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Edited Transcript of HMSG.L earnings conference call or presentation 17-Dec-19 1:00pm GMT

Q3 2019 HMS Hydraulic Machines & Systems Group PLC Earnings Call

Moscow Jan 9, 2020 (Thomson StreetEvents) -- Edited Transcript of HMS Hydraulic Machines & Systems Group PLC earnings conference call or presentation Tuesday, December 17, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Inna Kelekhsaeva

HMS Hydraulic Machines & Systems Group plc - Deputy Head of Capital Markets

* Ulyana Egorova

HMS Hydraulic Machines & Systems Group plc - Specialist of Capital Markets

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the HMS Group 9 Months 2019 IFRS Results Conference Call.

I will now hand you over to your host, Ms. Ulyana Egorova. Madam, please go ahead.

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Ulyana Egorova, HMS Hydraulic Machines & Systems Group plc - Specialist of Capital Markets [2]

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Good afternoon, ladies and gentlemen. Thank you for joining us for HMS Group webcast devoted to IFRS financial results for 9 months of 2019.

Before we start, the company would like to pay your attention to the responsibility limitation for the forward-looking statements, which will be made during the call according to the disclaimer. Any statements made or discussed today that do not constitute or are not historical facts, particularly comments regarding the company's future plans and expected performance, are forward-looking statements that are based on assumptions the company believes are reasonable but are subject to a range of uncertainties and risks. Many external and internal factors could cause the actual results to differ materially from those contained in the company's projections or forward-looking statements.

Now let me represent the speakers. It's Kirill Molchanov, First Deputy Chief Executive Officer and Chief Financial Officer; Alexander Rybin, Head of Capital Markets; and Inna Kelekhsaeva, Deputy Head of Capital Markets.

Now I'm handing over the call to Ms. Kelekhsaeva. Dear Inna, please go ahead.

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Inna Kelekhsaeva, HMS Hydraulic Machines & Systems Group plc - Deputy Head of Capital Markets [3]

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Good afternoon, ladies and gentlemen, and thank you for joining our webcast. Let's start our presentation.

For the 9 months 2019, revenue increased by 15% year-over-year to RUB 36.7 billion compared with almost RUB 32 billion for the 9 months 2018 due to the growth in the compressors business segment. In terms of contract start, revenue from recurring business grew by 18% year-over-year and revenue generated by large contracts was up by 9%.

EBITDA declined to RUB 3.4 billion by 21% year-over-year, mainly due to weak performance of the oil & gas equipment and project business segment. In terms of contracts, EBITDA from recurring business increased by 37% year-over-year and from large contracts decreased by 45% year-over-year. EBITDA margin was down to 9.2% compared with 13.6% for the 9 months 2018.

Gross profit was down to RUB 7.1 billion by 13% year-over-year compared with RUB 8.1 billion for the 9 months 2018.

Operating profit was down to RUB 1.6 billion compared with RUB 2.7 billion last year.

Profit for the third quarter together with the second quarter compensated the loss in the first quarter, so profit for the 9 months was RUB 195 million, but it was lower by 83% year-over-year compared with RUB 1.3 billion profit for the 9 months 2018.

Total debt increased by 10% to RUB 21.1 billion. Net debt was up to RUB 17 billion. Net debt-to-EBITDA LTM ratio grew to 2.98 compared with 2.4 for the 9 months of 2018.

Next slide, please. HMS demonstrated temporarily weak results due to a combination of several main factors. And the first factor was a change in a mix of large contracts portfolio, large contracts based on compressors increased their share in the portfolio, and they traditionally have lower margins compared with pumps and oil & gas equipment. HMS addressed this by working on prospective profitable contracts. Today, the company has signed already a sustainable volume of large contracts in the pumps and the compressors segments. In the oil & gas equipment and projects segment, the portfolio of large contracts is improving. In addition, based on a current pipeline of large products, the oil & gas equipment and projects segment has a potential of the further portfolio's development.

The second factor that affected HMS' results were weak results of the oil & gas equipment and projects business segment in recurring business. HMS had analyzed the factors that affected financial results of the segment and has taken actions to mitigate their impact on the next year financial results.

The third factor was the postponement of a number of oil & gas equipment deliveries from the third and fourth quarters of 2019 to the next year due to customers' decisions. On the one hand, this factor will affect and has already affected this year financial results, and on the other hand, it should positively influence next year financial results.

The fourth factor was the Arctic Cascade project of NOVATEK. This was the first ever HMS project in the field of designing and manufacturing of compressors for liquefaction of natural gas. HMS Group had analyzed the project and has taken actions to prevent losses in foreseeable projects of that kind. The equipment was manufactured under the innovative proprietary natural gas liquefaction technology called the Arctic Cascade patented by NOVATEK in 2018. The aim of the project was to localize the manufacturing and assembly of LNG equipment to decrease the overall cost of liquefaction and develop a technological base within Russia. While the participation in the project incurred losses for HMS due to the fact that HMS has developed a new product, the successful execution of the project has given the access of the new and prospective LNG market in Russia.

The fifth factor was the austerity measures time lag. HMS had started the cost-optimization program at the end of the first half of 2019. It has taken several months from the implementation of austerity measures to the decrease of fixed costs and increase of profitability, which were clearly seen at the improved results of the third quarter.

Next slide, please. As a reaction to the decline in EBITDA and the growth of net debt, HMS launched an aggressive cost-cutting program. The cost-optimization program of HMS Group consists of 2 types of austerity measures: short term and long term. The short-term measures have been already implemented and realized. Next year, the short-term ones will be partly complemented or replaced by long-term measures.

The short-term measures include: a temporarily decrease of wages, which has been already realized in the second half of this year; and a decrease of cancellation of dividend payments in 2020, which decision will depend on this year results and general situation with large contracts portfolio in the spring 2020.

The long-term austerity measures include, among others: rightsizing; minimization of operating costs, including optimization of procurement processes and improvement of products' design solutions; reduction of capital expenditures to RUB 1.5 billion that is due to a maintenance level; strengthening of control over working capital; and analysis of nonperforming assets for further decision-making regarding restructuring of HMS business.

On the next slide, you can find a general picture with the segment performance for the 9 months 2019. To have a more detailed look at their performance, let's go to the next -- Slide 7. Pumps revenue grew by 24% year-over-year to almost RUB 14 billion, and EBITDA grew by 56% year-over-year to about RUB 2 billion. The growth was based on both recurring business and large contracts.

EBITDA margin was up to 13.5% compared with 10.7% last year due to a number of factors, including the implemented cost-optimization program as well as the higher share of large contracts under execution.

There are 2 low-margin production facilities in the pumps business segment. Their negative effect has been already reflected in the company's financial results. And currently, HMS is working on an optimization strategy of their operation.

Next slide, please. In the oil & gas equipment and projects business segment, revenue was down to RUB 8.6 billion by 48% year-over-year compared with RUB 16.5 billion for the 9 months 2018. EBITDA was minus RUB 171 million compared with RUB 2.7 billion last year. The segments' losses were connected with HMS Neftemash, that specialized in EP projects and needs infrastructure for execution of engineering projects.

After a decline of large projects backlog in the middle of last year, the facility didn't manage to cut quickly its fixed costs. Also it didn't manage to sign a sufficient volume of profitable recurring contracts to replace large contracts. The combination of those factors resulted in a decrease of revenue and margins in the period from the third quarter last year to the second quarter of 2019. Consequently, recurring business generated less EBITDA than expected.

To speed up the cost-reduction process, HMS Group has changed management at HMS Neftemash and implemented austerity measures resulted in the recovery of the whole segment results.

The management has a positive outlook for this year results, though by customers' requests, HMS Neftemash postponed deliveries from the third and fourth quarters of 2019 to the next year worth about RUB 400 million of EBITDA, that should positively influence the first half of 2020.

Next slide, please. Compressors segment shows good results, though the Arctic Cascade affected its profitability. Revenue was up to RUB 13.3 billion compared with RUB 5.3 billion. The growth was based both on recurring business and large contracts.

EBITDA grew to RUB 1.3 billion compared with RUB 438 million for the 9 months 2018. EBITDA margin increased to 9.5% compared with 8.3% for the 9 months 2018.

Among others, one of the main factors that affected the compressors segment's EBITDA was execution of the pilot Arctic Cascade project. The Arctic Cascade was a project to supply a main gas compression system for the construction project of a complex for gas production, treatment and liquefaction as well as shipment of LNG and gas condensate from the Yuzhno-Tambeyskoye gas-condensate fields. The Arctic Cascade technology was created for gas liquefaction using the ambient temperature of the Arctic region, while reducing energy consumption and capital costs.

On the one hand, it generated losses for HMS Group, but on the other hand, the company has analyzed the project, has taken actions to prevent them and today, it is fully prepared for execution of similar projects in the future.

In addition, the successful execution of the Arctic Cascade turned NOVATEK into one of HMS largest clients. Moreover, in September 2019, NOVATEK and HMS Group signed the memo on localization of LNG equipment.

The Arctic Cascade project allowed HMS to develop competencies in the new area of equipment for liquefaction of natural gas and penetrate the Russia's booming LNG market.

Next slide, please. Cost of sales was RUB 29.6 billion, up by 25% year-over-year compared with RUB 23.8 billion the 9 months 2018 because of the combination of 2 main factors. The first factor, large contracts to produce compressors have a higher share of outsourced components in their costs of sales, and as a result, their profitability are lower than those ones in pumps or oil & gas equipment segment; and the second factor was connected with recurring business portfolio that consisted of less profitable contracts compared with last year.

Distribution and transportation expenses increased by minus 2% year-over-year, mainly due to an increase in transportation expenses, that was up by 16% year-over-year. As a share of revenue, distribution and transportation expenses was down to 3.8% compared with 4.3% last year.

General and administrative expenses were up by 3% year-over-year to RUB 4 billion compared with RUB 3.9 billion last year, mainly due to increase in bank services and depreciation and amortization. Bank services were mainly consisted of payments for banking guarantees required according to terms of contracts with HMS customers. And as a share of revenue, general and administrative expenses decreased to 10.9% from 12.2% for the 9 months 2018.

Let's go to the next slide, please. Labor expenses decreased in the third quarter, resulting from the implemented cost-optimization program. Herein, we used a term labor expenses defined as the sum of labor costs and social taxes. Labor expenses in quarter 3 in cost of sales slightly grew as a share in HMS revenue to 12.4% in the third quarter compared with 12.3% in the second quarter 2019. The main reason was that orders under execution had a higher labor intensity in the third quarter compared with the second quarter due to a change in the mix of contracts.

Labor expenses in social, general and administrative expenses decreased to 6.6% as a share of HMS revenue in the third quarter compared with 8% in the second quarter 2019. That was also one of the factors that improved positively the third quarter profit for the period and increased the company's margin.

Next slide, please. Working capital was up by 2% year-over-year to RUB 11.5 billion compared with RUB 11.3 billion for the 9 months 2018. As a share of revenue, it was down to 20% compared with 25% last year.

Free cash outflow increased to RUB 2.6 billion from RUB 2 billion last year because of a decrease in operating cash flow and the acquisition made in February. If excluding this acquisition, free cash outflow stayed unchanged compared with last year, though operating results worsened.

Capital expenditures were RUB 1.2 billion, down by 17% year-over-year compared with RUB 1.4 billion last year being the result of the implemented austerity measures.

At the end of the third quarter, total debt was up 10% year-over-year to RUB 21.1 billion compared with RUB 19.2 billion at the end of the third quarter last year. Net debt was up to RUB 17 billion, and net debt-to-EBITDA ratio increased to 2.98 compared with 2.4 last year.

In November 2019, the group refinanced a number of credits repayment due in 2020 and 2021, shifting loan repayment dates to the 2020 second year. Average interest rate was decreased to 8.55%.

Current total debt level is RUB 24.3 billion, and HMS attracted RUB 3 billion bank credit that was deposited and which will be utilized for the corporate ruble bonds redemption this February.

On the next slide, we will describe our business prospects. Total backlog was up 9% to RUB 41.4 billion compared with RUB 37.9 billion last year. Thanks to all main business segments. The growth was based also on both recurring business and large contracts.

Pumps bonds backlog grew by 8% year-over-year to RUB 18.8 billion due to recurring business and large contracts as well, mainly in the sphere of pumps for nuclear power stations.

Backlog of oil & gas equipment and projects was up by 23% year-over-year to RUB 9.4 billion compared with RUB 7.6 billion for the 9 months 2018 due to recurring contracts as well. Compressors' backlog increased by 18% year-over-year to RUB 11.9 billion compared with RUB 10.1 billion last year based on growing backlog of large contracts. Backlog for construction declined to RUB 1.3 billion.

Order intake grew by 18% year-over-year to RUB 36.2 billion compared with RUB 30.7 billion for the 9 months 2018 based on growth in all main business segments. Both recurring business and large contracts contributed to this growth.

Order intake of industrial pumps grew by 22% year-over-year based on both recurring business and large contracts.

Oil & gas equipment order intake increased to RUB 11.1 billion, up by 26% year-over-year, compared with RUB 8.8 billion for the 9 months 2018 fully based on the recurring contracts.

Order intake of compressors was up by 6% year-over-year to RUB 8.6 billion compared with RUB 8.1 billion, mainly due to large contracts signed.

Construction order intake consisted of contracts worth total RUB 129 million. We do not expect new contracts here. After the reporting date, HMS Group announced the signature of a number of large contracts worth RUB 7.5 billion.

And the final slide, please. Share of NOVATEK grew to 10.8% from 2.4% last year. The company was ranked #2 of the Gazprom. HMS does not have any contract that generates more than 10% of this revenue. And the largest contracts in the recorded units generated 7% of HMS revenue.

In terms of project product structure, HMS revenue growth was based on the recurring business that grew by 18% year-over-year. Revenue generated by large contracts increased by 9% year-over-year to RUB 12 billion.

With regard to [2019] guidance, we are changing our forecast for the year. We expect revenue to be in the range from RUB 50 billion to RUB 55 billion, and EBITDA is expected to go down to around RUB 5 billion.

Thank you for listening to the call, and we are ready to start the Q&A session. Mr. Kirill Molchanov and Mr. Alexander Rybin are ready to answer your questions.

As not only Russian speakers are listening to the call, could you please ask your questions in English. Thank you.

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Operator [4]

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There are no questions. I hand back to you, ladies.

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Ulyana Egorova, HMS Hydraulic Machines & Systems Group plc - Specialist of Capital Markets [5]

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Dear participants, as for now, the Q&A session is over, and our conference call is going to be finished. Thank you all for your attention, and goodbye.

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Operator [6]

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Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.