Good morning, and welcome to the Macfarlane Group PLC interim results investor presentation. Throughout this recorded presentation, investors are in listen only mode. Questions are encouraged, can be submitted any time by the Q&A tab situated on the right-hand corner of your screen. Just click Q&A, scroll to the bottom, and press send. The company may not be in a position to answer every question received during the meeting itself. However, we view all questions submitted today and will publish responses where appropriate to do so. Before we begin, we would like to submit the following poll. I would now like to hand you over to Peter Atkinson, CEO. Good morning.
Thanks, Paul. Good morning, everybody. I am Peter Atkinson. I am here with my CFO today, Ivor Gray, and our objective is to talk you through our half- year results for the first part of 2023. The agenda will cover off three key areas. We will firstly give a little bit of introduction to Macfarlane Group, then talk you through the results, and then finally turn over to Q&A. So if I begin with a little background to Macfarlane Group.
As a number of you will know, Macfarlane is a very well-established business, founded about 75 years ago, and came on the stock market in the early 1970s, and has been a fully quoted company on the London Stock Exchange since that time. We are headquartered in Glasgow, sales around about GBP 300 million. We have about 1,000 employees. As I will talk later on, we are a very decentralized business.
We like actually decentralizing and having profit ownership at a very local level. We operate primarily in the U.K., growing in Ireland and increasingly and fast-growing in Europe with operations in the Netherlands and in Germany. Our customer base is biased towards the U.K. because of our history, but obviously we are fast-growing in Europe and our business mix is B2B, 75% industrial and 25% retail, of which retail majority of that is e-commerce customers. If we look at the business, the business is a specialist in protective packaging materials, and we have two operating divisions. We are the U.K. market leader in the distribution of protective packaging materials. For the uninitiated, that is basically cardboard boxes, void fill to stop the contents of boxes rattling around, tape and stretch.
Then we have a smaller specialist design and manufacture business where we design and manufacture very highly spec protective packaging for customers in the industrial, aerospace, automotive, MOD sectors, where they have very high value items that need serious protection. If we talk about our performance history, as you can see on the slide, we have seen consistent profit and earnings per share growth over a sustainable period, and 50% of that growth is built around our acquisition program, and 50% of that is built around our organic growth. How do we maintain our growth? It is one of the key questions that has come up in the Q&As that we have been given, and there is really six key building blocks to our growth story going forward.
Firstly, we have a very strong leadership position in the U.K. market and we continue to grow organically with a strong added- value proposition that customers find really interesting and exciting, and it fully differentiates us from competitors. U.K. organic growth is a key part of our growth platform. Secondly, U.K. acquisitions. We have been acquiring in the U.K. over a long period of time, typically doing two acquisitions per year, and we have a very strong pipeline of further growth opportunities in the U.K. market. We are very focused on input price management, ensuring that we can work with the right suppliers to drive gross margin performance improvement, and that is the key part of our growth strategy. We are looking to streamline our property footprint.
As I will talk later on, we have just done our first site consolidation in North West and we have further site consolidations planned, which allows to be more competitive in terms of the way we manage our property portfolio. From new move to Europe, we have currently got about a 1% share of the European market, so the growth opportunity there is significant. We have got a team operating out of Venlo in Holland that is driving organic growth through a program called Follow the Customer, taking customers we know in the U.K. who have got European subsidiaries or they themselves are part of a European group, and using our U.K. relationship to open doors in Europe, and that is going very successfully at the moment. Secondly, we are obviously very focused on acquiring in Europe.
We did our first acquisition in Europe just over a year ago, a company called PackMann in Germany. Again, we have got a very strong pipeline of acquisitions going forward. The final component to our growth strategy, continuing to invest in our people, really makes a difference in terms of in front of the customer. We have got very strong supplier relationships and we are looking to build and continue to develop those, particularly as we move into Europe. Finally, as a corporate business, we have a very strong ESG underpin. We are very confident in the medium term outlook. Let us move right on to talk about our H1 2023 results. When we reported our results for 2022, we flagged that we could see that 2023 was going to be a challenging year. Clearly for general economic reasons, there was a softening of demand.
We could quite clearly see that operating cost increases were going to come through, particularly energy and particularly labor costs. Obviously with what is happening in the banking sector, rising interest costs. I think what you see in these results is a demonstration of a very resilient business model because the performance that we have achieved has all been built around self-help programs because clearly we have not had any help from the economy at all. The self-help programs that have delivered the profit growth and the sales growth in the first six months are, A, we have accelerated our acquisition program, completed two acquisitions already, hopefully one more to go. We have also grown our new business, both in the distribution business and the design and manufacturing business, and distribution new business there is up 24%.
We've got increasing momentum in Europe, GBP 1 million more of revenue coming from Europe. So an exit rate this year in Europe of around about GBP 10 million from almost a standing start. Then we've been able to offset most of the operating cost increases, the labor increases, the energy increases I mentioned earlier on, by improved buying, working with our suppliers to get far better buying prices than we previously had. I think the results that you see demonstrate a really resilient business model. Just over the page, this is how we see the resilience of our business model. We serve across a whole range of different sectors. As I mentioned, 75% of our business is industrial, 25% is retail, but 25% of retail is e-commerce. Even within that e-commerce sector, we're doing health and beauty, we're doing electronics, we're doing food, we're doing clothing.
Again, natural hedges. Again, in the industrial market, we're doing automotive, we're doing aerospace, we're doing medical, we're doing diagnostics. Again, spread across a whole range of different sectors with natural hedges. Our biggest individual customer is less than 1.5% of our revenue. Again, that gives us a nice spread. While we would hate to lose any customer, even if our major customer was lost, it would not be life-threatening for the business. We are a pure protective packaging business. The majority of our competitors, the major competitors we have in the U.K., are multi-product distributors. We think protective packaging 365 days a year, 24 hours a day. We're not distracted by any other product ranges, and we've built up a range of knowledge and expertise, which is no one can compete within the industry.
The way we differentiate ourselves is through a very strong value-added proposition. I'll touch on that later in the presentation, but that really distinguishes us from our competitors and allows us to demonstrate real value for customers, not only in terms of products and price, but also in terms of all the added value components that are driven by their packaging choice. Supplier relationships, very, very important to us, and we're well aligned and have got supplier relationships that go back 30, 40 years, and they're a key part of our resilience. We have a strong performance-driven culture. I mentioned in my intro that we devolve profit responsibility to as low a level as we can get it. It's not just Ivor and I who have sleepless nights about the P&L. We make sure it's right down into the guts of the business.
Our sales teams are all driven by gross margin performance, not by revenue performance. Again, there's not the vanity of sales. It's actually about driving bottom-line performance. Finally, majority of what we do is bespoke for the customer. In our distribution business, 70% of what we do is bespoke for their requirements. In the design and manufacture business, 100% of the things that we do are bespoke. We're not just selling any old piece of packaging. We're trying as much as possible to develop and design packaging that's personalized for the customer. I think that resilience is the thing that underpins our first half performance. With that as a little bit of background, I'll pass over to Ivor just to talk you through some of the specifics with regard to the numbers.
Thanks, Peter. Good morning, everyone. This slide will just cover some of the key financial metrics of the business in H1 2023. Just looking along the top there, our revenue and profit metrics, we grew the business by 2% in the first half of the year, and that is a combination of 6% improvement related to the acquisitions we did. If you remember, we did the acquisition of Suttons Performance Packaging in March this year and Gottlieb Packaging in April this year, and that has added 6% into our sales line. And we have seen weakness in the organic growth. So we have seen organic growth go back -4%. And kind of breakdown by division is distribution has been flat year -over- year, and the manufacturing business has moved forward 13%, clearly with the benefit of the Suttons acquisition, as well as some good organic performance.
In terms of the profitability, we have moved the profitability forward by 13%, and that splits down 6% improvement within distribution, 36% improvement in manufacturing. Clearly a strong input from the acquisitions, but we have seen some organic improvement in profitability. So despite the weakness in sales and we have seen some inflation in operating costs, the strength of our gross margin has flowed through to a strong bottom line. In terms of the returns and balance sheet, we have maintained a strong return on capital employed, 18%, similar to last year. Our bank debt has nudged down from GBP 3.4 million at the end of 2022 now to GBP 3.3 million, and I will cover the cash flows a bit more detail in a minute.
And it is pleasing again to see our pension surplus move in a positive direction from GBP 10.2 million at the end of December to GBP 12.8 million at the end of June this year. And in terms of our EPS, our EPS growth has been 9%, not as significant as the profit growth of 13%, and that is really because of the increase in tax rate this year in the U.K. from 19% last year to 25% from the 1st of April this year.
And again, we have managed to increase our dividend reflecting the improvement in profitability of our business from GBP 0.009- GBP 0.0094 . Just moving on to the results of the business, just want to cover off a couple of points in this slide. Peter will cover off some of the kind of sales features as he delves down into the kind of individual business performances.
But you will notice from this slide that the gross margins improved significantly year -over- year, and that is a 1.9% improvement within the distribution business and a 3.7% improvement in manufacturing. And that is really helped to offset some of the incremental costs we have seen in our overheads. So the overhead increment year -over- year is broken down primarily acquisition related, so GBP 2.2 million of incremental costs related to the fact that we acquired PackMann in June last year.
So we have only had it for one month last year. We have had it for six months this year. And as I mentioned earlier, the two acquisitions we did this year. But also we have had inflationary increments on our employee costs and energy costs. So this time last year if you look at our energy costs, we spent GBP 0.5 million in the first half of last year.
That's more than doubled to GBP 1 million in the first half of this year. We've also seen inflation in employee costs. The wage increase that we gave our staff at the beginning of the year, our lower paid staff were paid 8% rise, going down to 3% for the higher paid. So it was a blend of around 6%-7%, and we've seen that flowing through our employee cost base. However, that's been offset partly by the fact that we've used a lot less temporary staff through the course of the first half of the year, reflecting the lower volumes that we've seen in the business. Just moving on to the cash flows. As I described earlier, we've actually improved the net debt position by GBP 100,000 in the first half of the year and that's really down to a strong inflow from the operations of the business.
You'll notice the working capital, part of the reason the working capital has been so strong in the first half of the year is good management of working capital, but also an unwinding of working capital as we've seen lower volumes towards the half year compared towards the full year last year. You can see we spent quite a significant amount of money on acquisitions. That GBP 11.4 million is broken down to GBP 2.9 million related to earnouts related to the GWP Group and Carters Packaging acquisitions that we did two years ago. So they were on two-year earnouts and we've now made the final payouts. Both businesses performing extremely well. GBP 8.5 million is the initial payments that we made for the Suttons Performance Packaging and Gottlieb Packaging acquisitions earlier this year.
Just for information, we have a further GBP 2.5 million outstanding on earnout for the Suttons Performance Packaging acquisition, GBP 1.25 million for next year and GBP 1.25 million in 2025. We have GBP 800,000 of earnout opportunity in the Gottlieb Packaging acquisition, GBP 250,000 next year, GBP 550,000 in two years' time. The capital expenditure, GBP 1.3 million. The main capital expenditure we had this year was the opening of our Northern Innovation Lab. Peter Atkinson will touch on that when he discusses the packaging distribution business. But more than half of the CapEx spend this year is on the opening and investment in the Northern Innovation Lab, which should give us some real benefits in terms of new business opportunities going forward. Again, a positive outlook, a positive inflow of cash in the year despite the fact we've made significant to both acquisitions and capital expenditure.
I'll pass back to Peter now to cover some of the detail around the individual business operations.
Thanks, Ivor. I will talk first about the packaging distribution business which, as you know, is our main business. We talked about the economic headwinds that we were facing, and we have been able to offset those headwinds by the benefit of the acquisitions, the Gottlieb acquisition this year and the PackMann acquisition just over 12 months ago. In addition to that, we have done a really good job in accelerating our new business momentum. Our new business growth was 24% up on the same period a year ago. We are also starting to benefit in terms of new business from our Innovation Lab which Ivor touched on. This is the second Innovation Lab that we have opened.
This one is up in Heywood in the North West of England and it is really a place where we use it for customers to bring them in to understand their business, to model their cost structure around packaging and then send them away with a fully costed proposal and samples of products to allow them to evaluate and make decisions. It is a key part of our new business growth platform in 2023 has been the opening of the new Innovation Lab in the North West.
I mentioned about our gross margin performance and because of the operating cost increases that we have been incurring, we worked with our suppliers to actually negotiate better buying prices and that has allowed us to more than offset the increase in overhead costs. Two other things I will just mention. Net Promoter Score, I think most of you are familiar with it.
It is quite a sophisticated customer service measure, customer loyalty measure and you can see a dramatic improvement in the Net Promoter Score in the period. The average for B2B companies is 25 so we are way above average. The top performers are in the 70s or 80s so we are nudging some of the top performers but I think it is demonstrating how effective the customers value what we do for them. The other number just to reference for you is our net margin, our EBIT margin, currently 7.6%, up from 7.2%, and beginning to nudge the 8%-10%, which has always been our medium-term target for the distribution business. If I just dig into the overhead costs in a little bit more detail.
The key feature here is the employee cost which Ivor has talked about and we have been able to offset a big proportion of the inflationary wage increase that we gave by reducing our base of temp workers. At the same time we have got utility cost increases but both those major cost changes we have been able to offset by the improved gross margin through better supply negotiation. On that point in terms of the raw material pricing, what we have got here is a graph that shows you the last couple of years in terms of how the two key raw material indices that decide what prices we buy at, how they have moved. 70% of our business is paper related and 30% is polymer related.
As you can see we've seen a steep rise in both those up to sort of middle of 2022 and then the prices have started to come down, partly market related, partly supply and demand related. I think the important thing about this slide is that if you track these graphs back for probably 10 years, the important measure is the stability of our gross margin. So whatever is happening with raw material prices upward or downward, we've got a very demonstrable effective track record of being able to translate raw material prices into selling prices to underpin a strong gross margin.
Next slide just gives you, I'll not go through all the detail here. It is quite well-populated, but this is the agenda the distribution business are working to. Top right is important. We've got some new software programs we've introduced. Major one is around customer relationship management.
We're in the process of now beginning to see the benefits coming through from that. So that is good news for us going forward in terms of our ability to engage more effective with customers in terms of improved retention rates and improved product penetration rates. Bottom left-hand corner, we're in the process of developing a new program to improve our online capability. In relative terms, we would argue our online capability is not as strong as it should be. So, work going on there, investment plan for 2024 in terms of improving our online capability.
Then bottom right-hand corner, the property footprint, as I mentioned, we've done our first site consolidation in the North West, and we've got further site consolidations to go to actually streamline our property footprint consistent with our customer service metrics, but also to ensure that we are always in control and are able to keep our operating costs under control. If I move on to design and manufacture, becoming an increasingly important part of the group, and is now moving towards quite an important number in terms of 30% of the group profitability. Key thing to note here is a strong performance from the Suttons Performance Packaging acquisition that took place early on in the year. Very pleased with that business acquisition.
Then again, we've got some really good new business momentum, some strong new business wins in H1 2023, which will help us in the end of 2023 and into 2024. I think most of you are aware that the design and manufacture business partners with the distribution business, they are a supplier to of specific products and specific solutions, and we're increasingly encouraging our distribution business to use our design and manufacture facilities as in-house suppliers to keep profitability in-house, and we're getting some good momentum in terms of that. A similar action plan in terms of the agenda for the design and manufacture business going forward. Top right-hand corner, utilizing both GWP Group and Suttons Performance Packaging for more in-house supply opportunities. We're yet to evaluate the European opportunity for this business, sort of in the middle and the bottom rank there.
We will be doing some work going forward to see what opportunities there are to actually move this business into Europe as part of our underlying growth strategy. As you know, we have done a couple of acquisitions in this space recently, and we see further opportunities for acquisitions. We have got a good pipeline, and so hopefully more growth to come from our acquisition activity. I am just moving over to acquisitions. I have got this slide in the pack just to give you a flavor of our acquisition history. Typically doing two or three acquisitions per year. We have very strict acquisition criteria. We only target quality businesses. We are all too busy to spend our time fixing damaged businesses. We have got a strong pipeline in the U.K., got a strong pipeline in Europe.
The good thing is, when we buy businesses and when we integrate businesses, typically around about half the owner- managers who thought they were planning to retire have decided to stay on with us, which is obviously an effective recommendation for the way we go about buying and integrating the acquisitions that we make. So, some more acquisitions to come, and as I said, it is a key part of our growth strategy. If I move quickly on to ESG. Clearly a range of investors, this becomes an important part of their agenda, and we recognize that. The key things that we have been focusing on are firstly reducing our own environmental footprint, the impact we are having on our operations have on the environment.
The major feature there is how do we find a way of replacing 120 diesel trucks, because they are the major carbon emissions that our business makes. So we have started off with a steady program introducing electric trucks. We have currently got five on the fleet. It is very early days, but certainly the feedback we are getting from both our staff, and as importantly our customers, is very positive. So we will see how the technology develops, and our objective at the end of the day is to find a way of replacing our diesel fleet of trucks. In terms of supporting our customers, I mentioned the Innovation Lab.
The Innovation Lab becomes a fundamental tool in helping our customers, and to help them, guide them, advise them, direct them on how they use packaging and how they use it, making sure they use sustainable products and they use as little of it as possible, but as much of it to ensure that the product that they are shipping is protected so they do not incur damage and all the CO2 footprint increase that comes about damage and returns and so on and so forth. So we have got an extremely good track record of working with our customers. We would argue it is part of our key differentiation from our competitors is how we work with our customers to support them in reducing their environmental footprint.
Clearly a commitment to our staff and the way we treat them from a health and safety point of view, from a training, development, communication point of view, we have been doing that even before ESG was invented. We are very happy with the progress we are making, and we will continue to drive forward in that area. From a governance point of view, one of the key areas that we were concerned about was the diversity, particularly around the board. We have now got a better balanced board with a more diverse board. Again, making good progress in that area as well. Let me move back to Ivor, and we will talk through the pension, and then I will make some concluding remarks before we go into the Q&A.
Okay, this slide just gives you a wee bit more flavor for the movement in the pension surplus. As I said earlier, it is pleasing to see the surplus moved in a positive direction, and that is primarily driven by the fact that the discount rate has increased from the end of last year from 4.8% to 5.3%, and that has reduced the liabilities. That is matched by the movement in the liability-driven investments. The liability-driven investments are there to hedge any movements in inflation and bond yields, and that is really doing the job it was made to do. We are getting the benefits of movements in the other assets, primarily equities, and also the fact that the company put a further GBP 600,000 into the scheme in the first half of this year.
In terms of cash outflows going forward, the company is committed to paying a further GBP 1.25 million into the scheme between now and April next year. We are going through the process of a further triennial valuation now, which should complete around about February next year, and I would fully expect that the cash outflow from the company going forward will significantly reduce from its current levels. This then just gives you a breakdown of the assets that are held in the scheme. What we will now be doing now that the scheme is in surplus, and really the plan of action now is really to have the scheme self-sufficient, going forward, and looking at options for buy-in and buy-out in the next two to four years.
We will gradually be moving that asset base away from the more volatile assets, like equities, to more stable assets like the multi-asset credit fund we have got there. You will see quite a movement in the assets as we go through the second half of the year, and that is really just to lock in the surplus we have got, and be in a position that the pension scheme can be self-sufficient. You can see the right-hand side in terms of the pensioner base. It is a mature scheme. We do not have any active members. The scheme is closed to future accrual last year, and a majority of the scheme members are actually in pensioners at this stage.
So again, the scheme's well-funded, in good shape, being well managed, and really from an investor point of view, the important thing is the cash withdrawal from the company is getting less going forward. Pass back to Peter just to give you a summary of the presentation.
Thanks, Ivor. I guess the key takeaways from the half-year results for 2023 are the challenging headwinds, us pivoting towards self-help actions to offset those headwinds, and really reflecting and demonstrating the resilience of our business model in terms of our sales performance and our profit performance, both have grown. In terms of the second half of the year, as part of the announcement with these results, we announced that our profit expectations for the full year were unchanged. The medium-term outlook for the business is very strong. We are well-funded. We have healthy acquisition pipelines. We have good organic growth momentum. So we feel that we are well set up for the remainder of this year and for the next three to five years. My final slide is just a refresh of the Macfarlane business case. We have simple, flexible, and resilient business model.
We have two strongly focused operating companies, both of which sell a differentiated proposition to their target customers. Both businesses have got good market positions, strong players in both markets, but with significant growth potential. Clearly, if you look at our historic performance, we have a track record of growth, and we have a plan for future growth. Thank you for your time this morning. We will now move over to Q&A.
Fantastic. Peter, Ivor, thank you very much indeed for the presentation. Ladies and gentlemen, do please continue to submit your questions using the Q&A tab just situated on the right-hand corner of your screen. Just while the team take a few moments to review those questions submitted today, I would like to remind you that a recording of the presentation, along with a copy of the slides and the published Q&A, can be accessed via your investor dashboard. Peter, Ivor, we have received a number of pre-submitted questions from investors, and I want to perhaps kick off the Q&A session with those, and we will move on to any further ones we get live. One you have kind of covered off, but if there is any further to add, it reads as follows: Could you explain your growth plan, in particular acquisition opportunities internationally?
Would you consider using higher debt leverage to achieve higher return on equity?
Thanks for the question. Hopefully in the presentation we have described our growth plans. We have built up a strong pipeline in the U.K., and we have been executing against that pipeline on a consistent basis. We have now got an equivalent pipeline in Europe, and we are focusing on Scandinavia, Benelux countries, and Germany are our three target geographies. So we have got a similar strong pipeline there, and we are building up, doing the courtship with the acquisition targets, and we are very, very positive about the opportunity to grow through acquisition, both in the U.K. and in Europe. A key part of our strategy going forward in terms of our growth building blocks. I will pass over to Ivor about the funding question.
As you know, we have got a GBP 35 million bank facility, and we are certainly not frightened to use that facility to do the right things. Clearly our priorities in the business are to invest in the business for organic growth. We clearly want to continue to pay a progressive dividend as the profits improve in the business. And really the third priority is really acquisitions. Clearly we have been successful with acquisitions over a period of time, and we certainly want to continue that program going forward. So primarily that is our focus. Clearly, if the business generates excess cash and we do not have those opportunities to invest, particularly in acquisitions, then clearly we would look at other ways to return money back to shareholders. And that is something that is always under consideration by Peter and myself and the rest of the board.
Fantastic. Thank you very much indeed. I think this one is definitely for you, Peter. We all love Peter, so it would be good to have some idea of how much longer he plans to stay in the job. Is there any succession plan in place?
Easy one to answer. I have got no plans to leave. Yes, the board is working on succession plans.
Perfect. Thanks, Peter. You have touched on this again in the presentation. The question reads really as follows, in the risk section, it says you have one freehold and 52 lease sites. This sounds like a rather inefficient use with a lot of small warehouses, presumably due to the various acquisitions you have made over the years. Would it be better to consolidate into fewer larger warehouses and automate processes instead of operating out of numerous smaller warehouses?
Yeah, as Peter described earlier, we have already started our site consolidation. We did one in the North West. The next one is planned for East Midlands, where we are looking to consolidate four sites into one larger site, near the East Midlands Airport. The plan going forward clearly is to move from some of the smaller sites to larger sites. You are right, part of the reason we have got lots of smaller sites is because of the acquisitions we have done over time, but probably, certainly if you look at the number of lease sites we have got, we do have a number of leases where sites are very close together. If you take our site configuration over in Andover , for example, that is one operation, but we have actually got four leases with sites that are very close together and operate as one unit.
Yeah, no, the strategy going forward is certainly to move to larger, more efficient sites where it makes sense. Clearly, the things we have to consider there as in a process of change, we have to absolutely minimize disruption to both employees and customers, because otherwise the benefits you get from the consolidation easily eaten up if you do not look after your customers and look after your employees in that transition.
Yeah, just to add to that is to me, the key driver of our property footprint is we need the property footprint to make sure that we can serve our customers effectively. In effect, our warehouses become our customer warehouses, so our proximity to customers is a key part of our DNA. While, yes, we do recognize we have got opportunities for site consolidation, unlikely in the near term, we will move to a low- single- digit number of sites. It will be sites that are there to support our customer base. Just a reminder, 90% of the orders we take today, we deliver tomorrow. So we have got very tight turnarounds and that drives in a way the proximity to our customers' locations.
That is fantastic. Thanks, Peter. Thanks, Ivor. Last one we have got here, a bit of a statement/question. Could you please start reporting adjusted EPS, stripping out amortization of acquired intangibles to give a true picture of your profitability and align with both your house broker's forecast and your peers?
Clearly we will take that into consideration. Clearly as a business, we always want to give consistency of information to our investors year in, year out, so that when they are looking back, they can measure the business over a period of time. We do tend to try and avoid adjusted measures where possible. We do provide operating profit before amortization within our results, but that is the only alternative profit measure we use. But clearly we want to provide information to investors that are useful. So we will definitely take that under consideration.
That is fantastic. That concludes the pre-submitted questions. As you can see, we have had a number of questions throughout today's presentation. Thank you to all the investors for submitting those. Ivor, if I may perhaps just hand over to you, just click on that Q&A tab and start at the top and just where appropriate to do so, read out the question or pass it to Peter and give your response and I will pick up from you at the end.
The first question we have got here is, you claim to be U.K. market leader, but what does that mean in terms of market share? I will answer that one. In terms of our market share today, in terms of what the market that we operate within, which is the defined market of protective packaging distribution, then we have circa somewhere between 20% and 25%. If you look at the protective market as a whole, which is significantly larger when you bring in all the manufacturers into it, then clearly it is about six times less than that. But in terms of the pure market that we play in, the protective packaging distribution market, our market share is somewhere between 20% and 25%. The second question I have got here is, can you give us some more detail on your acquisition criteria and about your post-acquisition philosophy, please?
Yeah, I will pick that one up. What we do is we do a huge amount of desk research on acquisition targets, this is U.K. and Europe. We build up knowledge from our supplier base, and we build up knowledge because particularly in the U.K., a lot of the distributors that we are looking at and evaluating are also competitors. We can get a judgment of how we are competing with them and how they are competing with us. As I mentioned in my intro, we only focus on quality businesses, and quality to us is quality of returns, that they are added value distributors, they are doing more than product and price, and quality in terms of the culture of how they operate and how they do business. Obviously we pick up that because we know them as a competitor. That is the criteria we use.
Alongside that, we look at some, where are they located? Are they overlapping with us or are they in areas that we are not very strong geographically? What is their product mix? Does their product mix overlap with us or does it complement what we do? Then also then we look at their supplier base as well in terms of what are the opportunities in terms of supplier base overlap. That is all the pre-work we do. We then engage and we do all our acquisitions ourselves. We view it important that we, as the leaders in the business, we engage directly with potential sellers. Ivor and I drive that program. When we get to an agreed process and agreed program, we agree a value for the business.
Then typically we agree growth targets for the business as well, and we pay 70% of the agreed valuation up front, and then the remaining 25%, 30% we pay on earn-out basis over one or two years. Majority of the businesses we buy achieve the top end of their earn-out targets, which is obviously really good for them and for us. In terms of integration, we do soft integrations. We start off looking at supplier synergies, we then start looking at back office synergies, and then we look at sales synergies, recognizing that for 12- 24 months, these companies are in an earn-out process. We do not want to do too much interference to avoid the risk of them potentially getting involved in that, messing up their earn-out. Soft integrations, careful integrations. A key thing for us is keep the staff, keep the people.
Where there are big opportunities for cost savings, integration cost savings, it tends to come where we can make property moves, so we can move our business into the acquired company's property or the other way around. Certainly on some of the acquisitions we are now able to do that. Again, the priority is in doing that and make sure we keep the customers, make sure we keep the staff, make sure we keep the service. I think hopefully that covers off most of the points in that question. Thanks for the question.
Just moving on to some questions on the market itself. Can you provide some color on your main customer sectors around market share and growth opportunities? Has the e-commerce sector stabilized or is demand still falling following the pandemic?
Okay. Start with the second part of it. We are still seeing the e-commerce sector adjusting, because obviously during the COVID period, we all had not much to do but press buttons on computers and buy stuff. Stores were closed, so customers pivoted towards e-commerce. The market is still going through some adjustment. Part of what we are seeing in our first half- year numbers is lower e-commerce revenue than previous because of that spike that we saw during the COVID period. If we look at our e-commerce revenue pre-COVID, we are 15%- 16% ahead. In normalized terms, we are still growing.
If you look at the industry sectors, sorry, if you look at e-commerce in terms of the total e-commerce industry, again, if you take out the spike, the IMRG stats show that the e-commerce industry, taking out the spike, the trend is continued growth and there is expected to be continued growth going forward. For Macfarlane Group, e-commerce represents about 25% of our business, and we see that about the right level in terms of the blend and mix. Within e-commerce, we have no one dominant sector. As I say, we do a lot in the home furnishing sector, we do a lot in the electronic sector, we do a lot in the health and beauty sector, but within that 25%, there is no one sector that is more than 5% either.
Yeah. Okay.
In terms of the industrial markets, again, a strong blend of sectors that we service, and it is part of our sales strategy and our marketing strategy not to get overweight of any one sector. So we have these natural hedges. The strong sectors for us in the industrial market are aerospace, automotive, industrial consumables, electronics. Again, you have not really got any one sector that is more than around about 6% or 7% of that industrial market either. So back to that resilience story, the resilience we have is based on the fact that we are not overweight or overdependent on any one sector, either in industrial or in e-commerce. Yes, we still see e-commerce as a good place with growth credentials.
Okay. Thanks, Peter. Just now one on gross margin. Can you expand on the drivers contributing to the gross margin improvement? Do you see this as sustainable?
Good question. Two key points here really. One is we have a very good, as I mentioned in the presentation, we have a very good track record of translating buying price movements into selling price movements. That has been proven and tested over a long-term period of time. So we are very happy with the model that we use to ensure that we can translate buying prices into selling prices. What we are seeing at the moment in terms of trends is obviously softer raw material prices, and we are benefiting from that in terms of our buying prices. Then we are working with our customers to ensure that we translate those buying prices into selling prices, but are able to sustain our cash gross margin and at the same time pay for the increased labor costs that we are incurring and the increased energy costs we are incurring.
From our point of view, we see the gross margin as sustainable. It always sort of nips around 0.5% , 1%, but that mid-30s gross margin in distribution, early 40s to mid-40s in manufacturing, we see those as sustainable levels. And relative to our competition, they are not out of line with any of our major competitors in either of those sectors.
Okay. Another one here just on the market rating. Your stock market rating appears far too low, 9x PER next year. Given track record and opportunities, has this unfair rating hindered you from making larger acquisitions?
Sorry, is that-
Yeah
read it?
Your stock market rating appears far too low.
Yeah.
Has this unfair rating hindered you from making large acquisitions?
The stock market rating is the stock market rating. We just continue to drive the performance of the business, and the stock market will judge accordingly. Has it impacted our ability to make larger acquisitions? No. The acquisitions that we make, we want to make sure they're within our operating bandwidth, and I described the acquisition criteria previously. We're not afraid of making larger acquisitions, but it's just that the opportunities that we're working on at the moment, and have delivered, executed previously, are in what we would call our sweet spot. When you look at some of the larger companies, they fall out of our criteria in terms of maybe performance or culture or some of the hard numbers and the soft things that we use for criteria.
Here is one in the pension scheme. It's positive to see a pension moving in the right direction. Can you talk more about the medium-term plan for the pension scheme? I think I covered that off earlier. I think the short-term is obviously to get the scheme to be self-sufficient, so it's not drawing on additional funds from the business. But obviously in the medium term, it's moving and investigating opportunities for buy-in and buy-out. Given the well-funded position of the scheme at the moment, then we're certainly in a good position to investigate that properly. Another one here, just one on volumes. Are you concerned about volume trends? It looks like volumes are down mid-single- digit. How do you know you're not losing market share and that the volume will come back?
Yeah. Good question. We don't see ourselves as losing market share. We see the volume decline consistent with the industry metrics that we have access to. The very fact that we are new businesses 24% up, versus the previous year demonstrates that we are continuing to grow organically. As I mentioned earlier on, clearly the acquisition program we've got will allow us to increase our growing our market share. Good question, but no, we don't see the volume decline being about market share. It's more to do with what we see happening in the broader market.
Another one here. Do you expect the European business to have a similar EBIT margin than the U.K. business from 2024 onward, or is it a midterm target? What could this split between distribution manufacturing be in 5- 10 years? Should we expect most of the future acquisitions to be in the manufacturing segment?
Start with the last question first. No, our major business is packaging distribution. The balance of acquisitions will probably be slightly biased towards packaging distribution, more so than manufacturing. Do we see manufacturing acquisitions as a good opportunity? Yes, we do. Do we see the balance between distribution and manufacturing changing materially? I don't think we'll see it changing materially. The balance at the moment is probably slightly over-balanced towards distribution, so maybe we'd nudge manufacturing up a little bit, but it's not going to be a material change. Which one did I miss?
European margin.
European margins. The work we have done so far is indicating that net margins from European distributors are not materially different from the margins that we are seeing in the U.K. We do not see dynamics currently that would indicate that net margins in Europe should be materially different from those that we see in the U.K.
One here related to the Gottlieb acquisition. Gottlieb appears to be a fairly generic packaging distributor, but higher margins than the rest of Macfarlane. Was the company able to learn things from Gottlieb that we are able to implement elsewhere to improve margins?
Yeah, good question. When you look at our business, in broad terms, in distribution, we have 60% of our business which is in larger customers, annual spend GBP 100,000+ . We have then got about 30% of our spend in medium-sized customers, so the GBP 10,000- GBP 100,000. And then we have got about 10% of our business in customers who spend less than GBP 10,000.
The benefit that we have in terms of margin mix is clearly the larger customers, the margins there tend to be not as strong. While the smaller customers, the margin tends to be a little bit higher. And what we have got in a company like Gottlieb is a really good family-owned local distributor operating in that local customer sector. So that is the reason why they are able to deliver the sorts of margins, because they do not focus on the bigger, larger national customers.
Yes, there are things that we learn from all our acquisitions, and certainly the way Gottlieb go about working with customers and developing customers in that local sector is certainly something we can benefit from. All the acquisitions that we make, Gottlieb included, we start with the principle of these are successful businesses, they are doing well, what can they teach us? And what can we use in their business into our business to improve our performance?
Okay. With the current valuation of Macfarlane shares only slightly above the price you tend to buy companies at, isn't there an argument for diverting funds from the dividend and acquisitions towards buyback? I think we've covered that. Primarily, our focus would be in developing the business, both organically and through acquisition. You are correct in terms of the valuation at the moment. Excluding IFRS 16, we're probably up towards the high 6x compared to acquisitions we're doing between 5x and 6x. There is a difference, but not significant. It's certainly something that we keep under consideration, but clearly our preference would be to invest in the business, both in terms of organic growth and acquisition, and obviously use buybacks where we've got an excess cash position. But we do understand that investors more and more are looking at this, and it's certainly something we're taking under consideration.
Let's try to see if there's another one. How does the -4% organic growth break down between volume decline and price increase?
The majority of that is volume. We began to see as we exited H1 2023 a degree of price inflation coming through. But in H1 2023 as presented, it's predominantly a volume effect more than a price effect.
One on the returns. So historically you've generated about, I think it says 40% return on invested capital over the past five years. Do you expect to generate these types of returns going forward? What are the drivers to generate these returns, and what are the outlook for these drivers? I suppose the key driver is a relatively capital light business. It doesn't require significant amounts of capital expenditure. The operating cash flows are very strong. And I don't see really going forward that changing much, over the next few years. Clearly, we have to continue to invest in the business on the manufacturing side. If you think of our manufacturing side, it's a large degree of assembly work, with some automation. So it's more capital intensive than distribution, but maybe not a significantly capital intensive business. And clearly the distribution business is very capital light.
All of our properties and all of our vehicles are leased, so it does not require significant amounts of capital expenditure. I think the main things are maintaining the margins in the business, managing the working capital well, which I think we do a good job on. It is relatively capital light, and I do not see these factors changing significantly going forward. Let us see if I can go back and see. There is one question, is there a Forex issue? I am not quite sure I understand that question to be fair, but we do not have a huge amount of foreign exchange exposure. Most of our businesses operate overseas, operate within those geographies. There is not a lot of crossover of currency, and there is certainly not a significant impact on our profitability and our sales line because of movements in Forex.
If I have not answered that question well, please obviously elaborate on the concern that you may have in that particular area. I think we have a few on gross margin, which I think we have covered. Obviously one referring to our new managing director of the distribution business. Just simple question, does that free up time for you, Peter?
Yeah, it does. He is taking a lot of my workload. It just strengthens our leadership team. That is the most important thing. He is a real true professional in the market, having worked at Sealed Air for a long period of time, and more recently working within the Bunzl protective packaging business. So he is known to us. I have been trying to bring him into the business for quite a long period of time now, and we finally got him on board and certainly we are very pleased to have him on board and his contribution already has been important to us. So, yeah, it just strengthens the team to underpin and support our growth plans going forward.
Let us see if I have missed any kind of questions that we maybe not covered. There is one here. So the company does not give like- for- like sales figures in the results announcement. Is this not a key information gap for an acquisitive business?
I do not understand that question.
Yeah. I think the question, Peter, is breaking down the growth year-on-year between the acquisition and the organic sales.
Okay.
We probably give a lot more detail in our annual report, certainly in our interim report. If you go to the management report side, we do disclose the growth impact of the PackMann and Gottlieb acquisition and distribution. I suppose just to be clear on that for everyone, if you look at the revenue on distribution, growth of GBP 0.5 million, GBP 6.3 million of that was the PackMann and Gottlieb acquisition, which we set out in the management report, and a GBP 5.8 million decline on the organic side, so that is roughly about 4.8%. As Peter described, the impact in the first half of the year was primarily volume, with a small amount of increment in price inflation. Again, going to manufacturing business, the manufacturing business was broadly flat year-on-year organically, and Suttons contributed GBP 2.5 million of extra sales to the business.
Clearly, that acquisition was a key part of the profit growth, but we actually had growth organically of around GBP 200,000 as well. Again, I think as I explained earlier, we have had weakening sales. We have had inflation in operating costs, but I think with the strength of the gross margin, we have made some offset to that to allow us to grow the profitability organically around about GBP 200,000. Hopefully, that covers that question.
Yeah, and I think the only thing I would add is it's always a balance between making sure we give investors enough information to make decisions on, but also not to give too much information that is advantageous to our competitors. We recognize both those two things in trying to share information with our investor community.
Just one maybe final question. We're just about run out of time. As executive directors, what do you each see as the key responsibilities of your respective roles? How do you meet those responsibilities?
Wow.
That's a big question.
That could take the rest of the day.
Yeah.
At the end of the day, as an executive team, we all have individual sort of responsibilities, but the group is there to ensure we have the right strategy and agree that strategy with the board. Then ensure that we have got the right plans to execute against that strategy, to make sure we have got the right measures in to measure us in terms of the execution of those plans. Underpinning all that is making sure we have got the right people in place with the right reward systems in place and the right career objectives in place. In reality, that is what we spend most of our time doing, aligning those strategic, executional, and operational plans, and ensuring that we have got the right people properly motivated to deliver on those plans. Don't know you want to add anything to that?
Yeah. Clearly, sustainability is important to us, going forward, to make sure what we are doing is done in a sustainable way in terms of the product we offer our customers and the solutions we offer our customers. Also taking control of the things that we can influence internally within our business. I suppose clearly my role is very much about the financial controls around the business and the governance around the business to ensure that the numbers are delivered on a sustainable way, and to make sure that there is proper governance and controls around those numbers that the investors see.
That is fantastic. Look, thank you guys for taking so many questions today. That is great. Of course, any further questions that do come through, the team will be able to review those and we will publish responses where appropriate to do so on the Investor Meet Company platform. Peter Atkinson, just before redirecting investors to provide you with their feedback, which I know is particularly important to you and your team, if you do have any final closing comments.
Yeah, thank you. Firstly, thank you for your support and thank you for your time today. Key themes that we've tried to share with you is firstly, resilience. Secondly, that we're a very focused business in terms of the markets that we support and serve. That we've got really good market positions, that we've got significant growth potential, both organically and through acquisition. If you look at our history, we've demonstrated very good success. I know history is, you can't be sure of history going forward, but we're very confident that if we execute our plans as we've previously done, we can continue to sustain the success and the growth and profitability of the Macfarlane Group.
That's fantastic. Peter, Ivor, thank you indeed for updating investors today. Please ask investors not to close the session. You should be automatically redirected to provide your feedback in order the management team can better understand your views and expectations. This will only take a few moments to complete and is greatly valued by the company. On behalf of the management team at Macfarlane Group PLC, we'd like to thank you for attending today's presentation and good afternoon to you.