YIT OYJ ADR. (OTCPK:YITYY) CEO Kari Kauniskangas on Q2 2016 Results - Earnings Call Transcript

| About: YIT OYJ (YITYY)

YIT OYJ ADR. (OTCPK:YITYY) Q2 2016 Earnings Conference Call July 28, 2016 3:00 AM ET

Executives

Sanna Kaje – Head of Investor Relations

Kari Kauniskangas – Chief Executive Officer

Timo Lehtinen – Chief Financial Officer

Tero Kiviniemi – Head of Business Premises and Infrastructure

Analysts

Mika Karppinen – Evli

Ari Jarvinen – Danske Bank

Anssi Kiviniemi – SEB

Johannes Grasberger – Nordea Markets

Sanna Kaje

Good morning everyone and welcome to YIT's Q2 Results Presentation. My name is Sanna Kaje and I'm the Head of Investor Relations. I have here with me today our President and CEO, Kari Kauniskangas.

Kari Kauniskangas

Good Morning.

Sanna Kaje

CFO, Timo Lehtinen.

Timo Lehtinen

Good morning.

Sanna Kaje

And Deputy to the CEO and Head of Business Premises and Infrastructure, Tero Kiviniemi.

Tero Kiviniemi

Good morning.

Sanna Kaje

As usual, Kari will first go through the Q2 highlights; Timo will then dig a bit deeper into the financials, and Kari will then conclude with a couple of comments on the outlook. After the presentations, we will have time for some questions, both from the audience and from the telephone lines. Kari, please.

Kari Kauniskangas

Okay. Today's agenda again is traditional. Let's start from the highlights of the Group. In Q2, our results sought an expected turn for the profitable growth when our adjusted operating profit based on segment reporting increased by 9% year-on-year and even more from the previous quarter, also revenue grew strongly. We expect this positive turn now to continue and the outlook are good, especially in Business Premises and Infra, and Housing Finland and CEE segments.

After Q2, our backlog order is extremely strong when we were able to close the Mall of Tripla investor deals. Both in Housing Finland and CEE, and Business Premises and Infrastructure, their profitability development continued on a very good level. In CEE, we had high residential starts-up and one of the most important was the first start-up in new country Poland. In Russia, we had a good sales leading to positive cash flow according our targets, but again the profitability was weak.

Also this picture is important. During Q2 we introduced with the market Smartti housing concepts which has enjoyed extremely good demand. The plan is to start construction and sales of first Smartti projects during Q3. I am also proud that we are educating new employees for YIT. At the moment we have more than 650 active summer trainees in our sites and offices.

The revenue grew clearly even 15% at comparable exchange rates. The profitability starts to improve driven by Business Premises and Infra, and Housing Finland and CEE. The backlog of orders in Finland and CEE area is on a record high level when we exclude the Russian operations. It's always a pleasure to present a positive change in the figures as today in EBIT.

Compared to previous quarter year-on-year, we have clearly positive development in Business Premises and Infra. Also in Housing Finland and CEE, the targeted turn to watch consumer sales is proceeding promisingly. The drop came purely from housing, for us where the profitability was weak. In other items we had temporarily higher costs and that will normalize during the coming quarters.

Turning Housing Finland and CEE, the consumer confidence has been improving during the spring which has been also visible in our sales offices as increasing housing demand. Also the last tick in Finnish consumer confidence, it has a little bit negative, it's clearly up over the long-term average level.

The price levels in Helsinki region and also in other parts of Finland, is according to statistics, increasing. That's also indicating the changes in the supply portfolio where more smaller apartments are available. And the mortgage demand is on a very good level during the – or compared to several previous years.

In CEE area, all the curves are going to a positive direction, the situation being a bit stronger still in real CEE countries like Czech Republic, Slovakia and Poland. The revenue even it decreased slightly, the performance of this segment was quite solid. The reason for the negative development in revenue was less revenue from capital release actions is like bundle sales deal or plot sales deals.

The profitability improvement has happened as we have expected. The main reasons being lower amount of those bundled sales deals and plot sales deals, and also growing share and amount of consumer sales. Return on investment of this business is also developing positively to the right direction.

In consumer sales there was a clear growth compared to previous quarter and it was around on the same level than a year ago. It's on a good level. We have increased clearly start-ups in H1 and it's on a higher level than the sales which is indicating our trust to the positive development in housing market and out trust towards the consumer demand improvement.

As said the Smartti concept, the launch was successful in all 10 projects that we are going to launch during this year. The demand has been excellent in pre-marketing phase. In July the sales has been around on the same level than a year ago.

In CEE area, we had even a lack of salable apartments in certain cities and that challenge is now helped by several new start-ups in those cities. These higher start-ups will be seen also as strong on sales in coming quarters. In July the sales has been a little bit or will be a little bit better than year ago.

Overall, in this segment the production volumes are growing. Extremely important history is that we were able to reduce our number of unsold completed apartments in Finland to a level of 237 and at the same time we closed this part of capital release program when we set ourselves a target to reduce €50 million, tied capital for completed apartments in Finland. Almost half of the ongoing production is already in CEE countries.

Then the situation in Russia. Oil price has stayed stable for several months. Ruble exchange rates has strengthened and housing sales price level have stayed stable. Indicators in graphics indicates also the change in supply portfolio where more, smaller and affordable apartments are available, and those apartments stay at price per square meter can be a little bit higher than in the previous supply portfolios. Also we feel that the worst drop in the market is behind, but we can't see the improvement in the near future either.

Good sales, improving sales, was seen as an improving revenue in ruble terms and the growth was 6%, at the same time in euro terms the decrease was 16%. The order backlog decreased due to lower number of start-ups at the same time strengthening ruble increased it a little bit.

Our probability was still weak being on a negative side. At the same time, our main target in Russia is to reduce invested capital, and in that area, we proceeded very well cash flow being well positive. We almost reached the internal target for sales, but we still had to digest the margins in certain projects.

At the moment, as I said, we expect that the drop in market is behind and we don't expect similar changes in project margins anymore. Therefore, we believe that the target to have a positive EBIT and operating profit in this business in second half of this year is still quite realistic.

As I said, sales increased compared to previous year similar quarter previous year. Mortgage availability is good, and the sales in July was around on the same level than a year ago or a bit higher. For sure, we have still two days left, so – or three days actually in Russia left, so the exact figures will be seen later. The start-ups were low, but I think it's better to look average figures than figure of certain quarter.

The number of unsold completed apartments is quite low. As you can notice, the production volumes according to this graphic is not reducing. We will have – we didn't have practically any completions during Q2 which can be seen also in our IFRS result, which was quite weak in Q2. At the same time we are expecting several thousands of completions during the second half of the year.

Then, Business Premises and Infra where the performance was extremely strong. During the quarter there were several larger projects in the tendering phase. The investor demand has stayed stable, especially in office market, there is an intense competition for tenants, but again good locations are selling quite well. Overall, the construction volumes in markets are growing.

The revenue grew was huge, almost 60%, it was supported closing this Mall of Tripla investor and financing deals. The extra revenue from that was around €30 million which was recognized as an revenue, and then part of profit also. Those works were done before in Q2, and of course the works during Q2 proceeded well and that give some extra also. Backlog of order is of course now all time high level.

The profitability in Q2 was on a good level and operating profit of course was great. We saw also clear improvement in return on investment being above the strategic target level 2015. Also in a long run in this business the return on investment will be even higher. It's also good to remember that this extra boost in revenue around €30 million given by this Tripla revenue recognized on the start give also some boost to the operating profit of Q2.

We are expecting that in this business the profitability in second half will be around on the same level than on average in H1 this year. So the closing of Tripla Mall was successful and we succeeded as we estimated already three months ago. We got the building permit. We got all the decisions from public authorities. We signed the financing contracts. The works are proceeding well on site and also the renting activities are proceeding well.

We established a new company, Regenero to increase our project development volumes in bigger projects together with good partner of us during the last 10 years. That company will focus to bigger projects worth more than €100 million mainly in Helsinki region.

We continue all development actions that we have had in-house so far also. We have been successful in several tenders like, Helsinki Central Library, police station in Lahti, also the big projects in our backlog of orders are proceeding quite well.

Timo will not continue with the financial figures.

Timo Lehtinen

Thank you, Kari. So, good morning, all. As Kari mentioned, I will now continue with financial position and our key ratios. I think that we have a satisfactory quarter. We had positive cash flow, also mainly all of those key financial ratios improved. We also had a positive translation difference from our Russian operation. And also one highlight was the Tripla financing package and the deal closing.

Positive cash flow of €26 million covered the biggest start what we had in Q1. As Kari mentioned, Russian cash flow was positive. Cash flow of plot investment on a low side, but at the same time those equity investments to those joint ventures mainly Tripla, €40 million in total.

We have had relatively stable invested capital being on level of €1.1 billion. There was a slight improvement in return on investments. I think that it is worth mentioning the good development what we had in Housing, Finland and CEE, and especially there in Business Premises and Infrastructure. However, we are still clearly below of the group target of 15%.

Concerning then the debt development, so gross debt down, net debt quite precisely on a level of what we had in end of March. We have now repaid that bond matured in June with the bond issued in March and we have also increased the activity in commercial paper market as planned. Balanced financing sources average interest rate of 3.8% hedge rates relatively high, share of fixed rate on a level of 86%.

And of course concerning Tripla, the strong financing package was a crucial part of the financial and deal close. Then those key ratio, so gearing was on a level of 105%, equity ratio developed positively, we had a bit stronger ruble and also we normalized our cash position, however there is still some room left.

Net debt EBITDA development was mixed, low number of project completion especially apparent the IFRS result and also weak under the IFRS ratio, respectively. Anyhow, we are on a unsatisfactory level and we have to improve that ratio.

I already mentioned that ruble appreciation and the outcome was a positive translation difference of €19 million. YIT's Russian exposure is stable on euro terms on a level of €340 million in total.

In capital release program, we are now on a level of almost 90% and we made a good progress here in Finland concerning those completed unsold apartment, meaning that we now have achieved the reduction target of €50 million. So, that is also a good progress.

Kari will now then continue with outlook and guidance, so please.

Kari Kauniskangas

First Finland, so the outlook in Finland is around the same than three months ago. As I said in Business Premises and Infra area that the market activity overall is growing and the higher construction activity in market is seen also in lack of resources, maybe that's the only addition that we have done in this area. And as you can see the outlook is slightly positive, the arrow is total positive direction.

In Russia, our outlook is at the worst, seems to be behind of us. We have not changed the text or the comments, but we have changed the direction of this arrow being or expecting the current situation to continue, but not coming worst. In CEE we expect a good situation to continue.

To now end the guidance. As a result of strong Q1 performance, including, closing of Tripla, success in tenders, improving housing demand and extremely strong backlog of orders. I think we have good reasons to specify our originally quite wide revenue estimate. So the new guidance is that the Group revenue growth is estimated to be in the range of 5% to 10% at comparable exchange rates and adjusted operating profit is estimated to grow from the level of 2015. And some smaller comments, which I almost mentioned already during my presentation.

Then at the end, I have a pleasure to invite you all at our Capital Markets Day, which we'll hold at the end of September in Bratislava, where we have several great projects ongoing and one of the most rapidly growing and most profitable unit at YIT, YIT Slovakia hosting the event.

But now, if there are any questions, we are willing to answer, and if you start from the Capital [ph] room, so please.

Question-and-Answer Session

Q – Unidentified Analyst

Couple of questions, looking a little bit more longer-term. How about the housing market sharing – Housing Finland market share, how it has developed let say, during the last three years?

Kari Kauniskangas

For sure, it doesn't decrease. We have followed quite accurately the markets here, and we know that the markets have compared to bigger competitors. It has stayed stable or increased, but during the last two three years in Finland, there has been several new players coming on the markets taking the markets here.

Q – Unidentified Analyst

So, how you consider that in longer-term, what's the future outlook related to YIT housing in Finland?

Kari Kauniskangas

Overall, it looks like that there will be more supply. There will be more players and I think we have a strong competitive edges, good portfolio. We can keep our good position in Finland. What it will mean then in markets here, I can't predict.

Q – Unidentified Analyst

The second question related to CEE growth opportunities. Let say longer term, three to five year, how you would describe, what kind of growth is available in that area? For example, how long time it takes if we could double the market house sales in that area?

Kari Kauniskangas

The experience is that when we established a new unit, it will take around five years before it gives remarkable impact to group figures. Czech Republic, Slovakia are good example on those having good impact to our figures already this year, and especially in coming years. In Poland, we started this year or actually a year ago, so before Poland has remarkable impact, it will take still some years. But in capital markets today the plan is to open a little bit the strategy in CEE and tell the examples how we have been proceeding there, so welcome.

Q – Unidentified Analyst

Thank you.

Kari Kauniskangas

Any other questions?

Mika Karppinen

Mika Karppinen from Evli. In Finland, this housing market seems to be a bit warming up. So, how well have you managed -- guaranteed your results stays to your current and ongoing projects?

Kari Kauniskangas

As you can see from the figures, we have increased clearly number of start-ups for consumers. Reservation rates of new projects are higher that has been during the last few years. There are more visitors in our websites, in our sales offices, so the overall activity seems to be higher. During the weaker times, we've directed our resources more to investor projects, and as we said already, at the beginning of the year, or at the end of last year, strategy that we to increase amount of sales to consumers and now we are also directing our resources to that direction. In housing area, the resources that we have been enough, at least so far.

If no more questions here, then online.

Operator

[Operator Instructions] Our first question comes from the line of Ari Jarvinen from Danske Bank. Please go ahead with question. Your line is now open.

Ari Jarvinen

Yes. Hello. It's Ari from Danske. A few questions, starting like with Tripla project, so could you describe a little bit that, when you booked revenues and you had a positive impact on the EBITDA as well in Q2. What is the kind of profile going from here because the construction works are in the early phases? So, are there some differences of profitability which you expect to book like within the next 12 months compared to what you booked in the Q2? So that was my first question.

Kari Kauniskangas

First of all, the value of Mall of Tripla in our backlog of orders is around €500 million. Secondly, the profitability that we are recognizing there, it will be on the same level during the coming quarters than it was in the Q2 in gross margin level. But of course, if you compare the amount of gross margin in Q2, it was clearly higher than it will be in coming quarters. Therefore, the impact of total operating profit level in Q2 was a little bit higher than it will be in coming quarters. And I repeat the comment that in Business Premises and Infra, we expect that the profitability on average during the second half of the year will be on the same level than it was in H1 on average for the same segment.

And then, I may repeat also the way how we are recognizing the revenue and profit of the project, so via this ownership of the joint venture is 38.75%, so we are recognizing from this project 61.25% of the revenue and gross margin according to percentage of completion. And the rest will be recognized when we sell of our share of the joint venture.

Ari Jarvinen

Okay that's clear. Then about Russia, basically you said after the Q1 already that the corrections to the project margin profitability should be enough and we should see a better earnings or margins in Russia. So, why didn't they realize, what like weakened to the Q2 performance and why should it change now?

Kari Kauniskangas

The change is, the result of Russian operations was a bit weaker than we initially expected. But overall, outlook is as I said already, before. So, we are strongly believing that this kind of changes in project margins are behind and we are able to reach the positive EBIT level there during the second half of the year.

Ari Jarvinen

Not for the full year anymore?

Kari Kauniskangas

That is a change that has been done.

Ari Jarvinen

Then finally on the Polish market. It surely will offer huge growth opportunities because you are starting up your operations, really. But the overall comments recently from Polish construction have not been so positive, and there are several companies claiming that, well this is maybe delayed by the Infra mainly, but the overall development in Poland hasn't really been as good as expected. So, what's your view on the Polish market conditions?

Kari Kauniskangas

It's still clearly better than in several other countries in Europe.

Ari Jarvinen

Okay. So you are planning to continue your expansion there without any changes, given the recent events?

Kari Kauniskangas

Yes. I said it will take several years before we are in the full speed there. So, first of all during that time there will be good and bad times.

Ari Jarvinen

Okay, that's all from me. Thank you.

Operator

[Operator Instructions]. Our next question comes from the line of Anssi Kiviniemi from SEB. Please go ahead with your question. You line is now open.

Anssi Kiviniemi

Hi. This is Anssi from SEB. I already asked a couple of my questions, but perhaps I can then ask on the cash flow effect of Tripla There is a negative effect of €41.2 million on investments in joint ventures, but could you please specify the positive FX of doing the -- starting the project in Q2? Thanks.

Kari Kauniskangas

The impact was positive, few tens of millions of euros in Q2.

Anssi Kiviniemi

Sorry, could you repeat that?

Kari Kauniskangas

The cash flow impact was positive in Q2, about few tens of millions of euros.

Anssi Kiviniemi

Okay, great. Thanks.

Operator

Our next question comes from the line of Johannes Grasberger from Nordea Markets. Please go ahead with your question. You line is now open.

Johannes Grasberger

Hi gentlemen it's Johannes from Nordea. I have a few questions here as well. First of all on the Infrastructure, I suppose, I think someone touched it already regarding the second half guidance, and I'm just you know, really to make sure, are we talking about in the guidance that H2 is going to be in line with H1? Are we talking profitability or nominal profit/EBIT? That's my first questions.

Kari Kauniskangas

Profitability, operating.

Johannes Grasberger

Okay. Thank you. And it's in terms of, if I'm just thinking profitability, I suppose Q2 as such had kind of excess revenue both because you had sort of the start-up work at Tripla so far done, being fully booked into this one quarter. And those start-up works have been nice and paused, been underway more than the first half. So, in that sense the revenues coming in from Tripla, would those be in line with second half or maybe little bit lower? Or is that too precise of a question?

Kari Kauniskangas

First of all this €30 million revenue or works done before Q2, the work started summer 2015, so around nine months work included there. At the same time, the speed of construction is growing. So, I can't say exactly what will be the impact of Tripla in revenue in H2 compared to Q2.

Johannes Grasberger

That's fair enough. But either way, it's -- they are talking about the profitability and that's what we are supposed to expect to be in line with average of Q1 and Q2 for the second half?

Kari Kauniskangas

Yeah in gross margin level, the profitability will in that project be around the same level than it was in Q2.

Johannes Grasberger

Then my other questions would be, regarding first of all on Russia. I'm just thinking here that, can you just give some light on how the IFRS accounting balance sheet would develop in the second half. If I heard right, you have the big amount of completions in Russia, and would those kind of have a positive impact on the balance sheet or negative impact?

Kari Kauniskangas

Maybe Timo, take this question.

Timo Lehtinen

We are now estimating to complete quite many residential project in Russia in H2, meaning that from balance sheet point of view, we are getting out the work-in-progress of those completed project, and at the same time declining those advances from our customers. So, in that respect, the balance sheet total will decline.

In addition as I mentioned of course, we are then recognizing also the revenue and the respective profit, and the estimated, of course then to improve the IFRS performance and those races respectively.

Johannes Grasberger

Just could you say what kind of a gearing level ambition are you having for the full year, in order for us to have some kind of understanding how the net debt position develops in the second half? And are there some material and substantial cash flow effects to net debt coming up during this year that we should be aware about, and that would also have a material effect on the gearing?

Timo Lehtinen

You see us obviously continuing those thrust on completions. So the cash flow impact will be quite limited due to the fact that quite much our clients, they are using those mortgages and also they are paying 100% payment. So, from cash flow point of view, there are some completions, the impact is quite limited.

On the other hand, we will continue that capital release program especially concerning the slow moving assets. And then if you are thinking the growth, so consumer sales, consumer projects here in Finland in CEE, and of course now big issue is that we have closed the Tripla deal and we are proceeding with the construction and we are getting then the payments there in line with the progress. So, in that respect, good part of the business is proceeding, growing concern, principal.

Johannes Grasberger

Just continuing on Russia, I'm just thinking here that, assuming that you could sell the entire apartment inventory that you have in the market at today's market prices, can you give us any idea of the cash flow impact you will be talking about them. Because then you would, I suppose you would have quite a meaningful positive net reduction in that case.

Timo Lehtinen

I don't have the exact figure, but some indication you can have from order backlog so that is unrecognized revenue. There is also a figure concerning cost to complete. But still I think that the key issue is that we are continuing in Russia, we are continuing in those seven [ph] series meaning also start-up. So, in that respect the question is somehow theoretical.

Johannes Grasberger

Okay. Thank you. And just thinking again the net development in second half, so if I take it right, it seems to me that there will not be any material meaningful impact that would drive the net debt considerably down during the next two quarters? Did I get that right?

Timo Lehtinen

If you are thinking the net debt EBITDA development, I think that our strong target is now to increase EBITDA, and that is then the way how we are improving that rate, at the same time meaning that we will not see a major decline in net debt as such.

Johannes Grasberger

Okay. Then my last question will be on the finished market. Have you witnessed any sort of increased competition level, now that we have this apparently kind of a pick-up in activity, but I would -- myself, I would guess that everyone wants a part of the cake so to speak, so just thinking on the tendering offers and other competitors out there. I heard there were comments that the market share in the past few years has declined. So, two to three years is a long-period of time, but what has happened in the past six months.

Kari Kauniskangas

First of all there are more apartments available and the supply portfolio overall in market is high, is bigger now than it has been in the past. At the same time it is good remember that the average size of apartment is smaller, clearly smaller than it was three four, years ago. The change can be quite dramatic like 20% to 25% on average, per apartment. Meaning that even the number of apartments in which will be sold, this year is expected to grow according to [indiscernible] being even more than 30,000 PCs in square meters that number [indiscernible] is quite close to average level still. But it's growing, and of course when consumers, the confidence is growing, the intense to buy a new apartment during the coming year is growing. First of all there are companies starting new projects for that market.

Johannes Grasberger

But in kind of terms of the market prices and, okay, we have seen that prices have been coming up a little bit, but I'm just thinking that, if the finished construction market is coming up from really -- from a really low level, I would myself expect that there is quite fierce competition trying to grab the volumes that are available in the market, and I'm just thinking whether you have seen or witnessed any kind of behavior like this from the competition side?

Kari Kauniskangas

It's good to remember that in housing, it's always question on location. So, usually when the demand increases also that the plots which are far from the city center, from the public transportation hubs are more interesting from point of view of consumers. In those plots, in those projects which we have, which are in pre-marketing or which are ongoing, we don't feel that the price pressure due to competition. It's more like demand question than competition question.

Johannes Grasberger

Okay. Thank you. That's all from me.

Operator

[Operator Instructions]. We do appear to have no further questions from the telephone participants. I'll hand the conference back to you sir.

Kari Kauniskangas

Okay. If no more questions, I thank you all and for those who are now starting the vacation, I wish a warm summer. Thank you.

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