thyssenkrupp AG (OTCPK:TYEKF) Q4 2016 Results Earnings Conference Call November 24, 2016 8:00 AM ET
Claus Ehrenbeck - Head, IR
Heinrich Hiesinger - CEO
Guido Kerkhoff - CFO
Michael Shillaker - Credit Suisse
Ingo Schachel - Commerzbank
Alessandro Abate - Berenberg
Bastian Synagowitz - Deutsche Bank
Seth Rosenfeld - Jefferies
Sylvain Brunet - Exane BNP Paribas
Roger Bell - JP Morgan
Alain Gabriel - Morgan Stanley
Christian Obst - Baader Bank
Carsten Riek - UBS
Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today’s thyssenkrupp’s Earnings Call Fiscal Year 2015-2016. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions]
I would now like to hand the conference over to your first speaker today, Dr. Claus Ehrenbeck, Head of Investor Relations. Please go ahead, sir.
Thank you very much, operator. Yes, hello everybody. This is Claus Ehrenbeck from the Investor Relations department speaking. On behalf of the entire team, I would like to wish you a very warm welcome to our today’s conference call. Before I hand over to the speakers, just a few housekeeping remarks first. As always, you can find all the relevant documents for this call on the IR section of our website. And, when it later comes to Q&A, just to make sure that many people have a chance to ask the question, please do not ask more than three questions, so that more people can come in.
With that, I would like to hand over to the speakers Heinrich Hiesinger and Guido Kerkhoff. Please Heinrich the floor is yours.
Yes. Claus, thank you very much; also from my side, a warm welcome. Let me just set the scene.
In a very difficult environment for our material businesses, especially in the first half of the year, the methods, which we have initiated as part of our Strategic Way Forward, had a clear stabilizing effect. Thanks to group-wide joint efforts and almost €1 billion of ‘impact’ effect, we could generate a positive and further improved free cash flow, and hence came out even slightly ahead of our original target, despite very clear headwind from the material markets and the low order intake at Industrial Solutions.
We had to revise our full year earnings forecast after six months, as the recovery on the materials markets, especially in Europe came later than originally expected and started from a lower price level. However, thanks to our increasing focus on our higher margin and less volatile capital goods business, and our consistent execution of our ‘impact’ program, we could however limit the decline in EBIT and keep net income in positive territory and at the prior year level. We have improved through the year our earnings and cash flow in each and every quarter. And in the final quarter, we’re already above the prior levels again.
Furthermore, we have launched an aggressive and extensive transformation program at Industrial Solutions. We thank Jens Wegmann for his outstanding work. With the comprehensive transformation program he has initiated, Industrial Solutions will become quicker, more flexible and more efficient. Notwithstanding, Jens Michael realized that his conduct and his dealings with a sales partner was not in line with thyssenkrupp strategies. In standing down, he’s shown that he accepts his responsibilities. Stefan Gesing, CFO and acting CEO at IS and his entire team will make sure that this does not affect at all the implementation of the program, and will continue to systematically execute the agreed roadmap.
We have also initiated a comprehensive transformation program at Steel Europe. We do see clear cyclic silver lining but to be clear, you should not confuse cyclic improvement with structural weaknesses of an industry. The pressure from imports from raw materials, especially in coking coal, from excess capacities and from current and especially threatening cost decrease related to the European trading scheme, remains high. Despite the strong position versus most peers and great efforts and achievement from leadership team and our employees, Steel Europe has earned its cost of capital in the last fiscal year.
That is the reason why we have launched the ‘one steel’ program and the measures developed will be implemented step-by-step. We’ve also started to analyze further restructuring options to ensure sustainable value creation. The process to decide where the steps or restructuring will be necessary will take until early summer. Our preferred option clearly remains unchanged to do this in a meaningful consolidation step. For quite some time now, we have said that consolidation in the European steel industry is needed and that we are amongst others in talks with Tata Steel. However, if, when and between whom consolidation might ultimately happen is still early. [Ph] Until we have the clarity, we will continue to focus and execute on the steps we can realize standalone.
Most progress in the past fiscal year was actually achieved at Steel Americas. The team managed to increase output and shipments to strengthen its market position, to further significantly reduce losses and generate positive cash flow. Moreover, we received the operating license from the Brazilian authorities and established full 100% ownership in CSA. This has all significantly improved the performance and opportunity profile of CSA and gives us greater room to maneuver for its further development. Overall for our Group on this basis we therefore look to the new fiscal year with cautious optimism and expect some potential earnings increase as well as positive cash flow.
In this context, we believe it is balanced and appropriate while of course satisfying for the future to propose a dividend on last year levels. Despite the continuous aggressive focus on impact, on efficiency improvement and cost savings across all businesses, we do not cut back at the expense of future value upside potential. Indeed, we do quite the contrary. We have increased our R&D spending for the fifth year in a row, now 25% or €151 million versus the start of our Strategic Way Forward.
This impact is clearly visible. We have further increased the number of patents to 18,000, now up more than a third. We also have increased our IT expenses, now up 50% with a very clear target to increase IT security, to prepare the next level of productivity gains and drive our digital transformation to make sure that our Company, thyssenkrupp is able to claim a big chunk from the huge value opportunities which are linked to the Internet of Things or Industry 4.0.
The corresponding innovation and sustainability, present growth of our value pipeline become increasingly visible across all our key development areas. Just to give you a few examples. This includes for example technologies for the energy transition. Our RedOx flow batteries that are based on our years of experience and strong technology position include alkali electrolysis. They can provide a key to stabilize the electricity grid which becomes increasingly important as the share of renewable energies rises constantly.
And sustainable mobility, this includes for example our new electric powered steering systems with supplier nominations from all international OEMs, worth more than €7 billion over the product life cycle. This does also include intelligent service offerings, two examples here. The big data application MAX, a concept already in successful use to provide predictive maintenance for elevators by systematically analyzing operating data. Another example from our cross-sector innovation. We have launched together with most catalyst [ph] industry and research partner, the Carbon2Chem project. Their intent is to convert industrial emissions into valuable chemicals using renewable energies. It has positive results and gets recognition.
This year, we were ranked a world leader in climate protection by CDP and were are added to the global Climate A List. This does reflect or consistently higher level of performance and transparency in terms of climate protections. This does also include a significant improvement in energy efficiency, as well as a comprehensive data model covering our total carbon footprint from Scope 1 to Scope 3. So that means it includes our suppliers and also the use base of our broadly developed customers.
Let me come to the outlook. Going forward, we expect that further progress on our Strategic Way Forward will be reflected overall in our key performance indicators. Our efficiency program ‘impact’ will again be a key driver where we target once again €850 million. Furthermore, we assume that the economic effects of the future course of the USA, the potential weakening approach in China and the impact of the Brexit referendum will remain manageable. In addition, as is our principle, we intend to pass on price increases for raw materials just like recently seen in the coking coal sector to the market.
Overall, group EBIT adjusted will increase to around €1.7 billion. CT and ET will see slight top-line growth and further margin improvement, in line with the mid and long-term targets. As I add, clearly, the short-term focus is on turning around for the intake and cash flow before returning to growth after implementation of the transformation program, ‘planet’. In the current fiscal year, we expect slightly lower sales with plant engineering activity safeguarding margin at the bottom end of the target range of 6% to 7%. However, in Marine Systems, we will clearly see, on a temporary basis, lower margins.
Materials Services in Steel Europe should both significantly increase, improve adjusted EBIT in slightly more favorable market environment. At Steel Americas, we expect roughly flat EBIT adjusted in a very volatile pricing environment. We will clearly work against the negative cost effect from a stronger Brazilian real and should benefit from increasing shipments to the more stabilizing Brazilian market. Another positive element is the other long-term select supply contracts, securing a base-load linked to the solid U.S. steel market environment.
Overall for the Group, we expect significantly increased net income despite continuing restructuring charges to prepare the future progress. We also expect a slightly positive free cash flow, net earnings improvement to price and volume related higher net working capital deployment at our material business, assuming however, there will be no lasting dislocations on the raw material markets.
Guido, with that, I will hand over to you.
Thank you. Let me come to the order intake. Order intake declined in the past fiscal year. Materials businesses came under very high import and price pressure particularly in the first half of fiscal year. Market environment for chemical plants was still affected by customer caution, the mining equipment business continued to bottom out and the prior year included larger naval contracts, in 2015, 2016, we didn’t see a big takeover. Nevertheless, orders at CT and ET clearly had a stabilizing impact. And in Q4, we’ve seen nice increases of orders at Elevator and Americas. At Elevator, this reflects especially -- and Americans, ongoing growth in new installation in the U.S. and Asia Pacific, strong growth and demand from new installation in China as well as in Korea. In China, new installation in units excluding Marohn in Q4 were up -- were again up, year-on-year. Also services in China have been growing nicely from the lower base, but up 28% year-on-year. Asia Pacific, we also booked a major contract with the Doha Metro which included 174 escalators, 96 elevators and 18 moving walks.
In Europe, order intake was rather flat due to a strong prior year quarter. Finally, orders at Access Solutions were significantly up, benefiting from a major contract for Istanbul airport which was 143 passenger boarding bridges. Increased orders at Steel Americas reflect higher volumes, 7% up and especially higher prices, almost 50%. EBIT adjusted Q4 was up. Group EBIT adjusted is up year-on-year as well as quarter-on-quarter. There is a continued reliable year-over-year progress at components now for six quarters in a row as well as at elevators now for 16 quarters in a row. Comparing to this, the current run rate at IS is weaker, reflecting a weaker mix of built milestones as well as underutilization at some of our chemical plant operations. All materials businesses showed continuing sequential improvements benefiting from higher prices as well as in the case of Americas benefiting from higher prices and higher volumes.
Net debt is virtually unchanged. We saw slight increase despite positive cash flow because of ForEx related effect and dividend payments, but just smaller ones. Positive and improved free cash before M&A despite lower EBIT adjusted reflects price and volume related lower inventories especially at materials services; lower receivables including positive effects from effective management at elevators, material services and steel; higher payables as well as sale of non-operating real estate at corporate.
Free cash flow includes pension amortization149 million. Given the mature scheme of our pensions, the payments exceed costs as we amortize the liability. That means at constant discount rates, the liability should have gone down this year by 150 million. The increase of the pension liability therefore is purely driven by the change in the discount rate assumptions and is partly compensated by the amortization. Let me clearly highlight, there is no cash requirement for that. It is largely due to German pensions which are completely un-funded and there is no cash effect and higher payout or any funding that we have to do.
The lower discount rate assumptions also had a negative effect via OCI on the book value of our equity, corresponding to the increase of the cushions to a certain degree by the text shield. The gearing therefore has gone up essentially due to these discount rates. At constant discount rates, our gearing would have been at 100% and therefore slightly down year-over-year.
This brings me to the outlook for the first quarter of the new fiscal year. Quarter-on-quarter earnings should be mainly seasonally down at the Group as well as at almost all business areas. More importantly, however, year-over-year EBIT adjusted is expected to be significantly up to around €300 million for the Group. All business areas except IS and SE should be up year-over-year. At IS, the decline is billing related as well as explained by some capacity underutilization. And Steel Europe, a much better underlying performance is temporarily diluted by the reline of blast furnace B at our joint venture HKM as well as by spillover effect from the production issues we had at the bolt-on facility, slowing down the increase of realized prices, while we see first effects from higher raw material cost already reflected in Q1.
Free cash flow should develop similar to last year’s levels. Q1 is always the seasonally weakest cash flow quarter. In addition to that, we expect higher net working capital requirements due to rising volumes and raw material prices as well as effects from timing of milestone payments at IS. Overall, you therefore should expect free cash flow in Q1 to be well above 1 billion negative and correspondingly then significant cash flow improvement throughout the following quarters to bring us to our full year guidance of slightly positive.
Let me comment, 2015-2016 was a difficult year. The economic has been and continues to be highly volatile. Overall, it is important to have a clear plan and to execute it. And despite clear headwinds, we’ve made important progress in many areas on our strategic way forward.
thyssenkrupp has clearly become more robust, reflected by positive net income and cash flow in a highly adverse materials environment, and we have continued to feed our value pipeline by consequent execution of our impact program, by continued structural growth at components and elevators, by comprehensive transformation programs at Industrial Solutions and steel, by successfully turning around ASP and proactive adjustments and material services, by a much improved performance and opportunity profile at the Steel Americas, by consistently increasing investments into R&D, digitization and into our planned protection strategy, by consequently executing on our zero tolerance compliance policy and most important, by improving the performance ambition across the entire organization.
In 2016-2017, we will return to top and bottom-line growth. Nevertheless, we are far away from where we want to be. There is a lot of homework and improvements potentials left at every BA and thus clear value upside on our transformation journey.
With that, let me end with a clear remark that we will have on December 9th, our Capital Markets Day and would like to invite you to come here and have a very efficient opportunity for investors and analysts to learn firsthand from all BA leadership teams, how they will do, whatever it takes to execute the homework and how to realize the value upside from our Strategic Way Forward.
Thank you very much, Guido and Heinrich. Operator, please take over for the Q&A session.
Thank you very much. [Operator Instructions] Our first question comes from the line of Michael Shillaker from Credit Suisse. Please go ahead.
Yes. Good afternoon. Thanks very much for taking my questions. My first question on Industrial Solutions, obviously the order intake is now running in the sort of consistently the 6 to 700 million range; the sales number is still around double that. So, can you give us a bit of an outlook for earnings beyond the next couple of quarters? How long does it take? Given the backorders is still very strong, how long does it take for that order intake to basically see through to sales and therefore the P&L? Can you take costs out as fast as this is going to fall? And can you give us a little bit more guidance in terms of where you think earnings is going to go beyond this current or the next current fiscal year, given all you know about restructuring of the business relative to the order intake? And also, can you give us a feel, a little bit more of a feel for the end markets? You’ve got not just current order intake, but in terms of looking at sort of one, two years, are you getting any feeling that some of your end markets are turning the quarter in cement, mining and similar is my first question.
Second question, we seem to be in a situation where we’re kind of almost hitting a wall with the net debt at the moment. Is it Q4 net debt goes down, Q1 net debt goes up, cash flow within the Group, because relatively limited, so back in the similar situation. Looking at the mix of business, the most obvious way that you can generate free cash to getting that done would be for a material recovery in the steel or material cycle, which actually looks like it could be about to happen. Now, this is at time when you decided to get rid of steel or to de-merge it and I guess de-merge it means would be to de-merge the cash flows to go to 50% or sub where you don’t keep the cash flow. And if we look back to history, just selling iron ore in 2002, some of the opinions in the mining business thinking about selling assets six to eight months ago, now keeping those assets. At what stage do you say look we’re going to hang on a bit here, because maybe we got steel wrong, we’ve been through five very bad years like the end of 90s early 2000s and actually maybe it is worth hanging in there, because actually we could do with those cash flows? Thanks.
Michael, I’ll start with the Industrial Solutions question. So, we are quite optimistic that at least from an order intake side, we can really turn it around in the coming year, because really none of let’s say the promising project in our fund actually turned into the positive, in the running year that’s the reason that we are so low, but the maturity is constantly increasing. So, we are strong believer that you can see the trend in order intake and constantly also in the cash flow already in the running business here. Naturally and this is also our guidance, sales will be slightly lower. But we also clearly said despite that effect, we will stay as far as our Industrial Solutions is expected for marine systems on the lower bottom of our margins at around 6%.
So, this is different, clearly marine systems, where some of our very promising projects come to an end. The boats are delivered to our customers. And until we have new orders, we have to live, let’s say it’s primarily coming from a Turkey project, where we have clearly also publicly announced that we struggle from the very beginning. This was a project acquired in 2009. And you can imagine that the present situation in Turkey, the execution of that is not an easy one. So we believe for marine systems will stay positive but on a much, much lower level beyond let’s say the 6% to 7%. To give you a little bit some guidelines on some end markets. On the chemicals side, we believe that we will be able to hit fertilizer project in the coming years and also electrolysis is continuing to go on.
On the mining side, it will continue but we will not see large expansions. But as the output is constantly high, we have more and more, let’s say requests for quotation on replacing equipments like breakers and material handling side. Cement is quite solid. So, we are quite confident that also we had this large ticket order last year in Saudi Arabia, we will be able to have a similar order in the running year. So, cement probably will stay high. But also on the system engineering, our funnel is very full. But, I think where we start to harvest is really the outlook, the instance already given that we want to move away from our high, let’s say the sensibility to large turnkey projects and going to service. And to be honest, also this year, really 40% of the profit in IS was carried from service. And as we have now formed an old service unit, we believe that this business will grow and really also if sales might be slower over the last year’s project that we have a robust underlying business which really is touching let’s say the volume effect and is protecting our margin.
Yes. With that let me come to your question regarding steel. I mean, once again, what we’ve seen underlying in this industry is an overcapacity here in Europe and worldwide, and that was forming our belief that a consolidation move overall can help to overcome this issue. Now, steel market is always cyclical. So, you might have always couple of months that look better and a couple of months that look worse, as we have largely experienced last year where the first half was very bad. That doesn’t mean that overall the necessity of consolidation as we’ve lined out is clearly out there and we still see it, and that’s why we continue to go down that route. And improving situation, as you indicated, we hope and we want to see it, we clearly expect for Q1 increased pricing, that’s what we’ve clearly indicated. Nonetheless, raw materials are moving up quite significantly, especially on the coking coal side. So, we have to see where it ends, but still improvements are needed but the necessity for consolidation remains unchanged and can only give us upside.
And as a follow-up in terms of can only give upside, what does the consolidation process you are talking about? Is it a prerequisite that this requires deconsolidation of sales from the Group or would you consider consolidation where you actually increase your net exposure, even if you decrease your stake?
Mike, the most important thing for us is that by a consolidation and by the underlying plan, we can address the issues of the underlying capacity and overcapacity. The deal structure and what however that looks like follows the logic of a transaction. We have never stated anything about consolidation, non-consolidation or percentages, and we don’t do that today as well.
Okay, clear. All right. Thanks a lot.
Thank you very much. Your next question comes from the line Ingo Schachel from Commerzbank. Please go ahead.
Yes. Good afternoon. I’ve three questions. The first one is on the Industrial Solutions management change. You have made very clear that the planets program will continue to be executed under Stefan Gesing’s team but more generally on Industrial Solutions is of course spoken a lot in the last year about what should be the right portfolio for this business; does it need bigger acquisitions, bigger divestments, the new submarine business and then how other compliance risks to be assessed. Just generally speaking, if and when you hire a new CEO for this business, do you think, you would have to mandate to sort of look at all these decisions from scratch or what you say the step’s already been taken on the Group level, and there is no reason to sort of looking to them again also in light of the current execution of a bigger program?
And the second question is on the shared service units. Thanks for the additional transparency in the corporate line EBIT reporting. Could you just help us understand what the mid-term cost level of these service units is or how that’s allocated to the divisions i.e. whether this is just a structured cost center that should be losing 50 million or 60 million figure to perpetuity or is it transfer pricing done in a way that there is actually something that should have a breakeven results if service are delivered at the market based efficiency level?
And the last question is from elevator CapEx. I think your spending this year was 15 million below the original CapEx budget and also for next year your CapEx guidance for elevator is 15 million below the budget you had for last year. Could you explain as what drove this shortfall, is it that you are more negative or less inclined to spend CapEx on some of the growth markets because I think the big projects like Rottweil are still ongoing. So, I was surprised to see that elevator CapEx is below budget.
Yes, let me start with the IS. Naturally, let’s say, it was not planned that Jens leaves but it was absolute necessary after let’s say the way he handled let’s say compliance issues. Now, we said we will look for a successor in a very structured process. And just to make clear, in that progress, we will let’s say, give a high priority whoever is the successor will fully stand behind planets, because it does not make sense once again to invest one year in analyzing because these fact finding and deep dive was down very diligently. We were always kept in the loop and we believe and also the team believes that the program is addressing the right drivers. We have changed 80% of the leaderships in the next two levels and they together now with Stefan Gesing and also Mr. Höllermann, they will try forward.
So, we would not select the candidate for the CEO position who really claims I want to have a plant launch and I won’t reconsider again, because this will cost us half a year and we are in execution mode, and turn these businesses around.
Yes. And maybe adding on that one when finally everybody on the management team of IS they all agree that a solution about Jens has to be found, they clearly approached and said, but want to continue. They deeply believe in the way forward and they continue to work on it as strongly as a team. So, it’s not us pushing for that strategy, it’s really that the team wants to continue, and they saw it as a potential setback and are starting heavily to continue on that one. So, it’s not just top down.
Coming to the shared service side, yes, you saw overall, the corporate service at minus 66, which is true but only 20 million out of that is our shared services of HR, IT, finance and accounting, which came down by the way from minus 60 years ago. What we do there as cost allocation, so the transfer pricing we’re doing is we charge to our entities the minimum of be it the full cost that we do have including the tax upswings, they need to add 3% to 5% or the market price in that region that you get. And you can see at the minus 20 out of that, that we’re making a loss. That means in certain regions and that’s for especially for the old services we have in Germany where we have a very high cost base, which is not so easy to restructure. We got it already down. But the cost base is higher than usual cost to pay here. And why do we have that? We leave the cost -- where we have too high cost, we leave them where they are because they should really be reduced where they were incurred and not transferred to other entities. So, we want to get it further down. The rest, the 66 is corporate services and regional services we have in Germany, not the shared services. And there again, we have the target to drive them down over time and we’ll keep you updated on that one.
Let me come to the elevated CapEx, where I -- to be honest, do not really get your point, because we increased this year from last year’s 87, the CapEx to 135. We’ve not given out any budgeted number. So, I was a bit surprised by your comment. We’re spending more and we’re running all the projects. I mean, we had Shanghai where we have the new building, we have the new building which cited to build in India, we have the tower we built in Rottweil. By the way that ends on the books of corporate as we have it centrally. But no, we’re investing in everything max, so we’re increasing CapEx here.
Okay. So, the number came really from the comparison of the initially guided number and the percentage of last year versus the actual outcome, so that was the budgeted number I got?
Okay, got that. But that was my explanation. We’re really driving up.
Thank you very much. Your next question comes from the line of Alessandro Abate from Berenberg. Please go ahead.
Good afternoon, everybody. I just have couple of questions. I just wanted to know, what a situation we have going with the unions related to steel but actually if there is any ongoing? And also related to your cautiousness on structural, cyclical aspect of steel price just back in Europe, I mean, what actually is going to happen in your strategy, if you’re going to realize maybe in six months time from now the things structurally change, so for the better? Would you keep on considering material division, the Europe mostly as part of the Group or you might actually also think consider strong cash flow that is generated from that IPO? I assume that for example, there is no possibility to go into an M&A deal in the European space.
The second one is related to the situation in Brazil that you highlighted that is getting slightly better. I mean, I would like to get a little bit more granularity in terms of demand for slabs, high quality slabs, considering what actually is happening, apparently Brazil is bottoming out. And relative to the results that you generated in H2 2016, which has been quite remarkable, I was wondering how much is basically due to the price effect and how much is basically due to the efficiencies that you capture in your assets. Thank you very much.
Let me start with the dialog with unions. I think we have a very constructive dialog. What actually do and for quite a while that we have to explain to them the rationale which drives us to consider potential consolidation. Naturally, they do not like it very much, but we clearly outlined to them. Also if you go forward alone, efficiency measures and restructuring will be part of the game. So with that, clearly we faced the demonstration by end of August. But how constructive the situation here is, you can verify at the point that nevertheless the unions fully agreed with the totally reshaped organization, which we became effective 1st of October.
So, we are in consistent dialog. Clearly we have different roads. And therefore, the unions sometimes want to show the public that they have such a position, but internally it’s quite constructive thing. Also they made clear that they have different positions, the management team, meaning us and them, but it’s not limiting at all the improvement.
Now, look, the point -- and it was already a little bit the answer Guido has given Michael. I think the big mistake in steel industry always was this stop and go mechanism. Whenever the cycle was down, everybody was ready to solve the problem, and when we came better, everybody let’s say stepped back and we clearly said, we separate the cyclical format of the operative business, and the strategic relevance because the underlying problem is now changing.
How, it will look like, we have clearly said, we never have commented on that. But we only want to find the meaningful industrial logic which handles the constant issue of overcapacity in Europe, because without solving that, we are in a constantly restructuring mode. Our theme was straight achieving several hundred million cost savings in the last three years. But if this overcapacity remains, what we have seen in all the years, in five to six years, again it will be different types of the markets and the next restructuring route will be changed. And this will go on as long as we do not solve structurally in an industrial logic that topic.
And to highlight on that one, and I feel it does not address the issue at all and makes even decisions later on to do it not easiest but more complex. We as a 100% owner can decide. If you have some stockholding somewhere and if you have a major shareholder, it gets more difficult. And then underlying, I feel that people would still say and whatever happens, look maybe the cycle’s currently good but there is overcapacity issue. So, if that’s helpful, I’m really solving the underlying issue, questionable.
Now, on the steel guidance, to come back to your point there, steel guidance for one year, whether it’s cautious or bullish, taking a look half year back, did you expect that coking coal price would to go to 300? There seem so many surprises in the past that we all saw that the prices are increasing, we all liked it, and saw all the market is recovering. And then suddenly, all the prices went up for the raw materials to a degree nobody has expected. So, what will happen in the second half of this year, let’s wait one when we’re there. I mean, it’s not that we don’t want to give a clear guidance or that we’re afraid of delivering later on to what we promise. But honestly, to say what will finally happen in the second half, I don’t know and I think nobody knows it.
So therefore, I would say this is what we currently see going forward, and then let’s see how the year goes. And whenever we can be more precise, we have always given more precise guidance in the past. To talk about the second half, again, I don’t have the crystal ball for that. On CSA, what we see as price was helpful, volume and the improvements in the performance as well. We see what the team has achieved and how the cost base has improved. In such a difficult year, if you take a look at the 12-month, we were highly negative in the first half. And we covered for the full year back to a minus 33 on adjusted EBIT…
Positive cash flow.
In such -- and a positive cash flow, in such a difficult environment. And you can clearly see without significant improvements on stability and the cost base, this would have never been the end. I think it was among the strongest team performances in our management teams that we have seen was what they did at Brazil.
Thank you very much, Guido.
Thank you. Our next question comes from the line of Bastian Synagowitz from Deutsche Bank. Please go ahead.
Yes. Good afternoon, gentlemen. I’ve got three questions. My first one is on your performance in Steel Europe. If I benchmark your fourth quarter EBITDA per tonne against your European peers, you essentially underperformed by at least €15 per tonne on average, no matter whether I compare this against the average of the first nine months of this year, against the average of last year or the average of 2014 margins. And this is despite the fact that some of your peers had some major maintenance work in the last quarter. That’s obviously a massive number but you are now saying your first quarter will fall even back from these levels. I understand that there have been some issues at your hot rolling mill and you will have the HKM relining also in the first quarter. But, could you please give us some sense how your margins would have looked like in Q4 and how they will look like in the first quarter, if you wouldn’t have had these operational one-offs, and will they fully reverse until Q2 or are you in fact structurally falling behind your peers when it comes to profitability in steel?
Then, my second point is on pensions. It feels like the cash out for pensions has been just around €500 million versus the €560 million last year, which is obviously quite a relief. What has caused this and will it be sustainable or will we be back to the upper 500 next year, again?
And then, lastly also on your cash flow guidance. When you say, you will be free cash flow positive if there are no major displacements, are you in fact assuming that the current raw material prices will last or do you expect a certain mini reversion here?
Yes. Let me start on steel. Definitely what was important for us was the hot rolling mill clearly, and preparation of the HKM work, but what you have to keep in mind is we have a more-longer term contract than others. So, 50% of our contract base is six months and longer and 25% is three month. So, therefore, you could see in Q1 and in our first half that we were not going down like the others that are closer to spot and commodities, and we didn’t recover as strong as they did. We have, to a certain degree, a slight bit of a cushion in there, and we don’t see that our performance overall is falling behind, clearly not. That’s why we’re working in the one steel program as well, like we did so far always on the cost programs to improve our performance and keep our market position.
So, I don’t see that and I am not that negative as you are but we have some balancing out due to longer-term contract. So, the reaction in the first half was weaker in our case recovery and second half was a bit weaker therefore as well. Now, the cash out on the pensions, we paid more. We paid €20 million more because we had some effects coming out of payments for prior years for some pensions here in Germany. So, it was a onetime hit that was bringing us up from 560 to I think 587. So it was more, it was not less. It’s going to come down again because there was some one-time effect on payments to prior years.
Coming back therefore to the free cash flow above zero, what you have to keep in mind is the free cash before M&A was 198 this year; 126 was coming out of the sale of our real estate. If you take that out, because we won’t have the same amount next year, we were positive. So, we say basically it’s the same. We will see some improvements on our EBIT, on the other hand, we have some restructurings as well and we do see more net working capital requirements. We drove it down and business was as well in material services strongly, which will not continue and maintain. So, therefore, that’s what we see. Do we assume there that raw material prices remain where they are? No. I mean, we’ve seen an increase from -- in coal, going up from 90 to 310 right now, which is outrageous and is driven by the underlying demand we think that’s going to normalize over the year again.
That’s at least the underlying assumption. What will finally happen, we’ll see.
And just following up on my first and also second question, maybe starting with pensions. So, just in the free cash flow bridge, which you show -- in the pension bridge, which you shown in your presentation, basically you say the net periodic payments have been €505 million last year, it’s been €560 million, and apparently, probably the delta is coming from the cash outs which you had from your plant assets. So, has there been a one-off in the basically higher suppositious influence from the cash payments from plant assets, because it really seems from at least this chart the actual physical cash out for pensions in total, as you show it on this chart…
It’s less. No, no, you’re completely right on that one that the total cash payout, I am always referring to is cash payout to pensioners including some payouts from funds. That’s correct. That’s difference between media...
The total number for the next business year, will this be going up again or just be around 500 which we had this year or…
No, no, about the same, slightly decreased.
Slightly decreased, okay. And then, just coming back on the points regarding the steel margin. So, you said you’ve not been falling behind. If I just take for example voestalpine, which has pretty much the same contract structure. They basically had a margin expansion of I think close to €30 versus the first quarter in this year and the third quarter and this was despite a relining. Basically, they outperformed, if you want, probably by €15 on a per tonne basis. Is this really, if you say, you don’t see you have been falling behind, can we expect you to fully recover this gap until the second fiscal year quarter?
I think you -- yes, but don’t take just the quarterly look, take a couple of more quarters and then see how we are, because in the past we -- we have some difference to voestalpine. They have a good structure; they’re well invested and good capacity utilization. So, referring back to the past, we’ve always been a bit behind that as we’re bigger and then larger scale contracts or more commodities. But, I don’t see that we are falling more behind voestalpine.
Okay. So, you basically expect this to recover?
I think Bastian the falling -- you use the expression that we’re falling behind peers, and this is what we really corrected. As we’re always in the head-to-head competition with voestalpine, in some quarter, they are better; last quarter, we came really close to each other. Normally, they’re flying slightly better as we are doing. They have a really, very optimized structure and they have is also some benefits, let’s say on the raw material side. So, but clearly, you should consider that if you take the average gaps over the last quarters, we definitely will not let that going down. If you look quarter-on-quarter, sometimes we were close, sometimes they are little better, but the average that the two of us, we’re really riding the wave.
Thank you very much. Our next question comes from the line of Seth Rosenfeld from Jefferies. Please go ahead.
Good afternoon. Thanks for taking my call. I have two questions; first, on the outlook for Industrial Solutions. I was wondering if you could give a bit more detail on the planned restructuring efforts there. What do you think you can do especially to -- where you’d flagged for lower utilization rate in the coming year? And can you give us a bit more color on how you’d be able to transition toward more maintenance business as opposed to the large longer lead time items you mentioned were harder to secure?
And then, secondly, on the broader cost cutting measures, the 850 million targeted for next year. Now, in past years, you announced a number of cost cutting programs but unfortunately haven’t really seen the full benefit of this hit the bottom line, also I would imagine that was passed onto customers. What level of confidence do you have that perhaps today there would be better ability to retain these savings looking forward?
Let me start and give you a very precise example of other restructuring. Naturally, there is low order intake in our chemical business. We have right now an underutilization in Germany. So, the planet program actually did include reduction of workforce by 300 for our location Dortmund. But we founded very fast and flexible solution with the unions. We agreed on the following that 90 people are taken out of the organization and for rest, there is overall a weekly reduction of working hours, so 31 hours, which is equivalent to 300 full time FTEs. The benefit for us we had immediately 1st October much-lower expenses. So, this is just one example. And we have clearly similar plans in marine systems and others. We have already heavily reduced, by the way, our workforce in Australia and in South Africa as a consequence of the mining equipment. So, just to have some examples. Clearly, the program that they are writing is significant three-digit million part of the impact program in the running year.
And again, this measurement that we reduced working hours in the beginning is very helpful, later on orders do come back; you don’t news of the capacity and the good engineers. So, you can restart again, as we are in pretty good negotiations of some other contracts. So, therefore, it gives you the ability to breathe a bit. Otherwise, you have to build up capacity later on. So, I think a very intelligent way of doing it. Our cost cutting overall on the bottom line, it has hit the bottom line. In the past, I mean take a look on how the EBIT really did develop. And what we always clearly said, we’re measuring always against previous year numbers. So, we’re not measuring our cost cuttings budgeted figures. So, not avoided cost increases, cost cuttings in our case.
And we’ve always said, it’s about 30% that will hit next the bottom line. So, gross is everything is on the bottom line, but you always have other cost increases like personnel cost, or expected price declines by customers that will eat up a bit of it. And for the upcoming year, we have the same structure as we had in the previous year, meaning half of it is going to come from our procurement program Synergize Plus, the rest from operational improvement. And more than 70% are currently already on a DI2 meaning we have measurements clearly defined that we will now implement.
So, just some more flavor on the maintenance work. Right now, our service business, Industrial Solutions has already grown about €1 billion. But, we are still unhappy, because what is happening and we have an unbelievably large installed base, probably more than 3,000-plant. But what we clearly recognized that it’s certainly be difficult for the same sales team which is actually hunting for the mid and last year projects to really go for the detailed work on maintenance, gaining uptime or increasing output by 3% to 5%. That’s the reason why we really have built out these own service units with own service sales force and a dedicated service execution. We will not report this service unit externally. Every quarter, we will expect the earnings to the end customer segment because we want that the end customer segment is fully supporting and actually also investing on the R&D side in the serviceability of product. But, we did not believe anymore that there within those end customer segments, the focus on service is good enough to really step up to our goals expectation. So that’s the reason why we have formed this own service, found a leader with experience in service business, and we believe this will give a significant push forward in that business.
Thank you. Our next question comes from the line of Sylvain Brunet from Exane BNP Paribas. Please go ahead.
Good afternoon, gentlemen. First question on the discussions with Tata. Could you please confirm? Again, that’s in spite of the changes we’ve seen at the helm, people you talk to and potentially even the management is still committed to find a solution for their steel operations? That’s my first question. And essentially around that if you can elaborate a little bit on how important was the pension deficit, which seems to have been reducing quite materially in the last few months?
My second question was on Steel Americas where it’s clear evidence of a turnaround. I was wondering why your outlook for the year was remaining still pretty cautious there. Obviously, we don’t know yet the pace of development between prices and costs, but in this case, there is quite evidence of some pick-up in scrap prices in the U.S. So, there seems to be room for higher scrap prices in the U.S. I just wanted to know what assumptions you run basically to keep your guidance as cautious. And as was reported in the press, could you confirm if you received any interest from [indiscernible]? My last question, if you could please give us a bit of outlook and also breakdown of this pretty large steel central cost that we’re talking about. I understand the logic of investment there for the restructuring in IS, but this 500 million is of course a pretty heavy number in the context of a 1.7 billion EBIT. Could you tell us whether we should assume this is a trigger program and then, we would revert back down to what I believe is more like a normalized €250 million [ph] number? A bit of guidance there would be helpful.
Let me chime on the first question related to Tata. Immediately after the change of the chairmanship, Tata has officially announced in the press that they will continue with the talks to us. And I can confirm that in personal dialogs, Guido and myself, with the present leadership team, this was once again emphasized in personal meetings. Clearly, what is defining, let me say the pace of creating the environment is clearly a solution for the pension scheme. Because we all said also we strongly believe in a necessity of a consolidation in Europe. If we talk to other companies, there are some criteria which need to be fulfilled. And for us naturally, we would not be in a position to take liabilities for these unbelievable large pension schemes. So, this is definitely as far as Tata is concerned, the milestone which needs to be achieved for us to go on the detail.
Yes. And coming back on Americas, clearly, I mean, we do see nice scrap price developments in the U.S. as well. There are always some positive and some negative movements; you never know where finally the price will go for the Brazilian real. So, we’re happy with the turnaround. We see some positive effects. But again, it’s like Steel Europe. And Alessandro was already asking for that to see how the second half will move and what will happen, is Brazil going to continue. Let’s see, ones we’re down the road, we will definitely grab any opportunity and we are operationally on a very good way. So, we do what we have in control and let’s see what we will finally end.
On the discussions that have been mentioned in the press, we don’t comment on that one. We clearly say now that we have achieved the full operating license, performance is better and that we own a 100%. We’re in a better shape but nothing more to say about that.
On the breakdown of central cost at corporate and the Group initiatives you see here. That will indeed continue for quite some time, because the level we have on our processes and data management on IT, on structures that we have to do that there is quite a lot of that we have to change. And compared to by the way, our overall IT expenses we do have, we’re rather at or below our benchmark, so which is indicating on the other hand, there is a lot of opportunity and as we further invest to take part into digitization, Industry 4.0, but on the other hand in getting more efficiencies out, because largely we will have too much G&A expenses throughout the Group where we’re not running in efficient processes; and given our IT structure, we have to do more there to improve.
Thank you very much. Our next question comes from the line of Roger Bell from JP Morgan. Please go ahead, sir.
Good afternoon. Thanks for taking my questions. First question is just around the guidance. So, you’ve given guidance for Q1 of €300 million, so that implies to get to €1.7 billion for the year, you need EBIT jump back up to a run rate of around €470 million per annum. Could you just explain to us to what extent you already have visibility on the coking coal costs into Q2 and therefore, based on the current steel order book, does that support such a large jump in EBIT going into Q2 or does this guidance depend upon further improvement in steel prices in Q2 and beyond?
Then, the second question is around the consolidation. You’ve said consistently that Tata may not be the only party involved in such a transaction. Can you give us any color on whether you have indeed been having recent conversations with anybody else? Could you see a scenario where more than two players end up joining up together? And could you just reiterate what you were saying before that this is entirely driven by what’s best for the industry rather than any motivation to unlock any -- some of the parts discount in your portfolio?
Yes. Let me start on the €300 million and that leads to 1.2. In the year we have always a second half that is stronger, and that’s not only due to steel. What you have to see in our calendar third and fourth quarter, which is basically spring and summer are more working days than the first half and where construction business is for example, and this is beside automotive, the stronger sector we’re addicted to has more business, in the winter time construction is not that much. So, let me give you an example in 2014-2015. We started with 317 and ended at 1.8 in the EBIT. So, therefore, Q1, Q2 are always the weaker quarters on EBIT and even on elevators, you will always see that Q3 and Q4 are stronger than Q1 and Q2 due to that effect to certain degree. So, the 300 million is not indicating that we might miss the 1.7, it’s the opposite; it’s pretty much in line without if you take the normal seasonal movements that we do have. Otherwise, other talks what we have always clearly stated is, among others, we’re talking to Tata and the Tata one is confirmed. And there is nothing more we will talk about.
There is point why we confirmed Tata was when Tata changed their way of going forward in UK by July last year, they announced they are in talk to us and in order to be telling the truth, we had to confirm. Otherwise, we would not have made any of those talks public. And we are not ready to add any further name, because normally such dialogs are not done in public, just to make that clear.
Okay. Just to come back on that without naming any names, can you confirm whether you could see a scenario where there’s more than two companies coming together here? And then, also just back on the guidance again. So, you’re saying 1.7 billion is achievable just as normal seasonality in the capital goods businesses. Can you therefore confirm that you are not necessarily assuming a dramatic improvement in the steel margins versus what you are currently seeing in the market right now?
No, we do expect over time -- I mean, we have given clear effects what we do see spillovers from the production issues we have and the relining of HKM that our Q1 [indiscernible] indicated for the rest of the year. So that needs to improve over the year. Otherwise that’s at least included and you can see mathematically and other ways we announced. So, over the year, it should improve and price wise we should already see something on Q1. But the production issues, the two ones I mentioned will lead to effects leading into the other direction. So, therefore Q1 is not the real indication of what we expect the performance throughout the year.
And asking for other options, I think we have really demonstrated in recent years where we tackle the issues where they are, and issue right now is overcapacity in Europe and not in any other part of our portfolio of this thyssenkrupp. There we focus on solving that problem. Now, and the best solution is, is a combination of companies, because if only one would do the restructuring, the only -- the others will gain the benefit. And the one restructuring cannot increase the utilization. I think the only way that you can really take the pain of taking capacity out, but also having the benefits of higher utilization of the rest if you combine two companies. And that’s the reason why we are focusing so strongly in seeking a solution in that direction.
Thank you. Our next question comes from the line of Alain Gabriel from Morgan Stanley. Please go ahead.
Yes. Good afternoon, ladies and gentlemen. If I may focus on the elevators business, you seem to be quite confident in your outlook for 2017. And this contrasts a little bit what your competitors have been seeing, especially on the pricing power in China. What are you seeing or doing differently than the rest of the street? Thank you.
I’d say the judgment of the Chinese situation is quite similar from different companies. I think we all have the same judgment and probably number of units from a market perspective in this year and probably out the next year, the number of units might go down by roundabout minus 5%. I think this year, we were just lucky that our end customer segments were more in a commercial and infrastructure sector. That was the reason by number of units we could grow by 1% while the market was going down by minus 5% on a comparable basis. But also for the 2016-2017, we believe that the number of units will go down somewhere between minus 2% to minus 5%, and we will see additional price pressure also in a single-digit area.
So, I think the judgment as far as the market is concerned in number of units and some price pressure is quite similar. The point only is that we still have the potential to defend or grow our margin even in China, because the team really has now the transparency, because we implemented [indiscernible] to really tackle the levers in detail. But the assessment of the market I think is quite similar for the major players.
And overall, you have to take into account that the share of China in our overall revenues is less than with our competitors. For us, there are other markets in Asia that are developing nicely and we were strong like Korea. And the U.S. which is growing really good and nicely in the market overall is for us by far more important than China.
Thank you. And our next question comes from the line of Christian Obst from Baader Bank. Please go ahead.
Yes, hello. I have two questions, first on Industrial Solutions. For the first time, over almost eight quarters, you talked about a positive business cash flow in Industrial Solutions. Maybe you can describe this a little bit further, where does that come from, and what is your guidance going forward, especially where you’re talking about expected rising order intake going forward? And the second one is over the last five years, you almost saved approximately €4.5 billion and €5 billion on the cost side which is approximately 50% of total costs, and this led you to an EBIT of €1.7 billion. So, there is a lot of pressure coming from the market, and this will go on going forward. So, the target is in a longer term to achieve the €2 billion. If everything stays stable from the economic framework, where is the most important driver where you like to get the additional €300 million to €500 million EBIT to achieve your long-term target?
Let me just come on the order intake and as a result hopefully the swing in free cash flow in IS. Look, we had an exceptional weak year for example marine systems. We had only an order intake of €514 million; this is quite unusual. So, we do believe that we most likely can turn this back to at least a €1 billion. Also in a chemical plant, we did not have any contribution from the fertilizer business; also our funnel is quite promising on that side. So, we do believe that this should also bring in higher volume than we have seen this unbelievable low quarter. As said before, we believe that we can repeat once again a large order on the cement side. And we also see some upside, not only on a big stream but maybe we’re talking about 4 to 500 million on the mining sector just by replacement of equipment, which was really let’s say run to the maximum by the high output. And this should really bring us back to significant better number of order intake and as there is some down payment involved in that also contribute to the swing on the free cash flow side.
And the €300 million delta we have seen from Q3 to Q4 to the positive business cash flow, what was that; what was the main reason for that?
We have milestone payments in one of our large contracts and this really came in, in very last days; the customers paid those milestone payments. There is a mention in one of our last year’s business, those milestone payments, one milestone can be responsible for 100 million in just one payment.
On the cost cutting, I think what we’ve achieved so far and impact is €3.8 billion. And if you assume and just do the math that we say 30%, we want to keep, that’s around 1.2. And if you see the improvements we’ve made on the adjusted EBIT coming from 0.3 to last year 1.7 or 1.5 this year, you see that that comes really for the difference that we’ve made in our EBIT adjustments so far. We can continue a lot. I mean now we see for example on elevators, we’re at 11.5%, we’re targeting 15%. Just do the math; this is a lot.
But what is important and that’s the reason why we make all these investments into IT, we know that we need the additional contribution from global shared services. First, let’s say bring the losses to zero, but also gaining. We always made announcement that we believe that we can gain lower three-digit million savings from global shared services. The next things is one of the reasons why our G&A is not on the most competitive level is that our automated end-to-end process still on a low level. That means, let’s say the efficiency of our work is still not where we want to be. So, we strongly believe with the investment in IT we are doing right now, to certain extent hits our EBIT line. We don’t have the benefit strongly in the years coming. So, this -- we can see a very clear payback in that area.
Okay. Maybe a follow-up on that. So, you have a lot of the shared service centers, the Group initiatives, all the IT things, you will start a new plant, components technologies, you have a clear plan for the elevator business. With everything equal from the economic framework, normally, you should have some kind of an idea when to reach or exceed the €2 billion EBIT. Is that right?
The pint is the following, in the last years, we have never seen an equal economic framework, and therefore, we would not like to comment on that. We have a clear understanding, but this is not real what you’re saying that we have clearly stable economics; it does not make sense there to be really -- give you a timing indication here. We will use any opportunity to move on that step, but let’s see when we are there. We did not plan that we come all in 1.5, but the material hit us and we had to let’s say 5 back as we come in at 1.5; also you understand that.
Of course. One short additional one is on marine systems. Capacity utilization is going down. You will make some adjustments going forward. You have a goodwill of approximately €900 million. Is there a certain risk in that?
In every year in closing, very normal procedure is that we make an impairment test in each and every unit. But this is a project, which we have right now in the funnel going forward, the business is strong enough to really carry the amount, which is allocated to the business.
Thank you. Our next question comes from the line of Carsten Riek from UBS. Please go ahead.
Thank you very much. A few questions left from my side. The first one is back to the free cash flow because it doesn’t really look that comfortable the guidance of a positive free cash flow for 2016-2017. Obviously if you guide for around €200 million more in EBIT, you deduct almost €130 million from the real estate disposal, then you are actually left with €70 million you could actually save for higher net working capital, and that includes actually the same kind of payable and receivable year-end management. So, for me, is it really only €70 million in net working capital you actually include in your guidance? And what would the net working capital increase be, if raw material prices, these coking coal and iron ore stay at that level? Am I right, it’s about €600 million to €700 million for next year then?
First of all, what you missed in your calculation done before is that we guide for a higher EBIT, which should turn into some cash.
Yes. That’s 200 million which I already have for 1.5 to 1.7.
Yes, that’s fine. But we started at 200, so you do that, you end at 270 in your calculation. Everything else is being equal, so 200 plus makes it 400 and then you deduct the real estate sales, which is still then positive. If we stay at current levels, we’d be higher but not to your degree. I think you’re a bit too high there.
Okay. So, because I assume simply three months of inventories in iron ore and coking coal, am I right here?
That’s two to three months.
Okay. With regard to Tata Steel, that’s the second question; a lot of discussions are around the pensions and how Tata will handle the pensions. If I turn that, how would you actually value your pensions in case of a tie-up with Tata; is it what is in the books or would you revalue it; how would you do that? I’m just curious.
Fine, but look, that remains to be seen. First of all, what we need to find, Tata needs to solve the issue of this huge pension plan in the UK, which clearly -- and changes in that can be carried to the full of new entity, if we were to get it. And then, the second thing remains to be true, as we’ve always said. First of all, logic of a transaction is what is important and that drives the structure of the transaction. And then, we will see how we can get where we really want to be. So, what pensions and how, that’s bye far too early. And I don’t want to add any speculation to there.
The last question is rather short-term nature. The fourth quarter calendar year 2016, steel price increases. We have seen from what some of your competitors pretty steep announcements, but the spot prices haven’t really moved that much; there is a bit of a discrepancy here. What are the chances actually to see significant steel price increases towards the end of the year, which is clearly a destocking period?
The destocking period, usually that’s true, but take a look at the raw material pricing and where they are going, and I think the rest of the industry is still trying to recover. So everybody is really looking forward to pass on the price increases to the customer base.
Thank you. Our next question comes from the line of…
Operator, I think we have now reached the end of the conference call and I think we have to stop here. But of course the Investor Relations department is available for all the people out there who have more questions. We would like to thank you all very much for joining the call and for getting into these interesting discussions with us. And we look forward to continuing to the discussions. In particular, there is an opportunity at our Capital Markets Day. You can register; there are still free seats for you. And we look forward to seeing you there. Thank you very much. And bye, bye, look forward to speaking with you again.
Thank you very much, sir. That does conclude our conference for today. Thank you everyone for participating. You may now disconnect.
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