August 7, 2019 – D&L Industries’ recurring income reached P1.41 billion, or earnings per share of P0.20, in the first six months of 2019 (1H19). This is 7.5% lower than last year. Earnings before interest and taxes was lower by 5% at P1.85 billion. In the second quarter alone (2Q19), net income fell 15% y-o-y to P665 million, or earnings per share of P0.09. Earnings before interest and taxes for the quarter was lower by 12% y-o-y to P881 million.
Challenging environment dragged volume growth
The decline in income for the period was a result of the confluence of external factors which dampened demand in industries that the company caters to. The negative consumer sentiment due to the inflation scare last year persisted in the first half of the year. The effect on aggregate demand was exacerbated by the delayed passage of the national budget which translated to government underspending. While the budget was approved on April 15, government spending has been slow to pick up. Though government revenues were up 9.7% in the first half, spending declined by 0.8%. Moreover, the earlier anticipated boost from elections spending did not materialize. We believe that these factors have contributed to the slow recovery in customer demand, despite easing inflation. This in turn translated to lower factory output across various industries. The Philippine Statistics Authority (PSA) reported that the monthly production output has been on a monthly consecutive decline for the last seven months until June. In June alone, the Value of Production Index (VaPI) or the value of locally manufactured goods fell 9.6% y-o-y.
In addition to the unfavorable macro backdrop in the domestic market, the company was also affected by the uncertainties in the global market brought about by the US-China trade war. The Thompson Reuters/INSEAD Asian Business Sentiment Index showed confidence among Asian companies in Q2 falling to its lowest since the 2008-2009 financial crisis, with global trade war cited as the primary risk to business by ASEAN companies. While the company does not export US-bound products to China and vice-versa, overall negative sentiment resulted in cautious demand and uncertain projections from customers across various industries regionally and in the Philippines as well.
BASF, one of the world’s biggest chemical companies, has likewise highlighted the high uncertainty, low visibility, and poor predictability in global trade after it had reported EBITDA and EBIT decline of 27% and 47%, respectively, in 2Q19. BASF’s results are indicative of the broader industry outlook in the chemicals space. The performance of our non-food group of products that include colorants, resins, and oleochemicals, mirrors this situation as well.
Because of the external factors outlined above, D&L’s total volume for the first half of the year fell by 9% y-o-y with High Margin Specialty Products (HMSP) and commodities posting a decline of 4% y-o-y and 14% y-o-y, respectively. In the second quarter, volume decline was steeper at 18% y-o-y, partly as the Easter break occurred during April this year vs. March last year.
Progress in key strategic initiatives
Despite a challenging environment, the company made progress in key strategic initiatives which are fundamental and are indicative of future growth. The impact of the company’s investments in R&D can be seen in the margin recovery across all four business segments. This is also a sign of the company steadily progressing up the value chain. In 2Q19 alone, blended gross profit margins expanded by 4.6 ppts to a record high of 22.5%. HMSP margins for the quarter stood at 26.7%, up 4.5 ppts y-o-y, while commodity margins stood at 11.8%, up 2.1ppts y-o-y.
Another area of progress is the improvement in HMSP sales contribution which stood at a record-high of 71% in 2Q19, bringing the first half 2019 contribution to 70%. The company continues to focus much of its resources in growing the high margin side of the business. Assuming improvement in the macro environment, positive momentum in both margins and HMSP revenue contribution should translate to better growth moving forward.
D&L Historical Blended Margins
The company’s return ratios remain healthy. In 1H19, Return on Equity (ROE) and Return on Invested Capital (ROIC) stood at 18% and 22%, respectively. Meanwhile, the balance sheet remains robust with net gearing at 8% and interest cover still comfortable at 19x. As of end-June 2019, net debt stood at P1.2 billion with average cost of debt at 5.63% (inclusive of DST). The company generated positive free cash flows of P1.4 billion for the period as commodity prices continue to decline.
High value, high margin products are the foundation of future growth: Exports and “pack at source” strategy
Exports as percentage of total revenues stood at 19% in 1H19. In peso terms, export revenues declined by 25%, mainly due to a combination of the negative sentiment due to the trade war and lower commodity prices which were passed on to customers. Coconut and palm oil average prices were down 40% y-o-y and 19 y-o-y, respectively.
While export sales were down in 1H19, it remains as one of the key pillars of growth and the company remains optimistic that it will reach its long-term target export contribution of 50%. The ongoing construction of its new plants in export zones is expected to be completed in 2021. This will add a significant amount of capacity, focusing mainly on higher value and higher margin products which will allow the company to cater to more customers in both local and overseas markets.
The upcoming facilities will add the capability to manufacture downstream packaging and will allow the company to capture a bigger part of the production chain. For instance, while the company primarily sells raw materials to customers in bulk, the new plants will allow it to “pack at source”. This means that D&L will have the ability to process the raw materials and package them closer to finished consumer-facing products. This will enable D&L to move a step closer to its customers by providing customized solutions and simplifying their supply chain. All these investments and strategic efforts should lead to a more entrenched relationship with customers while providing an additional runway for growth.
“While unfavorable macro factors have weighed down our growth for the period, we believe that this is more of a one-off event, rather than something that is structural in nature,” remarked President & CEO Alvin Lao. “Looking into the second half of this year, there are more reasons to be optimistic given lower inflation, expectation of a more accommodative monetary policy, and ramp up in government spending with the Build, Build, Build program. In addition, to cushion the impact of soft volume for the period, we have implemented cost saving initiatives across the company which translated to just single-digit growth in OPEX vs. double-digit growth in prior years. The effect of this should carry on to the succeeding quarters. Looking beyond 2019, the prospects of our business remain exciting as we see growth coming from various strategic areas and as we continue to invest in initiatives that will allow us to continue maximizing our value to our customers and shareholders.”
The food ingredients segment posted record high blended margins for the period, as both HMSP and commodity margins showed improvements. Blended margins expanded by 3.9ppts y-o-y in 1H19. Meanwhile, total volume fell 10% y-o-y, as HMSP volume was flat while commodity volume fell 19% y-o-y. The decline in commodity sales was a conscious effort to focus only on margin-accretive commodity sales which, in turn, resulted to a margin expansion of 2.6ppts in the commodity business. Total gross profit for the segment increased by 8% y-o-y but lower forex gains and higher interest expense resulted in a 4% y-o-y decline in net income in 1H19.
Oleochemicals and Other Specialty Chemicals
Chemrez group saw its margins expand by 5.4ppts in 1H19. This was fueled by margin expansion on both Oleochemicals (+7.2ppts) and Other Specialty Chemicals (+3.1ppts) segments. However, margin expansion was not enough to offset the 3% decline in volume. As a result, the group posted a 5% y-o-y decline in net income for the period.
Specialty plastics net income was down 5% y-o-y in 1H19. This was mainly due to the 13% decline in total volume as demand for both engineered polymers and colorants and additives remained soft. Uncertainties have plagued the global auto industry as a result of the US-China trade war, affecting the demand for engineered polymers used in the automotive wire harness industry. Around half of specialty plastic revenues are derived from automotive end uses. Meanwhile, the spillover of the negative consumer sentiment and delayed passage of the national budget have affected the demand for colorants and additives which are mainly used for F&B packaging. On the positive side, however, there was a 3-ppt improvement in blended margins.
Volume for the aerosols business has started to pick up in 2Q19, posting an increase of 7% y-o-y from a decline of 10% y-o-y recorded in 1Q19. Meanwhile, blended margins improved by 2.1ppts in 1H19, primarily driven by the 4.1-ppt margin expansion on the maintenance chemicals segment. Overall, net income for the period declined by 5% y-o-y. –D&L Industries is a Filipino company engaged in product customization and specialization for the food, chemicals, plastics, and aerosol industries. The company’s principal business activities include manufacturing of customized food ingredients, specialty raw materials for plastics, and oleochemicals for personal and home care use. Established in 1963, D&L has the largest market share in each of the industries it serves, as well as longstanding customer relationships with the Philippines’ leading consumer and chemical companies. It was listed on the Philippine Stock Exchange in December 2012. For more information, please visit www.dnl.com.ph.