OC Oerlikon Corporation AG Pfaeffikon
SIX:OERL
Earnings Call Analysis
Q3-2023 Analysis
OC Oerlikon Corporation AG Pfaeffikon
In the third quarter of 2023, Oerlikon continued its strategic pursuits, pushing technical innovation and integrating the newly acquired Riri, albeit against a backdrop of economic headwinds, indicative of sluggish industrial and consumer spending, coupled with currency challenges. Orders overall stood at CHF 567 million, with Surface Solutions eking out a 3% organic increase, but this gain was overshadowed by a sharp 11% drop in sales when adjusted for constant currency effects, resulting in CHF 623 million in group sales.
In the Polymer Processing Solutions sector, customers kept investment on the sidelines, significantly reflecting on the order intake volumes. The Filament subsector has been particularly hard hit, culminating in what is now the fourth consecutive year marked by adversity, driven by surplus inventory and cautious spending in China. Yet, hopes are pinned on a potential uplift in 2024, bolstered by government stimuli within the machinery industry. Orders in this segment slumped by a notable 49% in local currency terms to CHF 199 million, while operational EBITDA dipped to CHF 28 million, equating to an 11.1% margin that bore the brunt of negative operating leverage, the Swiss franc's appreciation, and the rising cost of inputs.
The Surface Solutions segment managed a more sanguine outcome despite prevailing industrial slowdown, with a 3% organic growth in orders amounting to CHF 367 million for the quarter. Supported by sectors such as Automotive, Energy, Luxury, and Aviation, the division saw a stable EBITDA margin year-over-year at 17.1%, and an uptick in operational EBITDA by 6% to CHF 63 million. The steady performance stands as a testament to the efficacy of strategic cost and pricing actions, which are expected to buttress profitability in the mid-term.
Oerlikon is actively counteracting the economic pressures with strict cost controls and a sharpened focus on innovation. This proactive stance is vital as they tackle reduced consumer demand, especially marked in sectors like Non-Filament and the softer transitions in Flow Control which anticipates rejuvenation with a forecasted surge in car launches come 2024. The Luxury segment, although experiencing a deceleration, still holds promising mid-term growth prospects, underlain by robust indicators like enduring tax-free shopping trends.
The Aviation sector displayed resilience with rising flight hours aiding the Maintenance, Repair, and Overhaul (MRO) activities, with trends moving towards pre-pandemic levels aided by the reopening of China and the resurgence of travel. Similarly, the Automotive segment began to recoup lost ground with a modest upswing in Q3 following a slow start to the year, and industry estimates suggest moderate growth in light vehicle production throughout the year.
Oerlikon's leadership views the downturn within the Polymer Processing Solutions domain as transitory. Reaffirming a commitment to strategic cost-reductions and efficiency increases, the company is set to review operations, including a re-evaluation of joint ventures and investments initiated in 2019. The company's mid-term future appears resilient, banking on the eventual uplift of demand in segments like Filament, and the innovative pace in Surface Solutions that continues to underpin its growth trajectory.
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Ladies and gentlemen, welcome to the Oerlikon Q3 2023 Results Conference Call and Live Webcast. I'm Sasha, the Chorus Call operator. [Operator Instructions] And the conference is being recorded. The presentation will be followed by a Q&A session. [Operator Instructions]
At this time, it is my pleasure to hand over to Stephan Gick, Head of Investor Relations. Please go ahead.
Good morning, ladies and gentlemen, and welcome to Oerlikon's Q3 results call. With me on the call, I have Philipp Muller, CFO of Oerlikon. Philipp will start the call presentation providing an update on our end markets, financials and guidance. We will then follow up with Q&A.
With that, I would like to open our presentation and hand over to Philipp. The floor is yours.
Thank you, Stephan. Good morning, everyone, and welcome to our third quarter results presentation. In Q3, we continue to execute our strategic objectives and successfully drove forward technical innovation and the integration of Riri. We are doing this in a difficult economic environment as industrial production and consumer spending continue to be subdued and currency headwinds persist.
I will start the presentation with an overview of the group results, followed by an update on our end markets, the divisional results, and I'll conclude with our outlook.
At the group level, orders were CHF 567 million. Polymer Processing Solutions customers continue to delay their investment decisions. In Surface Solutions, orders were up 3% organically. Group sales decreased 11% at constant FX to CHF 623 million. This includes a 5% contribution from our acquisition of Riri. In Surface Solutions, we achieved a slight FX adjusted organic sales increase in Q3 and a solid 7% growth in the first 9 months of the year. This was more than offset by the declines in Polymer Processing Solutions. Operational EBITDA was CHF 98 million and EBITDA margin of 15.7%.
Profitability was impacted by negative operating leverage, with strength in Swiss franc and higher input costs. We're executing a clear set of cost and pricing actions, which will support our profitability in the coming quarters. We have seen first benefits in Surface Solutions where margins improved sequentially.
With that, let me provide you an update on our end markets. Polymer Processing Solutions, customers continue to delay their investment decisions, which is reflected in our order intake. On the Filament side, 2023 is the fourth challenging year in a row for our customers. Chinese customers are exposed to higher stockpiles in the textile industry this year, and selective consumer spending as the increased cost of living has put pressure on discretionary spending budgets. This follows the past years, which were impacted by higher input costs, logistics challenges, tighter financing and COVID-related lockdown in China.
As a result, we see Chinese Filament customers holding back their expansion and replacement plans. They started postponing CapEx decisions and preserving cash in the second half of last year. To date, we have not yet seen a meaningful recovery, but we do note increasing governmental stimulus for the machinery industry. We continue to expect an order recovery to happen in 2024, our first positive indication that price cost spreads of our customers improved this year. This means our customers have a positive cash margin on every ton of product they sell, which is a precondition for them to invest into our equipment. I will elaborate further on this topic later on in the presentation.
In our Non-Filament business, where end markets and geographies are broadly diversified, we saw impact from globally weakening PMIs, the nonwoven and carpet yarns businesses are seeing some customers delay their investment decisions. Typically, orders are smaller with lower financing needs and returned faster when consumer demand picks back up.
In Flow Control, where performance is closely related to car model launches, we saw impacts from a transitory reduction in car launches in the quarter. We expect car launches to accelerate again in 2024. In the Surface Solutions division, we are operating across the tooling, automotive, luxury, aviation and digital industries end markets, particularly the general and tooling industries have a close correlation to industrial production. Manufacturing PMIs in Europe and the U.S. entered contraction zone in the second half of last year and have not recovered since. Also, in China, we see subdued momentum despite the opening in the beginning of the year. Weak industrial activity had therefore an impact on our general industries and tooling sales in Q3.
In automotive, we hear mixed signals from our customers, particularly in the Premium segment. After a relatively slow start to the year, you have seen a catch-up in Automotive in Q3. This is supported by light vehicle production growth, which industry forecasts expect to be mid-single digits this year. We continue to drive innovation and Oerlikon has made significant commercial progress with e-mobility solutions this year, particularly in battery shielding.
In Luxury, the integration of Riri is on track, and we achieved solid sales during Q3. We are currently seeing a slowing momentum in the fourth quarter related to China and destocking. This is underscored by some leading indicators like Swiss watch exports while other indicators such as tax-free shopping remains strong. Midterm growth drivers for Luxury remain well intact.
Finally, in Aviation, we see continued growth as rising flying hours are driving MRO activity. The China reopening and returned from all travel are a key factor as the industry returns towards 2019 levels. Oerlikon Solutions will support more efficient and more sustainable aircraft engine technology.
Summing up, the difficult market environment for Polymer Processing Solutions will impact 2023 and 2024 sales. We have taken proactive measures to preserve profitability and emerge even stronger. In Surface Solutions, we see continuous weak industrial momentum. We are confident that our value proposition of improving efficiency and sustainability is in demand particularly in difficult times. Innovation and joint R&D with our customers will drive midterm growth.
With that, let's move to Page 4, where we discuss the financials for our Surface Solutions division. Orders improved 3% organically to CHF 367 million despite the softening industrial activity. The book-to-bill ratio was at 1x as per the end of the quarter. In terms of sales, we achieved 1% organic growth in the quarter and 7% in the first 9 months of the year. Growth is supported by the Automotive, Energy, Luxury and Aviation end markets.
Operational EBITDA in the quarter improved 6% to CHF 63 million. EBITDA margin was roughly stable year-over-year at 17.1%. The business continued to be impacted by the strength in Swiss franc, higher input costs and a difficult economic environment in China. The latter has an impact on margins as we sell a high-margin product portfolio in China. The cost actions, which we initiated towards the end of last year as well as earlier this year, started to support margins. The continued pricing actions we are taking are also having first positive effect.
Accordingly and sequentially, margins were up around 100 basis points. As I said earlier, we remain very confident in our actions to drive profitability in the midterm. The actions we are taking, operating leverage, portfolio optimization and some normalization of activity in our service business will allow us to bring the Surface Solutions business back to strong margins in the midterm.
Next, on Polymer Processing Solutions. Orders in Polymer Processing Solutions were CHF 199 million. This is down 49% in local currency, particularly as customers are postponing Filament orders. Orders in Non-Filament decreased by a mid-teens percentage in the context of weakening PMIs globally. Third quarter sales of CHF 255 million were down 31% in constant FX. This was mainly driven by the lower order book in Filament. We expect slightly stronger deliveries in the fourth quarter.
Operational EBITDA was CHF 28 million. Margins were 11.1%, impacted by operating leverage, the strength in Swiss franc and higher input costs. In line with last quarter, we passed through higher input costs only to a limited extent in order to maintain volume. This effect will strengthen in the fourth quarter, and it will be counteracted by first impacts of our previously announced cost-saving measures.
Another factor which impacted our operational margin in Q3 were additional expenses to improve efficiency of a smaller joint venture, which we entered in 2019. In line with our strengthened capital allocation approach, we are currently reviewing this joint venture and are contemplating further steps in Q4.
With that, let's conclude the presentation on the next slide. Our third quarter results reflect the current weakness in our end markets and currency headwinds. We are managing short-term headwinds with stringent cost containment and acceleration of our innovation pipeline. In Surface Solutions, we achieved 7% organic sales growth year-to-date despite contracting PMIs. Our EBITDA margin improved sequentially, which is supported by the sided cost and pricing measures.
In Polymer Processing Solutions, we are executing in a challenging environment. We communicated on the challenging demand environment already last year, and we are proactively preparing our cost base. These actions are on track. The underlying trend of growth in Filament is unchanged, and makes us confident that this downturn is only transitory in nature. The chart in the middle of the slide highlights cash margin that our Filament customers earn on every ton of product they sell. The green line represents the average annual selling price of polyester products, minus raw material cost, minus conversion costs. Our customers saw a negative margin in 2015, which turned again positive in 2016. Given a certain time delay, this resulted in a challenging 2016 for Oerlikon which was followed by our order recovery in 2017. Looking at the current downturn, the margin of our Filament customers was negative in 2022. It improved again into positive territory this year. This provides a positive indication to order recovery in 2024 in our view. Obviously, the situation of today is not perfectly comparable to 2016. While the downturn in 2016 was driven by overcapacities, this downturn is driven by the difficult market environment in China as well as weakening global consumer demand and GDP. As such, the timing of the recovery is difficult to predict and will also depend on globally economic recovery and the return of consumer demand.
Despite the currently difficult market environment, we believe that midterm, we are absolutely in the right markets. We continue to execute on our midterm strategy in both of our divisions. Latest market introductions were successful and include a carbon-based coating for processing nonferrous metals as well as our innovative EvoSteam process for a more sustainable staple fiber production. Our innovation pipeline for the coming quarters is filled with solutions that will increase the customer value of our product portfolio.
In parallel, we continue to leverage our core competencies into new areas and geographies. This includes the Luxury segment with Riri, battery shielding, e-mobility and double-digit sales growth in Americas, which is supported by the new organizational setup. In terms of profitability, we continue to execute on our midterm plan. Oerlikon is positioned as a market leader in niche markets with technology entry barriers. This is a very solid base to generate attractive margins.
Also, portfolio optimization will continue to help us realize margin upside as we highlighted at the Capital Markets Day. Our recent exit from in-line ePD was the first step. We are conducting a review of a number of portfolio investments in the fourth quarter and will decide on further optimizations. Depending on the outcome of these reviews, we might face certain one-off charges in Q4, which would be predominantly of a noncash nature. These actions will support profitability in 2024.
Finally, we are on track with our sustainability journey to reach our 2030 ESG targets. Our value proposition is to improve our customers' efficiency and sustainability. This is strongly in demand, both in difficult and good times and will enable profitable midterm growth.
Overall, we have made solid progress on our strategy execution in the first 9 months. For the full year, we continue to guide for an organic mid-single-digit sales decrease at constant currencies. The decrease will be closer to the mid- to high end of the mid-single digit given challenging end markets. We note that the Swiss franc recently further strengthened. For EBITDA, we foresee a group margin of around 15.5%, unchanged from our prior expectations.
With that, let me open it up for Q&A.
We will now begin the question-and-answer session. [Operator Instructions] The first question is from Sebastian Vogel with UBS.
The first one, I have two questions. I would ask them one by one. The first one, quickly focus a bit on the luxury side of things. And can you be a little bit more precise there? What was actually really underlying growth in the third quarter? And when you mentioned about some pressure in the fourth quarter, does that also mean that would even turn this sort of subsegment growth into negative territory?
Yes. Sebastian, thanks for the question. We're still seeing growth in Luxury. So very clearly, underlying mid- to high-single-digit percentage growth is still what we're seeing. We're seeing a little bit of slowdown here in the third and fourth quarter, but that doesn't turn into a negative growth trajectory. I think the overall performance is still on track. And what we've historically also seen in this segment is that there's a pretty quick catch-up on demand once the overall sentiment turns more positive. So we're really looking more at a maybe Q4 event here.
Got it. And second question would focus on Polymer Processing. You mentioned there that you expect an order recovery in 2024 without being more precise there. What is the sort of base case? Do you prepare your business more for the beginning, for the mid or for the end of such recovery taking place in 2024?
It's hard to predict when exactly that's going to take place. I think we will receive quite a bit more clarity here in the fourth quarter or at the back end of the fourth quarter. Our customers will go through their budgeting cycles, just like most all companies do. And I think we're going to get further clarity on the government stimulus in China. And so I'm expecting more clarity in the discussions with the customers throughout the backstretch of this year. And then I'll tell you as soon as we have more clarity on the exact timing of this, we'll share it with you. The only other thing that I'll add is that historically, the exact timing of those things have been very difficult to predict. Our customers tend to behave a little bit on the first customer moves and then they all move. And so it tends to be difficult to predict, but sort of what we're trying to share with you is our best view of the world today.
Got it. Then the third and last question, in the final remarks when you mentioned the growth strategy over there, obviously the optimizing your portfolio and your plan for the fourth quarter, is that mainly related to Polymer Processing? Or is there also some views into Surface Solution? And can you add some more details what sort of sub-business might be under review in that context?
Yes. Sebastian, it's not limited to Polymer Processing solutions. It's really -- I think we're going to head into a challenging -- continue to be in a challenging economic environment, at least for the next 6 to 12 months. And so pretty much all investments that currently don't have the payback that we're expecting or under review, and we're really looking with a lot of hope at when do we expect them to make a contribution and depending on the outcome of that, we're going to take further actions really with a view on protecting profitability of the company in 2024.
If I may follow up, one quick follow-up in that regard, but does it also potentially then impact additive manufacturing?
We're looking at all investments in the portfolio and are also looking at additive manufacturing.
The next question is from Alessandro Foletti with Octavian.
Yes. I also have a couple, take them one by one. First, going back to Luxury. I was surprised to hear that you do not expect any decline in Q4. Now really is the biggest part of the Luxury business, if I calculate properly. And now they are in partial unemployment until, I believe, from the newspaper, read January or February, maybe even later. So if that's the case, are they not having less sales?
No, Alessandro, I think it's a good clarification. I think in the fourth quarter discretely, demand might be down a little bit. My comments were more for the total year. And then for the -- really our growth expectations for the next year and so on fourth. So in the fourth quarter, discretely, just with what we're seeing in the business, it might be down slightly.
Okay. Okay. Good. And then I was wondering if there is an impact on the margin. I mean -- or maybe broadly speaking, the margin in Surface Solutions, I mean, it was flat, but still 10 basis points lower, kind of lower than what I was expecting. So what drives the margin of Surface Solution? Why is it sort of not coming?
I think a couple of things. The #1 thing that you've seen this year is still the effect of the labor inflation and our continued effort to offset that with the structural cost out and pricing. And I would say that it's really an ongoing effort in a lot of the business areas, in the service areas that we're in, it takes a lot of work to do that, we're maybe a little bit later on that than what we expected, but it's really an ongoing effort. I think driving prices in a sensible manner with our customers is the right strategy, we'll continue to go on and the enhanced technology pipeline that we have for that will help us tremendously.
I think that's the #1 that's the biggest thing going on. And then what we continue to highlight is certainly also a little bit the mix in here. Europe organically is basically flat in the third quarter. Americas continues to grow, so that's positive, up about 10% in local currencies and 12% year-to-date. But Asia sales are down mid-teens in the quarter, and Asia is in China, the most profitable part of our portfolio. So I think that will normalize again that industrial production picks back up. But I would say when I look back at our assumptions for the total year, that's certainly something that we -- that has changed. We expected a stronger year in Asia, a stronger year in China, and that hasn't happened.
Right. Can I add one thing here on the mix regarding Tooling and Surface Solution? It used to be well above -- or automotive I think sorry, well above CHF 110 million, CHF 120 million, and now it sort of has come down to CHF 90 million per quarter. Why is that? Is that the new situation? Or is there like a pent-up demand at some point you go back to that level?
No. I think there's -- sometimes there's equipment shipment, discrete equipment shipments that are in there and so on. I would say that's probably the biggest driver and -- but there's really no underlying change in what you've seen, we've reclassified some of the sales that we have in North America between the two groups, but there's no structural difference and really no sales drop on the Tooling side specifically.
All right. Okay. Good. So maybe I can take that up with Stephan, for example. Can I ask you another final question on Polymer Processing? Now the order intake has really started to go down, right? So at some point, I would expect that you have much lower sales, maybe touching as well, the CHF 200 million level per quarter there. And do you think you can keep the margin like in double-digit territory, if that happens?
Yes. Alessandro. The answer is yes. I think the CHF 200 million is maybe -- is exceptionally low. Our overall expectations for next year are basically unchanged from what we told you earlier in the year, foreign exchange certainly puts pressure on that overall level. But we're targeting double-digit EBITDA margins.
We have concluded our -- the key negotiations in Germany with workers' representatives and have executed in line with what we told you before. We have been able to negotiate in a very good level of flexibility in those arrangements that also extends to structural cost so to administrative labor costs and so on. So our expectation is that we will be able to flexibilize the cost base significantly and maintain double-digit EBITDA margins in that business.
The next question is from Michael Foeth, Vontobel .
Yes. Two questions from my side, also one on Luxury. I was wondering, looking into 2024, in particular. And how far can the expansion of your product portfolio in Luxury and eventually, the expansion of the customer base counter the sort of relative weakness that we see now towards the end of the year? So just to understand the dynamics better of what is really organic or, let's say, customer volume related and what is related to the expansion of your business with those customers or with new customers?
And then the second question would just be a clarification on -- you mentioned this joint venture that potentially is impacting also in Q4. Can you be a bit more specific what that relates to?
Yes. For Luxury, I think the commentary is really for Q4. And in Q4, I don't expect our ability to deploy the new technology and reach a larger customer base to materially offset the margin weakness yet. I think that's early. For 2024, we're expecting to make significant inroads here. I think very good view on the synergies that we're generating between Coeurdor and Riri and with the PVD technology in Luxury. And I think that will support sales.
But Michael, I would also say we're not expecting any market weakness there in 2024. I think we actually have a pretty positive view. Again, this business tends to bounce back pretty quickly. And we're expecting that maybe in the first couple of months. But overall, we're expecting a positive 2024 also from a market growth standpoint in Luxury. The second one is, this is really a joint venture that we've entered a number of years back. It was really centered around a specific technology and in technology enhancement or a broader technology we can deploy in the market. Now after a couple of years, we really have to see what the commercialization strategy still is of that joint venture and whether it makes sense to continue this specifically in light of the more demanding -- the more challenging demand environment in 2024. So I would say -- and then depending on how that turns out, we would obviously have to exit the joint venture. The final decision has not been made, but I think that's basically what it's about. It doesn't really change anything in the overall OPP strategy.
Okay. And that's in Surface Solutions?
That's in Polymer Processing Solutions.
Great. So thank you, everybody. This concludes today's call. In case of further questions, don't hesitate to contact us in the IR team. Thank you for your attention today, and goodbye.
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