2023-08-09 14:05:09 ET
Novozymes A/S (NVZMF)
1H 2023 Earnings Conference Call
August 9 2023 3:00 AM ET
Company Participants
Tobias Bjorklund - Head of investor relations
Ester Baiget - President and CEO
Lars Green - EVP and CFO
Amy Byrick - EVP, Strategy and Business Transformation
Tina Fano - EVP, Agriculture and Industrial Biosolutions
Anders Lund - EVP, Consumer Biosolutions
Claus Fuglsang - CSO and EVP of Research and Development
Conference Call Participants
Alexander Jones - Bank of America
Lars Topholm - Carnegie Investment
Chetan Udeshi - J.P. Morgan
Soren Samsoe - SEB
Nicola Tang - Exane BNP Paribas
Sebastian Bray - Berenberg
Presentation
Operator
Welcome to the Novozymes conference call regarding the Interim Report for the First Half Year of 2023. [Operator Instructions].
Today, I am pleased to leave the word to Tobias Cornelius Björklund, Head of Investor Relations. Please begin your meeting.
Tobias Bjorklund
Thank you, operator, and welcome, everyone, to Novozymes' conference call for the first half of 2023. My name is, as mentioned, Tobias Bjorklund, and I am Head of Investor Relations department here at Novozymes.
At this call, our CEO, Ester Baiget; and our CFO, Lars Green, will review our performance and key events of the six months of the year as well as the outlook for whole year. Also attending today’s call are Tina Fano, EVP, Agriculture & Industrial Biosolutions; Amy Byrick, EVP, Strategy & Business Transformation; Anders Lund, EVP, Consumer Biosolutions; and Claus Fuglsang, CSO and EVP of Research and Development. The entire call will take about 45 minutes, including time for questions at the end.
As always, I would like to remind you that the information presented during the call is unaudited and that management may make forward-looking statements. These statements are based on current expectations and beliefs and they involve risks and uncertainties that could cause actual results to differ materially from those described in any forward-looking statement.
With that introduction, I'll now hand over to our CEO, Ester Baiget. Ester, please.
Ester Baiget
Thank you. Thank you, Tobias, and welcome, everyone. Please turn to Slide #3. Overall, the first six months of the year were much in line with expectations, and we delivered organic sales growth of 3%. Reported volumes declined by 3%, while underlying volumes were down slightly less, and pricing was positive by roughly 6%. In the second quarter, organic sales growth stood at 2% with pricing at a similar level as for the first half year.
Pricing, both for the first half and the second quarter, was roughly similar across business areas, however, slightly less positive in Household Care. Household Care and Agriculture, Animal Health & Nutrition delivered according to expectations in the first half of the year. Bioenergy has clearly outperformed whereas Food, Beverages & Human Health and Grain & Tech Processing both were more challenge. Consequently, we're adjusting the sales growth indication by business area for the year and narrow the full year organic sales growth outlook to 4% to 6% following destocking and lower consumer demand, mainly in the food-related parts of the businesses.
As earnings are similar across business areas, we delivered a 25% EBIT margin before special items for the half year and 24% for the second quarter. This is in line with expectations and reflects the benefit from pricing initiatives. It reflects -- it offset by higher input costs and reduced leverage on the higher fixed cost base. We are pleased to see the strength developing in the gross margin with sequential improvements since Q3 2022.
And we maintain our view of a flat year-on-year gross margin for the full year. Price initiatives and our productivity improvements are key levers to enable this development, offsetting the higher input costs. We are in a good place when it comes to earnings and returns and maintain the full year outlook for both EBIT margin before special items at 25% to 26% and ROIC including goodwill before special items at 16% to 17%.
As initially assumed, we continue to expect a stronger second half of the year driven by multiple factors including the benefit from product launches, continued market penetration, as well as a softer comparator. We expect destocking to level off in the second half. Destocking and lower consumer demand impacted especially the food-related part of our business in the first half of the year.
Consequently, we're adjusting downward our organic sales growth indications for Food, Beverages & Human Health and for Grain & Tech Processing, whereas we are raising the growth indication for Bioenergy following a very strong performance for the year-to-date. Net, and as mentioned, we expect solid 4% to 6% organic sales growth for the year.
We have engaged in exciting new collaborations, and we highlight two of them here. The first project explores the possibility of producing food protein from captured carbon dioxide. We're doing these in collaboration with the Novo Nordisk Foundation, the Bill & Melinda Gates Foundation, as well as few other relevant industry players. This is a project where the two foundations inject the required capital, DKK 200 million for now and Novozymes contributes its strong technology toolbox. Using CO2 to produce food protein is part of solving both the future food supply and environmental challenges, especially as the global population grows.
Secondly, in Advanced Protein Solutions we have teamed up with Arla Food Ingredients to explore opportunities in precision fermentation of protein ingredients, with initial focus being on medical nutrition. Both projects clearly signal the picture of what biotechnology and with that Novozymes has to offer in a world of increasing scare resources, where consumer and health solutions can be based on natural, cost efficient fermentation technologies.
As a final introductory remark, we're addressing the distribution of an interim dividend to honor Novozymes shareholders ahead of the closing of the combination with Chr. Hansen, which is still expected to take place in Q4 2023 or in Q1 2024. With this, let's now look at each of the five business areas in more detail, starting with Household Care.
Could you please turn to Slide #4. Thank you. Household Care delivered 1% organic growth, despite the negative impact from the war in Ukraine, impacting the first quarter and industry volume softness in developed markets, impacting the first half of year. Softness in consumer demand and downgrading had a negative impact on our volumes. This was more than offset by innovation across geographies, including the freshness technology.
In emerging markets, we see continued penetration of enzymatic solutions as the main growth driver, with the strongest growth in Latin America, and pricing had a positive impact. Organic sales growth in the second quarter was flat. We have seen the same trend since Q3 2022, with lower consumer demand in developed markets as well as down trading having a negative impact on industry volumes and our sales. Also here in the second quarter, growth in emerging markets was driven by penetration of enzymatic solutions led by Latin America.
The full year organic sales indication for Household Care is maintained at low single-digit growth. We expect performance to be driven by enzymatic penetration in emerging markets and we also expect the freshness platform to contribute to growth. The outlook includes the expectation of the consumer down trading trend leveling off, as well as stabling market volumes in developed markets in the second half of the year. Finally, we expect pricing to continue to contribute to the full year developments.
Please turn to Slide #5. Thank you. Food, Beverages & Human Health had the soft first half and declined 6% organically. Organic sales were negatively impacted by roughly four percentage points, as the first quarter comparator included sales of a specific enzyme solution, which is not expected to be sold this year. We saw positive impact from pricing, partially offsetting the negative volumes. The underlying slightly negative growth was below expectations and driven by destocking across the value chain in Food and Beverages in combination with weaker end market demand. Excluding the timing impact, Food had the relatively strongest performance for the subareas with good progress on customer activities.
Human Health was soft. The supply chain constraints impacted our ability to accommodate demand in the robust healthcare practitioner channel. And additionally, there was a general softness in North American demand for probiotic solutions. Looking at the second quarter, Food, Beverages & Human Health declined 3% organically, the performance was softer than expected and driven by destocking in the value chain across subareas in combination with weaker end market demand. And this was partially offset by pricing.
Innovation is key to drive growth. And we are very excited about our public launch of Novamyl BestBite in baking. The solution is based on a new molecule that enhances the eating experience and keeps bread for fresher -- fresh, much fresher for longer, and additionally reduces the need for added sugar. We have seen a very positive response in the market with strong sales pipeline building up.
Human Health was soft as per the first half year, however, we did see an improvement in the North American probiotic market towards the end of the second quarter and going into the third quarter. Additionally, we now expect to have resolved the supply chain constraints that impacted our ability to accommodate demand in the first half. For the full year, we adjust our indication of organic sales growth to low single-digits from previously high single-digit following higher than expected destocking effects, the reduced end markets as well as lower growth expectations in Human Health, where we now expect single-digit growth following the soft developments of the first half of the year.
We still expect a strong second half in Human Health as we will again be able to accommodate demand for our solutions now that the short term supply chain constraints have been resolved and supported by the improving trend in the North American probiotic markets. Overall, for the business area, we also expect a stronger second half of the year, as we expect destocking to level off, increase market penetration with support from product launches and a positive impact from pricing.
And could you please turn around to Slide #6? Thank you. Bioenergy sales grew 27% organically in the first half. The strong performance was supported by solid market fundamentals and driven by the continued penetration of innovation and geographical expansion. Growth was driven by innovation and strong penetration in North America, creating additional value for our customers.
Ethanol production is estimated to have declined by 1%, according to the EIA. Growth also benefit from capacity expansion of corn-based ethanol in Latin America and biodiesel. And we saw a very strong growth of enzymes used for biomass conversion, commonly referred to as second generation biofuels, although from a small base. Additionally, pricing had a positive impact. The second quarter organic sales growth of 26% was driven by factors similar to those for the first quarter and supported by solid market fundamentals. The EIA estimated the US ethanol production was flat year-on-year.
Looking at the full year, we now expect growth in the mid-teens, following a stronger than expected year-to-date performance driven by a stronger market fundamentals and a faster penetration of recent innovations. We have a tougher comparator in the second half of the year, so expect reduced growth relative to the first half. Growth for the year will be driven by pricing, market penetration enabled by innovation, capacity expansion in Latin America and market penetration in biodiesel. Additionally, we expect growing sales from second generation biodiesels, the outlook assumes flat to slightly declining US ethanol production.
Please turn to Slide #7. Sales in Grain & Tech Processing declined 11% organically in the first six months, driven by the decline in Tech. Tech was negatively impacted by significantly lower sales of enzymes for COVID-19 test kits, as expected, and a much softer than expected textile market. Performance in Grain was driven by increased market penetration in vegetable oil processing and continues to be underpinned by innovative strength. This was offset by a softer grain market impacted by destocking as demand is normalizing. Pricing had a positive impact in both Grain and Tech.
Second quarter organic sales declined 14% driven by factors similar to those of the first quarter including a further softening of the textile market and destocking impacting the food-related grain exposure. Looking at the full year, we now expect growth to decline by the low single-digits from previously low-to-mid single digit growth.
Performance is expected to be supported by pricing and growth in Grain will be led by market penetration in vegetable oil processing. Tech is expected to decline, driven mainly by reduced sales of enzyme for COVID-19 test kits and a much softer than expected textile market following a slower recovery in the global textile production.
Please turn to Slide #8. Thank you. Agriculture, Animal Health & Nutrition sales increased 7% organically in the first half, driven by Animal Health & Nutrition and supported by pricing. Growth in Animal Health & Nutrition continued from innovation with recent product launches doing well and higher end market driven demand. Performance in Agriculture was soft, impacted by destocking and a volatile end market. The second quarter organic sales declined 7% driven by a tough comp in Agriculture and as expected, a negative timing effect from Q1.
The negative developments in Agriculture additionally impacted by destocking and a volatile end market, were only partially offset by positive pricing and a better than expected performance in Animal Health & Nutrition. For the full year, we maintain the indication at mid-to-high single digit growth led by Animal Health & Nutrition. Growth will be driven by pricing, innovation, end market growth and increasing demand for sustainable solutions.
And with that, I'll hand over to Lars for a review of the financials. Lars, please.
Lars Green
Thank you, Ester. Please turn to Slide #9 for a review of our financial performance. Sales grew 3% organically and 2% in reported Danish kroner in the first half of the year. Currencies and divestments provided a one percentage point headwind during the period. For the second quarter, sales grew by 2% organically and declined 2% in Danish kroner, as currencies and divestments had a four percentage point negative impact.
We delivered a gross margin of 54.7% in the first half of the year. As expected, this was below last year's gross margin for the same period, mainly due to the high input and logistics costs and partly offset by continued progress in pricing and productivity improvements. The second quarter gross margin was 55.4% compared to 55.5% for the same period last year. The gross margin improved sequentially from the first quarter by 1.3 percentage points, emphasizing the solid progress we're making to offset higher input costs.
The EBIT margin before special items for the first half of 2023 was 25.0%. This was one percentage point below the reported EBIT margin for the first half of last year. That decrease was mainly result of the impact from the lower gross margin due to high input costs, and reduced leverage in the higher fixed cost base as we continue to invest in the business. Currency has had a minor positive effect during the period.
Moreover, the EBIT margin before special items for the first half included to one-offs from the first quarter. These were the positive effect of the divestment of selected wastewater treatment solutions, and the negative effects of resource alignments in the commercial organization. The net positive effects of the two one-offs was approximately half a percentage point in the first six months of the year.
The underlying EBIT margin before special items for the first half of the year was roughly two and a half percentage points lower compared to that of 2022 and was driven primarily by a lower gross margin, as well as lower operational leverage from a relatively higher fixed cost base as we continue to invest in our commercial footprint and future growth opportunities.
Looking at the second quarter, the EBIT margin before special items was 24.0%, which was 1.9 percentage points lower than in the second quarter of last year. There were no significant one-offs to consider in the second quarter of 2023. And hence the underlying EBIT margin before special items in the second quarter was approximately three percentage points below the underlying second quarter EBIT margin before special items, last year.
That decrease was driven by the lower gross margin and reduced leverage on the fixed cost base due to the higher operating costs and lower reported sales in Danish kroner. The reported EBIT margin was 22.6% in the first half of the year, which include special items amounting to DKK 212 million. For the second quarter, the reported EBIT margin was 20.5% and include special items of DKK 146 million. In both periods, the special items were entirely due to costs related to the proposed combination with Chr. Hansen.
Net profit for the first half of the year amounted to DKK 1,415 million, which was 15% less than in the same period of last year. For the second quarter net profit amounted to DKK 614 million which was 25% less than in the second quarter of last year. The decrease was due to the lower profit before tax, higher special items cost and higher effective tax rate compared to 2022.
ROIC including goodwill before special items ended at 17.0%, or around half a percent lower than in the same period of last year, driven by lower operating profit in the period. Free cash flow excluding acquisitions was DKK 470 million in the first half of the year and DKK 583 million in the second quarter. The year-on-year decline in the first half was primarily driven by a reduced cash flow from operating activities including higher net working capital, primarily driven by the timing of payables from the first quarter. In the second quarter, working capital improved following favorable developments mainly in receivables.
Now, please turn to Slide #10 for an update on the 2023 outlook. We are narrowing the outlook for the organic sales growth, now with an expectation to grow by 46% in 2023. Sales in Danish kroner are expected to be around three percentage points lower. For the full year, we expect growth to be driven mainly by pricing with a similar impact across most of the business areas.
We reiterate our expectation of stronger growth in the second half of the year, driven by a combination of pricing as well as volume growth, which will be driven by innovation and increased market penetration. While we do not assume any major changes to the current state of the global economy in our outlook, we expect destocking to level off in the second half of the year following the considerable impact on our food-related areas in the first half of the year.
Turning to the gross margin, we expect to see a level similar to that of 2022. While we started to see an easing of certain input costs from the peak levels of last year, there was still a negative impact on the margin this year due to the delayed P&L effects some of these higher costs have. This delayed effect is also true for the remaining two quarters of the year, will be on average expect to deliver gross margin similar to that of the first half of this year.
The outlook for the EBIT margin before special items remains at a solid 25% to 26%. The margin would benefit from price increases, sales growth, and productivity improvements, whereas continued investments in the business and considerably higher input costs are expected to have a negative year-on-year impact. The outlook for the return on invested capital, including goodwill and before special items is unchanged, at 16% to 17%.
For the modeling assumption, the free cash flow before acquisitions is maintained at DKK 1.8 billion to DKK 2.4 billion. The level of net investment is unchanged and includes around DKK 400 million for the final year of construction of the advanced protein solution facility in Blair, Nebraska. As described in the merger document, and to honor existing shareholders, Novozymes is now planning to approve and pay out an interim dividend on October 17 for the period January 1 to August 31 st 2023 of around 50% of the net profit for the period. October 12 th will be the last trading day of trading cum dividend.
To round off, and building on the results of the first half of the year, we are confident to deliver on our full year sales and financial outlook supported by the resilience of our diverse and unique portfolio as well as our robust production setup. We are also confident that our strong operational setup, innovative pipeline and sustained investments for future growth will drive the desired performance towards reaching the 2025 targets as set out in our strategy, unlocking growth powered by biotech.
With this, I'll now hand back to Ester for a wrap up before we open up for questions. Ester, please,
Ester Baiget
Thank you. Thank you, Lars. Please turn to Slide #11. Let me summarize our main messages today. We've delivered growth and earnings in line with our overall expectations for the first half. Our diversified portfolio and end market exposure show strength. While the sales mix looks different compared to our initial expectations, as earnings profiles are similar across business areas, we maintain the profit outlook for the year. We've narrowed our sales growth forecast slightly as we're impacted by destocking special in the foods-related exposure, as well as reduced consumer demand.
On the positive side, we see increased demand for our broad toolbox of solutions in the Bioenergy area. We continue to invest in our strategy and where it matters the most. Our continuous focus on short term targets and the long term potential of Novozymes is further exemplified by the two additional opportunities we've noted in this Q2 interim report, food proteins from carbon dioxide and advanced, especially proteins through fermentation used for medical nutrition. With our unique technology platform and fermentation insight, we can address both consumer and planetary needs as the population grows and puts more pressure on resources.
Finally, the work to close the combination with Chr. Hansen is progressing very well and according to plan. We have now filed applications in all main jurisdictions, and we're in a good dialogue with relevant authorities. We continue to expect closing to take place in Q4 2023 or Q1 2024. Novozymes is uniquely placed to enable a transition towards a more sustainable world. Together with Chr. Hansen, we can enable this transition faster and with greater impact to the benefit of consumers, customers, shareholders and the world we live in.
And with those concluding remarks, we're now ready to open up for questions. Operator, please begin.
Question-and-Answer Session
Operator
Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] The first question comes to Alexander Jones from Bank of America. Please go ahead.
Alexander Jones
Great. Good morning. Thanks very much for taking my questions. Both on Food and Bev, I guess the first one, if I take the guidance at face value, then you're going from minus 2% underlying in the first half to something like high-single-digit growth in the second half. And you mentioned a few factors behind that best buy, Human Health and less destocking. Can you talk about the relative importance of those three or other factors in driving the improvement? And perhaps whether you're seeing that significant acceleration already come through in July, August? Whether it's more of a sort of Q4 weighted improvement? And then the second question specifically on Human Health. You called out weaker end market and supply constraints. But those were also factors you called out in Q1. So could you tell us a little bit about what's got worse and hence you've downgraded it from double-digit growth to single-digit growth for full year? Thank you.
Ester Baiget
Thank you, Alex, for the questions, I will let Anders build on the Food and Beverages and then Amy on Human Health but maybe a remark from my side on the growth of the second half or stronger growth of the second half of Food and Beverages, not only Food and Beverage, also the component of Human Health, a stronger Human Health with the constraint on supply chain behind us and then capturing the opportunities we see in the market. And with that, Anders?
Anders Lund
Yeah, so talking about the drivers for why we're sort of taking guidance down, if you look at what we've been sort of experiencing, we've been experiencing more down trading than we had in our initial plan and also lower consumer demand. Part of our optimism for the second half relates to improvement on both. We are having good dialogues with customers, and some of them are saying that destocking is coming to an end. Some are also saying that there's still something to burn through. We are seeing on consumer demand, some of our largest customers are now reporting positive volume growth that is taken from negative volume growth earlier in the year. And again, that's also an indication that things are normalizing.
And then a very important point, comps are also easier for the second half, that will make sort of it a little bit easier for us to deliver the growth rates that we have in front of us. It's also I think, important that here, it’s five, six weeks into the third quarter. And it confirms the guidance we have. And we believe it's the right ambitious plan for the segment. And again, it relates to improvements in the market overall.
On emerging markets, specifically, that a long story. But we are seeing similar effects on destocking and also on consumer demand. And then specifically in Africa, a few related ForEx challenges that has also been sort of challenging our growth numbers. Again, the same drivers are here to improve in terms of destocking will level off and consumer demand is also looking to be coming back, and maybe not to ’21 and ’22 levels, but just to normalized levels.
Amy Byrick
And maybe just to build on that on the Human Health question, I think you rightly point out Alexander, the -- we talked about the weakness in North America and the supply chain constraints. I think what we've seen is that weakness starting to turn as we've exited the second quarter and entered Q3. And we've also now had the time to work through and I'm pleased with all the actions that we've put in place in terms of addressing the supply chain constraints so that we put ourselves in the position to be able to realize the underlying demand. We also spoke about it last quarter. We do see some additional resilience in our healthcare practitioner channel in North America relative to the underlying broader probiotics market.
So building on that, and then also some of the innovative launches of cross selling across some of the different acquisitions we've made. In the past few years, which we've launched, we see that those innovation driven growth accelerating into Q2. So we believe as we go through, we feel confident in the ability to start to really deliver on and realize the underlying demand for our solutions.
Alexander Jones
Thank you.
Operator
The next question comes from Lars Topholm from Carnegie Investment. Please go ahead.
Lars Topholm
Yes, a couple of questions from me as well. One is on your pricing outlook. So you have 6% pricing in Q1 and Q2 and while I recognize organic growth comps will be somewhat easier in the second half of the year, can you comment on if pricing momentum will slow down or will stay around the 6% level? And then a second question if I may, I just wonder you point out specifically the lack of revenue from COVID test kits and also the supply chain constraints which you just discussed. Is it possible to quantify the divisional impact for the quarter for those who watch, we call them one-off impacts? Thank you.
Ester Baiget
Thank you, Lars for your questions. Always a pleasure, hearing from you. I’ll let Lars building out on the pricing outlook that you nicely mentioned. We see a strong contribution of pricing in the first half. Pricing going to continue to be there but it's the relative comparison, relative to the long time effort that we have been working here, maybe the one that's driving the lower impact, and then also volume coming in. Relative to the individual components of COVID testing, I'm not sure we’re sharing that level of detail. To the specifics, I will let Tina bring you the granularity, but not necessarily to the total impact on the division.
Lars Green
So Lars, if we started on pricing, you will recall, as we started to talk about our pricing efforts and also impact through 2022, we started to see pricing contribute positively as we entered the second half of the year. And therefore, you can say some of the pricing contributions that we benefited from in the 6% of contribution in the first half of the year, we’re sort of already in the base now, in the second half as we enter that. So therefore, you can say our indication of price contribution now for the year is that the majority of our 4% to 6% growth will come from pricing and the residual from volume. And so you can say, relatively speaking, it will be slightly less in the second half compared to the first half, because we have now -- now we're entering a period where we already have some pricing built into the baseline.
Tina Fano
And a bit more info on Grain & Tech and the performance there, so overall, in terms of size, then the performance in Grain & Tech in Q2 is driven to the vast majority by the Tech part of Grain & Tech. And of the Grain & Tech part, textile or Tech is roughly a third to a fourth of that segment and I think you know that Lars. And a little less than half of the Tech segment is textile. And that was the case both in ’22 and ’23.
If we then zoom in specifically to the COVID-19 test kit, and what we call the Biocatalysis segment, that is the biggest driver of the decline in the Tech segment. But as we also said textile is also performing softer than we do had expected, but the biggest driver is the lack of COVID-19 test kits. It's roughly and I think we have said that earlier, it is roughly 5% of the segment.
Lars Topholm
That's very clear. And then I'll just plot that you are now disclosing the volume mix growth, that's very much appreciated. Thank you very much for taking my questions.
Ester Baiget
We thank your applaud, charmingly. Thank you, Lars.
Operator
The next question comes from Chetan Udeshi from JP Morgan. Please go ahead.
Chetan Udeshi
Yeah. Hi, morning. I think the first question I had was to just follow up on Alex's comment or question and I wasn't very sure of the response. Are you saying that for the first few weeks of 3Q you've already seen an improvement in F&B growth momentum? Or is it more to come in the remainder of the years? That is the first question.
The second question was, I'm just looking at your inventory. It seems it has ballooned, significantly in Q2. Well I would have thought in this environment, you would have been a bit more proactive in managing the inventory levels. But it seems it just went up even in Q2 versus Q1. I'm just curious, how are you thinking about that? How are you thinking about that inventory management through the year? Are you going to cut production to bring that under control? And what does that imply for the gross margin as we think about the remainder of the year? Thank you.
Ester Baiget
Thank you. What I heard Anders saying is that with a few weeks, within Q3, everything we're seeing it's fully in alignment with expectations and the guidance that we're putting in place. And that's not only true for the Food segment that's across the whole the whole divisions. We live in a volatile environment. We continue to show the resilience and the robustness of our offering. And yeah, I'm extremely pleased of the continuous improvement of the gross margin expansion. That sequential expansion that shows that, be it the demand in Bioenergy, be it the demand in Food, it the demand in Animal, we're capturing it and we continue to deliver growth, and then also sequential gross margin expansion. Lars, I'll pass it to you for the working capital.
Lars Green
Yes, thank you. And you're right that the balance sheet is showing an increase in our inventories over time. And what you have to keep in mind here is that there is a certain delay in the effect between the spot prices of the raw materials and energy that we procure and use in our production and the time that it hits our first inventory and therefore balance sheet and later on the P&L. And that's really because we are diligently managing our input cost in the first place by having certain contracts and hedging in place, which means that we are sort of mitigating the effect of the, let's say, day-to-day volatility of those.
But of course over time, when there is a marked shift in the level of raw materials, hedging and contract prices will eventually expire and run out. And we will also see the effect on our inventories. So the effect you see on our balance sheet is entirely related to the increased input costs, and not related to volumes that are sort of not supporting our future outlook. So, therefore, when you look forward, we are managing our input cost, and also our inventories in a way that volume wise supports the future forecast we see on our business. And where we, as spot prices of raw materials and energy start to come down, we will also overtime see that benefit both on our inventories and on our cost of goods sold and therefore gross margin.
So we're very confident that over time, we will be able, with our mitigating actions on price and with a diligent management of our procurement, we will be able to bring our working capital levels down, here driven by the inventories, and therefore support our long term target for EBIT margin for profitability in line with our targeting in ’25 of 26%. So you just have to sort of bear in mind that sort of sequence of events coming from diligently really managing our exposure to input cost and the delay this has between the spot rates and the time it hits our financial statement.
Chetan Udeshi
That’s clear. If I can squeeze one more question related to the merger, you know we’ve seen with dsm-firmenich, post the closure there has been significant cash leakage cost on this merger transaction, restructuring, blah, blah, blah. Is that something we should be thinking about for Novozymes Chr. Hansen in terms of significant cash leakages on M&A fees and restructuring or how are you guys thinking about that as we look forward into next year? Is that something we should be bearing in mind, given what we've seen with dsm-firmenich? Thank you.
Ester Baiget
I'll give you a very short answer. And I'll let Lars build up, the short answer is no.
Lars Green
And you can say that the longer answer is that we have provided guidance on what we expect in terms of transaction and integration costs. So of course, those are one-time cost that cash wise have to be paid. So there is a very strong correlation between the integration cost and transaction cost that we have guided on and the cash flow effect. And I would not expect anything over and above that effect from basically realizing and completing the transaction.
Chetan Udeshi
That's great. Thank you.
Operator
The next question comes from Soren Samsoe from SEB. Please go ahead.
Soren Samsoe
Yes. Good morning, everyone. Just two questions from my side. One is on Bioenergy ratio, very strong growth, 26%. Given that there seems to be no growth in the ethanol production, could you maybe break down this growth into its components, both in terms of price mix and volume? But also break down the mix component into maybe product mix and country mix and segment mix? That would be great, thank you.
Ester Baiget
And the other question, Soren, I think you mentioned two questions.
Soren Samsoe
Yeah. Yeah. It was just a short follow up on Lars’ question. Just whether you could indicate, whether the Grain growth was positive or negative? Thank you.
Ester Baiget
Tina.
Tina Fano
Yes, so and we don’t disclose price mix on the individual reporting segments. We do that a corporate level but what I can give you is the elements and what it is I’m most excited about in Bioenergy. So, as you know, Soren, the Bioenergy segment consists of both bioethanol as well as biodiesel as well as enzymes for second generation biomass. And in the area of ethanol which is a key driver and in terms of numbers the biggest part of all of this, it is both the enzymes for traditional ethanol production then it’s also enzymes for yeast and fiber and allowing our customers to pivot to what more fiber or more protein rich solutions. And what we have seen over the time is that our innovations and our closeness to our customers have allowed us to outgrow the North American market and it is due to these new innovations that that has enabled that growth.
And as an example, we are also in this quarter, is launching another yeast product, the Innova Apex Dry or ADY. And that’s one of the example what it is we do. But on top of that we do also see strong growth in Latin America. And Latin America today, there is more than a billion gallons of ethanol being produced and that is growing with solid double digit. So that is also a good driver of the growth.
Biodiesel is also a good component of the growth and then second-generation biomass. But as we have talked to second-generation biomass is more lumpy and it is from a smaller base but especially in Q2 that is something that is worth mentioning. So it’s all of these components which together is enabling us to outgrow the market. And I think it is also important to think of that also longer-term on the bioenergy business, it’s something that relates to what we talked about a number of times also on these calls, on the corn cracking.
It is about securing but we keep evolving what it is that you get out of a biorefinery and allow customers to pivot to watch more low carbon intensity ethanol or to watch more protein rich solutions. And then over time, new solutions will also evolve like the sustainable aviation fuel or chemicals or whatever it can be. So that's as much as I would say, on the bioethanol business. And then on Grain & Tech --
Soren Samsoe
So if I just could press on that, would then be, I mean, is it unrealistic to think that ethanol as part of the Bioenergy division will be less than 50% in a few years? I mean, given that it sounds like the growth is becoming a lot more broad based?
Tina Fano
So that ethanol is less, well, that has to be some years out in time, I would say. It is still the vast majority of what it is we do.
Ester Baiget
Maybe from a value perspective, right Tina, if we think about the value that our customers generate already today, 30% of the value is by byproducts.
Tina Fano
Yeah.
Ester Baiget
So from that perspective, maybe that's a way, Soren, of looking at the question.
Tina Fano
Yeah.
Ester Baiget
Of the value that we enable for our customers in that direction.
Tina Fano
Yeah. And then maybe also to add a bit more, you could say we have talked about the 50% coming from traditional ethanol. So from that perspective, you're right. But that's from the perspective of how much is North America and that is where it is we have the EIA Data. And then how much is the traditional enzymes. And that's correct, that is roughly 50%. Then the second question on Grain, there I would say, Grain is roughly flat, and then the decline comes from Tech.
Soren Samsoe
Thanks very much.
Operator
The next question comes from Nicola Tang from BNP Paribas. Please go ahead.
Nicola Tang
Hi, everyone. And the first question was on Household Care. I think we talked a lot about sort of general destocking mainly on the Food and Bev side. But I think you also mentioned that in your second half outlook, you're assuming the downgrading in Household Care will stabilize. So could you just talk a little bit about what gives you that confidence in that in the second half?
And then the second question is for Lars, you know, I hear what you're saying in terms of the delay of a lower input cost on to your P&L and your balance sheet. But could you maybe talk a little bit about what you're seeing in terms of spot input costs, whether it's also energy? Thanks.
Ester Baiget
Thank you, Nicola. Anders, if you could take the first question. And then pass it to Lars.
Anders Lund
Yeah, so thanks. I think it's important to stress that destocking is not a significant thing in Household Care. That is actually something we saw last year. The driver or the negative driver in Household Care has been sort of downgrading among consumers, and also a few cases sort of changes between some of the large brands that had been losing volumes, and then it's being picked up by locals and private labels.
I think the very strong position of Novozymes is the resilience, well we serve, basically the entire industry. So what we lose one place, we pick up somewhere else. And that is actually what keeps the business delivering to our expectation. So while there is rather significant changes in market shares among our customers, then we pick it up somewhere else. It's also important to stress that we are seeing good pricing dialogues with our customers and good pricing performance.
So while there is volume decline, we do actually compensate by pricing. And then in addition continued, I think, very, very strong dialogue with our customers around the innovation agenda, both when it comes to freshness, but also when it comes to biological detergents. It does support our growth,
Ester Baiget
And maybe the penetration on emerging geographies, also.
Anders Lund
Yeah, I think I mentioned that, yeah.
Ester Baiget
As well as, probably what is important is that the pricing on Household Care, it is slightly slower than the rest of the division. So we're seeing pricing, but we're seeing as little bit softer than the rest, mainly by the length of the contract. So we see that impact, but we will continue to see that moving ahead in the future.
Lars Green
And on the input cost, I think we can say that we have seen sort of the peak behind us compared to where we are now. So certain of our chemical’s input costs have come down compared to the peak. We are also seeing the spot rate of energy coming down. Here, you just have to remember that we do have a certain level of hedging, which means that we have hedged some of our consumption of energy here in say, in 2023, at levels that were significantly below the peak of last year, but slightly above the spot rate that we see right now. And therefore they sort of host further promise of improvement as we look into ’24.
So I would say the peak in terms of spot rates are still behind us. But we are, with these delay factors, still going to see an impact on our gross margin this year. And therefore we expect a gross margin for the second half, as I said in the scripts, in line with the average of the first half.
Nicola Tang
Thank you.
Ester Baiget
One more question, last. Thank you, Nicola. One last question, operator.
Operator
The last question comes from Sebastian Bray from Berenberg. Please go ahead.
Sebastian Bray
Hello, good morning. And thank you for taking my questions. Can I start with bioethanol, please? The California Low Carbon Biofuel Standard has been around for a while as has the desire to extract more protein from corn. Why exactly is now the time which customers start upgrading and buying higher value solutions from Novozymes as opposed to two to three years ago? And what stops the organic growth in this segment being minus 10% in 2024, if the trends reverse?
My second question is on the sales and distribution costs, these are up quite heavily in Q2. What is the reason, on a year-on-year basis, what is the reason for this given that freight seems to have declined? And just thirdly, on the protein solution facility, the growth in plant-based meat categories has been quite negative for some time now. What type of visibility does Novozymes have on the ramp up of this facility such that it's not left with high fixed costs without the organic growth to support it in ’24? Thank you.
Ester Baiget
Thank you, Sebastian for the broad range of question. Let me tip toe across all of them and then let Tina, Lars and Amy also build up. Bioenergy, we're extremely pleased with the diversity of the portfolio and slow and effective and swift of implementation of our strategy, which is diversification from products, diversification from value, diversification from geographies, diversification also on technologies, with biodiesel, with biomass, it is a broad range of toolbox, the ones that we're bringing in and this takes time. But we're slowly capitalizing on the value that we bring in, but also the pull that we see from the market.
On investments for the foundation of growth, they're not linear, they're not by quarter. We, investing for the future, and we continue to move safely. And it's through that in Q2, you'll see an increase. But that's a plan of the investments of the long term, which they are not at the quarterly basis, we look at them at the yearly basis. And we are full on track on our aim of investments and also on the delivery and expectation for the EBIT margin for not only to this year, but also the expectations of 2025.
And then on plant-based, yes, a volatile market, but we continue to see the pull of the solutions that we bring in, and that actually the collaboration with Arla Food Ingredient is one sign more of the strength of our robustness and the value that we bring in.
So with that, I'll pass that over to you, Tina.
Tina Fano
Yeah, and thank you for the two questions on biofuel. So first of all, why it is that we see a significant growth right now? I think it's, the key driver has been innovation because it's true the California Low Carbon Fuel Standard has been around for quite a while. But it is a lot driven by innovation, the Fiberex platform, which we have talked about a couple of times, and that has contributed, a significant contributor for growth.
But on top of that, I also think it's important to think and also I would say, many quarters have been the proof that we have moved away from a sole reliance and a direct coupling to the ethanol produced volume in the Novozymes numbers. Yes, they do influence and that's also why we quote them and also because you like the EIA Data quite a bit. So therefore we like referencing them so that you see how it is that part of the market is performing. However, our business is so much more than linked to the US ethanol volumes, as Ester just alluded to.
Then in terms of 2024, it is a bit, we don't guide yet on our 2024 numbers, so I'll refrain from that. But in terms of market, both EIA and HPC are already out with some indications for how it is they look at the market for 2024 and that is a flattish, maybe 1% or 2% growth but roughly flattish. But I think the key for 2024 is also and longer term, this is the discussions on E15 and the continued focus on exactly low carbon fuels, but then also for our business, on the diversification.
And that's as much as we can say now, Sebastian. But we can talk more later on. But then also longer term, it's also a matter of sustainable aviation fuel, chemicals and all the other things. So, over to Lars.
Lars Green
Just a couple of points of color, in essence, Ester said the overall sort of answer, namely, that we are investing in the continued growth of our business. A couple of examples of that is and we are sort of building competencies for our customer co-creation centers. So we have recruited competencies and people that sort of hit the sales and distribution line. So that's an example of an investment we are making for future growth. And then also in the quarter, our distribution costs were slightly up because of the rates. So that's sort of another factor in our sales and distribution costs. But in essence, we are continuing to invest to support our future growth.
Amy Byrick
And then Sebastian, just your question on the commissioning of the Blair facility, I mean, first and foremost, just to say that the project continues to run on track, and we are on track to commission that plant for first sales in Q1 of 2024 per the commitment. I think in terms of the plant-based meat market, I think what we see and gives us confidence in the ability to deliver the sales growth that we've committed to, is that the winning companies in the plant-based meat market continue to be defined by superior products, superior eating experience based on taste, texture, and nutrition. And that's exactly the focus of our entire advanced protein solutions pipeline, is really to use precision fermentation towards those high-end, high-value additives and new protein molecules.
And so I think is, as Esther said that we continue to develop our pipeline. And of course, we have our anchor, customer contract which gives us visibility towards the ramp up.
Sebastian Bray
That's helpful. Thank you for taking my questions.
Ester Baiget
Thank you, Sebastian. And now with that, let's close the call today. Thank you all for your participation. And thank you for the good questions, and then looking forward for the dialogue with many of you in the next couple of days. Thank you. Bye.
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Novozymes A/S (NVZMF) 1H 2023 Earnings Call Transcript