Broedrene A & O Johansen A/S

CSE:AOJ B

Earnings Call Transcript

[Niels Johansen, executive]

Good afternoon, and welcome to our third quarter '23 webcast. This webcast will focus on our third quarter '23 performance, and we will share with you the highlights and management's observations. Let us look at some of the highlights of the third quarter. In any way, third quarter share progress in our strategic focus areas. AO gained market shares in the third quarter as we have done in the past years. We also saw an increased number of customers in our broad network of outlets throughout Denmark. The EA assortment has been fully integrated in AO sensor warehouse for almost a year. And as of today, it has been introduced in 4 AO outlets. Additional 2 will follow before the end of this year.

During the third quarter, the EA assortment showed from AO.DK and the 4 AO outlets amounts to 20% of the total sales of the EAs as well. We will continue the journey in making EA nationwide with more outlets, adding the EA assortment during the year. AO saw a strong cash flow in Q2. Cash flow from operations amounted to DKK 209 million against minus DKK 12 million for third quarter last year. Financial leverage went down from 2.0 to 1.7 during the third quarter. Inventories have been reduced according to plans. Compared to the end of first quarter '23, inventory levels have been reduced by DKK 136 million, which is the main driver for the strong cash flow in '23. Let us look at the management observations.

End of Q3 showed a sudden reduction in demand, while market activity in Ag July and August was in line with estimates September brought an unexpected decline. I have been around for some quarters and I don't recall many incidents of such a sudden and significant change in activity. The tough times with high cost inflation and lower activity have also caused a higher-than-expected number of customer bankruptcies. We are now not significantly hit by losses, but it said to be weakness customers with a long and impressive history of business having to give up.

We see a strong pressure on margins. The competition is fair and we see tough fight when it comes to pricing the project. The overcapacity in our business drives fierce competition with lower margins. We monitor the market and stay selective in our bidding, although we will not be immune to lower profit margins. Let us look at the market trends as reaching you. As previously said, the level of activity took a sharp decline in the beginning of September. Although a market decline was included in our estimates the decline became more certain and more significant than we had expected.

In September, the outcome was an approximate 10% activity drop in heating and sanitary of which approximately half was due to a decline in heat pump. In the sour market, AO continued to gain market shares. And as you will recall, our ambition is to grow faster than the market year-by-year. AO is in a good position also in volatile market conditions. Our omnichannel strategy secures both digital efficiency and close customer relation. We offer our customers the convenience from digital ways of doing business and the convenience of parking into will assorted outlet close by the best of 2 worlds.

AO has the broadest coverage towards the professional craftsman. We show many lines of business and one way to recognize a one-stop advantage for customer, is a high level of cross-selling across product categories. So the high number of outlets combined with the largest variety of product categories, ensure good position. EA sales synergies are keeping in 20% of the EA assortment is now sold through AO outlook. Thereby both serving carpenters in AO regions and addressing cross-sales to existing AO customers.

We believe in our culture where the customers came and we are not shy to put forward both ambitions of outperforming market growth and also reaching a huge 10% EBITDA margin. As shown in this slide, we have always been and will always be guided by our culture, which includes our customers and we lead ahead. Our professional craftsman knows that AO is a part of our customers' team.

We care, not only for the order, but for that business, it is really important areas we lend a hand. AO 365 is a good example how we lend a hand by giving them a digital key to all our outlets, securing those convenience and flexibility to the customer. We take pride in our customer relationship, and we have an ambition to remain #1 in repair, modernization and maintenance. AO has expanded our services and business for the larger construction projects. And our ambition is to continue to do so.

We want to be the preferred partner of the large construction customers. The B2C business continued to be a good and strategic business for AO. It gives us the advantage of knowing the consumers' behavior and preferences. It is a knowledge that we use towards our suppliers to create new campaigns and offerings. We will remain a consumer's preferred digital DIY partner. Investing in IT is highly central to AO's transformational part but the most important thing for AO's competitiveness is our employees and their daily passion and effort in lending our customers ahead securing that the customer is always king in AO. Now Per, please take us through the financial performance.

[Per Toelstang, executive]

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Thank you. As Neils said, our Q3 estimate and guidance did indeed include a moderate decline in business activities. However, we saw a higher-than-expected reduction of activity in September, hence the announcement made 12th of October. For the quarter, B2B delivered index 92 and B2C index 95. That was against our expectations of approximately Index 96 combined.

The gross margin in the quarter reduced from 33.5% to 33% The reduction was expected and was due to the one-off gain from supplier-driven price increases back in the third quarter last year. External costs and salaries were at power last year. We are satisfied to note that efficiencies and reductions has thus mitigated the cost inflation. EBITDA came in at DKK 95.6 million against DKK 122.1 million last year the reduction being a result of the lower gross profit. Financial costs were higher due to the vast increase of interest rates, the higher interest bank debt and a hit from foreign exchange in Sweden and Norway exchange rates.

Finally, EBIT ended at DKK 72.1 million against DKK 93.9 million last year. Let's turn to the margin development comparing Q3 '23 to Q3 last year. The quarter saw a margin step from 23.5% to 23%. And as you can see from the chart, the primary reason being last year's one-off price gains from supply driven price increases. From a distribution point of view, margin took a 0.3% point hit due to the higher number of drops related to a lower basket size. We saw a mix impact of plus 0.8 percentage points, which is mainly due to reduced sales of lower margin head points, but also due to a higher maintenance share in relatively lower project share.

Let's lead the margins and turn to the segment info. The B2B segment accounted for 89% of revenues and the B2C segment accounted for 11% of revenue. The segment split was [ 8911 ] in Q3 '22 as well. B2B sales gained market share, but in a more sour market than expected. The B2C sales index is in line with web sales development within house improvements. Given the market development, we are satisfied with the margins and the profitability changes in the segment. In direct, non allocated cost was 10% lower than last year. Let's turn to the investments. Please be aware that the chart does not include M&A investments.

The green band shows the normal level of maintenance investments in AO. As you know, AO has invested heavily in expanding warehouses, Genelba and Horsens during the past 2 years in order to prepare for the future. Q3 investments amounted to DKK 24.2 million. Approximately 1/3 relates to expanding relevant AO shops to include EA assortment in order to make EA nationwide. The outlets throughout the country is a cornerstone in AOs business model. This is where we meet thousands of customers each day.

Let's turn to cash flow and net interest-bearing debt. AO had a strong cash flow in Q3. As planned, net interest-bearing debt decreased during the quarter. Gearing reduced to 1.7x EBITDA compared to 2.0x EBITDA end of Q2. Here in Q3 last year was 1.6x EBITDA. As Niels mentioned, we have continued to reduce the stocking levels as supply chain on strategy has reduced. Inventories have reduced DKK 63 million in Q3 on top of the DKK 73 million reduction achieved in Q2, adding up to DKK 136 million in total. As previously said, AO will always choose to have a buffer stock if the alternative is to disappoint customers.

Payables is DKK 100 million lower than last year due to the lower procurement related to the inventory reduction and the lower activity. Net interest-bearing debt is expected to reduce further in Q4. Now let's leave the financials and turn to the outlook 2023. Due to the lower-than-expected market activity in September, AO announced a reduced guidance the 12th of October. Sales guidance is reduced to DKK 5.15 billion to DKK 5.3 billion. That's DKK 200 million down and reflecting a Q4 activity level as we saw in September.

We expect EBITDA to be DKK 400 million to DKK 430 million, which is down from DKK 435 million to DKK 465 million. And we expect an EBIT to be DKK 260 million to DKK 290 million, down from DK 300 million to DKK 330 million. The updated full year guidance is based on the current momentum and reflecting the Q4 activity level as we saw in September. We stressed the fact that market activity is more volatile than normally and that this puts an additional uncertainty to estimate these days. This concludes the presentation, and we are ready to take your questions.

[Operator]

[Operator Instructions] The first question will be from the line of Kristian Johansen from [indiscernible]

[Unknown Analyst]

Thank you. I have a couple of questions here. So I will do them one by one. So first of all, this market slowdown you speak to in September. I'm just curious what your analysis of this is. So why do you think the slowdown hits and also you highlight heat pumps and sanitary. So heat pumps, I understand, but why do you think sanitary is harder hit than other sections.

[Niels Johansen, executive]

We're going to try and answer your question that, as you know, I've been around for quite some time. And it's a few times I have seen such quick change in the market. We don't have any real explanation apart from the pumps, the heat pumps but we also believe that the installer has finished many of their modernization drug. So what has been left back now is more repair and maintenance and these jobs carries fewer materials at more breaks.

We also see it in the basket size from our customers. They have dropped quite a bit, although we had the same number of visits into our shops. So our belief is that less modernization in that type of the repair business and more repair and maintenance.

[Unknown Analyst]

Okay. That makes sense. And then maybe just a follow-up. So being a large part through October as well -- have you seen this slowdown continue into October?

[Niels Johansen, executive]

Yes, we have seen that from the our 18 working day as we gone and we have the same index in our turnover.

[Unknown Analyst]

Okay. Very clear. Then my next question is about the 4 stores, which sell the products. So I'm just curious if you can comment a bit on the sale of the EA products in these 4 stores in Q3 versus Q2 or more? I mean, are you seeing a growth here? Or have you reached the stage where that just follows the market?

[Niels Johansen, executive]

No, we do see a growth there and we see a growth also the carbons but also naturally to our installer groups being electrical insole entrepreneur of plumbing, heating sanitary installers. So it is a growth of the proportion of the sale is growing month by month.

[Unknown Analyst]

Okay. Good to hear. My next question is on the B2C business. So the gross margin in B2C in Q3 is sort of notably lower than what you had in Q1 and Q2. Can you explain this cash margin decline in the B2C business?

[Per Toelstang, executive]

Yes. Perhaps I can take that one, Kristian. What your nominal see in answer economy is slowing down. You would see a larger part of the traffic going on low-cost websites, and that was also the case during and also Q2 in our B2C businesses.

[Unknown Analyst]

So just on a sense of people are buying products with lower gross margin.

[Per Toelstang, executive]

Yes, yes. And they are buying from[indiscernible] with a lower price points, we have a low pace [ VBS and Bili VBS ] a slightly different price profile.

[Unknown Analyst]

Sure, sure. Okay. That makes sense. Great. And then just my last question. your business in Sweden, you highlighted the growth potential, but can you just share how that performed in Q3 as well. So did you see the same market slowdown in Sweden, as you have seen in Denmark?

[Niels Johansen, executive]

In Sweden, we are only in a VA and sewage and water supply. So actually, we don't have the plumbing heating sanitize and tools business as we have in Denmark. And we are doing well in the Swedish markets. It's very much a project market, but good projects with fierce competition naturally but we are satisfied with the development in the third quarter, if that was your question.

[Unknown Analyst]

It was. So it sounds like revenue is actually growing in Sweden in Q3. Is that correctly interpreted?

[Per Toelstang, executive]

It's a project-driven business in Sweden, and it's quite volatile, Kristian, but it came in according to our expectations in Sweden.

[Unknown Analyst]

Fair enough. I understand. Great. That was all my questions.

[Operator]

That seems to be all for the call. I will therefore hand it over to the speakers for any written questions online.

[Per Toelstang, executive]

Okay. We also got a couple of written questions I think we have a couple of questions relating to a share buyback. How is that linked? Or how is that a part of our capital allocation policy and is it a tool that we should expect AO to use I think we have had these questions a number of time, and I understand the question and the reason for asking, it is definitely a tool that we are aware of, and it has also previously been used back in time in NAO.

I think our skepticism around this tool will be the lower liquidity that we may see going on in our trade in our shares and stocks. So I don't -- I'm not prepared to give you a solid answer. It is being discussed, but we also have some skepticism regarding this tool.

Then we have a question regarding our M&As. Back in Q1 '23, we were discussing potential acquisitions during 2024. Is that still the case? Question mark. Well, we are looking, and we are interested in following the market. I think I was saying back in Q1 was probably that we see that the annual report 2023 will probably be the moment of truth for many companies. And when one analyzes the annual report for the fiscal year 2023, that may lead into more normal multiples than what we saw in -- during the Corona I think we will watch closely.

And if we see something that fits our business and what we expect is creating value for our shareholders, then we will be interested. Then we have a question if we could tell more about a new deal with the Danish farmers. And that's right that we have a new deal reaching out also to Danish farmers, which are using quite a bit of tooling in their business. It's ongoing. It's not notable in the numbers. So it's not big, big numbers for now, but it is an important segment for us, and we want to do our best to serve them in the future.

We also have in the same question, if we are interested to serve the industry segment and the Danish Army. I think we have -- I think we have spoken about the industry segment earlier. It is an attractive and an interesting area. We only have a small presence for now in AO. And I think I will make a reference to our M&A talk in the previous question. And we are interested in looking around.

Then we have a question the credit policy towards our customers and the credit we have from our suppliers. And if there are going to be a change in this. Well, basically, I don't think that our payment terms differs from other businesses in our line of business, perhaps neither towards the customers or towards the suppliers. We don't see a big change in that area going forward.

Then we have a question. A rest of year question. If the profit estimated in Q4 being the difference between Q1 to Q3 and our guidance. If that is in the level of what we reached in September and you're right that the guidance is based on current trading. And as Niels said, the trading folk follows the trading that we saw in September and so do the guidance. And that's it with the questions. We didn't receive more questions.

We want to thank you for participating and we are looking forward to discuss Q4 and full year with you in February 2024. Thanks for now.