Good morning, ladies and gentlemen. Welcome to the Bodycote Trading Update Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. I would now like to turn the conference over to Mr. Stephen Harris, Group CEO. Please go ahead, sir.
Thank you. Good morning, everybody, welcome to the call. I'm here with Ben Fidler, our CFO. I'd like to say this morning that, as you can see, the company is in rude health. We're humming along very nicely. We've got a great management crew in place, we're on top of the business and the numbers. I think at this point, I should just interject that that's one of the reasons, clearly, that I'm comfortable at this point in time to think about hanging up my boots. You'll see that we put out a separate announcement with the trading update this morning that says that I've actually informed the company that I will be looking to retire next year, no time soon.
That will be at the appropriate time once we've actually identified and selected a successor, and I've done an orderly handover to that person. Still around for quite a while, the company is in very good shape. Let's move on to the trading summary itself. Clearly, a strong start to the year. The main numbers we'd like you to focus on in these releases are the numbers excluding energy surcharges. Whilst we reported group net revenue up 22.1%, the number we'd like you to focus on is the constant currency, excluding surcharges, which is a group increase of 9.5%, and that's more indicative of the underlying trends in the business.
As you can see, we've stated the surcharges are trending down, and that indeed is the case. It's steadily falling in each country and its location month by month at the moment, and we are marking the surcharges to market almost everywhere on a monthly basis, following the indices down. We don't know where or when that will happen. Obviously, it won't ever go negative. We would expect, along with the rest of the world, these energy prices to still keep falling, at least until we get to the winter. At that point, I dread to say this, but it depends on the weather. It's not something I normally say. We'll see how life goes in the fourth quarter with that.
Generally, the surcharges are coming out, and therefore, the underlying growth is gonna be more reflected in the reported top-line growth. Things are looking pretty good. The margins in the business, of course, are expanding as these energy surcharges fall. Indeed, as the volume comes through, we also get the kind of drops that we normally get. Our margin progression is exactly where we thought it would be. Just looking a little bit more deeply into some of the numbers and pulling out a little bit of color, I'm not gonna go through the two businesses. You can see the Specialist Technologies numbers there as well. Just picking on each one of the market sectors a little bit.
Aerospace & Defence, the excluding surcharges number is up 9.4%. I'll be honest, that's a little less than we would expected. We were hoping that it was gonna be higher than that. Certainly, it's not a bad number, but we have been seeing that some of our customers, in fact, quite a lot of them, they've still got these supply chain issues. The numbers are ticking up every month through the year, and that's something that we would expect to keep going and that growth rate probably going higher as the year goes forward. Right now, it's just a little bit behind where we thought it might be. In contrast, automotive is higher.
We were a little bit cagey about automotive because it's such an uncertain area for most people, but with 8.8% growth excluding surcharges, that's quite a nice print. We must remember that we've got a soft comp there for that from the prior year. The other thing to note about automotive is that one of the things that's driving it along for us is we are picking up increasingly more and more electric vehicle work. Whilst I won't go into a lot of detail today, it is something that we want to comment about more at the half year because some of the contracts we've picked up are material, and they are long-standing. That is quite interesting, and it's helping to drive that automotive growth.
General Industrial, it's pretty much the same as we said at the full year results earlier this year, 2022. We've still got the two sectors that we've referred to that growth is moderating in. No change in that trend, but there are other areas within General Industrial that are getting really quite strong. We're quite pleased with our medical growth, and that is picking up quite rapidly. And in medical, what we're having a lot of success with is prosthetics, implantable prosthetics.
It's not just the underlying growth in the normal cobalt chromium hips and knee joints that you've seen around for years, but we're picking up quite a lot of the titanium alloys additive manufactured work that requires HIPing and heat treating, that's quite high, high-value work. It's growing from a smaller base, but it's still very nice growth that's going on in that part of GI. Of course, the other one is energy, which we put in GI right now. We used to report it separately, but once we decided to retreat from fossil fuel extraction, we thought it was not a material part of the group, and we put it in General Industrial. The growth area in energy, particularly for us, is in what you might call energy security....
Securing people's energy supplies, and the way that is manifesting is it seems like anybody with a gas deposit off their coast is putting in wells. We've got quite a lot of subsea gas work that we're working on, which, of course, is through one of our Specialist Technologies, PowderMet. That is really going very strongly. It's a small part of the group, but it's growing rapidly. Unfortunately, that business is also lumpy, but it does have quite a long time horizon in terms of the project. We've got good visibility of that particular piece of the business right through 2024, and that is quite strong. Just moving on to Emerging Markets. Emerging Markets really not going to go out there.
The only slightly offsetting piece there is China. We got 6.5% growth in China, and we don't have surcharges in China either. Some people might think that's great. Our internal performance in China, we always reckon that we should be higher than that. We always have been, in part, but of course, China's just come out of the COVID lockdowns. I think a lot of people are finding that the rebound is not quite as fast as they thought it might be. We get intelligence on it now every couple of weeks, now that things have opened up. Things are moving, but it's quite an intense type of activity in China, particularly in automotive, which we have a lot of exposure to, particularly the EV market in China.
What we're seeing is lots of price wars going on amongst all the Chinese players, and that is certainly causing work to be switching around and giving us opportunities and growth. China, I think, it will be slower to row than we might have originally thought, although we never factored that in very heavily. It still looks pretty good in the longer run. Moving on, our financial position, of course, is very strong. Summary of that, look, well, you know, we're four months of the year in, there's eight months to go. Clearly, we're in a good place, and we're comfortable with where, you know, our expectations are. We're not going to be changing those at the moment, let's see where we get to at the half year.
With that, I'll turn the call over to questions and answers, then Fidler can take all the questions. I'm just kidding. Yeah, I'll help him as well. If you could open the call up, please, Lara, I'd appreciate that.
Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by 1 on your touch-tone phone. If you would like to withdraw your request, please press star followed by 2. Your first question comes from the line of Andrew Douglas from Jefferies. Please go ahead.
Morning, Stephen. Morning, Ben. Thank you, thank you for that. Stephen, I won't wish you a retirement, a happy retirement just yet. Feels like you got a bit more time under your belt, but congratulations on that. Three questions for me, please. Firstly, can you just talk to us a bit more about automotive? I hear what you say about contract wins and wanting to talk more about that in the summer. Can you just talk about Eastern Europe in particular? You know, very strong growth there. I'm assuming that's partly moving the capacity over from the West, but that's kind of where the EV will be kind of seeing the main benefit. Is that right, or is there more to it?
That's exactly right. Exactly right, Andy. I'll take them one at a time, John, with your questions.
Sure.
That's exactly right. I mean, we've got significant contracts coming in in Eastern Europe, and indeed, the rest of the Emerging Markets in EV work. Not just the EV specific work, but also the general work, such as, you know, brakes and steering and stuff like that. A lot of that stuff will end up on EVs. We've also got very significant EV specific exposure that we're being contracted to do. In fact, our investments have been geared that way for some time, and we've actually got more equipment that we're moving in there now. It helps the fact that we've got the right kind of equipment, and it's mostly our Specialist Technologies on hand, and we're moving that into the right locations.
Sometimes we have to adjust the map a bit because our customers don't always send that where we thought they would. That's, that's actually what's going on in Eastern Europe. General Industrial, actually, is also going quite well there, too. Certainly, the move of the supply chains in general to the Emerging Markets is what's driving that.
Yeah. The commentary about just being cautious of, or cognizant of the kind of potential consumer slowdown in the second half and what that might mean for auto, is that just a kind of a general comment rather than anything that you're seeing or hearing?
It's my natural outlook.
Okay. Okay, fair enough. We were talking about M&A, last time we spoke, a couple of months back, and I sensed that there was a bit more enthusiasm for maybe some newer deals that come to market, maybe some bigger deals, some more interesting deals. Can you give us a refresh on what you're thinking about M&A? I've got one for Ben.
No, there's no change in what we're thinking. We wish some of these private equity companies would calm down a bit, but other than that, life is where it was. There's certainly a lot of activity coming to market, and clearly quite a number of companies that have financial stress.
Yeah.
Some we don't, but a lot of companies out there that do, and that's bringing stuff to market. Whether we manage to pull off a deal or not, time will tell. As we get towards year-end, of course, if we haven't pulled off a deal of any size, then we will be sitting in a very comfortable position on the cash side, and that's where we'll be contemplating what we do with that cash with regard to shareholder returns.
Okay, understood. Lastly, just for Ben. Ben, can you just give us a little bit of help on the shape of this year's profit numbers? I'm working on the assumption that they're not too different to last year in terms of first half, second half split. Is that right, or is there an update you can give us?
Yeah, thanks, Andy. Look, what I'd say on that, if we remember where we were last year. Last year was around about a 45, 55, H1, H2 split looked at the operating profit level. I think this year we would still expect to have something the second half bias. I'd probably work on the basis it's a little bit less pronounced than the second half bias that we had last year, but I would still plan on the basis of something of a second half bias in 2023 again.
Okay, understood. Thanks, guys.
Thank you. Your next question comes from the line of George Featherstone from Bank of America. Please go ahead.
Morning, everyone. Thanks for taking the questions. I'll go one at a time. I just wondered, firstly, maybe one for Ben, can you help us with the mechanical impact that you're seeing on margins from the moderation in surcharges in the first half? If you've got any color for the rest of the year, that'd be also super helpful.
Yeah, well, look, I mean, the mechanical implications are it clearly boosts the top line. Surcharges are there rightly to recover our energy costs. We don't make money out of those surcharges, therefore, de facto, they are dilutive to margin. They are absolutely the right thing to do to cover us from an inflationary cost perspective. Yeah, this morning. This trading segment is all around the top line. We're not gonna talk about profits. We're not gonna talk about margins at this point. You'll have to draw your own views and conclusions, understanding, as I'm sure you do, the operational gearing that we have in the business to top line growth.
You know, what I would do is reiterate the comments we've made in our full year guidance, which is we do expect margins to expand for the full year as those surcharges moderate. Now, the pace of moderation in those surcharges requires rather a large crystal ball on both sides, your side and our side. You clearly have seen what we've been able to achieve in terms of surcharges in the first four months, up 7.1% year-over-year. What I would flag as you forecast forward though, George, is just the fact that that first four months does compare to the early part of last year when we had a lag in putting in place those surcharges in the first place.
I wouldn't annualize that number, the 7.1%. Building on Stephen's comment and what we made in the statement, recognizing that surcharges as a percentage did peak in the fourth quarter. They have been declining from there. Clearly just bear in mind that first four-month number, not working on an annual basis as you forecast through Q2, Q3, and Q4. Where surcharges are really gonna land during the second half and particularly over the winter months, it's hard to predict. What I would say is, okay, that's gonna cause you to modify your top-line expectations, but it isn't gonna cause you to modify your profit expectations because it's net neutral at the profit level.
Okay. Thank you very much. Then maybe a couple for Stephen. Just I wondered if you could help us a little bit with the subsectors that you're referring to, again, in General Industrial, that are sort of a bit more sluggish. Equally, I think before you were talking about some CapEx related investment. Just wondering if that's still something you're seeing a lot of traction in those markets, or if the early moderation is all there as well?
Okay. I mean, the two areas that we talked about, the same two areas that we're talking about now. Excuse me. That's tooling, which has been over the years quite a nice leading indicator for automotive. The thing you remember about tooling, though, is people tool up before they start producing, and then once they start producing, there is a replacement requirement, but not anywhere near as much as the original tooling that they started putting in place when they were gonna ramp up their production rates. We saw a quite a large growth of tooling back last year originally, and then it started to moderate, as you would expect.
If people were going to be going into production, we hadn't seen the production coming through, but we did see the tooling coming through, as a moderated growth, and that moderation has continued. What that really means in the fullness of time, is automotive going to just be at steady state, and that's just replacement, or is there going to be a bit of a decline because people are maybe worried about consumer spending? That's not something I can actually answer as to what the customers really are doing, but it's, it's in line with they're not expecting any massive drops, but still obviously mindful of what's coming down the pike as the economies generally go their merry way. That's just one small snippet. Don't read too much into it.
The other one is industrial machinery. That tends to be CapEx driven. That is long cycle. It is, it's generally stuff that people have to invest in as they, you know, expand their production. The growth in that was very steep at one point, and it has been for probably the last six months. The growth in industrial machinery pretty much all around the place, is slowing in its growth. It's not gone down. There are plenty of pieces of evidence of that, not just from Bodycote, but all kinds of other places. In the industrial machinery, particularly machine tool producers, have been talking about their growth in exactly the same way that we're talking about the work that we see, because obviously we're servicing those kind of people.
That's just a CapEx cycle. It's a general, not so good as tool, but sort of indicator about people's thoughts about the future economy. Once again, these are people's thoughts. They're not really tangible in terms of how general economies are going. It's just people doing their future planning. The trend changes in those have really been along the same lines as we talked about already. No new news, really, is why I spend a long time explaining that.
Okay, thank you. Maybe just a final one on civil aero, which I appreciate seems to be quite difficult to call now, given the supply chain challenges. But I just wondered if you could help us with a little bit on of kind of what customers are saying in terms of sort of H2 levels of demand that you might see, and whether or not that supply chain could be unblocking anytime soon?
I think it is unblocking, and, people are certainly planning it that way. I know you directed this question at me, but actually, the aerospace expert in the room is Ben, so I want to hand it over to him.
Thank you, Stephen. Yes, look, I would concur with that view. We saw progressively through the first four months of this year that, although some of those supply chain constraints throughout the whole supply chain are still evident, there are signs that they are progressively easing. We saw that in the first four months, and we are expecting to continue to see that as the case. A number of our customers we know are putting incremental capacity in, both capital capacity, headcount capacity, to help deal with some of the upstream supply chain challenges. I think as far as commercial aerospace is concerned for us, that 11% growth that we saw in the first four-month period, we would expect to see some improvement in that growth as we go through the remaining parts of the year.
Obviously, critically, it does depend on the exact timing of some of these supply chain constraints easing.
I'd just like to add another point on that, because we don't often talk about defense, but I won't spend a long time talking about it either. It is a small part of the group. We are starting to see the budgets of the different countries around the world spend money on the replenishment and inventory restocking in the defense side of life. That is starting to pick up. It had to come sooner or later, and it is coming now. Not as fast as anywhere near civil aerospace, but it's a healthy government.
All right. Thank you very much.
Thank you. Your next question comes from the line of Harry Philips from Peel Hunt Newworld. Please go ahead.
Good morning, everyone. Three questions from myself, we can bear. Just coming back to Aerospace, just one of the supply chain sort of bottlenecks appears to be in the casting and forging side. That takes a while longer to unwind, so maybe a little more detail, if you have it, around that. Just on pricing, not just surcharging, but is pricing just good across the piece or are there particular pockets, say, in Specialist Technologies or Emerging Markets where you're getting more through or getting more of your value passed into your selling price? Lastly, I guess for Ben, the comments around M&A and the activity of private equity and so forth, a very strong balance sheet.
Maybe first thoughts, maybe not the appropriate time, but our last question on the left, but first thoughts around capital allocation and the balance sheet, please.
All right. Thanks, Harry. The aerospace supply chain, I mean, yes, I mean, you're right. People talk about the castings and forging end of the world. That is, you know, we start with that work pretty much on the West Coast of the USA. That's where the concentration of that stuff for us is. To remember that, generally speaking, the castings and forgings that are being produced today end up on airplanes probably two years in the future. That's the kind of supply chain late latency that is there in that work. In fact, the issue is not what it was. I mean, one of the problems that people were all worried about was the lack of material. I mean, there was a huge scare about titanium, for example.
You don't hear a lot of that in the noise at the moment. Really, it's about production capacity, and that's all about them gearing up and trying to take the production rates up, and that's proving tough. We've got quite a lot of capacity waiting for it, and we deal mostly through, in fact, I think all through Tier 1s in that area, that they're in the market. They're putting in the capacity, it's their capacity constraints. It takes quite a long time to lay this stuff down, and it started, I mean, they started investing in it quite a while ago, but it takes time to put it online. That is coming online gradually.
Some of the really dominant players are kind of not quite as fast as some of the smaller ones, but we see that moving ahead quite nicely. It's certainly they're telling us, "Okay, it's more, it's coming, it's coming tomorrow, it's coming tomorrow." We get used to that kind of drumbeat. That's where that's going. The other end of the supply chain, which is at the, for us. Getting on the planes in our thermal spray business, particularly the Ellison business that we bought, and then the volumes are coming through quite nicely. The issues on pricing, generally, I don't think that you can say there's an area where we're getting better traction or not, because we're very good with the pricing side.
I think, we're one of those businesses where we tend to get our prices through and at the level that we want. The only area where it's tougher, actually, is what I've just referred to, which is in some of the major OEMs that are seeing, you know, big inflation from all over the place, and they're a bit more reluctant to raise prices, one in particular. Yeah, nothing material, I would say, for the group. Overall pricing, very, very good. Passing through what we need, what we want. I've always said, inflation is a nice environment for Bodycote because we are able to do that, where many other companies don't have the same luxury. I hope that answers your question.
That's lovely. Thank you. Capital allocation, Ben, do you have a thought?
Yes. Yes, happy to share some thoughts with you on that. I think the first point to frame it is that this is a high quality issue. I was gonna use the word problem, but it's not a problem. It's a high quality issue to have. We are a business that is highly cash generative. We have a strong balance sheet, and clearly, as we progress through the course of this year, we would expect the level of debt to diminish further as we approach the year end. you know, at the same time, we're conscious in terms of leverage, that we are operationally geared, and therefore, as a business, we have to be mindful of the level of financial gearing that is appropriate and prudent to put in the business.
Clearly, on a medium-term view, that level of financial leverage is higher than it is today, which gives us the opportunities to pursue different routes as far as capital allocation is concerned. What I would say is, we will be disciplined about that. Those different uses of capital will and have to compete with one another. Those will be organic investments, dividends, M&A, and potentially supplemental distributions through either special dividends or share buybacks, as and when appropriate. They will compete with one another in terms of what the risks are, what the returns are. What I would say is I would expect, you should expect to see organic investment and M&A to focus on very clearly support of our strategic areas that we desire to grow in, Specialist Technologies, commercial Aerospace & Defence, Emerging Markets, and electric vehicles.
That's exactly where we are focusing more of our spend and efforts on the organic expansionary capital expenditure, as well as the pipeline of M&A deals, where inevitably, as always, in our industry, there are a number of those that are under consideration at any point in time.
That's great. Thank you very much. It's interesting, just on your M&A comments, availability with another chief executive changing, or announcing his change, what, 10 days ago or so, and, anyway, we'll see what it all brings. Many thanks indeed.
Thanks, Harry.
Thank you. Your next question comes from the line of Stephan Klepp from HSBC. Please go ahead.
Morning. I guess it was a gender change. It's still Stephan, but anyhow-
Yeah. Good morning, Steph. Morning.
Yeah, hello. There was many questions already asked and many answered. I have only two. I understand your conservative stance regarding the full year, but are you currently, because we are basically at the end of May, are you seeing any changes in the demand dynamics in the short term that would cast a different picture on H1?
No, look, we haven't thus far seen any difference. If we had, you'd have seen it reflected in the statement that we've just put out this morning. It clearly was a good start to the year. That has underpinned our confidence in the full year, and underpinned our confidence in the guidance that we gave in March, that we're reiterating today, clearly dependent upon the trading pattern that we see in the next couple of months. When we announce our half year numbers, we will, take a rain check and look at where things are then.
Yeah, that's fair enough. Good. Then, second one, it's about the strong growth in Specialist Technologies, so which is very good, obviously, because the mix shift continues to high-margin areas. I know that you're not specifically talking about margins, but are there any reasons we shouldn't assume, not assume that the positive mix shift and delivering on the energy, or declining energy surcharges should have a very supportive effect on the margin?
I think you can assume it'll have a supportive effect on the margin, yes.
Say that again. I couldn't hear you.
I'm sorry. I think you should assume that it will have a supportive effect on the margins.
You're not specifying anything else or any color on that?
I think that's enough for today.
Okay. Fair enough. Thank you.
Thank you. Your next question comes from the line of Sanjay Jha from Panmure Gordon. Please go ahead.
Yes, thank you for taking my question. I think my question is probably around automotive, and I know you've talked about getting a lot of new contracts in EVs. There's probably another trend, which is clearly the Chinese domestic brands are pushing for exports. I'm trying to understand the shape of your automotive business, because you still have a lot of business in Western Europe, which is clearly gonna get exposed by shift to Eastern Europe and to China. To what extent do you feel you're going to be, have problems in Western Europe? You know, you have a lot of assets there, which clearly are going to be stranded.
Well, good morning, Sanjay. I mean, first of all, if you recall, we did go through a restructuring program, moving a lot of those assets out of Western Europe, and we did that in 20, into 2021. We have a vastly less exposure to the Western European automotive scene. That exposure that we do have in Western Europe is primarily on platform-agnostic equipment. That is things like brakes, steering gear, seatbelt clips, and all those kind of interesting things, as opposed to any vehicle, any type of transmission type. The threat from China is probably in electric vehicles as opposed to anything else. There's a side note on that. I mean, we are resisting taking business in automotive today that's associated with internal combustion work.
Remember, the only IC work that we do, it's not associated with the engine itself. It's associated with parts of the transmission to the engine, and we're resisting expanding that because quite a lot of that work is being outsourced as people tool up for electric vehicles. That is still growing. You might say in five, six years, there might be stranded assets there. We don't have those kind of assets in place in Western Europe. The Chinese export side, a lot are written about it. Our guys on the ground, it's a real bun fight going on in China, with all these guys playing the local market at the moment. There's talk about quite a lot of consolidation happening in China.
It, it clearly, I mean, they'll break out of China at some point in the future. It's not something that we necessarily would be concerned about anyway, because we're on the ground there, and I don't think we're gonna have stranded assets. One of the things about our assets is they are reusable into different segments. It's not as if something that is doing a transmission system for a car today can't be used for doing wheels somewhere else on a different kind of vehicle. You know, it's the same kind of processes. Only the Specialist Technologies that tend to be more focused on specific types of work. On Specialist Technologies, they're not gonna be stranded. I mean, those are actually focused on very high-growing areas.
I would say in general, Sanjay, I wouldn't be pessimistic about this. I mean, you can if you want, but for us, we see it actually as quite an opportunity.
Are you saying that, you don't expect to do any more restructuring of your, or sorry, substantial restructuring in your sort of, Western European, capacity?
Correct.
Okay. Thank you.
Thank you. There are no further questions at this time. I'd now like to turn the call back over to Mr. Stephen Harris for any closing remarks.
Okay. Thank you. Thank you very much, everybody, particularly to those people that have been sending me messages this morning. It's a little quick to congratulate me, though, and the office to buy me a beer. Don't buy it yet, 'cause it'll get very warm by the time I leave town. Looking forward to seeing you in time as we go through the results at the half year and the full year. Thank you very much for listening.
Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your line. Have a lovely day.