Edited Transcript of SFSN.S earnings conference call or presentation 6-Mar-20 10:00am GMT

A slight organic growth to sales of CHF 957.1 million or 0.2% was achieved. The EBIT margin adjusted reached 17%; prior year, 18.2%, largely due to lower capacity utilization and mix effects. Significant improvements in the second half can be reported based on project ramp-ups and stabilized markets. Sales increased by 10.7% in the second half versus the first half. The adjusted EBIT margin accelerated as well by 170 basis points in the second half versus the first half. CapEx came down by minus 19.1% due to the planned completion of the Nantong project. And above all, a firm project pipeline to fuel future growth can be reported.

The key messages of the Automotive division can be well summarized with continued outperformance of the market, which further underlines the just-mentioned importance of a strong and firm project pipeline. Even though weakened regional demand resulting in a global car sales decline of minus 5% to minus 6% in our relevant market segments, ongoing ramp-up of customer projects limited the sales decline versus 2018 to minus 1.1% like-for-like. In the second half 2019, a 2.4% sales growth versus the second half 2018 can even be reported.

Continued project wins of plus 49% in value above prior year and customer awards demonstrating the strong competitive position as well to the significant progress on volume gains in the strategic application field of electric parking brake and power break systems. Despite the positive and solid development of the division, we are still expecting a flat development in the fiscal year 2020 for the division Automotive due to the high uncertainties in the global economy and consumer confidence when having to decide on which drivetrain to select for their new vehicle.

When talking about drivetrain, it is important to state that the SFS Automotive business growth is largely independent from specific drive concepts. This, since 80% of 2019 revenues are independent from specific drivetrain concepts. And the remaining 20% can be categorized relatively easy in end markets, which remain largely combustion engine markets, like India and the Americas, and end markets like Europe and China, which potentially will convert to 10% fully electric vehicle sales as early as 5 years from now. Pursuing this model, top line sales impact on the division is expected to be roughly around CHF 8.8 million in sales or minus 2.2% of 2019 sales in the division — on the division level and minus 0.5% sales on the group level.

We are coming now to the key messages of the Electronics division, where the transfer to the new Nantong site has been completed and can be seen as the key highlight and achievement, not just for the division Electronics but also for the entire SFS Group in the past business year. Besides, dynamic growth in consumer and lifestyle electronics were able to largely offset the decline in HDD applications segment. The project pipeline continued to be well filled with relevant opportunities for key customer groups.

The new Nantong site being now fully operational 4 months ahead of time and a 30% lower relocation costs, combining all core technologies under one roof. In addition to the mentioned relocation, the Electronics team managed several demanding, successful project ramp-ups, underlining with that the position as best-in-class partner for key OEMs. Despite the positive and outstanding performance of the division, we still arrived at our only moderately positive development forecast due to the higher global uncertainties.

Taking into account the COVID-19 virus, the resumption work at the new Nantong plant after the Chinese New Year shutdown is around 70% by this week, which is in line with other industries in China. Some factories have already higher, some lower resumption rates, depending on their geographic location and origin of their workforce. In China, wearing of face mask is still compulsory and temperature taking, twice per day at all sites is still practiced. The total headcount approved by the government to resume work in Nantong is 1,519. The actual return was 1,252, slightly lower because some employees are still pending to complete their quarantine or have various other private reasons.

The division Industrial achieved in the year 2019 the same like in the previous year, in namely varying development of individual business units due to their strong niche characteristics. Overall, a slightly negative sales development had to be accepted. Still, the team maintained a solid level of profitability. The business was driven by Aircraft showing continued growth, backed by the continued ramp-up of Airbus A350 and strong growth with plastic injection molded parts and components for medical projects.

Same like with the previous 2 divisions, a record-high volume of new projects were acquired and supported by our business units and stand clearly out as the major key achievement of the fiscal year 2019. Along a site expansion at the Stamm facility in Switzerland for micro injection molded medical parts has been decided with expected completion in 2021. Despite the robust performance of the division, a flat development is expected in the fiscal year 2020 due to the already mentioned global uncertainties.

We are coming now to the key messages of our Medical division, where, in 2019, the management team continued a positive development. Highest attention was given to the conversion of the solid project pipeline into sales, achieving continued double-digit organic sales growth in the second half. A strong project pipeline, driven by top 10 customers, is expected to reach well into 2020. Top line gains and productivity improvements resulted in EBIT growth. The standardized production machine park and the high customer proximity continue to be a solid foundation for project wins. For fiscal year 2020, we expect an ongoing positive development.

Approaching now the headlines of the Fastening Systems segment, where the market position has been considerably strengthened in the fiscal year 2019. Strong sales growth of 14% to CHF 498.3 million was driven by the consolidation of HECO and TFC. Accordingly, the market position expanded with the acquisition of TFC and mbe later in the year. Nevertheless, divergent trends among the divisions were observed: in the Construction division, stable demand, organic growth and positive consolidation effects; in the Riveting division, a significant drop in demand from automotive and industrial customers.

The EBIT margin at 9.2% compared to previous year at 9.8% leaves no doubt. In Construction, further progress was achieved due to a positive industry environment. In Riveting, the results got heavily burdened by lower capacity utilization and restructuring efforts due to the observed market slowdown.

Looking into the details of division Construction. We can state that the growth story continued, thanks to positive customer sentiment, resulting in a stable market development; organic growth and significant consolidation effects driving sales; the integration of TFC running smoothly and yielding the expected results; the acquisition of mbe, further strengthening the market access in Central Europe. As a result, further improvement in profitability has been achieved. Looking out, a positive development in a stable market environment is expected to continue in the fiscal year 2020.

The acquisition of mbe, or the Moderne Befestigungselemente GmbH, is expected to further strengthen the division Construction’s facade business in Germany. Path of SFS since January 1, 2020, the strategic rationale is clear: acquisition of strong, long-standing customer relationships with speciality retailers for premium facade solutions; access to vast expertise in painting technology, differentiating itself through quick response and delivery times as key in the construction market for the building envelope. In return of mbe — in return, customers of mbe will benefit from the broad product range of SFS. The key figures, annual sales of approximately EUR 10 million achieved with roughly 70 employees.

In contrast, the Riveting division’s development has been severely burdened by weak customer demand. Significant exposure to automotive and industrial markets and uncertainty due to the Brexit strongly impacted the business. Continued product innovations are expected to positively impact the future results. Shifts in capacity utilization got addressed with a set of comprehensive measures to mitigate the impact on earnings. In addition, Urs Langenauer, former Head of Automotive in North America, took over the leadership for the division in July 2019. The outlook, probably most difficult to predict of all divisions, arrived not surprisingly at a slightly negative development expected in fiscal year 2020 due to the challenging markets and the erratic purchase behavior by the main customer groups.

Continuing with the headlines of the Distribution & Logistics segment, where profitability improved based on the adjusted EBIT margin for the third year in a row, even though sales for the year with CHF 326 million represents a slight decline of minus 2.5% year-over-year due to weaker demand. Customer wins contributed to the positive results and proved a strong competitive position as well do the comprehensive offering, the positive contributions from the tools business and the intensified multichannel activities.

Strategically, the HandwerkStadt network got expanded to 29 sites. Profitability further strengthened, as shown with an adjusted EBIT margin of 7.9% compared to previous year, 7.6%. Our reported EBIT of CHF 40.5 million resulted due to book gains on disposal of non-core assets. For the fiscal year 2020, a further solid development is expected.

With that, I conclude the presentation of the development by segment and hand over to Rolf Frei for the development of key financials.

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [3]

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Good morning, ladies and gentlemen. Let’s start directly with the key financials.

The sales bridge repeats what we just have heard from Jens. The change in scope added 4.4% to the growth year-over-year. The appreciation of the Swiss franc starts to become, after around 3 years, an issue again. This impacted sales by minus 1.3%. And in spite of the catch-up in the second half year with organic growth of 1.1%, the full year closed with a negative organic growth contribution of 0.6%.

As you remember, the weakening of the global economy started sharp and unexpectedly back in November 2018, mainly in Automotive and Electronics. Throughout the year 2019, we experienced a slow but steady sales increase until September and then a minor flattening in Q4. The first 2 months in 2020 show a stabilization on previous year’s level in terms of organic growth. The volatility between the 2 months should not be overestimated as there are always short-term effects, for example, fewer or more working days in 1 or the other month.

When it comes to the coronavirus, it is currently almost impossible to predict the impact on the financials. What we can state is that up to now, no employees are infected and the top line is developing as expected. Even our Asian Electronics division matched the previous year’s sales level at the end of February. However, at some point, there will be an impact. The question is when and how?

The pie chart on the left indicates a robust sales breakdown by end markets. Strong and double-digit growth in Construction, plus 14.9%, thanks to the changes in the scope. And in Medical, plus 16.8%, thanks to organic growth, yield their sales share, both gained weight, Construction to 29.6% and Medical to 7.5%.

Both the change in scope with Triangle Fasteners and the strong organic growth of Medical catapulted the sales share of America to 21.6%. This is shown on the right side of this slide. As such, America has almost doubled its portion since 2015, where it stood at 12% of group sales. Compared to 2015, the share of Europe remains stable at 39% whereas the sales share of Asia is down by 5.9% to 20% and Switzerland, down by 3.5% to 19.4%.

The adjusted EBIT was burdened by mix effects and a soft economy, which resulted in lower capacity utilization. The adjusted EBIT margin reached 13.4%, which is above the guidance given in December 2019, however, with CHF 239 million, 1.7% short of the EBIT in 2018. The 2 one-off effects debited the P&L with a net of CHF 2.8 million. This is substantially lower than anticipated, thanks to a highly professional execution of the relocation project to Nantong of our Chinese colleagues. Noteworthy was again a strong performance in the second half of the year. In 2018, the outperformance over the first half year was 80 basis points. And in the second half of 2019, it was even 160 basis points.

A business cycle of a company contains all shapes of ups and downs. In the past 12 years, Swiss companies have faced many challenges in terms of financial and economic crisis and too strong appreciation of the Swiss franc. In the same span, SFS disposed non-core businesses but also strengthened its core activities with substantial CapEx and with strategic M&A. SFS has managed this cycle successfully and has not only kept but even increased its strong EBITDA margins into a bracket of 18% to 20%.

We constantly measure the share of Swiss franc expenses against the total group operating expenses. In 2019, the percent share reached a midpoint of our target range. The drivers for this trend are the strategic goals to relocate labor-intensive processes to foreign SFS sites as well as to pursue international acquisitions. Nevertheless, the Swiss sites are important technology and innovation flagships. Their excellent productivity levels, know-how and passion are decisive for the SFS Group. The number of employees in Switzerland remained stable at just below 2,500 heads.

With the recent uncertainties, the appreciation of the Swiss franc is back on the agenda. We did some sensitivity analysis on the strengthening of the Swiss franc to CHF 1.05 against the EUR and CHF 0.95 to the U.S. dollar. Based on this simulation, combined impact on SFS Group EBIT margin is expected to be limited to a maximum of 90 basis points. This is calculated against the average foreign exchange rate in 2019 with the euro of CHF 1.11 and then U.S. dollar of CHF 0.99. As in the past, this is probably a short-term impact, partly mitigated with cash flow hedges and over time, wiped out with productivity gains and natural hedges.

Business as usual can be reported on the development of net working capital. It remains very stable in a narrow range of 30% to 31% of net sales. This is especially true when we take into consideration the rather low exchange rates 2019 and compare it on a like-for-like basis with 2018.

Our capital expenditure was 6.6%, leveled out in the normal range of 6% to 7% of net sales. 42% of the CHF 117 million were spent in Switzerland. The Swiss flagships keep its CapEx focus on innovative and capital-intensive processes that contribute to a high degree of automation and above-average EBIT margins. Engineered Components are a development and innovation partner to its customers. Some project wins trigger from time to time substantial CapEx and lead to high capital intensity.

In 2019, 81% of CapEx was spent in this segment. Fortunately, Engineered Components also achieved year-by-year attractive returns on capital with a ROCE well above 23%. For 2020, we scheduled CapEx to come in on the high end of our bandwidth of 6% to 7%. In some areas, we reached full utilization of our infrastructure, which make expansions for future growth necessary. One of the site expansion, the micro injection molding plant, Stamm, was mentioned by Jens.

2019 shows strong cash generation, similarly seen back in 2015 and 2016. The operating free cash flow reached CHF 101 million or 48.5% of the EBITDA. With this solid operating free cash flow, together with the proceeds from the sale of the properties, we were well positioned to finance our M&As of CHF 95 million and to pay the dividend of CHF 75 million out of our own cash pocket. And the beauty was that we even could increase our net cash position from CHF 59 million to CHF 69 million. The equity ratio is 75%, remains strong and solid and is part of our DNA.

The financial flexibility to exploit external and organic opportunities as well as projects is secured due to various existing fund positions. A syndicated bank loan of at least CHF 150 million, by the way, has been extended prematurely to October 2024.

One of our internal KPIs is the return on capital employed. The adjusted EBIT is measured on the average capital employed in fixed assets and net working capital. The pretax return ROCE fluctuates in the attractive range of 20% to 25%. The return on invested capital is a tight measure and was at 9.2%, tight in respect of the invested capital, which includes the goodwill offset of around CHF 1 billion. This almost doubles the capital as denominator from CHF 1.1 billion in the ROCE to CHF 2.1 billion in the ROIC calculation. In other words, the bridge between the 2 KPIs is made up: a, by 8.2% for almost doubling ROIC, mainly due to the goodwill offset; and b, by the tax impact of 3.2%.

In the next few years to come, we expect the effective tax rate to fluctuate and then average around 17.5% on earnings before tax. This is due to the fact of lower Swiss tax rates to be put in place from 2020 onwards. The new Swiss tax rate had a first one-time effect based on the revaluation of deferred tax liability on existing temporary differences in 2019. This reduced the income taxes by CHF 5.9 million and reduced the tax rate by 2.6%.

The second one-off effect is triggered from an expected improvement of the operational performance in North America. In contrary to the previous year, we came to the conclusion that the taxable net income will be much stronger in the 5 years to come. This assumption is heavily supported by the realized implementation of effective operational measures, the strong organic growth of Medical with improved profitability and the successful integration of Triangle Fasteners. The onetime impact is CHF 11.3 million or 4.9% on earnings before tax. Currently, we have, for this title, a deferred tax assets in the U.S. balance sheet of CHF 21 million. This amount will be reversed step-by-step over the next 14 years and will increase in the years to come, income taxes in average with CHF 1.5 million year-over-year.

Consistency in the payout to shareholders is important to SFS. The Board will propose to AGM general meeting a payout of CHF 2.10 for each registered share. Total dividend distribution amounts to around CHF 79 million and represents an increase of 5%. With a 38% payout ratio, SFS stays historically on a like-for-like basis, very stable at the low end of the target range of 35% to 50%.

Summing it all up. The SFS Group looks back to a business year with good progress. Top line grew by 2.5%. The adjusted EBIT fell slightly short of the previous year but came out above the guidance of midyear. Net income increased by 6.5%. The financing of the group with a 75% equity ratio is outstanding. The CapEx has leveled out of a normal range to 6.6%. The cash generation represented by free cash flow is very strong and increased with over 40% year-over-year. With this solid and healthy bunch of KPIs, SFS is well prepared to tackle the challenges in the near future.

The outbreak of the coronavirus predominates the discussion around the guidance. SFS has taken a lot of measures to safeguard all stakeholders as much as possible. However, nobody knows precisely what is next. And at this point, we are not yet in a position to assess the impact on our business. With that in mind, we try to anticipate both the market development and our own market strengths without the effect of the coronavirus.

We believe that the demand in the key markets will be subdued, especially in the automotive industry, and that the volatile political, economic environment will continue. Thanks to our strong market position and attractive project pipeline, we expect to grow our top line up to 2% in local currency and including M&As. Amid this challenging environment, we forecast an EBIT margin for 2020 in the range of 12% to 14%. The lower end of this range might be interpreted as EBIT margin 2019 of 13.4% minus a potential short-term currency impact. Guidance, of course, is valid in case no significant deterioration in the economic conditions occurs.

Due to the shift in the SFS sales mix and the general downturn in global economic activity, we have set a new comparable midterm sales gross target of 3% to 6% and an EBIT margin target of 13% to 16%. Compared to our performance achieved in recent years, we believe that this better reflects the reality on top line growth and on EBIT margin level. The historical sales growth development between 2015 and 2019 give some additional insight for you to the numbers achieved in the past. The compound annual growth rate in this period was an attractive — was attractive with plus 5.7% and at the upper end of the new midterm guidance. The change in scope and the organic growth share this historical growth rate of 5.7% half and half.

With this, I hand over to Jens to comment on the group priorities in 2020, and thanks for your attention.

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [4]

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On the operational side, we continue to focus on specific priorities tailored to be most relevant and beneficial to the — to reach maximum performance for the end markets and customers we serve. These are strengthening of our innovation efforts, in particular around the mega trends, digitization and autonomous driving; investment in future growth projects, in particular in the med tech, automotive and electronic sectors; constant evaluation of the economic environment and proactive cost management; creation and use of synergies from the takeovers of TFC and mbe as well as evaluation of other relevant targets; implementation of the set sustainability goals and review of the carbon footprint.

With that, we thank you for your attention, and now approaching the end of the active presentation of the full year 2019 results and are now available for your questions. First, we take the questions from participants here in the room before we take questions from participants joining us by web meeting or sending in their questions by mail.

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Questions and Answers

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [1]

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Yes. Marta Bruska, maybe wait for the microphone, if you could also state your name and then state the question.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [2]

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Marta Bruska from Berenberg. I have five regarding the mid-term guidance. So first of all, it seems that the outlook you have on the automotive industry or underlying assumption is different for Riveting and the Engineered Components. For one, you expect a bit challenging environment and declining sales for Engineering Component you expect flat. For mid-term, what do you expect with your outlook for Automotive?

Secondly, you mentioned in — as one of the reasons for downward revision of the growth guidance, that the sales mix had shifted and this has also impacted profitability. I a little bit wonder with the titanium inserts out, which were a low-margin business, why we haven’t seen an improved actually margin due to improved product mix in the Engineered Components.

Thirdly, you mentioned that you do not include a full impact from coronavirus. So what sort of impact do you include? If not full, then is that partial for Q1? Fourth point is on M&A. Is this included in the mid-term guidance or not? And finally, in the historic data, you show only 2 years out of the 5 you show. You actually alluded to it in the new mid-term guidance. So isn’t it still too challenging?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [3]

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The last one, can you please repeat the last question?

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [4]

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The table on Page 37, you show 5 historical years with the gross sales performance. And only in the years 2017, ’18, your organic growth would fit within your new mid-term guidance. So the question is if that it’s still not too challenging.

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [5]

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Maybe I’d just start with this last question on Page 37. What you see there is the gross sales increase year-over-year. And that it’s made up by 2 components: the organic growth and the change in scope. And the 2 — these 2 elements are now included in the new guidance. And you see the new guidance, mid-term is 3% to 6%. And basically, in all of the 5 years, we were above of this new guidance. In ’15, it was 4.6%; in ’16, 3.5%; in ’17, 13%; and so on. So we compare now this gross sales top line there with the new guidance of 3.6%.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [6]

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So basically, the mid-term guidance includes M&A?

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [7]

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Exactly.

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [8]

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Maybe to go through the previous 3 — the first 3 questions, #4 and #5 are now answered. First, on — yes, on the Automotive side, we see different development on the Riveting side. And on the Automotive division side, we see that Automotive division is mainly driven due to this new innovative trends like autonomous driving, so more cameras, more sensors, new braking systems. And there, we see, in the mid-term, a positive momentum. Currently flat as we have predicted for the year 2020, but then we would also expect a pickup of the momentum again and moving into organic — back into an organic growth mode as indicated in the mid-term guidance.

On the Riveting division side, we are not as close to innovative solutions with the technology. This is not tied somehow to the new innovations like sensors and cameras and such. Riveting technology is mainly used with existing technologies. So you fix some kind of technology or some kind of element to the frame of the car. So whether it’s a seat or whether it’s a loudspeaker or whether it’s another application, you fix it, you attach it to the frame of the car. And there is no substantial change in technology. There’s also no innovative trend which we would expect happening in that field. So the Automotive portion within division Riveting, we expect, will develop according to the larger automotive market, which is probably flat for the mid-term all along.

Sales — then the second question, sales mix shift due to titanium inserts being out and being a lower-margin product. Why did the EBIT margin not increase? I think here, we have to keep in mind that we had also the acquisition of Tegra Medical in 2016, which has below group average EBIT margins. Then we also had numerous acquisitions in the Fastening Systems segment. And also in Distribution & Logistics, we had a minor acquisition back, I think, in 2015, top of my head. So we have not foreseen or predicted that we will see such M&A opportunities come up in Fastening Systems and D&L. But when they come up and they fit into the strategy and contribute to an EBIT improvement and to cash flow improvement, we’ll certainly happily take them in.

When we talk about the coronavirus, I think we have seen in the slide here in the financial section that, so far, we don’t see an impact of the coronavirus on our sales development overall. I think it’s too early to be able to talk about the full magnitude. I would expect that probably for the next 2 months, we’ll see some activity on a high level because inventories get low, customers ask for refillment of their inventory activities. And then probably in the second quarter, we are in a position to truly calculate the impact of coronavirus and also the inventories are probably normalized. For the second half of the year, it’s probably a big guess. Will people be relieved and start spending more money because the coronavirus issue is all behind us or not? I think we will find out later on in the year and talk about that in the half year or when we talk about the — about the half year results and then the full year guidance again in July.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [9]

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Have you not seen any issues with the logistics either so far?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [10]

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We have not seen any logistics issues. Certainly, they are coming up now after we are now 6, 7 weeks into the coronavirus. We see here and there popping, some shortages are up. For instance, face masks is a big issue at this moment in time. So when you do some kind of polishing and grinding activity in your refurbishing or MRO environment, then face masks are a shortage at this point in time. But besides that, we have not larger issues to declare or to manage at this point in time.

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Michal Lichvar, Bank Vontobel AG, Research Division – Analyst [11]

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Michal Lichvar, Vontobel. I have a follow-up question regarding the mid-term guidance. Can you maybe make a split between how much do you expect to come from the M&A and how much from the organic growth? That would be my first question.

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [12]

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It’s hard to predict, of course, into the future, what targets come up and what not. But if you look at historic numbers, remember this compound annual growth rate of 5.7% over the period 2015 to 2019, I made the calculation, it was exactly 50-50. 50% of the growth came from acquisitions and 50% of the growth was from organic growth. So that’s the best case I can make right now.

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Michal Lichvar, Bank Vontobel AG, Research Division – Analyst [13]

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Okay. Then just interesting, on Page #9, you have this very nice split of the applications in Automotive. If we would look in the future, for example, in 5 years, how would this split look like?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [14]

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But probably in 5 years, we’ll see that the electric braking and the electronic braking bar will grow probably faster, above the rest of the application segments. Restraint will probably stay stable. ABS/ESP will probably stay stable or grow as the market grows. Interior, I would assume as well, grows as the market grows. So that’s — truly the expansion will be happening on the electric and electronic braking side. On the powertrain side, mid-term, I would see also flat development, maybe a slight plus.

We see further consolidation in the supply chain, meaning customers coming and consolidating volumes with us since they also reduced complexity of supply chain. So probably also flat development is the expectation for the next 5 years, until probably fully battery-powered cars are accelerating more after 2025. Hybrid cars are neutral to us since they have both technologies in there. So probably in 5 years from now, we’ll see a new bar, which is the electronic driving brake. And this is probably the one which will be of equal size to the one today with electric braking, which are the parking brakes.

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Michal Lichvar, Bank Vontobel AG, Research Division – Analyst [15]

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Last question regarding the electronics market, with these new projects that you had with your large smartphone customer, with these power adapters and the AirPods, did coronavirus kind of change your outlook there because you expected quite a fast ramp up in sales there? Can you give us an update on that?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [16]

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As the projects are developing as per expectation, plus/minus, certainly in the first quarter, this year, we have now seen stable sales development even though the factory is not full to — back to full pace. We still see a stable development because we have hired new people and we have added new programs, like the ones for power adapter, which now kind of bridge the gap. I would expect, for the first half of the year, maybe first or initially in the first quarter, maybe a little bit slower development because of the coronavirus.

And then in the second quarter, probably a pickup, probably a refilling of the inventories on the customer side and due to that, active participation of the supply chain to make that happen. For the full year, we still see that there’s a penetration going on. That means the power adapter solution is not yet specified into all devices. That means every time a legacy program is being dropped out of the product portfolio and a new program comes in, we win allocation with the power adapter and with the content we have in there. So we expect also there a positive development on the side of electronics and lifestyle products in 2020.

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Unidentified Analyst, [17]

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Yes, I have a few questions. So first, on the CapEx, right? You expect a negative organic growth in 2020. So how come that the CapEx is still at the higher end for — of the target range? Then also longer term, you’ve sort of alluded that the growth will be a bit lower. You’ve lowered the targets there. Is it still realistic that you stay in that target range of 6% to 7%? Or shouldn’t it be lower?

Then the second question is again coming back on the mid-term guidance, right? I mean you must have an idea about the organic growth you target, otherwise, it would be very difficult to come out with the guidance. I fully understand that you have no visibility on the M&A side. So should we think about the 3% as sort of the organic growth you assume there? And then the last question is in terms of the competitive environment, is that at their worst? And is there more price pressure, either from the customers or from the competition as well?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [18]

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Yes. Why is the CapEx high? I think in the presentation, we have pointed out at several divisions that we have a full project pipeline, meaning these are usually new programs, new generations, new technologies, different specifications. So for that, we usually need some amount of dedicated equipment. Some equipment can be used from the past as it’s generic. Some new equipment will need to be purchased because it’s specific to the application. Now the CapEx that we foresee 6% to 7% and maybe being on the higher side is due to the fact that we have a full project pipeline, which will create organic growth in future. That’s the expectation. However, there’s the underlying existing business, which is breathing as the market is performing. So it means in a positive economic environment, the existing underlying business is breathing in, inhaling, and usually absorbs more of the existing capacity. And when things slow down, then the existing capacity will be less utilized.

On top usually come then the new innovations, the new programs, which then usually needs a fair amount of fresh and new CapEx. I would touch at this point in time, we could probably easily increase sales with CHF 30 million to CHF 40 million without adding new capacity if the orders come in where we have exactly the spots available, the capacity available at this point in time. So meaning a machine is running today 18 hours a day, where maybe 2 years ago, it used to run 22 hours a day. And besides that, then we have the new machines coming in for the new programs.

Then I think on the guidance side, as alluded, I think we have midterm plans. So that means we have the midterm plan reaching from 2016 to 2020. And in that midterm plan, we had an organic and M&A guidance in there of 5% to 7%. I think now, 5 years smarter, we redid the midterm plan, 2020 to ’25, and we said 5% to 7% is probably too high, probably the environment, the GDP globally has changed, and due to that, we adjust slowly down or slightly down to the mentioned 3% to 6%. We also opened it up, give it a little bit more room. After having now made 5 years experience in the investor community, we also said it’s probably better to open it a little bit up, 3% to 6%. The 3% to 6%, our expectation is maybe 3% to 4%, maybe 3% to 5% organic growth and the rest M&A. That’s maybe also the wish a little bit. As Rolf explained, the past 5 years, it was more 50-50. We’ll see how that develops in the years to come.

That’s on the CapEx and guidance side, maybe on the price pressure side, price pressure. Interesting enough, we had this discussion this morning when we drove here. And overall, it’s maybe subjective answer I give, but overall, we see a little bit less price pressure in most of the end markets where we are active. The interest rates are low. Cost of capital is not as high. Inventories are managed, but maybe not managed as tightly. And cost of inventories maybe also not managed as tightly. Today, we see, in general, the customers look more for innovation. They look more for differentiation. And depressing the price down is certainly always an element and is always tight, it’s always tough, it’s always a challenge, but it has not accelerated. Sometimes, you see, customer by customer, some tactical changes which they bring in. They usually last for a year and 2, and then they bring in maybe a new tactic, but that’s course of normal business. In general, I would not say that price pressure increased.

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Unidentified Analyst, [19]

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Then a quick follow-up on the CapEx. What is the level of maintenance CapEx then relative to sales?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [20]

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I mean in the Engineered Components, we are an innovation partner, development partner. So the new business always triggers quite a big portion of the CapEx ratio and, I would say, probably 2/3 to 1/3; 1/3, maintenance, 2/3 new business.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [21]

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I have a follow-up question on the CapEx, Marta Bruska again. So your CapEx stays at the higher end to fuel the future growth and yet, you take down your midterm sales growth guidance. I think it’s fair to say that your capital intensity is increasing over time. And I was wondering if you have a view what drives that?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [22]

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On the CapEx side, I think we have also differentiated and maybe pointed out several onetime effects we may — also maybe had. So — for instance, in the last 2 years, we had the new Nantong facility, which was a lease in the past. So that means we were leasing all of those buildings. And the CapEx, due to that, also accelerated because we said we switched from a lease to owning a facility. This is not very common in the group. This happens not very often because, usually, we own the buildings from the beginning.

When we acquired Tegra Medical, for instance, there, we also have around 2 sites where we lease. So it maybe could be that at one point in time we decide to switch from lease to own because then we have more stability on the costing side, on the — yes, on the building side. Usually costs come down over time, but you see a peak on the CapEx side. I think over the years, over the cycles, we were in line with 6% to 7%. I think that’s still a good guidance. I think it still has not substantially changed over the years because, depending in which segment we grow the CapEx, intensity is higher or lower. So for instance, in the last few years, we had very large projects in Engineered Components. And due to that, we have seen an elevated CapEx level. We have also seen very new applications where we had not been in before. Those had also an elevated CapEx to it. I think looking forward now, we should see a more normalization of CapEx back to 6 to 7 percentage points. That’s the expectation. But going back probably 8 years, 10 years, also the year we had sometimes peaks in CapEx as we maybe prepared for complete new technology.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [23]

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Okay, I understand. So CapEx will go back to normal if the growth is slower. And still, I didn’t really see my questions being answered, what had driven that? So you think it’s accumulation of one-offs from what I understood?

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [24]

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It’s accumulation — yes, it’s accumulation of one-offs we had in the last 5 years. That’s why CapEx, over those 2 years, accelerated very heavier.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [25]

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Do you plan for any cost-cutting programs? I have seen now your organic growth guidance of about — from what we discussed, more or less 1% to 3%. While the wage inflation in the — in developed world, even EU, U.S., also China, is in mid- to high-single digits, very high. How are you going to offset this increasing costs?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [26]

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Certainly, through productivity improvements, which is a constant task and topic we have as a contract manufacturer. So the last year, depending on the division, we have also seen reduction in head counts, depends on the division a little bit. So for instance, in our Automotive division, we probably had a reduction of FTE of around 5%. In the Riveting division, we probably had an FTE reduction of around 10%. So we certainly adjust as needed.

On the other hand, in the Electronics side, we probably had an increase of around 4% in FTE because of the ramp-up of the new programs, which is not unusual. And on the Medical side, we, for instance, also had an increase of around 7%, 8% on the FTE side. So it depends truly on the division. But certainly, SFS, the group, is very much dedicated towards productivity improvement. That’s the nature of our business.

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Armin Rechberger, Zürcher Kantonalbank, Research Division – Analyst [27]

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Armin Rechberger from ZKB. You mentioned project ramp-ups in the second half year. Can you shed a little bit light on these projects? What kind of projects and how they ramped up? Are you happy with the ramping? I suppose, because you had a good growth in second half year.

And then about China, do you feel the situation there? You said almost all your workers are back in the factory and you also say production is up to normal almost. That’s a surprise to me because I hear other things in China that nobody — well, all the workers are back in the factories, but there is nobody asking for their products anymore, almost comes to a standstill. So it has changed maybe a lot in the last few days.

And then your biggest customer in electronics, sometimes he comes above the 10% threshold and you disclose it. I think this year, you didn’t have to disclose it. So I suppose he was below 10%, even with the earphones and the power locks?

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [28]

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I can start with the last question. It is disclosed in the report, it’s below 10% as previous year. Even though we had shown good growth, but it’s below 10%, yes.

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [29]

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On the growth side in the second half of 2019, I think we had 2 elements. As mentioned last year, we had the automotive element, which were the electronic driving brakes. And there, we have been, I would say, satisfied with the ramp-up. We have seen the quantities as per expectation. We have seen also that the productivity was in line or even ahead of our expectation, overall. We had some onetime costs because of shipping costs. There were some delayed deliveries. So we had maybe some extra cost as it’s normal in ramp-up with elevated or increased shipping costs. But overall, as per project expectations, we have seen the ramp-up on the Automotive side. And in our Swiss plant, since we produce all of those components, the new ones in our Swiss plant, we returned back to organic growth in the second half of the year due to this project.

When we talk about the electronics projects, that’s the power adapter, over the year, we have seen an increase, slightly below expectation, mainly because of product mix. As mentioned, the new power adapter is in the high-end phones, specified in. On the lower end phones, it’s not yet specified in, that’s still to come, probably in 2020. And due to the sales mix that more lower end phones were shipped than higher end phones, we have seen a little bit of mix and probably not such a steep ramp-up, still steep but not as steep as maybe initially expected. So we still expect in 2020, continued ramp-up there and in ’21 as well.

That’s the reason why we are performing on previous years. When we talk about coronavirus and electronics in China, they’re performing on previous year, and this is basically the reason. It’s the new product ramp-ups, which kind of cover and bridge the slight gap we see due to having less staff on site supporting the existing business and the new staff hired on site also at 70% rate is filling in the gaps compared to previous year.

When we talk about demand, we see good demand patterns from our customers. When you go into a store and you try to buy an electronic product, usually, they are sold off. So that means that the supply chain is heavily looking for supply. And from that perspective, we are not concerned that we see a slowdown on the Electronics side.

On the Automotive side, we have also some activities in China. There, we also see good demand because it’s usually new design-ins. It’s usually replacement of an existing supplier, and this then happens. Whether it’s on 70% or 80% of demand, it still happens. It’s still an increase compared to previous year. That’s why having a strong project pipeline is key, especially it’s key in times when maybe the — as mentioned, the underlying business is not performing so well.

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Armin Rechberger, Zürcher Kantonalbank, Research Division – Analyst [30]

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Then a follow-up on the electronic drive/brake. As far as I know, last year, you just were in 1 model with this new brake. Did you have an inroad now in more models? And can you disclose the models?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [31]

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Top of my — honestly, top of my head, I don’t know all of those models, but it’s the premier European brands like BMW where it’s specified in. It’s in Audi, specified in, Alpha Romeo, Ford, for instance, it’s also specified in. So it’s broad. It’s usually where our customers win allocation, we are in as well. And as we perform according the ramp-up plan for the year, we have seen that our customers has won all of this allocation and was also able to deliver and perform on his side. So we don’t see any issues there.

We see that the application — the power brake application is gaining momentum, it’s gaining acceptance. And we also specifically see that the design concept we pursue is the leading one, meaning we have good response from our customer side on new projects we discuss and quote on.

If there are no more questions, then we may take questions from people participating by web meeting.

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Operator [32]

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The first question comes from Alessandro Foletti from Octavian.

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Alessandro Foletti, Octavian AG, Research Division – Financial Analyst [33]

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I would like to ask you a couple on the sizes of the divisions, maybe could you — in the past, you used to give a bit of an indication how the divisions — how big the divisions were. Could you give that indication again, please?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [34]

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That main figure, contribution…

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Alessandro Foletti, Octavian AG, Research Division – Financial Analyst [35]

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Yes, turnover would be okay.

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [36]

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I guess, it’s Alessandro, right?

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Alessandro Foletti, Octavian AG, Research Division – Financial Analyst [37]

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Yes.

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [38]

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I’ll give you just some broad indications. We know that EC, Engineered Components, contribute all in all with around 54%. This is made up by 4 divisions, the biggest being Automotive, roughly a little bit above 20%; half of this, about 10%, is Industrial; Electronics in the range of 15% to 17%; and Medical in the range of this 7%. Fastening System contributes 28%; it’s basically 20% Construction and about 6% to 7%, 8%, it’s Riveting, and the remaining 18% is Distribution & Logistics.

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Alessandro Foletti, Octavian AG, Research Division – Financial Analyst [39]

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That’s helpful. A second question on the acquisitions you made in Fastening Systems, the Triangle, is that margin-dilutive? And if yes, can you give an indication and whether this is really structural or if this is a temporary effect because of the first year integration?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [40]

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TFC is probably on group average EBIT margin. And it’s certainly the margin we expect to consistently get in the first years and the years after.

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Alessandro Foletti, Octavian AG, Research Division – Financial Analyst [41]

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All right. So a follow-up on this subject. The fact that you sort of moved one step forward in your supply chain, right, because this is more a distributor than a manufacturer, does not seem to be structurally negative for your margins. So you could actually do much more of this acquisition and expand much more aggressively these products.

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [42]

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The distribution, it depends geographically. In the U.S., distribution has a very strong position. A major portion of the construction goods and products are sold via distribution. That was the reason why we strategically decided to move into that channel. The availability of such targets is usually rather low. This is once-in-a-lifetime opportunity, doesn’t happen very often.

With mbe, we have seen that we moved in a similar direction. Also here, this is kind of covering the distribution channel, and we’ll also pursue that in Europe step-by-step as well.

So it’s not a landslide change we see now. I think these were just 2 opportunities coming along at this time. Could be that for the next 5, 6, 7 years, we don’t see another one happening. But certainly, SFS is dedicated to serve both channels, the ones towards the direct installers and users, but also the ones going through distribution.

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Alessandro Foletti, Octavian AG, Research Division – Financial Analyst [43]

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Okay. That’s clear. My last question maybe on the Riveting. You mentioned, Rolf, I think in your comments that you made — you had some restructuring in the Riveting. Can you give an indication how big they were? And if there is more to come?

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [44]

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There was restructuring due to the low demand in Automotive, especially Germany and the U.K. And all in all, there was a reduction in the workforce, total Riveting of roughly 10%, that’s roughly 50 to 70 people. And we believe that most of it is done now. And of course, they’re here and there are always analysis done and there might be, here and there, a change, but the majority is done. And we’re looking forward now to acquire new business and hopefully grow again.

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Alessandro Foletti, Octavian AG, Research Division – Financial Analyst [45]

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All right. Can I just take the opportunity for a very, very last one. I think this is for Jens. You said, regarding the Automotive business, that you expect drivetrain to lose about CHF 8.8 million. Is that cumulated by 2025? Did I understand that correctly?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [46]

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That’s not cumulative. That would be in year ’25, assuming that 10% of European and Chinese cars are really battery-powered vehicles. That’s just assumption.

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Operator [47]

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Your next question comes from Jörn Iffert from UBS.

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Jörn Iffert, UBS Investment Bank, Research Division – Director and Analyst [48]

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The first one would be, please, on the project pipeline you have for 2020 and ’21. I think for 2019, and assuming unchanged market, your incremental contribution was around CHF 20 million sales. What are you seeing here for 2020 and ’21, assuming again unchanged market to make it easy? And what kind of projects these are for example. I mean you’re about a ballpark of this?

Second question would be, please, on Asia. I mean do you see that some peers of you could financially struggle if sales are down significantly for 3 or 4 quarters? And is your M&A team now more and more screening area for opportunities to gain market share?

And last question is on your medium-term targets. I mean you have relatively high CapEx of sales. You also have acquisitions as key part of your strategy. So the return on invested capital including the goodwill, is it fair to assume that this should remain relatively flattish for the next 5 years?

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [49]

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Let’s start with the question on the pipeline. Yes, last year, we were able to highlight 2 or 3 major projects, which we — where we have seen or where we had scheduled and targeted the ramp-up in 2019.

In 2020, we do not have 1 or 2 or 3 single ramp-ups which accumulate the surface to such a size like last year. It’s broad. These are usually smaller- to medium-sized projects, so in the range of CHF 1 million to CHF 2 million to CHF 5 million annual sales, which are ramping up. But I think more important is to know that this project’s all in the strategic application fields as identified. So these are projects being around ABS/ESP application in Automotive, electric parking brake, electronic driving brake, for instance. So it’s broad. It’s specified in into the strategic applications. But there’s no accumulation like 1 specific product line which will have a major ramp-up of CHF 10 million to CHF 15 million. Certainly, the driving brake, as mentioned last year when we had a major ramp-up, this ramp-up will continue now in the year 2020, ’21, ’22, ’23. We’ll see, every year, incremental increases as new models are being switched over to this braking concept in Automotive.

On the Electronics side, it’s still the continued penetration with the power adapter, as mentioned, which will also continue for the next 2 to 3 years. We also got some new allocation for countries where we have not done yet a design like Australia, New Zealand, India for instance. So this is all adding on over the next 1 to 2 years. Then also the AirPod application is a topic again for 2020. So there, we also see various products and new launches by the customers.

There are also new phones coming up, some with same value content, some with some elevated value content. We are certainly eagerly looking forward to foldable phones. Because there, the amount of screws will increase by around 50%, so would be nice if this is a break, new — or breaking new technology and widely accepted by consumers on that side.

When we talk about China and Southeast Asia and maybe a slow development over the next quarters to come, we do not expect such a scenario. And even in such a scenario in China and Southeast Asia, we are not very eager or motivated to go after M&A targets. I think we focus on engineered solutions. We focus on high value-added products and there are usually not many targets around. This is why we see mainly organic growth in China, Southeast Asia. These are new technologies which we bring from Europe and localize. These are existing solutions where we follow the customers to China and Southeast Asia. This is the objective. M&A is probably more topic in Europe and North America. It has been that way for the last 5, 6 years. We have not seen much activity. I would assume we’ll not see a pickup of activity on that side in China, Southeast Asia. And then maybe hand over for the ROIC question.

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [50]

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Jörn, maybe you could repeat question #2. I was not quite sure whether I understood it correctly. Were you talking struggling of our customers financially?

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Jörn Iffert, UBS Investment Bank, Research Division – Director and Analyst [51]

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Yes, I think it was also answered by Jens already. I was asking if some peers of you, some competitors, if you — I mean they are private. Their financial information is not so much public, but if you have a few and this is a, “Struggle,” if sales would be down significantly, if you would use this as M&A opportunity, but I think Jens has answered this already.

And then yes, the return of capital question would be still open.

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [52]

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The ROIC question, whether the ROIC will stay rather flattish development. That was number 3, right?

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [53]

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Yes. Well, if you look into the numbers, it’s quite heavy to increase the ROIC. And the impact is this CHF 1 billion of goodwill, which we carry forward. That will never disappear because it’s not amortized. And we did — if you do a quick calculation, with the current capital invested, you would need an EBIT margin of 14.7% to just come up to the 10% level. So it’s quite a tight measure for us. So internally, we really work with the ROCE, and that is our guideline when we look into the divisions, but also in the second row, we confront our divisions with the ROIC. But it will — as you see also in the development, it will take time to bring it up. And of course, the trigger and the lever would be higher profitability.

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [54]

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One question more here maybe. Can we have the microphone over here, please?

There are no more questions on the web call. We have one here in the room again.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [55]

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Marta Bruska. Just following up on the EBITDA and the profitability. Between 2016 and 2019, your EBITDA for Engineered Components declined by more than 600 basis points from some 28% to 21.8% this year. I was wondering — and this despite this phaseout of titanium inserts. I was wondering if you could quantify how much to that contributed the Tegra Medical that you mentioned was dilutive? And what was the rest?

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [56]

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Well, on the Engineered Components, the EBITDA, the 21.8% is not adjusted. So in there, we have the full relocation costs of the 17 — basically CHF 17 million. So if you would compare it to the past years, we would need to add the CHF 17 million, which represents almost, say, rough guess, 2% on net sales. So comparable, it would be more like 23.8% compared to 24.1%. That would be a fair comparison.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [57]

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That compares to 28% in 2016?

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [58]

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2016?

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [59]

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Yes.

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [60]

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And what was the number?

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [61]

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That’s still 400 basis point decline?

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [62]

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Yes.

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [63]

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The question was on how much the dilution of Tegra Medical was. Probably, that — we’ll need some time to calculate.

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [64]

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Yes. That — I can’t tell out of my head. There is a certain dilution. But if you look at 2019, you have first to add at least 2% on relocation expenses.

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [65]

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Take a look at 2016 to ’17, and then you see the step. You clearly see the step in between. And then that’s the step…

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [66]

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I think it would be just interesting to make the bridge between 2016 and ’19 because it’s 3 years and 600 basis points of margin decline. So I understand now the 200 basis points that comes from the relocation, but still what was the rest?

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Rolf Frei, SFS Group AG – CFO, Member of Executive Board & CEO of SFS Services AG [67]

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Maybe we can look into it and let you have an e-mail or a call later on.

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Jens Breu, SFS Group AG – Chairman of the Executive Board & CEO [68]

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Okay. Since there are no more questions, we thank you for your attention, and wish you, hopefully, disease-free spring, all the best. Thank you for your interest. Bye-bye.

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Operator [69]

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Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call, and thank you for participating in the conference. You may now disconnect your lines. Goodbye.