Letter from the CEO
The year 2018 was a very successful year for our company in almost every way. The hard work and engagement of our employees delivered very strong results of which we can all be justly proud.
Strategy 2018 successfully delivered
Delivery and growth
2018 was an excellent year for DSM in which we delivered again well ahead of our strategic targets, creating significant value in all our businesses. Even when we exclude the benefits from a temporary vitamin effect (due to supply disruptions in the industry), giving us an estimated one-time additional Adjusted EBITDA of €290 million, we still had again a record 2018 in which we delivered strong organic growth with a significant step-up in profitability. For the so-called 'underlying business' (excluding this temporary vitamin effect), organic growth was 6%, clearly above market, and Adjusted EBITDA was more than €1.5 billion, being a 6% increase (in fact just over 10% when excluding the negative currency effect) versus last year. The ROCE of underlying business, was 13.3%, up 100 basis points compared to last year and the total net profit was €1,079 million. Our total sales (including the temporary vitamin effect) increased by 7% to more than € 9 billion with 11% organic growth. Total Adjusted EBITDA was more than €1.8 billion, up 26%.
With this record year, we completed a very successful three-year period in which we clearly outperformed on our strategic targets as set in Strategy 2018. We stepped up our organic growth rate, our profitability and our financial returns, while simultaneously delivering on our ambitious sustainability targets. Strategy 2018 has been a great success, through which we have created a strong platform to drive continued above-market growth and deliver further improvements in profitability and returns.
Both our Nutrition and Materials businesses contributed to this strong performance. Nutrition's broad, global portfolio in food and feed ingredients, as well as its expanded portfolio of solutions (including premixes and forms), drove strong growth. This enabled us to invest in the future – for example via new nutrition facilities in Poland and India. We were also pleased to announce a global partnership with Mixfit for personalized nutrition. Meanwhile, Materials continued its 'silent transformation', successfully focusing on higher-growth, higher-margin, specialty segments and delivering higher-performing solutions that are innovative, safe and lightweight, as well as being more sustainable and environmentally friendly. We are investing for the time ahead here as well — an example is the investment in global Dyneema® production capacity, and the introduction of Akulon® RePurposed, a polyamide 6 made from recycled fishing nets. In addition, we are investing in major innovation projects in Nutrition as well as Materials. We feature many examples of these innovations throughout this Letter and Report.
As a global company, we are well represented in all major growth areas of the world: 43% of our total sales are from high-growth economies, in line with our stated ambition for a balanced global presence. The execution of extensive cost-reduction and improvement programs delivered run-rate cumulative savings of approximately €275 million versus the 2014 baseline by the end of 2018. Consistent improvements in capital efficiency were achieved in 2018, with ROCE today at 13.3% (underlying business; as much as 16.8% including the temporary vitamin effect), almost doubling from 7.6% in 2015.
Acting on our commitment to monetize our remaining Pharma and Bulk Chemicals joint ventures, we divested our non-core participating interests in DSM Sinochem Pharmaceuticals and Fibrant in October 2018. Together with our cash generation, this all led to a net debt reduction in 2018 of €629 million to €113 million at year-end. We plan to divest our remaining minority shares in AOC Aliancys (18.9%) and AnQore (35%) at the right moment in the coming period. Since 2015, we have monetized our non-core joint ventures in pharma (especially Patheon) and Fibre Intermediates for a total of about €3 billion, providing the company with a strong financial position and balance sheet. For more information on our full financial performance, see Profit.
Science and innovation
We are leveraging our unique technology capabilities to develop innovative, sustainable solutions. In 2018, we invested 4.5% of sales in R&D and created a strong and refocused innovation pipeline to drive long-term growth. Consequently in 2018, 19% of our sales came from innovations introduced in the last five years, achieving our aspiration of around 20%.
We made good progress on our large innovation projects. The construction of our new USD 200 million facility which will produce the omega-3 fatty acids EPA and DHA from natural marine algae for our Veramaris® joint venture with Evonik is on time and progressing according to plan. We are also preparing for regulatory approval in various markets for our Project Clean Cow, our new innovative feed solution that delivers a more than 30% reduction in emissions of the greenhouse gas methane from cattle. With our fermentative Stevia, now a 50:50 joint venture with Cargill, we bring zero-calorie, cost-effective sweeteners to market faster by combining our respective proprietary technologies. We also successfully launched a new proprietary yeast, as well as an enzyme cocktail, for the production of bio-ethanol from agricultural residues. Our solar business also provides an alternative for fossil resources, through our anti-reflective coatings, which boost solar panel yields, and our endurance backsheets for solar panels, which are fully recyclable and have a lower CO2 footprint than fluorinated backsheets. Another example is a new enzyme for broilers that facilitates digestion, supports better health, and permits the use of less feed. We made great steps with Niaga®, our fully circular carpet project for preventing carpets from ending up in landfill or being incinerated. We are now even applying this design philosophy more broadly to categories beyond carpet: DSM-Niaga together with Royal Auping achieved a breakthrough in the creation of fully recyclable mattresses.
Sustainability and business
At DSM, sustainability is not only our core value and a key responsibility; it is also increasingly an important business driver that is fully engrained in our strategy, business and operations. Our approach for bringing about positive change is to improve, enable and advocate.
Improve is all about the impact of our own operations. In 2018, we continued our sustainable approach to our own operations. We apply an internal carbon price of €50 per ton of CO2 to help guide our investments and operational decisions and are making good progress in reducing our own greenhouse gas (GHG) emissions. Our GHG efficiency improved from 26% in 2017 to 33% in 2018 versus our 2008 baseline, strongly outperforming our aspirations. Also, in absolute terms our emissions fell by more than 8% in 2018. Last year 41% of our purchased electricity came from renewable resources, compared with 21% the year before, which puts us on track to achieve 75% in 2030. In addition to this our energy efficiency improved by 1.4% year-on-year, compared with a 1% average annual target.
Not only do we work hard to improve our own operations; we also enable our customers to do the same with our innovative solutions. We ensure that the solutions we offer are better for people and/or the planet than existing offerings. In 2018, 62% of our sales came from products that have a better environmental (ECO+) and/or social (People+) impact than mainstream solutions. We call these our Brighter Living Solutions. Our innovative solutions are applied within three domains: Nutrition & Health, Climate & Energy and Resources & Circularity. They include our Project Clean Cow, Veramaris®, fermentative Stevia, Niaga®, light-weight materials and green energy projects in solar and bio-based, which enable our customers and the entire value chain to be more sustainable. We took further steps to tackle malnutrition. More than a decade ago, we entered into our partnership with the UN World Food Programme (WFP). We extended this for another three years in 2018, and today reach over 39 million people worldwide annually with essential nutrients. We have now decided to also address nutrient deficiency among at-risk populations by means of local initiatives, for example, through our Africa Improved Foods (AIF) project we started in Rwanda, where together with partners we are working hard to address the issue of malnutrition and stunting by using local sourcing and production.
We continue to advocate on issues that define our times and can be addressed by our competences. Malnutrition, Climate and Circularity are therefore the most important issues we address. Among others by our advocacy to address hunger and malnutrition, via the UN, WFP, UNICEF, but also via the Scaling Up Nutrition Global Business Network that we helped to establish, composed of over 400 national and international companies scaling up programs to address malnutrition globally. We were again a positive voice with our participation in organizations such as the World Economic Forum, the Carbon Pricing Leadership Coalition (CPLC, convened by the World Bank and supported by the UN, IMF and OECD), the Corporate Leadership Group, and We Mean Business. We continued our support for the UN Global Compact in 2018 and remain committed to reporting our progress toward this initiative.
We are proud to be recognized as a constructive contributor to a changing world, achieving this by working side by side with governments, industry bodies and peers. We were recognized for the contributions we made during 2018. To mention only a few: we featured in the Fortune Magazine's 2018 'Change the World' list for the third consecutive year. I myself was humbled and honored to be named among World's 50 Greatest Leaders by Fortune Magazine. We were part of Forbes' best employer list globally. Our company was also among the winners of the Ethical Corporation 2018 Responsible Business Awards. We were pleased to be again ranked number one globally by Sustainalytics and we topped the Dow Jones Sustainability World Index for the eighth time.
Our people and leadership
The organizational adjustments of the past strategic period have enabled us to develop a stronger, more diverse, results-oriented company and culture. The brainpower, willpower and passion of our employees, who say with pride that working at DSM is about Doing Something Meaningful, have made this happen. Our people feel even more inspired, engaged and committed: our annual Employee Engagement Index rating increased from 75% in 2017 to a highest-ever score of 76% in 2018. Almost all elements of our Employee Engagement showed improvement. The most notable increases were seen in career opportunities and opportunities for learning and development.
We continued to focus on improving our performance in inclusion and diversity. Although our work in this area is far from done, it is pleasing to see that today, more nationalities than before are represented across our company, and there is also a better gender balance at management and executive levels, as well as among their direct reports. The same goes for our Supervisory Board. Going into 2019, the percentage of women in our Executive Committee as well as our Supervisory Board is 43%, both meeting the target of 30% prescribed by Dutch legislation in terms of gender balance. Also, the Supervisory Board of DSM Nederland B.V., a subsidiary of Royal DSM, meets the gender balance target (33% female). All these boards have helped us to set the right course, with an innovative mindset, to deliver on our strategic, financial and societal promises. I would like to warmly thank Tom de Swaan, who retired from the Supervisory Board in 2018, for the significant contribution he has made over the course of so many years.
We worked on further improving our safety performance in 2018. We focused on keeping safety awareness high and we developed a new set of global performance indicators to help us more proactively tackle safety observations and prevent incidents from occurring. However, in September 2018, a tragic accident took place at our Tortuga site in Pecém, Brazil, where one of our subcontractors lost his life when opening a container. This has deeply shocked us all. It demonstrates once again that Health and Safety must always remain our top priority, and that we must work to continuously improve our safety performance, day in, day out.
Purpose-led and ideally positioned for growth
We have very successfully implemented our Strategy 2018 and with that made again important steps to transform DSM and future-proof our company. We have built strong businesses. We have become a growth company with ambitious sustainability efforts that creates value for all stakeholders across the three dimensions of People, Planet and Profit. Over the last decade, we have made decisive steps as a performance-driven and purpose-led company that creates brighter lives for all with science-based solutions that help build a brighter world for our customers, employees, shareholders and society at large, for people today and generations to come. Ten years ago, many people believed that contributing to a better and a more sustainable world could not go hand in hand with financial returns and profit. Today, we are proving that doing well financially can go together with doing good for the world. We are convinced this will only become more important in the future. Within the next ten years, good financial results will have to go hand in hand with purpose, providing companies with their continued license to operate in a broad sense. We currently see a growing belief among our shareholders confirming this view.
Our purpose is fully anchored in our strategy. It drives our performance and sets the scope for our growth, financial returns and the evolution of our portfolio. In June 2018, we presented our strategy update, detailing how we will evolve further toward being a purpose-led, science-based company active in Nutrition, Health and Sustainable Living. We will focus on strong platforms for growth, centered on developing innovative solutions addressing Nutrition & Health, Climate & Energy, and Resources & Circularity. Increased customer-centricity and large innovation projects will enable above-market growth. At the same time, we will remain focused on cost control and operational excellence, allowing us to accelerate profit and cash generation. Organic growth will be complemented by acquisitions, predominantly in Nutrition.
We have set two headline financial targets for the period 2019–2021: (1) High single-digit annual percentage increase in Adjusted EBITDA; and (2) ~10% average annual increase in Adjusted net operating free cash flow. We are also stepping up our ambitions regarding the reduction of GHG emissions, increased energy efficiency and increased use of renewable energy.
We are well placed to move forward and to deliver on our 2021 strategic targets, to drive continued above-market organic growth and deliver further improvements in profitability, returns and sustainability. Working together with our stakeholders, we will create a brighter future. I am truly excited about what we have realized already and can achieve together. On behalf of the Managing Board, I would like to thank everyone who helped make 2018 a great year for DSM: our customers, our business partners, our shareholders, our people, and my colleagues in the Executive Committee, as well as the Supervisory Board.
CEO/Chairman Managing Board Royal DSM