Azelis Group NV (AZE) Earnings Call Transcript

Good morning. Welcome to the Azelis Group's First Quarter 2023 Trading Update. As usual, we are joined by Dr. Joachim Müller, CEO; and Thijs Bakker, CFO. Joachim will start with the strategic highlights for the period, followed by Thijs, who will give a financial update. Joachim will then wrap up with an outlook for the remainder of the year and open the floor for Q&A. We remind everyone that this presentation may contain forward-looking statements that are subject to risks and uncertainty. [Operator Instructions] We will make the recording of this presentation available on our website later today. Joachim, over to you.

Thanks, Pam. Hello, everyone, and thank you for joining us on this update call. I am pleased to report a robust set of results for the first quarter of 2023. Our revenue increased 12% to EUR 1.1 billion, and adjusted EBITA grew even faster to 15.5% to EUR 134 million. Organic revenue was slightly behind by 1.2% compared to the level we achieved last year. To put a slight decline into context, we are comparing these results to Q1 2022 when we reported a total revenue growth of 59%. Since the beginning of the year, we have closed 3 acquisitions that further strengthened our letter of aging: Smoky Light in the Netherlands; Chemiplas in Australia and New Zealand; and Lidorr in Israel. In early April, we also signed the agreement to acquire Vogler Ingredients, a leading food and nutrition platform in Brazil. That acquisition expands our footprint in Latin America, following our entrée into the region with the acquisition of ROCSA in Colombia in July last year. Together, these 4 acquisitions had combined annual revenues of EUR 260 million in 2022. The strength of our business model is even more reflected in our gross profit growth of 12.7%, of which 2% was organic. Our adjusted EBITA margin increased by 15.5%, of which almost 4% was organic. As a result of the profit growth, the EBITA margin expanded by 36 basis points, and our conversion margin improved by another 123 basis points to 50.4%. The 100% cash conversion ratio during the period is another demonstration of the strength and effectiveness of our business. Operationally, we continue to work towards our objective to be the industry reference in digital, sustainability and innovation. We continue to make progress on the rollout of customer portals, and we now have 25 e-Labs live. We also continue to move and invest in our lab network, which is at the heart of our innovation strategy. Let's now go through some of the highlights of our growth drivers in the next slide, what you see now. Across the 3 regions where we operate, the normalization from the exceptional growth in 2021 and 2022 is ongoing. In addition, the macroeconomic uncertainty in markets around the world, including the impact of high inflation, is reflected some of the trading trends we have been serving since the final months of last year. Notably, in the Americas. Thanks to our diversified footprint, the continued growth in EMEA and APAC offsets the weaker trends in the America. In EMEA, where we generated 4.4% organic growth, momentum remained strong in Life Science and stable in Industrial Chemicals. Worthwhile noting that the region, Middle East and Africa, looking at the annual run rate, the EUR 300 million plus business for Azelis continued to see strong organic growth rates comparable to last year. In the Americas, the weaker trends we reported for Q4 2022 continued in Q1 this year, namely in FNF and CASE. The situation in the Americas was disappointing, but we see some uptick and are confident that things have bottomed out. In APAC, Southeast Asia has continued to be strong across most end markets. India is also holding up very well. Although China has probably bottomed out, the recovery is not evident in Q1 yet. Having said that, we see promising trends in the order book in China as business activities start to resume following the lifting of restrictions in January. The strong performance in EMEA and APAC offsets the weaker trends in the Americas. The outlook for the 3 regions allow me to remain positive for the full year. Besides the 4 acquisitions already mentioned, we continue to see a lot of effective acquisition opportunities to further strengthen our lateral value chain. Let me now give the floor to Thijs for an overview of our financial performance in the first quarter. Thijs, to you.

Thank you, Joachim. Good morning, everyone. As per usual, I will now provide you with a brief summary of the group's financial performance for the first quarter. Let me start on Slide #8, where you will find a summary of the 3 months P&L with a revenue split between Life Sciences and Industrial Chemicals. Azelis started a year with good business momentum, and we delivered according to our expectations in the first quarter of 2023. We recorded revenue of EUR 1.1 billion representing a 12% year-on-year growth. This robust Q1 performance follows a record-setting year for the industry as well for Azelis in 2022, especially with regards to revenue growth. Organic revenue for the group was 1% lower in year-on-year Q1 2023 compared to organic revenue growth of 33% in the first quarter of 2022. This resilient performance in the first quarter reflects the diversified nature of our business across branches and market segments and principles. The revenue growth from contribution from M&A during the first quarter of 13%, while FX translation was neutral. Diving deeper into the composition of the EUR 1.1 billion revenue in Q1, EUR 669 million of revenue came from Life Sciences, which is up 12.9% over Q1 2022, supported by continued positive momentum across end markets, especially in EMEA and APAC. Our Industrial Chemicals business delivered EUR 424 million of revenue, representing a 10.8% increase versus prior year to limited organic growth. Performance in Industrial Chemicals showed a high degree of variability of demand across our geographies as well in the underlying segments, reflecting the current environment. Our gross profit for the first quarter was EUR 265.8 million, a 12.7% year-on-year increase, of which 2% was organic. Gross profit margin expanded by 13 basis points to 24.3%. The expansion was the outcome of disciplined pricing and mix effects from existing businesses, tilting more towards Life Sciences, offsetting dilution from recent acquisitions, which came with lower margins. Despite the mix effects and the dilutive effect of M&A, this increase in gross profit margin demonstrates our ability to navigate the current environment and still consistently expand our margins. In the first quarter, we generated adjusted EBITDA of EUR 141.7 million, with the adjusted EBITDA margin expanding 47 basis points to 13%. During the period, we achieved an adjusted EBITA of EUR 134 million, a 15.5% step-up from prior year and results in an adjusted EBITA margin of 12.3%, representing margin expansion of 36 basis points compared to the already very strong margin achieved in the prior year. This all resulted in a conversion margin of 50.4%, which is a 123 basis point step-up from the same period last year. So let's move on to the next slide. I would like to provide a quick overview of the growth breakdown of our headline financial metrics between organic and inorganic. As already mentioned, organic revenue in the first quarter was broadly stable, which is strong performance in EMEA and APAC well ahead of market growth, offsetting a temporary weakness in the Americas, where we have a higher concentration in Industrial Chemicals, both organic as well as by our M&A in Lat Am. After such strong growth in the prior year, we are pleased to have been able to broadly hold our ground on group organic revenue even after accounting for the headwinds seen in the Americas in the first quarter. The first time inclusion of acquisitions generated 13.2% of our revenue growth for the first quarter as we continue to execute on our M&A pipeline. FX translation impact was neutral as the positive currency evolution in the Americas offset the negative impact in EMEA and APAC. Our business in EMEA and APAC continued to deliver solid organic growth. EMEA delivered 11.2% revenue growth in the first quarter to EUR 501 million. Organic revenue growth in the region was 4.4%, performance we are pleased with given that it is coming on top of a record organic growth in the comparable period last year of 34%. Performance between Life Sciences and Industrial Chemicals varied across different countries, with our EMEA business performing strongly amidst general good performance for the region as a whole. Revenue growth contribution from acquisitions was 8.9%, and we recorded a 2% negative revenue impact from FX translation. Asia Pacific also delivered strong total and organic revenue growth. Revenue increased 47.5% with the region, delivering strong organic growth of 11%. That is following the 44% organic growth in the first quarter of 2022 and despite China not being back to pre-COVID levels yet during the period. In particular, the performance in Southeast Asia was positive. Revenue growth contribution from acquisitions was 38.5%, and the region faced a revenue headwind of 2% from FX translation. Strong performance in EMEA and APAC offset the weaker trends in the Americas, which was impacted by destocking in flavors and fragrances and in Industrial Chemicals, in particular, CASE in U.S. This put pressure on organic revenue offsetting the performance by 13% during the first quarter. Revenue growth contribution from acquisitions in the Americas was 7.5%, and FX translation had a 3.7% positive impact on our revenue. So bringing it all together, total revenue of the group increased by 12% to EUR 1.1 billion in the first quarter of the year. Despite slower top line evolution, we were still able to grow our profits. Adjusted EBITA in Q1 2023 was EUR 134 million, an increase of 15.5%, of which almost 4% was organic. This clearly demonstrates the strength of our business model allowing us to continue to grow the profitability even with a more subdued top line development. Let's move on to the regional update. Starting with EMEA. gross profit increased with 16.3%, of which 9.4% was organic. Faster growth in gross profit relative to revenue growth were driven by positive mix effect tilting towards Life Sciences particularly pharma as well as disciplined margin management initiatives accelerated by M&A integration progress where 5 companies went live on our Central European analytic platform. The EBITA margin in EMEA expanded by 113 basis points to 14.5%. This translated into a 203 basis point step-up in conversion margin to almost 56%. In the Americas, despite the revenue headwinds, gross profit margins held up 24.5 -- 25.4% despite slightly weaker top line and addition of M&A at lower margin levels. Adjusted EBITA margin also held up at 13.6% with the conversion margin remaining strong at 53.7%, reflecting the strength of underlying business. Asia Pacific continues to be an important part of the group's growth engine. Gross profit grew 43.5%, of which 11.8% was organic. Gross profit was slightly behind the level in prior year at 19.3% due to the dilution from new acquisitions, which tend to come with lower margins initially until they are fully integrated. We made excellent progress by adding 5 companies on our ERP and analytics platforms in the first quarter. Adjusted EBITA margin in APAC increased 58.1% driving a 62 basis point adjusted EBITA margin expansion to 9.2% during the quarter, resulting in a very strong 439 basis points step-up in conversion margin to 47.6%, clear demonstration of scale benefits, offset temporary margin dilution from M&A. Now let's look at the main driver of our cash flow generation, working capital on Page 11. Net working capital to revenue normalized for acquisitions was 14.7% at the end of March, broadly the same level as last year and following historical patterns. This is partly due to revenue development compared to the peak of Q1 2022, but mainly due to the impact of new acquisitions, which have higher DIO levels and it takes time to get them integrated and get them to Azelis standards. As communicated before, we believe that there will be more upside in this area, working hard on that as we integrate these acquisitions and bring them on our ERP with integrated S&OP capabilities closer in line with group policies. To give you an idea about our progress in our working capital improvement of our newly acquired companies, last year, our working capital as a percentage of sales was 14.6%, which is now in the organic bucket and is performing at 13.2%. The difference between the 32% and 47%, driven by higher gross working capital of newly acquired companies. This further supports our confidence in our cash generation ability regardless of business economic cycles. With that, I'm handing the floor back to Joachim for some closing remarks and the outlook.

Thank you, Thijs. The results we just presented demonstrate the strengths of our business model, the benefits of our diversified footprint and our unique lateral value chain approach. Azelis performs in challenging times, delivers profit growth and we continue to make progress on our growth strategy. Accordingly, we remain confident that we will achieve or, actually to be more precise, exceed our midterm guidance for the full year 2023. As a reminder, we promised an 8% to 10% annual revenue growth and the 10 to 15 bps EBITA expansion in our midterm guidance. Thijs informed you in the year-end call and actually also another publication that our revenue run rate is around EUR 4.4 billion at end of 2022. We also mentioned in today's call that year-to-date, we acquired business with annualized sales of EUR 260 million. So the revenue portion for 2023 is well covered. It will take us some time and Thijs spoke just about it, to improve the margin profile of recent acquisitions. Regardless, we also stick to our guidance to expand our EBITA margin by 10 to 15 bps annually. Anyway, let's now open the floor for some questions. Operator, back to you. Please go ahead and open the lines.

[Operator Instructions] We will take our first question from Suhasini Varanasi, Goldman Sachs.

Just a couple for me, please. I think in 1Q, is it possible to give some color on how the volume versus price dynamics have generally been and whether the sequential trends on volumes, how have they been in March and April? And it looks like maybe on the order book, you're seeing some signs of inflection. So am I right in reading it that you're seeing maybe some positive signs with inflection that bodes well for the third quarter growth onwards?

Sequential volume, we basically see -- Suhasini, we see a shift into Life Sciences. We still see basically the destocking effect in FNF in Americas, where volumes are declining. Prices are holding up as much are holding up. And you can see that also clearly demonstrated in our gross margin performance. Overall, the volume development in Asia is positive, especially in Southeast Asia, which we indicated. And Europe, yes, is doing actually quite okay, and we have a higher percentage of Life Science effect, which is much more resilient and not that impacted by macroeconomic volatility. So that -- I hope that gives you some color.

And on the order book, I can talk on that. We have reported end of -- actually, for the end of last year when we reported, then earlier this year, we have said that FNF was kind of the harbinger of volumes going down. That has bottomed out and we see it's marching up a bit. Then CASE followed up and that was really related also, obviously, late cycle with just regard to that -- we all know that household starts looking into the U.S. now, which is a very significant market for us that this kind of came down already mid-last year. We did see the effect coming to us end of last year. And then obviously, we had -- the supply chain was very full. So there was -- the effect of low demand plus the full supply chain, which was not good. But also in here, we see now in North America, in the U.S. specifically, an uptick. We have a very mixed picture here in Europe, where some of the markets are really holding up well also on the industrial side with regard to volumes on Life Science. Thijs spoke, this is still doing good. But again, it's a mixed bag of different countries we do business in. And yes, on the order book on China, we were hopeful that the development after Chinese New Year would really start stronger, but has also indicated, we see an uptick in order intake there over the last couple of weeks.

Sorry, just a follow-up, please. So is it fair to assume that Q2 basically is your trough in terms of volumes and then, therefore, it should pick up towards the end of 2Q and going to 3Q?

Sorry, can you repeat your question? Is it a trough?

So the volume...

We think we are -- have seen the bottom of it and we're getting out of [ the door ]. So it's getting better going forward. This is what we have from the analysis on looking into different markets and regions have completed.

So Suhasini, to give you in a summary, we gave you some points also in the press release. We have open order of 3 months visibility, so as Joachim was saying, okay, China, we expected to come in earlier. We see that now coming back. Americas, we see also an uptick in our open orders. But okay, we operate in a volatile time. So we're relatively positive here.

The next question is from Stijn Demeester of ING.

The first one is on the guidance. When you confirm the total sales growth guidance of 8% to 10% for '23, would you also confirm the 4% to 5% organic growth leg, which is embedded -- which I understand is embedded in that guidance? And if so, when would you expect to pick up with organic growth again in terms of quarters?

On the organic growth portion of it in, in the second -- to answer the second question, the organic growth portion, it's really very hard to tell whether what we are seeing right now is translated on a sustained development of top line growth. We ever remain confident that we will stick to our margin guidance. So this is what we are monitoring. We clearly -- and with regard to the guidance, what we always have that in the medium term, we will deliver this and as I said, the margin expansion is something which is very high on our agenda as long as we continue to expand our lateral value chain, we will also be able to, on the midterm, expand out EBITA margin is what we have been doing year after year after year. And we're confident that this will also happen in the midterm going forward.

Stijn, the comparables are getting easier. Yes. So in this -- on the first quarter was our highest in 2022. So yes, we'll only get better from here.

Yes, I understand. And it also leads to my second question regarding 10 to 15 bps margin expansion guidance. If you would -- arguably could have been the toughest quarter of the year, if you're managing 36 bps expansion, what would impede you to sort of extend these gains throughout the year? And maybe related to that, could you quantify the element of reduced bonus accruals in Q1 in terms of EBITA margin?

Okay. The margin expansion is the consequence of a couple of things. Obviously, the first one is organic growth, where we also win Pillar B, and we are expanding basically our lateral value chain, which leads to a gross margin expansion. Second, also is basically a consequence of the number of products and that we sell them to a customer and in our formulation capabilities. Second one is obviously scale as we also integrate these M&A companies. I gave an indication how many companies we've integrated on our platforms. For them, basically our pricing and our margin algorithms and our S&OP algorithms can start running. And third one is obviously variable cost. On the one hand, we have also higher cost because we travel much more on the T&E. There are a lot of trade shows in Q1. So that has went up significantly. These are not cheap, these trade shows. On the bonus side, we're still trending on budget, yes, but it's obviously not at the peak of prior year. So if we take a look at our total bonus from Q1 to Q2, there's a difference of about EUR 6 million in there, Q1 '22 versus Q1 2023 to be more specific. So if you take that offset with -- you need to offset that with the T&E increase, which is about EUR 3 million to EUR 4 million. So all in all, our costs are very much under control and there are no incidentals in those costs.

That's very helpful. These are my questions, and congratulations on your very resilient quarter.

The next question is from Annelies Vermeulen from Morgan Stanley.

I have a couple, please. So firstly, you've mentioned several times throughout the call that you're seeing some uptick on the U.S. industrial side. I was wondering if you could elaborate a little bit more on which end markets or customer segments you're seeing that in, given there's sort of a mixed macro picture coming out of the U.S. So I'm just curious as to whether you're seeing it in residential or in autos or any kind of additional color you could give or any indicators that you're tracking that look more encouraging in that regard? And then secondly, just a follow-up on China as well. In the statement, each sector to remain relatively muted through the first quarter. But obviously, you've talked about the order book being more positive. So do you think that, that's a benefit that will come through in the second quarter already? Or is this going to be more of a second half story?

Thank you for your question. With regard to the U.S., the uptick we're seeing in activity in order intake is twofold. What we're seeing is, on one side, on the industrial side, that the supply chain, obviously, which was full, now appears to be empty. We also hear that from our partners we work with in that market. So we see an increased activity of orders coming to us. And at the same time, obviously, macro U.S. despite all the noise we're hearing from the market there, there is an uptick in home buys and there's an uptick in home applying -- application for home builds. So both of them indicate that we're coming out, and this is again supported by what we are seeing on our coatings, especially on the coating side of things. That's to the U.S. And to the China question, when that -- whether this will be a Q2 event or a Q3 event, again, the order build we're seeing indicates that we have a stronger July and June. Whether we see it really in the aggregate number of Q2 for China already to be seen, whether June pans out the way we currently see it. But it will be second half with regard to delivery of the orders we have second half of the second quarter and then certainly, hopefully, if there's not another downturn of the economy then in the second half.

And just a follow-up. Sorry, I'm just thinking about the second half for China. When you talk about that recovery, is that an expectation just over recovery versus 2022? Or do you see that returning to 2019 levels?

As 2022 was we were -- lockdown in China in 2022 was a real one. And actually, in 2022, we actually went backwards on our volumes and sales in China. As Joachim indicated, we were actually hopeful that China was opening up. We have positive macroeconomic signals. We have positive order book signals, but we have to just basically view when that is really materializing and Joachim was indicating, we see that materializing towards the end of the second half of the year -- the end of Q2. Yes.

The next question is from Matthew Yates of Bank of America.

Firstly, thank you for the additional information around the bonus provisioning. I think that's helpful to understand how the cost base has evolved. Can you just perhaps help me understand a little bit better what you mentioned earlier on working capital? There were 2 different numbers given 14.7% and 13.2%. I guess to correct for the distortion from the acquisitions, but could you just run through that one more time for me, so that I make sure I understand how sort of the organic development of the working capital has been?

Yes. Matthew, it is purely basically after 12 months, they're basically the M&A companies, they move into the organic buckets. So we also measure, of course, the progress in these M&A companies. When you buy an M&A company, you cannot from day 1 immediately reduce the working capital. There's a system approach, an S&OP approach in there as well. So we basically said, if you take the set, and I'll try to give an indication after 12 months, we take about between the difference between 32% and 47%, we take about 1.5 percentage point of working capital out when you move into the organic bucket. But that's basically a progress on the M&A bucket. And on the cost base that I indicated, I omitted actually, we also have, of course, labor cost increases that we have also absorbed in Q1 versus Q1 2022.