Earnings Call: Q3 2022

Nov 8, 2022

Earnings release

Good morning, and welcome to the interim management statement. My name is Charlie, and I'll be coordinating the call today. I'll now hand over to your host, Roy Twyke, to begin. Roy, Please go ahead. Thank you, Charlie. Good morning, everybody, and thank you for taking the time to join us today. I am joined here as usual by Dan, our Finance Director. I'm just going to take a moment to summarize the highlights from the IMS before we take your questions. So to begin with, I'd like to thank all of our employees For their excellent efforts and continuing dedication to our strategy and to our purpose, Breakthrough Engineering for a Better World. It has been another strong performance as we recorded our 7th consecutive quarter of organic growth. Group revenues were up 10% versus the Q3 of last year and up 4% on an organic basis, while year to date margins continue to increase versus the same period last year. The organic order book is up 8% at the end of the quarter. We continue to see great momentum in our growth up and sprinting right across the divisions, and we now expect to deliver over £40,000,000 of orders on these projects in 2022. Our restructuring program continues to reduce complexity, and we remain firmly on track to deliver the expected benefits. Precision Engineering delivered organic revenue growth of 3%, led by our Precision Fluid OEM business, We delivered strong organic growth of 9%. Adjusted revenue in Precision was up 16%, and we are really pleased with our Acquisitions of Daptus and Bard, which are integrating well and contributing positively to the division's performance. You will also have seen our announced Acquisition of Core Solutions last week, which nicely complements our analytical instruments offering in Life Sciences. Critical Engineering had another excellent quarter with organic order intake up 21%. Momentum in the aftermarket continued with 24% growth and we also saw a pickup in new construction activity. The order book is 11% higher than the same period last year, reflecting strong demand in LNG, oil and gas and power. Hydronic Engineering organic revenue was up 3% as we continue to see demand for our energy saving products. I'm extremely pleased to announce the proposed acquisition of Heatmiser. It's one of the UK's leading smart Futureally enabled HVAC control manufacturers. HeatMiter will become part of HiMI Hydronic Engineering And provides an opportunity to accelerate our growth in smart buildings. Adjacent to our existing HVAC product offerings, HeatMiser will provide an attractive entry point into connected residential thermostatic control, which is a fast growing market where Heatemiser is already a UK leader. The demand for smart temperature controls is growing rapidly And it's expected to accelerate further with more than 200,000,000 buildings in Europe requiring renovation to upgrade their heating and cooling systems. There are significant opportunities to leverage IMI Hydronic's strong brand and market presence to scale Heatonizer's offering Across Europe as well as leverage Heatonizer's proven connected technology capabilities across both our existing and new products. We expect to generate significant synergies as a result and, of course, exceed IMI's strict acquisition hurdles, Delivering attractive returns for shareholders. We expect to close the acquisition before the year end. Given the continued momentum in the business and based on current market conditions, we are upgrading our EPS guidance for the full year from above £1 To now be in a range from $103,000,000 to $106,000,000 And we remain confident in delivering our group growth targets 5% plus and operating margin target of 20% through the cycle over time. With that, I'm going to hand you back to Charlie, who's going to manage the Q and A for us. Thank you, Charlie. Of course. Thank Our first question comes from Max Yates of Morgan Stanley. Max, Your line is open. Please go ahead. Thank you very much. Just my first question was around pricing. And if you could give us any indication for what pricing looked like, maybe particularly in the hydronic divisions, trying to understand whether Volume or to what extent volume growth was still positive there? That would be my first question. Yes. Thanks, Max. Max, so we're obviously not going to give too much detail on pricing because as you probably appreciate, it's pretty commercially sensitive Object. But what I will say is that our pricing across IMI is now slightly above single mid digit across the whole piece, And it is slightly higher in hydronic. So you can deduce from that that hydronic volumes were slightly down versus The same quarter last year. But remember, in Q3 last year, volumes in Hydraulics were 9% up because obviously There was a bit of a rebound from COVID and still that we're working weekends and flat out not taking holidays to To compensate what happened during COVID. The other thing, Max, is we are getting a little bit of wholesaler destocking in Hydronics as well. So I think that's probably slowed their overall unit growth. I think I was going to punch your customers last week in Sweden. And the overriding message was that versus 2 years ago even, that energy saving was right up the agenda of our customers. So Actually, I think Ardronic is in a pretty good position. Okay. Thanks, mate. And just a quick follow-up on Precision. I mean, if we think about kind of the changes that you've made to the business, it's obviously been quite expensive kind of restructuring Across the group and in Precision. I guess when you look at the division and you think about potentially seeing Sort of growth negative in 2023 and potentially a sort of industrial recession. How do you think about the changes that you have made affecting the sort Seeing the sort of margin resilience of the business and sort of your ability to defend margins, maybe if you could just comment a little bit If we do see a sort of minus 5%, minus 10% for Precision next year, where would you think that margins would trough out? And do you think What you've done has made the business more resilient. Yes. I think firstly, the restructuring has obviously improved IMI's margins Sort of 14% to 17% plus, right? So I think it's clearly dropped through to the bottom line. Typically, our cash paybacks have been less than 2 years. And what we've done principally is consolidate some of our poorer performing sites into our best performing sites, Often in low cost countries. So we put proper structural cost savings into our business. I think as you sort of indicated though, Max, on top of that, it hasn't just been about cost because the sites we've integrated into had Higher employee engagement, higher customer net promoter scores and a higher customer service ethic culture and Undoubtedly, better lean systems, which I think is one of the real positives of the last sort of 8 years, The lean systems and how that's gone into factories like the ones in Brno, Mexico, Shanghai, Czech Republic. So I think right across the board, those factories we're consolidating into are more flexible. They are leaner. They are able to react better to a reduction in volume. So if that does happen, I do feel better placed. I think the other thing you got to remember, Max, is that our restructuring is on budget. It's on time. And that will deliver £20,000,000 of savings into next year, $15,000,000 of which will go into precision, which would help to cushion if volumes do indeed come down in precision. That's very helpful. Thank you. Thanks, Max. Thank you. Our next question comes from Alexander Virgo of of Bank of America. Alexander, your line is open. Please proceed. Yes. Morning, Roy. Morning, Dan. Couple of questions from me then, please. First one, just on PE to follow on a little bit from Matt. So I wondered if you could give us A bit of regional color. And I guess, in particular, thinking about IA, commercial vehicle a little bit more obvious, I guess. But thinking about IA, it looks like You slowed pretty materially in the quarter. And I just wondered if you could give us a little bit more color around the drivers of that, Perhaps both regionally and even end market. And then the second question, just on Heatmiser. I appreciate you've given us an EBITDA implied margin which looks to be in the 40s. Is there much in the way of D and A in the business? And can you give us any steer on PPA? Thanks very much. Yes. I'll do the easy one on 8 Mileage, which is Actually, EBIT is very, very similar to EBITDA. There's very, very little in terms of D and A in that business, Alex. So I'll let Dan take the complex PPA one after I've taken the other one on IAA. But yes, it's very, very close. It's a good margin business, And that's principally because it adds tremendous value for its customers. I've actually got the Achronizer system probably in a few years ago. It's tremendously in terms of making sure that you're not wasting energy within a building, that you hit the temperatures that you're comfortable with at the exact time of day that you want them, Which right now is more important than ever, I think. So yes, no, it's a high margin business. It's been growing double digit. It's in a nice space, and I think you explained the plan in the notes reasonably well. So nice strategic acquisition. On PEIA, I would say that The U. S. Is so overall, IA Precision is doing pretty much what we expected. We've got slower growth in IA. And IA does sort of follow the PMIs. We do want to break that trend over time, obviously. But for the last couple of decades, Yes. It's pretty much for the PMI, and that's pretty much what we expected it would do. U. S. Is still slightly more positive than Europe, Alex. So Europe is pretty well flattened out. I think it might have been minus 1 or something in the quarter. Again, pretty much what we expected. And then China is the other issue, obviously. And the China lockdowns has hit both IA and CB, our truck business in the quarter. So I'm not going to predict what's going to happen in China on lockdowns. I've noticed today that the incidences of COVID are increasing again. I hope That they can find a different way through this, obviously, and we get and the business will pick up again. But that gives you the overall geographic position. So Dan, do you want to comment on CPL? Yes, Alex. Yes, we're obviously just getting into that fund accounting activity. But As we look at it, my expectation is it will follow very similar to the acquisitions we've done earlier this year. We'll go through the exercise. There will be some intangibles that we'll put on. There will be goodwill, but it'll match Similar ratios of the deals that we did like Adaptus. Okay, great. Thanks, both. And if I could just follow-up quickly, Roy. Any kind of indication of what How much you would attribute to China and China lockdowns sort of hampering the business in the quarter, Just so we can get a better feel perhaps for the underlying business. Yes. I think it's So APAC for us was slightly negative for IA. And about half of IA is China For us, which has been the major drag on that, Alex, just to give you a sort of overall feel. And normally, Asia for us is obviously growing Mid to double digit. So for our overall growth trajectory, normally, It's quite a significant change. Okay, great. That's helpful. Thanks very much, both of you. Brilliant. Thanks, Alex. Thank you. Now. Our next question comes from Jonathan Hurn of Barclays. Jonathan, your line is open. Please go ahead. Hi, guys. Good morning. I just had a few questions on Crispall, if I may. Firstly, just obviously on the strength of the order book at the end of Q3, obviously, plus 11% for the year. Can you just sort of break out how you think about that order book going into 'twenty three, the question, just in terms of growth? That was the first one. I'll just take the other 2 as well while I'm here. 2nd one is just on the aftermarket, obviously good Can you just give us a feeling of how that's breaking down? Is that because some of the upgrades coming through? Or is it parts and labor? So which is the main sort of driver there? And then the third and final question, just wondering if you could give us a little bit more color on the trends you're seeing in LNG and Power. Obviously, you flagged these things as it's going. So How long do you think that's going to go on for? Are we seeing a lot of sort of upgrades coming through in power? Just need a bit more color there. I think that's very helpful. Thank you. Yes. Brilliant, Jonathan. Right. So yes, the critical order book, obviously, up 11% and strong aftermarket So we're now up 19% year to date and total orders up 10% year to date. So yes, we feel good about The order book. And we feel good about the quality of the order book. We did pick up a couple of larger orders towards the end of last year. So I'm not quite sure if we're finished at plus 11% for the year. But as you know, Jonathan, I'm not going to make too many predictions About next year, I don't think wise people are doing that right now. But in terms of Critical, we do have a 9 month order book. And so that Order book strength does bode well for next year. And I think if there is a recession that FX Industrial Automation in particular, it's nice to see that Critical is doing what it normally does, which is countercyclical and shows a real benefit The portfolio of the fluid control businesses. So, yes, it's a good position to be in, and it was a good strong quarter on top of the Previously strong quarter. I'd say that and this sort of goes into your next questions really, but We're not yet seeing the investments that will come as a result of the Russian invasion of Ukraine. Because as I said on the last call, We won't really see that until about the second half of next year just because of the way the lead times work on Even new LNG compression plants. So this is good news, and it's a continuing trend in our aftermarket, obviously, heavily supported by the growth of our projects, Retrofit 3 d, aerosol, the ones we presented at the Capital Markets Day. So I'm really pleased with that. In terms of the nature of the aftermarket, It's pretty broad based actually, the strength in the Q3. And we're seeing good strength in upgrades Skills. So upgrades in the quarter were up 29%, Jonathan. The very profitable parts were up 19%. So it's pretty good. And you know that we get that annuity from the parts business from achieving the upgrades. Obviously, once we've got the installed base there, those Parts flow, a very good margin. So I think we did a rough calculation the other day, and now over 50% The profits in Critical are coming from the recurring revenues of the parts business, which is obviously bodes well as that goes into the future. Just in terms of LNG, well, as I said, we're not really seeing the benefits yet of any recent investments. But LNG's strength, I think, is going to be there, well, certainly for the medium term. We think LNG is going to be strong Certainly, for the next 3 to 5 years and potentially well beyond that. And power in China, China is putting some More conventional power in place, and we'll be doing that over the next few years. And as you know, we're well placed in the severe service Applications on turbine bypass on those power sections. So yes, I think certainly versus even probably 6 months ago, The outlook for Critical over the next sort of medium term is actually a pretty good job then. That's great, though. Thank you. Great. Thanks, Jonathan. Thank you. Our next question comes from Mark Davies Jones from Stifel. Mark, your line is open. Please go ahead. Thank you very much. Good morning, both. 2 Unrelated questions from me. Firstly, maybe one for Dan. Obviously, the acquisition today slightly muddies the water in terms of the cash flow performance for the year. But can we just check Are the expectations for working capital working down through year end as they were or any change to that? That would be my first one. Yes. Mark, yes, we're seeing some reduction in working capital. I think we're I don't think we'll be back To an overall normalized level, I suspect we'll see that come out as we watch the supply chain into next year. But in the note, we kind of gave the guidance with the Deep Mizor acquisition, putting ourselves around A 1.8 percent. So if you run the math there, you'll see that's supported by some working capital coming out in the second half. Okay. Thank you. And then the other one was around Hydronic. You've mentioned the energy Efficiency focus, which is clearly very topical. But how does that offset against what are some quite sharp slowdowns in construction activity and forward Expectations in the construction market, particularly in sort of core Europe, do you think the specifics of that energy play can offset the Border slowdown in construction and RMI. Yes. I think that's the $1,000,000 question, isn't it, Mark? And We are absolutely focused on growth in Hydronic and have a very strong plan B in place. Okay. I think my obvious detailed memory is 2,009 when industrials were dropping 10%, 15% and Ironic Dropped 4%. And actually, its profits increased because the price of The raw materials that it uses dropped significantly, and obviously, it's got very strong pricing power. So I think what tends to happen, and again, meeting with these customers last week, is that they very much switched their focus during the recession to Refurbishment, because they are still being hampered by a lack of other products to finish their projects. So things like heat pumps, for instance, are still on very, very long lead times. And that is that means there's pent up demand For the projects they're doing, that will tend to move to refurbishment. I think in 2,009, the vast majority of what our customers did was refurbishment because of some new construction. Certainly, by 2010, it's pretty well ground to a halt. So I think that's one effect. The second effect is obviously governments. And certainly, these customers are asking for saying this is what they expect to happen. Governments incentivize energy efficient refurbishment On top of the existing sort of legislation because, one, it drives local employment. Obviously, all these people are working within their own countries. So obviously, they want the energy efficiency, particularly now. So yes, I expect Hydronic to be reasonably resilient Even if things get tougher in terms of consumer spending next year. Thank you very much. Thanks Mark. Thanks Mark. Thank you. Our next question comes from Bruno Giangi of Exane BNP Paribas. Bruno, your line is open. Please go ahead. Thanks Thank you for taking the question. I just wanted to follow-up on Mark's question on working capital, specifically as it relates to inventory build. So in H1, we saw inventory rise Quite notably. And I think at the time you said that reflected supply chain constraints and also a conscious effort on your side to build in stock of some components. I guess could you provide just some color on how inventory levels developed in Q3, whether you started to see that unwind and how we should be thinking about H2 overall Can I have a slight follow-up on the back of that? Yes. Hey, Bruno. Yes, we did start seeing some of that come down. We're basically to focus on ensuring we keep the customers And got the library in good shape. So we're managing that as we go through. But we did see some cash come off The balance sheet in terms of that, and we expect that to kind of come through like it did last year, if I'm perfectly honest. If you look at the Trends last year where we did build stock in the first half and then draw that down, that's part of the seasonality of some of our businesses. And again, if you back calc against the leverage position, I think you can see that, that's going to come through. And we will also see some benefit from debtors coming down again. That's also some seasonality there as well. Got it. And it doesn't sound as if you're thinking about the new to cut production to clear new tree levels. How should we think about that? Is there any risk as we look towards next year, particularly in the weaker macroeconomic backdrop that you might have to under produce Perhaps clear some inventory, any implications that might have for margin development or not really? Yes. I think it's Roy now. Thanks for your questions. Now obviously, we will match production At the appropriate levels. I think some of the stock that we've got, some of the excess stock is around the site moves as well, Bernardo, right, which is Obviously, the sensible thing today, as you know, we're consolidating 3 sites at the moment in Precision, and that is what's Generate that $15,000,000 of savings for next year. So as we're doing that, effectively what you're doing is moving People or jobs, I should say, from one site, typically in a high cost country to a low cost country and simply will employ less people In those low cost countries, to match the production rate required for the appropriate stock level. So I think there's plenty of opportunity still on working capital. I think as Dan said, he described the sort of What's going to happen this year and plenty of opportunities still for next year, depending on how global supply chains perform. And as we as Dan said, we will always prioritize customer service and growth, but it still remains a nice opportunity for us at Bankburne. Got it. Got it. And I just wanted to follow-up on the acquisition. So it's great to see Hydronic allocated some capital, and I think the last deal of No, I was running in line with the big things around energy transition. So I was just wondering if you can expect more capital So to be allocated towards Hydronic going forward, is this market step change in divisional capital allocation priorities that has been taken by you? Or is this just I'm reading too much into it. No, yes. I think I mean, I was actually running Hydronic when we did the last two acquisitions. I did feel about the other day. I think and the team actually. I think no seriously now, Phil and the team have done a fantastic job. We bought this The company through the relationship with the family. It's a wonderful family, the Kay family. And I was really pleased that their strategy to expand across Europe fits exactly With what we wanted to do and what we talked about at the Capital Markets Day and many, many times, Bruno Wright, which is find A company with a really fast growing product that has limited distribution across our core markets, Where we can really expand that distribution, preferably in the connected smart space, because that's the bit that's growing the fastest. And this company absolutely, we've been following it for a long time. There's more exciting opportunities in the Hydronic funnel. Yes. Over time, you can definitely expect more acquisitions in Hydronic. And I think this is the start of That trend's reawakening, if you like, from more than a decade ago. And we're really excited, same as you are, about the trends on energy saving in buildings, Particularly, but not only in Europe now. I think the U. S. Is starting to take it seriously. And as I said earlier on the call, certainly Customers are really our customers are really feeling that pull now in the market. So yes, we I will expect over time more capital to be allocated to Greg Hydronic, yes. And just following up, I'm just wondering if you could perhaps Put some numbers around the revenue synergies that you're targeting. So it's a great U. K. Business. So where do you think you could take this year and take 3 to 5 years? Yes. We expect it to reduce returns above our cost of Capital, which we've obviously revised up, given what's happening in the economic systems, but we expect it to be above that in 3 years, and we expect it to be Fairly diluted. We've moved our overall ROIC. So we moved the whole incentive system for IMI top Management to ROIC. And in ROIC, obviously, in the denominator, we've got all of the goodwill of the investments that we made. We put that in the annual report, as you know. And we've moved back from, I think it's 11.3% roughly from memory to over 13% in the last 2 or 3 years, Right now, and we don't want to be dilutive on that number. We are incentivized on that number. So certainly within a sort of 5 year period, we expect You know, Heat and Ice has been contributing at about our overall returns rate of 13%. Thank you. At this time, we currently have no further questions. I'll hand it back over to Roy Twight for any closing remarks. Excellent. Well, thank you very much for joining us today. For me, the absolute highlights were obviously Critical orders and the order book in Critical, which I think sets us up Well for next year. The growth of momentum, I think the fact we're now going to go over the £40,000,000 of orders and clearly that is contributing to Critical aftermarket success as well. And then obviously, the acquisition of Heatniser, another absolutely strategic acquisition for us that will Help accelerate that growth within the Hydronic division. And then, of course, lastly, raising the guidance, upgrading again. So really appreciate everybody joining the call today. And I hope you have a great closeout for the rest of the year. Thank you. Ladies and gentlemen, this concludes today's call. You may now disconnect your lines.