KONE Oyj (KNEBV) Earnings Call Transcript

Good morning, and welcome to KONE's Q2 results presentation. I'm Sanna Kaje, Head of KONE's Investor Relations. And I have here with me today our President and CEO, Philippe Delorme; and CFO, Ilkka Hara. But before I let Philippe and Ilkka present today, a short notification. We've heard that there are currently some global telecom issues, and there is a risk at the moment that we might not be able to take your questions online. So I wanted to give that as a heads up, but let's see how things develop. But with that, I'll hand over to Philippe.

Good morning, Sanna, and good morning, everyone. Glad to be with you today. So I'd like to start by sharing a couple of highlights from the quarter. First and foremost, I'm very pleased that the focus on Service and Modernization is delivering results. We saw, again, strong Service sales growth at 9% and record high Modernization orders. We also saw the sixth consecutive quarter of profitability improvement, which has been and is high on our agenda. The market outlook has mostly remained similar to what we saw 3 months ago. We still have a couple of updates. The first one is the China New Building Solutions market continues to be challenging, and we have downgraded the market outlook slightly. At the same time, we have upgraded the outlook for the North American Modernization market. Finally, something I'm very happy about, which is our employee engagement improving and being well above the global benchmark. So now let's take a look at all of this in more detail. I'll start, as usual, with the financial highlights. So for me, the standout of the quarter was the double-digit growth in orders in 3 out of our 4 Areas. As said, we had very strong orders in Modernization, but also some good wins in New Building Solutions, for example, in Europe. At the same time, Chinese New Building Solutions market continued to be challenging. Overall, our orders received grew by 3.6% at comparable exchange rates. Our sales were stable in the quarter at comparable currencies with continued strong growth in both Service and Modernization while, as I said, the New Building Solutions sales declined significantly, driven by China. Our adjusted EBIT margin improved by 20 basis points from the previous year, now the sixth consecutive year-over-year improvement, and the cash flow was solid. Ilkka will, as usual, elaborate more on the financials in a couple of minutes. So next, I'd like to share a couple of exciting customer references. And as usual, we've taken the 4 Areas of KONE, 2 examples in New Building Solutions and 2 examples in Modernization. First, a very tropical project ahead of the Olympics, the Grand Paris Express. We have delivered 56 escalators to the Saint-Denis-Pleyel station, which serves one of the key venues for the Summer Olympics. It's been of utmost importance for the customer that we are able to deliver on time and with high quality despite the complexity of the project. So it was, in fact, our earlier track record in reliability and good collaboration that has been one of the key reasons for being trusted with several orders in this project. The second case I want to share is a high-rise project, Wasl Tower in Dubai. This is a project where there was a lot of groundbreaking innovation on sustainable construction in the building. And sustainability was also one of the key criteria for choosing KONE as a supplier for the over 30 elevators with regenerative drive and 4 escalators. We also enabled efficient construction during the project with our superfast construction time use elevators, and the customer chose also our 24/7 connected Service for predictive maintenance. I also want to highlight a couple of exciting Modernization orders, which again is a highlight of Q2. The Xujiahui Garden is a residential complex in Shanghai, where we will upgrade 14, 20-year-old KONE mini-space elevators. The project is a great example of the rapidly growing Modernization opportunity in China, where actually we are doing very well. The last reference is from Chicago in the U.S., where we were awarded a large office redevelopment project, the Thompson Center. Once completed, the building will become a Google campus with more than 1,000 workers. And also in this project, sustainability was highly important for the customer. Now let's take a look at some other highlights for the quarter by business lines. So first, Services. We had another quarter of very strong growth in our Service base, taking us above 1.7 million units in Service. The recent bolt-on acquisition contributed to about 1.5% of the growth, but also the organic growth remained above 5%. We also continue to scale and to further develop our new digital tool that enables us to perform Services in a smarter way. One example is the remote Service that we talked about last time that we are expanding to more countries across Europe, and it's a real hit with our customers. In Modernization, the clear highlights were the many project wins that demonstrate both the market potential, but also our competitiveness in the market. We continue to strengthen this competitiveness by developing further our KONE upgrade, partial Modernization solution by broadening the coverage of the offering for both KONE and non-KONE equipment. The great thing about partial Modernization is that instead of replacing the whole equipment, we can improve the reliability and arrive comfort significantly in a sustainable way. Last but not least, in New Building Solutions, we've worked hard to further improve our offering, especially for the highly cost-conscious residential segment to even better match the customer needs in a cost-competitive way. And as a final highlight, I want to mention our GenAI-assisted tendering tool that we've been scaling. It's quite exciting how we can improve the responsiveness and sales efficiency with the help of GenAI that everyone is talking about. We also got valuable feedback from our employees and customers from our annual surveys. And these 2 points are 2 key strategic goals for us. So they are really important. So first things first, employees. I'm really happy that our employee engagement improved during this period of many changes in the company and continue to be well above the global benchmark. We saw strong results in well-being, inclusion, and intent to stay with KONE. And I'm also very thankful for the very high 92% participation rate in this survey. In the customer loyalty survey, we improved on many aspects. For instance, we saw a strong increase in Modernization. And at the same time, the results provide us with very good insight on the areas where we need to work hard to improve the customer experience. Finally, we have also made a new appointment to our Executive Board. So Kaija Bridger has been appointed Executive Vice President, People and Communications for the company as of July 1, 2024. Kaija began her career at KONE in 2015 and has held various leadership positions in People and Communication, most recently as Vice President, People and Communications for KONE Asia Pacific, Middle East and Africa. I'm really happy to have Kaija on board in the executive team, and I want to welcome her warmly. She is a fantastic addition to the team. I would like next to hand over to Ilkka, who will go through the market development and the financials in a bit more detail. Ilkka, the floor is yours.

Thank you, Philippe. Let's next look at how our markets are developing in second quarter. In the quarter, the market was actually quite similar to what we saw in the first quarter already, with a couple of things to highlight. First, in the New Building Solutions, we saw gradual stabilization in Americas and Europe, while the market continued to be difficult in China, actually even slightly tougher than what we expected. The markets continue to develop positively in Services and in Modernization across all areas with even some pickup in North America. The Asia Pacific, Middle East and Africa markets continued to be the most positive overall, although there was some temporary slowdown in decision-making, for example, in India related to elections that happened during the quarter. Then let's look at the financials for the second quarter. Our orders received grew by 3.6% at the comparable currencies in the quarter, which was a bit higher growth than what we've seen on average during the past couple of years, and is a good result given the tough market environment. This good development was driven by significant growth in Services and Modernization. In the New Building Solutions, our orders declined clearly at the comparable exchange rates, driven by China. As Philippe already highlighted, our orders grew at a double-digit rate in 3 of our 4 Areas, when measured at comparable exchange rates. Our margins of orders received was again fairly stable year-on-year with a decline in China and a slight improvement in the rest of the world. Then to sales. Overall, our sales were stable at the comparable currencies in second quarter. Our New Building Solutions sales declined by 11.1% as a result of the slow construction market in China. On the positive side, we saw, again, strong development in Services with 9% growth and in Modernization with 11.1% growth. Geographically, we saw quite a strong growth in Americas at 9.9% and in Europe at 5.8%. Asia Pacific, Middle East and Africa continued to grow well at 6.6%, but this was below the trend for the area. And the reason for this was a slowdown in order book rotation due to, for example, the India elections that I mentioned already earlier. In China, we also saw slower order book rotation due to a slowness in construction market. We also managed the deliveries very tightly to ensure our healthy cash flow for the business. As a result, our sales declined by 17.2% in Greater China. What's probably worth mentioning on China is that the Services and Modernization businesses have continued to develop positively there and now represent 1/3 of our sales in the area. Then moving to adjusted EBIT and profitability. As said, we had the sixth quarter of margin improvement in a row. This is important as improving profitability has been a clear focus for us. The adjusted EBIT margin improved by 20 basis points, and our adjusted EBIT increased to EUR 335 million. The positive drivers of profitability were the better margin in our New Building Solutions and Modernization deliveries outside of China as well as the positive impact from the business mix. We also continued to see some positive impact from savings from the operational model renewal completed last year. On the negative side, our margin declined in China as a result of the earlier seen decline in the margin of orders. And overall, the broad-based inflation increasing our fixed cost. We continue to be focused on product cost reductions, aligning our operations to the current market environment, particularly in China. Last, but definitely not least, is cash flow. We had a solid cash flow from operations in the quarter at EUR 313 million, which was a bit above last year's level. Year-to-date, we are now slightly down from previous year. Our working capital continues to be strongly negative, although now slightly less negative than in the beginning of the year. The key drivers for the year-to-date change have been the positive we always get in the early part of the year from Service invoicing cycle and the increase in accounts payable, where we've been working on the payment terms. Our inventories increased somewhat as a result of the challenges with logistics in Red Sea. And our accounts receivable increased slightly outside of China. Then let's look at the full year business outlook. For 11 out of our 12 end markets, the outlook is actually positive. Modernization markets are expected to remain very active, and the outlook is positive also in Services. In the New Building Solutions, the market outlook continues to be mixed with stable outlook in North America and Europe, growth expected in Asia Pacific, Middle East and Africa, and China expected to remain difficult. We have made a couple of changes to our market outlook expectations. We now expect China New Building Solutions market to decline by over 10% in units with continued price pressure. On the other hand, we are even more positive than before on the outlook for North America Modernization market and expect that to grow over 10%. Then to the business outlook. We have specified slightly our guidance for the year now that we have already 2 quarters behind us. We now expect our sales to grow 0% to 4% at comparable exchange rates in '24, while previously the range was 0% to 5%. The adjusted EBIT margin is now expected to be in the range of 11.5% to 12.2%, while the previous range was 11.5% to 12.3%. The drivers supporting our performance are expected to be the continued strong growth in Service and Modernization, improved margin coming through in deliveries outside of China, and the strong order book and the savings from the operational model renewal, which we saw still in the first half. The drivers burdening our performance are the decline in New Building Solutions market in China, persistent cost inflation, and our decision to increase investments in R&D and IT side. I would also like to mention the logistics cost as something where we see some risk related to the Red Sea situation. I would now like to hand over back to Philippe to summarize our presentation.

Thank you, Ilkka. So to summarize, we are happy to show another quarter of strong growth in the resilient Service and Modernization businesses, and we expect that to continue also in the coming quarters. When we look at our markets, the outlook is mostly positive, while the Chinese New Building Solutions market continues to be difficult. And finally, our profitability has been on an improving track and that was the case also in the second quarter. Going forward, we intend to stay on this positive track. I would like, again, to say a big thank you to everyone at KONE for driving these results. We appreciate it hugely. And with that, hopefully, we are ready to take your questions if the system does work. Let's hear from Sanna about that.

And the system doesn't work. So how we'll do this is that we've been getting some questions by e-mail. So let's go through those. And then whatever questions you might have afterwards, please reach out to Investor Relations. We'll help with all of your questions.

And we apologize for that.

Yes. I'll try to group these a little bit, because there's now a couple on orders, a couple on sales, and a couple on EBIT, and I'll start with the orders. So the first one is, great to see better orders outside China. Seems to be driven by strong growth in Modernization in all regions and then solid NBS growth in Europe and APMEA. Can I just confirm that the repairs business and the bolt-on M&A is not the key driver here, it's really Modernization and NBS explaining it?

I can confirm that. So that's the case. We've actually had a very good execution. Both market opportunities, but good execution also for us to be in a good position to deliver good growth.

And then another on orders. North American orders were weaker in Q2. What drove this?

I'll start, maybe you want to comment also. But in North America, in Q2, yes, it was a bit weaker. But if you look at the first half, we actually are performing quite well. So particularly in North America, there's relatively larger orders, and they tend to be a bit lumpy between the quarters. So I would look at it more with 2 quarters in mind. So overall, good performance there as well.

And great performance in Modernization, yes, in Americas.

What about Modernization margins in orders?

I'll take it. So we continue to see actually a positive development in Modernization, both in order margins, but also as we're scaling the business, we continue to see profitability improving in the business. So overall, very, very good, strong quarter in Modernization.

Okay. Then let's take a couple of questions on sales. There was a strong drop in sales in Q2 in China versus the rate in Q1. What drove this?

In the quarter, we've continued to see construction activity being low, if you look at the indicators for that. And as I said, we've also been very focused on cash flow. So managing also our deliveries with a credit risk in mind. So it's a bit both the market as well as our own focus on managing the risk in the market. And I have to say that the team actually has done a very good job, as I already mentioned, and part of the cash flow that we saw continued good performance there in China given the market environment.

And just building on your answer on China and sales. There is a bit of a good news, bad news depending on what you say. Basically, China is a bit less than 25% of our sales. But now with actually the growth of Service and Modernization in China and the decrease in NBS, now the sales we have in NBS in China are slightly more than 15%. Well, actually, there were much more than this 4, 5 years ago, we were more in the 30%. So what we are trying to explain quarter after quarter, and actually, quarter after quarter it's even more true, is that we are more of a Service and Modernization engine in China and out of China. In China, 1/3 of our sales are Service and Modernization and they keep growing, while indeed, NBS goes down in line with the market. So every quarter that pass makes KONE actually a more resilient model that relies on Service and Modernization. And we're going to be very repetitive, because this is the core of our strategy. And it doesn't mean that we don't keep a fighting spirit in China on New Building Construction. We do. We actually adjust our cost. We are extremely diligent on cash. We think, actually, it's a great way also to be a more competitive company, because competition helps to be the best in our business. But it's true that we are remodeling our business and adapting our business consciously to make it a more resilient model altogether. So that's really important to understand.

Good. Thank you. Still on sales, the guidance of 4% at the top end of sales growth guidance implies a strong acceleration in second half. What would drive this if that would materialize?

Well, first, we have a strong order book to deliver on and continue to see good opportunities to drive sales growth. And we are expecting somewhat better sales growth in the second half than we've seen in the first half. And of course, there's many parts contributing to it. In the first half, we already have very good sales growth in Services. We have good order backlog in Modernization. And I have to say that outside of China and also in NBS business, we continue to see quite a good development. So all of those combined gives us an expectation for the sales development for the rest of the year. And it's also good to remember that there is certain seasonality in the business more heavily weighted to the second half.

Yes.

Good. Then still continuing on sales, and now more specifically, Service sales. So you discussed that you had 5% organic unit growth on top of which about 1.5% inorganic growth in Service base, which leaves around 2% of price mix growth in Services. So could you please break this down in terms of pure price, so the effect you get from escalation clauses, the digital effort, and then the geographic outings for mix, pricing and then the digital?

Yes. So first, Sanna, you're doing a good job conveying the questions real time. So thank you for that. So if I look at the whole Services business with 9% growth, I think I'm very happy with that. We've been now accelerating the growth consistently from where it used to be. And that's in an environment where the NBS business is actually not helping similar to previously. And yes, like you said, we've gotten help from a very good scale-up of our acquisition strategy. So really, these bolt-on acquisitions contributing positively. But then mix is negative when it comes to the value. We had, in all markets, actually more residential buildings there, lower value, but also geographically, the mix has a negative impact. I wouldn't comment actually the pricing in more detail. It's also a bit competitive topic where we want to have some magic in our side and sensitive to our competition. But overall, in pricing, we've developed quite well. But definitely, there's an opportunity to continue to drive pricing more aggressively going forward. That we've actually seen as we've gone through the last years with inflation that once you start to really look at it more detail, there's more opportunities to it. And yes, digital contributes to it, but more and more we sell our contracts with a digital and physical maintenance combined. So yes, we get a benefit, but it's a package that we deliver that also then impacts how we are able to provide a better customer experience, better uptime. For example, retention is clearly higher with the connected units. And one of the highlights, by the way, behind the sales growth is that our retention is developing positively and actually very good competition balance. So all of those contributing to it.

And Service is a people business. And the attitude we have and what I've heard in the past 6 months is we seem to be very strong in our customer relationship. We take our customers seriously. They provide us business and we honor that business, and we're thankful, and we are creating, with the tens of thousands of field technicians, relationships on the ground that are really important, and we take them seriously.

Still on Services, one more question. How is the M&A pipeline going forward?

We continue to see the market being quite active and see good opportunities. Then let's see how those materialize. But I'm actually quite positive about the opportunities. Clearly, the fact that the business is digitalizing is giving opportunities for larger companies to make it happen. And then second, what is also visible is that there is a war for talent, skilled labor. And we have been a good -- as Philippe was talking about employee engagement, so people actually want to be working for KONE, and we're in a better position to attract talent, which is an edge compared to some of the smaller companies. And as a result, we've seen good active market in the M&A front.

And it's also, I would say, a weapon when we engage with those family businesses, because we talk about their life and the fact that we are a respectful buyer, we are a demanding buyer, meaning we would keep want to raise the bar on safety, on quality on digital, but we are a very respectful buyer. And we are known for this in the marketplace. And for a family business, it's very important. So the fact that we respect these people and that we onboard them with respect, we take some time to drive the right synergies is actually making the difference every time in the difficult discussion we're having, because these are critical decisions for these people, and we make a big difference here.

Good. Then switching gears to margins and profits. So margin expansion beyond 2024. What will be the key drivers of this, as the backlog margin has been stable now and the operating model renewal savings finish in 2024.

First, I'll start from the top. So clearly, the fact that we continue to see very strong growth in Services and Modernization has a positive mix impact to our results. And also, strategically, we want to build scale. The fact that we want to drive growth is also helping us deliver in margins. And I would say that the operating model renewal savings from the initial phase has been actually materialized now that we have a full year behind us. But one reason why we actually built these 4 Areas to operate this, they also are able to take their commercial strategies forward, build scale in how we operate in the field. How are we getting the scale in the operations in those 4 geographical areas, which provide us opportunities to drive it further. Clearly, from my perspective, as I've said previously, we want to grow, but we also clearly want to continue to drive the profitability up. So both are important.

And we do quite a bit of work on the productivity. I mean, the lower negotiations, sourcing, and so on. So we are working hard on that part of the house also.