Applus Services SA

MAD:APPS

Earnings Call Transcript

[Operator]

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today's Applus First Quarter 2019 Results Presentation Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Tuesday the 14 of May 2019.And now I would like to hand over the conference to your speakers today, Chief Executive Officer, Mr. Basabe; and Chief Financial Officer, Mr. Amigo. Please go ahead.

[Fernando Basabe Armijo, CEO & Executive Director]

Good afternoon, all. Thank you for joining the call today for our first quarter 2019 results presentation. I am Fernando Basabe, CEO; and with me here is Joan Amigo, our CFO. The agenda for today I will go through the highlights. Joan will then present the financials. And I will present the business review and outlook. At the end, we'll open the telephone line to take your questions.For Q1 and Q3, we only saw the profit and loss down to the profit before taxes level. Last year exceptionally, we showed it down to the EPS level due to the acquisition of Inversiones Finisterre in 2017 changing quite significantly the figures. And for the divisions, we just saw revenue in Q1 and Q3. We had a strong start to the year. I'm very pleased with the first quarter results, especially as we saw that the strong growth momentum from last year has continued into this year and that gives us confidence for continued growth in the quarters ahead.All the key financial indicators performed well. Revenue total on organic, profit, margin and cash flow were all good. All 4 divisions had strong organic and total revenue growth and all 4 divisions had an increase in the margin. The organic margin increase was from the 2 largest divisions, Energy & Industry and Automotive. Automotive benefited from the timing of Easter with more revenue in Q1, and some of this will be given back in Q2. We made 2 acquisitions so far this year, both in the Labs division. And although small, they come with high margins and were bought at good prices and had a good stability. We expect to continue making acquisitions.For the financial highlights, which now saw the profit and cash flow under the new accounting standard on leases, IFRS 16. What we've done in this presentation and as you would have seen from the announcement this morning is we are showing the figures both under the old method of accounting and under the new method. But when we use a new method, we've done a pro forma of the prior year numbers so it is like for like. At actual rates, revenue was up 9% with organic revenue being in the high single digit 7.6%. Adjusted operating profit was up 19.3% on a pro forma basis and 17.5% was organic.The margin for Q1 is now 9.3%. This was an increase of 80 basis points. And this was mainly due to the organic margin increase. And cash flow was very strong this first quarter as we expected it to be after running last year with a higher level of working capital than usual due to a strong growth we saw right at the end of the year in Energy & Industry.And with that, I hand it over to Joan.

[Joan Amigó I. Casas, Chief Financial Officer]

Thanks, Fernando, and good afternoon, everyone. I will start the Q1 2019 revenue reach. Strong Q1 2019 revenue with a 9% increase. We had high single-digit organic revenue growth of 7.6% similar to Q4 last year coming from all divisions. And positive FX impact 1.2%, mainly due to U.S. dollar appreciation against the euro. There are 6 small acquisitions that add growth of 1%, partially offset by the nonstrategic business in Energy & Industry that was disposed in Q4 2018. Now at this disposal, we've a good revenue via further EUR 10 million in the rest of the year.Regarding adjusted operating profit, as Fernando has mentioned, this is the first year we have to account under IFRS 16, the new accounting policy on leasing. I will explain the changes in more detail in the income statement on the next page. But as you can see in the bridge, we have done a pro forma of the Q1 2018 including IFRS 16 impact. All the percentages and margin increases are on a pro forma basis so that you can see the genuine like-for-like increase. Therefore, to the EUR 30.3 million recorded in Q1 2018, we have added EUR 1.9 million as IFRS 16 adjustment to get a pro forma Q1 2018 of EUR 32.2 million.So overall, adjusted operating profit was EUR 38.4 million, up 19.3%. Organic growth 17.5%, plus 2.3% net inorganic. FX impact is slightly negative 0.5% mainly due to Argentina peso. Margin was up 80 basic points and the majority of this increase was organic coming mainly from Energy & Industry and Automotive division.Slide #8, a summary of the income statement. In order to clarify IFRS 16 impact, on the left side hand of the page, we have included the income statement excluding IFRS 16. In the middle, the IFRS 16 impact and on the right, you have the new income statement including IFRS 16 with the pro forma of Q1 2018. As we guide at year-end, IFRS 16 is quite near to our net profit level, but increases the EBITDA of the company which is offset by an additional depreciation and finance cost. Below the adjusted operating profit, we have the amortization of intangibles by an amount of EUR 14.8 million, same as last year and the other results that corresponds mainly to transaction cost of EUR 0.2 million.So overall, the reported operating profit was up 37.1%, on a pro forma basis. Net financial expense of EUR 5.4 million including EUR 1.9 million from IFRS 16 is EUR 2.1 million lower than last year due to a lower amount of debt and interest rate. We expect financial expenditures for the whole year of around EUR 22 million, EUR 23 million, including EUR 7 million, EUR 8 million from IFRS 16.Although, we are not reporting taxes of minorities at the Q1, as Fernando said, the guidance for the full year of 2019 remains the same as we said at the last results meeting. With minorities, we expect around EUR 20 million, EUR 21 million for the whole year, and the expected effective tax rate will be in the range of 24%, 26%.Regarding cash flow, the IFRS 16 [indiscernible] money increases the EBITDA which is offset by an additional amount of financing which comes at the bottom of the cash flow table. I will focus on the cash flow excluding IFRS 16 for this Q1, so that you can get a better stand of it. [ From ] adjusted operating cash flow of EUR 44.5 million, more than double Q1 last year and also a strong free cash flow of EUR 33 million, up EUR 15 million as of last year. The working capital change is the most important items here. If you would remember, working capital increased in Q4 last year due to the double-digit growth in Energy & Industry.And of course, that increase in revenue at the end of the year mean more receivables. The receivables has now been collected and hence the Q1 working capital change is a reduction of EUR 5.8 million. Capex of EUR 10.3 million, up EUR 2.5 million as we guide what we expect a little bit higher than the usual 3% of revenue this year, up to 3.2%, 3.4% of our revenue for the whole year due to the additional investments mainly in Labs, in the electromagnetic compatibility chambers and IDIADA for a new autonomous vehicle truck.Taxes, EUR 7.9 million, in line with our expectations to have around EUR 34 million, EUR 36 million for the whole year. Just to remind you that in Q1 2018, we had some one-off [ rate on ] mainly in Spain and Colombia. Increased cash outflow EUR 3.5 million, up EUR 0.6 million that's from last year due to the [indiscernible] time. We maintain our guidance of around EUR 10 million for 2019. Below the adjusted free cash flow, what we expect is minorities around EUR 20 million for 2019. And in Q1, we have acquisitions that corresponds to LEM, a Spanish metrology company and A2M-I, a French material testing company.And for my final slide, we show the net debt bridge also with and without the impact IFRS 16 to help you understand it better. The one on the left is excluding IFRS 16 and how our bank covenants are tested. The one on the right is under the new accounting policy IFRS 16 and hence the opening borrowing increased by EUR 180 million as we guide when we reported our full year result. Like the cash flow, I think it's better to focus on the left-hand side excluding IFRS 16 as we are more familiar with these numbers. Net debt has reduced by EUR 22.2 million. It means a leverage level of 2.2x from 2.3x at the end of 2018.The financial covenant from the lenders is set at 4x, so we are comfortable with the debt and covenant levels, and this provides us with a financial flexibility to support our M&A strategy. That concludes the financial slide. In the appendix, we provide further slides with the usual analysis that we always provide as well as on the slide on the main current debate.And now let me hand over to Fernando.

[Fernando Basabe Armijo, CEO & Executive Director]

Thank you, Joan. I'll go now through the key points of the quarter for each of the 4 divisions. Starting with the biggest, Energy & Industry, which accounts for 57% of group revenue in Q1. Total revenue growth of this division was 8% and organic of 6% was good. This is now the fourth consecutive quarter of positive organic revenue growth for this division. And it demonstrates that the market and our strong market position both continue being favorable and our ability to execute on our growth strategy is coming through.The main growth in this quarter has come from power and aerospace and market with oil and gas growing at low single digit. By region, Southern Europe was the strongest with Spain being the main part of this due to a good market and our leading position here. We also saw good growth in Canada that was partly a continuation of a large contract that started in Q4 last year, and Middle East, in particular, Saudi Arabia and Oman, and in Latin America, mainly in Chile and Central America.I said at the start that this division together with Auto generated most of the organic margin improvement. This is mainly due to the continued improvement in the top line and also without suffering from the negative mixed effect that we saw last year.In Laboratories, good growth continuing here across all the main business lines. The division is seeing a lot of demand for electromagnetic compatibility testing which is EMC for all sorts of projects that have electrical parts to them, including of course cars. 11% revenue from acquisitions is mostly from the 2 made last year in the U.S. and U.K., and this will continue to be seen as acquisition revenue in Q2, after which they will be part of organic.The 2 small acquisitions made so far this year were at the end of the first quarter. LEM is a group of metrology labs in Spain and joins our already extensive network of metrology labs here where we have a strong position in this attractive business. And A2M is a material testing lab in France with relevant accreditation for the nuclear and aerospace industry, and having as main customers [ Areva ] and [indiscernible]. And we expect this division to continue making acquisitions and building leading positions in some of the areas in which we operate.Now Automotive, total growth of 6.4% was made up of organic revenue of 9% less a currency negative impact of 2.7% due to the Argentinean peso devaluation last year. As a reminder, Argentina currently accounts for around 5% of the division revenue, and excluding Argentina, organic revenue growth was 7.1%.We had good underlying organic revenue growth across all our main regions, which benefited in Q1 from the late Easter, whereas last year we came right at the end of the first quarter. Hence this division, which depends on the volume of daily vehicle inspections, had more volume in the same contract in Q1 this year than last year. Of course, we will see the reverse of this in Q2.We estimate organic growth excluding Easter impact would have been in the mid-single digit. As well as the underlying volume growth, we had a small benefit from the new contracts started in half last year in Uruguay and Ecuador. On the other hand, our contract in Menorca came to an end in half 2 last year.Still to come this year our new contract in Buenos Aires for taxis, Republic of Georgia and the second one in Ecuador. However, these are all quite new. And we've won another contract this year in [ Velosi Ecuador ] making it 4 in total now with expected revenue of around EUR 4 million when they ramp up, and we expect more tenders in the coming months. Finally on Ireland, there is no news yet. We presented the bid back in March. And the timetable is to clear the outcome later this month or in June. We will announce to the market the outcome as soon as we can.Last division is IDIADA, where we are back in the double-digit growth rate after a slower Q4 last year. Inorganic comes from the acquisition of Karco in California last year. The market for our services remains strong and we continue to build new facilities to add capacity to capture this flow. For example, we've started a building of a new product for autonomous vehicle testing within our main track at Tarragona and we expect it to be finished by the end of the year.In summary, we've had an excellent results in Q1 with high single-digit organic revenue growth and good margin improvement. Acquisitions have performed well and we have generated strong cash flow. Even though it's early in the year and there is some possible seasonal effect from Easter, this good results and our forecast for the rest of the year have prompted us to slightly raise the margin guidance. On revenue, we continue to expect organic growth to be in the mid-single digit range, but we now expect our margin to improve by at least 30 basis points versus our previous guidance of an improvement of 20 to 30 basis point.And that concludes the presentation. We are -- Joan and I are now ready to take your questions. Thank you.

[Operator]

[Operator Instructions] And our first question comes from the line of Will Kirkness from Jefferies.

[William Kirkness, Equity Analyst]

And I've got 3 questions please, 2 on the margin. You talk about most of that increasing coming through E&I. So I'm assuming that most that is sustainable and some of it reverses out with the Easter impact in Automotive. I just wondered if you could maybe quantify what you believe is sustainable or what's coming from E&I.And secondly on the margin, I think for the last couple of years staff costs have been increasing at a faster rate than revenue. Would it be reasonable to assume that in this financial year that that switches around? And then my last question just around the growth, just looking at the IDIADA division. Just wondering the comp is getting easier. So is there any reason that we should see that rate of growth in Q1 slow?

[Fernando Basabe Armijo, CEO & Executive Director]

I'll start with the last one. In IDIADA, the growth rate close to 10% in this Q1. What we expect is the rest of the year to be similar, maybe a little bit lower, but always for the year I would say high single close to double-digit growth is what we are expecting.And on your first question was about the margins and the improvement in Energy & Industry or Auto, were they sustainable? I mean we don't disclose margins by division by quarter. We'll do it at half year and you'll have a better view. What we are guiding for the full year is at least 30 basis points. In Q1, it was 80 basis points. So Q1 is the lowest of the year. We had some positive seasonal effect. So it's, I would say, early in the year to say, but I think in Energy & Industry as long as revenue continues growing, which is what we expect. The margins are sustainable. In Auto, there is some positive impact from Easter. But again, we also think the improvement is sustainable.And your second one, I'm not -- could you repeat it please because we are not sure we understood it.

[William Kirkness, Equity Analyst]

Yes, sure. If you look back in the annual report for the last couple of years, it looks like staff costs has been increasing at a faster rate than revenues. You've sort of been layering people back into the business. My guess is that the growth in coming back. Would it be fair to assume that in the 2019 year that you sort of caught up with that and therefore, the top line should be growing at a faster rate than the staff cost?

[Fernando Basabe Armijo, CEO & Executive Director]

Not really. I think to look -- you have to -- we have a lot of subcontractors also. So looking only at staff costs might be misleading. So staff plus subcontractors, what we will call direct cost, is -- has been pretty steady over revenue in Energy & Industry during last year. So I think if the growth last year was higher than revenue, there are some mix effects and also there are regions where we can have more level of subcontractors than others. So I don't believe it's an indicator that means anything.

[Operator]

And the next question comes from the line of Paul Sullivan from Barclays.

[Paul Daniel Alexander Sullivan, Director & Analyst]

Just a couple from me. Firstly, can you tell us what's driving the growth in power and aerospace within the E&I and your thoughts on the sustainability of that growth? And then secondly, in terms of oil and gas, it looks a little bit weaker than perhaps we were expecting, given the stronger fourth quarter. I know there's this upper comp in Q1. But can you talk about the underlying dynamics there and kind of pipelines and the prospects that you see now for the rest of this year? And then thirdly, finally, any sign of pricing returning across any of the portfolio?

[Fernando Basabe Armijo, CEO & Executive Director]

The power and aerospace have grown more than, I would say, usual in this quarter. In power, most of the growth is coming from Latin America where we have had a very strong growth and there are several contracts that we started Q4 last year and continue doing well. And also in Spain, where we have had very good growth in this Q1. The market has been good and we had a very strong position.In aerospace, we made several investments during the last year and the year before, and they are paying back. And also the acquisition we did in the U.S. there -- we've had some early revenue synergies there. So we don't expect this to continue growing, let's say, double digit, but growth should be quite good in both end markets, especially, I would say, in aerospace, which is smaller and we have more room for growth.In oil and gas, well, weaker. Q1 is the very -- is the lowest quarter of the year by far in Energy & Industry. I think the -- there are also many moving parts and we are happy with the trend we have seen. This quarter was low single. We expect this to be better in the coming quarters. And looking at the general trend we are seeing in the market, we are comfortable with the mid-single digit for the year which is our target.On pricing, I would say no news. So things continue to be tough in the market. I've said several times not as tough as they were 2 or 3 years ago in the sense that we don't have our customers calling to change conditions. We are able to raise some prices in places where there is more inflation or wage salary inflation. So -- but this is still a top environment. But not a big change from previous quarters.

[Operator]

And the next question comes from the line of Alvaro Lenze from Alantra.

[Alvaro Lenze Julia, Research Analyst]

I have a couple of questions. A follow-up on the previous one. Regarding the Energy & Industry, you said that power in LATAM has been growing fast in Q1 due to a large contract gain in Q2 last year. And I was wondering if we should expect a decline in -- or a slowdown in organic growth in Energy & Industry or if we should be offset by higher growth in oil and gas?And then secondly, regarding Auto, you said that organic growth could have been around 5% in Q1 excluding Easter effect. I just wanted to know if this 5% was also very good due to easier comparable or if we could expect something like this for Q2? So I mean, expecting like 1% organic growth in Q2 to make an average of 5% for H1, if that would make sense or if that would still be hike? And lastly, I didn't get the number. If you could please repeat the guidance for tax rate for the whole year?

[Fernando Basabe Armijo, CEO & Executive Director]

The guidance for what, sorry? Tax, okay.

[Alvaro Lenze Julia, Research Analyst]

Full year tax rate, yes.

[Fernando Basabe Armijo, CEO & Executive Director]

On your first question, Energy & Industry, it's not only 1 large contract in Latin America. There is a few of them. And I think Latin America growth in Q4 last year and Q1 last year has been very, very high. And yes, this will slow down. But overall, it couldn't impact Energy & Industry. So there are other regions that are in the opposite situation. So yes, power has benefit from some large contract in Latin America. That will decline in half 2. But other areas will pick up. So we don't expect that the -- we continue to expect, let's say, mid-single digit growth organic for Energy & Industry in the year.In Auto, excluding Easter is not a mathematical calculation. It's always quite difficult to evaluate the impact because it's not only a question of days, depending on when Easter comes. Many customers go before Easter to pass their test before traveling. So it's not straightforward. What we think is that it would have been around mid-single digits. And in Q2, we don't expect growth to be as high, but we don't expect it to be 1%. So it should probably be higher than 1% organically. And your last question on the taxes?

[Joan Amigó I. Casas, Chief Financial Officer]

Yes. And regarding taxes, Alvaro, so our effective tax rate for the whole year should be in the range of 24%, 26%. So it means adjusted corporate tax over adjusted profit before tax.

[Operator]

And the next question comes from the line of Andy Grobler from Credit Suisse.

[Andrew Charles Grobler, Analyst]

Just one quick one please on North America. Could you just talk about the operating environment, one? And what type of contracts you are winning and bidding for in the region? And especially, whether any of the larger pipeline contracts are beginning to come back to the market please?

[Fernando Basabe Armijo, CEO & Executive Director]

In the U.S. in first quarter last year, I think we were growing almost at double digit due to a large contract that we had at the time. What we are seeing now is a lot of permitting issues and large new pipelines being delayed or -- well, not really coming to the market. So in that sense, it's not a -- we don't expect in half 2 to see a lot of activity. On the other hand, the smaller pipelines and the pipeline integrity activity and other activities that we do there are going well. So I would say, difficult environment for large projects because of permitting issues, especially in certain states. We had -- we won one good contract, one of the largest pipelines that is going to be built in the -- probably in the second half of this year because it has already been delayed, Atlantic coast pipeline, and that should help us if it finally happens in half 2 as we are expecting. But overall, I would say the environment is not bad, but it's not booming. And we don't expect a huge activity in large and new construction pipelines.

[Andrew Charles Grobler, Analyst]

And if I could follow up in that the kind of medium terms through 2020-2021. What are you seeing in kind of that longer-term opportunity set for the business in North America?

[Fernando Basabe Armijo, CEO & Executive Director]

We see the need of new infrastructure in order to transport all the oil and gas that is being produced there. But we already have seen this need in the last year and the reality is that permissions -- permits are getting tougher and tougher. So we are, I would say, optimistic because we think the need is there. But on the other hand, we are realistic in the sense that we are seeing it's not happening. So we are -- it's not difficult for us to mobilize, especially in certain areas of the country. So if this happens, we are ready. But we are not counting on that to make our -- the numbers of the year and our guidance is not based on expecting many new contract coming up.

[Operator]

And the next question comes from the line of Edward Stanley from Morgan Stanley.

[Edward Stanley, Equity Analyst]

Apologies if these have already been asked and ignore them if they have. But on working capital, it clearly gets a very good sign that there's an inflow in Q1. I presume that was dominated by the E&I division. I wonder clearly having a more stable organic growth in that division through the year is the best possible scenario for cash generation. And correct me if I'm wrong, but if you can hold 6%-ish or mid-single digit in the E&I division, where do you feel like you could be in terms of free cash flow for the year or working capital or the phasing of cash through the year, so we can understand how cash progresses?And secondly, on the Auto division, you mentioned Buenos Aires, Georgia and Ecuador. Are there any contracts that are dropping out thinking of the other side of the order book that we should be aware of during the year?

[Joan Amigó I. Casas, Chief Financial Officer]

So regarding working capital, so the first thing is that, honestly, I think that working capital within the company is in a very good shape. So it's not more than 6%-7% of our revenue. So we are always moving in the range of 20%, 23%. And this was the same in Q4 2018. But obviously, we follow the trend of the revenue. And this is the reason why the working capital increased at the end of 2018.Normally the seasonality during the year following as well the seasonality of the revenue is that normally in Q2 and Q3 is then when the working capital used to increase and normally decrease in Q4. So what we expect is that the working capital should increase a little bit in Q2, much more stable in Q3, and decline again in Q4.The final numbers that we have, it will depend again on the level of activity that we'll have in the last quarter in terms of revenue. But I think this year should be much more stable. But again, the final number will depend on the level of revenue in the last month of the year, November, December. And coming back to what you say in terms of free cash flow, what we expect is another year of a good cash generation with a cash combination grade in the range of 70%, 70% something. So I think should be again a good year in terms of cash generation.

[Fernando Basabe Armijo, CEO & Executive Director]

And Edward, on your second question on Auto, we don't have any contract coming to an end during the year. We have at the end of the year Washington in the U.S. that will not be continued and that's for next year. The revenue on that is EUR 8 million a year.Buenos Aires, the contract theoretically ends in September/October. It has already been extended once and we expect it to be extended again. There is no way it can be retendered again in such a short period of time. So no negative variation during the year coming from the end of contracts.

[Operator]

Thank you. As there are no further questions at this time, please go ahead.

[Fernando Basabe Armijo, CEO & Executive Director]

Okay. Thank you very much to all.

[Operator]

Thank you very much speakers. Please go ahead.

[Unknown Analyst]

Have we finished the call?

[Fernando Basabe Armijo, CEO & Executive Director]

Thank you very much. This finishes the call for Q1 results. Thank you. Bye.

[Operator]

Thank you so much. So that does conclude the conference of today. Thank you for participating. You may all disconnect. Thank you.