Knorr Bremse : Transcription of the Q2 2023 Conference Call

Transcript of Webcast and Q&A session of Knorr-Bremse's Q2 2023 financial results

Date: August 10, 2023

Operator:

Hello, ladies and gentlemen, and welcome to the Knorr-Bremse AG Q2 '23 earnings call. At this time, all participants have been placed on a listen-only mode. The floor will be open for questions following the presentation. Let me now turn the floor over to your host, Andreas Spitzauer, please go ahead.

Andreas Spitzauer:

Good afternoon as well as good morning, ladies and gentlemen. I hope all of you are very fine. My name is Andreas Spitzauer, head of Investor Relations of Knorr-Bremse AG. I want to welcome you to Knorr- Bremse's conference call for the second quarter results of 2023. Today, Marc Llistosella, our CEO, and Frank Weber, our CFO, will present the results of Knorr-Bremse, followed by a Q&A session. The conference call will be recorded and is available on our homepage, www.knorr-bremse.com in the Investor Relations section. Here, you can find today's presentation and later a transcript of the call. It is now my pleasure to hand over to Marc Llistosella, please go ahead.

Marc Llistosella:

Thank you, Andreas, and welcome everybody to our conference call. Before we get started, I would like to take the opportunity to express my deep sorrow about the sudden death of Daimler Truck CFO Jochen Goetz. For me personally Jochen was a highly valued former colleague, always fair, always great. My heartfelt condolences, which I express on behalf of the entire Knorr-Bremse Group, go to his family, to whom I wish much strength at this difficult time.

Frank Weber:

Thanks for your kind words, Marc. Let me tell you that for me words can hardly express what I feel. I am deeply saddened about Jochen's sudden passing. Jochen was much more to me than a very longtime colleague in various functions. He was a friend! He was an exceptionally knowledgeable, persistent, pragmatic and trustful professional as well as an outstanding and down to earth individual. For me he was unparalleled in terms of reliability, integrity and kindness. I will forever miss him. My heartfelt condolences go out to his wife and kids as well as to my former colleagues at Daimler Truck.

Marc Llistosella:

Thank you, Frank. As usual, I will start with an overview of the highlights before Frank dives into the details, followed by a Q&A session. Let's kick it off on chart 2 with our main messages of today: Number one, we continue to see strong customer demand across all regions in both divisions. As a result, order books reached record levels and are a solid foundation of our outlook for 2023. Number two, as promised at the Q1/23 presentation and our strategy update in July: we saw a turnaround of profitability in the past quarter. This is a consequence of our successful Profit and Cash Protection Program (PCPP). Number three, together with Indian Railways, we could find a mutual solution to solve the technical issues with freight wagons in India and we concluded a settlement. We are therefore confident that the outstanding payments by Indian Railways will decrease near term. Number four, a meaningful part of our BOOST program is "Brownfield", which we presented to you in our strategy update. A major cornerstone of it is the focus on portfolio optimization. It took quite some time, but we could sign a deal to sell our Group subsidiary Kiepe Electric to Heramba. We are confident to close the deal soon. Number five, Let's talk about our company's efforts to fight climate change: We have increased our Scope 1+2 target to reductions of 75% by 2030. In addition, we have defined an ambitious Scope 3 target and we delivered on our commitment to obtain target validation through the Science Based Targets initiative (SBTi). This was a major step forward and shows our strong commitment to sustainability. Number seven, last but not least we confirm our Guidance and increased our revenue target for 2023 from 7.3 to 7.7 billion euros to 7.5 to 7.8 billion euros.

On chart 3, I want to share our market view with you and focus on 5 main messages. Overall, the good demand in the rail industry continues - driven by the political will to support green mobility. After Corona, ridership levels and rail traffic are recovering across the globe. As a result, aftermarket business grows and postponements decrease which results in high order books of our global OEM customers. The market in China is back and is already showing a positive effect on our AM business. The demand in Metro, however, is still challenging as the provinces and municipalities suffer from the weak real estate market and the accumulated debt burden of the past Corona years. The truck market shows high demand in Europe and North America. Truck production rates significantly increased in both regions in the past quarter and are also expected to grow slightly on a full year basis. Overall, in terms of demand, we hardly see any signs of weakening. In addition, Content per Vehicle growth is supportive for CVS. After the Chinese truck market struggled last year, we see strong recovery in 2023. CVS benefitted from this recovery due to our leading market position and leading position in the field of technology. In addition, there are good opportunities

regarding content per vehicle, driven by rather lower safety standards and move towards innovative and reliable technologies also in China.

Let's move to the second quarter KPIs on chart 4. All major financials moved higher year over year! The most important one for me was, that the operating EBIT margin is up by 60bps to 11.1% in the second quarter 2023. This development was driven by higher revenues and the success of our cost initiatives. In addition, order book reached a new record high with 7.1 billion Euros. It provides good visibility and confidence for the quarters ahead regarding utilization rates. Last, but not least Free Cashflow: It turned positive in Q2 as planned and we expect this good trend to accelerate further between now and the end of the year. I would now hand over to Frank for the financial insights.

Frank Weber:

Thanks Marc and welcome also from my side. Let's move to chart 5. Capex in the past quarter amounted to 75 million euros, representing 3.7% of revenues. It was stable in absolute terms year-over-year, but lower in relation to revenues and currently well below our target range of 5-6%. I expect some higher spendings towards the end of 2023 as usual. Net Working Capital increased by roughly 180 million Euros versus last year's level, but scope of days improved slightly year over year. I will go into more detail regarding this development on the next chart. I also believe that the level of 1.56 billion Euros should mark the peak in 2023 and that scope of days will strongly decrease in the second half year. ROCE for the second quarter 2023 increased slightly to 17%. There is still some way to go before we reach our target margin of more than 20%, but the development was definitely in the right direction.

On chart 6, I would like to provide you more details regarding our Free Cashflow, which was positive as expected and came in at plus 34 million euros in the past quarter, 69 million euros better than in the previous year. In the first half of 2023, the improvement even added up to around 100 million Euros. Traditionally, our Free Cashflow is significantly weaker in the first half of the year and 2023 is not an exception. The biggest impact on the development of our Free Cashflow is still the higher net working capital. The major driver for this was the increased accounts receivables among some larger customers, which tend to delay some payments. In addition, we maintain a high level of inventories in order to be flexible in response to customer requests and to ensure a high degree of supply security. Due to the further improving supply chain situation, we also expect the Scope of Days to improve. We have launched Project "Collect", which is made up of cross-divisional teams such as direct/indirect purchasing, logistics, supply chain as well as sales and aftermarket, in order to systematically improve our net working capital.

Therefore, I expect in the quarters ahead, that we will improve, also driven by higher payments from Indian Rail again after finalization of the settlement. I am still confident, that Knorr-Bremse will reach its Free Cashflow Guidance of 350 to 550 million euros in 2023.

Let's take a closer look at the divisional performance in Q2, starting with RVS on Chart 7. In the second quarter of 2023, order intake in the Rail division was again very strong and above 1 billion Euro. The lion's share of this absolute performance was in Europe, followed by Asia and North America. The book to bill ratio is now above 1 for the 7th consecutive quarter and reached 1.07. This development will support the positive trend of RVS. It is particularly important for me to mention that the current price quality for new longer-term orders is the same as it was before the sharp increase in inflation last year. The order backlog as of June 30, 2023, amounted to 5.1 billion Euros, reaching again a new record high.

Let's move to chart 8. Revenues of RVS in Q2 amounted to 958 million euros, an increase by more than 16% year-over-year driven especially by Aftermarket business which outperformed OE business in the quarter. Additionally, price increases supported this development, too. Operating EBIT for RVS in the second quarter 2023 was 141 million Euros, up 19% year-over-year. As a result, the operating EBIT margin increased from 14.3% to 14.7% in the second quarter of 2023. The main drivers for our margin improvement were: First: Good operating leverage driven by higher revenues in all regions. Second: The aftermarket revenues in China, which increased double-digit year over year, because of the sharp increase in ridership following the end of the Zero Covid policy. We also recognized pull-forward effects on train maintenance. Therefore, it remains to be seen whether this level of the second quarter will be sustainable in the coming quarters. Last but not least, price measures and cost improvements could offset some of the inflation. We also expect a good development of profitability in the further quarters of 2023 due to a solid revenue development and further successes of the Profit and Cash Protection Program, but at the same time our forecast confirms, that RVS-margin for full year 2023 would be below last year's level.

Let's continue with our truck division on slide 9. Sustained high demand, which was already mentioned by some truck OEMs, has led to significantly increased truck production rates since the beginning of the year in Europe, North America and especially China. Incoming orders of CVS amounted again to more than 1 billion euros, which is an increase of 18% year-over-year. Main drivers for this significant growth were Europe and APAC, especially China. Both regions still benefit from good demand for transportation services. The order book of our truck division amounted to almost 2.1 billion euros, which is again remarkably 7% higher year-over-year.

Let's move on to slide 10. Thanks to price increases and higher volumes, CVS posted a 15% year-over-year increase in revenues to 1.05 billion Euros in the second quarter of 2023. The division was able to increase revenues in all regions. Operating EBIT in our CVS division amounted to 98 million Euros in the past quarter, up 31.5 % year-over-year. As a consequence, the operating EBIT margin improved from 8.1% to 9.3%, due to the strong aftermarket business, the successful implementation of cost measures and higher customer prices. We are close to successfully finish our second round of price increases, our so called "Wave 2", which will support CVS's EBIT and EBIT margin starting from the current quarter. And with that I hand over to Marc for the guidance 2023 and some final remarks.

Marc Llistosella:

Thank you, Frank. I want to finish with our guidance for 2023 on chart 11. Our main assumptions are as always outlined on the right side of this page. As one aspect of those, we expect that all net extra costs due to inflation also this year will be once again compensated with our comprehensive PCPP measures. For 2023, we now expect an increased revenue target of 7.5 to 7.8 billion Euros. This uplift was mainly due to a higher, than expected, truck production rate and a better development of the aftermarket in the Rail Division. Furthermore, we expect an operating EBIT margin between 10.5% and 12.0% and a Free Cashflow between 350 and 550 million Euros.

As you can see Q2 results have shown first signs that we are heading into the right direction. We all know: One swallow doesn't make a summer! We will use the following months to rigorously implement and execute our plan for value creation that we showed you a few weeks ago in our BOOST-presentation. We say what we do and we do what we say! So, the heat is on, and we will not cool off in autumn nor in winter. We announced a further relevant update of our roadmap to you for February next year. And rest assured we will deliver on time! Thanks a lot for your attention. Frank and I look forward to your questions now.