Outotec OYJ (OTC:OUKPF) Q1 2019 Results Conference Call May 8, 2019 7:00 AM ET
Markku Teräsvasara - CEO
Jari Ålgars - CFO
Conference Call Participants
Omid Vaziri - Jefferies
Magnus Kruber - UBS
Manu Rimpelä - Nordea
Antti Suttelin - Danske Bank
Thank you. Good afternoon, and welcome to Outotec's Quarter One Result Release. It has been a promising quarter with improving market sentiment and strong service growth.
Now, let's look at the more -- the quarter more in details. While customers continue to focus on improving existing operations, we also see some large accretive projects moving ahead. Market continues strong for mineral processing equipment and hydrometallurgical plant, but now also some accretive projects are moving ahead. And we have improving workload in Metals, Energy & Water engineering from a number of basic engineering projects.
So where the demand is coming from? Battery metals continue to be active and we are involved in most of the lithium projects globally. We also are well positioned in the fertilizer industry with our sulfuric acid plant technology. As you know, most of the sulfuric acid plants we sell go to metallurgical applications, but we also have a good position in the fertilizer industry.
Looking at the segments, mineral processing again experienced some solid demand, so mineral processing continues to develop in all areas. In Metals, Energy & Water assets, we had improving workload as we have several projects in basic engineering phase and they are ongoing. This is not yet visible in sales, but we believe that at least some of these large projects will proceed to construction phase this year.
And service order intake also performed well. What developed particularly well in service side was long-term service agreements and modifications and upgrade projects, and these are the areas that we have been focusing on lately. And maybe further one step that -- don't remember, we actually, in the beginning of 2017, we changed the way we report order intake in service. So today, service agreements are reported on a monthly basis, not on a quarterly or yearly or long-term basis. So comparing this column for quarter 1 this year to the previous ones from 2016 and beyond, you would need to add for quarter 1 about €10 million more to this.
When it comes to ilmenite smelter project in Metals, Energy & Water, we have the negotiations ongoing in cooperation with the customer. We remain confident that we are provided adequately for the project. And of course, we'll update the market, announce any following substantial news.
Our work with the 5 strategic focus areas continues and we have had progress in all of them. Maybe a few examples to mention is that from product competitiveness and project excellence point of view, we have actually already visible in our quarter one results, a good impact when it comes to improving project margins. And Jari will tell a bit more about that in his session, but clearly, that is a result of these focused activities.
Again, mentioning also service side, particularly good progress in long-term service agreements and modification and upgrade projects are resulting from this mostly better program. But now let's look at more in details the main financials.
Yes. Thank you, Markku, and good afternoon also on my part. If you look at the numbers, the order intake was good through the first quarter of the year. It was on the same good level as last year. It was particularly important to have a good order intake now as second half last year was slow in getting big orders. If you look backwards, we might have to, we have to look over 5 years to find numbers which are on the same level, so it is a very good start, a promising start. If we go into the sales, yes, it was slower than last year. But as we guided earlier, our sales figure tilted more towards the end of the year.
Despite the low sales, our result clearly improved, supported by solid project execution. If you look first at MP more in detail, order intake was good, increasing with 19%, €194 million compared to €163 million last year. And obviously, as we want to continue to grow our MP, have our successful story continue, it is important as we can see from the sales due to the second half last year getting no bigger orders, have led to that the sales have been flattening out year-on-year comparison. Now with this clearly improved order intake, we can continue on the growth path.
What is also very positive is that service sales grew with 11%, which is according, or over our target level. With the flat sales, the result was on the same level as last year. If we then go into Metals, Energy & Water, we, our order intake was €143 million, which is not a bad number as such, but a clear decline compared to last year's when we had a very strong order intake in Q1. But if you look at it as an absolute figure, it is clearly above the sales currently and clearly above the sales we had last year, so it's paving also room for growth going forward. What else to say about MEW is that despite the sales declined considerably, the profitability still improved somewhat. And this was due to that, the bigger projects developed solidly going forward.
If you look at this in graphical form, we can see that margins clearly improved year-on-year and helped a little bit also by fixed cost savings while again, the lower volume decreased the profitability. And this solid project execution helped us improve our result despite the sales was lower. If you look at the cash flow, there were timing issues in payment and also our work in progress increased. This led to that the free cash flow was negative for the fourth quarter. This impacted, was impacted by the net working capital increase of €39 million. Other things to mention in the quarter was that we paid hybrid interest of €11 million during this quarter.
And if you look at the financial position, the net working capital, I said, decreased compared to end of last year. And this was explained by -- or this is explained by lower milestone payment as well as increased work in progress. And if you look at the numbers also, you see they have changed. This is due to implementing IFRS 16. It has impacted the key ratios and the leasing liabilities, which has now been booked into both sides of the balance sheet as a right on the asset and as a liability, on the liability side was €67 million. And if you look at the footnotes, you see what the numbers are without this implementation of IFRS 16.
And then if you go to market outlook and guidance, Markku, please.
Thank you, Jari.
Before we look at the outlook, let me just summarize quarter one. One more time it has been a promising quarter with improving market sentiment for our products and services. We see some accretive projects moving ahead. Service continues to grow and our must-win battles are bringing result as we see our profitability in projects improving.
So what are the drivers behind the early signs of market recovery? Main drivers are coming from activities in copper, gold and battery metals. And as I mentioned, we have a number of basic engineering projects ongoing with the customers in MEW also, MP, but even more so MEW space. Many of them are related to copper so there is signs that in the copper space, investments are being prepared. And of course, we are hopeful that they will turn into construction projects then later on during this year.
As one sign of that, we have this €140 million greenfield order from a Saudi Arabian mining company. It is a typical quick order for Outotec where our competencies and experience comes well in use because our technologies and equipment cover the whole process from mineral processing to metal refining. We have the project expertise and we can also, in this case, we did it and we can also do it in another case. We actually can test and pilot the whole process in our R&D center.
We have proven track record in application. And of course Ma'aden, as a customer, is a long-term customer where we have done a number of projects together with them successfully, ranging from mineral processing to alumina calcination technology and three sulfuric acid plants for fertilizer application, each plant actually being the largest in the world. And what is, of course, good for the workload point of view, that this order is more or less 50-50 split between Minerals Processing and Metals, Energy & Water.
So as we see, the market is active and some of the larger projects moving ahead, so we are reiterating our guidance for 2019. We believe that we have better and more stable market. Service continues to increase. MP is improving and smaller order intake is turning faster around. And of course, last but not least, we have these bigger projects which are 1, 2 have actually been already received and there's an opportunity for more.
So now let's open the line for questions.
[Operator Instructions] The first question comes from Omid Vaziri from Jefferies.
I have 3 questions. First one, with a more positive outlook that you are giving here today, how should we interpret that? Should we be expecting, do you expect sequential improving of orders in the subsequent quarters from sort of visibility that you have looking ahead at what you're engaged with, the bidding activity and engagement with the customers and so on? Second question relates to the timing and the schedule of when you might next have an update or yourself have an update from the ilmenite smelter project in Saudi Arabia, just to kind of help us understand time line and when we might be getting an update from there. And lastly, how much of the current backlog should we be expecting you to deliver this year within the current year?
Yes. If I start from the bidding activity, what I said already during the presentation, I think we see a difference compared to the second half of last year. There, we, there was more uncertainty. These big projects were not moving ahead. Maybe you remember us in the last results release after quarter 4 saying that now there's more optimism and we expected to see some of the projects moving ahead. And that is exactly what we see happening at the moment. Ma'aden order was, of course, the first one, but there is a number of sizable, large basic engineering project that we are doing. So far, not so much visible in order intake and the sales.
However, if they then turn into construction projects, of course, that requires customer decision. Then they will all be sizable projects. So in that sense, there is a fair bit of optimism in the area. When it comes to ilmenite, we continue our dialogue with the customer in cooperation. We have not, basically nothing new to tell at this stage other than, of course, we are confident that our provision we made in 2018 is sufficient and we continue working closely with the customer. And of course, whenever we have some new things to report, then we will come back. And maybe the backlog question, maybe Jari, you can finish on that.
Yes. We are expecting that €760 million out of the backlog will turn into sales this year.
The next question comes from Magnus Kruber from UBS.
Magnus here from UBS. I think first, you guided off the nominal value you expect to invoice from your backlog sequentially this year from Q4 into Q1. I think this has only happened once before in the past 10 years. So could you give us a little bit more color on what that is? I think obviously you saw some positive build on the service backlog, but I don't think that's enough to explain it. Any color there would be very helpful.
Yes. The outlook -- the backlog, obviously, also some of the orders or the order intake we've had is more smaller orders, maybe which you also see in the margin during this quarter. So it's just from smaller orders, shorter orders, orders that are faster to turn around currently.
Okay. So no difference there, then, in what you told us at Q4, though. I think you said the same thing then on this. I think secondly, sort of in regards to the lower invoicing in Metals, Energy & Water, was that an underlying issue, essentially lower backlog? Or was there any slippage of project delivery there from Q1 into Q2?
Sorry, could you repeat the question? Sorry.
Yes. Was there any slippage in project deliveries in Metals, Energy & Water in Q1, something that you expected in Q1 that now falls into Q2?
There were some, yes.
Okay, perfect. And finally, could you give us an update on the remaining high-impact projects? Have you seen any progress in any of them and do you still expect them to close in 2019?
This is our target. However, we are also dependent on the customer and customer actions. So this is the target and obviously, we are doing our best to do it in this way except for the ilmenite, which we have earlier said that we'll -- it'll go into next year.
Perfect. But nothing closed yet, right?
No, nothing closed.
Our next question comes from Manu Rimpelä from Nordea.
My first question would be on the EBIT bridge that you showed. So could you help us a bit better understand this project execution, which was a big positive in the quarter. That -- is this the kind of reversal of no longer having the negative extra costs from those high-impact projects? Or is it actually the new projects that you're taking on which are generating higher margins than the old projects?
I would say it's roughly half and half if you look at it from that standpoint.
And then are you able to say that this is mainly in MEW or is it also in Minerals Processing?
It's mainly in MEW but also in Minerals Processing, we have improvements.
Okay. And then I was just wondering if you could also help me to understand the logic in MEW where you had the significantly lower sales compared to year-over-year, but then the earnings were still only -- or earnings improved. So even if you kind adjust for these loss-making projects. I would just like to understand how does that, kind of the cost, flow through. Is the rationale that you have been taking on these new large projects? Are you able to allocate the cost to them and that's why you are able to kind of with lower sales show good profitability?
To a smaller extent, the latter. But yes, there is that too, that we have a good workload at the moment and that has improved the profitably somewhat. But the main part is coming from no impact from legacy projects and secondly, then also the projects that led to revenue had good margin on average than planned margins.
Manu, maybe add to that also that I think we have several times earlier discussed about that this resource utilization impacts our result. And of course, in MEW, I think we are fortunate to have a higher workload in our early start than we have seen for quite some time. And of course, there is less under-absorption, if any, and that improves the result. Here also it actually has impacted that we did some trimming last year. So it's kind of helped both ways. We have more work and we have also less under-absorption in the area where we have had. It is positive both ways.
Okay. And I assume that as we go forward and kind of get higher revenues in the coming quarters from the backlog and some projects that are pushed forward, so should we then kind of see a multiplier on this effect? Or the other way to ask this that we think we're going be in black figures in Q2? Are you willing to comment that in MEW?
We are not giving guidance on the different segments. But I think it is obviously when you look from the numbers, we need more volumes. So more order intake is needed. This Q1 was a good start. I said, yes, it was lower than last year, but still it was a good absolute number going forward that these big projects will move ahead. We'll further build on that. So it's really continuing on the good volume now and then having good workload and good project execution. We are definitely going in the right direction.
Okay. And final question, can you give us a sense about the kind of number of these basic engineering projects that you have been working on?
Of course, they are many. But what I meant in that case, I meant projects -- sizable projects that if they go into construction, they would all be bigger than €100 million. I don't give any more guidance, but I would say that they are all €100-plus million size of projects. And we have a number of those that we are doing basic engineering for the moment. But of course, as said, we finalize the basic engineering. Then the customer decides whether it goes for bidding or not, and then of course, at some point, there will be a construction project. We believe that at least some of them will turn into real construction projects later on. And then of course, having been done the basic engineering, we are quite well positioned.
[Operator Instructions] The next question comes from Antti Suttelin from Danske Bank.
You have partly already answered, but just to be crystal clear, when you say that you have big projects in basic engineering, does this mean that they are not reflecting orders already received? They are rather indicative of future orders? Is that correctly understood?
That is correctly understood.
But of course, I think what we have done is that if it's a basic engineering project like you see that -- if you noticed we had these Indonesian smelter projects where we announced actually a front-end engineering and design contract. That is only engineering, but it is fairly sizable because we announced that as €10 million project. So all that €10 million is basic engineering.
Maybe to clarify a little bit on this. Also, we have -- there are projects out there where the customer is using an engineering company to do the pre-engineering and then ask for bids, for instance from us, on the process or equipment. And then there are customers who come to us and ask that we should do this work. And obviously, this gives us an advantage going forward. First of all, obviously, we get our quotation costs paid for. And then secondly, when we build -- do the process engineering as part of the pre-engineering, we do it in such a way that this is positive for us when it then finally moves into the bidding phase. So then it's more a question of does the project move ahead than are we going to get the order. That's a bigger question.
Okay. And then on the ilmenite project, can you give any update? Now that you have been looking into the plant, how does it look like? And how confident are you that you can get it operational?
I think what I said initially is basically, we don't have so much news to tell. Answering your question, yes, we are confident that the provision that we have made is sufficient. And also we believe that that plant is going to be commissioned, again, early next year.
There appear to be no further questions. I will turn the call back to the speakers.
Unidentified Company Representative
Okay. Thank you, operator, and thank you for everyone for participating this Q1 briefing and Q&A. And just as a reminder, the second quarter results are coming out July 26. Have a nice day. Thank you.