SFS Group AG (SFSN) Earnings Call Transcript

Good morning and welcome to the presentation of our first half 2020 results. Today's speakers are Rolf Frei, CFO; and myself, Jens Breu, CEO of the SFS Group. The agenda over the next 60 minutes will be key takeaways, development by segment, development of key financials, updated guidance 2020 and group priorities, Q&A before closing. I will start with the key takeaways, first half 2020, which can be best summarized as defended profitability despite a difficult Q2. The priorities of first half 2020 were driven by the COVID-19 pandemic, turning attention to employee safety, balancing manufacturing capacity and focusing on cost management while maintaining innovation activity. After a solid first quarter 2020, the financial development was significantly impacted by the pandemic due to decline in gross sales by minus 10.8% versus first half 2019, organic, minus 10.4%, mitigated by balanced exposure to different regions and end markets but also by the first-time consolidation of TFC, Triangle Fastener Corporation; MBE, Moderne Befestigungselemente; and T&M, Truelove & Maclean, resulting in sales contribution of plus 3.4%. All in all, despite the decline in revenue, a healthy EBIT margin of 9.2% and an EBITDA margin of 15.5% were achieved. A strong equity ratio of 72.7% and robust earnings secure liquidity and entrepreneurial freedom to pursue investments into innovations and the realization of future growth projects. Looking out, we expect a slight recovery in sales at similar profitability in the second half versus the first half 2020 under the assumption of no massive second global wave of the COVID-19 pandemic. Continuing with the development by segment. Starting with the headlines of the Engineered Components segment, where different end market developments could be observed. COVID-19 was the trigger, with significant impact on demand. In the first half 2020, reported sales declined by minus 16.3% year-over-year. Electronics and Medical managed still to achieve an organic growth. The acquisition of T&M completes the North American manufacturing capabilities with deep drawing. Temporary measures were quickly taken to offset the impact on profitability from the decline in end market sales, resulting in an EBIT of CHF 35.1 million or 9.1%. In order to realize the acquired growth projects at Industrial and Medical divisions, significant investments in site expansions are made in Switzerland and the U.S. The key messages of the division Automotive: challenging markets accentuated by COVID-19 further underlines the just mentioned development of the segment. The market environment was driven by reduced car sales, customers' temporary factory shutdowns and supply chain adjustments. At SFS, manufacturing capacities were temporarily reduced to match the current levels of order intake. In North America, a deep-drawing platform was established by the acquisition of T&M. On the organic side, continued investment into growth projects in the areas of electric brake systems and camera/sensor housings were driving forward. Based on the project pipeline, we aim to maintain a position capable to outgrow the automotive market. The acquisition of Truelove & Maclean, or our new deep-drawing platform in North America, is an investment in a Connecticut-based supplier of deep-drawn components, mainly to the automotive industry. It strategically complements the North American manufacturing technology footprint to supply the customer base with deep-drawn components. Core applications are including components for our restraint systems, fuel injection and sensor housings. The key figures of fiscal year 2019. Sales of approximately USD 36 million and around 110 employees. First-time consolidation is as per April 1, 2020. The key message of the division Electronics: stable demand situation of end users on supply chain in electronics alike, confirm the intact demand for smartphones and lifestyle electronics and below-expectation decline of HDD components, hence, leading to organic growth in the first half 2020. The freed-up capacity from HDD business reduction will be used for manufacturing of medical device components and to serve existing and new customers with supply chain needs outside of China, mainly due to the trade conflict issues between China and the U.S. The site transfer from Shanghai to Nantong is completed, and the previously leased properties have been returned to the lessors. Sales in the second half of 2020 is expected to be higher than in the first half, fueled by the expected seasonal product launches. The key message from the division Industrial: demand from industrial customers sharply lower. The individual business units were impacted differently by COVID-19 pandemic as there is relatively stable demand for plastic injection molded parts and components, and aerospace and other industrial end markets had to cope with significantly reduced order intake. The manufacturing capacities were temporarily reduced to match the levels of order intake. The site expansion project at Stamm, with its differentiated micro injection molding core competency, is proceeding as scheduled. In general, the demand is expected to remain subdued in the second half of 2020. The key messages of the division Medical can be best summarized with: sustained growth across applications, solid demand and ongoing ramp-up of new projects, resulting in high single-digit growth. The achieved growth is broadly based across different product portfolios and production sites. A new and larger industrial property with 12,000 square meters in additional building space has been acquired in proximity to the current Tegra Medical headquarters in Franklin, Massachusetts. This, to accommodate the acquired growth projects, to provide space for future growth and expansions, but also to move out of the current lease situation in the next few years to come. As observed in other areas of the SFS Group, the COVID-19 pandemic left a hole in this division its mark, resulting in capacity bottlenecks due to the unbroken high demand and higher production costs caused by the special safety measures as required to implement by the local government. In the second half of the year, growth is expected to be similar to the first half of 2020. We're coming to the headlines of the Fastening Systems segment, where continued investments were taken to expand market reach. The segment has seen a less pronounced impact of COVID-19 on the construction market and, together with the scope effects, a limiting decline of the segment sales with minus 5.8% year-over-year. Investments into the expansion of market reach through the acquisition of MBE were taken. The development at the Riveting division was significantly impacted by low demand from automotive and industrial customers alike. The impact of weaker demand on the operating results were offset by temporary capacity reductions and tight cost management, resulting in a first half EBIT margin at 9.5% or CHF 22.7 million, which is a 10 basis point improvement versus first half 2019. Looking into the details on the progress with division Construction, we can summarize that solid results were achieved despite the difficult environment. After a good Q1 with moderate organic growth, Q2 confronted the division with declining demand. Business with systems manufacturers, and distributors were affected most, while demand with specialty retailers and installers increased. Market access for the façade fastening systems in Central Europe expanded with the acquisition of MBE as per January 1, 2020. Investments into continued expansion of e-commerce activities are ongoing. Supported by seasonality effects, demand is expected to be slightly higher in the second half of 2020. Coming to the key messages of division Riveting, where the 2019 initiated recovery was slowed down by the COVID-19 pandemic. The difficult market environment in key end markets was further accentuated by COVID-19 pandemic, strongly impacting the business. Structural measures as taken during the previous years, together with temporary measures, were helping to adjust the manufacturing capacities to the actual order intake levels and to defend profitability. Continued focus is given on the development and launch of innovative products to complement the product portfolio and to improve market penetration. The general demand is expected to remain subdued in the second half of 2020. Closing with the segment reporting with the headlines of the Distribution & Logistics segment, where positive results, despite the difficult environment, have been achieved, along with the reported sales of CHF 159.6 million, representing a decline of minus 3.4% year-over-year. The multichannel approach of D&L has been particularly beneficial during the COVID-19-induced lockdown, with the e-commerce services being an effective alternative. The EBIT margin at 8.9% compared to 7.9% adjusted in the first half 2019 was supported by a wide range of cost measures. Iso Raunjak, who joined SFS in 1992, has been appointed as the new head of the segment as of January 1, taking over from Josef Zünd, who retired. The general demand is expected to remain subdued in the second half of 2020. With that, I conclude my explanations and will now hand over to Rolf for covering the development of the key financials.

Good morning and welcome. Rolf Frei speaking. The first half 2020 was quite a challenge with COVID-19. This impacted the development of the key financial numbers substantially. In order to have a better understanding and to receive higher transparency in such a crisis, the financial presentation is a bit more detailed today. The first slide shows the influencing factors of the sales development of minus 10.8% year-on-year. The organic growth suffered from the massive impact of COVID-19, especially in the second quarter. The lockdown in various countries around the world resulted in a massive lower and customer-driven demand. Many of our customers shut their operations temporarily and did not accept any incoming shipments for quite a while. Organic sales in Q2 was CHF 95 million or 21% behind Q2 of previous year. The global economy remains weak since late 2018. In spite of this, Q3, Q4 2019 as well as Q1 2020 showed slightly positive growth. Then in Q2 this year, corona hit the global economy very severely. Depending on the end market, they lost from moderate to strongly in dynamics or came partly to a standstill. The hardest downturn suffered the automotive industry, organic sales down 58% in Q2, and the other industrial sectors like aerospace and capital goods industry, organic sales down 16% in Q2. Due to the divergent sales development in the end markets, the sales split changed significantly, with the automotive industry falling slightly below 20% of total sales. The difference was mainly captured by construction, plus 310 basis points, which was driven by first-time inclusion of Triangle Fasteners in Q1 and MBE in the full first half. Electronics, plus 230 basis points, and Medical, plus 110 basis points, increased their share -- their sales share, thanks to organic growth. The region hurt most by COVID-19 was Europe. The sales share declined by 550 basis points to 36.6%. America and Asia strengthened their positions with 23.2% and 18.5% of share. In the midterm, it remains our strategic target to achieve balanced regional sales, with 40% in Europe and 20% in the other geographies. COVID-19 left its mark also on the profitability and drove EBIT down to around 6% on net sales in Q2. The backdrop was a result of the unsufficient capacity utilization due to lower customer demand. For the full 1H '20 the operational margin stood at 9.2%, under the current circumstances, a solid result, benefited from a relatively flexible cost structure. Personnel expenses were down CHF 35 million, the majority resulting from Q2, which showed a decrease of 23% year-on-year. Hiring freeze, terminating temporary working contracts and selective layoffs reduced the full-time equivalent in the first 6 months by 420 FTE on a like-for-like basis. The majority is coming from division Automotive and division Electronics. Furthermore, short-time allowances, salary cuts and temporary layoffs were contributors to the decline in personnel expenses. Other operating expenses were down CHF 19 million, almost all achieved again in Q2, with a decrease of 26% year-over-year. This came with lower expenses to production utilities and tools as well as lower traveling, advertising and transport costs. Looking at the development in the past, the second half year shows typically higher profitability than the first half year. The catalyst for this in the second half of the year are, in most cases, product ramp-ups in Automotive and seasonally higher sales in Construction and Electronics. In the upcoming 2 -- second half 2020, we're confronted with much less visibility and transparency due to COVID-19. Are we going to see a second global wave or wider regional lockdowns? This makes it here impossible to predict the bottom line as of today. As in the crisis in 2009, we again quickly decided and implemented measures on the expense and CapEx level and continued the efforts to push innovation project forward. Compared to 2009, SFS today is more balanced in geography, higher sales in America and Asia, and in the end markets, higher share in an Electronics and Medical industry. This more robust setup turns out in less volatility on top line, but also stronger financial power measured at EBITDA. In face of this major crisis, the EBITDA in the first 6 months of this year is stronger than in the full year of the financial crisis 2009. The net working capital at midyear was at the peak of 34% of net sales. Seasonality has an impact, but also inventory. Inventory levels do not react very fast as they have a certain time lag to decline. The reasons are the shipments towards the customers, which came partly to a full stop, while our manufacturing department completed already started production orders. In addition, SFS continued to receive deliveries from the suppliers that originated from purchase orders issued prior to Q2. Nevertheless, we expect that net working capital will normalize over the next couple of months. Notwithstanding that some CapEx projects in these uncertain times have been put on hold or have been delayed, total spending reaches 7.3% of net sales. The reason for this relatively high level are the 2 infrastructure projects for Stamm (Switzerland) and Tegra Medical (USA), which added 230 basis points to this spending. Tegra Medical invested in a building next door. Over the last 3 years, this site in Franklin showed a compound annual growth rate of 13% and runs now out of manufacturing space. The substantial investment supports this growth with entering interesting customer projects and also the intention to be rather owner than lessee in the long term and in strategic businesses. This pushed the share of CapEx for America from 13% to 36% in the first 6 months. The site expansion at Stamm was already announced and will create the capacity to realize new projects in micro molding technology. The completion of the expansion is expected in mid-2021. For full financial year 2020, we anticipate CapEx to stay around 7% of net sales. In the reporting period, we generated CHF 103 million in cash from operations. With that, we fully financed CapEx and net working capital increase. This left an operating free cash flow of CHF 46 million, which represents an EBITDA conversion rate of 38.2%. This demonstrate the strong financing power of SFS even in a crisis. We await for the full year a slight acceleration of both free cash flow and conversion rate. SFS' balance sheet remains healthy and solid. The equity amounted to CHF 1.2 billion, and the equity ratio stood well above 70%. Net cash at year-end turned into net debt of CHF 11 million, a decline of CHF 80 million. This was influenced by the acquisitions of MBE, Germany and Truelove & Maclean in U.S. as well as the dividend payment in April. Last year, at the same time, we stood at a net debt of CHF 52 million, also seasonally low and last year, with an additional outflow for M&A of around CHF 30 million compared to this year. As seen in the past, we expect an improvement back to a net cash situation by the year-end. During the crisis, the lower EBIT and the constant capital measured at a much lower sales influenced significantly the return on capital. This is particularly true in the SFS business model, which implies a high capital intensity. 2/3 of capital employed is invested in fixed assets, which have a long time horizon and stays pretty constant. Pretax ROCE came down to 12.6%. More tough measure, return on invested capital suffered from similar effects and reached low 5.3%. Tougher means that the calculation is after tax and includes the goodwill offset in capital invested of CHF 1 billion. The main driver to improve return on capital will be higher sales, which will lead to stronger operating profitability. Let me summarize the financial key indicators for the first 6 months 2020 in a single statement: robust performance in difficult times was achieved, thanks to well-balanced positioning by end markets and regions as well as quickly taken temporary measures on the expense side to at least partly offset the impact of profitability. With that, I hand over to Jens, who will further explain on the guidance and the key priorities in the next couple of months.

Thank you, Rolf, and welcome back to the guidance for the second half 2020, where a cautious development is expected. Due to the unclear further course of the COVID-19 pandemic and the still volatile political and economic environment, it is difficult to assess the further business development. Nevertheless, we expect slightly higher sales in the second half of the year with an approximately comparable EBIT margin, like for the first half of 2020. This assessment is based on currently available information and the assumption that no second massive global wave of COVID-19 pandemic further affects the economic development. Certainly, when looking back, as Rolf explained in his presentation, profitability usually increases in the second half of the year due to seasonal sales increase and higher capacity utilization. However, since local governments in many countries require to still pay out full salaries, even in case of a full lockdown, for instance, we will remain prudent at this point and reflect such or similar COVID-19-related potential cost burdens, as said, short of a global massive second COVID-19 wave within our guidance. Coming to the last slide of the active part of our presentation and with that to the SFS Group priorities going forward. As strongly rooted in our DNA, we aim to follow tightly the identified and relevant mega trends, which means strengthening of the innovation, in particular in the megatrends digitization, autonomous driving and health and wellness. Under the key priority growth, we focus on further investments in future growth projects, in particular in the medtech, automotive and electronic sectors. On the employees side, we continue with the important preventive measures to protect our employees' health and safety. Under profitability, we focus on balancing production capacity with demand while ensuring fuel -- full supply capabilities and keeping costs under control. Sustainability means implementing of the set goals and the development of a road map to reduce the carbon footprint. With that, we are at the end of the presentation of the first half year results 2020 and now available for your questions via phone and later, via chat.

First question is from the line of Marta Bruska from Berenberg.

I have a couple of them. So first of all, if I may ask you, is there a limit for how long you can apply the short-time work scheme? [indiscernible] but why it doesn't want, if possible to?

Yes. You have Jens speaking. Short-time workweek depends by the country, how long we can continue with it. It's regulated by the different countries. And visibility is not given to the degree as in all the countries. So for instance, in some of the Eastern countries, we don't even know whether in the fourth quarter or first quarter next year, short-time work will be possible. In Switzerland, we know we can continue with the current scheme of short-time work for the majority of 2021, for instance. In Germany, probably as well. So there are certain degrees of unknowns yet on how we can further structure our capacities in the plants and also how we can keep our employees semi-busy in the plants, but then also support them with short workweek solutions and governmental programs. This is part of the unknown, as I mentioned and concluded in the outlook, that we don't know exactly what kind of governmental support and what kind of environment on the cost side we will have towards the end of this year, but probably also in the first half of next year. On the other hand, I can say that we see increasing demand placed by our customers. So from today's perspective, in the second half of this year, we do not expect that we will have to fall back as large and as strongly on short-time workweek solutions like we did in the second quarter of 2020.

That's clear. And in your annual or in you half year report, you mentioned also some rising price pressure in electronics that is relatively new in the outlook section. Could you please tell us a little bit more what drives that? And what is the degree of the pressure you expect to see in the second half, please?

Exactly. Yes. We hear from our electronic customers that they are very cost sensitive and that they are also reevaluating again what kind of products they did bring to the market, how they differentiate themselves in the market, what kind of pricing points they've put into place. So we see a lot of thoughts and discussions and positioning activities which we have not seen over the last 2 to 3 years in this market. So we are rather cautious, and we talk about it. We inform about it as we did, and we would like to make the market aware that discussions are ongoing. As of today, we don't see major changes. We also don't see that our prices and the prices for our components are largely under pressure than in the past. The market is always very competitive. Prices on pressure is an ongoing daily activity, and improving productivity is also a daily path we all have in the organization. But I think it's important to know that customers think about their product lines, they think about how to position their product lines. And I think in the year 2020, we'll also see product-related changes and positioning-related changes in the second half of 2020.

Okay. So just to confirm I understood that correctly, so this is not included in the outlook? So you're flat H2 on H1 profit, which normally you would expect to be seasonally better in the second half, and that's largely -- typically in the past, was driven by Electronics, does not include the negative -- possible negative effects from pricing in Electronics yet?

I think the fairly cautious guidance for the second half of the year goes mainly back to the unknown due to COVID-19 and to maybe a little bit of flatter seasonality in the second half of the year due to COVID-19. Overall, we do not expect large shift changes in any of our end markets. I think we have already seen those large shift changes. We still expect the seasonality in the Swiss trading business in the construction business and the electronics business for the second half of the year. But although, we also expect a continued recovery in the automotive sector and to a mild degree, probably also a recovery in the industrial sector.

Okay. So is there anything in particular that gives you this confidence that you see the price pressure but then you don't guide for any impact on the second margin? Is this anything in particular that you have that lever to pull when this would materialize?

I think no, we do not have anything in particular in mind at this point in time. I think it's just as part of our DNA, it's being cautious, it's being transparent. And we believe it's important to communicate clearly what we see and experience in the end markets and also predict a little bit what kind of shifts we probably expect on the customer side in terms of how they bring the products to the market and how do they position it.

Okay. I just may have one last, and then I'll leave other analysts as well to speak. Yes, so I would like you to -- if possible, just to walk me through your logic of comparing this crisis to the great financial crisis for SFS, given that you had, in the meantime, the transformational in still view. And your -- both end market and regional exporters have changed so dramatically that I have a little bit of troubles to follow that comparison very clearly. Maybe if you could add a few details, how do you see that given those changes that SFS went through in the meantime.

I think yes, as Rolf mentioned in -- during the presentation of that slide, I think, was clearly said that SFS is now broader balanced, has a broader exposure to different end markets, but also geography. And therefore, we see that we have more stable development and probably due to that also, a better recovery out of the crisis. I think that was the analogy we tried to make. 2008, 2009, that was the last crisis we have experienced at SFS. I would say a similar impact to the group that, within a short time, we have seen a sharp sales decrease, and then the organization is challenged to respond. And I think what we have seen in comparison to 2008, 2009, we have seen also a quick reaction of management and the whole organization through the crisis. I think we have also seen a well organized cost reduction program, which also helped us to deliver good results and also remain in a good level of profitability and also generate, still, good cash flows to the organization. I think that was the major message. So overall, I think the SFS group has further developed itself, has broadened its exposure and revenue intake, is a more stable organization, but is still capable as such to recover quickly as we have shown in 2008, 2009, same now in 2020.

[Operator Instruction] Next question is from the line of [ Kaspar Enz from San Carlo Tagblatt, Kaspar Enz at Swiss Media ].