H+H International A/S

CSE:HH

Earnings Call Transcript

[Operator]

Welcome to the H+H Financial Report for the First Quarter of 2023. [Operator Instructions] This call is being recorded.I will now hand it over to the speakers. Please begin.

[Niclas Kristensen, executive]

Thank you. And good morning and welcome to H+H conference call for the first quarter of 2023. My name is Niclas Bo Kristensen, Head of Investor Relations and Treasury. Joining me this morning is our CEO, Jorg Brinkmann; and our CFO, Peter Klovgaard-Jorgensen. This morning interim financial report and supporting documents, including the presentation for this call, were published and uploaded to our Investor Relations website. During today's call, management will present the interim financial report and after which, there will be a Q&A session. Please note that this conference call is being recorded and will be made available on our Investor Relations website after the call. Before I hand over the call to Jorg and Peter, I would like to direct your attention to the disclaimer on Page 2. During this call, the Executive Board may make certain forward-looking statements regarding various matters related to our business and company that are not historical facts. Such statements are based upon the current expectations and assumptions and are, therefore, subject to certain risk and uncertainties. Many factors could cause actual results to differ significantly. For further information about the risk factors, please see the annual report.And with that, I will now hand the call over to Jorg.

[Jorg Brinkmann, executive]

Thank you, Niclas, and good morning to everyone participating in this call. Before discussing how the business is doing in our 3 regions, I will first provide a brief overview of the quarter's financials before sharing with you an important update regarding our factory network. But first, please turn to Page 4. As expected, it was a challenging start to the year with very low newbuild activities across our markets. Higher building costs in combination with increased interest rates for mortgages have led to high uncertainty both with private and also institutional homebuilders. As a result, a significant low number of homes have been started to be built. How does that translate into financial terms? Organic growth amounted to minus 25%. This result is mainly driven by a negative volume trend of approximately 40%. However, in a market that was declining, we were able to successfully implement the planned price increases throughout Q1 and pass on inflation.The lower volume has also impacted our production and as a consequence of this, gross margin declined to 24% compared to 28% in Q1 2022. The massive hit in sales volume also impacted our EBIT as depreciation and SG&A was unchanged compared to FY '22. EBIT before special items amounted to DKK21 million in Q1 2023 compared to DKK110 in Q1 2022 corresponding to EBIT margins before special items of 3% and 13%, respectively. The return on invested capital is still above our long-term target, but was 15%, below the 2022 number of 21%. Free cash flow was negative by DKK309 million. Main reasons for this is: number one, the impact of inflation on working capital; and number two, the planned stock buildup in Q1 before we now scale back production. And finally, financial gearing was 1.4x EBITDA, which is double as high as it was last year, but remains within our long-term financial target of 1x to 2x EBITDA.In total, a weak start into the year with 40% lower sales volumes impacting our financial performance significantly. However, good progress to land price increases as planned and also clear view to manage capacity going forward. Now I will provide an update of the situation of our regions starting with the Central Western Europe region on Page 5. In Germany, permissions for new buildings for January 2023 decreased 25% compared to last year and high interest rates have resulted in a reduction of new mortgage loans for private investors by approximately 35% since summer 2022. However, the underlying housing demand remains high due to a continued shortage of housing especially in the larger cities and the number of building permits issued continues to exceed the number of completions adding further to the construction backlog. Although there is some reluctance to undertake new projects in multifamily houses before selling current portfolios, the rental market remains undersupplied.As a consequence of this, the German Association of Building Companies still expects 245,000 completions of dwellings in 2023 equal to a less negative, but still substantial decrease of 13% compared to last year. Also in Scandinavia, newbuild activity has significantly slowed down. However, we do see some positive messaging from Danish volume housebuilders regarding their sales rate. In the current market environment, our CWE business has delivered minus 12% organic growth. We have seen some positive impacts in South Germany coming from our latest acquired AAC plant in Feuchtwangen and also in North Germany where the upgraded Wittenborn factory is fully back in operations. Despite those positive developments, we will adjust the shift patterns in our network using Kurzarbeit and prepare for lower volume situation. Also we have successfully implemented sales price increases as planned to pass through the inflation to the market.Finally, I'm pleased to see how the new leadership team in CWE is coming together and is executing on their plan to further advise the integration of the organization and gain substantial synergy. Next please turn to Page 6 for an update on the U.K. market. In the U.K., housing activity witnessed a significant slowdown due to the prevailing high levels of uncertainty, interest rates and poor weather conditions. However, over the last weeks we have seen slight recovery in consumer confidence even though coming from a very low level. In this context also, some of our large volume housebuilders have reported an improvement of their weekly sales rate, but still significant below the 2022 level. The market situation heavily impacted our U.K. business with an organic growth of minus 36%. Part of this extremely negative result is also coming from the merchant business who have stocked up towards the end of 2022 and a very favorable Q1 last year.On the price side, we have successfully and in close dialog with our partners implemented the needed price increases to pass through inflation and production cost. Additionally, the team is working intensively to win back market share. As a result from historic undersupply of the U.K. market, we are now able to position ourselves again in the foundation block business and also start working with new customers. Also in U.K. we are adjusting the shift pattern to lower demand after having built sufficient stock in Q1. As we remain positive for the long term, we also continue investing into more capacity starting with an upgrade of our Borough Green factory giving us 10% more volume on top of the total U.K. capacity. Please turn to Page 7 for an update on the Polish market. The building industry in Poland is experiencing the most significant impact from the high level of economic uncertainty with building activity further constrained by growing inflation and continued high interest rates.As a result, individual investors loan capabilities have been reduced. In February, the number of building permits has decreased by 36% year-on-year with developers being the most affected and the number of starts declining approximately 40% for both individual investors and developers. In this market environment, our Polish business delivered an organic growth of minus 36%. As a consequence, we have already started to reduce shift and will continue to further adjust the network capacity to meet the lower demand. Despite the huge volume decline, I am pleased to see how the Polish team has implemented price increases, which are needed to pass on inflation. However, the competitive environment in Poland is challenging and we are monitoring the market very closely to protect our leading position. Next I will provide an important update on our factory network on Page 8. As mentioned, we are seeing lower volumes in all markets we operate.As we have built up sufficient stock in Q1, we are now ready to implement the next round of capacity adjustments. Next to further shift reductions, we will use the current market conditions to also strategically improve our factory network. The basic principle of this is to consolidate the number of plants in a certain region by redirecting volumes to bigger and more efficient plants, which leads to scale and lower unit cost and ultimately better service for our customers. In total, we'll permanently close 5 factories, of which 3 are located in Germany and 2 in Poland. All closures will be completed by 1st July 2023. In Germany, we will streamline our CSU plant in the Northeast from 3 to 2 plants by closing our Demmin plant. In the Southwest region, we will go from 4 to 2 plants by closing our plant in Kronau and Niederrimsingen. All sites were acquired in 2018 without having intensively looked into further optimization so far.In Poland, we will close our CSU plant in Pisz located in the Northeast and redirect the volume to Kruki, which is only 50 kilometers away. Additionally, we will close our AAC plant in Warsaw and redirect those volumes to 2 other plants with significantly lower unit costs. For all reasons, we've identified enough capacity to service our customers not only this year, but also when the markets will start picking up again. Beyond that, we will focus our future strategic investments into the remaining plants and further improve uptime and debottlenecking. The optimization plan is funded with restructuring costs classified as special items exclusive of impairment in the range of DKK70 million to DKK80 million for the full year 2023. I believe that the consolidation will strengthen our position in the market and add long-term value to H+H. As much as the closure makes sense from a business perspective, we should not forget that this decision impacts many of our colleagues who have worked for us for many years. Our local leaders will ensure that all needed discussions and agreements within the next weeks are done in a professional and also respectful way.This concludes my remarks and I will now turn the call over to Peter for an update on our financials.

[Peter Jnsen, executive]

Thank you, Jorg, and welcome to this morning's call from me as well. I will take you through the financials for Q1 2023 starting with the revenue on Page 9. Total revenue decreased by 27% to DKK641 million in Q1 compared to DKK874 million last year. Organic growth was negative 25% compared to positive 29% in Q1 last year. Organic growth across the group was driven by 42% lower volumes offset by 17% price increases compared to Q1 last year. Price increases have been implemented across all regions slightly faster than expected. Revenue in the Central Western Europe region decreased by 13% to DKK345 million compared to DKK396 million last year. Organic growth in the region was better than market development, but still negative 12% as a result of lower sales volumes for AAC and to a lesser extent for CSU, partly offset by higher sales prices for both product categories.Revenue in the United Kingdom decreased by 39% to DKK146 million compared to DKK239 million last year. Organic growth in the United Kingdom was negative 36%, which was demand driven offset by higher sales price as planned. Revenue in Poland decreased by 37% to DKK150 million compared to DKK239 million last year. Organic growth was negative 36% driven by lower sales volumes offset by sales price increases. Of the total revenue in Q1 '23, AAC and CSU constituted 65% and 35%, respectively. Now please turn to Page 10 for a few comments on our earnings margins for Q1. The earnings in Q1 2023 is heavily impacted by several factors. Firstly, we had a significant drop in sales volumes across our system. Secondly, we had a carryover of price increases of certain raw materials, mainly cement and lime, which is being passed on but has a delayed phasing. Thirdly, we have started to adjust capacity. These lead to higher incremental production cost combined with higher [ usage cost ].Together, these effects are impacting our margins negatively. Gross margins amounted to DKK154 million compared to DKK244 million last year, corresponding to gross margins of 24% and 28%, respectively. EBIT before special items amounted to DKK21 million in Q1 compared to DKK110 million last year. The decrease is driven by the lower gross margin combined with inflationary impacts of SG&A, partly mitigated by continued focus on cost savings. As Jorg also mentioned, we expect restructuring cost classified as special items excluding impairment in the range of DKK70 million to DKK80 million for the full year 2023. This includes the already initiated programs for capacity adjustments and SG&A savings as well as the announced planned closures. We expect payback on the combined restructuring to be less than 12 months. Net book value of equipment related to the closures of around DKK130 million is subject to impairment and is expected to be treated as special items.We expect this to be partly mitigated by sale from all reuse of assets in the existing factory network. On Page 11, you will see the development in our net debt for the year. On 31st of March 2023, net interest-bearing debt totaled DKK800 million, of which DKK103 million relates to lease liabilities. The company's net interest-bearing debt excluding leasing totaled DKK701 million on 31st of March 2023 corresponding to an unused committed bank facility of DKK0.3 billion. The increase in net interest-bearing debt since the beginning of the year was primarily driven by planned stock build and inflationary impact on working capital for the period. We do not expect further stock build, which is expected to stabilize net working capital. On 31st of March 2023, the company's financial gearing was 1.4x the net interest-bearing debt to EBITDA, which is within the company's long-term financial target of 1x to 2x EBITDA.Next please turn to Page 12 for a walk-through of our financial expectations for the full year 2023. Despite uncertain market conditions and a challenging start to the year, we maintain the financial outlook for the full year as we expect the market to continue to improve during the year combined with the slowdown seen in the second half of 2022. We expect organic growth for the year to be around 0%. Further, EBIT before special items is expected to be in the range of DKK330 million to DKK400 million. The financial outlook for 2023 is based on the assumption that exchange rates; primarily the British pound, the euro and the Polish zloty; remain at mid-April 2023 levels.This concludes my prepared remarks and I will now turn the call back to Jorg for closing statements.

[Jorg Brinkmann, executive]

Thank you, Peter. Before we open up for questions, let me conclude with few final remarks on Page 13. Number one, quarter 1 was an extremely slow start into the year but as expected. Second, despite uncertain market conditions, we still expect the market to recover during the year and therefore keep our guidance. However, visibility is extremely low and we will need to see a positive trend line in Q2. We have successfully implemented price increases in all markets and are passing on inflation, which is good. And finally, we are using the current market conditions to also strategically optimize our factory network for when the market will pick up again.And with that, we are now ready to take your questions.

[Operator]

[Operator Instructions] The first question is from the line of Sebastian Grave from Nordea.

[Peter Grave, analyst]

I'll do them one by one. So first, coming back to your full year outlook, which you maintain and taking like point in your low end of the guidance which is 15% volume decline year-on-year. So your volumes declined 41% in Q1 and according to my calculation, this implies that you need to see a 50% uptick in quarterly volumes from Q1 and the rest of the year and this despite planned closures in the 1st of July. So can you please help maybe elaborate here how does that really make sense and what makes you confident that you're going to see such a significant uptick in volumes from this point?

[Operator]

There seems to be a technical difficulty, Sebastian. Please wait while the host will be back online. Sebastian, please start with your first question again.

[Peter Grave, analyst]

First question on your full year outlook. So the low point of your guidance points to minus 15% volumes year-on-year. Then you have minus 40% volumes in Q1 meaning that you'll have to see a 50% Q-on-Q uptick in Q2 and that level for the rest of the year to make the low end of your guidance and this despite planned closures. So could you maybe help me understand this dynamic? Do you see any firm signs that volumes are picking up significantly here in April or May? Any comments will be helpful.

[Operator]

Sebastian, I'm sorry. But it appears we are losing the hosts. If you could just wait a minute again with your question. Sebastian, please repeat your first question.

[Peter Grave, analyst]

Yes, I will try again. Your volumes declined 41% in Q1 and according to my calculation for you to meet the low end of your volume guidance, you have to see a 50% uptick in quarterly volumes for the rest of the year despite planned closures. So could you please help me understand how does this make sense?

[Jorg Brinkmann, executive]

Sebastian, thanks for your question and sorry for the technical problems here. Certainly want to answer your questions. So how the forecast is built is we are expecting also for Q2 a decline in volume and then recovery over Q3, Q4 if you compare year-on-year. Peter can also add some more color to that. But this is how it's built actually so it's a recovery year-on-year towards the Q3, Q4 result. That is how that is built. And then the second part of your question is it's very important to understand the plant closure, this is really the supply of the market. It's really independent of the demand side. So what we are doing in essence is by region optimizing the footprint of our network, right? And so as I elaborated, in Northeast Germany for instance, we're going from 3 plants to 2 and then really servicing the market not only for this year but also for future demand. So the capacity we have is far beyond the volumes we sold in 2022 to give you an idea of that. So we look into that and there's enough capacity to really go into the markets once the market is picking up again.

[Peter Grave, analyst]

Okay. And are you seeing any -- I know you said that you're seeing negative volumes also in Q2 or expect negative volumes. But are you seeing any sort of incremental pickup in volumes from Q1 at this point?

[Jorg Brinkmann, executive]

So essentially when you look at the different regions; for U.K. and CWE, we have seen incremental pickup during the first 4 months of the year whereas Poland is more stable I would say.

[Peter Grave, analyst]

Okay. So I mean very difficult markets indeed, but you're still committed to this passing on price increases. Could you maybe provide a few comments on sort of the current pricing environment across your end markets? That would be helpful.

[Jorg Brinkmann, executive]

So I think in general the way that we typically operate is that in the U.K. of course, we have a very close partnership with our customers and there we have a good and healthy direct dialog with our individual key accounts. That dialog is still good and healthy. We had a good start to the year on implementing price increases and of course in general that has happened in line with expectations. In CWE, also typically there we announced price increases towards the beginning of the year to take effect during Q1 and Q2. This has also happened in line with expectations and we're quite pleased with that. And then lastly, Poland is the most price dynamic market that we have. We are quite pleased to see our abilities there to also implement price increases, but we are always striving for higher price; but there are other players in the market less focused on pricing.

[Peter Grave, analyst]

So how do you see that? Have you maintained -- do you think you have maintained your market shares in Poland in Q1 or do you start to see pressure on that front?

[Jorg Brinkmann, executive]

So overall when you look at the current official data for the Polish market, I would say that our performance in terms of volume has been in line with the market development. So overall, that is our impression. Typically when you are in situations of declining demand because we want to defend pricing can have some volume impact. So we are anticipating that. But so far, we are trending in the market.

[Peter Grave, analyst]

And then my last question, it's on this sort of the plant optimization exercise that you've been practicing here. So could you maybe help shed some light on the sort of rationale behind plant closures. So why not temporary closures instead of like permanent closures? According to my understanding, you have previously at least in 2021 you have been running at full capacity. Now you take out I assume significant capacity, which all else equal will hamper I mean the long-term growth prospects of the business. So maybe to understand the rationale here, please?

[Jorg Brinkmann, executive]

So listen, I can add some color to it. I started in October with the H+H company and one of the first things I really looked into is what is the capacity, what is the footprint and also what is the growth potential of the existing assets, right, and then really to understand how can we generate further organic growth. And one of the outcomes is actually that we really identified the sleeping capacity in the assets and so we used the last couple of months really extensively to prepare that plan and now with the current market situation is the time to accelerate that plan and put that into action. And how does that work? I give you an example on Germany. In Germany we were not really using the full shift potential especially in our CSU plants. So instead of running them 24/6, which we have permission for, we were running them way below.So we are able in the existing plants to increase the number of shifts and produce more in existing plants plus and you've heard us talking about debottlenecking. So what we are currently doing in the Borough Green plant in London for instance really with this fairly low CapEx, getting significant more volume out of the plants. We have that potential as well. In Germany, I would say this is untapped potential after the acquisition in 2018. This hasn't been done and so we've looked into that together with the new leadership team and we have very clear plan of number one, how to increase shift in the remaining plants and then also how to debottleneck the existing plants. At the end what you get is a network that is running more efficient, that is delivering blocks for lower unit cost and at the end also better service for our customers, right? So that is really the basic thinking behind it.

[Peter Grave, analyst]

Okay. And a ballpark estimate, how much capacity are you taking out from these plant closures?

[Jorg Brinkmann, executive]

Yes. So if we start in Germany on the CSU side, it's roughly 20% of capacity we take out. And then in Poland, we're talking 8% on the CSU side and then 15% on the AAC side. But bear in mind this is based, let's say, on the 2022 performance, right, and without that debottlenecking options because when you take that into account, the capacity will be very bigger than it was in 2022.

[Peter Grave, analyst]

Okay. And then maybe just a last question here. So what is this plant closure? Where does this put your sort of overall M&A strategy?

[Jorg Brinkmann, executive]

For us it's important that the block business is a regional business. That means we are running regional supply chains. So that means when looking into M&A, we certainly want to extend our footprint into regions where we are not operating and then really get more capacity out of business and regions where we are already operating to service the market better and then buy into regions where we are not operating. That is the basic principle. And then also once bought these additional businesses, we're also able to apply that optimization to those assets to really create a very profitable network of plants.

[Operator]

[Operator Instructions] The next question is from Peter Sehested from ABG.

[Peter Sehested, analyst]

It is just one pertaining to the impairment charge. I expect that to go directly into the P&L of course, but the offsetting impact of sale of assets, I expect that to only impact the cash flow. Is that correct?

[Peter Jnsen, executive]

It is correct. So in P&L, the impairment would be noncash as such. But you're absolutely right that to the extent that we externally sell equipment or later on land, that will have a positive cash flow.

[Operator]

As there are no further questions at the moment, I will hand it back to the speakers for any closing remarks.

[Niclas Kristensen, executive]

All right. Thank you for dialing in into this call and looking forward to see some of you on the road within the next days. Have a nice day. Bye-bye.