Review of Q2 2024

Total sales was 8% above our forecast of SEK1,882m and amounted to SEK2,024m (2,258), corresponding to -10% growth y/y. The organic growth y/y was -18%, somewhat better than our forecast of -23% - and above the -27% in Q1. While the y/y numbers remain negative, sales grew by 14% q/q. Although Q2 is a seasonally stronger quarter than Q1 (which has been masked during the big swings in demand in recent years), we believe there is an underlying sequential improvement.

The trends seen in the quarter are very similar to recent quarters, with US duct, UK and German FTTH being soft while Harsh Environment and Data Central experience solid markets. Also, the US FTTH business did, once again, surprisingly well. According to management, the US FTTH business had only slightly lower sales than in last year’s record-high Q2 – most likely outperforming the overall FTTH market. In addition, Hexatronic recently gained a new major FTTH-system deal in the US, SEK400m, over three years with Novos Fiber. We expect to see more deals with similar characteristics as the market rebounds.

Inflation, higher interest rates, and inventory build-up still hurt the y/y figures in the US duct/FTTH and UK and German FTTH segments. However, the inventory levels are normalising, and the inflation and has decreased. Thus, in addition to the governmental support, especially BEAD in the US, macroeconomic factors also support a rebound in late 2024 – although interest rates remain rather high. However, this quarter, pricing pressure continued to be an issue in these segments.

The quarter’s development and the positive Q1 statements from many US peers indicate that the market has bottomed out in Q1. Although Hexatronic kept its market outlook unchanged – we believe some investors would expect more optimistic guidance given what US peers have said. But considering the strong share price reaction to the report, we were wrong. We are getting closer to the expected rebound in late 2024 and combined with the solid improvement q/q, data points towards Hexatronic gradually experiencing more positive market conditions and financial performance.

As seen in the recent quarters, Harsh Environment and Data Center had strong numbers, and management expects the solid market conditions to persist for a long time. Acquisitions mainly drove the growth within Harsh Environment, while the growth in Data Center was strong organic. Harsh environment sees solid customer demand within oil & gas, defence, and renewable energy. At the same time, Data Center benefits from the increased demand for AI – all long-term structural growth drivers, except for perhaps oil & gas. Hexatronic has mostly been exposed to enterprise data centres rather than the hyper scalers (although it has some exposure to those in Europe), where AI has had the greatest impact. However, as AI gets more mature, we believe AI will also boost enterprise demand as well.

Hexatronic’s three most important markets, the US, UK and Germany, the so-called strategic growth markets, all have significantly lower FTTH/B penetration rates than Sweden. First, the number of households in the US, UK and Germany is ~42x the Swedish number. Second, the FTTH/B subscription penetration rates span from ~25% in the US to ~10% in the UK and Germany, compared to Sweden’s ~70%. Thus, there is a vast market to compete for in the strategic growth markets.

While these markets experience a slowdown in FTTH/B investments due to cost inflation and high interest rates, we believe these markets will be important over the next ~5-10 years.

EBITA was SEK222m (405), corresponding to an EBITA margin of 11.0% (17.9). Despite the significant decline y/y, EBITA beat our forecast by 15%. The EBITA increased by 32%, and the EBITA margin expanded by 1.6% percentage points q/q. Although Q2 is seasonally stronger, the solid q/q also implies a better underlying performance. Somewhat better market conditions in some segments and efficiency measures drove the q/q improvement. OPEX as a share of sales was largely unchanged q/q, while the gross margin improved from 40.5% to 42.0%. The company sees some pricing pressure but managed to offset it with higher utilisation.

EThe operating cash flow was SEK193m (310) and was positively affected by a net working capital (NWC) contribution of SEK28 (38). Thus, Hexatronic strengthens its balance sheet by combining positive EBITA and releasing working capital. As mentioned in the previous Update, except for the new duct plant in Ogden, Utah (expected to be finished in Q3 2024), Hexatronic’s short- and mid-term CAPEX needs are limited. For our 2024 forecasts, EBITDA equals 1.5x net debt at the end of 2024. Thus, even though we expect decreasing EBITDA in 2024, the net leverage is well within healthy territory.

We increased our sales forecasts for 2024-25 by 3-4%. The increase is driven by higher confidence in a market rebound in late 2024 due to Hexatronic retaining its guidance, and many US peers are experiencing improving market conditions. Also, the SEK400m FTTH system deals with US-based Novos and provides some support for 2025 and beyond.

We raised our EBITA forecasts by 7-16% for 2024-25, driven mostly by increased utilisation following the raised sales forecasts. However, the relatively strong margin seen in this quarter motivates a slight increase as well.

Note that Q1 and Q4 tend to be softer regarding margins due to seasonality, while Q3 is often the most profitable because of vacations.

While we are rather convinced that Fiber Solutions will see a rebound in late 2024/early 2025, the more interesting and more difficult question right now is, what kind of market will we rebound to? Is the strong market seen from late 2021 to mid-2023 what to expect, or was that an overheated market (regarding growth rate and margins) never to be seen again? We find arguments both in favour of and against a rebound to those strong levels.

Arguments in favour of a rebound to late 2021 to mid-2023 levels:

Arguments against a rebound to late 2021 to mid-2023 levels:

Overall, we expect a market in 2025 and beyond that is not as strong as in late 2021 to mid-2023 in terms of growth rate and profitability. However, we still expect Hexatronic to grow organically from the peak levels in 2023, especially in the US, where small increases in Hexatronic’s market share have the potential to offset changes in market demand. For the Rest of Europe (dominated by the UK and Germany), we expect about 10% in average annual organic sales growth from 2025-2028 – a softer UK but a stronger Germany relative to late 2021 to mid-2023. For North America, we estimate about 20% average annual organic sales growth 2025-2028. Thus, we assume continued organic sales growth but far below the very strong levels seen in 2021-2022.

Regarding margins, we expect Hexatronic to gradually approach the lower part of its 15-17% EBITA margin target – which still is a strong level from a historical perspective. We believe it is too aggressive to assume the 17-18% level seen in some quarters during 2022-2023 – especially considering the strong margins on duct (where Hexatronic’s competitive advantage is weaker and thus the normalised margin probably lower compared to 2022-2023). However, if successful in expanding its FTTH offering in the US – where margins are high – there is potential for higher levels.

In summary, we expect the new normal market conditions to allow for solid margins in the lower range of Hexatronic’s EBITA margin target (15-17%) and an annual organic growth of about 14% from 2025-2028. Thus, not as strong as in late 2021 to mid-2023, but still enough to achieve solid profit growth from the 2023 profit peak.

We increased our Base Case to SEK59 (40), following the increased forecast, primarily for 2025 and beyond.

While the Bull Case assumes slightly higher growth and margins for 2024-2030, the main difference is in the 2030-terminal period. Unlike our Base Case, where we expect the strategic growth markets to have negative sales growth from 2030 and onwards (like in Sweden post-2017), our Bull Case assumes flat sales and minor margin declines.

In our Bull Case, we expect Hexatronic to increase its sales from non-FTTH sources until 2030, fast enough to limit the expected downturn in FTTH. While Hexatronic has exposure to Harsh environment, core networks, 5G, and data centres, most revenues are generated from FTTH. However, Hexatronic has a solid M&A track record, and several recent acquisitions, such as DCS, Rochester, and Fibron, have added exposure to non-FTTH segments. Also, at least five to ten years are likely left until the FTTH boom is over in the strategic growth markets. Thus, Hexatronic has plenty of time to add additional sources of revenue until then, and M&A will likely play a major role.

Our Bear case assumes slightly lower growth and margins in 2024-2030. However, the major difference concerns the period after 2030. For example, our bear case assumes 5% in terminal EBIT margin compared to 8% in our base case. In the bear case, we believe the maturity of the current growth markets, the US, the UK, and Germany, will significantly negatively impact growth and margins, and Hexatronic cannot offset the downturn with new markets or segments.

Hexatronic is currently trading in line with peers for 2025e and at a c15% discount on 2026e.