's more -- they look at the inventory levels, they start to order and they order when they need it. And this -- and especially when you look at how the chemical industry is now behaving with profit earnings of almost all of the big companies. And this is usually a very early indicator of how the economy in total is developing. We decided to stay on the very conservative side to make really sure we can deliver on our guidance. But as said, that, of course, does not mean that we will not do all that is in our power to exceed that guidance.

Okay. Understood. But maybe I can steal another question on this topic. One of the questions or one of the problems of the chemical industry was also the inventory levels at customers. Do you have any idea of where the inventory levels that your customers are? And potentially most at risk would be then customers in the automotive space here, the destocking has started quite late. And also in the capital goods space, where most of the capital goods companies had pretty strong -- or backlogs and now they fear they're coming down. So how is it one regarding the inventory level at the customers?

I'd say, overall, and I think we have a pretty good view on that because one of the services we offer for our customers is their liquidity management, their inventory management as well. So this is why for a lot of customers we see that. We do not really see a significant change in behavior in terms of how much they put on stock. What we rather see is them being more cautious in terms of when do we reorder. So it's not like, okay, please monitor for the level yourself and once it's below a specific threshold, you can deliver, but they now really say, okay, we want to face the order to really make sure they can manage. But what we see is that the inventory levels has been pretty stable and this is, I think, due to the fact that we are [indiscernible] linked into the crisis phase and help them manage the crisis phase as well. So this, I think, for us not be that applicable, I think mainly due to the fact that usually our product for the overall production cost of our customers are not very significant, but they are mission critical. So I think what we deliver to them is one of the last things they would look into when saying we will somehow lower our security staff, so we have to [indiscernible].

Your next question comes from the line of Isha Sharma from Stifel Europe.

I have 3 questions, please. The first one is, as you try to win business in China, are you experiencing price competition? Is that the reason why we saw a sequential decline in EBIT margin in Q2? And is this the run rate that we should assume going forward given that volumes are difficult to find? The second question is on the gross margin. We saw an improvement sequentially by around 130 bps in Q2 versus Q1, but this did not drop down to the EBIT margin. Can we expect this to change in the second half through cost management that you've also mentioned in the presentation? And then the third one would be on just the price momentum. So we see that the price momentum is moderating. Was I right in hearing that you said 70% of the prices are bound by clauses? And how should we think about the development in the second half and more importantly, in '24, please?

Isha, thanks for your question. So towards the competition in China, I think what we see in China, obviously, right now is still somehow China finding their path towards the new normal and this, I think, is especially challenging for the Western company which reps our customers. So what we are trying to do, and this is where we harvest from the investments we did over the last years that we now have a fully-fledged R&D team, a business development team, grease plant in China is that we can -- we're now really focusing on winning business with Chinese customers. Of course, I mean, when it comes to margin, there's always a mix effect in there that you have to cater for as well, depending which industry you look at, what kind of products you look at -- so I wouldn't generally say that the competition is more heavy or that we win an industry that we somehow win Otis that are not as lucrative but maybe different industries, different kinds of customers, and this is why we have some kind of mix effect in there. But I think margin effect, of course, there's very high cost inflation in China as well because of the supply chains that have been disrupted so long because of the higher labor costs you have there, although they start to come down with a high unemployment rate. China is now facing for the first time -- but I think that this is the biggest reason why it is yet to come that the full effect is dropping through. But I think the margin effect has really moved to the effect that we have a very different mixes. We have customers from different industries now there that we win business was really Chinese customers, especially with Chinese OEMs. We're really proud of that. But of course, to put your foot in the door, you need to invest a lot, you need to talk to them a lot. So what we expect once our base business is bouncing back that the margins will be back at one point in time to pre-COVID level. Talking about the entire group in terms of gross margin versus EBIT margin development, we already see the first effect of the price -- light price declines we [indiscernible] decline because it's very moderate what we see there in the gross margin although bigger effect yet to come because, obviously, as we've reduced our inventory levels, a lot of inventory with a higher price was still used in the second quarter. So we expect to see the full effect in quarter 3. Why did not all of that dropped down to the EBIT margin? Well, because when you remember last year Q2 was really the quarter that topped up most from all the price increases we saw due to the invasion of Russia in Ukraine with energy prices skyrocketing with freight suddenly skyrocketing. So this is why you see the biggest effect because most of that came through after that in second quarter. But I believe that most of this is absorbed by now, so this is why it should tackle down to the EBIT margin move in the months to come. And then price effect, we have, especially with the big customers, we have so-called price variation clauses. So at the end of every quarter, we review their prices to make sure we do not need to spend a lot of months negotiating. But this is not 70%, but roughly 25% of our revenues. The 70% was the raw material price increase for our basket from mid-2021 to end 2022.

The next question comes from the line of Martin Roediger from Kepler Cheuvreux.

Sorry to come back on, your EBIT margin was 11% in Q2, basically stable versus Q1. Why is there no sequential margin improvement despite some sequentially shrinking raw material costs while you have actually raised selling prices still at the beginning of this year. Does fixed cost inflation, you mentioned the salaries increase have such a huge sequential impact that Q1 costs have completely eaten up the rising spread. That is my first question. Secondly, and then getting a bit more in detail. Regarding the part of your portfolio, which is based on price variation gross so 1 quarter of your portfolio. In Q1 conference call, you said that the effect from price variation clauses has not been what you had expected. I recall that it was the hope of the Whiting spread for this customer group. Did this perception changed now in Q2 that you had more benefit from that? And thirdly, regarding the other business, which is not based on price variation causes, do you receive pressure from customers to lower your selling prices and pass on shrinking input cost to them because they also reduce paper and they know what base prices and additive prices are doing?

Yes. Thanks, Martin, for your questions. So going towards the 11% EBIT margin for Q2. This is very similar to what I said earlier. So I think this is a mix of 2 things. Point one, really the fixed cost impact being massive in quarter 2 compared partially to last year, then as quarter 1 as well with the full year impact of all the labor cost increases, we saw the freight in the energy prices. Yes, I think there's still a big impact on what we cannot neglect as, of course, once raw material prices start to come down. I mean, I think you still have to take into account the chart we showed it normalized the beginning of 2022, and it only comes down slightly. So it does not mean that we suddenly have an impact of 20, 30 percentage points. it's still in the single digits. But this still has to take a flow, right? You already saw the full effect in the cash flow, obviously, this is what we pay. But then we still have to wait for our entire inventory to turn around. This is why we did not see the full impact, but this will continue to take a thorough in quarter 3. And for the price variation clause is -- it is true that we said, okay, we did not really see an impact or not that much of an impact because prices were so stable in quarter 1. But although we recalculate that number at the end of every quarter, so we saw first banks coming down, but although still at a very, very moderate level as that normalized the beginning of 2022. So this is not yet as significant as we would have expected it to be. When we looked at the beginning of the year because we somehow food that at one point in time, prices will come down to more, let's say, pre-2021 level, but we are not there yet, and we do not see big shifts in this part. And this answering your last question, is there a lot of pressure from customers? Not yet. And I think we still have a very good, good leeway to explain that prices are still on a very inflated level right now, especially when you look at our mix that we say base oil 1, which is close to crude oil, maybe only 10%, 15% of what we buy and the rest of the portfolio, especially additive packages single chemicals, they are only coming down very, very slowly. This is what we obtained.

Your next question comes from the line of Sebastian Bray from Berenberg.

I would have 2, please. The first is on OpEx inflation. I think it's been mentioned in the past that part of this was due to relatively elevated rates for things like road transport via truck of lubricants and so on. But I think those may have started to ease a little and the number was still relatively high for H1 at 9%. What is a good through-the-cycle figure to start thinking of from 2024 onwards for the OpEx line of folks? And my second question is on volume growth. I suspect that volumes were probably a bit weaker than was anticipated at the start of Q2. What type of year-on-year volume development do you have baked into your EUR 390 million guidance and which end industries have been weaker than others? It seems as if automotive demand held up reasonably well in Q2, which leaves me scratching my head as to where the industries were weaker.