Knorr-Bremse AG

Hello, ladies and gentlemen, and welcome to the Knobrand, the AGQ223 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 Spitzhauer. Please go ahead.

Good afternoon, as well as good morning, ladies and gentlemen. I hope all of you are very fine. My name is Andreas Spitzhauer, Head of Investor Relations of Knobrand, the AGQ223. I want to welcome you to Knorr Bremse's conference call for the second quarter results of 2023. Today, Martin Sesea, 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 Investigation section. Here you can find today's presentation and later a transcript of the call. It is now my pleasure to hand over to Martin Sesea. Please go ahead.

Thank you, Andreas, and welcome everybody to our conference hall, from my side. Before we get started, I would like to take the opportunity to express my deep sorrow about the sudden death of Simon Strachan, C.S.O. Joplin. For me personally, Joplin was a highly valued former colleague, always fair, always great. My heartfelt condolences which I expressed on behalf of the entire Knorr-Bremse Group goes to his family, to whom I wish much strength at this difficult time.

Thanks, Mark. Let me tell you that for me, words can hardly express what I feel. I'm deeply saddened about Jochen's sudden passing. Jochen was much more to me than a very long-time 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 to my former colleagues at Daimler Truck.

Thank you, Franz.

So, 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 number two, which is our main messages of today. Number one. We continue to see strong growth in 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. As promised at the Q1 2023 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. Together with Indian Railways, number three, 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 for Indian Railways will decrease near term. Number four, a meaningful part of our boost program is brownfield housekeeping, which we presented to you in our strategy update. A major cornerstone of this is the focus on portfolio optimizations. It took quite some time, but we could sign a deal to sell our group subsidiary, Keeper Electric, to Aramba. 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 one and two 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 validations through the Science-Based Target Initiative, SBTI. This was a major step forward and shows our strong commitment to sustainability. Number six, last but not least, we confirmed our guidance and increased our revenue target for 2023 from 7.3 to 7.7 billion euros to 7.5 to 7.8 billion. Next slide, please. On chart three, I want to share our market view with you and focus on five main messages. Overall, the good demand in the rail industry continues, driven by the political wish to support free mobility. After corona, ridership levels and rail traffic are recovering across the globe. As a result, aftermarket business growth and performance decreased with 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 Mekong, however, is still challenging as the provinces and municipalities suffer from the weak real estate market and the accumulated theft burden of the past coronavirus. 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 in a four-year basis. Overall, in terms of demand, we hardly see any signs of weakening. In addition, concentrated vehicle growth is supported for CVS. After the Chinese truck market struggle last year, we see a strong recovery in 2023. CVS benefited from this recovery due to our leading market position and leading position in the field of technology. In addition, there are good opportunities regarding concentrated vehicles driven by rather lower safety standards and moves towards innovative and reliable technology also in China.

Chart number four.

Let's move to the second quarter KPIs on chart number four. All major financials move higher year over year. The most important one for me was that the operating average margin is up by 60 basic points to 11.1 in the second quarter of 2023. This development was driven by higher revenues and the success of our cost beneficiaries. In addition, Audible reached a new record high of €7.1 billion. It provides good visibility and confidence for the quarters ahead regarding utilisation rates. Last but not least, free cash flow It turns for the distant quarter to act time than we expect, and we expect this good trend to accelerate further between now and the end of the year. With this word, I would like now to hand over to Frank for the financial insights. Frank, please. Thanks, Mark, and the figure comes from my side as well.

Let's move to chart five. CapEx in the past quarter amounted to 75 million euros, representing 3.7% of our revenues. They were 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 spending towards the end of 2023, as usual. Networking capital increased by roughly 180 million euros versus last year's level, but scope of base 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 sales will strongly decrease in the second half of the year. Rosy for the second quarter of 2023 increased rightly 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 six, I would like to provide you more details regarding our free cash flow, which was positive as expected and came in at plus 34 million euros in the past quarter. With that, some 69 million euros better than in the previous year. In the first half of 23, the improvement even added up to around 100 million euros. Traditionally, our free cash flow is significantly weaker in the first half of the year and 23 is not an exception. The biggest impact on the development of our free cash flow is still the higher networking capital. The major driver for this was the increased accounts receivables among some larger customers, which tend to delay some payments. In addition, we still 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 currently 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 and indirect purchasing, logistics, supply chain, as well as days and after-sales in order to systematically improve our networking capital again. Therefore, I expect in the quarters ahead that we will improve KPIs, also driven by higher payments from Indian Rail, again after the finalization of the performance. I am still confident that Knorr Bremse will reach its free cash flow guidance of €350 to €550 million in 2023. Let's take a closer look at the divisional performance in Q2, starting with RBS on chart 7. In the second quarter of 2023, order intake in the rail division was again very strong and above a billion euros. 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 seventh consecutive quarter and reached 1.07. This development will support the positive strength of RBS. It is particularly important for me to mention that the current price quality for new long-term orders at the same as it was before the sharp increase in inflation last year. The order backlog of 30th of June amounted to 5.1 billion euros, reaching again a new record high. Let's move to chart A. Revenues of RVS in Q2 amounted to €958 million, 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 of 2023 was €141 million, up 19% year-over-year. As a result, the operating EBIT margin increased from 14.3% to 14.7% in the second quarter. The main drivers for our margin improvement were, first of all, good operating leverage driven by higher revenues in all regions. Second, the aftermarket revenues in China, which increased double-digit versus the previous four-year quarter, because of the sharp increase in ridership following the end of the zero COVID policy. We also recognize pull-forward effects on train maintenance and spare parts delivery. Therefore, it remains to be seen whether this level of the second quarter will be sustainable in the upcoming quarter. Last but not least, price measures and cost improvements could offset some of the inflation as well. We also expect a solid development of profitability in the coming years due to a very solid revenue development and further successes of the profit and cash protection program. But at the same time, stick to our forecast that RBS margin for the 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. These coming orders of CVS amounted again to more than a billion euros, which is an increase of 18% year over year. Main drivers for this significant growth were Europe and APEC, especially China. This is on good demand for transportation service. The order book of our truck division amounted to almost 2.1 billion euros, which is again remarkably 7 percentage points higher year-over-year. Let's move to slide 10. Thanks to price increases in higher volumes, CVS posted a 15% year-over-year increase in revenues to 1.5 billion euros in the second quarter of 2023. The division was able to increase revenue in all regions. Operating EBIT in our CVS division amounted to 98 million euros in the past year, up 31.5% year over year. As a consequence, the operating EBIT was 6.1 to 9.3 due to the strong aftermarket, successful implementation of cost measures and higher customer price. We are close to successfully finish our second round of price increases, our so-called Wave 2, which will support CVS EBIT and EBIT margins, starting from the third. And with that, I hand over to Mark for the guidance 23 and final remarks.

Thank you, Mark. Thank you, Frank, and sorry for my cutting. I don't know, an allergic reaction. I want to finish with our guidance for 2023 on chart 11. Our main assumptions are as outlined on the right side of the page. As one aspect of those, we expect that all next extra costs due to the inflation also this year will be once again compensated with our comprehensive PCT measures. For 2023, we now expect an increased revenue target of 7.5 to 7.8 million euros. This uplift was mainly due to a higher than expected truck production rate and a better development of the aftermarket in the real division. Furthermore, we expect an operating EBIT margin between 10.5% and 10.8% and a free cash flow between 350 and 550 million euros, which concerns our guidance. On chart 12, as you can see, quarter 2 results have shown first signs that we are heading into the right direction. We all know When Swallow doesn't make it summer, we'll use the following months to vigorously 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 it 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 assures we will deliver on time. Thanks for your attention. Thank you very much, Frank and I myself. We will look forward to and to answer your questions now.

And the first question comes from Sven Weyer. Please go ahead.

Yeah, good afternoon. Thanks for taking my questions. First one is on RBS, where you mentioned on the EBIT price that the price increases compensated high inflationary costs. And Q1, you were still a bit more reserved on that in terms of only partial compensation. So are you making quicker progress there in terms of the impact of the legacy contracts than you assumed so far?

Sorry for the delay. We had a technical issue here.

Thanks, Ben, for your question. Basically, the plan going forward in regards to the degree of compensation of cost via pricing has not changed. Maybe kind of an understanding issue that we have here. It's clear that last year overall we were able to roughly compensate 66%. of our cost increases via pricing only. This year, we should overall, for the whole group, be able to achieve roughly 80%. And towards next year, it will then again get better until it's completely consumed, so to say. And this plan has not changed. It's gradually getting better, but it's not fully compensated yet.

But in Q2, it was. Now we have, at least.

Pardon? Q2 it wasn't. It wasn't. It was compensating but not to the full extent.

Okay. I just referred to the comment on the slide on slide number 8 where you said price increases and cost measures compensated high inflationary costs so maybe not fully.

Prices and cost measures fully compensated but not price measures only.

And then just on the second point regarding China and wider shares and reopening, were you also a bit surprised by this? Because on the strategy update, you sounded still a bit more defensive on China. You said aftermarket was already relatively sound also during the pandemic, so the catching up there was maybe not so much needed. I was just wondering what has changed between now and the strategy update.

I think the very general outlook, I wouldn't say we were surprised. We said that we do expect out of this change, drastic change of the zero Covid policy. Some had tailwind on the aftermarket side, but not on the OE side. We still see in actual results and also in our outlook for the full year in regards to the production assumed for metros as well as for high-speed trains, the same numbers that we have talked about just several months ago when we do think that maybe on the OE side we can reach some 100 high-speed trains throughout the year and we can see the same level of roughly 5,100 metros within China. So OE isn't the big lever for impulses in 2023 for us. This is still confirmed on the aftermarket side a bit as ridership levels have really grown strong there in the first quarter and in the second quarter, which were even higher, above 2019 pre-COVID levels already. And this is a bit better than we thought indeed. And also this resulting aftermarket business, including some pull-forward effects in the second quarter, is stronger than expected.

Could you quantify the improvement you saw in China's frequency on the aftermarket?

Yeah, it's a double-digit Euro revenue number, I would say, in the quarter alone. And the big question out of that is you can hardly distinguish clearly what are really pull-ahead effects from customers trying to get their shelves uploaded. This is difficult to say what's out of that kind of sustainable, but low to mid double-digit revenue figure in terms of euros, million euros. Okay. Thank you, Frank. You're welcome, Sven.

And the next question comes from Akash Gupta.

Please go ahead. Yes, hi. Good afternoon, everybody. It's Akash from J.P.

Morgan. My first one is on the guidance. So While you have raised your revenue guidance, but if you look at the implied second half, the midpoint is kind of implying flat year-on-year growth after you have reported 15% revenue growth in the first half. So can you elaborate, like, is this only because of the accelerated pricing of backlog in the first half, or are you just taking a more conservative view of the second half development? That's the first one.

I think that the distribution between the quarters and the half-year one and half-year two has also not changed if we look at our forecast levels. The fact is just that a bit stronger quarter one and quarter two came in on the CVS side. You know that we have been a bit more cautious potentially there over wintertime and giving you the guidance. a bit for CVS development, but we already back there saw that towards the second half of the year it's getting a bit weaker in terms of revenues and this has nothing to do yet with a significant drop in order intake that we would expect. We have a quarter coming up, which is usually a rather weaker one on the supplier side, at least as also our customers go into kind of summer vacation in regards to their plants. So this is typically a lower one, and the fourth quarter is still a bit out there. Given the current EDI numbers that we have, we also see it a bit on the weaker side. So that, so to say, hints to the imbalance that you point out in between half year one and half year two.

Thank you. And my follow-up is on the guidance, again, from this TP electric divestment. Can you elaborate more on the financial implication of this divestment and whether there will be any impact that we should see later in the year?

First of all, as we talked about, the key bill overall isn't that much of a performing unit of ours. That's the reason why we are in the current process. And as we are already now in August and we have baked in basically already kind of six to eight months into our actual results, it will not make a big difference, so to say, for our guidance evidence whether it will be closed in August or in October or so. If we could close the deal as soon as possible, there would be a slightly positive effect for the remaining months to come. That is clear, but this is not the make or break point for reaching our guidance.

Thank you. Thank you, Arkas.

And the next question comes from Gilde Bright. Please go ahead.

Oh, thanks very much. Good afternoon, everybody. I have two questions, Peter. The first one is about CVS. Could you quantify or at least provide more color on the magnitude of the wave to pricing agreements which were concluded in the first half? And then the second question is on the strategic program and following the the update you had in July. I think it would be useful if you could provide some color and maybe regular updates on the growth and margin performance of the 1.4 billion euros of revenue that's under review and perhaps starting now.

Thank you for your questions. First, I mean, the the wave 2 that we're currently basically finalizing as we speak. This is in the dimension of similar magnitude like we have had in last year, so to say, but comes needless to say on top of it. Last year's negotiations have been also sustainably increased in the price levels. So similar amount to what we were talking about last year. Last year we were with that kind of two-thirds of the inflation compensated by pricing only on the group level. Two-thirds of that last year came from trucks and in that similar amount we are talking year over year than for the CDS colleagues in 2023. That's the wave too. In regard to the 1.4 billion that we talked about in the strategy update, it's like you can also see back in the days on the slide. that we showed in the margin walk is we roughly expect a level of 200 base points of EBIT margin improvement out of the respective countermeasures for the non-performing units that we're having and they could either be selling those units or fixing them or bringing them up to the levels that we strategically target.

So we confirm what we said back then, 200 base points roughly. Okay, I will do that. Thank you very much.

You're welcome, Gail.

And the next question comes from Riddick Vida. Please go ahead.

Thanks very much, everyone. Good afternoon. I have two questions on demand. So the first question is on rail. Your rail orders have remained at a high level so far this year. Do you expect to be able to continue to get orders at around that $1 billion per quarter run rate in RBS for the rest of the year? And maybe if you could give any updates on how your order pipeline is developing.

Thank you. Thanks for the question. We also do... I think that ASTRO now very, I think more than four, five quarters in a row with more than a billion of all the intake on the RVS side. And you know also kind of this project business is not kind of sustainable where you can like cutting coupons. forecast into the future. We do expect that all the intakes should be a bit lower. Moving in, given all the tenders that are out there, we have the transparency basically all around the world in these conditions. Just given the tenders that are out there, we do expect all our intakes to go a bit down going into the next four months. but this does not at all fundamentally change our core and strong belief of a fully intact growing market in RBS in basically all regions, like you said, except for maybe China, if you take OE here as a case. So this is the situation. A bit less of an intake to be expected, but not at all a change in the fundamentals.

That's very helpful. Thank you. My next question is on trucks. With the comments on trucks remaining at a good level, I was wondering if you could give any latest thoughts on where the truck cycle will develop into 2024, if you have any.

Thank you.

So when you speak about trucks, you speak about nations, right?

So in Europe, we see civilization on the high level. In North America, we see it the same. And in Asia, mainly in India, especially on China, we see extreme recovery. The question is now, we see a slight slowdown in the recovery in China. We see a steady increase in India, which is unfortunately not that important so far for us, because the content of the vehicle in India is not a third of what we are used in other markets. The significance of this market will be an upside for the near future and the next future, but it will not be a game changer for the next six or 12 months to come. What we see in China is that it will be the question when the Chinese truck market is picking up to the level of the cars. And that is something which will come from our point of view relatively erratic. It can be faster, it can be slower than expected, so we cannot say when it is coming. But one thing for sure, you see the acceleration in the truck market by volume, and now the question is, when is the acceleration coming by content per vehicle and by the level of technology? That is the name of the game in China. Flex the volume itself, whether it's 700,000 or 800,000 units this year, It's more the question, when do we see that the latest technology will be built in? That's more a driver for the Chinese market. Besides the others, we are always, and you know that now, for at least the next six months, last six months, we have been a little bit modest and a little bit moderate with all numbers, because if it gets better, it's good for you, it's good for us, and if it gets what we expect, then it's okay, that's the baseline. So we say we see no significant acceleration growth in the key markets, Europe and EFTA, but we see a massive, interesting shift will come up the next five years in China. So for the next six months, it could not be, but it could be very, very easily the case in 12 to 18 months.

Thank you very much. And the next question comes from Lukas Verhagen.

Please go ahead.

Thank you. My first question is on RVS. There was a big step up sequentially in the margin. How do you see the margin moving going forward? Is it likely to be a bit more stable? Could it be a bit lower? I think you said there was some kind of pull forward of aftermarket demand in China, for example, that potentially could impact in H2. So how do you see a little bit the margin development in areas specifically in H2? Okay.

Thanks, Salve.

I would like to start that. As you rightly said, we had a certain form of surprising uprise of the aftermarket in China, which was in fact good for our margin. But in order to be also very clear, even there is a certain form of downside in this, like a pre-ponement. We can say that in the overall business, in the overall, also in the OA business, you see a release of the pressure, because now more and more of the new orders are coming into, fall into place. That means, as you rightly know, because we communicated this very clear, from the activated OE business this year, 31% of this business in RBS was to prices before Ukraine, but cost after Ukraine. So this was a certain form of burden to the business. More and more in the year to come, we will see a release of this 31 for the whole year, and we will see new contracts coming into and falling into place. So this will have, this is more a tailwind. And you see the procurement of the market and the orders and the billing in China for RVS, that is a slight headwind for us in the next six months to come. This would be a slight tailwind to come. But in 2024, we have only 10% to 50% of the so-called pre-inflated pricing orders. That means the real kick-in of the margin improvement will come then the next month to come, especially the next year to come. So for the next half year, we don't expect any acceleration of our margin, but we don't see a massive increase of the margin. What we see then for next year is supported by what I just described. But Frank, please add to this. Yeah, thanks, Marc.

Absolutely correct. I mean, going towards the half year two, I would guide you with a kind of a level that is roughly on the half year one level, which is potentially in a quarter, even below quarter two. but definitely above quarter one's level. So this is what you can see. And as it's a project business, it's totally different kind of revenue scope that you would potentially have in the first quarter compared to the one that you would have in the fourth quarter. So that's just the kind of volatility that you, of course, have in the structure of the product mix.

Perfect, thank you for that. My second question is on kind of the guidance. Again, you increase the revenue, very strong orders in H1 that gives you visibility into H2. You kind of know the moving parts in terms of what's going to be the margin. I'm just surprised they're not narrowing maybe a little bit the edit margin guide. seem quite conservative now to kind of be at the at the lower point so what risk specifically do you see uh which would lead to kind of a lower margin in h2 or you not being towards kind of the the middle top half of the range um by the end of the year uh basically this is due to the fact that uh so to say that all of after the negotiations wave one wave two uh you have uh in the meantime a very good kind of

back-to-back insurance in regards to inflationary cost increases but at the same time also in regards to cost reductions that you would potentially see. So you have to give away then also a certain pricing once costs come down. Compared to your assumptions like energy costs or personnel costs on your or our supplier side, CO2, CO3, CO4, what have you. If this is coming down, then you also have to reduce the price levels again towards the end customer. That's just the nature of the game. And as this is kind of still a situation that is ongoing, there's not so much fluctuation around the margin anymore. And I think with the midpoint, as a result of this, with the midpoint of the margin, you're on a safe side, so to say. And narrowing it down further compared to this, I mean, there's still issues out there in regards to the project dimensions on the RBS side more or less, which is, of course, not that plannable as there are big tenders usually out there and big deliveries out there which can easily, so to say, cause a 50 basis point up or 50 basis point downside.

That's the reason. Okay, perfect. Thank you. Okay, so at the moment there seems to be no further questions. So if you would like to state another question, please press 9 and the star key on your telephone keypad. I will leave the line open for a couple more seconds.

Okay, in case there are no further questions, then thank you very much for your time and your attention. We wish you a great summer holiday. Looking forward when you are back that we talk to each other again, and thanks a lot.