DEUTZ AG

XETRA:DEZ

Earnings Call Transcript

[Operator]

Ladies and gentlemen, welcome to the DEUTZ AG conference call regarding Q1 results 2018. [Operator Instructions] The floor will be open for questions following the presentation. Let me now turn the floor over to your host, Mr. Christian Krupp.

[Christian Krupp, Head of Finance, Investor & Public Relations]

Ladies and gentlemen, good morning, and thank you for joining the conference call on the DEUTZ interim management statement for the first quarter 2018. We apologize for the 30 minutes delay of the call on short notice due to logistical reasons. In this call, we will present you the full set of the final Q1 figures, after we have published preliminary Q1 figures already in April. With invitation, you received also a web link. You can follow the presentation during this conference call by using this web link. Alternatively, you will find the presentation on our website, deutz.com, under Investor Relations, Presentations, Financial Year 2018, Conference Call First Quarter 2018. You may download the presentation as you wish. After the presentation, you will have the opportunity to ask questions. With these remarks, I shall hand over to our CEO, Dr. Frank Hiller. Thank you.

[Frank Hiller, Chairman of Management Board]

Dear ladies and gentlemen, a warm welcome to our analyst and investor conference on Q1 2018 results. Andreas Strecker and I will give you a presentation on the following topics, so going on Page 2, key messages and updates -- update on E-DEUTZ, financials and outlook. After the presentation, we are open to your question. On the key messages on Q1 2018, we had a strong start to the 2018 financial year. Exceptional high volume of new orders because of strong market environment, new customers and applications and also to the effects on EU Stage V. We achieved marked revenue growth and substantial improvement of profitability.Another topic is the review of carrying amounts on the joint venture DEUTZ Dalian. Out of the intention to be more successful in China and Asia in the future, DEUTZ engaged an audit firm to review strategic options for the joint venture. According to preliminary estimates, the necessary write-down might impact to consolidated financial statement in the range of EUR 16 million to EUR 32 million. All issues are related to the part mainly to the years 2011 and 2014 -- 2013. Going on Page 4. I would like to give you an update on our E-DEUTZ activities. So we had a successful transfer insofar of the e-technology from Torqeedo to DEUTZ. The first DEUTZ hybrid concept was presented at the trade fair Intermat in Paris. And we are working on our modular scalable hybrid system, so this is a combination, what you see on the picture, of TCD 2.9 Stage V diesel engine with an electric motor. We are working right now on those prototypes for customer application, which will be presented during the year 2018. Besides our E-DEUTZ activities, another technical highlight was the award of our new diesel engine, TCD 9.0, as diesel of the year by the magazine DIESEL. The TCD 9.0 is a 9-liter, 4-cylinder engine with 300-kilowatt power coming out of our cooperation with Liebherr. The award shows the high acceptance for this modern new engine. Going to the financials on Page 6. This is an overview of our key figures. Almost all key figures have improved on Q1 related to the quarter 1 2017. New orders on a very high level with a plus of 42.6%, revenue more than EUR 410 million. And also, EBIT developed very nicely with EUR 21.7 million. The negative free cash flow is according to our plan, and it's caused by the increased working capital to fulfill the high customer demand on the volume side. So overall, we had a very dynamic revenue and EBIT improvement in quarter 1. Looking at the sales figures on Page 7. You'll see the nice order -- new order development, now with an order intake of EUR 575 million. Unit sales increased up to more than 48,000 units. Hence, the revenue also increased to EUR 414.5 million. The deviation between unit sales and revenue or the deviation increase is caused by the product mix, so we have a stronger move to engines below 4 liters. And also, the Torqeedo products were included in Q1 2018. Torqeedo sold in Q1 2018 2,133 electric drive systems. Looking at the book-to-bill ratio on Page 8. You see that we have a very nice book-to-bill ratio with a factor 1.39. So we see a strong increase of new order intake in all regions and, more or less, for all off-road application, so the business conditions are very favorable. And also, we also have a change in the customer behavior, which comes out of the high demand in the market and the introduction of emission standard EU V -- Stage V in the coming year, which leads to some prepaid effect.Revenue by region on Page 9. We had an increase in Europe of around 20% if you compare Q1 2017 to Q1 2018. This was a quite strong increase. But also, in our other important regions, Americas, here, we see an increase of more 13%. And also, Asia Pacific increased by 10%. Taking the activities in the joint venture Dalian into account was 100%. We are on a level of EUR 506 million turnover in the first quarter, and the total share of Asia Pacific is on a level of 25%. Revenue by applications on Page 10. All the major applications are running very well. First of all, very nice increase on the Material Handling side, which is a portion of around 20% overall. Here, we see an increase of 30% in the comparison of quarter 1 2017 to quarter 1 2018. Our biggest segment, Construction Equipment, was around 31%. Total turnover increased by 28%. And also, Agricultural Machinery, which is 15% of the old portion of turnover, increased by 25%. So very good development in all major segments. And now I would hand over for the operating profit and net income to Dr. Strecker.

[Andreas Strecker, Member of the Board of Management]

Good morning, ladies and gentlemen. We are on Page 11 of the presentation. We've seen a significant improvement of the EBITDA by 42.5%, mainly driven by higher business volume. The EBITDA margin improved from 8.1% to 9.9%. The EBIT before exceptional items increased strongly by EUR 14.1 million to an amount of EUR 21.7 million. The return on sales improved accordingly from 2.2% to 5.2%. In the prior year, you can see here an exceptional item of EUR 10 million. It was based on the special occasion of the property sale from the super company. The net income also improved accordingly to EUR 18.2 million from EUR 15.4 million. D&A decreased by about EUR 2 million. That was according to plan as well and that contributed as well to the higher EBIT. If you go to Page 12, there you can see the split between the DEUTZ compact engines and the customer -- customized solutions. Both segments improved strongly. For the most part, you can see the improvement by compact engines as they can -- could really increase volume in that segment. If you go on Page 13, some more detail to application segment. Material Handling improved 31.4% year-over-year; Construction Equipment, 30%; and agricultural equipment, 24%. So you can see that the growth is very broad based over all our applications.The positive trend also on the service side where the revenue increased by 4.6% year-over-year. And the profit -- EBIT improvement of EUR 15.5 million year-over-year on the compact side, which is one of the best results we had in this segment for many years. If you look on Page 14 on the customized solution, there, you could see on the new orders, was more or less flat compared to the first quarter. You can say it's slightly less, but on the other hand, the very good order intake with a book-to-bill ratio to -- of 1.33. That means that going forward we will see a further improvement on that side, a very strong development on the business, service business side in the customized solution, and that contributed to the 20.3% increase on EBIT.If you go on Page 15 with the R&D, capital -- and capital expenditure. On the left-hand side of the slide, R&D expenditure increased by EUR 2.5 million, which is fully according to plan as we roll out new products and also increase expenditure in the E-DEUTZ strategy. The capitalized net R&D expenditure is EUR 4.3 million, which is slightly higher in the year before. On the capital expenditure, on the right side of the slide, excluding R&D, increased. We are fully in budget. The first quarter 2017 had seen some delays, and therefore, the increase in Q1 2018 looks high. But if you normalize all things, then everything is according to budget. On Page 16, as Dr. Hiller mentioned previously, working capital increased. As you may have heard of in other industries, it is really important that we have all materials on site right now to quickly react to customer needs. Also, there, the working capital ratio of 16.9% feel very good and it's all according to expectations. And the operational cash flow decline in Q1 to EUR 10 million is even higher than planned, driven by the better EBIT.On Page 17, the free cash flow, left-hand side of the slide, there's EUR 33.7 million in the last 12 months. It's a bit lower than 2017, but again, that will improve over time when the shipments increase further and working capital needs were done. The net financial position on the right side of the slide at 88.9 million is still extremely healthy for DEUTZ. Page 18. According to the group numbers, you could see that the equity ratio is now at 49%. We surpassed the EUR 600 million mark on the EBIT side. On the financing terms, you can see that the bulk of the loans are due in 5 years from now, we extended the credit line of EUR 160 million with the bank consortium until June 2022 and the loan from European Investment Bank is also repaid only by July 2020. As we mentioned in earlier calls, we are in good position to [indiscernible] on each [indiscernible] rather than to finance a lot from in-house. Page 19. In summary, we have a very high volume of new orders. It's driven also, then transferred into dynamic revenue growth and EBIT improvement. We will see a very successful transfer or invested transfer of new technology from Torqeedo. The first E-DEUTZ hybrid concept successfully presented at the trade fair Intermat. The review of the carrying amount of the joint venture in DEUTZ Dalian is initiated, and we will know more in the coming weeks. And the balance sheet is extremely healthy and strong. So for the outlook, I would come back to Dr. Hiller.

[Andreas Strecker, Member of the Board of Management]

Coming to the outlook, so forecast for key end-customer markets 2018. Overall, very positive market outlook in nearly all segments and all regions. Construction Equipment and Material Handling is very strong, especially in China. Only weaker or little segment is Agricultural Machinery and here especially in China. But overall, we are seeing a very positive market. Coming to the financial outlook. We are confirming our financial outlook means, marked interest on the revenue and moderate increase from the EBIT margin. This, for sure, is subject to the final results of the review of carrying amount at JV DEUTZ Dalian. We expect also a strong second quarter. Third quarter will be seasonally lower than the second quarter. But in comparison to the last years also, quarter 3 will be quite strong. We are not planning with a summer shutdown like in the years before. So also, quarter 3, the outlook is quite positive and quite strong. So far for the presentation and we are now ready for your questions. Thank you.

[Operator]

[Operator Instructions] And the first question comes from Ms. Friedrichs.

[Charlotte Friedrichs, Analyst]

Yes, my first question would be if you can give us an update on the current trading. Second question would be around the engine sales that you saw in Q1 and if you have an idea how much of that was sort of underlying demand and how much of that was driven by prebuying. And then thirdly, on the working capital development, how do you see this progress across the quarters?

[Frank Hiller, Chairman of Management Board]

Maybe starting with the quarter 1 and what is driven by prebuying. So we are talking now about order intake. So this is on a level, I would say, of around EUR 50 million to EUR 60 million. We are planning on the prebuy effects for 2018 and 2019. So also, in 2019, will be a prebuy effect because the engine taken between 56 and 130 kilowatt, the emission legislation change will be in 2020. So we think that also in 2019, there's a prebuy effect. All in all, we see around, I would say, 10,000 to 20,000 engines in these 2 years. And our intention here is to reduce this prebuy effect. And so we are planning for 2018 around [ 20,000 ] units and 2019 might be, right now, on [ 25,000 ] units.

[Andreas Strecker, Member of the Board of Management]

You can [ develop ] from the working capital ratio the standard 16.9%, end of March. When do expect, by the end, a ratio between 15% and 16% of revenue.

[Operator]

There are no further questions at the moment. [Operator Instructions]

[Frank Hiller, Chairman of Management Board]

I think the question on the current trading was not answered yet. Current trading is developing in Q2 nicely. We'll see again a quite good order intake that most likely will be above Q2 in the last year, not necessarily that we could achieve the level of Q1 and of the current year, but can't rule that it might get close. And with regard to the top line revenue, we'll see another good quarter in the current year. So the trends that we have seen, the different applications remain valid also in the current quarter.

[Operator]

Then we have a question from [ Mr. Spanning ].

[Unknown Analyst]

Yes. Just a question on the guidance. You just said that your guidance is subject to the outcome of the review on DEUTZ Dalian. As I understand the guidances on revenues and on EBIT before exceptional items, then DEUTZ Dalian shouldn't have an effect on either one, so I don't understand why your guidance is subject to the outcome. And then the second question is I haven't -- unfortunately, I hadn't understood acoustically what you said, the second part of what you said about the prebuying effect. You said you were expecting 10,000 to 20,000 engines over 2018, '19. What I haven't understood is how this is distributed over the 2 years.

[Frank Hiller, Chairman of Management Board]

Okay. Maybe to the guidance, we are still in the analysis about what has happened in DEUTZ Dalian and if this is an exceptional item, then for sure there is no change in our outlook, yes? Second point is about prepaid effects. So prepaid effect is caused by the change of the emission legislation and the EU Stage V. There will be a change in 2019, January 2019, for all the engines, exceptional the engines going from 56 to 130 kilowatt. For these engines, the initial legislation change will be at the 1st January 2020. So -- and this means that they will cause a prepaid effect in 2019. And so we are planning more or less than we have a prebuy effect potential of 10,000 additional units via prepay in 2018, and then in 2019, another 5,000. That's the rough calculation so far.

[Unknown Analyst]

Okay. So half, half the volume impact than you will have in 2018?

[Andreas Strecker, Member of the Board of Management]

Yes.

[Unknown Analyst]

10,000 in 2018, 5,000 in 2019.

[Andreas Strecker, Member of the Board of Management]

Yes. That's what we're planning so far with the...

[Unknown Analyst]

That doesn't give the overall 20,000, so it's...

[Andreas Strecker, Member of the Board of Management]

And so it's difficult to [indiscernible] right now until we say so. Overall, the range might be between 10,000 and 20,000 engines overall. So we are in a lot of discussions with our customers how to surpass. They are used, really, to actually prepay activities, to have engines with the emission [ education ]. But now the change from Stage IV final to Stage V is not that big. And we also make it happen that these are brought in solutions for our customers, that they don't have to change on their equipment that much than in the past. And this is also the driver where we're using this prepaid effect. Because overall, the prepaid effect is not positive for us as a company because it leads to very high volatility. So our intention is really to reduce that.

[Unknown Analyst]

Okay. I just want to come back to the DEUTZ Dalian issue. So what you have said so far, that this could lead to a write-off. So write-off is necessarily an extraordinary item. So what else -- what regular items could be affected by the review? Do you think there could be already an intake on sales or on EBIT in the [indiscernible] in 2018?

[Frank Hiller, Chairman of Management Board]

We came out with that message early and we had PricewaterhouseCoopers on the analysis of that. And what we will actually do now in the next phase is to discuss that result with the local auditor because the local auditor gave us always a certification of the audit. So this is has to be discussed with the local auditor. And it is also -- this discussions with the joint venture partner, FAW. So they are not, I would say, inputting information so far.

[Andreas Strecker, Member of the Board of Management]

With -- Frank Hiller speaking before. One technical remark, we are in discussions with PwC, keeping this as an exceptional item. I think the [ onetime ] item [indiscernible] for sure, but the question is whether technically in everything, an exceptional item or whether it will be the source of the issue like many years later or if an operational issue, yes? So if you have tougher inventory, then it's operational. And then maybe technically, you have to shoulder it in every -- even if it's a one-off, yes? And then -- and the question is, do we have to shoulder it in 2018? Or would it be a big growth adjustment in 2017? So it's too early to tell, but I hope I could clarify a little bit the exceptional and one-off items.

[Operator]

Our next question comes from Mr. Heimbuerger.

[Hans-Joachim Heimbuerger]

We have 2 question remaining. At the time of the analyst meeting, you guided for roughly 100 basis points increase in the EBIT margin in 2018 year-on-year. Now after the strong Q1 performance and also given that you indicated a rather strong Q2 and also Q3, don't you think that this 100 basis points rough margin increase this year is a little bit too conservative, excluding negative effect from the potential write-down, so just looking on the underlying operating EBIT margin?

[Frank Hiller, Chairman of Management Board]

Yes, Frank Hiller here. Yes, I think maybe we are a little bit on the conservative side. So on one side, we have very nice EBIT ratio of more than 5%. And what is important to us is more or less the long-term or midterm target to show us the EBIT margin of 7% to 8% within the next 5 or 4 -- 4 to 5 years. And so we don't want to have a back-end-loaded development, so it was always our interim target to achieve 1% point absolutely improvement on the EBIT margin. Maybe it could be a little bit better this year, but we'll see what's coming out in quarter 2. And also, the topic is -- which I mentioned [indiscernible]. So let's stay a little bit on the conservative side. And we would like to surprise you later on with some good news.

[Operator]

The next question comes from Mr. Terzic.

[Jasko Terzic, Research Analyst]

My first question is also a little bit on EBIT and one-off and maybe also getting back on your remarks during the analyst conference. At Customized Solutions, you were kind of underutilized. So could you give us an update if you still feel underutilized? And what are the measures you've taken there to improve capacity utilization? And could it potentially lead to additional cost in the running fiscal year?

[Frank Hiller, Chairman of Management Board]

Yes. About capacity utilization, so overall, it's very much depending on the different lines, engine lines and on the different locations. For example, if we are looking into China, there is a clear potential to have more volumes. So the load of the factory is at a level of, I would say, 30%. And now looking here into Cologne in our sub-4 liter engines, here, we are quite good still. We started the 3-shift model and increasing now the efficiency. So overall, I think there are not really restrictions on the efficacy side. And this is one -- part of the most successful in the future is to gain more business. And I think even though we've done a quite good job in the past years, we're always addressing this KION project, which we started in 2009, which is the real nature project, but also for smaller customers in a number range of 500 to 1,000 engines. We won quite a lot of new customers on that side. On customized solutions, yes, here, this is very much related to our location in Ulm. Here, it's always a topic to increase the volume. But it's our, I would say, very mature engines and also at the end of the life cycle. And all we are doing here within the next year, we are transferring one engine, the engine 2011 to Ulm to have more space here in Cologne for that 4 liter. So these activities are ongoing and we are still optimizing on the capacity side. But really to invest in new production equipment is very much needed.

[Jasko Terzic, Research Analyst]

But taken from that effect, do you expect one-off costs? Or is it likely to see one-off cost regarding DEUTZ Dalian and customized solutions to optimize those utilization levels?

[Andreas Strecker, Member of the Board of Management]

Andreas Strecker speaking. I think the Dalian and customized solutions are 2 different topics. In the Ulm factory, most of the customized solution is built. We will improve utilization in Ulm very much by transferring the 2011 model to Ulm. That will happen until next year. So that means that fixed cost allocation in Ulm will improve significantly, also for the other engines that are built there. And by the same time, we will free up more capacity in Cologne after taking more volume like the KION sub-4 liter engine. DDE, technically, it's reported under customized engines -- sorry, complete engines. So if something happens in Dalian, one way or another, it will not be under customized solution. And again, the optimization of the European network is going on after we close the DEUTZ side and move many things to Porz. And now the next step to move some engines from Cologne to Ulm before we optimize capacity utilization. And the situation in Dalian DDE is separate from these 4. These are different engines and a different market.

[Jasko Terzic, Research Analyst]

Okay. And the next question is pertaining to your Torqeedo business or your others line you're now showing. Could you confirm your breakeven target for 2019, if I remember correctly? And could you help us out, what seasonality throughout the year should we take into account to model those units on orders and sales?

[Andreas Strecker, Member of the Board of Management]

Breakeven was planned for 2020. And more or less, it's running according to plan so far. In terms of seasonal business, so now the order intake starts with the summertime. And these are normally always [indiscernible] in winter, so this fits quite well into our business model.

[Frank Hiller, Chairman of Management Board]

Revenue of Torqeedo will be, at the end, in the range of EUR 30 million. That's the plan and that should go up to some EUR 50 million in the years to come and breakeven in 2020.

[Andreas Strecker, Member of the Board of Management]

On the EBIT side, it will be a single-digit negative million this time.

[Frank Hiller, Chairman of Management Board]

In 2018?

[Andreas Strecker, Member of the Board of Management]

2018.

[Operator]

And then [ Mr. Kiernan ] has a question. [ Mr. Kiernan ], over to you.

[Unknown Analyst]

So many question from my side. First question for the equity results. It increased EUR 1.2 million, especially because the Dalian increase was about EUR 2.7 million. So the other earnings contribution, I guess, must be Argentina and South Africa. Had a declining results. Are there any special items in there or anything we have to take a look at? Or what is the reason why the other 2 have a negative or a declining result? The second question is on the average selling price in DCE, which also declined from 8,300 to 7,900. For engine, it's normally, I would guess that the value of the machine should rise over the cycle -- or over the times that we would -- with the higher inflation, et cetera. So is this a trend to smaller engine? Or what is the reason behind it? And the third question would be on the raw material development. Maybe you could give some remarks on this development.

[Frank Hiller, Chairman of Management Board]

Yes. Maybe starting with the average price. Some of this has a little of the decline to an average price of EUR 7,000, nearly EUR 7,100 and this is related by the smaller engines. So you see that we have a very high increase on sub-4 liter engines.

[Andreas Strecker, Member of the Board of Management]

On the other income, yes, Dalian, from an operative standpoint, without the ongoing benefits, improved the results. But there are -- other that, there are no substantial issues that need to be taken consideration going forward.

[Operator]

And then we have a question from [ Mr. Jimbull ].

[Unknown Analyst]

My question actually was answered earlier, though.

[Operator]

Okay, then we have no questions at the moment. [Operator Instructions] And then we have a question from Mr. Schönell.

[Gordon Schönell, Analyst]

Yes. Three questions from my side. So first one on the strong improvement in EBIT in contact engines in Q1. So would you say this is totally driven by the much higher revenue and the capacity utilization? Or did you also enjoy some tailwind from the component side? Because in past conference call, you indicated that you are in negotiations with suppliers for better pricing conditions. So how is this program running? The second question is, can you remind us of the strike situation in Q1? So did you have a shutdown in Q1 due to strikes and how many days? And has there been an impact on your operating results? And then the last question, to follow up on Torqeedo, so you had a negative EBIT at Torqeedo in Q1. You indicated the summer season to bring up revenue. So is it possible that maybe in Q2, Q3, Torqeedo might be even slightly positive? That's it from my side.

[Andreas Strecker, Member of the Board of Management]

Yes. So it's Andreas Strecker speaking. The utilization plays a big role in the compact engine. That is for sure we -- last year combined. The factory is in Porz, in DEUTZ, so there are some residual items, positive items from a cost base that you've seen in Q1 of 2018. Of course, pricing discussions with all the suppliers are always ongoing. We will have, for the whole year, we are on track in these reductions that are in the double-digit millions. We have to see, unfortunately, that some of the raw materials are increasing. So we have to even increase our efforts to compensate that effect. But on a net base, our mature costs are going down. When it comes to strike, we had 1-day strike in Porz, but there was no negative overall impact. We had some special shifts to make up for that, so the strike was not an issue. When it comes to Torqeedo in Q2, that should be a strong quarter. Whether it will be strong enough to breakeven in the quarter, we have to see as the expenses in new product development are still holding up very, very strongly, so that we have to look. But for the whole year, it will still be a loss driven by the additional infrastructure that we build up because also the Torqeedo people helped on the DEUTZ side, on the DEUTZ strategy.

[Operator]

Then we have no further questions anymore. [Operator Instructions] Then we have no questions anymore.

[Christian Krupp, Head of Finance, Investor & Public Relations]

Ladies and gentlemen, given that there are no further questions, we herewith end the conference call. Thank you for your participation and bye-bye.