FLSmidth & Co. A/S (FLS) Earnings Call Transcript

I would like to welcome everybody to FLS' earnings call for quarter 2 and first half of the year. It's 20th of August, and I'm in the studio celebrating my birthday with Roland and we are going through the numbers. There has been a lot of changes in how we are reporting. And the reason for that is that Cement is now a discontinued business. So what we decided to do, we are actually opening up as requested by you and the market, to give a little bit more visibility for the performance of different businesses. And the split is Service business line, Products and Pumps, Cyclones & Valves. Pumps, Cyclones & Valves includes both capital business and service business. In typical steady state, it's 25-75. It's very simple if you think about our business model, we sell products to sell spare parts and wear parts. We focus on excellent lifetime service to our customers. And we want to be a technology leader in our products. And if you look at the Pumps, Cyclones & Valves, you see the picture 25-75. But you can also plot the same combination looking at Products and Service. It means that we sell products that are service-intensive. And in this quarter, around DKK 0.7 billion Products and then about DKK 2 billion service. So it looks a bit similar to Pumps, Cyclones & Valves. And in terms of overall performance, PCV business line is our internal benchmark for high performance: high performance for growth, high performance for profitability and we try to replicate that in the Service business. And if you are looking at the picture, I was trying to think how to describe it to you. And one word came to my mind, which is money tree. '25 capital with a higher aftermarket intensive service business. It's sort of money tree for investors. Some of the highlights are that we have a continued disciplined execution of our priorities. And it's also that we are able to execute, get stuff done. We've been also talking over the last few quarters about SG&A and need to reduce SG&A., and now you can see that the fixed costs is coming down in absolute terms. What it means that we are aiming to have a lean support functions, lean head office and scalable business. Scalable business means that we have a fixed cost, which is steady over the cycles. And then the cycle returns, upmarket turns, it's totally scalable. We have extremely good order intake in PCV area. Product is good, but of course, the comparison point is low. Organic service order intake was only minus 1%, and that's mainly due to low order intake in North America. Cash is good. And Cement disposal continues exactly as planned. And we have a firm agreement, unconditional agreement, to sell the headquarters in Copenhagen, so we get cash in from that sale as well. Out of this chart, all KPIs are green. And my personal main focus is safety. Safety is the fundamental -- of fundamental importance in mining and in mining operations. It's still not at good enough level, but I'm happy that it's positively developing. Then if we think about market a bit. Service is stable. There is no big change in the market. But the market activity in Products, and Products means heavy capital equipment in our terminology, it continued to be soft and we are still expecting market recovery in the latter part of '26. And I would like to also remind that our strongest market is South America. Big copper plants, big equipment, and that is still slow. And when that market will return, you will see good growth in the Products area. So that is our sweet spot. PCV, impressive development both in terms of growth and profitability. And the biggest improvement or big area where we are excelling is also conversions at the brownfield sites. We have quite a few nice big pump conversions from third-party equipment, total pumps in different parts of the world. Then if you think about Service. Organic order intake, minus 1%; and reported minus 8%, so it was a low quarter. I highlighted in the beginning of the year after the first quarter that we have a weakness in North America. That weakness continued and it's in the area of retrofits and upgrades. That has been slow in North America, in U.S. in particular. All the other markets are doing fine. And we have plans in place how we can turn around North America in terms of order intake. We have target measures in place. And if you look at the book-to-bill at the moment, it's around 1. So we are able to deliver and execute. And now we can focus on growth. So what I highlighted sometime in the past that we need to have improvements in the supply chain and supply chain performance, our execution works and now it's more part order intake and getting more orders in. If you think about Service EBITA, 19.9%; adjusted, around 20%. For me, it's reasonably good and we focus on high profit mix and that will support profitability long term. So our mix in Service is dominant spare parts and selected consumables. We don't want to go all -- into all consumables because it's very low -- some parts of consumables business, very low margin. So we are selective there. We don't do basic labor services anymore. So it means that the mix is good and it will support long-term profitability. Product markets continued to be soft. The comparison point last year was low. So therefore, there's a fairly significant percentage growth. The market is still slow. In the first quarter, we saw orders from India, large HPGRs and 18 vertical mills, and that's why the quarter 1 was good for us. So the baseline business, what we have, is quite slow. And it also has to do with the portfolio of what we have. We have market-leading position in large mining equipment, HPGR, gyratory crushers, and they are not volume products. They are one-off products, one year you sell 8, another year 1. It might be a year that you don't sell any. So the demand pattern for those orders is very lumpy. And then if you think about EBITA, you might be surprised that is negative and that has to do the lack of volume, and lack of volume both in orders and revenues. But we promised to you that we will not fill up the capital volume for the third-party products. So we are very disciplined. We don't take third-party products into our order intake because there's no aftermarket business. We don't want to do extended scope because there's no aftermarket for that one. And we'll be reducing risk. So the backlog and the business is low risk. And the margin on the Product -- Product margin is actually all right. So we are lacking volumes, and when volume will come back this goes into positive territory. In the meanwhile, we are streamlining our Product business operations in a way that it becomes totally scalable because we are focused on products, technology and not in engineering, not material handling. So it means that the platform, what we will create for Service -- sorry, for capital business is totally scalable. We will have product lines, which can support the same number of resources. In low end of cycle and high end of cycle it will be totally scalable. So that is action that is ongoing by Julian who is heading this business. Well, I think PCV business is quite easy to comment. I would say it's an in-house performance benchmark, both in terms of growth and profitability. And this is evidence that our investment to PCV business is paying off. We invested to the front end of the business. We invested by separating this from rest of the businesses. So those two decisions have resulted in continued growth of the business. And we are trying to repeat this success also in the Services, but this is an internal benchmark. And then if you think about profitability. Historical profitability, there's variation. But at steady-state with a steady mix, it should be around 24%, 25% EBITA business if you are doing things all right. Anything lower is not really -- then you are not really managing this business too well. It means that it's a very good business, and underlying profitability in this space would be around 24%, 25%. And Roland, I think you will go through numbers in a little bit more detail.

Yes. Thank you for that. So looking at the consolidated financial performance. Now the continued business is our Mining business. Orders up by 3%. And another good quarter gross profit margin-wise, north of 35%. And that means that we are delivering an adjusted EBITA of 15.2% and a reported EBITA margin of 15.5%. And the profit and loss from our continuing operations then yield DKK 260 million. Cement has been moved below the line as a discontinued operations. And in that connection, the activities and the liabilities sold have been impaired and the sales proceeds deducted and that leads to a total loss of minus DKK 715 million, fully in line with what we communicated when we disclosed the Cement sale and financial impacts to the company. And that means that the profit for the period for the group in this quarter equals minus DKK 455 million. Gross margin, still improving to the north of 35%, driven by revenue mix. Still relatively low revenue from the Product business line, but Service and the PCV business lines are pulling the relatively higher gross margin forward. SG&A costs continued the traction down in nominal terms and now also as a percentage of revenue. This bucket here includes DKK 50 million of transformation and separation costs in Q2. So the higher gross margin combined with continued lower SG&A leads us to improve EBITA margin, and therefore, an adjusted EBITA margin now of 15.2%. And that compares to 10.3% last year in Q2, admittedly with the NCA in that number. And without NCA in that number, we would be around 13% versus now 15.2%. So still good progression forward on this metric. Net working capital is improving significantly this quarter. It's a mixed bag of Cement net working capital moving out. Also having a relatively good quarter in collecting receivables and also reducing our work in progress and then currency tailwinds. The effect from the Cement move-out here is around DKK 145 million. And all that leads us to strong cash flow from operating activities, DKK 527 million for the quarter. This includes the group's combined cash flows, including Cement. And a free cash flow of DKK 309 million and adjusted for small stuff M&A and a free cash flow of DKK 332 million for the quarter. And Q2 was the quarter where we started our share buyback program. We didn't do a lot of it, started only late June. And we also paid almost DKK 460 million out in dividends to shareholders, but we still keep our leverage ratio of 0.6x, comfortably below our target of around 2 through the cycle. And the 15.2% margin in Q2 and also a good margin in Q1 led us to revisit the full year guidance, and we announced that last week. For our revenue guidance that used to be DKK 15 billion, we, last week, adjusted it to DKK 14.5 billion to DKK 15 billion, predominantly because of the relatively low intake in Product business line and slightly slower execution there than we had expected. And the EBITA margin for the full year for the continuing business were previously 14% to 14.5%, and we last week adjusted that up to 15% to 15.5%. And let's just recall that adjusted means that we are deducting the transformation cost and the separation costs that we have announced since the beginning of the year of DKK 200 million. But we're also now excluding other operating net income, this is sales of bits and pieces, summer houses and a few other real estates. And for the first half this year, that has equaled an income of DKK 77 million. So it's a true adjusted EBITA margin that reflects the underlying business performance. And then we will ask all of you that are interested to save the date, 11th of March, as you know, we're spending some time updating our strategy as we speak and we'd like to tell all of you more about that on the 11th of March, where we will invite for our Capital Markets Day and deep dive a bit further on what we have to come up with. And with that, we move to questions and answers.

[Operator Instructions] The first question is from Chitrita Sinha with JPMorgan.

I have three questions, if I may. So my first question is on the margin on the Product segment. This has clearly been volatile in recent quarters, and as you said, it's linked to the low volumes. What is the best way to think about the margin going forward? Is it simply that as volumes come back, this will get into positive territory? And then is The Product margin in the PCV business positive or at a similar level?

Yes. So there was a little noise on the line, but I think you were asking about the margin in the Product business line. And the intention here is that we are restructuring that business line a bit on the cost side. And then also once volume comes a bit back in that business line, it has to go into positive territory. But we're not guiding on margin by segment this time, but this we can say, on a normalized volume, that business line should be positive.

I'm sorry. The second part of that question was what the Product margin is in PCV. Is it at a similar level or positive at the moment?

So Product margin, you mean in PCV in the Product business?

Yes, exactly. Yes.

Yes. I think it is -- if you look back when we said that the business is capital business is not high margin but positive territory, that was a combination of PCV products and heavy capital equipment. Now they are separate. So PCV definitely is better because that combination when we said commentary in the past that is around kind of breakeven or low profit. So that was a combination of both. So it depends on the volume, but it's definitely better than heavy capital equipment, which is describing maybe the Product business line.

Very clear. My next question is just on the gross margin. So about 35% -- or 35.5% actually in Q2, this is higher than the rate you previously gave for Mining. So is this the new gross margin range now slightly higher? Or how should we think about that?

No. So we still say that through the cycle the gross margin, you should expect 31% to 33%. But obviously, for a while now, at least for the next 2 quarters and part of the guidance, is that the Product business line won't get significantly higher seen from the order intake. So that means that the mix will still be in favor -- the combined mix will be in favor as Service and PCV will have a relatively larger share than hopefully further on where the Product business line will have higher volumes.

Perfect. And then my final question is just on the delays you're seeing from customers and deliveries. I mean, how many of these orders were already H2 weighted? And how much of it is due to the pushout from Q2 into H2?

So if I think about the -- if the order question more about orders, not revenue, so that if I comment the orders first, so we've seen continued delays in customers deciding. Last time we discussed about high level of activity by the engineering companies in the main engineering centers both Vancouver and then Santiago, but it seems that customers are delaying sanctioning a lot of capital projects. So typically, expansion. So of course, there's activity ongoing as we speak. But if I think about South America, in particular, things have been delayed. We know it will come, but now that's why we're expecting regarding order intake for the capital business, heavy capital equipment products to pick up towards end of '26, that's how we see it at the moment. And remember that our sweet spot is the HPGRs, large gyratory, large equipment, South America and copper. So when that market will come back, then you see that in numbers.

The next question comes from Christian Hinderaker with Goldman Sachs.

Happy birthday from me as well. I wanted to start on the Products margins, if I can, but maybe tackle it from another direction. I guess, just curious how we think about the sort of SG&A for this business structurally versus the other parts of the portfolio. Maybe there's two parts to it. Is there a higher SG&A burden today versus those other segments? And how do you see that evolving? That's the first one.

So we've been very transparent about the structure of the business. So we are saying that the 3 business lines have kind of 95% control of the P&L and it means also the fixed cost. And we don't move too much kind of cost around between the businesses. It means that at the of the cycle, it's quite clear that our fixed cost, fixed SG&A, fixed COGS, is too high in the Product business line. And then we knew it and now it's transparent. And of course, we are now looking at rightsizing, streamlining how we do business in non-volume product area. And our aim is that we can get -- we do the kind of rightsizing and focus on core competencies, what we need to keep in-house, core technical competencies and make it scalable meaning that the idea is that in the future, even at the low end of the cycle, it should be closer to breakeven. And then, of course, then when the volumes will come back it will be a positive territory. And we make it scalable, meaning that the fixed cost SG&A is same whether you have a DKK 3 billion volume or DKK 5 billion volume. So it should not vary. So fixed cost can't be 100% scalable in that business. And there are some -- then we will scale the business for the -- we have a good engineering center in India. So we will scale in the upmarket that for our [ COGS ] engineering resources in India. So it would mean that the fixed cost of that business along in the cycle should be closer to the breakeven and then pushing to positive territory when the market will come back. But as you see from the number, we are not there yet. But we wanted to be transparent of this transformation. And Christian, also other thing is that we focus on the products that generate significant aftermarket. That what I was referring to as a money tree kind of business model. And then we took out the material handling, third-party staff, steel structures, all that sorts of things which would actually help to pay for the SG&A. But then you are kind of fooling yourself kind of that you take bad business in just to pay for the fixed cost. So we decided we don't do any of that. We are super strict with the order intake. We rather rightsize, streamline the operation to reflect the volume because then it's the kind of clear link that these are the products we get in. We get significant aftermarket kicks then once those are installed in operations. So that's the logic. So we didn't want to do anything so low the quality standard because it's quiet at the moment.

Understood, Mikko. I wanted to then ask on the second one, you're talking about South America strength. And obviously, as well in North America, you have quite a strong presence in terms of footprint. I just want to understand maybe on the sort of country level basis, how we think about your positioning in terms of competitive strength? I mean, is that more led by where your footprint is? Or is it more led by, say, strength of relationships with given customers? I'm sort of thinking if we should think of certain parts of South America as better -- sorry, is FLS being better positioned in certain parts of South America, for example?

If I pick one country, which is the most important country to us and then our market share is the highest is Chile. Chile is still producing 50% of the copper in the world, and we are leading in Chilean market if I look at the installed base today. And typically, mining companies are quite conservative so that if you do an expansion, incumbency gives you an advantage because of the conservative nature of the customer base. And also that if you have another line with a similar equipment, you tend to kind of use the same piece of equipment for the extension. It's not guaranteed, but it's quite common. So it means that when that market will come back, and it will, we don't know exactly when, I think we would be in a good position. Of course, Peru is a strong market for us as well and then U.S. But if I need to pick one country, I would say Chile, 50% of the world copper supply, we are a leader there in terms of installed base and market presence.

The next question is from Claus Almer of Nordea.

And also from my side, Mikko, congratulations for your birthday.

Thank you very much.

The first question goes to -- you in the report were mentioning that you would do some initiatives to make the Service division more resilient. Which initiatives are you talking about? That will be the first one.

I think what we see in the Service is that technically, we are very strong. And sometimes when we looked at our organization, kind of commercial acumen wasn't strong enough in some parts of the world and in some parts of the world where we're too much office based. So we are basically improving our commercial skills of our sales force and also kicking people out from the offices. So we do not have any service salespeople sitting in the office because customers are the site. So we emptied the office and sent people to the sites, and then at the same time, improved the commercial skill sets. It is actually quite simple, still takes time to do it. And I think that's the area where we can actually improve. So we do some changes in North America, Australia, a few other places just to strengthen our kind of customer interface and presence at the sites.

I guess this has been an ongoing process for the last quarters or maybe longer than that. How far are you with this? Is this in the 20, in the 50?

Regarding the whole change of the company, you mean?

No, all these initiatives to become more commercial.

I think that is actually -- so we see differences in different parts of the world. So the commercial excellence, as I said, we have a benchmark inside the company, which is PCV, high growth, kind of high profitability. And for example, we are rotating some people out from PCV into other areas just to kind of speed up the kind of that best practice sharing. So I think you will see improvements in Service soon. But yes, I can't tell you exactly when, but I'm confident that we can replicate PCV success. That's why I say that we have a benchmark in-house. We need to be able to leverage that one and take learnings to the other businesses.

Okay. Makes sense. Then my second question goes to the PCV segment. The order growth we are seeing or the order growth potential, given all these initiatives you have done, the added salespeople and so on, should we expect a more stable growth going forward? Or could there also be even an acceleration in the growth?

I think, Claus, that's a good question, right? PCV should definitely grow, but we are not guiding on growth now. So the 13% organic growth we had in Q2, I think, is a good quarter for us, but we are not guiding. PCV is definitely set to go. So I'll leave it at that.

That's why I didn't ask for exact number, it was more about the momentum or the direction of the growth.

There will be opt-outs. But 13% is definitely a good quarter. So I'm not going to quantify it more than that. We are -- there's a reason we have separated out PCV. We have strengthened the commercial front end. It looks like it works for that business line now. There will be more momentum, but Q2, albeit was a good quarter.

The next question is from Casper Blom of Danske Bank.

And obviously also a happy birthday from my side. First of all, I would like to ask, given your new updated business split into the 3 divisions, Mikko, could you comment what split you would like to see longer term between Service and Products. Taking away the PCV business, is it the Service to have double the order intake of Products? Is that a guiding star?

So of course, it's so cyclical, the Product business. And so it's difficult. But I think 70-30, 67-33. So I think I'd like to see it kind of Service be above 60% of that split, but it's highly volatile because Product order intake is highly volatile, but -- well, it's -- yes, I think -- so that's why we are not concerned that if the Product business is not growing. As fast as long as we are picking up our markets and we are picking up the right orders, that is more important than the volume of the Product business. So that we pick up the kind of high aftermarket-intensive product orders. But I would say, maybe ideally, 70-30, but there will be high end of the cycle where we see more capital order intake and revenue coming in as well. But Pumps, which is more steady business, of course, there's variation in the Pumps as well, now it's around 25-75. But that's more steady because the fluctuation in the capital business is less in pumps, but that's why I said that if we create a similar picture that in the Pumps Product and Service together, even though we are running it as two different businesses yes, 70-30 would be optimal, but you will see times when order intake and revenue for products will be higher.

That's very helpful. Then secondly, you mentioned now, Mikko, that you expect to see an improvement in the market. I think, first, in the call, you said second half '26 and then you said late '26, something like that. Is there any, how could you say, tangible evidence that sort of allows you to now put, yes, maybe a little bit more precise timing on it than it's been before? I think until now, it's been a lot that you saw things happening, but you couldn't really say when it would pick up. Now at least you're saying a year from now. Has something happened? Or is it discussions have become more precise or tangible with customers?

Typically, what happens, why we see, let's say, maybe 9 months ahead more or 6 months because then the EPCMs, they've done -- 3/4 of the cases, EPCMs are running the process of expansion. So they are kind of fronting suppliers together with the customer. So typically, we've been working with the EPCMs, specifying, doing engineering for the process line and so forth. And then we've given budgetary prices for the kind of -- for the flow sheet and the products. And then typically, then EPCMs are waiting for customers to sanction the project. Once their [ Board ] will sanction it, then typical suppliers give final prices because we don't know the cost base today what it is in one year's of time. And therefore, typically, once it's sanctioned, they come back to suppliers and say, now you need to quote firm prices for all of this equipment and then there's a kind of commercial technical selection process. And typically, that would mean that if we have -- if you give now the firm prices, then we are hoping to get some decisions by the customers 6, 9 months later. So there are not so many cases yet, which would ask for the firm prices. So they are still stuck in the previous phase that plans are done based on budgetary prices. And in many cases, customers who could have decided already technically this year, it's quite clear some of those cases will be decided next year. So it's really, I would say, this boardroom dynamics of the mining companies when they will release those projects. So sorry not to be more specific, but if we would be in the kind of bidding phase of many of these -- final bidding phase of many of the cases, I would say it's imminent, but I think it's still a little bit more further out.

Okay. So they're in the sanctioning process still...

Yes. And of course, there are something always moving. So we got India orders for HPGRs and vertical. But what I'm thinking about, volume of activity is still low in relative terms. If I look, for example, 3 years ago, '22 was kind of mini peak in our business. And since '22, it has been declining up to this point. And I think it stays at the low point also in '26.

All right. That's very helpful to understand the process. And my last question, you've previously expressed your appetite to do M&A and basically grow the company to have a larger size. And obviously, you're still left with a strong balance sheet and you will also get money from the sale of the headquarter next year. Any comments on those processes? When we could or should expect announcements from the M&A scene of larger sizes, obviously.

Yes. Thank you for that, Casper. So there's nothing imminent on that. We have a short list that we are working with -- working on. But there's nothing imminent. So that's where that is. We have allocated resources. We're starting to spend a lot more time on this now, but it's not forthcoming any -- within the next month or so.

The next question comes from Kristian Tornøe with SEB.