KONE Oyj (KNEBV) Earnings Call Transcript

Good morning, and welcome to KONE's Third Quarter Earnings Call. My name is Natalia Valtasaari. I'm Head of Investor Relations here at KONE, and I'm very pleased to be joined as usual by our President and CEO, Philippe Delorme; and our CFO, Ilkka Hara. So Philippe will start, he'll talk about the highlights of the quarter, how we're executing on our strategy. Ilkka will then follow up with more color on the markets, on the financials, on our outlook. Philippe will summarize as usual, and then we'll move into the Q&A session. [Operator Instructions] With that Philippe.

Thank you, Natalia, and good morning, everyone. It's a pleasure to be discussing our third quarter results. with you today. So Q3 was another good demonstration of the resilience of our business model, particularly in an environment increasingly shaped by geopolitical developments and their broader economic impact. We delivered another quarter of healthy order growth, and it's particularly encouraging to see this positive momentum continuing across several quarters with modernization once again leading the way. We also continued to expand our adjusted EBIT margin supported by a favorable business mix and disciplined cost management. At the same time, we are moving forward with our strategy with focus and speed. This quarter, we saw several tangible examples of innovation across our businesses, showing how we are turning our strategic priorities into solutions that create value for our customers. And finally, our planned combination with TKE is moving forward as planned and extremely well, I would say, and I'll come back to that shortly. But first, let's take a closer look at our financial performance. Starting with order received which grew by 5.5% in the quarter and 6.8% year-to-date in the last 3 quarters. And again, I'm very pleased to see that -- we have now delivered consistent order growth across several quarters. This gives us a strong foundation for future performance. I would also like to highlight the particularly strong performance in Asia Pacific the Middle East and Africa. Growth was broad-based across the region and across all 3 businesses showing how we are capturing opportunities in the structurally attractive markets. Turning to sales. We delivered growth of 3.8% in the quarter being year-to-date growth to 4.6%. This was a good outcome and keeps us well within our guidance range for the year. Our adjusted EBIT margin expanded by 40 basis points -- it's good to see operating leverage becoming an increasingly important contributor to margin expansion, demonstrating that our performance initiatives are delivering results. Cash flow was affected by higher inventories related to logistic disruption in the Middle East. And despite this, year-to-date cash flow remain at a very healthy level. So overall, I would describe this as another quarter of solid execution with performance very much in line with our expectation. Let me now turn to some of the exciting developments we saw on the innovation front this quarter. First, the 1-week modernization launch in Europe. By combining our modular offering with a more standardized and industrialized approach to installation, we can significantly reduce both delivery time and disruption for our customers. And at the same time, we connect the elevator, giving customers access to our full range of digital services, including greater transparency and predictive maintenance. This is a great example of innovation translating directly into tangible customer value. Staying with digital. I'm particularly impressed by the progress our team in India has made in accelerating connectivity. We also made -- we also recently opened our first digital experience center in India in Pune, where customers can see first-hand how AI, data and connectivity can improve both building performance and the user experience. Moving further east, I'm very proud that our new KONE home leaf concept designed specific for China's growing luxury residential market received the Red Dot Best of the Best award. It's a fantastic recognition of the strength of our design and innovation capabilities. And at the other end of the bidding spectrum, we are pushing the boundaries of what's possible in high-rise construction. Our latest high-rise innovations combine proven engineering with breakthrough technology to enable exceptional travel heights, make better use of valuable building space and move people smoothly through even the most complex building. And importantly, we already have a landmark project where this innovation will come to life. We've been indeed selected to equip Burj Azizi, which is at a planned height of 725 meters is set to become 1 of the tallest building in the world. So why were we chosen? I would highlight 3 key strengths. First, our unique hoisting technology, our UltraRope, which enable elevator travel of up to 1 kilometer. That's a significant step forward as building continue to reach new heights. Second, our next-generation destination control system, which uses AI and self-learning capabilities to further optimize people flow and reduce travel time. And third, but very important are people -- we bring the deep expertise and project management capabilities needed to successfully deliver high-rise projects of this scale and complexity. So for me, Burj Azizi is a great example of what innovation as KONE is ultimately about, which is solving customer challenges, creating a better user experience and opening up new possibilities for the building of the future. Let me now give you an update on the planned combination with TKE. The regulatory process is moving forward as anticipated. We are currently in the prenotification phase with the European Commission and are engaging in a constructive dialogue. In the other required jurisdictions, merger control filings have been submitted and we have already received approvals in 6 countries. In parallel, integration planning continues -- our key focus is on preparing for day 1 and laying the groundwork for SUS transition and business continuity following closing. As part of this work, we conducted a cultural survey across the organization and the finding reinforce our belief that we share a strong foundation while bringing together complementary strengths that we can build on going forward. In parallel, we are detailing the synergy road maps translating our EUR 700 million synergy target into concrete execution plan for the combined company. So overall, I'm very pleased with the progress so far and with a strong collaboration between the team. All of these reinforce our confidence in the opportunity ahead to accelerate innovation and create greater value for both our customers and our shareholders. With that, let me hand over to Ilkka, who will take you through the market developments and our financial performance in more detail. Ilkka the floor is yours.

Thank you, Philippe -- as usual, we -- and a warm welcome from my behalf on our third quarter results web cast. As usual, let me start with how we see the markets developing across the different regions over the past 3 months. In new building solutions, market conditions remained difficult in China. In Europe, market activity was stable. In the Americas unit volumes declined slightly, but there was a strong activity in larger projects in this quarter. which drove the market growth of more than 10% in value terms. So a clear difference between value and volume. Asia Pacific, the Middle East and Africa remained at a strong level, in line with previous quarters. And in service and modernization, we continue to see healthy growth across all geographies. Next, let's go through our financial performance in more detail. Let's start with order received. As Philippe mentioned, we saw healthy growth in the quarter with orders up to 5.5% on a comparable basis. For the first 3 quarters, that puts us at 6.8% growth. Modernization remained the key driver with orders increasing by approximately 10%. New Building Solutions also contributed to the growth as it repair orders in service. Looking at the regions. Europe declined slightly. However, it's worth mentioning that the comparison point was impacted by a few larger marine orders in the prior year. Excluding those, underlying development was more positive. Asia Pacific, the Middle East and Africa performed particularly well with a good development across the region and business line. Despite ongoing cost inflation, our mitigation actions are gaining good traction. And Q3 order margins outside of China were stable year-on-year. Then moving to sales. We delivered solid growth of 3.8% in the quarter at the comparable exchange rates. Growth in services and modernization more than offset the slight decline in new building solutions. With sales increasing by 5.9% and 8.1%, respectively, at the comparable currencies. From a regional perspective, the picture was much the same as previous quarters. China declined, reflecting continued weakness in the new building solutions, while all other regions delivered growth. Turning next to adjusted EBIT and profitability. Our adjusted EBIT margin expanded 40 basis points year-on-year, taking adjusted EBIT to EUR 369 million. Adjusted EBIT excludes items affecting comparability, which amounted to EUR 30 million in the quarter. We currently expect a further EUR 40 million in Q4 and mainly related to the planned DK transaction. Looking at the drivers of profitability. The main headwind continued to be the new equipment market in China. This was offset by favorable business mix and good leverage over fixed costs. So overall, another quarter of solid and consistent execution on profitability improvement. And finally, to cash flow. Despite the logistics-related challenges in Q3, year-to-date cash flow remained at a healthy level of close to EUR 1.3 billion. Working capital developed favorably supported by advances received and the timing of payables. FX also contributed with a positive impact of EUR 55 million year-to-date. Let's then look at our market outlook and guidance for the year '26. Starting with markets where we have made 1 small update our outlook. We now expect China new Building Solutions to decline slightly over 10%, consistent with the development we've seen so far this year. Our outlook for the other areas is unchanged. We expect slight growth in Europe and Americas and clear growth in Asia Pacific, the Middle East and Africa. For service and modernization, our outlook remains positive, with growth opportunities across all regions. Then to our business outlook. With 3 months left in the year, we have narrowed our '26 guidance slightly. Taking the midpoint up. We now expect sales to grow 4% to 6% at the comparable exchange rates and the adjusted EBIT margin of 12.5% to 12.9%. The FX impact on profitability is expected to be limited. Assuming exchange rates stay at the October level. And the performance drivers are very much consistent with what we have discussed in the previous quarters this year. Finally, let me give you a first look into how are we currently thinking about '27. The key themes affecting next year's performance are unlikely to come as a surprise. As I always say, boring is good. Starting with the headwinds. We are not seeing signs of challenges in China easing, so this is still a burden. At the same time, our exposure to the market has continued to decrease over the past year. Geopolitical uncertainty also remains a risk. However, together with associated inflatory pressure which we will continue to actively mitigate. On the positive side, we expect to benefit from the continued growth opportunities in service and modernization, our main profitable. As mentioned, we have achieved good leverage over the fixed cost this year and we expect this to remain supportive also next year. We also expect further contribution from our performance improvement initiatives. So those are our initial thoughts for '27. We will, of course, provide more color when we report our full year results in early '27. Let me now hand back over to Philippe to close the presentation before we move to Q&A.

Thank you, Ilkka. So to wrap up, let me first thank the KONE teams for delivering another solid quarter. Importantly, we continue our order book. We continue to build our order book during the quarter. together with the consistent progress we are making in strengthening our customer offering, and this supports our growth ambition for the next year and beyond. At the same time, our continued focus on profitability improvement is delivering results as demonstrated by the consistent quarter-by-quarter expansion in our margin. And finally, we continue to make great progress as we prepare to combine with TKE. Our focus is clear. being ready to execute our plans and serve our customers seamlessly from day 1. Thank you all for your attention, and let's open the line for questions.

[Operator Instructions] The next question comes from Daniela Costa from Goldman Sachs.

I have 3 questions. They're all relatively quick. So I'll ask them now. First, I wanted to ask on China, given the deterioration you still mentioned on the environment and on the margins. Is China still profitable? My second question is just on pricing outside of China. I would have thought that given where inflation is trending, pricing there would be positive, but your commentary does look a little bit more stable, maybe to clarify there. And then just the third 1 regarding the order growth rates in OE in Europe. It sounds like there was a bit of a deterioration quarter-on-quarter. But of the growth rates -- is that just comparable? Or do you see some things sort of weakening in Europe at the moment?

Thanks, Daniel. I'll start. So China, is it profitable? Yes. It's a simple answer. And on pricing, so I commented on order margins. Pricing actually has developed positively, given that there's been a cost inflation. So in order to achieve that, I think we've done a good job on improving pricing across the businesses to make that happen outside of China. And then order growth in Europe, I did mention that the comparison period for the order orders in last year was quite high. We had some large marine projects that were booked in '25, which are naturally impacting then the growth in '26. If I look at the underlying business, -- without those, it's much more healthier the development there. .

The next question comes from Vivek Midha from Citi.

I'll stick to 1 question. Again, on the new order margin comments. -- you changed your wording relative to the second quarter comments. You previously commented on a global basis. Now you ex China. Can I ask, please, is the global new order margin down overall? And could you maybe give us some color on how the sequential change has been in the new order margin from the second quarter?

Yes. So first, on the commentary. So we did see in Q2 that the inflation actually was quite rapid, and it we took actions, but to see that in order margins, it took some time. So that's why the Q2 commentary was valid for not only for China and ex China as well. In Q3, now we've seen quite a good result out of those actions on the pricing. And therefore, the margins have stabilized and actually are improving sequentially when you look at the look at the margins outside of China. Then in China, the continued very, very tough competition continues to impact the pricing and also the margin of orders is slightly down putting the total order margin slightly down also, but fairly slightly. .

And of course, the other components that impact the margin, selling price and pricing, the rest is the cost -- and we are intensifying the work we are doing in our product cost base in China, in India to make sure that we actually support some other cost evolution that will happen.

The next question comes from John Kim from Dutch Bank.

I'm wondering if we could stay on the China topic for a moment. Given the realities of this market, -- when do you see your book of business coming into balance in the sense that MBS continues to contract well service and modernization continue to grow -- is that something we could foresee in the next few years? Or is there something structural about the market that prevents us? .

So maybe I can start. So first of all, if you stay because we keep being fixated on the new construction -- the market in China is already a majority of modernization and service number one. Number two, we are approaching the goalpost where half of our business will be in service and modernization versus new construction. So we are following and trying to accompany the market switch as fast as we can. Today, as you see, we still have let's say, the downsize in NBS not being offset by modernization and service -- every quarter, the NBS part go smaller and the modernization and service part goes bigger. So it's going to take time. It's -- we have a crystal ball on when the MBS market will stabilize and be back up. I think Ilkka has been pretty clear that for '27, we don't see a major change in the trend in the market trend. So time will tell. The best mitigation for us in China is cash #1. Number 2 is prioritizing gross margin and contribution margin. And number 3 is moving as fast as we can to service and modernization because it's a more resilient business.

Okay. Helpful. A quick follow-on, if I may. -- if we focus just on the Chinese remit within the modernization mix between full and partial what's the ambition on a 2-, 3-year view?

So we won't today, the biggest part is more on full modernization. We've been actually seeing a very strong traction on our 1-week modernization, which really comes s as a big opportunity for our customers. And clearly, that's where we want to push more. It has higher margin, faster order book rotation. It's a better value proposition for customers on top of it. So that's where we want to go.

The next question comes from Vlad Sergievskii from Barclays.

I'll ask 2 questions 1 by one. First one, service growth this quarter remained around 6% despite you are now relatively easier comps in China. What do you think needs to happen for the total service growth globally to approach this 10% target that you are lying within the 3 year the?

So if we look at the performance of the 6% we get, so first of all, it's 6%. It's still significant. Now what we see that we still have some unit growth that's not to the average of the rest happening in China because we are prioritizing still cash and margin. So we keep working on, I would say, the long tail of some of our service base, which is explaining a part of the lower growth on service side. Second one, we had for pretty obvious reasons, less bolt-on M&A which was historically counting for 1 to 2-point growth. So it's -- we have prioritized other big deals, and I guess you will very likely understand why. Now we clearly see an opportunity with more repairs. -- even more pricing to get to an acceleration of our service growth. And we have this ambition insight, and we believe it's absolutely within our reach.

And sorry, Vlad, we -- 1 thing we didn't mention, but we are also very disciplined on improving the margin. because it matters also. And we actually see with digital and with the pricing and everything. But actually, we are improving -- not only we are improving, we have more service in our overall business, but we're also improving our margin in service, which helps our P&L. So that's important.

This is a very clear plan. And my second 1 on 2027 and thank you providing additional head and tailwinds that you see them today. Among those, you haven't mentioned IFRS 18 impact. while some of your competitors did. Does it mean that this impact will not be material for you?

Yes, is the answer. And if you check the appendix of our presentation, we gave the estimated impact for our P&L on that one, but it's not a big impact on our P&L.

The next question comes from Andre Kukhnin from UBS.

Can I ask about the guidance and the implied margin for Q4 in your narrowed margin guidance, I think if calculations are right here. we're looking for about sort of 80 to 90 basis points improvement year-on-year. And sequentially, this would be quite a nice step up. I think 1 of the higher ones we've seen in the history. So -- just wanted to check what drives that? Is there anything in particular for that quarter? Or is that a step-up that you expect to be as an underlying run rate?

Well, I think your math is right as normally. And yes, we do expect a quite a healthy pickup sequentially on the margins. Fourth quarter tends to be higher volume quarter for us. And now we continue to see service and modernization also being a bigger part of that volume growth at the end of the year. So those are the drivers for that improvement in margin for the remainder of the year. .

Great. And if I may, the follow-up on the service growth, could you give us some idea what kind of portfolio unit growth you've seen in Q3 and maybe year-to-date as well?

Well, maybe I'll start and Philippe made already a very good comment on the service earlier. So yes, indeed, if I look at where the growth opportunities are, we are seeing slightly less unit growth than we have in the trend line. And 1 part of that is China. Other parties that the M&A activity is somewhat lower due to natural reasons. So we want to make sure that every deal we make is also in context of the larger deal relevant. And clearly, where we see a big opportunity to continue to drive growth is in this repair business, really digitalizing the whole end-to-end repair business -- and also by doing that, improving the safety and reliability of the elevators going forward for our customers. .

If I may just check for [indiscernible] , but double follow-up. I mean, just given the size, relative sizes of your portfolios in Europe, U.S. and China, this must apply that you're pruning China units by bull digit, right?

We -- so last year, we did actually look at the portfolio in detail. I think what you're -- maybe you need to take into account as well that the new units coming from NBS are coming down. So it is some of the impact there...

In China.

In China.

The next question comes from Alexander Virgo from Evercore ISI.

I wondered if you could -- if I could approach this, the guidance and the margins in Q4 from a slightly different angle. And I guess really what I'm trying to get at is the top end of the guide. I think it would imply closer to 15% margins in Q4. And I'm just wondering if you could maybe help us with bridging to the top and the bottom end, so we can understand what needs to happen to get to the top or what would happen to keep you at the bottom end of the guidance?

Clearly, the revenue growth is 1 big driver. So how are the progress with our customers, both in NBS as well as in more how are we able to take the projects forward in the remainder of the year. And that's also then giving leverage on the fixed cost on the bottom line of the guidance. Then as I highlighted, a big part of the opportunity to grow continues to be on the repair business, which is a very good margin business for us, helping also to get leverage from margin point of view on that one. If I look at the other drivers for results, for example, material cost and those, they are quite fixed for the year given that we have locked into pricing with our suppliers. . Then lastly, of course, there's quite a bit of uncertainty related to the geopolitics and particularly Middle East. So in that environment, I have to give credit to our team done a fantastic job being able to continue to deliver to our customers despite the logistics challenges, but that's, of course, a moving part that the more we can deliver, the more effective we are then the more we get revenue and also profits.

Okay. That's super helpful. Could you perhaps just pick up on the pricing point here and talk to when you might be able to push pricing up again to account to the fact that we're still seeing sustained inflation on the raw material side?

Today. So of course, we're working on the pricing continuously. And like you said, so I think the difference between the '21 and today is that, first, we clearly were too slow to react in 2021. And now we took action immediately. And of course, there's a slight delay between -- from tender to order to see that in your orders. Very happy how quickly we reacted now in this situation across all businesses. Then secondly, -- from a product cost point of view, we have continuously room to improve and see that coming through as well. So you need to do both pricing as well as the productivity. And then lastly, when it comes to service business, I think the pricing with more inflation, we have also more opportunity to drive pricing and growth from pricing. But more importantly also that we see digital now driving productivity more and more, and Philippe was commenting as we start to -- and see that also in the profitability of the business.

And the last thing I would add is we've really stepped up our game on customer satisfaction with very simple things like following how fast we respond to our customers, how we are monitoring what we call the down equipment, the equipment that are not working. And it's always easier to price up when customers are happy and are satisfied. So the starting point of everything and we repeat it and repeat it is happy customers. So -- and can we still do better in that front? Yes, and we are working in customer satisfaction so that then customers are not a victim of a price increase, but they are actually following the price increase and they stay with us because they believe they have the best service with KONE.

The next question comes from Phil Buller from JPMorgan.

I've got 2. The first 1 is on North America MBS developments, which continue to be down in unit terms. But I think you said it was up 10% in value terms. I guess the volume doesn't come as a surprise -- so I was wondering if you're seeing any price elasticity kicking in, I have to comment in answer to Alex's question, but how are those discussions with customers going? Is there any change in market share given the pricing actions you're taking. That's the first question, please.