Ontex Group NV (ONTEX) Earnings Call Transcript

Good afternoon, everyone, and thank you for joining us today. I'm Geoff Raskin from IR. Unfortunately, Gustavo, our CEO, could not make it today. He is recovering from a medical procedure and is expected back soon. Peter, our CFO, will take the whole presentation this time. Before that, let me remind you of the safe harbor regarding forward-looking statements. I will not read out loud. But I assume you will have duly noted them. Also, as you may know by now, we are in the process of divesting our Emerging Markets division. So these have been accounted for as assets held for sale and discontinued operations since 2022. When presenting continued operations, this consists solely of core markets; when we refer to total group, this also includes the discontinued Emerging Markets division. So Peter, with that, over to you.

Thank you, Geoff, and good afternoon, everyone. Gustavo passes you his greetings. He regrets he can't join us to share the strong progress that we're making. And to kick off first, we are delighted to have announced the closure of the Mexican divestment on Tuesday. The regulatory process has been long, but EUR 225 million of cash is now in the bank, giving us an immediate 25% reduction on our net debt. This allows us to pay back the EUR 220 million term loan without delay. The total net receipts of the divestments is about EUR 265 million, including the deferred payment of approximately EUR 40 million, which we will receive within the next 5 years. Important to note, this is not an earn-out. It's linked to a receivable that Softys will have to collect for us and transfer once received. If not collected and transferred fully or partly within the next 5 years, the remaining amount will have to be paid by them. On the operational side, as you know, we have retained the Tijuana plant and the North America partner brands business, which form part of our core business and are key to our coast-to-coast manufacturing footprint that we now have in the U.S. While this is only one step in our portfolio transformation process, it's an important one, as this business represents half of the emerging markets scope we are set to divest. We continue to make progress with the remaining emerging markets divestments, and we expect to tell you more in the coming updates. Turning now to the Q1 results on Slide 4. First, at the total group level, including the discontinued Emerging Markets division and so also Mexico, we have delivered a significant increase in our results in quarter 1 '23 despite continued cost inflation. Revenue is EUR 652 million, up 16% like-for-like compared to last year, driven by the impact of the positive pricing actions we took in '22 and continue to take in quarter 1, together with overall stable volumes, which saw a little more of a seasonal impact than quarter 1 last year. Total group EBITDA recovery was even stronger, more than doubling versus last year, and the margin at 8.5% nearly doubled as well, growing by 4 percentage points year-on-year and 1 percentage point versus Q4. It is worth noting that the recovery of Emerging Markets was also important in this with margin up more than 5 percentage points year-on-year to 7.3%. Net debt was largely stable at the end of the quarter prior to proceeds from the Mexican assets. The leverage ratio improved significantly, coming down from 6.4x at the start of the quarter to 5.3x at the end, thanks to the significant recovery of the adjusted EBITDA. Focusing on our continued core markets. Revenue is up a similar 15% like-for-like to EUR 446 million, and the adjusted EBITDA margin stepped up strongly to 9.1%. This represents an increase of close to 4 percentage points versus Q1 last year and 0.4 percentage points versus Q4, demonstrating the strong momentum in Ontex's recovery. More detail on this in the following slides. On Slide 5, let's now look at the year-on-year revenue bridge for core operations in quarter 1. The 15% like-for-like revenue increase I was talking about was mainly driven by the impact of pricing. As we said before, with the massive increase in raw material and other input costs, pricing was and is an absolute necessity to rebuild profitability and our balance sheet, and this could never have been achieved just through cost savings. So here we see in the quarter the full impact of continued pricing actions. Around 1/4 of the impact has been generated from the most recent pricing taking effect in quarter 1, and 3/4 of it over the course of the pricing we took over the course of last year. On the volume/mix front, we are comparing to a strong quarter last year that was helped by forward buying in Baby and Fem Care in anticipation of higher prices. This year's quarter 1 volume/mix has been positively driven by continued strong growth in baby pants and in Adult Care, where we see an acceleration to 22% growth in the quarter. This was offset by a slightly slower U.S. market with inventory reduction in the Lifestyle segment. The underlying trends remain favorable for our growth drivers, including in the U.S. where we are continuing to build our operations following the carve-out of Tijuana and the ramp-up of the new plant in North Carolina. We also benefited from a small positive impact from ForEx of 1%, mainly through the year-on-year appreciation of the U.S. dollar and the Russian ruble, which offsets U.K. sterling. On Slide 6, the year-on-year bridge of adjusted EBITDA of our core markets shows how we nearly doubled adjusted EBITDA to EUR 41 million, thanks to the following. First, improved focus on driving growth in products and channels that create better value, which has generated a EUR 5 million mix benefit. Second, operating cost reduction measures that continue to deliver consistent additional savings. The EUR 60 million savings brings operating costs down by more than 4% year-on-year as in 2022 with delivery across procurement, design to value and manufacturing efficiency initiatives. Third, our pricing actions. In quarter 1, pricing has delivered EUR 58 million to adjusted EBITDA. This offsets the continuous increase in input cost inflation, notably EUR 38 million of higher raw material prices and EUR 17 million of higher operating costs, especially driven by fluff, energy and wage inflation, both in our operations and at our suppliers. Increasing year-on-year cost reflects the cost inflation we saw throughout last year, but also a further increase versus Q4, more specifically on certain raw materials, energy and wages. Importantly, this is the first quarter where the benefits from pricing have offset the impact of inflation on a year-on-year basis. However, while we are making good progress against cost inflation, pricing has not offset the full hike of inflation that started in 2021. You can see that in the table on the right-hand side of the slide. The net impact of pricing and cost inflation since 2021 remains in negative territory. So we are not there yet. SG&A costs were up slightly with inflation, but remained firmly below 10% of sales. The ForEx impact was negative as the positive impact on revenue was more than offset by the U.S. dollar impact on raw materials. So turning to momentum of the EBITDA turnaround on Slide 7. On this slide you see in the blue bars the evolution of adjusted EBITDA, with core markets in dark blue and the emerging markets in the light blue above that. As of the second half of last year, you can see the steady recovery in adjusted EBITDA since the low point in the first half that was hit hard by the unprecedented cost inflation. The adjusted EBITDA progress in quarter 1 '23 confirms the recovery process we set in motion, both for core and emerging markets. On the margins, that's the orange lines, you can see core markets on top at 9.1%, steadily improving quarter-over-quarter since Q2 last year. In light orange at the bottom, you can see emerging markets where cost inflation hit earlier, but also where price implementation could be implemented faster. The margin has been steadily improving here since the start of 2022. So across divisions, we have been recovering over the last 3 quarters as we continued to generate cost savings to drive our margins up and caught up on the additional inflation with gradual pricing. But we're not yet at our historic margin levels, and we strongly believe we can do better. And this picture also illustrates that further potential. So turning now to our financial structure on Slide 8. This slide illustrates the net debt and leverage ratio evolution of the total group. The strong increase in EBITDA in the last quarters has been the driving factor in the reduction of the leverage -- that's the orange line -- from its peak at the end of September of 7.7x down to 5.3x in March, and we are on track to meet covenant tests in June. At the same time, net debt has remained -- been remaining largely stable at EUR 880 million, as shown in the green bars on the chart on the following moving parts, starting from a strong EBITDA, including EUR 10 million restructuring costs, of which half is cash. And our Q1 CapEx was slightly above 3% of revenue, going up, as we indicated before, ensuring we capture future growth and make our manufacturing operations more efficient. Working capital in Q1 increased slightly, impacted by higher input costs versus the end of 2022. And we paid slightly higher interest rates on the floating part of our debt. And remember that the semiannual bond coupon for about EUR 10 million falls in quarter 1 and quarter 3, so not Q2 and Q4. So this brings me to the positive impact of the Mexican divestments on our overall debt profile, on the next Slide, 9. The proceeds from the Mexican investment will obviously reduce net financial debt immediately by about EUR 225 million and EUR 265 million over time, as I said earlier. The positive impact on the leverage ratio will be more limited, as the divestment also includes an EBITDA reduction. As I said earlier, the proceeds from the divestment will be used to pay back the EUR 220 million term loan. That means that, pro forma, the majority of our gross debt, about 75% excluding the leases, will now be in the bond we issued back in 2021 with a fixed rate coupon of 3.5%. A very sound situation to [ be in ] given the current volatility in financial markets and interest rates. The remainder consists of the utilized portion of our revolving credit facility and some local debt. And only that revolving credit facility will be carrying leverage covenants going forward. So to conclude, a key important step forward in our financial profile. And important to note, of course, that further deleveraging remains a core priority for Ontex centrally. So turning now to our outlook on the next page. With still a volatile macroeconomic environment and strengthened by a good start of 2023, we confirm our outlook, with revenue of our core markets to grow high single digits like-for-like, adjusted EBITDA margin of the quarter improved from 6.2% in '22 to around 9% in '23, with a higher cost base to be offset by cost reduction measures and pricing as seen in the first quarter. Note that the cost base might still increase further in Q2 as we still partly benefited in Q1 of inventory from before. While there could be potential for less tension on selected raw material prices in the rest of the year, be aware that this would only impact P&L with up to 2 quarters lag. On Emerging Markets, excluding the Mexican business as of now, we expect these to continue to contribute positively to EBITDA and free cash flow, while we continue to work on their divestments. Including these elements, we expect the leverage ratio of the total group to come down by year-end to below 4x. So in closing my presentation on this encouraging set of first quarter results, we are very pleased to report that the recovery of Ontex is firmly underway. We've also passed an important milestone with the closing of the Mexican divestment, improving the balance sheet, and we continue with the other defined Emerging Market divestments. In short, the EBITDA recovery and reduced net debt gives us more space and allows more focus on accelerating our turnaround strategy, drive cost transformation through a drastic reduction in complexity, driving growth, profitability and strong cash generation. I am now available to answer your questions you might have.

Now before going over to Q&A, can I ask you for practical reasons, to limit yourself to 2 questions only, please, and come back at the end of the queue if there is need for more. Operator, over to you.

[Operator Instructions] We will take the first question from Charles Eden from UBS.

I'll keep to two as asked. So my first one is just, you mentioned the destocking impact in North America. Are you able to quantify the impact this had on volumes in Q1 and then whether you expect continued drag in Q2 from this destocking? Or have you seen this largely played out by now? And then my second question is on your full year guidance. You've obviously left the 8% to 10% EBITDA margin guidance range unchanged for core markets, but with 9% achieved in Q1, I can't help but see the 8% as extremely prudent. Why did you decide not to raise this guidance to 9% to 10% or even 9% to 11% EBITDA margin guide for the year?

All right. Thank you, Charles. On the destocking, your first part of the question, the destocking in the U.S., yes, there's been a -- mainly temporary impact on quarter 1 in the destocking of especially the Lifestyle segment, that we've seen high sales and some stocking up at the end of the quarter last year. Most of that should have been factored out. U.S. remains for us a very important strategic X, which -- on which we are projecting double-digit growth in the years and the quarters going forward. So this should be mainly an impact we've seen in quarter 1. On your second question on the outlook. It's obvious, of course, that, as it does with you, that the quarter 1 provides confidence in the momentum and the turnaround that Ontex is delivering. We might be a bit prudent. I acknowledge that, but they're still -- it's still early days, first of all. And secondly, there are still quite a number of uncertainties in the context around us. Q1 has been indeed right in the middle of that margin guidance, and I'm certainly not happy with the 9%. So we'll continue to push very hard to grow that in the next quarters and years. One of the -- some of the flections behind it is that, first of all, inflation is factually not over. We had a Q1 that is higher than before for the reasons I've been quoting. And many of those input costs are still at or around record high levels. Q1 has partly been benefiting also from some inventory levels we still had from -- at the Q4 pricing level. So we might see a bit of an impact on that in the second quarter. There's -- if you look at the different components, there's ups and downs in some commodity costs. We are planning on what we have in April today. So we're not banking before anything happens. There could be potentially in raw material decreases, but we're basing on what we see today. And that's why we have confirmed the guidance of 8% to 10%.

That's great. And then just one quick follow-up on the destocking, obviously, flattish volumes in core markets reported for Q1. Maybe if [indiscernible] what would it have been without the destocking, plus 1, plus 2, just to try to get a scale of that -- the magnitude of that destocking impact in North America.

Yes, Charles, that is a good question. It is not that easy to answer it straightforwardly because there's different elements playing into that. When you look at -- on our net sales level, volume/mix is indeed flat. Now it's important to realize that when we're comparing flat versus Q1 last year, which had a lot of forward buying, we had a very strong month of March with forward buying on Baby and Fem Care, anticipating price increases that followed after. We have a bit more -- we talked about it in your first question -- some higher seasonality, not just in U.S. but the seasonality in emerging marketplace as well, within that between Q4 and Q1. An important additional element to note, or 2 maybe, one is we do see in Q1 the continued momentum on private labels, retailer brands across most categories in Europe and several categories in U.S. So that's something that is securing and strengthening our volumes. And next to that, we are focusing on improving our portfolio mix and stopping some dilutive contracts rather than just looking at purely volume expansion. Certainly also in emerging markets, we do that, which is part of the reason why these margins go up so strongly also there. And that effect, you can see in 2 ways, first of all, in the strong growth that we continue to post in our priority categories, baby pants and adults. And secondly, also in the fact that this neutral volume/mix on the net sales line becomes a positive on the EBITDA line.

The next question comes from [ Markus Schmitt ] from ODDO BHF.

I have just two. So first, could you comment, please, how Q2 has started so far, and if you see similar price and inflation trends as in Q1 or if inflation headwinds are coming down already? What you just said, obviously, implies there will be some assumed headwinds. But if you're able to expand the margin further because price and inflation amount, they're almost equal in Q1. So how will these 2 positions evolve in Q2 and in the remaining year? And then I have a second question.

Okay. So I'll start by answering the first one then. It's obviously the intent and the projection that we continue our momentum that we've been showing over the last quarters. I'm not going to give a specific guidance by quarter, we have done that for the full year, but what I can say is some of the moving parts is we will -- what I just explained to Charles about the underlying drivers on the volume: we will continue to see, we believe, the traction coming from consumers shifting into private label and hard discount -- and discounter segments, and we will continue to be focusing on the -- our optimizing, improving our portfolio mix as well. So that's something we'll continue to see in the second quarter. On the cost level, we'll see a number of things. I already talked about some of the increases that will come rather in Q2 rather than Q1 because we were sourcing still from some inventories in Q4. So that will be an upside. Roughly, honestly, cost levels will, I believe -- are going to be fairly much close in Q2 as we've seen in Q1. And I think we just -- we will be focusing on making sure that we continue the momentum. We had a reasonable start in April, and we hope to see that in the months going forward.

Okay. And second question is on the free cash flow. I mean, I saw that the gross debt went up and then cash on hand increased also, so maybe you could break down free cash flow generation a bit. I know you spoke of CapEx, working capital movements, and the cash interest on the bond was paid by Ontex. So maybe you could bring that a little bit together how sources and uses were?

Yes. Yes, right. I mean you recapped the major components already, but maybe a little bit more light in that, the adjusted -- starting, of course, from the adjusted EBITDA -- we've seen the step-up that you know we have posted. We had about EUR 10 million of nonrecurring investments in the quarter, which is mainly on some restructuring to secure that we align our SG&A below the 10%, and we keep it below the 10% as we divest our emerging markets business. So about half of that nonrecurring was based on that and the rest has been on projects. We have been gradually increasing our CapEx from about 2.6%, 2.8% in the last quarters of '22 to 3.1% this quarter. 70% of that being in growth and saving-generating initiatives. So that's the second driver. Working capital, as I mentioned, after improving it in Q4, we had to use a bit more -- we increased it a bit again in quarter 1. Mechanical inflect of inflation is one driver. Second driver, we have -- we are still being a bit more defensive than a normal run rate on inventory levels to secure the service levels. So that's something that has been playing on the working capital. And I've commented on the higher financing costs already with the bond coupon and then the minority of the floating part in our financing that led to a bit of an increase. So that's what's been driving that.

And that was financed by the increase of other debt, which went up a little bit. So you draw on the RCF then in the quarter or...

Yes, we continue to draw on the RCF, slightly higher than what we had at the end of 2022. But that's -- we have it to manage our working capital, and that's what we use it for.

We'll now take the next question from Karine Elias from Barclays.

I just had two broader questions. One was really on the drawings on the RCF currently as of the first quarter. Then my second question was more on the pricing. Obviously, some of the raw material prices are coming off. I'm not sure whether you were hedged on the fluff. But how should we think about pricing going forward? Do you have any pressure basically to reduce pricing as raw material prices are coming off?

Yes. All right. I think on the RCF in quarter 1, I've largely answered. So I think that hopefully is covered. On your question on the raw material prices and any pressure on that, yes, I mean, if I look back a bit at last year, I mean the whole industry has been pricing. So at the end of the day, our customers have clearly understood the need for pricing and it does not mean that there's no negotiation and there's no pushback to some point. But at this level of increases, obviously the whole industry, including ourselves, have been pricing. Today, there's probably a bit more pushback because the inflation is -- it's not decreasing, but it's going up less fast than it was in the second half of last year. So from that perspective, that slowdown of the increase is generating a bit more pushback. Now it's very difficult to answer to your question in an average way because we have customers on the one hand side that essentially they -- that we were able to price pretty fast and full. And on the other hand, there's customers, sometimes more in the health care side of the business, with longer contracts with more legal restrictions where we have not been able to price, and in some cases, even [ wait ] the extension or the renewal of the contract to do so. So there's no average answer I can give to the pricing that's to be done going forward. There will be more pricing selectively. But obviously, it's also fair to say that a very significant part of the margin growth going forward is going to come from cost transformation as a very big contributor and secondly, also the optimization of our portfolio by focusing on the most profitable part of our mix.

We will now take the next question from Patrick Folan from Barclays.

Can you talk about the benefit or quantify maybe what you saw from inventories for raw materials from a cost perspective in Q1 and maybe how that will look going into Q2? And then on the North American business related to volume/mix, in the previous question you said you were projecting double-digit growth in the coming quarters. What is the split between pricing volume there? And then within that North American question, looking at Slide 6 for the EBITDA bridge, there was a EUR 5 million mix impact in the quarter. What was embedded in your 2023 guidance for that number, and how should we think about that moving forward over the course of this year?