AkzoNobel's (AKZOF) CEO Ton Buchner on Q2 2014 Results - Earnings Call Transcript

Jul.23.14 | About: Akzo Nobel (AKZOF)

AkzoNobel Nv (OTCQX:AKZOF) Q2 2014 Earnings Conference Call July 23, 2014 3:00 AM ET

Executives

Sheryl Stokes – IR

Ton Buchner – Chairman and CEO

Analysts

Paul Walsh – Morgan Stanley

Jeremy Redenius – Sanford Bernstein

Neil Tyler – JPMorgan

Peter Clarke – Société Générale

Jean-Francois Meymandi – UBS

Mutlu Gundogan – ABN AMRO

Michael Rae – Goldman Sachs

Jaideep Pandya – Berenberg

Operator

Good morning, good afternoon, thank you for standing by. At this time, all participants are on a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator Instructions). Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

Now, I will turn the meeting over to Miss Sheryl Stokes. Please madam, go ahead. Your line is open.

Sheryl Stokes

Thank you. Good morning, everyone, and welcome to the AkzoNobel 2014 Second Quarter Earnings Call. I’m Sheryl Stokes, and today, we have our CEO, Ton Büchner to guide you through our Q2 results.

This morning, we will also be referring to a results presentation which you can either download from our website, www.akzonobel.com, or you can follow it on the screen at the same time. A replay of this call will also be made available. There will be a Q&A Session after the prepared statements. For any additional information, you can contact Investor Relations after the call.

Before we start, I need to remind you of the Safe Harbor statement that it contained in the back of the presentation. Please note that this statement is also applicable to this conference call and the answers to your questions.

With this, I would like to hand over to Ton, who will start with our Q2 2013 highlights on slide 3 of the presentation.

Ton Büchner

Thank you, Sheryl. Good morning and welcome to our second quarter 2014 call. Before I start, I would first like to express my sympathy to those around the world impacted by the huge tragedy concerning flight MH-17.

As you know, many Dutch people are affected. We do have a National Day of Mourning today. Almost everybody, almost every employee of AkzoNobel and everybody in the country knows somebody affected in the country, and our thoughts and prayers with all those Dutch or otherwise who are personally affected by this disaster.

Events like this, with quarterly numbers in a different perspective but we would want to make the next step to describe to you the events of the second quarter at AkzoNobel. We of course are pleased to note that Maëlys Castella will join AkzoNobel as the CFO on September 15. She does bring extensive industry financial and business experience. And we look forward to working with her to further improve the operational excellence and value creation drive at AkzoNobel.

Now, let us focus on our Q2 results. And what we would like to highlight is that or putting proof points in place to deliver, to increase the conviction to deliver towards our 2015 targets.

Volumes were positive in all three business areas. Revenues were down 4%, but primarily due to adverse currency effects or actually due to a very strong Euro.

Operating income, €353 million up 10% from the prior year, reflecting both the increased volumes and to the benefits from our improvement actions and the return on sales improved from 8.3% to 9.5%.

Restructuring costs were €45 million for the quarter, about €5 million higher in the same period last year, excluding these are return on sales were 10.7%, an improvement from 9.3% in the second quarter of 2013. It’s also noteworthy to see that all three business areas improved their quarterly return on sales, both before and after restructuring.

Net income attributable to shareholders, €205 million and that compares to €184 million in 2013 on a comparable basis. And that was of course mainly because of a higher operating income.

The adjusted EPS up 23% at €0.95 and that’s of course when it’s adjusted for the incidental tax gain of 2013 that was part of the EPS then. The net cash from operating activities was €393 million up from 2013, which was €261 million. Now we’re on track to deliver our 2015 targets despite the strong Euro and the continued expectation of fragile economic environments in various regions in the world.

Moving to slide number 4, we’ve depicted here the most recent numbers when it comes to the global PMI. In June, global output remained in growth but with a slight rate of acceleration. Europe was mixed, as you see with a different bubbles on the chart, with a clear Euro Zone, non-Euro Zone divide.

Germany saw some softening as the most Euro Zone countries, particularly France, which saw an, increasing, rate of contraction versus prior months. The U.K. and Sweden however remained strong with increasing rates of expansion. But as you see over here, France is on the left side of the chart as one of the bigger European Euro Zone countries.

The U.S. was again very strong, while Brazil contraction was disappointing. China’s manufacturing PMI has suggested some recovery, it’s actually moved to the right on this chart if you compare it with five months ago, which is a positive development for China. And the rest of Asia was mixed with some economies like Indonesia showing positive signs.

Stepping to slide 5, you see an indication on consumer confidence. Again these are fairly recent numbers that show various developments both in the BRIC countries and in several key European nations. And you see of course that this particular confidence drives several behaviors, specifically the buying behavior of consumers themselves, which in our case has a strong influence on the Decorative Paints business.

We see a constantly changing picture, but the Q2 consumer confidence results show an overall improvement compared to Q1, growing 1 point globally to 97.

Comparing to last quarterly developments, it’s still low. Europe shows some growth. North America growth is driven by the U.S. while Latin America decline is driven by Brazil. China remains stable while India shows some improvement, although also on this chart, you do see that France is on the right side i.e. on the lower side of the chart.

Stepping to slide number 6 our four key market segments that we’re addressing. If we first would speak about the general geographical developments, we see in Europe that the stabilization continues. We don’t see general growth rate in Europe, we see a kind of a mix of growth rate in the various countries of Europe. In the aggregate, it’s reasonably benign. It’s certainly stabilizing and it was signs of marginal improvements going forward.

If we look at Asia, we do see continued strength in China for all of our businesses. We also see countries like Indonesia, strengthening and Southeast Asia. We see very positive sentiment developing in India, which have not yet translated in significant business developments but the actual confidence of the nation has significantly increased. And a lot of positive signs are arriving also in our businesses.

The one region where we have seen continued weakening has been South America, where we have significant market positions but the overall, both the PMIs and the consumer in each year, has actually not significantly led to growth in this particular region.

If we then step to the market segments, buildings and infrastructure again, Europe still not very strong in its recovery. China is continuing as in the past with some fluctuations around the growth rates, but they remain quite high. The rest of Asia follows the descriptions that I’ve given earlier as well as the region South America, where the buildings and infrastructure segment has been affected by the weakening growth.

If we look at transportation, as you know, we’re not participating in the Automotive OEM Coatings part of the business. But when it comes to the automotive repair side, we’ve seen and for all their study developments, the Marine business has started to show some recovery. And the aerospace business has continued to be very strong.

The consumer goods businesses, on the durable side, the recovery goes in line with the general buildings and infrastructure recovery in the way we’ve seen it so far. And as a result, it’s been relatively lackluster and benign. Whereas, some of the packaged goods, whether it is the coatings for cans or whether it is some other things that we see in other consumer good applications that has actually shown a relative strength, almost around the world and some initial signs in Europe as well.

The industrial environment has the biggest differences among the different regions. We do see Europe being still struggling with the competitiveness of industry in various regions. What we do see is that Asia has continued growing whereas South America has felt some pain in some of the industries, not in the industry that is big for us in South America, which is the pulp industry, that one has been strong. But as an aggregate industrial activity, South America has certainly shown a reduction of that.

Stepping to slide number 7, we see the results for the second quarter. Positive volume was more than offset by adverse currency effects bringing revenue down 4% for just the second quarter last year.

Due to reported operating income includes restructuring charges of €45 million, which was €5 million higher than the restructuring charges in Q2 last year.

Please note that the full payable of restructuring charges by quarter can be found in the Appendix of this presentation. And if you look at the year-to-date restructuring, it’s been €89 million up €20 million from last year. So, as we’ve initially indicated, we have indeed spent more on restructuring in the first half of the year compared to last year.

We anticipate 2014 associated charges to total at least to €250 million in line with what we’ve previously stated with approximately two thirds of the remaining charges expected in Q4. We expect a little lower restructuring costs at Specialty Chemicals, while we expect higher restructuring costs at Performance Coatings in the second half of the year.

Longer-term we would expect to see average corporate restructuring charges equivalent to around 1% of revenue as part of ongoing operations as regular course of business, as normal ways of adapting the business to various market developments.

Driven by increased volume and benefits from improvement actions, operating income at the €353 million was 10% ahead of prior year.

Return on sale for the quarter, 9.5% excluding restructuring costs as mentioned earlier in the introduction, return on sales is 10.7% up from 9.3% for Q2 of the prior year. This is the fourth consecutive quarter that return on sales has improved both before and after higher restructuring charges. Additionally, as you will see later in the presentation, each individual business area has increased its Q2 return on sales both before and after restructuring.

Last but not least, return on investments, also return on investment has improved relative to the second quarter of 2013 from the 10.1% or – from the 7.7% in 2013 to 10.1% this year in the second quarter.

Slide number 8, we see the quarterly volume and price mix developments. Market conditions do remain challenging and they are fluctuating in various regions and they’re quite fragile when we see initial signs of growth very often in the next quarter, that growth again shows different characteristics.

With volumes continuing to improve in all business areas, and of course we are comparing this quarter with a weaker quarter in 2013. But it is good to see volume improvements in all of the three business areas.

In Decorative Paints, volume was up 3% compared to last year with strong volume development in both Asia and in many European countries. Price mix was down 3% in the quarter and we’ll come back to this later at Deco but it was largely because of a change in the distribution in Germany where we sold our own stores. And therefore the margin that those stores normally would add to the wholesale prices is not part of the AkzoNobel pricing anymore.

So, as that is a negative look on the price mix situation in Deco, it is a result of the right decisions that we took to change our way of marketing our business in Germany as such. And therefore it’s not a concern.

Performance Coatings volumes were 1% driven by our Powder and Marine businesses, is being variability across individual segments and within the regions that does continue an overall price mix has been up 2% for the quarter.

Specialty Chemicals, Q2 volumes rose 4% that’s quite a significant rise with higher volumes resulting from better market conditions in most regions.

Price mix was down 1% in the quarter of a Specialty Chemicals and that is primarily driven by one particular commodity that has reduced in its pricing which is caustic. The price pressure in caustic has been significant and we expect that actually to continue for the remaining part of the year.

Stepping to slide 9, we can focus on the exchange rates. And you’ve seen that we now had four quarters of very, very significant headwinds on exchange. Actually the only commonality in all of the exchange rate is that the Euro has been strong.

It doesn’t matter whether it’s been Brazil, Russia, Turkey, India, Indonesia, even China all of these currencies have shown significant reductions relative to the Euro and that headwinds has been going on for quite a while.

Adverse currency effects in the aggregate were 5% negative on the Q2 revenues with all businesses affected. But as you’ve seen in previous light, despite these currency effects, that also affected OPI, we were still able to increase OPI and therefore overcompensate on the OPI level for these currency effects.

The majority of our foreign exchange effects is translational, whereby most of our revenues are closely matched with local manufacturing, which is depicted in this slide. But we have to rise that in certain markets, such as Brazil, India, Indonesia and Turkey, we do import dollar denominated raw materials for the product that we sell locally. And these amounts are quite significant.

As a result, there is a transactional effect on foreign exchange on the raw material side as opposed to on the manufacturing side. And that can be seen in the cost developments, for example in Decorative Paints when we will be talking about things like Titanium Dioxide which is not available inside those countries.

We of course try to offset these price with price adaptations in the market but sometimes the competitive environment in these markets puts a delay of a quarter or two in full compensation of those increases.

On slide 10, we can see the operating income bridge for the first half of the year, with the key elements broken out. Foreign exchange on OPI has also been a significant headwind as you can see in the first part. Both volumes and price mix are more positive this year as markets improve.

Looking at raw materials, average raw materials costs were slightly down. So that purely looks at raw material parts, it would actually be a positive number. But the transactional foreign exchange impact that I just mentioned in some high-growth markets over importing raw materials have a negative impact on the overall year-on-year raw material development which is down €17 million.

H1 2014 restructuring costs are €20 million higher as mentioned earlier. And as we phase more cost into the first half of the year compared to last year, and while still anticipating overall restructuring cost reductions for the full year to something that is at least €250 million.

The other category includes additional benefits from restructuring, one-offs, depreciation and amortization and wage inflation. The incremental benefits of about €100 million have been captured from our continued improvement actions in H1. And they’ve been to a large extent offset by inflationary costs and one-off charges to the accounts.

Given the continued fragile economic environment and this ongoing inflation and other costs are focused on continuous improvement is the right focus and it is essential as we continue to adapt and positively impact our profitability.

We now see on slide number 11, the progression towards our 2015 targets on both return on sales and return on investments. We’re comparing the starting point full year 2012 with the first half result of ‘13 versus the first half of 2014.

And here you see that return on sales has improved from 7.4% at the end of the second quarter of ‘13 to 8% of the first half of 2014. Our 2015 target is 9%.

For the business areas Decorative Paints had a challenging Q1, including higher restructuring costs and one-off swings that contributed to an H1 rough decline from 6.9% to 6.1%.

The second quarter of Decorative Paints, return on sales clearly improved both above the line and underlying. And therefore it should be noted as well as the continued commitment to the 2015 expected outcome of 7.5%.

Showing return on sales improvements at the first half year 2014, performance coatings improved from 10.5% last year to 11% while Specialty Chemicals improved from 8.8% last year to 10.6%, both businesses have 2015 expected return on sales outcome of 12%.

Moving average ROI, improved from 7.8% at half year 2013 to 9.5% for the first half of 2014. The target for 2015 excuse me is 14%, as well all businesses have shown improvements in return on investments on a comparable basis, excluding impairment and divestment impacts.

These targets support the leadership and performance, no longer largely driven by revenue by primarily driven by the quality of returns. We’re making progress and remain committed to achieving our 2015 targets, despite the continuous headwinds in our markets, in our segments and in the currency environment.

Slide number 12, reflects notable Decorative Paints development in the second quarter. In line with our strategic direction and return focus, we’ve chosen to exit some low margin contracts primarily in Eastern Europe.

We don’t actively always specify these contracts but it is part of our strategy to focus on the quality of our business as opposed to the volume of our business. Sometimes these contracts have quite an impact on volumes, and most of these contracts are picked up by local players.

Influx (ph) includes improved return on sales. However, it sometimes negatively impacts the reported volume growth seen thoroughly in this year.

Q2 2014 restructuring charges for Deco were €23 million in line with prior year as we continue to adapt the operating model primarily in Europe and therewith the cost structure.

Underlying return on sales improves from 10.7% in the second quarter of 2013 to 11.6% in the second quarter of 2014, clearly showing progress in improving the underlying profitability of the business.

Notably is that our German Stores divestment was completed at the end of March this year. Exiting the stores had a clearly negative price mix impact on revenues as we’re now selling similar volumes but not anymore to our own stores who market up but we’re selling them to independent wholesalers. That has been large negative price mix effect, and it explains the largest portion of the price mix effect that you’ve seen for the numbers in Decorative Paints.

We are therefore selling at lower wholesale prices rather than the retail prices at which we sold before. And at the same time, we’re benefiting from our reduced cost base and deliver improved profitability. It was therefore the right thing to do but it needs to be noticed that the impact in price mix will continue for the next several quarters. It is a good thing, it is not a concern but it has this particular effect.

In order to address difficult market conditions in France, indicated at the start of this presentation, both with the PMI numbers and with the consumer confidence numbers, we are re-branding our stores and putting extra actions in place and we’re seeing the first signals that this is having a positive effect.

Finally, the sales of Buildings and Adhesives had an impact of €49 million in revenue and €5 million on operating income in the quarter. For reference, 2014 quarterly revenue and operating income, the divestment impact of Buildings and Adhesives can be found in the appendix of this presentation.

Turning to slide 13, we see Decorative Paints Q2 financial highlights. Revenues in the quarter were down 9% that looks like a very significant number but it’s primarily due to adverse currency effects and the divestments of Buildings and Adhesives. And as you see, the price mix impact which is explained with the correct measure that we took in dealing with our drum stocks.

Buildings Adhesives divestment was completed on October 1, 2013. Q2 volumes in Decorative Paints were up 3%, due to higher volumes in Asia and in most European countries. And as we indicated, some of this volume growth has been also impacted by us declining to participate in low-margin contracts that we had participated in the past.

China shows healthy growth rates and we continue to watch the property market carefully. European volume was up 4% and would be higher had we not walked away from the low margin businesses.

Regional performance is mixed as growth continues in the U.K. and Eastern Europe and partially offset by declines in Continental Europe in the quarter.

Price mix as indicated largely driven by the distribution channel change in Germany. And in Q2, restructuring measures and various operationally efficiency improvements continue to lower the cost base, certainly in Europe. And Q2 operating income of €102 million is in line with prior year.

Reported return on sales were 9.5% up from 8.7% but adjusted for restructuring cost, the return on sales was actually 11.7%, up from 10.7% for the same period last year.

Performance Coatings can be seen on slide number 14. Quarterly revenue and Performance Coatings declined 2% but again primarily due to adverse currency effects. Overall volumes were up 1%, higher volumes in Powder and in the marine business were part of the reason for that. Powder Coatings volumes from all regions were positive in the quarter, Marine saw increased volumes in deep-sea maintenance and new construction over the prior year.

Vehicle refinish volumes grew in China and in North America, while South America continues with weak demand. Q2 restructuring initiatives continue with the quarterly structuring cost of €70 million which were €12 million higher than the same quarter last year.

During the quarter, closure of a Marine and Protective facility in North America was announced. Due to the acceleration and restructuring activities at Performance Coatings which started a little later than the other business areas. And despite adverse currencies, the Q2 operating income of €178 million was 9% higher versus last year.

So, despite enormous currency effects both on revenue and also on operating income, we have been able to increase the operating income and the return on sales levels of this business as well.

The return on sales came in at 12.4% for the quarter. But if you exclude restructuring cost, return on sales was actually 13.6%, up from 11.5% for the same period last year.

Turning to Specialty Chemicals on slide 15, we see that revenues in Specialty Chemicals were down 2% and it sounds like a tape-recorder. But again, it’s primarily due to adverse currency effects.

Divestments include both the primarily A-means and the puree businesses that were completed in Q4 2013. Volumes during the quarter were up 4% compared to the previous year, supported by an overall improvement in functional chemicals, market conditions and also because of the absence of the previous year’s maintenance stock in industrial chemicals which was quite significant.

The Ethylene Amines business continues to be more stable and sees more stable trends compared to the past, and certainly compared to H1 and H2 last year. The price mix impact is primarily due to decreased caustic prices in industrial chemicals Chlor-Alkali business.

Overall, margins continue to be impacted by caustic, which we do not expect to significantly improve soon during the quarter this year.

Continuous improvement measures, continuous part of the operating income improvements that operating income was up on last year by 2% to €124 million largely due to cost control and operational efficiencies coming through. And then notably from functional chemicals, restructuring announced last year. So, also despite the price pressure on caustic, we were able to improve the result at Specialty Chemicals.

Return on sales is 10.1%, up from 9.7% last year, excluding the restructuring cost. Return on sales is 10.2% for the quarter, improved from 9.6% for the same period last year.

On slide 16, we repeated an announcement that we made earlier during the month. We announced the sale – of the intended sale of its Paper Chemical business to Kemira for €153 million. This business is currently part of the pulping performance business unit inside Specialty Chemicals. And that Pulping Performance business unit will focus on the continued global leadership that they have in Pulp Bleaching, Colloidal Silica and a number of their specialty businesses in the portfolio.

This is another proof point where we show that we prune the portfolio for businesses that have maybe less leading position or strength than the ones that we want to have. And on that basis, we will continue to prune portfolios in smaller parts.

The transaction is expected to be completed in approximately six months time, conservatively estimating Q1 2015. And it is subject to regular consultation both with employee representatives and it needs regulatory care. We expect to make a small profit on this deal when it is closed.

Proceeds from the sale will be used to further improve our general liquidity. And this actually summarizes the divestment of the Paper Chemicals business which is part of our Specialty Chemicals business.

Turning to slide number 17, where I would normally have passed it on to our CFO, we will continue at this point with the numbers. We reported no incidentals in the quarter, as most restructuring costs and non-recurring items are now included into the operations.

Financing expenses increased by €7 million to €40 million for the quarter. We continue to see lower financing expenses as a result of our bond repayments. However interest on provisions was a charge compared to a gain in 2013.

The year-to-date effective tax-rate is 26% which was positively impacted by an adjustment to previous years recorded in Q1. Excluding this and other one-off factors, the tax-rate actually is 28%. For full year guidance, we estimate the effective tax rate at 29% and the cash tax rate at 24%.

Net income attributable to shareholders was €205 million for the quarter, up from previous year quarter of €184 million on a comparable basis, and that is excluding the incidental tax gains and the profit of the sale in North America, which took place in the same quarter in 2013 within Decorative Paints.

Adjusted earnings per share, was up 23% to €0.95 for the second quarter of ‘14, up from the prior year’s €0.77 again on a comparable basis.

Turning now to Q2 cash flows on slide 18, lower outflows for working capital resulted in higher cash inflow from operating activities at €393 million versus €261 million in Q2 2013. Q2, 2014 operating working capital as a percentage of revenue came in at 12.1% in-line with Q2 2013, and down from Q1 ‘14 at 13.4%.

Last year’s profit for the period from continuing operations of €333 million includes €124 million tax gain which was non-cash and hence adjusted for in other charges in the slide that you see here.

CapEx was €150 million and below last year. 2014 full-year CapEx is trending towards the 4% of revenue and closer to the depreciation amortization levels of the company.

The cash dividend payment in the quarter was €175 million in-line with prior year. Approximately 40% was paid in shares as a result of the offer of a strict dividend. This resulted in the issuance of 2.3 million new shares in mid-May the number of shares currently in issue is 245.4 million.

Net cash from continuing operations was positive this quarter at €49 million. And net debt at the quarter end is stable at €2.1 billion for Q2 2014.

Turning now to the pension deficits on slide number 19, we can see that the total IFRS deficit has increased from €1.1 billion at the end of Q1 2014, to €1.14 billion at the end of Q2 2014. As it returns and lower inflation in the U.K. were offset by lower discount rates in all key countries.

A major fluctuation took place in Q1, which was related to the buying that took place, the fluctuations in Q2 are primarily driven by asset returns and discount rates.

As you’re aware, these are the IAS 19 numbers, please refer to the appendix slide for more details on the pensions and the actions that we’ve done to mitigate and/or remove risks for AkzoNobel.

Coming to the conclusions, both Q2 and H1 volume requirements were positive in all three business areas. Return on sales improved for the quarter in all three business areas, while return on investment showed improvements both in Q2 and in H1.

Continuous improvement program are ongoing in all businesses and we’re taking necessary action to improve our ability to leverage our strong brands and our leading market positions in the world.

We anticipate 2014 restructuring charges to total at least €250 million for the year, approximately two thirds of the remaining charges are expected in Q4. And H2 restructuring actions will be lower in (inaudible) and higher in the other business areas.

Despite the strong Euro, and the continued fragile economic environment, I’m confident that we’ve taken the right approach and are on track to deliver the 2015 strategic target.

With that, this concludes our formal presentation. And I’d be happy to take questions. Thank you. We would be ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And the first question comes from Paul Walsh. Please sir, go ahead. Your line is open.

Paul Walsh – Morgan Stanley

Thanks, good morning, Ton. And yes, our thoughts are with everybody relating to the disaster you talked about at the beginning of the call. Just three questions if I can.

Firstly, on the operational gearing front year-on-year in the first half, it looks to me like volume is up about 2.5% and you’ve reported operating income uplift of 76%, that’s gearing of over 40% on my numbers. Can you just talk a little bit about that given that the previous comments that were made around the flow-through from better volumes.

The second question was with a first full half under your belt, can you talk a little bit about market share developments in the Deco business obviously, in specific relation to some of your U.S. peers?

And then just a final piece, on the performance coatings restructuring and A-closed, A-plus at the end of last year, the improvement in margin we’ve seen in the second quarter. Does that reflect the majority of those closures or is there more cost to come out as the full effect of those closures is felt in coming quarters? Thanks very much.

Ton Büchner

Thank you, Paul also for the sympathy expression. Let me start with the last question, the performance coatings closures were announced many of them in the fourth quarter last year and the first quarter this year. They do take a good 12 to 18 months to close if you want to do it properly.

And therefore, these closures are not a reason for the improvements in the results that you’ve seen. They’ve been more general operational improvements, cost control, efficiency improvements in the various aspects of the business. But the actual closures that we’ve announced are closures that are ongoing as we speak.

One or two have been completed but certainly not the eight that we have announced or almost tend that we’ve announced if we add the ones in the first quarter.

Paul Walsh – Morgan Stanley

Okay.

Ton Büchner

If we look at the market share developments, we have not seen in the areas where we are active, whether it is China, whether it is Southeast Asia, whether it is South America, significant market share changes.

Also in Europe, we believe that we at least have maintained our market shares. It is very different over different countries. But in the aggregate, we believe that there will be no significant changes in market share among the various peers, not only the U.S. peers.

Most of the developments may have taken place in the U.S. which of course on the Deco side as a market we’re not participating in anymore.

Then on the operational gearing, we’ve in the past mentioned to you that the operational gearing is a mixture of areas where gearing is not very high because we constantly have to add either sales and marketing cost or even additional factories to accommodate growth. Whereas in other areas such as Europe, when we grow on the basis of an existing factory base, again, would actually be higher.

Therefore during quarters, gearings will change with the relative growth levels that we see in various regions. We’ve seen some decent growth in several European countries, which may have upped the gearings for this quarter.

I do remain with the actual statement that we made also during the Capital Market day that our gearing is certainly not hovering around the 40% plus on average. When we look at it, it is quite a bit lower. At that point in time, we gave you numbers between 25% and 30% I recall. That will be the average. But again, if Europe starts growing, it will tilt that average to the higher point of that bracket.

Paul Walsh – Morgan Stanley

Okay, understood. Thanks very much indeed.

Operator

Thank you. And the next question comes from Jeremy Redenius. Please sir, go ahead. Your line is open.

Jeremy Redenius – Sanford Bernstein

Hi, it’s Jeremy Redenius from Sanford Bernstein. Good morning everybody. Three questions. First of all, could you talk about the price developments in Specialty Chemicals that are more from seen plus one year-over-year in Q1 to minus 1 in Q2? When I had looked at caustic order price, I had seen that the vast majority of the price decline has already happened by the start of Q1, somewhat a bit surprised to see a more negative development into Q2. If something, if that’s – it’s just continued trends in caustic soda or if there is something else happening in specialty chemicals as well?

And secondly, thanks for the guidance on the restructuring charges for the second half. Could you perhaps give us some guidance, should we expect the cash outflow for restructuring charges to match the timing of the cash, of the restructuring expenses in the P&L, just want to check the expenses in the cash have same timing?

And then thirdly, perhaps if you could just talk about your few key priorities for the operational improvements of the business let’s say over the next 6 to 12 months? That would be helpful too. Thank you very much.

Ton Büchner

Okay. Price developments Specialty Chemicals were of course working with contracts with customers. They don’t exactly follow the spot prices that you see on the caustic commodities that you would look up. And therefore, they’re apparently in – as you stated clearly, is there I think some delay in that price reduction coming through into our businesses as such.

If I look throughout Specialty Chemicals, the price mix impact is absolutely the caustic impact that we’ve seen. And I don’t see any near similar impacts in any of the other businesses. In several businesses actually the price impact has been positive.

Guidance for H2, on average I would say yes, you can assume that the cash outage is approximately equal to the income statement charges with some of the factory closures, there is a certain delay. But for the accuracy that we’re referring to I think, the assumption of the timing approximately equal is correct.

And the key priorities again key priorities, is delivering the 2015 targets that we’ve communicated to you. An enormous amount of actions are going on both in factory consolidation, change of operating model in Deco, continued operational improvement both on the headquarter on the functional side, whether it’s HR, IT or finance but also continue to drive on the sales and marketing front, where we’re changing several focuses to drive for more organic growth. Those would be the key priorities.

Maybe, a thought from my side because we have quite a number of people on the phone, it’s probably helpful to restrict the number of questions to two to give many people a chance to ask and I hope you’re okay with that.

Jeremy Redenius – Sanford Bernstein

Thank you very much.

Operator

Thank you. And the next question comes from Mr. Neil Tyler. Please sir, go ahead. Your line is open.

Neil Tyler – JPMorgan

Good morning. I’d like to come back to the topic of pricing in the Deco business please. Can you give us a brief overview of regional price trends, whether the mix of growth in regions was impacting that?

It seems like the 93% equates to that €35 million which seems like a large number in the context of the revenue that was disposed with the German stores. So I wonder if you could perhaps be a little bit more specific on how that – how those two numbers match up and whether there is any greater price competition emerging in, particularly in the continental European markets? Thank you.

Ton Büchner

Okay. On the Deco side, the vast, vast majority of that €35 million is the sale of the drum stores. There is a small effect that is primarily driven by slightly lower margin countries in Europe growing faster than some of the higher margin countries. We always have that effect of different countries growing at different rates.

And therefore impacting our mix that has not been part of price pressure that we’ve sensed in the market, it’s entirely being driven by the mix impact of different countries growing at different rates that have different margins. But really the true vast, vast majority of that €35 million is the German store impact which we don’t expect to change in the coming quarters.

Neil Tyler – JPMorgan

Okay, thank you. Just to sort of expand on that slightly the price development in outside of Europe, any other regions?

Ton Büchner

We’ve seen again in those countries and regions, where we’re importing raw materials that significantly change in local pricing because of currency effects. There, of course there is price pressure up to compensate for that. And it’s not always possible to immediately compensate in full, which is driven by the competitive environment.

But if you look at normal markets, if I may call it that way, the price pressure has been benign so far. It’s not been a prime concern for this quarter.

Neil Tyler – JPMorgan

Thank you. That’s very clear.

Ton Büchner

Next question please.

Operator

Thank you. And the next question comes from Mr. (Inaudible). Please sir, go ahead. Your line is open.

Unidentified Analyst

Yes, good morning. Two questions please, Ton. First one is on surfactants call it consumer where you’re talking about weakness in Europe. I was wondering if you could give us some details around the end market, so personal care, this is Ag, this is oil and gas etcetera?

And then the second question is on Marine, where I think consensus was that the cycle was going to come back a little bit earlier this year. That’s like the recovery is delayed. I was wondering if you could talk about the competitive environment there and whether pricing could be under pressure based on, the fact that it looks like orders are throwing down et cetera. Thanks.

Ton Büchner

Good. Let me start with the last segment that you mentioned the Marine segment. The Marine segment has of course gone through a serious downturn. We actually showed graphs during the Capital Market Day that showed the order books of a variety of large players in the industry.

That order book has started to strengthen. And we’ve always said that it takes a while for us to see that strengthening because paint is actually ordered at the end of the construction of the ships. We have already seen growth in the system in the Marine business so far.

So, we’re actually quite early in seeing some of the order book improvements of the yards coming to us. Now, this is too early to call it a significant recovery. It will probably be a bit bouncy. But we’ve already seen some improvements which, means that the actual order book improvement starts to trickle through to people like ourselves.

The competitive environment hasn’t significantly changed. There is two European players and a Japanese players that are the large players in the market followed by a few others. But the marine business overall is one that for new builds largely takes place in Asia. And of course the other parts of the business, which are maintenance driven, are in all the yards or ships with more.

But overall, what we have seen is that initial order book improvements of the yards, has trickled through into our business. And it will be a bit bouncy but it is at least the first indication that things are getting better.

When it comes to surfactants, indeed we are very much focused on many of the industrial applications of surfactants. We’ve seen strong developments on the road construction side. And specifically in Europe, temporarily for this quarter we’ve not seen the strength that we’ve seen in history. It’s not something that concerns us at this moment in time.

But Europe has not been the strongest region for surfactants at this point in time. As I said, not a concern, there is not a lot of oil and gas activity on the surfactants side in Mainland Europe it would be primarily driven by the Middle East and North America. And personal care has actually been doing quite well.

Unidentified Analyst

If I can, thank you. If I can just squeeze in one question, where we did get guidance in the past earlier this year? Are you sticking to the guidance that free cash flow, it’s going to cover the dividend this year?

Ton Büchner

Well, my statement has always been that my aim is to be cash positive covering the dividends in 2015. I’ve always jokingly said that if we can make that happen earlier, I will not stop anybody. But I will not promise it to be the case. A very positive development I think that we’ve seen cash flow being positive for this quarter after dividend payments, which I think is a second quarter affect that we haven’t seen for quite a while.

So, you see us focusing on cash, cash is in the personal targets over the top 600 management team of AkzoNobel. You’ve seen the effects in 2013, and you see some improvements taking place in 2014 as well. It’s at the forefront of our mind but the promise remains 2015.

Unidentified Analyst

Okay, thank you.

Operator

Thank you. And the next question comes from Mr. Peter Clark. Please sir, go ahead. Your line is open.

Peter Clarke – Société Générale

Yes, good morning. Its two questions, I know you get a little annoyed when I ask about Valspar, only on about Valspar contract. But I’m going to try again. I think, are you confident that you can at least hold your share in the U.K. over the next 12-18 months given that Valspar, now claim to be in the 200 stores that will be at 350 at the end of the paint season looking into next year.

I know it’s a small business, I know it’s the tinting business but it does have an impact directly on your business in the U.K?

And then, on the second question is on the packaging, coatings, where you’re pointing at some recovery and you also see a lot of movement there with the BPA free coatings, etcetera. I’m just wondering how you see the marketplace, because the Americans have been talking a lot about our markets as well. Thank you.

Ton Büchner

All right, Peter. Thank you for the question. I’ve never been annoyed by Valspar question. I think it is a proper question that is perfectly fine to ask, also multiple times in a row. I do believe that Valspar and B&Q are executing on our contract that they’ve signed previously.

So, there is nothing new in what is taking place in the sense that it was always the intention to roll this out. We, at the moment that we have seen the start of this we have basically designed and implemented counter strategies. We have implemented increased tinting activities in and around the various stores. And we’ve actually seen a positive development of our own tinting business as well on the basis of the strategies that we’ve developed.

Overall, we take the situation serious. We watch it carefully. We believe B&Q is a very good customer of ours. We do believe that we are a good supplier to B&Q. The U.K is an incredibly important market to us where we are a clear leader. But the situations and developments like this are there to watch and to respond to. And that’s what we’ve done. And we’ll continue to respond to this.

You are asking are we confident of holding our share? So far we are clearly confident in holding our shares. But we’ll continue to watch this development very, very carefully.

On the Packaging Coating side, yes, there is of course a significant discussion around the BPA non-intent, the additional A removal of the Packaging Coatings which would be a technology transfer. It will be a different product that would need to be sold.

Now, all of us I guess that have a relevant technology in that area and AkzoNobel is clearly a player that has a good BPA non-intent development in the pipeline. All of us have done trial runs all of us have been on the production runs. So, this industry is indeed testing various ways to look at the applications of BPA non-intent as we speak.

And yes, it’s still a slow adaptation at this point in time. But it could accelerate going forward. And again, AkzoNobel is a clear player in this industry that has this technology at its fingertips. Thank you, Peter. Next question.

Peter Clarke – Société Générale

Thank you.

Operator

Thank you. And the next question comes from Mr. Jean-Francois Meymandi. Please sir, go ahead. Your line is open.

Jean-Francois Meymandi – UBS

Hi, good morning. Thanks for taking my two questions. The first one is, sorry again on this question on the pension review. How do you anticipate your upcoming pension review, do you plan on taking additional measures on the pension side in the U.K. before your review?

And the second one is, you were speaking about those four markets where you buy in U.S. dollars, just for pure modeling reasons. Can you give approximate percentage of Safe and Deco that are coming from those four countries so we can look at the future impact if any on the dollar side?

Ton Büchner

Thank you, Jean-Francois. Regarding the pension review, I guess what we’re constantly doing is reviewing possibilities to see whether we can either de-risk the pension fund or whether we can remove the risks of our balance sheet. You’ve seen us do multiple things and the biggest thing that you’ve seen happening is the supportive transaction that the trustees did in a buy-in situation at the beginning of this year.

That was a very significant buy-in that had a little bit of impact on the actual cash outflows for AkzoNobel and has reduced the risk for the ICI pension funds specifically. We’ve given quite some detail in the recent Annual Report on the pension funds.

We will continue to assess these things almost continuously as we speak. And if we find another way to do a proper correct and price worthy longevity hedge or some other measure that is actually positive for the risks on our balance sheet, we will have the time to do so.

At the same time, of course, we will have ongoing discussions with the trustees of the various funds to determine the top-ups for the future. And some of these discussions for next year’s agreement are actually starting during the course of this year. We’ve seen of course the pension deficit as you’ve seen on the IAS side, fluctuating and changing. And whatever the agreement will be, will determine our top-ups going forward.

And our appendix is many the presentations you’ve seen are best estimate on what the CapEx will be all the way to 2017.

Now I’ve just mentioned four markets that is your second question, because they are significant size markets where we’re importing things like Titanium Dioxide in dollars. In the actual bridge on slide number 10, we show you the negative raw material effect for the quarter that is the balance between positive raw materials with the currencies don’t have an impact and the negative ones in the countries where you do.

But the negative impact exceeds the four countries by a big number. I mean, there is probably 10 to 20 countries where the imported raw materials have an effect. And again, if currency exchange rates fluctuate in the 10%, 12%, 15%, 18% ranges that has a very significant impact on the actual cost in local currencies.

We are compensating it with pricing, but we are not able to give you the detail on exactly how much volume and which raw materials with which particular changes would actually take place. So I appreciate your question but it will be a level of detail that would be enormous. And I think the bridge that we’ve shown you is the best indication of what’s happened.

Jean-Francois Meymandi – UBS

Can we expect you to recover that over two quarters, is that the rolling two quarter thinking to pass through this?

Ton Büchner

It will take several quarters to pass it through, yes.

Jean-Francois Meymandi – UBS

Okay. Thank you very much.

Operator

Thank you. And the next question comes from Mr. Mutlu Gundogan. Please sir, go ahead. Your line is open.

Mutlu Gundogan – ABN AMRO

Yes, good morning Tom. Two questions, first, on the exiting of the low margin contracts in Eastern Europe. Can you tell us what the impact of that was on the volume growth in Deco in the second quarter? So, what was the volume growth excluding this – the exiting of the business?

And then secondly on Deco as well, in Asia, revenues here declined 5% year-on-year while this was still up 2% in Q1. Now, if I look at currencies or M&A, I think that those are broadly unchanged from the first quarter. So, could you explain why there is swing from volume growth and price mix first quarter? Thank you.

Ton Büchner

Okay. It’s been our philosophy and we change the strategy from a path focus, where volume was extraordinarily important to a focus on true quality business and improvement of our returns. And therefore in every quarter, we will walk away from orders that we may have taken in past times, under past strategy and the past management.

Now, in Q1 and Q2, we have also walked away from orders as such. And I actually really don’t want to specify each individual order in which we do so. What you do see is that our volumes are still growing, also in areas like Europe despite the fact that we walk away from these contracts. Growth would have been higher but specifying each individual contract would be unwise and I think inappropriate to do so.

We’ve seen a very significant contract that I referred to in Eastern Europe which was quite a sizable volume, but then again that will be out of the system. And so far it’s been compensated by growth in other parts of Europe, which have resulted in a positive European volume growth that we’ve seen.

And we certainly expect that to continue on the effect of these measures that we’ve taken are fading out. So, I hope and, I hope you understand that we’re not going to be specific on individual contracts.

When it comes to Asia, I guess you look at India, Indonesia, Vietnam, Thailand and even China and the surrounding countries, the largest effect on revenue has truly been the continued variation of exchange rate also in the second quarter. And it is bigger in some countries than in others big effects have taken place also in the three previous quarters before that. But it has continued for us in this quarter.

Mutlu Gundogan – ABN AMRO

Okay.

Ton Büchner

Next question.

Operator

Thank you. And the next question comes from Mr. Michael Rae. Please sir, go ahead. Your line is open.

Michael Rae – Goldman Sachs

Yes, hi there, thanks for taking my two questions. Firstly, can you provide just a bit more color on how Deco has performed in China through the quarter I noticed that you didn’t include the usual comment about double-digit revenue growth there and also a comment on how you see the rest of 2014 playing out in that division in China.

And then secondly, it sounds like there is mix of pricing trends within Specialty. Is it possible to quantify the EBIT impact of the lower cost actually the pricing in the quarter? Thanks.

Ton Büchner

All right, it’s a cute question to ask for color around the Deco business. Thank you very much. In China, the China business for all three business areas I must say has continued to be healthy. I mean, everyone is talking about China, reading about China. And we’re doing no different. We’re asking our management teams exactly what’s going on.

We have expected lower growth rates which in my eyes would actually have been my healthy. And we’ve seen it on the country overall. If I look at the first half of the year, the concern around the end of the year and the beginning of this year was high because we saw PMIs going below 50. We saw developments that were quite negative. Consumers though have stayed very bullish in China.

Subsequently in the last couple of months we’ve seen the PMIs coming up again in China. So, the concern is that we’re very much driven by the negative developments in industry seem to have reduced a little and the concern around the property market to continue.

Now indeed we have constantly set double-digit growth rates in China. When we look at the businesses, it’s still very, very healthy. And it depends on somebody you’re talking liters or otherwise. But we’ve had very healthy growth rate in Deco in China continuing. And we’ve also had good growth rates all both Specialty Chemicals and Performance Coatings in China.

So, whereas we have not specified the detailed growth rates as such, they are still very healthy and very good. And there are no concerns yet although we’re very, very much watching everything that goes on in China specifically the property environment that is of course being written about even more than any other piece of the industry.

Pricing times in Chemicals, one of your colleagues earlier has looked at the cost exchanges over the last two or three quarters. You can almost calculate of course what the actual difference has been in absolute Euros, specifying how much of that stuff we’re producing every year. But the impact is quite significant and what we then automatically do is to immediately enact counter acting measures to make sure that we can compensate as much as possible of that margin loss because of reduced prices.

Volumes are actually quite good in the Specialty Chemicals business, almost throughout. You’ve seen a 4% and also industrial chemicals were the costs that were being sold have seen increased volumes for this particular quarter. But overall to specifically elaborate the caustic impact itself, we’ll do very clear indication of some of the measures that we have taken to compensate, do it, towards the back end of this year.

Michael Rae – Goldman Sachs

Okay, thanks very much.

Ton Büchner

I see signs that we have two more questions to go.

Operator

Thank you. And the next question comes from Mr. Jaideep Pandya. Please go ahead. Your line is open.

Jaideep Pandya – Berenberg

Yes, thank you. First question is actually on Asia, on Deco where in your quarterly report you say that there was adverse price mix effect. I’m a bit confused here because it should be that you should be increasing prices to compensate for FX at least. So if you can give us a little bit more color where are you seeing price mix negative that would be very helpful, that’s the first question.

And the second question is just on your portfolio pruning approach in general, I mean, we have now seen a surface chemistry sort of weak-ish or let’s say sidelining growth for the last couple of years at least just from a qualitative comments that you provide in quarterly reports.

So, just want to understand when you’re pruning businesses, what is your approach, because you have exited businesses where you have strong market positions with the last couple of deals. So I just want to understand that, please. Thanks.

Ton Büchner

All right. And price mix effects, I mean, Asia, specifically we’ve seen a mix effect. And again it’s very similar to Europe. Asia of course is a group of high variety of countries with very different growth rates and with different individual margins.

So, in individual quarters, you’ll see some countries growing faster than others and if the countries that have a slightly lower margin will actually grow faster in a certain quarter than others. You will see that coming through in a mix effect. That’s normally something that we don’t generally concern so much around as long as the fundamental strategic positions in these countries stay the same. The pricing strengths stay the same and the markets share developments continue to be strong.

And this is what you’ve seen in Asia as well, different countries with different margins growing at different rates. And in this particular quarter, the lower margin countries have grown a bit faster than the ones that have slightly higher margins in this system.

When it comes to portfolio pruning, we’ve taken the approach that we want to focus on leading market positions in businesses that fit us. We perceived that in the paper business that we’ve recently announced the intended sale for that we did not have the market position over strength as we were happy with.

And therefore it was the strategic position and the consolidation presently ongoing in that industry, anyway even changing those strategic positions that elaborated us to test different options for that business.

When I refer back to the Buildings and Adhesives, we were talking about a business that we truly tried to do synergies with our Decorative Paints business on. We found out that it’s truly different businesses. And as a result it did not fit in the strategy of selling Decorative Paints because the synergies were truly limited.

So, in the situations that we are considering divestitures of it, either weak strategic positions and it always starts with strategy or this positions that maybe strong but truly don’t fit the portfolio as such. Those have been the primary since that we think in the sales for. And that includes even the Decorative Paints North America decision.

Again, it started with strategy not necessarily with the underlying specifics after that. And that’s anyway the approach that we will continue to take going forward for any portfolio pruning, it will be strategy based followed by other criteria.

Jaideep Pandya – Berenberg

Thank you.

Ton Büchner

Last question.

Operator

Thank you. And the last question comes from (inaudible). Please go ahead, your line is open.

Unidentified Analyst

Good morning, Ton. Thanks for taking my two questions. I’ll keep them short. The first one is on the operating income, which you used to split that out by benefits from the performance improvement program and cost inflation. You don’t do that anymore. Is it right to think that it’s both in the others line and there will be exactly cancel each other out? So that’s my first question.

And the second one is on FX. Could you give us guidance for the third quarter based on current spot rates please? Thank you.

Ton Büchner

All right. On the OPI bridge, it is true we always had that during the performance improvement program where we specified the cost and we specified the benefit from the gains, we would give happier updates and we’ve done so. In this particular bridge slide which is on slide number 10, it is indeed correct that the cost inflation and one-offs is compensated by the improvement parts that we have achieved.

They are both in the order of magnitude of about €100 million plus a bit. So, we’re talking €100 million here, both in terms of wage inflation and one-off costs that are compensated by improving measures in the system.

Unidentified Analyst

Thank you, and on the currency side?

Ton Büchner

On the FX guidance, basically it seems that most of the large fluctuations have taken place in the last four quarters. And they’ve been affecting us negatively in the last four quarters.

I’m not a currency trader, I’m not a currency expert I always know that if you make a prediction, it probably will be wrong. But it does feel that the last four quarters have shown an extraordinary effect. And we would hope that it would reduce towards the backend of the year.

Unidentified Analyst

Thank you.

Ton Büchner

Thank you very much. Thanks everybody for dialing in. And we wish you a good remaining part of the day. Bye-bye.

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