Kuehne + Nagel International AG (OTCPK:KHNGF) Q3 2020 Earnings Conference Call October 20, 2020 8:00 AM ET
Detlef Trefzger – Chief Executive Officer
Markus Blanka-Graff – Chief Financial Officer
Conference Call Participants
Daniel Roeska – Sanford C. Bernstein & Co., LLC
Sathish Sivakumar – Citigroup Global Markets Ltd.
Andy Chu – Deutsche Bank
Mark McVicar – Barclays Plc
Sam Bland – JPMorgan Chase & Co.
Alexandra Thrum – Morgan Stanley
Neil Glynn – Credit Suisse
Frans Hoyer – Handelsbanken Capital Markets AB
Christian Obst – Baader Helvea Ltd.
Ladies and gentlemen, welcome to the 9 Months 2020 Results Conference Call and Live Webcast. I am Sandra, the Chorus Call operator. I would like to remind you that all participants are in listen-only mode and the conference is being recorded. The presentation will be followed by a Q&A session. [Operator Instructions]
At this time, it’s my pleasure to hand over to Dr. Detlef Trefzger, CEO of Kuehne + Nagel. Please go ahead, sir.
Thank you, Sandra. Good morning, good day, good afternoon and good evening to all of you, and welcome to the analyst conference on the 9-months 2020 results of Kuehne + Nagel International AG. Our CFO, Markus Blanka, and I welcome you as always from sunny Switzerland.
We published our 9-months results and the respective slide-deck early this morning. And we get started on Slide 3.
Kuehne + Nagel manages the crisis successfully, especially in quarter 3. And in September in quarter 3, we saw gradual improvement of volume and gross profits, which continued across all business units.
Our underlying earnings recovery outpaces improved volume trends, a reflection of control of cost, cost control, favorable product mix and improving market conditions. As a result of your strong operational performance, we were able to increase our free cash flow by 31.4% versus previous year.
Let’s go into more details on the next slide. The group EBIT ended for the first 9 months with CHF 790 million, which came almost on the same level as previous year where we closed the first 9 months with CHF 794 million. The quarter 3 performance showed an EBIT of CHF 371 million, up by 31%, and underlying operational improvement, EBIT improvement of 8.8%.
Sea Logistics showed a very strong quarter 3 and in the first 9 months was an EBIT of CHF 304 million, and a conversion rate of 36.2%. Especially in Sea Logistics, and we will come to this later in our presentation, we saw increasing volumes of the small and medium size enterprise customers. And we saw a very favorable portfolio mix development and tight cost control getting traction in quarter 3.
Air Logistics continued strong performance, closed the EBIT for the first 9 months with CHF 350 million and the volumes in automotive and perishables industries came back in quarter 3. Also here we will share some more details with you during the course of the presentation.
Road Logistics closed the first 9 months with an EBIT of CHF 38 million. We saw domestic transport volumes back to pre-crisis level in Europe, while the cross-border volume recovery is still lagging, and we saw still low volumes in North America.
Contract Logistics, our fourth business unit, closed the first 9 months 2020 with an EBIT of CHF 98 million and posted market share gains in pharma & healthcare and in e-commerce fulfillment. A strict cost management led to a very strong operational improvement.
Let me lead you through the business unit update. On Slide 6, and the picture, the graph shows it all. Sea Freight, Sea Logistics, volume trends improved month by month. And let me give you some details on the figures. In June, we saw a minus 8% volume development. June marks most likely an inflection in the Sea Logistics market, while July/August showed a minus 6% volume decline, and September only a minus 3% volume decline.
We gained share in higher yielding Asia to Europe trade and saw a significantly improved Europe and North America import business. The SME volumes, I mentioned that before, gradually came back and showed a very strong volume development in quarter 3.
Less dynamic were clearly automotive and U.S. agricultural products for example, while the winners, the volume development were sports and garden equipment, furniture, farmer, reefer and less container load businesses.
Sea Logistics volumes in quarter 3 were down 5.1%, while for the first 9 months we posted minus 7.7% volume development.
Air Logistics, the volume trend materially improved. We saw quarter 2 volume decline of minus 22%, while in quarter 3 we saw a decline of only minus 12.8%. Our market share is stable to maybe up on some trade lanes. And we saw a very strong volume trend being evident in European export business. This was driven especially by automotive and perishables.
Let’s go into the details of the Sea Logistics business. I mentioned the positive, small and medium size enterprise volume development, a reversal of a trend that we have seen in quarter 2 2020. The strong increases of imports into Europe and North America, from Asia, and a tight cost control.
That leads on Slide 8 to unit figures per TEU with a very favorable above CHF 300 per TEU gross profit, a result of the portfolio development and the SME customers being back into our portfolio, a tight cost control with unit costs below CHF 200. We mark here of CHF 198 per TEU, unit cost development. And the highest EBIT ever in Sea Logistics was CHF 113 per TEU.
In quarter 3 we posted CHF 378 million gross profit, which was 3.3% below previous year, while year to date, the gross profit development is minus 10%. And then EBIT in quarter 3, that was 12.3% above prior year.
We continue in Sea Logistics on focusing on excellent customer service and have fully deployed the implementation of the concept of customer care location and operating care center to get closer and most efficient to our customers.
Air Logistics, I mentioned automotive and perishable volumes recovering and the positive one-off impact of net CHF 63 million. Therefore, the figures you see on Slide 10 of the presentation. The Air Logistics figures are unit KPIs adjusted for impairment of intangibles in quarter 4, 2019 of minus CHF 14 million and the quick one-off in quarter 3, 2020 of net – positive net CHF 63 million.
The unit, if you look into the unit KPIs unit meaning 100 kilo. We see a normalization of the average yield, which is a result of the improving cargo mix. While still the long-haul PAX belly capacity is depressed. The active cost management in all business units, but especially also in Air Logistics showed a stable unit costs on the same level as previous year’s quarter 3.
We have a result – adjusted EBIT result of CHF 287 million, 9.1% above prior year, while in quarter 3, we posted CHF 106 million adjusted EBIT, which was 19.1% above prior year, a very strong operational performance. And as you know, we have made a statement in our press announcement, the whole KN Group, Kuehne + Nagel Group, but especially our Air Logistics colleagues are well positioned to serve ongoing COVID-related demand, and especially the potential distribution of COVID-19 vaccines.
Our next business unit, the Road Logistics business unit. As mentioned before, the demand for domestic transports in Europe is almost back on pre-crisis level. While the high yield in cross border volumes are still lagging. North America volumes still lag, except for pharma and e-commerce. And I would say that the Americas somehow are still in the eye of the hurricane, the COVID-19 hurricane.
From a performance point of view, [indiscernible] is our hardest hit business unit driven by 3 effects, which I would like to mention: a material drag from expo and events; the shipment recovery almost on the same level as previous year, as mentioned before in Europe, but with lighter average weight, which drive obviously pressure on productivity; and North America still being distressed somehow by the COVID-19 situation.
We see nevertheless sequential improvements continuing and expect this to continue in the next couple of months. And we have a very positive market reaction on our digital platform eTrucknow, which drove a lot of the volume development, especially in Asia during the last 6 months.
Contract logistics, we posted market share gains in essential goods sector as well as continued with the strict cost management. But I don’t know whether you remember what I said to you in our previous call, I have spoken about the 2 phases of Contract Logistics, one phase, the not so beautiful phase, where at that time the automotive sector, aviation and industrial, while the nice phases were pharma healthcare, essential goods and e-commerce. Today I can say that we see improving trends in all sectors, so there is no 2 phase for Contract Logistics anymore, some are more shining than others.
In detail, on Slide 14 you see the Contract Logistics business unit, excluding our real estate transaction, so the pure operational business performance. You see that – you don’t see it, but let me mentioned that e-commerce accounts for more than 150 fulfillment centers globally. That quarter 3 has been operationally the strongest quarter in the last 7 years, the clear result of the consequent restructuring of the Contract Logistics business unit. The ongoing cost management shows more effect and we have seen the lowest idle space ratio ever was 0.2 – was 2.4%.
From an operational point of view in quarter 3, we saw an improvement of CHF 15 million to an operational result of CHF 49 million adjusted by real estate, as mentioned before, which was 44% above previous year. And one can say that the restructuring plan of Contract Logistics will close on plan end of this year was quarter 4 and will enable Contract Logistics to shift them into a selected growth year again.
And before we continue going into the details of the financial figures, I’d like to mention that all the figures that we have – that I have presented that Markus is going to present are driven and generated by the hard work and the full commitment and driving force of our colleagues, all our colleagues worldwide, and I would heartily and heartfelt thank all of them, all of you that are participating in the call for your commitment and your support in a very special year.
And now I hand over to Markus to give you details on the financial figures.
Thank you, Detlef. Also for my side, welcome to everybody, ladies and gentlemen. I’m going to the first page, income statement. And what I want to open with is a confirmation that what we said in our half year call would happen in the third quarter also happened. So what we anticipated, I think, really turned out to be true.
We have seen coming back most of the business units in a normal situation in terms of how volume and margins develop. You may remember, we said after the second quarter extraordinary high margins in Air Freight, we would expect through normalization of gross profit margins per 100 kilo. That’s the average comes down a little bit. At the same time, the mix has normalized again, so some of the perishable volumes and business came back. So hence, all of that has happened and we have seen that in the numbers.
Sea Freight, I think, Detlef, already highlight very clearly, a good development on cost. At the same time, we were successful in the market to have a good gross profit margin here to you. One thing I want to mention before I go into the third quarter numbers, we have not experienced our regular seasonality, I think the year 2020 has been bare of any regularities, so as such also the seasonality that we have usually seen has been different or certainly distorted.
When you follow me into the column of the third quarter variance between 2019 and 2020, you see that sequentially we have improved our development on the gross profit. You see here when the third quarter still that we are CHF 108 million in the quarter behind last year. But notably, we should say that in Sea Freight and Air Freight, we are 3 respectively 4% below last year, which is very little, we talk about CHF 13 million and CHF 14 million. So very close already coming up to what we have seen in the year 2019.
Second point I want to highlight is you have heard, there is a significant positive one-off effect in Air Freight, amounting to net CHF 63 million. Having said that, when we look into the EBIT line of CHF 88 million we would recognize that even without that effect, our growth would be between 8% and 8.5%. Quite remarkable, I think when we look through the quarterly sequential development of the numbers. Not to forget all that development against a backdrop of currency in average here, as you can see on EBT level, earnings before tax of 5.7% looks like a small number still represents CHF 45 million in absolute terms.
For simplicity reason, we have provided a simplified bridge, a reconciliation of the EBIT for the 9 month period. Again, we have tried to keep it simple and I acknowledge that many of you on the call would like to have far more details than what we have disclosed here. I appreciate that we have addressed that in many of our calls already today in the morning, and I’m pretty sure that Chris Combe is going to be happy to answer some of the more detailed questions around it.
However, what’s the message on that slide clearly reveals is that we are very close to our [indiscernible] 2019, thanks to cost control, cost control, cost control, motivation, and now it is really, really the time to keep that momentum into the fourth quarter and going forward.
I think echoing, what Detlef has already said it was the right decision to keep connected to our staff, to our employees, to our experts, and to bring them back into the business, the moment we need the most which is now at the time of recovery. Don’t ask me what shaped recovery is going to be the only thing I know is that it is happening at a point in time and we are able to gain market share by bringing our people back into the operation.
How can we do that a solid foundation is something that is needed for that. Everybody knows when I talk about solid foundations, I can only talk about balance sheet, 3 topics or 3 highlights if I may. First one, you see clearly the total value of the balance sheet has reduced around CHF 550 million simple calculation, you look quickly into the exchange rate impacts that we have experienced in the P&L very similar even a little bit bigger on that point on the balance sheet for the month end rate, September 30, 2020, but this is where the main driver is coming from.
Secondly, we have paid dividend in the third quarter to the amount of CHF 4 per share, which is a cash outflow of roughly CHF 480 million. After that, equity ratio as it stands 30th of September is still at around 24% equity ratio.
Last but not least, very important, everybody looks at it on a daily basis. We do for sure, cash and cash equivalents position; we are now at around CHF 1 billion cash on the balance sheet. I’m talking about cash and free cash flow, of course, you have on Slide 19 of the presentation, the reporting on the cash into free cash flow comparison on 2019 and 2021.
One remark which is technical nature operational cash flow and changes in working capital, you see there was a huge operational cash flow improvement with that little footnotes to it, this is the reclassification, if you like comparable with the one-off item from the quick acquisition that we have mentioned in the Air Freight business. That also means our working capital management has been significantly better than last year, I will allude to that on the next slide to come.
How does the trajectory look like the right side of the slide, we are currently at around CHF 811 million as you see at the end of third quarter. Anticipating some of your question, how is the fourth quarter going to look like? Last year, you may remember we had some special items of real estate divestment.
I would expect this year that a small item around this topic is also going to reappear. We have been on the process of selling a second portfolio of real estate locations. Hence, my projection for the fourth quarter would be that we would probably create a free cash flow in and around CHF 350 million.
Working capital, Page #20, extremely important message, and I reiterate that message as often as possible. We do closely monitor our receivable risk, our debtor risk until now, and I repeat myself what I said 3 months ago, we have had no significant problems. We have had no bad experience, no write-offs in significant numbers.
However, we monitor extremely closely how the development is. We are cautious. The operation is in alert on that section. So there is something we expect, but as so many things in these times, we don’t know exactly what to expect and where to expect it. We just try to be as much prepared as possible.
You see the working capital intensity at 3.3% currently, just below the lower-end even of our corridor that we have set ourselves between 3.5% and 4.5%. It’s a reflection of a very hard fight to keep the DSOs at a reasonable level and at the same time to manage the DPO as well. So my thanks go out again here to the operation who is the main driver for that.
Return on capital employed, we’re on Slide 21 of the presentation. You see that kind of wavy curve on the top. You may remember, when we talked in 2019, about restructuring of contract logistics that is exactly what you have seen there, there is a swing up. Then first quarter 2020, second quarter 2020, the dip in the – through the COVID-19 development, and let’s call it carefully, the recovery, then back into the mid 60%s on the return on capital employed level.
I maintain, we maintain our target of 70% return on capital employed, that we have already announced and already reiterated, for a longer period of time.
Moving forward to Page #22, and whoever was waiting for it, now it comes. How do we reach our conversion rate of 16%? eTouch is the answer, is still the answer and will remain the answer. So you can expect by our announcement for the full year 2020, a far more detailed progress report on eTouch including financial implications of this.
I can only tell one thing today, which is – and by no means, I would like to say crisis is good, but there is always a momentum that is created by disruption. And I think the disruption that we are living through and the crisis we are living through, I think has opened many doors for digitalization, automation, and a more remote approach to execution. And I think this is exactly what has also propelled some of our eTouch initiatives.
Again, confidence here that we can reach our targets 2022 with a 16% conversion rate. For illustration, if you like, to third quarter, if you take the recurring EBIT as we have reported it, you would find already a conversion rate in the third quarter, excluding one-offs of 16.2%.
Return on capital employed, I have mentioned that 70% remains our target. And the effective tax rate, as we have seen it here, we currently still work on the 24% to 26% brackets. I can say through the extraordinary profits that we have seen this year we might have a slight alteration in this tax rate. I would expect that by the yearend, we would move rather to the higher end of that bracket in 2020.
So for the financial targets, for the business units and also the markets, our outlook for the fourth quarter and you may appreciate that we have abstained at least in the second quarter of making any outlook, so we are now trying at least to have a certain view into the fourth quarter. And we would expect currently market growth in Sea Freight of around minus 6%, Air Freight of around minus 14%.
In both of the areas, I think our target clearly will be to be better than the market. I think we’re working on that. We are getting there for the full year 2020. For overland logistics, we will have – the market estimated around minus 8% and for Contract Logistics minus 4%. So you see our estimates are still rather on the cautious side, I think reflecting again uncertainties around not only the kind of next year what’s going to happen, but I think already when we talk about December, there is plenty of uncertainty at that point in time how December is going to look like.
So take this outlook with certain precautions. But that is our current view how things may develop until the yearend.
With that little view forward, and I would hand back to the operator and open our question-and-answer sessions for all the participants on the call.
We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Daniel Roeska from Bernstein. Please go ahead, sir.
[indiscernible] and good afternoon. 3 if I may, number 1, last time we spoke you mentioned that your forward visibility of the business was very limited. Could you just comment on how that outlook over the next couple of weeks is shaping up, and if that’s changed in the past couple of weeks, so you have a longer visibility at this time?
And then, if volumes continue to recover, even if it’s slowly, how should we think about the unit cost in Air and Sea? How much operating leverage can you capture kind of as you grow out of this crisis?
And lastly, connected to that, then if free cash flow continues on its trajectory, how would you think about the balance between dividend and, let’s say, the war chest for M&A, may there be more room for a bigger dividend next year? Thanks.
Thanks, Daniel. Let me answer the first question and then hand over to Markus for the other 2 questions. Our visibility for the next couple of months has not changed. Our outlook is limited to, let’s say, 6 to 8 weeks maximum. And that has given us the cautiousness of assessment of the markets as well as what Markus has presented before on development.
At the moment, as we have ended quarter 3, we don’t see a material change in the momentum that we have seen in September. But that statement, Daniel, is good for 4 to 6 weeks, not longer. So that would be our reading of the market, because there are a lot of uncertainties still remaining. You know that we have regional lockdowns or discussion of these. We have lot of limits to travel, leisure travel and business travel. All this will have impacts on the consumption patterns and consumption as such, which will directly impact or indirectly impact transport volumes.
We feel in good shape. We are in close contacts with our customers and industries. And as I mentioned before, we have seen most of the industries somehow starting a recovery, different levels, different speeds, but they are starting a recovery. And that should give us enough confidence that most likely in 2020, only in 2020, we might have seen the worst of the market situation already.
And for the other 2 topics, Markus will happily comment.
So, Daniel, I think the second question on the volume recovery and cost per unit, I mentioned cost a couple of times during my presentation. I think reflecting exactly what that let’s say, on the volume side we have a certain visibility, maybe even shorter than what we normally have. So we have to focus on what is our cost base to it.
And the cost base efficiency gains that we have already demonstrated in Sea Freight and that for me is the big lever, also going forward that we can bring cost per TEU below CHF 200.
And we may argue now there is also a currency effect in there that helps that. But at the end, the trend goes in that direction. And I think this is where we keep our focus on. So cost per unit, cost per TEU below CHF 200, that’s something that we feel is also sustainable going forward.
So if we are called it halfway right that there is going to be a recovery over time, and maybe we can expect until Chinese New Year that we have some traditional stronger trade lanes coming along, we should see a good operational leverage going forward. Again, the focus is on the cost side. Whatever comes then on the gross profit side, I think is something we need to be careful with.
Free cash flow question, your number 3, I think a fair question. First of all, first priority for us is the management team is creating the free cash flow. Second priority is our M&A strategy, that we are committed into the Asian area, with substantial view on step changing our game in Asia. That has not changed.
On the back of this M&A strategy that we have, the last at least 18 to 24 months, and communicated as well, I think you should look into payout ratios, as we have them originally planned at the beginning of the year, which was reflecting around 60% as something that – 60% of net profit after tax, that could be something that might also find the proposal going into the supervisory board, and obviously, after that into the general meeting.
So that is the, I think the connection somewhere around the free cash flow generation and the spending of the free cash flow that is coming out of that.
Perfect. Thanks very much.
The next question comes from Sathish Sivakumar from Citigroup. Please go ahead.
Good afternoon, everyone. Detlef, Markus, thanks for taking my questions. I have 3 questions. So firstly, on Air Logistics, could you please touch upon the booking window that you are seeing from shippers i.e., how much of the volumes are booked on spot basis versus 2 to 3 weeks window?
And how much of your Air Freight capacities are actually exposed to charter network versus freight versus the commercial airlines?
Secondly, on SME segment, you pointed a sharp recovery. Could you please elaborate where you are actually seeing a sharp recovery by verticals and markets? That will be helpful. Finally, on the employee count, in the financial statement, the full-time equivalent of employees actually reduced from 78,000 to 72,000. So question there is what will be the run rate into Q4? And is this number impacted by any short-term schemes?
Thank you, Sathish. I think I start with the last one on the employee count. We have to be very specific on this one. There is obviously the number of employees that are on the payroll, and then, there is the FTEs associated with this.
I think it’s very important to understand that the short-term labor programs that we have been enrolling people into, that counts against FTE numbers, of course. At the same time, we do see, we do see very clearly that we have also cost reductions and people reductions in place. So we are not all the – or let’s say, all the cost reductions have not been at the back of the furlough or short labor programs.
Unfortunately, there was also a number of people, of course, where such progress are not available, we had to let go. So your trans reading or your reading is correct in that terms. However, having said that, it’s an amount of around 4% or 5% of our staff. That is I think reflecting fairly the situation on the employment side.
Then you ask Sathish about the Air Logistics window and how we book our capacity. I have to say, we see the Asian market being very stable. We are seeing spot getting less particular, especially in quarter 4, and there is still COVID-19 [indiscernible] that apply on a monthly or quarterly basis?
But we do not have an over-proportional securitization of charter business, unless we would have clear demand, customer demand on specific trade lanes.
The sharp recovery, I’m not sure I’ve got the question to be honest. We never spoke about a sharp recovery. We didn’t even refrain from quoting any letter that would be a metaphor for recovery. At the moment we saw sequential recovery month by month and especially the consumer products in Europe. In LatAm and in North America get more and more – or drive more and more Sea Freight volume.
And I mentioned leisure or sports equipment, garden equipment and so on, outdoor equipment, whatever. So this is driving a recovery. Is this a sharp recovery? Is it sustainable too early to say?
Okay. Just on that point, just a follow-up. So you said about SME being a good positive contribution. So within the SME segment, which market are you seeing and performing better than the other market? Is it mainly in Europe where you’re seeing a good performance from SMEs versus North America?
No, Sathish, I mentioned it before. It’s Europe, North America and Latin America, where we see the small- and medium-sized enterprising – enterprises coming back to production, and thus starting to ship with us. This was a totally different situation in quarter 2. Please do not forget that our volumes are still clearly behind previous year. We are talking about a development – sequential development quarter 2 or quarter 3 versus quarter 2.
Perfect. Yeah, thank you.
The next question comes from Andy Chu from Deutsche Bank. Please go ahead.
Yes, good afternoon. A couple of questions from me, please. Just one point that I picked up in terms of seasonality, you’re saying that the business clearly isn’t behaving given the crisis and sort of typical seasonality pattern in Q3 would normally be the strongest quarter? Just wondered if you can make any sort of comments on Q4, I mean, just directionally are you therefore saying that the seasonality goes out the window such that Q4 could be a stronger quarter than Q3 in terms of profitability, which I think would make sense, given the trends that we’re seeing into October?
And then on the AF side, in terms of your OpEx, which seems to have come down very nicely below sort of a couple of CHF 100 million. Is that the sort of run rate that we should be using going forward? Thanks very much.
Let me come back to seasonality, Andy. In my 30 years or more in this industry, I’ve never seen a quarter 4 outperforming quarter 3, unless there were some special extraordinary items. Though, I think it’s absolutely not possible, especially with the unsecurity of COVID-19 that quarter 4 will be outperforming quarter 3. What we said, and that is maybe important to mention once more, that the momentum that we have seen in September seems to continue in October, but that’s all we see. We can’t even judge longer than 6 weeks, we said.
So therefore, be careful in assuming that quarter 4 from a pure operational point of view will outperform the previous quarter. We will nevertheless see a peak coming from Asia. Asia export, we will see a consumption peak around Thanksgiving and Christmas that’s a normal seasonal pattern. And we will see a preparation for Chinese New Year, which sometimes has an effect end of the year or early the following year, but nothing extraordinary or specific that we would need to state already today.
With regards to the OpEx statement, it’s a cost statement, its CHF 200 million or below CHF 200 million per TEU. And that is something that was driven by a lot of cost activities and I mentioned customer care location and operating care center. So a new way to operate in Sea Logistics by the way, we have implemented that in Air Logistics as well, which drives efficiency gains, and that is something we have always stated that through an improved process and IT infrastructure, we will be able to harvest from efficiency gains. And I think this quarter or last quarter has shown we can get them.
Apologies, probably that’s my line or my way of explaining things. But I was just wondering about the Air Logistics OpEx – sorry, in absolute terms, not per unit being running below CHF 200 million [indiscernible] making that clear. Sorry.
Yeah, yeah. No worries. I think the right way of looking at is still the cost per unit because this quarter in Air Freight, and that’s what we’re talking in Air Freight, we have the distortion around the extraordinary impact of the quick acquisition. So but if you look into the production costs, Air Freight per 100 kilo, we are at CHF 59 per 100 kilo.
From our perspective, that should be sustainable and a sustainable number going forward, unless, of course, the odd chance happens that that there is all of a certain massive increase in volumes that we have to manage. But under the current circumstances, CHF 59 should be a number that we should look at from a sustainable basis.
Fantastic. And could I just ask 1 point of clarification, I guess. Again, apologies, whether it’s my line, but I think you’re very clear around Q4 free cash flow, Markus, did you say CHF 350 million or CHF 300 million for Q4 or maybe both?
Okay, let’s settle for between CHF 300 million and CHF 350 million. No, I would be inclined to say CHF 350 million should be a number we should be able to reach.
Okay. Thanks. Thank you very much. That’s really helpful. Thank you.
The next question comes from Mark McVicar from Barclays. Please go ahead.
Good afternoon, Detlef. Good afternoon, Markus. A couple of questions, really, 2 questions. First of all, because you mentioned it, Detlef, with the COVID-19 potential vaccine rollout next year. So the 2 questions are, do you see that being organized at a very international level? I mean, is something like the WHO or the UN going to be involved? Or is this going to be bit more piecemeal than that and more country by country?
And the other half of that question is, I guess, do you think you’ll be able to handle that business on normal commercial terms? Or are governments and those international bodies going to put pressure on you to do this at cost or cost-plus or something like that from – there’s no clear view at the moment, but I just wanted what you thought you were seeing so far?
Sure, Mark, let me answer this question. So how will this be organized? I think it will be, first of all, dependent on which OEMs or manufacturers of pharmaceuticals and vaccines will make the race and depending on that, there will be most likely supranational bodies that will influence the distribution of vaccines, plus governments, the European community has already asked the national governments to come up with their national vaccination plans that will get involved.
To your second question, nobody can force us to do business. We are privately – or we are stock listed company. We are not a government body. And I think the market play will be applicable here as well. There will be providers that will offer solutions, and there will be a demand side that will seek solutions, and they will as always argue the business and will not only look for the cost of handling and distribution of COVID-19 vaccines, but also the experience, the compliance with the GxP standards, as well as the ability to deliver on time, undamaged without any peripheral.
So there will be a huge market potential and we will look for those segments in the market that we have the best solution for. Also, there will be different demand per region. And we believe that there will not only be on the long- or mid-term not only be 1 provider OEM producing it, but we will have contract manufacturers as well as a second or a third provider that might have listed and registered vaccine to offer to the market. And that will ease up the constraints that might be there in the first couple of weeks or months nobody knows throughout the course of the time.
Yeah, that [sounds helpful listening to it] [ph]. The second question I had, and again, I think it’s for you, Detlef, is that with the kind of Q1 and then the Q2 results, you said you were seeing a certain amount of flight quality and that you expected and inquiry levels were high. And you expected to see the market share gains. Has that followed through, because obviously, I’m looking at your –the financial targets page on the piece on volumes. And it doesn’t look as if you’re expecting to significantly outperform the markets other than a little bit in Air. Is that just Markus been very conservative with his forecasting? Or has that market share gain kind of normalized a bit?
We always try to be realistic with our forecasts. At the moment, we didn’t show a 2020 forecast on our Slide 22, be careful, we show the performance that we have seen so far on or drove or the basis is our year-to-date performance. Our ambition is still for the 2 network businesses, Air Logistics and Sea Logistics to gain market share. And we will see at the end of this year whether the mid-sized for Water Logistics companies were able to cope with market demand in a way that we were able to cope. For me, it’s to say, Mark, our ambition stays. And I think we are in a good shape and have a good run rate to show that we are gaining market share in the contracting market.
By the way, we have won substantial business, Mark. We wouldn’t – we would not have said so if we would not have seen our Qs or our response to our Qs being successful.
Okay. That’s great. Thank you very much.
Thank you. Thanks, Mark.
The next question comes from Sam Bland from JPMorgan. Please go ahead.
Afternoon. I have 2 questions, please. You’ve mentioned the strong September exit rates and trends in September. And obviously, you gave them monthly volume progression in Sea Freight on the call earlier. Was that – is the September strength you saw broader than that Q3 Sea Freight volume? Is it strong in September in other areas as well? Just wondering if you could give some detail there, please.
And then on the Sea Freight unit margins, it’s up quite strongly, it’s up year-on-year, but I guess it’s up even more strongly in U.S. dollar terms. I appreciate why it’s stronger than it was in Q2, because you get the SMEs come back? Just wonder why it might be up so strongly on a year-on-year basis. Thank you.
Sure, Sam. September was stronger across all business units. I think I mentioned that in my initial or introductory statement. We saw a sequential improvement I stated some figures for Sea Logistics or Sea Freight, but not only. So across our views, we saw an acceleration of volume recovery versus previous or sequentially versus previous months.
On the unit margins, I think, Sam, it’s obviously a very important question for all of us. You’re absolutely right the increased third quarter versus second quarter is significant, also taking the U.S. dollar in consideration also versus last year. The GP margin that we always report here has various components one of which is clearly the mix. And SME, better improvement means at the same time as a cross read if you like that commodity business has been reduced or has been on a lower share from our product mix in total.
And third quarter was maybe not so unexpected, but third quarter was clearly a lower share of commodities versus a higher share in the SME business. Of course, as the complexity towards it and you know that in Sea Freight, we also have to look into some of the trade line development, right. Some of the trade lines have a rather tight market a lot of these conversations went through the press as well, Trans-Pacific Eastbound. There is a tightening in the market, which always gives a bit of margin opportunities.
So combination of mix, so better SME versus lower commodity plus some of the trade lines in a tight situation, I think has helped the development. I would not bank necessarily on that development being going for the same time. It’s pretty much what I said during my presentation, I think we have more confident in where our cost level is then what we can forecast on the GP level, but for the third quarter, that is the explanation.
Okay, thanks very much.
The next question comes from Alexandra Thrum from Morgan Stanley. Please go ahead.
Hi, thank you for taking my questions. I just have 2 quick ones left. Just on the Air Freight market, Markus, I think you mentioned some – we’ve seen some normalization Air Freight profitability already. But I just wanted to ask what you see is the normalized level, because it seems that CHF 89 per 100 kg is still above the sort of 2018, 2019 level. And then the second question just on Contract Logistics, seen some decent margin improvement there, the conversion rate of around 5.96% in the quarter. How much of this improvement would you say is sustainable? What – how much has been driven by cost restructuring versus, say, some of the equivalent furlough schemes or the higher margin growth in e-commerce? Thanks.
Alexandra, thank you for asking the question, because I think you’re absolutely right on the Air Freight. I have been to be a bit – or not precise in it. When I talk about normalization would be normalized for Kuehne + Nagel’s product and cargo mix. So that meaning that around 30%, 35% of our volumes, traditionally going back into 2019 had been out of the perishable sector. And our GP at that point in time was always around the CHF 80 mark. What I meant is coming from the second quarter, where there was hardly any perishable, a lot of special transports on PPE, which was giving an extraordinary GP per unit, but at very low volume, obviously, that is trade off to that.
We are now slowly developing back into regular whatever, so hard cargo, the mix with perishables, with pharma, with e-commerce that mix starts balancing a bit closer to what is our normal cargo mix. And hence that GP comes from above CHF 100 into now into the region of CHF 90, and probably going forward back into the CHF 85 a region. So that is what I meant with normalized for our product and customer mix.
To your Contract Logistics question, Alexandra. What we have shown on Slide 14 is from our point of view, and operational performance. And the improvement very much comes from portfolio mix, a strong development in e-commerce as well as with pharma customers, pharma healthcare customers. I think I mentioned that when I presented that slide. And also a cost program that we have started years ago that gets more and more traction. Your question regarding furlough. Furlough is not to make profit, furlough is the benefit of our employees, and it’s a cost coverage to keep them in employment. That’s a totally different scheme.
And from our view, the performance in Contract Logistics was an improvement versus previous year quarter 3 of CHF 50 million or 44 something percent is sustainable. That was the aim of our restructuring and the targets and the Contract Logistics business unit and all colleagues involved hit those targets or meet those targets.
Okay, great. Thank you.
Thank you. You’re welcome.
The next question comes from Neil Glynn from Credit Suisse. Please go ahead.
Good afternoon, everybody. If I can ask 2 of Markus, and then maybe 1 for Detlef. First of all on the CapEx side, Markus. Your last couple of years before this year, you had over CHF 300 million a year, I guess this year is probably below CHF 200 million. And I’d love your thoughts on next year what kind of a CapEx level is reasonable to think about.
Second question with respect to the impressive working capital management, I guess the DPOs lengthened, which is quite impressive, given the tight supply on the air and the ocean side. Can you give us some flavor as to whether this is more on air or ocean, or whether there’s anything else to consider within the DPOs?
And then finally, for Detlef on the M&A side, you brought it up again today, we’re just interested, when you look towards Asia, would you prefer to buy a company that’s firing on all cylinders and has had a good pandemic? Or is there a bigger opportunity to find a company with good market presence that requires your expertise and a bit of TLC perhaps?
Thanks, Neil. So, CapEx, yes, you’re right, over the last couple of years, we were around and above to CHF 300 million expenditures, some of it being driven also through real estate investments that we have done. I think this year we will be around to CHF 200 million mark, most likely not substantially below, but somewhere in that area.
Going forward, we have to consider that we have restructured our Contract Logistics business quite significantly. And I’m not only talking about the divestments we have executed or are in execution. We also talk about how efficiently we’re making use of our own capital allocation.
I would feel comfortable with a number between CHF 200 and CHF 250 even going forward. So I’m very clear that we will not reach the CHF 300 million number in the foreseeable future.
Working Capital, very good observation, the DSO side obviously we have been managing, as I said in my presentation, as tight as possible. It is a hard fight. It’s a daily fight clearly. On the DPO side, yes, business pattern have changed slightly. When we look into the Air Freight market, of course, everything before was, if you like, regulated, you know – capacity, belly capacity was paid through IATA and CASS on a monthly payment.
Still that’s happening, but not much is flown on that capacity. So there is a bit of a different way of managing currently the DPOs.
Is that sustainable? I would like to think as long as we are in the situation as we are right now, that should be sustainable. But for us, the bigger focus or the more prominent focus certainly is having access to a good supplier relationship, rather than stretching our relationships, because of the big burden of this year.
So if something would have to give, if you asked me, then I think we would probably give half a day on the DPOs rather than not being available to service the customer.
Neil, your question regarding M&A, thanks for putting M&A on the agenda, because we didn’t mention it really. Our strategy has not changed. We have mentioned our criteria before. And I think it’s agnostic through the COVID-19 situation or development of some of the targets. We are looking to strengthen our domestic or local footprint, access to Asian customers, access to Asian distribution networks, and the like, and maybe also access to e-commerce solutions and infrastructure or IT infrastructure for those that could be scaled to the rest of world.
So having said that, we are in contact with some of our – with some of the targets that we have identified. But it’s not related to any of the recent developments that we have faced altogether during the last 6 months or so.
Okay, sure. Thank you very much.
The next question comes from Frans Hoyer from Handelsbanken. Please go ahead.
Good afternoon. Thank you very much. We’ve seen a very tight market in parts of the sea market and especially on Asia, North America. And we’ve seen some complaints from some of your peers regarding getting access to capacity. And I was wondering whether you might have some comments on that issue, please.
My comments would be we have no complaints. We see the market being liquid so to say, and we had – a lot of our customers to get the right space on vessels that were full. And we are seeing that some of the lanes Asia to LatAm, for example, are very constrained, but you get access. From that point of view, I wouldn’t mention any, any constraints.
Okay, thank you. And just one more regarding the consumer electronics vertical this autumn, whether you might offer any comments on your view of that season this year, please?
Consumer electronics is a very specific question. This is a seasonal business and through e-commerce fulfillment or e-commerce orders, as well as through countries or regions going back to a lockdown like situation, we will see demand continuing on a high level.
Thank you very much.
Next question comes from Christian Obst from Baader Bank. Please go ahead.
Yes, thank you very much and hello. Small balance sheet questions, 2 small balance sheet questions are left. 1 is can you give us some kind of a framework, your underlying framework for the impairment charges of CHF 53 million for Quick you booked? And the last one is on asset held for sale increased by approximately CHF 100 million in same amount or 150 millions on liabilities held for sale related to the UK activities, which you intend to divest in Q4? Can you also give us the idea why you increase that kind of numbers? Thank you.
Sure, Christian. I guess these are 2 questions for me or – just joking.
I’m kicking him.
Now, clearly, give you a bit of flavor around impairment charges, clearly the acquisition of Quick was hugely successful. The 2 operating units, if you like, were mainly around pharma and healthcare, which is very strong.
The other one is around the aerospace industry. And you can image that that is an industry that unfortunately has taken a huge hit by COVID-19 and continues to have a huge hit on this. And as it is with IFRS reporting, of course, and impairment testing towards that, that part has led us to make a justified impairment into that area.
What – sorry, maybe an add-on on that, what is the share of aerospace-related business within Quick?
I think we are not disclosing this.
Okay, thank you.
Second question, the asset held for sale and the associated liabilities, very well spotted. I think it’s a natural evolution around the fact that that transaction takes a bit of time. And I think the buyer as much as ourselves, we would have liked that transaction to be closed at a point when we talk already. But naturally, when you continue to operate a business, there is some right of use assets.
So renovation or renewal – sorry, renewal is the right word of longer lease liabilities and right of use assets associated with it. So it’s a moving number that we’re looking at. And you may remember that that is a quite large activity in the UK, Contract Logistics business. And hence, you will see at the point of taking on new assets to operate and/or transforming assets that had been owned in the past now into longer-term lease agreement, you will see these assets and liabilities as being a moving target at that point in time.
So it’s all associated with the way we have to report according to the IFRS reporting standards for asset held of sales, but it’s an ongoing business, right.
And you are still very confident to close the deal in Q4.
We are very confident that that’s going to happen. I think we are waiting for regulatory authorities to approve this. Clearly, the filing for the regulatory authorities is from the seller side. It’s not from the – sorry, it’s from the buyer’s side. It’s not from the seller’s side. So we are supporting here the process. And we hope that the UK authorities will deliver the answers before the yearend, yeah, absolutely.
Maybe they have to do something else in due course. But, of course, thank you very much and all the best. Thank you.
Thanks, Christian. Take care.
And so far there are no more questions.
And thanks, everybody, for joining our analyst conference today on the 9 months 2020 results of Kuehne + Nagel International. We say goodbye to all of you and wish you good health. Stay healthy and full of energy. So do we and we will talk again for the full year 2020 results on March 3 next year. Take care. Bye-bye.
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