Kuehne + Nagel International AG (OTCPK:KHNGF) Q3 2022 Earnings Conference Call October 25, 2022 8:00 AM ET
Company Participants
Stefan Paul – Chief Executive Officer
Markus Blanka-Graff – Chief Financial Officer
Conference Call Participants
Alex Irving – Bernstein
Robert Joynson – BNP Paribas
Muneeba Kayani – Bank of America
Satish Sivakumar – Citi
Operator
Ladies and gentlemen, welcome to the Nine Months 2022 Results Conference Call and Live Webcast. I am Sandra, the Chorus Call operator. [Operator Instructions] and the conference is being recorded. The presentation will be followed by a Q&A session. [Operator Instructions]. The conference must not be recorded for publication or broadcast.
At this time, it’s my pleasure to hand over to Mr. Stefan Paul, CEO of Kuehne+Nagel. Please go ahead, sir.
Stefan Paul
Thank you, Sandra. Good afternoon, ladies and gentlemen and welcome to our nine months 2022 analyst call. I’m here together with my CFO colleague, Markus Blanka-Graff and we are happy to present our results.
Before we begin, we would like to highlight three topics. First, we have achieved record high nine months results, as communicated this morning. Let me take the opportunity to thank all business unit and functional colleagues for their great commitment during this year. Second, we have the flexibility and resilience at Kuehne+Nagel to adjust quickly while maintaining the strength of our core business which is very important in these volatile times. Third, our focus remains on yield management and customer experience. We at Kuehne+Nagel, we are committed to create the best customer experience in our industry.
Let’s look into the figures, Page number 3 of the analyst presentation. The results for the first nine months of the year point to a strong organic top line growth with more of that growth converted to EBIT than in the previous year. This extends to the most recent quarter when EBIT grew by 17% versus the prior year and to a total of CHF924 million. The strength of these figures points to our resilience and ability to continue to provide an exceptional customer experience, I was just alluding to it in volatile markets. We remain in a strong position to manage through future market dynamics, leveraging our long standard experience technological capabilities. Yield management is and will continue to be a top priority. One of my key learnings from leading the Road Logistics business unit the last 10 years and what are going to leverage for the group moving forward.
Page number 4, strong earnings growth in all business units. You see on the left-hand side group, air logistics, roads and contract logistics. As stated, we have achieved strong results across all business units which is a reflection of our focus on yield management. Top line growth was boosted by increased yields and solid market share development. We’ll come to that on the next slide in more details.
In Sea Logistics, the average yield was 2.7x that of the 2019 average and still 2.4% in Q3 alone. For Air Logistics, 1.7% for the nine months and 1.6% in Q3. Our record nine months EBIT result of more than CHF3.1 billion marks a $71 million increase year-on-year and reflects a conversion ratio of 36% for the first nine months versus 27% in the prior year, an increase of almost 10 percentage points on the conversion rate.
Let’s go into the business updates. And as usual, we start with the volume development. The upper graph is see, the lower, as always, the air development. Sea freight volume in Q3 is down by 4.9% at Kuehne Nagel versus our market estimate of 6% to 7%. Airfreight volumes in Q3 are down by 7% versus our estimate 8 to 10% decline. Overall, in both business units in sea and air, we were able to expand our market share during the third quarter accordingly.
Let’s go into the sea logistics, Page number 8, where we see the details. Yield, cost per toy and EBIT. What you see is our flexible business model continued to deliver reliable for C Logistics customers. As congestions eased, we talked about that quite frequently during the last couple of weeks but volatility persisted. Unit gross profits or yields remained at a high level in Q3, while the corresponding EBIT per toy was 4x 7 the average for ‘19. This reflects a robust conversion rate of 58% in sea freight in Q3.
Looking into the future, we are focusing on yield management, market share optimization which you have seen already in Q3 and cost reduction measures which have kicked off already in the last couple of weeks.
If we move to Air Logistics, Page number 10 on the details, yield GP per 100 kilo expenses and EBIT. Here, the strength of flexibility in our business model are equal versus air logistics. A key distinction is the resilience of yields over the period with relatively modest change quarter-to-quarter. This speaks to a closer matching of capacity to the demand environment. Unit EBIT in Q3 remains at 2.8x that of 2019 and reflects a conversion rate of 46% in Q3. Here as well looking into the future, we are pretty much focusing on market share expansions and cost optimization.
Now to Road Logistics, detailed Page 12. Road Logistics delivered a record result over the first nine months of the year. In Q3 alone, CHF40 million of EBIT reflected a conversion rate of 12.3%. This is a credit to active yield management and high-end utilization of networks across all regions. The U.S. business showed particularly strong momentum as did demand for digital solutions. For example, strong traction of the eTruck, now a product in Asia which we have launched approximately 3 years ago.
The focus is on further scaling and leveraging off the U.S. platform, our brokerage model on domestic for existing air and sea customers, global expansion in custom stand-alone and, maintaining a high-end network density in Europe, in particular for the groupage business.
Last but not least, contract logistics, detail on Page number 14. As you can see from the graph, Contract Logistics delivered a very solid growth over the period and meaningful improvement in profitability. The Q3 result of CHF58 million revealed a best-ever conversion rate of 7.1%. These results are a product of continuous systematic efforts to improve margins through portfolio optimization, combined with nearly full utilization of warehouse capacity which is currently at around 99%.
Our focus remains on high value creation for selected verticals. Remember, we were always talking in the past about health care and e-commerce, this remains and a seamless implementation for all new customers and customer contracts.
With this, I would like to hand over to Markus for more details on the financials.
Markus Blanka-Graff
Thank you, Stefan, and good afternoon, ladies and gentlemen. Thank you for — first of all, thank you for your interest in Kuehne Nagel in the time today. As Stefan has outlined these business unit results clearly demonstrate our capabilities and the long-standing resilience to respond to changes in market dynamics. In addition and before I get into the details of the income statement, I would like to emphasize one thing. There’s a very strong earnings results that indeed has translated again into a healthy free cash conversion and generation.
So — but let’s start with the income statement as usual. Page 16 and very clearly, Q3 continues to outperform last year’s numbers on nearly every P&L line, more gross profit, higher earnings before tax, outstanding incremental conversion rate. The growth conversion rate to highlight one of the numbers was at 34% in the third quarter and 36% on a year-to-date basis. We have been able to maintain this conversion rate now at a very high level for more than 3 quarters.
Brief looking in — a brief look into greater details on the incremental development of GP, one of the KPIs we monitor very closely, we can see a steady growth in GP in absolute terms against even the tougher comps in Q3 2021. And when we look at this incremental gross profit development, you should notice the incremental gross profit to incremental EBIT ratio. This conversion ratio is in excess of 75%. So every incremental gross profit value translates to 75% into incremental EBIT. Something that we are aiming for also in the quarters to come.
On the very right side of the schedule, you will identify some headwinds coming from currencies with negative impact of around 3.8% on a gross profit level. Represents approximately €264 million, so quite a significant number. And the same calculation, negative ForEx impact on earnings before tax with around 3.1% equals €56 million. Operational efficiency and when we talk about income statement that is — that immediately comes to our mind on the side of operational efficiency and digitalization efforts, I just want to remind you of our eTouch project.
I can report another improvement of the conversion rate in sea and air freight. eTouch itself is all about internal operational gains in efficiency with automation, clearly, as one of the main pillars. Now we will talk about that pro during the Q&A session. But as operations in sea and air freight start or we expect them to start becoming more plannable and foreseeable, eTouch will help optimize execution and they will contribute more significant to the conversion rate. Every improvement we do on the eTouch side is permanent because then we have eliminated or automated or optimized a process for a task.
So let’s move to the balance sheet, Page number 17 in the presentation. Balance sheet is extremely solid. As usual, the largest balance sheet items, our trade receivables standing currently at around CHF6.4 billion and trade payables standing at around CHF2.9 billion. The balance sheet continues to provide the stable platform for all of our businesses and it is the backbone for our resilience. It’s an important building block for our confidence also in turbulent economic conditions.
Another important factor, cash and free cash flow generation, Page number 18. As we certainly have discovered in the presentation, we have strongly increased our cash and cash equivalent position to around CHF2.9 billion at the end of September. Additionally, we see a positive trend on the interest side so that we do expect to generate some positive interest gains in the future. The business continues to deliver a healthy cash flow. Free cash flow at around €2.6 billion is on the same trajectory in line with the previous years.
Some more details on the working capital development. Let’s move on to Page number 19, working capital. Changes in working capital, one of the topics that has been on the agenda for the last couple of quarters and just to highlight that, have been driven by the increase of trade receivables and contract assets together currently at around CHF7.3 billion.
In the future, we anticipate stable net working capital that we currently utilize for running the business. Illustrating what I just said on the working capital, we have around €1.9 billion level of working capital, unchanged over the last quarters to run the group. Comparing the DSO and DPO, so days of sales and days of purchase outstanding, you see very consistent levels between 54, 55 days on the DSOs around 56 under DPS. I do expect quite similar level also in the next quarter.
Moving on to the return on capital employed development, Page number 20. Very nice graph, clearly and we continue to focus on the trend in our return on capital employed knowing that the current levels are the top range. In Q3, we managed another small increase and expect to stay at this level in the next quarter.
With this comment, I would like to hand back to Stefan for the slide of the current perspective.
Stefan Paul
Thank you very much, Markus. Current perspective, I believe this is a slide where you are pretty much interested in what we are going to share in the next couple of minutes. Let’s look into the market first and then the response of Kuehne+Nagel.
So what we see is still a high demand for effective solutions and high-quality services. That’s the reason why I was mentioning customer experience at the beginning. We all see that and have seen that the GDP growth expectations continue to decline. Bloomberg consensus 3.5% in July now back up with 2.9%. There’s a global inflation ongoing and a certain economic crisis driven by the request in Europe and certain supply chains remain insufficient. What we have seen as well is that the consumer demand, the end consumer demand is slowing down, especially from Asia to the West bound, less prominent to the U.S., driven by the higher energy consumption prices, in particular in Europe.
How do we reflect on that? What is our answer from a Kuehne+Nagel perspective. Our goal is to create a unique customer experience, as stated a couple of times by providing superior service quality. We are striving to have the best product offering in the market. The question is how will we do that? We will enhance our offerings in the industries where we have already a strong position. In addition to that, we will explore value creation potential in other industries by building on our success in the health care industry. Remember, we have started health care pharma 6, 7 years ago and now we are one of the leading providers in clinical trials, primary distribution and in the vaccine business.
Looking at the current market expectations for earnings over the coming quarters, we consider the current median EBIT estimate for 2023 of CHF2.3 billion to be conservative. Yield management is high on our vendor and is prioritized over volume but both are important. So we will maintain our organic growth agenda. We will not give it up but pretty clear, we always look into the portfolio mix and yield management is very high for the key account and our SME sales force. Kuehne+Nagel’s long experience and asset-light model ensures our flexibility and our resilience, changing market environments and circumstances which I believe is extremely important in the current market environment. This has enabled us to manage through counters economic cycles and periods of unforeseen volatility. This is part of the Kuehne+Nagel DNA.
With this, I will hand over back to Sandra for the Q&A session.
Question-and-Answer Session
Operator
[Operator Instructions] Anyone who has a question may do so at this time. The first question comes from Alex Irving from Bernstein.
Alex Irving
Two for me, please, both on cost. So you mentioned earlier on cost reduction measures that have kicked off in the last couple of weeks. Could you please provide some additional detail on what these are the areas that you’re targeting for cost reduction and also areas where you are protecting spend? Second question, we also – we’re seeing on OpEx per unit and per TEU has remained broadly steady on prior quarters, where do you see this normalizing please? And is that going to happen faster, slower or at broadly the same pace as normalization in your unit GPs?
Markus Blanka-Graff
It’s Markus. Can you repeat the beginning of the second question, please, because we had interruption here on the line?
Alex Irving
Sure. So my second question, we’re seeing your unit GP start to come down but your OpEx per unit has remained broadly stable on prior quarters. The question is about where you see this normalizing and when?
Markus Blanka-Graff
Okay. So I take the first question, Alex. Cost reduction. So what will remain stable is the spend which we are going to have on our IT, the TMS landscape, everything what we do in automation, connectivity with our customers and suppliers and sales. We will not cut any costs on sales. We will maintain our position in the key account and SME arena, where we use the normal attrition rate which is a little bit higher than before the pandemic, we will not replace and hire new people. And we have started already to use that, utilize that in order to reduce the manpower cost. This is what we currently do or what we have started to do in the last couple of weeks.
Stefan Paul
And Alex, I’ll take the second question for the unit GP and unit cost. I think it was and it remains to be clear to everyone that a part of the gross profit on a unit level is an elevated gross profit. And I think it is in line with our expectations that, that level is going to reduce slightly as we have seen already over the course of the year. On the cost side, we must still remember that most of the cost increases per unit have been induced through the additional efforts and service that we have — that we’re needed to provide to guarantee the customer service that we are standing for. And at the end of the day, we are still facing some of the supply chain difficulties but also in line with the reduction of supply chain challenges, we expect cost per unit to come down. So efficiency, productivity is the theme of the next quarters to come. But right now, I think there is more — we are still on that side where the effort is elevated and hence, the cost per unit are not at the level yet where it’s most likely going to be — going to be in the future quarters.
Operator
The next question comes from Robert Joynson from BNP Paribas.
Robert Joynson
Welcome, Stefan. I know you’re going to get a lot of questions today on downside risks and cost reductions, et cetera. So I’ll focus on something different and ask about the balance sheet and potential cash returns. So firstly, on the balance sheet, you had almost €3 billion of cash at the end of Q3 by year-end. I guess that figure will be something closer to €4 billion. Just in that context, how much cash would you like to maintain on the balance sheet going forward? I’m conscious that before the pandemic, it was around €1 billion on average. But I guess, given that you’re more keen on doing M&A nowadays perhaps you’d like to maintain something higher going forward. So how do you think about that? How can you help us to think about it?
Markus Blanka-Graff
Thanks, Rob. That’s a good question for me, I think. And yes, you’re absolutely right. Cash levels are high. And I usually answer that question with that first line that says the most important is the free cash flow generation of the business. And I think that is the comfort level that Stefan and I and the team has that we can deliver that. Clearly, the €2.93 billion we are talking about, this is a decision for the Board of Directors. And that said, we believe that we will take into consideration a desired net cash balance that we usually keep on the balance sheet with respect to the overall macroeconomic, let’s say, challenging outlook, difficult outlook and the size and the likelihood of some of near-term.
For the M&A part I think we had also been relatively clear over the past. We struggle currently with valuations and expectations from the sales side, for sure, sustainable EBIT same as you have probably in your models, sustainable profitability long term is a difficult thing to assess currently. So I would think the capital allocation basically that you are talking about is we will keep always a net cash position on the balance sheet for safety and stability. We do — we are active in the M&A market, maybe not in an imminent deal situation that we could expect anything closing in the next 3 weeks or so but we are keeping our opportunities open.
Other than that and I can only refer to the historic facts, whenever there was exits cash, so beyond the net working capital requirements, the net cash position and nearer-term M&A opportunities, historically, that excess cash had always been paid towards the shareholders.
Robert Joynson
And just in that context, I guess, historically, when you’ve paid out excess cash, there’s a track record there of paying it out as a special as opposed to just kind of increasing the size of the ordinary dividend, is that consistent with current thinking in terms of distinguishing between an ordinary based on, let’s say, 60% payout ratio and then any excess is paid as a special?
Markus Blanka-Graff
When memory serves me right, we only declared onetime dividends as special when there was a large real estate portfolio sale a couple of years or many years ago. And other than that, we usually have increased payout ratios to deal with the payback, if you like, from the — out from dividends. I would think that’s also our current thing.
Operator
The next question comes from Muneeba Kayani from Bank of America.
Muneeba Kayani
I just wanted to go back to your comments on the focus on product mix and yield management. If I understood correctly, this is more focused on the C side. So can you kind of talk a little bit more about what would you focus on? And how can you maintain market share and kind of yields at elevated levels or not going back to 2019 levels from product mix? So that’s my first question. And then secondly, just from a capacity side, how much of your air and sea capacity is on contract versus spot? And how should we think about this mix going forward?
Markus Blanka-Graff
So let me tackle the first question, the product mix and the yield and the volume question. So as you know, we have 2 different sales forces. One is the key account channel and the other one is the SME. SME basically is medium-sized customers. And I think what we will see in the next couple of weeks to come due to the ease of the capacity we have access to a lot of capacity more than a couple of weeks ago. We can really tackle now the blue ankle line, our bread and butter business for the SME customers and they have normally a higher margin, at least that was the normalized margin expectation before the pandemic.
And then on the key account side, what we will not tackle is commoditized business, commoditized business with very low margins which we had in the portfolio years ago, this is not in focus. So taking the example of, for instance, of our 6 key verticals, you have verticals where the supply chain end-to-end is more complex than other verticals and we will pretty much focus on the complexity because we like complexity because this is where we can add value and create value for our customers. I think I’ve touched a lot of times already on health care. Just a little bit food for thought, there’s untapped potential for us in the semicon industry that goes for air freight, for instance, renewable energy is at all levels at our agenda. We see that pretty much kicking in now for the sea freight business unit for the aftermarkets later on in airfreight as well for the domestic activities out of the warehouse and distribution facilities for Road and last but not least, for contract logistics. So the message here is we look into the different verticals outside of the SME portfolios and we tackle areas and customer bases where we see there is more value creation from a demand perspective and which will give us and grant us a higher yield moving forward.
The second question was on the fixed capacity in – for the both sea and air freight. So let me start with sea freight. In sea freight, it’s around 10%, 15%, maximum 20%, 30%, is not fixed. And in air freight is a little bit higher, it’s around 2% is block space agreements. And before you ask the new 2 charters which we are operating one already in service. The other one is coming soon is between 1% and 2% of our entire capacity. So that is not going to move the needle. And by the way, this is already sold back to back to customers. So there is no basically risk portfolio from that perspective. Hopefully, that answers the question.
Operator
The next question comes from Satish Sivakumar from Citi.
Sathish Sivakumar
I got a follow-up on the yield and product mix. And then I just quickly want to touch up on the Apex. That’s my second one. So first on the yield and product mix. So does that imply that low-value cargo like recycling that are part of your mix back in 2019 and that will make a comeback as we see the rates coming under pressure. So any like color on that would be helpful. And also, what was your exposure back in 2019, say, on this low-value cargo? And the second one on the Apex, if you could just add any color on the volume and yield trends and how that actually business has performed versus the group? Is the volume decline and the rates were broadly in line or it’s kind of outperformed or underperformed? Any clarity around that would be helpful.
Stefan Paul
So on the product and volume mix, you are right. For instance, these kind of commodities crash and so on will not come back, we will not focus. What we have done in 2020, we have — in the key account arena, we have established a new sales channel which we call Global development accounts ties into the 6 key verticals with a portfolio of roughly 500 new customers identified, of which half of it is new labels. New labels completely untouched with a huge potential for us to grow. So we shift our activities from a key account sales perspective more into this DA arena in order to unleash the potential which we see in the marketplace. And that will replace the low-yield cargo moving forward.
Markus Blanka-Graff
And Satish, on the Apex question, so you’re aware that Apex is predominantly a transact player with a good share of capacity on charters and a good share on the capacity also with co-loading. So from that perspective, that piece is not entirely comparable with the Kuehne+Nagel mix, if you like. But on – on the transpac route itself, if we compare the Kuehne+Nagel and the Apex development on that isolated route and with comparable cargo, we would be very similar. That means both of our performance is indeed very good, although the transpac has been hit due to the lockdowns. The lockdowns in the 0-COVID policy, obviously, is something that that hits the numbers but it’s not a macroeconomic component, right? So it’s not about consumption. It’s about a restriction of activities through governmental ruling, right?
And we do see both of us in that transpacific trade line performing very much according to the market. So when we slice and dice the elephant correctly, both of us confirm – sorry, perform actually very well.
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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