Knorr-Bremse AG

Good day and welcome to the Knorr-Bremse AG earnings call for Q3 2020. Today's conference is being recorded. At this time, I would like to turn the conference over to Andreas Spitzhau, Head of Investor Relations. Please go ahead.

Thank you, Operator. Good afternoon, as well as good morning, ladies and gentlemen. My name is Andreas Spitzhau, Head of Investor Relations of Knorr-Bremse AG. I want to welcome you to Knorr-Bremse's conference call for the third quarter 2020 results. As a reminder, 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 as well. It is now my pleasure to hand over the call to Frank Markus Weber, CFO of Knorr Bremse. Please go ahead, Mr. Weber.

Thank you, Andreas. Dear ladies and gentlemen, I do warmly welcome you to our conference call for the third quarter results of Nordremse in 2020. We appreciate you joining us today and hope that you and your family remain healthy and safe. Today's call is made up of two parts. First, I will present the financial results of the last quarter, followed by an update on the guidance for 2020 and an initial view on the coming financial year. Thereafter, together with my two colleagues in the Executive Board, Dr. Jürgen Wilder and Dr. Peter Leier, we will answer your questions. Before we start the presentation, I would like to say a few words about our employees at Knorr Bremse. The whole Executive Board is very proud of the strong engagement, motivation, and execution by the team in the last months, despite an ongoing challenging environment. Everyone remains very focused and is highly committed to serve our customers and Knorr Bremse as good as possible. We think that is outstanding and worth mentioning before everything else. We are continuing to focus on health and safety as number one priority at Knorr Bremse for our colleagues, our customers and our business partners. So let me start with the main topics of the third quarter on chart two. In the third quarter 2020, again, financials were strong in both divisions and Knorr Bremse was able to give an impressive demonstration of its superior performance and the high level of resilience. In CVS, we saw a strong market recovery and managed to outperform the market once more. Our RVS division also proved its resilience driven by a stringent implementation of the defined measures. In terms of earlier reporting, we now made considerable first progress on our path. Compared to the same quarter in 2019, we already achieved an improvement by eight days. As mentioned before, earlier reporting and the IFRS migration will be a core focus of Knorr Bremse going forward. More to follow in 2021. Last but not least, I am happy to inform you that Dr. Jan Brosek currently Dr. Jan-Michael Mrozik, currently CEO of Digital Industries at Siemens, will be joining the executive management team of Nordbremse as of January 1st, 2021. The whole leadership team is very much looking forward to having him support very soon. We believe that he is a great addition and we will now complete our team. Let me continue with chart three and the market development in the third quarter. On the rolling stock side, global markets further recovered in the last month. The whole rail industry was spared from cancellations, but we still see postponements, which will have an impact on the revenue development of RBS in 2020 and also in 2021. Overall, OEM production capacities in almost all countries further improved to more normalized, almost pre-COVID-19 levels. But we are still in the midst of the COVID-19 pandemic and have to monitor the impact of the currently rising number of infected people basically all over the globe very closely. Stimulus packages with promising links to green mobility are in planning in several countries, which strongly supports the mood and the expectations within the rail industry. The aftermarket business is also affected by the pandemic to a certain extent. we have seen pull-ins from the second half of 2020 into the first half of the year due to the rapid COVID-19 development at the beginning of the year. Due to the ongoing restrictions and lockdowns over the past months, a low ridership in trains is recorded as passengers make adjustments due to social distancing. Nevertheless, we have realized encouraging signs of improvement ridership due to lower number of infected people during summertime Unfortunately, number of people in trains decreased again recently because of the increasing number of infected people. After the very negative impact of the COVID-19 pandemic on the demand for trucks and availability of production capacities in the second quarter 2020, markets for our truck business strongly recovered in the last month. All major markets, for example, North America, Europe and China significantly improved. and short-time work consequently could be suspended. China, where we saw record levels of truck production rates in the second quarter, still shows solid performance, which is expected to be ongoing for the rest of the year, supported by pull-in effects from 2021. The ongoing pandemic still challenges the whole industry, and significantly increasing infection rates could influence the currently positive drug demand and therefore must be watched very closely. Let us proceed to Chapter 4. I will walk you through the most interesting recent events at Knorr Bremse in Quarter 3 especially. We launched a new $3 billion debt issuance program in order to increase our financial flexibility quickly if needed. In October, we paid back €250 million out of the €750 million which we drew at the beginning of the COVID-19 crisis because the negative financial impact by the pandemic was less than expected so far and also beyond. The rail division won a major contract from Siemens for entrance systems for 94 underground trains in London. In addition, it has prolonged The contract with Bombardier regarding the maintenance of braking systems on tracks locomotives by five years. RVS announced that it will equip 30 high-speed ICE trains for Deutsche Bahn with an option of additional 60 trains. In order to meet the strong demand, the Truck Division expands manufacturing capacity in China by building a new plant and continues the strategic cooperation on automated manual transmission, advanced driver assistance, and highly automated driving with Dongfeng. Our spearhead in the North American truck market, Bendix, acquired full ownership of Bendix Spicer Foundation Brake LLC, a joint venture formed with Dana in 2004. Let me continue with the financial highlights overview on a nine-month basis before diving into the details of the third quarter results. On chart five, you can see the summary of the key figures, nine months, year to date. Considering the uncertain economic environment around the world in this very unusual year, Nordbremse's overall performance and resilience resilience since the beginning of the year has been remarkable. The numbers confirm the special robustness that is embedded in Knorr Bremse's business model, even if some segments are more affected by the crisis than others. Nevertheless, KB's results were negatively affected by the pandemic too, even though to a significantly lesser extent than other companies in the industrial sector. During the first nine months of 2020, revenues came in at 4.6 billion, 14% lower year over year. The EBITDA margin reached strong 17.5%, the upper end of our full year guidance for 2020. The free cash flow of 169 million Euro saw a sharp decline versus the previous year's period. especially the first quarter 2020 was weaker than 2019 and even negative. But free cash flow improved strongly in the last quarter and we expect so also in quarter four. Let me continue with an overview of the financial highlights of the third quarter on chart six. Overall, COVID-19 still had an impact on business development in the past quarter. even though performance has already improved significantly compared to quarter two 2020. Order intake was at 1.6 billion for the group and our order book of 4.5 billion remained on a high level and provides good visibility for the coming quarters. At 1.5 billion, revenues decreased by minus 10% compared to the third quarter of last year. Driven organically by both RVS and CVS, but also FX headwinds were recorded. Our EBITDA margin nevertheless decreased only slightly from 18.3% to 17.5% in quarter three, which we consider to be a very good level of profitability. It is a further proof of our resilient business model at Knopheim. The free cash flow in the third quarter amounted to €182 million and was up by nearly 10% compared to the previous year's level. Our cash conversion rate reached 129%. Let me dive deeper into our quarterly results on chart 7. Order intake on group leveling increased by 4% to €1.63 billion compared to the same period in the previous year. On an organic basis, the increase was even higher at around 6%. Compared with the development in the second quarter of 2020, in which we still had to record a decline in order intake of almost a third year over year, the performance in the past quarter was extremely strong. This result was mainly driven by CVS. which was positively affected also by a lot of pent-up demand in Europe and in North America after a very sharp decline before. Our book-to-bill ratio in quarter three was positively impacted as well, reaching 1.06 versus 0.92 in the previous year's quarter. The development of the order book at the end of the third quarter was particularly pleasing. Despite the ongoing impact of the pandemic compared with the previous year's order backlog, it increased by 1.2% to 4.46 billion. This level is only 5% below pre-COVID-19, which we showed at the end of 2019. Let me continue with our revenue development on chart 8. In the quarter of July to September 2020, revenues on group level decreased by minus 10% or in absolute numbers by minus 178 million to 1.54 billion euro. On an organic level, we saw better development. Organic development was better with a decline of only 7%. Compared with the development in the second quarter of 2020, with a revenue decrease of more than 20%, the drop in quarter three more than halved year over year. As in the second quarter, the APEC region must be explicitly mentioned. It entered the COVID-19 pandemic first, but this region was able to continue the good recovery from the previous quarter. As a result, APEC was able to grow by 1% year-over-year and kept the solid demand across quarter three. The regions North America and Europe recorded double-digit sales declines in the third quarter year-over-year, but these decreases were significantly lower than in the previous quarter. Nevertheless, North America still stood at minus 23% versus the levels of 2019. Let me continue with the development of our profitability on chart 9. In the third quarter of 2020, Groups EBITDA was €260 million after €313 million in the previous year's quarter. The EBITDA margin amounted to 17.5% after 18.3% in Q3 2019. This slight decrease continuously resulted from CVS. volume effects of a declining OE business with corresponding impact on the operating leverage and by a lower aftermarket share. Compared with the second quarter of 2020 with an EBIT margin of 17.2%, we were able to post already an increase in the last quarter again. The margin impact of declining OE business was predominantly mitigated by cost initiatives in both divisions, and on group level, which continued in the third quarter 2020. We were already able to reduce some of the measures in the past quarter as the demand situation recovered faster than expected in some segments. For example, RVS was already able to end short-term work in July and CVS ended short-time work at the end of October. The aftermarket share slightly decreased from 38% in the third quarter of 2019 to 36% in the third quarter of 2020 in absolute figures too. Aftermarket was not immune to the effects of the pandemic and recorded a decrease of 15% to 551 million euro. This decrease was driven by both divisions. The group's EBIT of €195 million also saw a decline of €55 million, which is less than half of the loss we did face in the second quarter year over year. At 12.7%, the EBIT margin was below the previous year's level of 14.6%. The higher deviation compared to the EBITDA of the previous year quarter comes basically from higher depreciation due to increased investment activities. In summary, we consider Q3 2020 to be a good proof of Knorr Bremses business model in the continuously challenging market environment. Turning to slide 10, we have initiated the CapEx management program in the recent months and watch ongoing spending very closely. In the third quarter 2020, we realized first effects from these measures. Accordingly, investments did not only increase slightly compared to the previous year in relation to sales. Investments were above our target range of 4.5%. We expect that with increasing sales, we will again be in this range of 4 to 5%. A substantial amount was invested in future growth options for both divisions. We continue to expand the capacity for air disk breaks in North America to support our market-leading position in this segment. We also made strategic investments in further software development for our global steering business and continue to invest what's necessary in technology and innovation. Networking capital at the end of the past quarter showed an increase to almost 1.2 billion euro. The year-on-year increase was around 100 million euro. which is less than in the second quarter where we had a plus of 150 million euros year over year. This development was mainly driven by measures to ensure the ability to supply our customers. Our corporate policy, customer first, is very important to us and has been a cornerstone of our business success for decades. Accordingly, we have kept a higher level of inventory to support our customers in those difficult times, and prevented a potential disruption of their supply chains, as well as granted longer payment terms for some customers. As a consequence, we also accepted a higher level of working capital. Nevertheless, we are continuously working on further optimizations and will reduce our working capital during the last quarter, but will still be prepared for a quick ramp up of a business in the first quarter of the year 2021. Annualized operating ROSI was impacted by both lower EBIT and increased working capital, but still with 22.2% well above most other companies in the capital goods sector. On chart 11, I would like to continue with the cash flow KPI. Our free cash flow in the third quarter 2020 reached 182 million, which is 10% higher compared to the third quarter 2019. It is more than three times higher compared to the second quarter of 2020. This significant increase is predominantly driven by stronger profit quality of our underlying projects and products and effective countermeasures regarding cash preservation, such as optimization of capex and inventory, but also on reduced tax prepayments in regards to the tax authorities. Based on the ongoing installed measures and driven by a normal seasonal pattern, EG projects tend to be finished at year end. We expect free cash flow to be significantly strong in quarter four 2020 as well. As mentioned in the second quarter presentation, the cash conversion rate is a very important KPI for me and for us. As a reminder, our definition is free cash flow before M&A in relation to the net income. In the third quarter 2020, Knorr Bremse reached a cash conversion rate of 129%, following 90% in the previous quarter and 41% achieved in the second quarter 2020. While it was strongly negative in quarter one with a minus of 43%. On chart 12. I would like to give you an update of the overall impact of the COVID-19 pandemic on our two businesses. Our Knorr Bremse team is very closely monitoring the market situation and is prepared to act quickly if necessary. Overall, we have seen a good market recovery in the third quarter, both in the rail but even more so in the truck industry. The major rail markets in Europe and APEC have further recovered. even though pre-COVID-19 levels have not yet fully been reached. We have not faced any cancellation of projects, but several projects are still subject to shifts and postponements. Therefore, also other intake, revenues and earnings might fluctuate from quarter to quarter. In North America, the freight market still faces challenges such as a lower number of built rail cars or parked locomotives. Ridership remains again on lower levels, but the development in the recent months was encouraging. The long-haul passenger traffic of Deutsche Bahn in Germany, for example, was down to 15-20% at the peak of the first wave of COVID-19 compared with the pre-corona timing. In the summertime, this level improved to around 75%. Currently, Germany, like many other countries, is in the middle of a second major lockdown wave. Accordingly, the capacity utilization of trains in the German long-distance passenger traffic is again down to around 20% of the pre-corona level. This development shows us that passenger numbers on trains will recover very quickly when the impact of the pandemic is reduced. What does this mean for our rail divisions? Our suppliers have showed a stable development in recent months and have, more or less, returned to pre-crisis levels. Our own plants currently are at high capacity utilization and productivity as well. The key sales markets of our truck division have recovered significantly from the lows and are still showing continuously ongoing improvements. Currently, our U.S. customers are back to approximately 90% of pre-COVID levels and the European ones on levels of 90-200%. Towards the end of the quarter, transport activity was back on roughly the same level as a year ago in most markets. The Chinese truck market remains a class of its own with market development on a high level even after record levels in quarter two of 2020. Japan and India further recover on a moderate level. In order to meet the increasing demand of the industry, we have taken precautious measures with our suppliers and at our own plants, e.g. securing the part supply and increasing the safety measures at our own production plant even more. Let's move on to the divisional view, starting with RBS on slide 13. In the third quarter of 2020, order intake of rail vehicle systems was at €726 million, a decrease of 24% in total and 20% on an organic basis. Impacts by the pandemic, which led to tender shifts and postponement, were the main driver for this development. Besides, I would like to remind you once more that developments in the rail industry with its long cycles do not go well with quarterly reporting, so to say. There are always fluctuating large orders in individual quarters, which make comparisons difficult. The low order intake in the third quarter of 2020 also resulted from a major order in Germany in the amount of significantly above 100 million euro, which Kipe Electric was not able to sign. In addition, there was the postponement of the 20 million euro contract in Taiwan. We firmly believe that RVS order intake in the fourth quarter 2020 will be meaningfully higher than in the last quarter. The book-to-bill ratio developed accordingly to the lower order intake and moved from 1.04 in the third quarter of 2019 to 0.88 in the third quarter of 2020. The order book, on the other hand, increased by 3% year-over-year and finished the third quarter at 3.4 billion euros. This level of order book is only 5% below the record level we have achieved in recent years. It provides a good visibility for the revenue development in the coming quarters and it shows the overall stability of our business. I am now moving on to the revenue and profitability of the rail division on chart 14. In the third quarter of 2020, RVS recorded revenues of €822 million, which only decreased by minus 5% organically year over year, but minus 10%, including FX and M&A effects. RVS recorded slightly declining sales in both the OE and the aftermarket business in the third quarter of 2020 year over year. As already mentioned in our last call, RVS recorded pull-forward effects from the second half of 2020 into the first half of the year in the aftermarket segment. Accordingly, revenues in this segment in the third quarter of 2020 were overall around 10% below the previous year's figure. Europe, which was affected by the pandemic, contributed about 40% of the year-on-year decline in the division sales, Predominantly, the OE business was affected by lower revenues for metro and light rail vehicles. The divisional passenger business overall grew and the aftermarket business mitigated the decline of the European business. APEC, including China, also declined overall, but less than Europe. We see that this region has already recovered significantly from the pandemic, but please keep in mind, it will take time for the process speed to return to normal level. Almost all revenue segments declined year over year. Despite this, our metro and locomotive business stood out positively, recording growth, particularly in China. In North America, we recorded an overall decline. Lower revenues, predominantly in freight, could only be mitigated by the development in the service business. The profitability of RVS in the past quarter was certainly remarkable when considering the respective revenue crop. EBITDA of RVS came in at €178 million in the third quarter 2020 and was down only minus 6% compared with last year's levels. The EBITDA margin increased from 20.6% to 21.6% and EBIT margin 2 increased from 17.3% to 17.8%. These margin improvements are also based on the following topics. First of all, the COVID-19 measures had a large impact in supporting profitability in this third quarter. Please keep in mind that the measures are predominantly of a short short-term nature. Nevertheless, we intend to make the biggest part of it possible, sustainable also for further years. Second of all, we sold the loss-making power tech unit, which supports our business beyond quarter three, 2019. I would like to continue with the development of our truck division on slide 15. Incoming orders of CVS were exceptionally strong and one of the highlights of the key figures in the third quarter of 2020 overall. At €902 million, the overall figure was 45% higher than in the previous year and fully in line with the organic development. This development is very pleasing after the severe negative impacts on demand throughout the COVID-19 pandemic, especially in Europe and North America. Both regions benefited from catch-up effects in the last quarter. In APEC, the development of order intake was again supported by China, already after a record demand in 2020, quarter two 2020. Japan and India also saw a solid recovery since the very low levels in the first half of 2020. The order book of our truck division amounted to 1.1 billion euro at the end of September 2020, which is a slight decrease year over year. The order book level of CVS therefore has almost reached pre-COVID-19 levels, among other things also supported by the acquisition of Shepard. Let's move on to slide 16. CVS posted 712 million Euro in revenues for the third quarter of 2020. Compared with last year's figure, this is a decrease by nearly minus 11% and on an organic level of minus 10%. In North America and Europe, the decline in revenue in the last quarter was more than halved compared to the development in Q2 2020. Both regions were nevertheless still strongly affected by the pandemic, but we saw a steady improvement in the general conditions. The North American truck market also improved in quarter three, although a little bit lower due to tougher comparable figures last year. The APEC region again recorded revenue growth in the third quarter year over year, well supported by China and market share gains from our commercial vehicles divisions. The share of aftermarket slightly decreased from 30% in the previous year to 27%, which is due to a very strong OE business in this respective quarter three of 2020. In the third quarter, CVS achieved an EBITDA of 102 million euro, which is significantly lower compared to the previous year, but is a doubling versus the second quarter 2020 with only €51 million. The EBITDA margin amounted to 14.3% compared to 16.3% a year ago, but also here. Compared to the second quarter 2020, it is a margin improvement by almost 600 basis points. In the past quarter, CVS also benefited from the successfully implemented cost measures. In addition, better capacity utilization supported profitability compared to the second quarter 2020. On chart 17, we compare the regional sales development of CVS with the regional development of TPR. In addition, we would like to give you our assessment of the TPR in the key regions until the end of the year 2020. Basically, we are quite confident regarding the truck industry in the foreseeable future. CVS once more strongly outperformed the underlying truck production in all major regions and markets year over year in the third quarter 2020. The CVS performance driven by further growth in content per vehicle and market share gains predominantly in the APEC region. Until year end, we expect an ongoing positive trend in truck production rates in Europe and in APEC, The rate in North America should be able to experience a stable development in quarter four versus quarter three. The drug production rates in China are also expected to continue strongly, driven by subsidies to accelerate replacement of vehicles with higher emission standards, as well as further governmental support. Let's move on to chart 18. which shows our management agenda and things we are on the way to change to support our future development. Please let me dive deeper into five rather important topics for us. First, as announced in the second quarter 2020 conference call, cash flow has and will have an even higher priority at Knorr Bremsen. In the third quarter 2020, free cash flow already improved to €182 million after €48 million in the second quarter 2020. In order to underline this focus, we are planning to include free cash flow target 2 consistently into our management and staff bonus system. Second, the world is changing and sustainable management is becoming increasingly important. We see no contradiction here with the interest of our shareholders. On the contrary, only those who grow profitable have the freedom to successfully implement sustainability topics. We also see opportunities here. Our rail division in particular is clearly benefiting from the desire for more sustainable and greener mobility. In order to strengthen the rising importance of ESG topics within Knorr Bremse, We are also planning to integrate concrete ESG targets into the compensation package as soon as possible. Third, earlier timing reporting is one of the focus topics going forward. We completely changed the setup of our IFRS migration project to strengthen our effort and ensure a respective go-live of the project. As an example, we also intend to include the IFRS migration project into the management bonus system. Number four, as a relatively young company at the capital market, we want to rise the capital market thinking and understanding within Snowbremse further. Therefore, we will expand the stock-based long-term incentive program for our middle management and implement a share program for all our global employees. where Knorr Bremse would subsidize a certain purchase of Knorr Bremse shares, our employees. Last but not least, overall we believe that Knorr Bremse has a very efficient and lean overhead and administrative setup. But as in every other company, there is always room for improvement. We want to further optimize our internal processes, and digitalize our activities to a higher extent. For example, we are currently organized on a regional basis to be as close to our customers as possible. Why shouldn't it be possible in the next step for efficient regional locations to take over overlapping administrative tasks on a global level? That is, for example, what we mean with the acceleration of global business services at Knorr Bremsen. Let's move on to chart 19, the outlook for 2020 and for most of you also quite important. Overall, SnorBremse performed strongly in the first nine months of this extraordinary year. Our rapidly implemented countermeasures were well able to mitigate the market turbulences in both of our divisions so far. Due to the positive development in the past three months, and the expected development in the fourth quarter, we confirm the guidance given in July 2020. Despite the fact that we did face some FX headwinds, especially in last quarter, subject to further lockdowns due to the COVID-19 pandemic and any related negative effects on the course of business until end of the year, we continue to expect revenues between 5.9 billion and 6.2 billion euros. and operating EBITDA margin between 16.5% and 17.5%. Overall, we feel comfortable with the upper end of both ratios. I would like to end the presentation with chart 20, which gives you our first thoughts for 2021. We are currently in the planning process here at Knorr Bremse for the next year. We should be completed over the next few weeks. So, in a nutshell, we would like to share with you our market outlook, our strategic focus, and the resulting first high-level indications for financials in 2021. For the rail segment, we expect the passenger market to develop strongly, and the aftermarket overall should only be partially developed. influenced by lower ridership in trains next year. In Europe, we expect more details regarding the Green Deal initiative, which clearly will be positive for the rail division mid to long term. On the other hand, we also expect that the autonomous policy in China will continue to grow, which will affect our rail business in the medium to long term as well. Overall, however, the opportunities in Europe should be much greater than the potentially negative effects in China. According to our initial assessment for 2021, this should lead to a solid increase in RVS revenues, as well as even a slight growth of the EBITDA margin. On the CVS side, initial European and North American data for the truck market suggest significantly higher volumes for 2021, The development in China should be negatively influenced by pull-in effects from 2021 into 2020. The overall aftermarket is expected to recover based on the assumption that transport volumes will recover too. Our strategic focus in the truck segment will concentrate on further increasing the content per vehicle, further integrating the acquired companies in the steering sector, and further expanding of our Chinese business in general. We currently expect CVS should be able to deliver solid growth in revenues and solid EBITDA margin improvements in 2022 compared to 2020. Once again, these statements do not represent a guidance, but they should help you understand the market and the conditions in 2021 as we see them at this point in time. Please note that these first indications for 2021 are subject to two important conditions. First of all, a generally stable market environment in rail and truck. And second of all, the negative financial impacts of COVID-19 are limited and manageable. With this, I would like to thank you very much for listening and for attention. Mr. Lyre, Mr. Wilder, and myself are looking forward to your questions from now. Thank you.