Carel Industries SpA

MIL:CRL

Earnings Call Transcript 2020-Q1

[Operator]

Good afternoon. This is the Chorus Call conference operator. Welcome, and thank you for joining the Carel Industries' First Quarter 2020 Results Conference Call. [Operator Instructions]. At this time, I would like to turn the conference over to Mr. Francesco Nalini, CEO of Carel Industries. Please go ahead, Sir.

[Francesco Nalini, executive]

Thank you. Good afternoon, and welcome to the presentation of Q1 2020 results. I take this opportunity to welcome on board our new CFO Mr. Nicola Biondo, who joined Carel on the 4th of May and who is taking part in this conference.

I'm starting from Page 2 with the main highlights on the period. Obviously, this was a pretty challenging quarter, especially on the supply chain side due to the several disruptions that took place first in China and then in Europe. However, thanks to the resilience of our production footprint, we managed to mitigate the effect of these disruptions, and reported revenues were substantially in line with the first quarter of 2019 with a decline of 1.7%.

We estimate the impact of the disruptions to be approximately EUR 6 million to EUR 7 million. This has generated a backlog, and part of it will be recovered in the following months. So moving down, revenues were substantially in line with what was reported in Q1 '19 with a decline of 1.7%. And this was despite the temporary shutdown of the 2 main plants of Carel Group, that is China and Italy that account for more than 60% of the total production capacity.

This confirms the validity of our long-standing strategy of having production resiliency and redundancy since, as you know, we can manufacture 90% of our product platforms in at least 2 plants. EBITDA margin was 18.2%, 130 basis points less than the full year adjusted results, and that's mainly due to the lack of operating leverage since revenues didn't grow as expected. Of course, we implemented a number of initiatives to mitigate the effects of the situation, especially containing Opex. The effect on the first quarter is limited because we started applying this effect in March. However, the full effect will be deployed in the following months. Net financial position at EUR 62 million is in line with the full year in spite of an expected increase in net working capital related to a seasonal effect in receivables.

Moving to Page 3. We can focus on the supply chain, as you know, we have one production plant in Suzhou, China, that accounts for approximately 30% of the total capacity of the group. The plant was shut down for one week at the beginning of February and then gradually returned to the full capacity in the following weeks. As of today, it's running at 115% of the planned capacity because in the past weeks, we increased very rapidly its capacity by adding shifts and adding machines, and the capacity is increasing even more in the coming weeks. In this respect, it was particularly important, the footprint expansion road map that we completed last year. Since now, we have 3x as much shop floor space in China as the one we had before, so it's relatively easy to increase very rapidly the capacity and increase the resiliency.

In Italy, we have one production hub in Padova and the Recuperator plant near Milan. And they account for approximately 30% to 40% of the capacity of the group. The production hub first slowed down and then stopped entirely for approximately 10 days at the end of March due to the COVID-related restrictions. Production restarted on the 7th of April with limited capacity related basically to the so-called essential supply chain, which, in our case, means the provision of assistance for health care, data centers and supermarkets.

Capacity then increased gradually over the following weeks as the restrictions were gradually loosened. And then we went back to 100% capacity since May 4 when the lockdown was lifted. The Recuperator plant never stopped its continued working for the essential supply chains and went back to 100% capacity again on May 4. As we speak, the total capacity of the group is more than 100% of what was originally planned in order to be more resilient and better cope with potential disruptions. The temporary shutdown of the 2 Chinese and Italian plants has created a backlog, which will be partly recovered after March 31.

Moving to Page 4. We put in place a number of initiatives to mitigate the effects of the pandemic situation, both on the top line side and on the cost side. So in terms of supply chain, during the shutdown of the Chinese plant, we moved very rapidly part of the production to Brazil and Europe and during the shutdown of the Italian plant, we moved part of the production to Croatia and back to China. Of course, the shutdown of the Italian plant had a significantly higher impact than the shutdown of the Chinese plant just because it accounts for a higher capacity as a share of the group.

In terms of costs, we started implementing a number of cost containment measures. We activated in Italy, the government social scheme and similar tools in other countries and we applied a strong reduction in discretionary expenses and obviously, business travel. The positive impact in Q1 of these actions was limited because we started in March, but the impact will be higher in the following period.

Moving to Page 5. We can see some economic figures. So looking at the top right with the revenue bridge. In Q1 '19, we had a turnover of EUR 80.1 million. Without the COVID-related disruptions, revenues in the quarter would have been approximately EUR 85 million. As I mentioned, we lost EUR 6 million to EUR 7 million for the impact of the lockdown and will end at EUR 78.7 million in Q1 2020. For sure, if it weren't for the shutdown of the Italian plant, revenues would have been growing in this period.

EBITDA decreased by 8.7% to EUR 14.4 million with a profitability of 18.2%, down from 19.6% in the same period of last year. This is mainly related to the lack of operating leverage since sales didn't grow, and in particular to the annualization effect of the new hires that we did during 2019. Of course, the incremental effect of the new hires is particularly visible in the first quarter because we see all of them. This effect will be lower in the following quarters as we go through to 2020.

Net profit went down by 14.1% to EUR 7.6 million. The decrease is related to the operating results as well as to higher D&A for the investment program we did in the last 2 years. And CapEx were EUR 2.4 million, so more or less half what they were last year since the footprint expansion road map is now over.

Moving to Page 6, with the revenue breakdown. To the left, we can see the breakdown by region. So EMEA grew by 2.9%, net of foreign exchange, and this is due to a very good performance of the refrigeration market that accelerated in 2020 as well as a very good performance in Eastern Europe where we have been investing recently, as you know, to increase our presence.

Asia Pacific decreased by 17.3%, net of foreign exchange, and this is entirely due to the Chinese lockdown and to the decrease in demand in Asia, which was entirely expected. North America decreased by 10.8%, net of foreign exchange. This is related to 2 elements: One is an expected normalization after a very positive 2019, where we had 20% growth; and the second effect is slowdown in demand in North America that materialized in March due to the COVID situation. Latin America grew by 4.7%, net of foreign exchange, due to a particularly good performance in Brazil.

To the right, we can see the breakdown by sector. HVAC decreased by 4.9%, net of foreign exchange, refrigeration grew by 5.4%, net of foreign exchange. So refrigeration as a good performance is accelerating, and that is what we had expected after Q2 and Q3 last year when, especially in Europe, the growth decelerated. The decrease in HVAC is mainly due to a higher impact of the shutdown of Italy due to product mix reasons. So this does not reflect the actual demand of the market. It reflects the shutdown of the Italian plant that affected mainly HVAC for product mix reasons. The noncore business declined by 8.8%. And so the total decline, 1.7%, is neutral in terms of exchange rate.

I'm moving to Page 7, and I'll leave it to Nicola to comment the items below the EBITDA.

[Nicola Biondo, executive]

Thank you, Francesco. The Slide #7 details the group results from EBITDA to net profit. The first quarter 2020 was impacted by higher D&A cost, mainly related to the relevant CapEx level of 2019. In the period under review, the financial charges were higher compared to last year due to an increased amount of loans available for the group.

The ForEx impact in Q1 2020 was positive for about EUR 20,000 compared to losses for more than EUR 400,000 realized in Q1 2019. The tax rate in the period was 19.3%, pretty in line with the first quarter of 2019. Since the Chinese authorities confirmed the reduction of tax rate for high-tech enterprises, we expect to close the year with a tax rate on around 20%. The group net profit of the first quarter 2020 was equal to EUR 7.6 million compared to EUR 8.8 million of the same period of 2019. Slide #8 shows the net financial position evolution of the first quarter 2020. The net financial position was pretty stable compared to December 2019 level. The fund from operations was equal to EUR 12.2 million, higher than the CapEx and the increase of the net working capital of the period. The increase in net working capital was mainly driven by a seasonal effect. It should be noted that the DSO at the end of the quarter improved compared with the same period of last year.

At the end of the quarter, the group has an amount of cash, cash equivalent and available credit lines of about EUR 90 million. The financing activity performed during the period, made even stronger the good financial situation of the group. At the end of April, the same amount is equal of around EUR 100 million.

I leave the floor to Francesco to go on with the presentation.

[Francesco Nalini, executive]

Thank you, Nicola. So I'm on Page 9. To summarize, in spite of the temporary shutdown of the 2 main plants of the group that represent more than 60% of the total capacity, our strategy proved again -- once again, its resiliency, since revenues were basically in line with the same period last year. It was particularly important, the production footprint expansion plan that we completed last year, since it allowed us to very rapidly increase the capacity in China, but also in Croatia, to mitigate the effects of the shutdown in Italy and to increase our resiliency even further for the future.

Looking at the demand side, revenues in Q1 were only slightly impacted by the global slowdown in demand. The impact was basically concentrated in Asia as we had expected, and North America. We expect a further deterioration of demand, however, in Q2 with a very high level of uncertainty and volatility. To mitigate this, we put in place several initiatives to reduce OpEx and limit nonessential Capex and to improve the liquidity level and the balance sheet position, which was already very strong to begin with.

So to conclude, the pandemic limits the visibility on the full year expectations. A further deterioration in demand is foreseeable in Q2, which, combined with a prolonged effect in April of the shutdown of the Italian plant should lead to a single-digit reduction in revenues in the first half. All -- in the medium term, all the underlying growth drivers of our business remain unchanged.

On the other hand, we foresee several new opportunities coming, for example, from data centers, whose development -- which development is increasing because of the acceleration in digitalization; from air handling units because of the increased sensitivity in indoor air quality, which could lead to a wave of renovations in commercial and industrial spaces, and that will benefit our control systems, but also very much our humidification systems and also the Recuperator heat exchangers.

We expect also a trend in refrigeration and other applications toward more remote monitoring and servicing, which is absolutely in line with our strategy of developing digital services. This positive effect could materialize already in the second half of 2020. Thank you very much for your attention. We are now more than happy to answer to all of your questions.

[Operator]

This is the Chorus Call conference operator. We will now begin the question-and-answer session. [Operator Instructions]. The first question is from William Turner of Goldman Sachs.

[William Turner, analyst]

I hope you're all well. My first one is on your comments that you made on the demand from your end markets. Could you provide any more color on -- is there any vertical, which is pushing back on orders or which you see as particularly challenged during the COVID-19 outbreak? For example, I know you do have some exposure to restaurants and food retail or supermarkets? And then -- and also the commercial construction market.

[Francesco Nalini, executive]

Okay. Thanks for the question, William. So in terms of end market, for sure, some of them, we believe, will be particularly challenged in the coming periods. One, for example, is food service. For sure, the food service segment will be challenged. Likewise, the industrial applications for the part related to automotive. It's been slowing down for months now, and probably it will be in bad shape for a while. Fortunately, these 2 applications count for not much in our global turnover.

In terms of food retail, we are pretty optimistic, especially for the small convenience store surfaces that probably we see a growth. Let's say, supermarkets, in general, have been working at full speed in -- during this crisis. So we expect that in the future, they will start again quite intensely to invest in renovating the stores and increasing the efficiency and complying with the regulation. And so we, in general, are pretty optimistic about the food retail, the food retail industry.

Going to commercial air conditioning, for sure, there could be a slowdown in new construction. We believe that on the other hand, as I was mentioning, there will be a number of projects of renovation to improve indoor quality to increase, let's say, fresh air inside environment to humidify more environments because that's very important for avoiding the spread of viruses and bacteria. So we expect that, that could have a positive effect even if construction slows down.

[William Turner, analyst]

Great. And then on working capital. I've got a couple of questions around this. So the first one is I noticed that inventories have increased quite a bit, even though, obviously, with the flat sales. Has there been any particular reason for this? Are you seeing any shortages in electronics programs -- sorry, electronic components, that was a bit of an issue in 2018? Or do you foresee that happening in the future? And then my second question on the working capital is obviously, you can see probably your 2019 numbers, there is a seasonality in trade receivables. But is it all entirely from that seasonality impact? Or are you finding an unusual amount of customers pushing back on payments, given obviously, these quite unprecedented circumstances?

[Francesco Nalini, executive]

Okay. Thanks, William. So starting from net working capital, let's say, the increase in inventory was basically wanted to, let's say, to increase our resiliency as you know, we were expecting disruptions in Europe. So we increased a little bit our inventory levels to be more flexible towards the disruptions.

In -- but in any case, working capital in the period was 15.8% of sales, so it was very, very low compared to historical levels. So it's still very, very low. An increase in inventory was wanted to increase the resiliency and will probably increase a little bit more also in the following quarters because we wanted to be more resilient towards possible disruptions.

In terms of the upstream supply chain, of course, there are some tensions, not all suppliers, both in Asia and Europe, are now back to, let's say, completely normal operations. But let's say, the situation is now much, much better than it was, for example, in March, and everything is fully being taken care of. And so looking forward, this basically is leading -- has led to some increase in lead times but no more major disruptions after, let's say, May 4, when the plants in Italy fully reopened. So we don't expect major disruptions coming from the upstream supply chain.

Talking about the receivables, the effect is absolutely seasonal. And let's say, as also Nicola was mentioning, the DSO in the period was 75 whereas the DSO -- sorry, it was 71 -- sorry, 71, whereas the DSO in Q1 '19 was 78. So let's say, we had a significant improvement over the same quarter of 2019. This is a seasonal effect that we have every first quarter. We had the same effect also in the first quarter of last year.

[William Turner, analyst]

Great. And then my final question is, could you comment a little bit on your product development pipeline even though obviously, you're cutting all nonessential Capex, can you talk about what your -- how you're thinking about R&D? Are there any new product verticals that you're thinking of launching in the immediate future? Or has the current weakness in the markets kind of possibly results in postponement of new product launches?

[Francesco Nalini, executive]

Okay. Of course, the R&D investment is the investment that we -- the R&D as well as operations investments basically are continuing. So we consider them to a very high extent, essential CapEx. So in terms of R&D, basically, we are concentrating on the applications where we see the highest opportunities in this rapidly changing environment.

For example, we are now investing in indoor air quality. We believe that our humidification systems, in particular, can be very suitable for this, and we are investing in this direction. We are investing in natural refrigerants, very much, not only in refrigeration, but also in air conditioning because we see a big trend in -- also in air conditioning now in Europe, moving to natural refrigerants, for example, in terms of heat pumps. And this is another direction where we are focusing our investment.

We also focus more and more on digital services and services in general because as I mentioned, this is one other area where we see the new normal, let's say, to be -- we see this area as being very important in the new normal. So investment in R&D is going on. Investment in operations is going on and especially is going on to increase the resiliency of the supply chain. And we are focusing on the applications that we see more promising in this new changing environment.

[Operator]

The next question is from Alessandro Tortora of Mediobanca.

[Alessandro Tortora, analyst]

I have 3 questions, if I may. The first question is on the action that you're going to put in place in order to keep all your cost items under control. If you can give us an idea of what's your target, internal target, in terms of profitability? if you believe that to the full impact of this measure, you will be able to keep probably, I don't know, in the low end of the your range -- profitability range that we discussed in -- during the full year results.

The second question is on cash management action. You mentioned before that you are clearly compressing Capex, nonessential CapEx. So if you can give us also an idea for the full of which level of CapEx you can, let's say, achieve.

The third question is on your first half guidance. Clearly, we are now -- you are now assuming single-digit reduction compared to, for sure, 2 months ago, you were still expecting a year of growth for Carel. For all the initiatives that you mentioned before, all the projects, do you believe that is still, let's say possible for Carel to achieve some growth? Or looking at all the other operators into the sector, maybe we should assume something, let's say, a sort of a transitional deal also for Carel?

[Francesco Nalini, executive]

Okay. Thank you, Alessandro. So in terms of costs, basically, we focus on all discretionary expenses. So we had -- we are enacting a significant reduction in consulting expenses, in marketing expenses, we are freezing all the exhibitions that are a major marketing expense for us. We just had one big exhibition, which was in the first quarter in February. So that was a big-ticket item, and which will not happen again in the following quarters because we are freezing all the coming exhibitions, of course.

In terms of personnel, of course, when -- especially when the Italian plant was shut down, we used the government social scheme for all blue collars and partly also for white collars. Individual countries are using similar tools according to the local -- let's say, to the local demand. So we are basically enacting all the necessary reduction of discretionary expenses, and we try to make salaries and labor costs as variable as possible.

On the other hand -- and then I come to your second question. On the other hand, we believe we have to invest for the long term, for the medium to long term, so we are not, by any means, reducing what we consider essential in terms of innovation. And so we are continuing to invest. So let's say, our initial expectation for CapEx for 2020 was approximately EUR 15 million. It will be probably something less, but not much less because we want to continue investing for growth in the medium, long term because as I was mentioning, we believe there are many, many opportunities in addition to the ones that we already had for the medium, long term.

In terms of the visibility on sales, so -- and our profitability target. So it's really too early to provide an expectation for the full year, unfortunately, because uncertainty is extremely high. And also, the visibility is very low. So in the first half, we will have a single-digit decrease in revenues. In the full year, we still don't know. I mean the underlying growth drivers could kick in already in second half, but it's too soon to say. In terms of our profitability range, let's say, the expectation that we always provided is a profitability range for the medium term. What is going to happen this year is something that is pretty difficult to say. Of course, I mean, we -- since we are forecasting for the first half, a single-digit decline in revenues, so we do not expect any dramatic reductions in profitability.

[Alessandro Tortora, analyst]

Okay. Let's say 2 follow-ups. The first one is on the outlook by region. Clearly, this first part of the year have shown some, let's say, weakness, okay, in the U.S. market, compared to an initial idea of consolidation. I understood that COVID-19 impacted but if we look at the timing in theory, you should see U.S. mostly impacted now. What has changed basically in the U.S. market because we know that compared to the, unfortunately, domestic Italian lockdown measure that country was, let's say, a bit more -- how can I say, more or less? So just an update on the U.S. market.

And second on China, being the first country exiting from the COVID-19 pandemic. Can you give us an update of the underlying trends into the market? And the last is on the M&A. If M&A activity for the company still alive in the sense that you are still monitoring or maybe you see incremental opportunities for Carel?

[Francesco Nalini, executive]

Okay. So going back to the markets. Let's -- first, let's have a look again at the first quarter. So in China, basically, the decrease was due to the shutdown of the plant, but also to a decrease in demand. If you remember the presentation of the full year results, we said that we were expecting a EUR 3 million to EUR 4 million reduction in Asia due to the pandemic situation, which is basically what happened. Of course, this has created a significant backlog in terms of demand. So part, let's say, there was a decrease in demand. Demand now in Asia and China, in particular, is picking up again pretty fast. And so we are pretty optimistic about the region.

Of course, we had the decrease of the first quarter, but now the outlook is pretty, let's say, improving in -- definitely improving, especially in China. While the rest of Asia is still in a pretty difficult situation because it's behind China in terms of the epidemic.

In general, looking at the group because you mentioned that we were expecting a growth this year. Of course, we were expecting a growth, but please consider that we lost like close to EUR 4 million just because of the shutdown of the Italian plant. So without the shutdown of the Italian plant and just for March, we would have been growing despite the decrease of Asia.

Now especially, the shutdown of the Italian plant has created a backlog because that was demand that was just moved ahead. Now we are working at full speed with more than 100% capacity to recover the backlog and so we are, let's say, we are working intensely to recover the backlog. What is going to happen on demand is still pretty uncertain. Of course, for the second quarter in terms of demand, we expect, like everybody else, we expect a reduction.

Going to North America, I have to say that already in March, we started seeing a decrease in demand, very cautious approach by the industry probably because they were seeing the pandemic coming. But that was pretty industry wise that there was a very cautious -- very cautious approach. So that was what we have been seeing in March in North America. And as you correctly said, North America is behind us in terms of the evolution of the pandemic. So it's particularly uncertain what will happen there. So we are basically optimistic in China. We are also pretty optimistic about Europe. In Europe, we have -- we expect, let's say, we expect to continue with a relative good performance in Eastern Europe.

Western Europe is a more mixed situation according to the individual countries. But in general, we remain relatively optimistic. On the other hand, North America is the most -- as well as Latin America by the way, are the most uncertain, let's say, scenarios because they are lagging behind in terms of the pandemic evolution.

Looking at M&A, as you have seen, we had EUR 90 million cash and cash equivalents on March 31. And then as Nicola was mentioning, we also strengthened our balance sheet after March 31. We are now around EUR 100 million. So we believe that we are in a good position to, let's say, take advantage of any opportunities that we would find. And yes, we are still looking, absolutely. Honestly, during -- especially during March and April, we were focused very much on the resiliency of our supply chain. But in general, we remain very committed to our M&A strategy.

[Operator]

[Operator Instructions]. Mr. Nalini, there are no more questions registered at this time.

[Francesco Nalini, executive]

Okay. Thanks, everybody, for attending. Thanks for the questions, and talk to you at the presentation of the first half results. Thank you very much.