Sulzer AG (OTCPK:SULZF) Q3 2022 Earnings Conference Call October 26, 2022 3:00 AM ET
Company Participants
Christoph Ladner – Head, IR
Frederic Lalanne – CEO
Thomas Zickler – Group Treasurer & CFO
Conference Call Participants
Arben Hasanaj – Vontobel
Alessandro Foletti – Octavian
Christian Arnold – Stifel, Nicolaus & Company
Dominik Feldges – NZZ
Operator
Ladies and gentlemen, welcome to the Sulzer Q3 2022 Order Intake Conference Call and Live Webcast. I am Sandra, the Chorus Call operator. [Operator Instructions]. The conference must not be recorded for publication or broadcast. At this time, it’s my pleasure to hand over to Christoph Ladner, Head of Investor Relations. Please go ahead, sir.
Christoph Ladner
Thank you, Sandra. Good morning, and welcome to Sulzer’s Q3 conference call. Today, with me is our CEO, Frederic Lalanne; and our CFO, Thomas Zickler. For this call, we have prepared a presentation, which you can find on our homepage. As always, I want to draw your attention on the disclaimer on Slide #2. Please read it through carefully. Having said that, I hand now over to Frédéric for a short presentation. Thereafter, you have the opportunity to ask questions. Frédéric, please?
Frederic Lalanne
Thank you, Christoph, and good morning, everyone. Despite many challenges, Sulzer enjoyed another very positive quarter in terms of order intake. Our markets continue to develop positively despite the geopolitical tensions and uncertainties. Sulzer has grown order intake in Q3 by 8% organically, which brings our growth rate to 10% organic after 9 months. I’m pleased with that development as last year’s Q3 was already a good quarter, and therefore, the baseline was higher than in the first 2 quarters of the year.
The highest growth came from the Chemtech division, where orders increased by 20% year-to-date and again another 17% in Q3. Here, we have seen investments across our markets as all businesses within Chemtech are growing double digit so far this year. We see a high level of activity in the chemicals, gas and refining space, as well as in the related services.
An even higher level of activities we observed in Chemtech’s Renewable and Water business segment. Here, demand for our solutions is very high. At the end of Q3, Renewables accounts for almost 12% of overall Chemtech orders. And this even so we have not yet booked any large PLA order in 2022. Flow Equipment also continued to grow by 9% in Q3, bringing the growth year-to-date to 12%. High energy prices had a positive impact on the demand of our solutions in energy, resulting in 18% growth in quarter 3.
Industry continues its growth trajectory with all relevant end markets up year-to-date, especially in the mining sector worldwide. Water was a bit slower in Q3, but this was mainly due to large desalination projects that were pushed out to 2023, especially in the Middle East.
Finally, the Service division was up 3% in quarter 3 and the same year-to-date. Here, we have seen a positive development in Pump services, which are up 7% year-to-date, while service on other equipment is down 2%, primarily due to the Turbo Services business. This Turbo Services does not only suffer from our exit in the Russian market, but also from the fact that with the high electricity prices, scheduled maintenance of gas turbine or steam turbine is pushed out by some customers who keep on running their assets.
Now let me turn to the outlook for the full year 2022 on the next slide. In the light of the positive development in Q3 and expecting our markets to remain in good shape for the rest of the year, we have decided to increase our guidance for order intake to up 6% to 8% versus our previous guidance, which was up 3% to 5% versus last year. On sales, we adjust our previous guidance, which was up 2% to 4%, excluding the impact from Russia to stable versus 2021.
The reason for this adjustment is not only the exit from Russia, but also some renewed lockdowns in China. Last week, in the Dalian area, northern part of China, we had our factory closed for 5 days. But also, we still see some shortage in electrical components as well as some delays in certain big projects where customers ask us to ship our products later, meaning especially in 2023.
The combination of increasing orders and stable sales results in a record high order backlog close to CHF2 billion, which is the highest backlog to execute in the recent history of Sulzer. This backlog will support our sales in 2023, but also some projects already to be delivered in 2024. The adjustment on sales has no impact on our guidance for operational profitability, which is confirmed at close to 10% and an increase versus 2021.
Let me summarize on the next slide. As I just said, we continue to grow our orders in Q3, thanks to a continued strong development in Chemtech and Flow. And despite all these geopolitical tensions and dark clouds on economy, we expect our markets to remain robust in the coming months. We have had no signs of slowdown in our tendering activities. That is why we have decided to increase our guidance for order intake up to 6% to 8% versus last year.
As just mentioned, lockdowns in China, shortage of some components, as well as project delays will shift some of our sales, which were planned in Q4 2022 to 2023. This record backlog is expected to be close to CHF2 billion, CHF1.95 billion at the end of the year. We also confirm our operational margin close to 10%, an increase compared to last year, then showing our confidence and capability that we have been able to mitigate all the various cost increases we have seen in 2022 from labor and for material.
Overall, Sulzer is very well positioned. While energy transition remains an important topic for the society, also for us, energy security and energy sovereignty have become even more relevant in 2022. Investments in the energy sectors, which have been reduced massively in recent years, are now going up. And at the same time, we increased our exposure to Water and industry in Flow equipment and to Renewable in Chemtech. On these words, I will now hand over to Christoph for the Q&A.
Question-and-Answer Session
A – Christoph Ladner
Thank you, Frédéric. Before we start the Q&A session, I would like to point out that we will only answer questions on our results, so on Q3 and operations, not about the leadership change announced last week, as we believe that we have given all the context and explanation in the press release, and it’s a companion communication last week. With that, I hand now over to the operator to start the Q&A.
Operator
[Operator Instructions]. The first question comes from Arben Hasanaj from Vontobel.
Arben Hasanaj
First, I was wondering around the situation in Europe. So your industrial customers in Europe. Have you seen any signs of downturn there, especially in the chemical space or pulp and paper. Yes, that would be my first question.
Frederic Lalanne
As you know, industry which is electro-intensive in Europe has been impacted and especially the chemical sector in Germany. So far, at Sulzer, we have not seen a major slowdown in the industry. Pulp and paper is very solid, fueled by the demand for cardboard. That’s clearly going ahead. We are not seeing so much — no, I have to say, it’s a bit — it’s great to see what’s happening at present time. We have no excuse for slowing down at present time.
And you mentioned Europe, and I really would like to express the fact that in Americas, we see a huge lever for our activity in the industrial sector. You mentioned industry. So the mining sector is extremely active at present time for us, and this is linked to the energy transition and the preparation of the industry. So overall, we might maybe expect some slowdown, especially in Europe. But for the time being, no site, but our other industrial markets, rest of the world are very, very active and very well oriented.
Arben Hasanaj
All right. And maybe just my second question would be around the Water business. Maybe if you can provide a bit more color there, what you’re seeing there. So you mentioned these delayed desalination projects. So what are the reasons there?
Frederic Lalanne
So as we know, in the Water segment, we operate within 3 main areas: desalination, I will come back; the wastewater for the wastewater treatment plant; and the clean water. We have seen, in fact, some delays in the desalination because this market is mainly in the Middle East; I mean, Middle East, including Saudi Arabia, Egypt. And some of the large projects have been delayed on the execution side, where the projects have been pushed, but also on the tendering activities. It’s more a delay than project being canceled.
And at present time, we see massive and huge projects coming, especially in Saudi Arabia, where the very old installations, which were built in the ’70s, are now being renewed with the latest technology, which are energy efficient, because you know that in the desalination, the cost of energy represents 65% of the OpEx for a desal plant. So when your operation is 65% based on the energy, some people have interest to redesign and reshape their future projects. So that’s why we see some change in projects.
But this project will be there, and we expect not only Saudi as I just mentioned, but also in the Emirates, in Qatar, in Dubai, strong and solid activity for desalination. And this also might or will come in other places like U.S. in California, but also starting in South Europe in view of what the whole summer we have experienced. So desalination remains the niche market compared to the side of Water, but we see more kind of not adjustments, but reshaping the size of the project.
For the rest of the business, we are, I would say, following the market trend, which is quite positive and stable, and Water segment overall growth is GDP. So if you want to have a good indication of the water segment, you take the GDP, and this market grows around that level. Sometimes you have some slowdown or going up. But overall, as I explained in the past, you have a very good, I would say, driver for this wastewater and clean water segment. So maybe less exclusive growth compared to what we have seen in energy and mining, but very stable and very solid and highly predictable.
Arben Hasanaj
And maybe just one final comment on Water. So you were mentioning that M&A was also kind of essential part of the strategy there. So can you maybe provide some info on that?
Frederic Lalanne
Yes. So on M&A, in the last year, we have done 2 acquisitions, as you know, GWC in California 4 years ago. And just last year, we acquired Nordic Water. And now we are deploying our strategic plants according to the plan, which is scaling up globally, these 2 companies, which were regional, GWC mainly in North America and Nordic Water mainly in Europe and Scandinavia. And thanks to Sulzer, now we have been able to book projects in Hong Kong or in Singapore for Nordic Water, which were not reachable for them in the past. But thanks to Sulzer, now these type of projects are reachable.
So overall, we are on our target for the integration of Nordic Water. And for future acquisitions, we are looking at the markets. You know that also the Water segment attracts a lot of attention, and the recent transactions that took place were extremely expensive, and we were not successful on 1 or 2 acquisitions because we put also some financial discipline in our approach. But we are looking, in fact, at present time to do things to expand our portfolio of products and solutions, which is one of the largest portfolio of products in the industry and expand it globally, and at the same time, looking at potential acquisitions that will keep on expand adjacent solutions to what we have in pumping solutions or filtration.
Operator
The next question comes from Alessandro Foletti from Octavian.
Alessandro Foletti
I was wondering, when I look at the outlook into Q4, just purely mathematically, you expect some form of deceleration — still growth, but some form of deceleration. Maybe you can explain that. And then I have couple of more other financial questions.
Thomas Zickler
Okay. So you’ve done your math. We did it as well. So it’s clear that we have taken a cautious approach for Q4, because as you know there are a certain number of uncertainties. And it is clear that when we upgraded our guidance up CHF6 million to CHF8 million, even in that there is some element of cautiousness, because when we see the trends today, and luckily for Sulzer — but it’s not luck, it’s because of our positioning and because how we positioned the company in the past year, we have been able to grasp and capture these opportunities.
But you know also that some of these large projects that can make a difference, knowing that if we book a project in November or in December, in January, when you have projects which have a lifetime of 3 years or sometimes more, the decision-making process can be slowed down for whatever reason. And we are not always mastering the decision on these large projects. So we were quite cautious in our approach. But good surprises are not excluded, if I can say so.
Alessandro Foletti
Okay. Good. And then maybe on 2 small financial issues. Can you give an indication on the free cash flow you might expect for 2022? If I remember properly, in H1, you were saying that due to working capital, it should sort of turn around and then deploy good cash flow in second half of the year. Any changes there?
Frederic Lalanne
So you’ve seen that we are again increasing the order intake 6%, 8% versus last year when our sales expect to remain stable, meaning that having a backlog of CHF2 billion, we will have to finance this backlog. And again, the pressure that we had at the end of H1 will remain at the end of H2. So the free cash generation is today the point of attention for us, and it’s absolute priority to generate this free cash. But we had to finance this growth despite the fact that we received some advance payment from the customer, but we have to prepurchase some of the components or fabricate it of motors, casting, whatever. So this is our point of attention for this year.
So Thomas Zickler, our CFO, is close to me. Maybe you want to say another word on that, Thomas?
Thomas Zickler
Yes, Frédéric. Just a couple of words from my side. Since we are in this call only updating on the order situation, it’s difficult for me as a CFO to really give you more insights on our cash flow or free cash flow. But I think what I can say in general, Sulzer has the same situation as most of the other industrial corporates in these days. We have the problem with the supply chain. We are missing in the process some components. So what I want to say is we also have a higher net working capital compared to the prior years. And the conclusion then you can draw by yourself that, yes, this year the cash flow situation will not get to the same levels as we had it last year.
Alessandro Foletti
Okay. But now without willing to open a Pandora box, in the first half, you had a negative cash flow from working capital. And I understand what you all just said, but this is still qualitative. So you’re not pointing for sake of trimming it down a little bit to another negative H2 in working capital terms. So can we still expect some positive cash flow from working capital in H2?
Thomas Zickler
Yes. This is what I can confirm to you, yes. So do not get too much worried about this. I just said that our cash flow is getting lower than last year, but still in the positive territory.
Alessandro Foletti
Right. Okay. My last question would be on the dividend. It has been now — if I strip out the CHF0.50 from the mix, basically flat for the last 3, 4 years. Do you think there is upside?
Frederic Lalanne
It’s a bit too early to answer the dividend. We are just in October at present time. So depending on the yearly results, we will decide on the dividend policy and the Board will decide at that time. But it’s too early to comment on this question.
Operator
The next question comes from Dominik Feldges from NZZ. We lost connection with the questioner. We will take the next question that is from Mr. Christian Arnold from Stifel.
Christian Arnold
A question from my side. In terms of your order backlog on record levels that is close to CHF2 billion. Can you comment on the profitability on this backlog? And do we have to fear any mismatch of costs and selling prices, thinking that some orders will only become sales in ’24?
Frederic Lalanne
So on this, I can give you a very strong level of confidence on the quality of the backlog. When we look and what we disclose, the full accounts at year-end, but the margin on order intake that we have had so far is at the same level as last year. This means that so far, we have been able to pass on to our customers all the cost increase we have received, can be labor and energy or mitigate all these costs. And that’s why we are very proud at Sulzer to be very cautious in our approach. And we are not growing for the sake of growing.
And being President of Pump or CEO, I was always very clear that when we grow, we want to grow in a profitable manner. And you never heard me talking about growth, but always about profitable growth. And when you look at the backlog today, the close to CHF2 billion, the quality of the backlog is very high. And the second indicator, as I mentioned in the past, I always look at 2 indicators. I look at the margin on order intake and then the margin when we sell, so when we ship. And you will see, and you have seen that at the end of H1, and you will see at the end of H2, that there is no discrepancy between the margin when we book an order or project and when we sell and when we deliver this project 6 months, 12 months or even 18 months ago.
So we have a clear policy in terms of hedging our cost or managing our cost. So that’s why this backlog is of very high quality, and the confidence for 2023 is very high that we are going to deliver according to the plan and according to what is in our books at present time.
Christian Arnold
Okay. And the plan or midterm target is 10% to 11% operating EBITDA, that we maintain that, right?
Frederic Lalanne
Yes. And a year ago, we said we’ll be close to 10% for this year in operational profitability. I’ve been in the company almost 7 years now, navigated in so many crises. And we have always year-on-year improved the operating profitability. Since 2016, every year, we have increased the operation and profitability. And this year, again, we confirm that we’ll be close to 10%. I cannot say exactly how much, and Thomas will confirm in a few months. But for sure, it will be again an increase compared to last year. And the midterm target, 10% to 11% is clearly within reach for Sulzer in the next 2 to 3 years midterm. But step by step, we are moving close to the 10%, and normally we will exceed the 10% bar.
Operator
[Operator Instructions]. The next question comes from Dominik Feldges from NZZ.
Dominik Feldges
I’m sorry, I got disconnected before. Could you hear me still with my questions?
Frederic Lalanne
Not at all. So could you please repeat it again?
Dominik Feldges
Okay. So I’ll repeat it. I’m really sorry about that. Sorry. My question was about the sales guidance. Just if you could clarify that for me, I mean, you say now that there will be some stable — or it will be stable, the organic growth there. Does that now include the impact from Russia? Or does it still exclude it? That would be my first question.
And then my second question will be really about if you could elaborate a bit again on the exit from Russia and Poland. I mean, what has happened now so far? Where do you stand there? And I was also wondering, I mean, on our front page in Neue Zürcher Zeitung today, you can read that apparently Poland has agreed that Russian activities could be really confiscated in Poland. I mean, just theoretically, or I mean, is that something which could happen to your assets there as well still? Or is there any danger about that?
Frederic Lalanne
Yes. Okay. Thank you, Dominik, for your questions. So clearly, we decided to not to talk about the various impacts including Russia and so on like we did in July. So if you remember, in July, we said we are up 2% to 4% excluding the impact of Russia. Here, when we say stable, it includes the impact of Russia, because it includes everything, in fact. It includes the impact of Russia, it includes the slowdown of the closing in China, as I just explained a few days ago. It also includes the fact that some components are missing, and we don’t get the components as expected from our supplier. So it includes everything. And when you put everything, we expect that we’ll be stable compared to last year. So that’s the first point.
Regarding the status of Russia and Poland exit, the Board decided to exit the Russian market in June. Since that time, we have engaged a process of negotiation with various stakeholders, third-party management as well who has some interest to take over. The discussions are ongoing now. And because we are under confidentiality, I cannot elaborate more. But the aim, of course, is to try to close a deal as soon as possible, but it’s a bit complex environment, as you can imagine, but negotiations are ongoing.
Regarding Poland, the situation is very simple. We have terminated all the employees in Poland. Our entities are completely inactive at present time. We just keep 3 or 4 people for the closing, or maybe 5 people exactly for the closing of our entities. And so far, we have transferred all the activities which were done in Poland for the Service division to other entities in Europe, in the Netherlands, or in other places. And for the market, we are now out of the market from our Polish entities. So, so far, there is no activities in Poland.
Dominik Feldges
Okay. Can I ask a follow-up question there, Poland? So how many people then have left the company in Poland? And I mean, how hurtful is that for you? I mean obviously, Poland is a booming industrial country, lots of new plants there. I mean, you have had to leave it right now. I mean, it must be quite — I mean, what’s the impact of that?
Frederic Lalanne
Yes. The impact was disclosed in June. But in terms of number of people who left, we have above 200 people, Some of them moved to other entities. We offered also some positions within the group in Europe, and we offered some of our colleagues to work in Germany, in the Netherlands, in other places as well. But from the total number of people at that time, it was more than 200 people for Sulzer only which were impacted by this decision.
Operator
Ladies and gentlemen, that was the last question. I would now like to turn the conference back over to the management for any closing remarks.
Frederic Lalanne
Yes. If no other question, once again, thanks a lot for your questions today, your support, but also your continued interest at Sulzer. I’m looking back at the last 7 great years that I’ve spent in this company, what was an amazing journey when I joined Switzerland and Sulzer almost 7 years ago. And I’m sure and convinced that I leave the company which is stronger ever than before and it’s very well set to continue on its growth path.
And we view, external stakeholders, it has been always a pleasure to work with you, can be from the journalists, but also for the banks, investors, and advisers. And I’m sure that we will see again each other in one of the events in the future in Switzerland or anywhere else. But as a French living in Zurich, I can tell you my intention is to stay here in Zurich and keep on living on the shore or the lake.
So thank you very much. Thanks for your attention. And yes, we’ll talk to you soon. Bye, bye.
Operator
Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call, and thank you for participating in the conference. You may now disconnect your lines. Goodbye.
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