Earnings Call: H1 2017

Jul 27, 2017

Summary

H1 revenue grew 16% and operating profit 13%, with organic growth accelerating to 4.2%. The Haniel JV reduced leverage, while upgraded medium-term targets reflect stronger focus on pest control, hygiene, and M&A-led growth.

Thank you all for joining us today. In a few moments, Jeremy will provide you with details of our interim results for 2017, looking at the overall performance of the group and our five regions. I'll then come back to provide an update, firstly, on how we've evolved our business model, how we've reset our strategic direction, and how we've upweighted our medium-term guidance following the JV with Haniel. Secondly, I'll provide more detail on how we are now focused on our two core businesses of pest and hygiene, and how they're well-placed to maintain their growth momentum. Finally, a short update on M&A execution and our differentiated approach. A lot to get through this morning, so let me start by covering the key highlights from the first half. We delivered a very good overall performance with revenue from ongoing operations up 16% at constant exchange rates. Organic revenue growth from ongoing businesses was 4.2% in the first six months, up from 3% in the first half of 2016. The reported number at the 2016 interims was in fact 2.5%, of course, which underlines the positive impact of our European workwear and hygiene businesses moving into the JV with Haniel. In addition, we delivered strong M&A performance, accounting for 11.8% of revenue growth. Pest control had a particularly strong first half, with revenues up by 25.8% and organic growth of 6.5%. Ongoing operating profit grew by 13% in the first half, reflecting good growth in North America, Germany, Asia, and Pacific. This was offset by lower profits in France and increased LTIP funding, given the increase in the share price. Cash performance continued to be strong, and Jeremy will cover that in more detail in a moment. Turning now to M&A. Execution in the first half was very strong. We delivered 25 acquisitions with annualized revenues of GBP 175 million, 19 of which were in pest control, and of course, we delivered the joint venture with PCI in India. If you add to that the extensive work that was carried out to complete the Haniel joint venture, including the acquisition of CWS-boco's hygiene business in Italy, then this was an outstanding six months for us. In addition, I'm pleased to report that we've also secured an agreement to dispose of eight French laundries, which mainly provide flat linen to the highly competitive healthcare sector. In 2016, this business had annualized revenues of around EUR 78 million and is operating at around break-even. Last week, we secured unconditional clearance from the French competition authorities, and pending the outcome of the employee consultations, we'd expect to complete that deal in the second half of the year. Before handing over to Jeremy, let me conclude with this slide, which summarizes just how important the JV with Haniel is for the company. First and foremost, we delivered an attractive price of over 40 times free cash flow and 15 times EBITDA. Over time, we'll be redeploying the proceeds from the deal into our two core higher growth businesses of pest control and hygiene. As I've already mentioned, our ongoing businesses are delivering higher levels of organic growth, up by 4.2% in the first half and 4.7% in the second quarter. And we believe there are further opportunities over the medium term for margin uplift through density building and driving scale in North America and in Asia in particular. In addition, we are now a less capital-intensive business, given our reduced exposure to workwear, and you can see this through our reduction in CapEx spend of around GBP 60 million a year. Finally, we continue to have a strong M&A pipeline in pest control and hygiene, and I am confident that we will continue to execute our strategy at pace. So, a strong first half, and we are confident of meeting our expectations for the full year 2017. With that, let me hand over to Jeremy. Thank you, Andy, and good morning, everyone. Before I run through the results, I thought it would be useful to start by grounding the numbers following the completion of the Haniel joint venture transaction on the 30th of June and the proposed disposal of eight of our French laundries. This chart shows the impact of the disposals on ongoing revenue and profit for 2017 and the first half of 2016. My presentation will focus on ongoing revenue and profit going forward, unless otherwise stated. I will now run through the key financial highlights for the first half. All the numbers I am going to refer to are in constant exchange rates, unless I state otherwise. As Andy has just mentioned, revenue for ongoing businesses grew by 16% in the half, driven by growth from acquisitions of 11.8%, and organic revenues up 4.2%. Ongoing operating profit before interest for the half was up by 13%, and adjusted profit before tax was up by 12.5%. On an actual exchange rate basis, adjusted profit before tax was up 28.5%, reflecting a GBP 9 million favorable impact of exchange rate differences in the period. With a slightly higher adjusted tax rate compared to 2016, adjusted EPS is up 10.9%. Free cash flow was GBP 68 million in the half, GBP 11 million ahead of last year, driven by increased EBITDA and lower interest payments, offset by higher CapEx investment and the phasing of working capital outflows. Based on our strong first half performance, we have declared an interim dividend of 1.4 pence per share, a 15.2% increase on last year's interim dividend. The first half of the year represents another period of strong delivery in revenue, profit, and cash. Our four-year compound growth level for revenue is over 10% per annum, supported by compound annual organic revenue growth of 2.6%. We have been able to leverage the increase in revenue, driving compound annual operating profit growth of 13.3%, supported by improved margins in our growth and emerging markets and reduced central and regional overheads. We continue to deliver a strong level of free cash flow in the region of GBP 150 million per annum. I will focus more on our ability to deliver strong cash flow performance later in my presentation. First, I am going to look at first half 2017 performance by region. In North America, ongoing revenue grew by 29.7%, with growth from acquisitions of 24.1%. Organic revenue increased by 5.6%, with organic growth in pest control of 6%. Operating profit in North America increased by 29.5%, reflecting the impact of acquisitions. Net operating margins were maintained in the first half, with improved margins in pest control services offset by a higher mix of lower margin revenues in our products business. The M&A pipeline has continued to be strong, and we have acquired five businesses in the region in the first half, with annualized revenues of around GBP 61 million. The focus for the second half of the year remains unchanged, driving organic growth initiatives, integrating Steritech, Residex, and the other recent acquisitions, thereby boosting the scale and net margins of the business. In Europe, which no longer includes the businesses transferred to the joint venture with Haniel and the eight French laundries held for sale, ongoing revenue was up 4.3%, with organic revenue up 3%. There were strong performances in the region from Germany and Southern Europe, and France also improved, moving into growth in 2017. In Latin America, which is supported out of the Europe region, we continue to make good progress through both acquisitions and strong organic growth, with total revenue up 38.8%. Profit in the region increased slightly in the half, with the stronger revenue performance offset by further reductions in France Workwear margins. While market conditions in France remain challenging, we are making good progress on implementing our France Workwear strategy and expect to make further progress in the second half. We have started to build an M&A pipeline in Europe, with six acquisitions completed in H1, including CWS-boco's Italian hygiene business, adding combined annualized revenues across the six acquisitions of around GBP 41 million. In the U.K. and the rest of the world, ongoing revenue increased by 7.1%, with organic growth of 2.1%. Revenue growth in the U.K. and Ireland of 5.6% was driven by strong performance in both the pest and hygiene categories, offset by weaker performance in UK Property Care. Growth in the rest of the world of 10.3% was led by strong performances in all the region's sub-clusters, the Nordics, Caribbean, Africa, and MENAT. Margins were 0.5 percentage points lower at 19.4%, with leverage from revenue growth offset by reduced profits and margins in the UK Property Care business. We anticipate further revenue and profit growth in H2 through the application of the successful U.K. operating model across the region. The Asia region had another strong half, with ongoing revenue up 29.7%, 7.4% on an organic basis, driven by strong growth in both pest and hygiene. We continue to see very high growth from the emerging markets of India, China, and Vietnam, which grew by 16.8% and 166%, including the impact of our recent joint venture with PCI in India. Profit grew by 30.5%, reflecting the revenue growth. Margins were in line with the prior year, reflecting the impact of the lower margin PCI acquisition. We continue to see opportunities to improve margins in the region through revenue leverage, increased density, and yield management from both organic growth and acquisitions. In Pacific, revenue in the region increased in the first half by 8.9%, with 4.2% from acquisitions, including three small pest control acquisitions in the period. Organic growth of 4.7% was achieved through strong contract performance in pest and hygiene. Profit growth of 8.9% was in line with revenue growth, and we see further opportunities for improved performance, especially through service productivity. As we already noted, we completed the transfer of our Benelux and Central European workwear and hygiene assets into a JV with Haniel on June 30. GBP 396 million in cash, net of costs, has been received, and a further GBP 30 million is anticipated in the second half, subject to completion adjustments. As a consequence, our net debt to EBITDA ratio has reduced to around two times at the half year, compared to 2.5 times at the year end. We will receive a fixed EUR 19 million cash dividend from the JV annually in arrears. The impact of the asset transfer is to reduce free cash flow by around GBP 18 million in 2017 and 2018, reducing to around GBP 10 million in 2019 when the first full annual dividend is received. We have treated the anticipated sale of the eight French laundries as assets held for sale, and we have accordingly written down the assets by GBP 19 million, reflecting the anticipated loss on disposal. The book profit on the transfer of the assets to the JV was GBP 481 million, resulting in an overall profit on disposed businesses of GBP 462 million. Operating cash flow in the first half of GBP 94 million was GBP 4 million lower than the prior year. EBITDA was GBP 38 million higher, reflecting increased underlying profit and exchange gains. This was offset by the phasing of working capital outflows and increased CapEx in line with revenue growth and exchange rate fluctuations. Continuing free cash flow in H1 of GBP 68 million was GBP 11 million higher than the prior year, driven by the phasing of interest rate payments. Spend on acquisitions amounted to GBP 207 million. The first half included a number of relatively large deals, and in the second half, we would expect the level of spend to be around GBP 50 million. Disposals relates primarily to the proceeds received to date from the Haniel JV. GBP 43.5 million of dividends were paid in the first half, a 16% increase on 2016. The impact of exchange rate movements on our net debt figure have been far less pronounced in the first half of 2017, with the impact of sterling strengthening against the dollar offset by sterling weakening against the euro, resulting in a net foreign exchange impact on our debt of less than GBP 1 million at June 30 compared to the 2016 year end. Our operating model and approach to capital allocation is designed to compound growth in revenue, profit, and cash. We look to drive our organic growth to improve density in our core categories, thereby improving gross margins. Through our low-cost operating model, we convert these gross margins into strong profit and free cash flow. This free cash flow has been used to deliver progressive dividend growth, but in the main, it has been reinvested in the business using differentiated hurdles for CapEx and M&A. This investment further drives our organic and inorganic growth, thereby turbocharging the cycle of value creation. In relation to capital allocation, the majority of the decisions that we make are in relation to M&A. The business has a relatively low level of CapEx as a percentage of revenue. Following the Haniel JV transaction, this number is around 7%, and around 75% of that is for day-to-day operational items such as service equipment and motor vehicles. The main discretionary CapEx investments that we are making are in the area of IT, which accounts for around GBP 20 million per annum, or 1% of revenue, driving our ongoing digital agenda in our core pest and hygiene categories. In 2013, our levels of free cash flow were low, as were our levels of free cash flow conversion. Consequently, we set absolute targets at the time around making significant improvements. The compounding nature of our model means that we have reset our targets a number of times over the last three years. Our free cash flow target was GBP 80 million in 2014, and as I will discuss in more detail in a moment, our guidance for 2017 is now a minimum free cash flow level of GBP 150 million. Reflecting on this, we will be changing our guidance on cash going forward to reflect the dynamic nature of our compounding model. We have been converting earnings into free cash flow at the rate of at least 90% over the last three years, and my guidance is that we would expect that we should be able to convert at least 90% of earnings into free cash flow over the medium term. One of the drags on cash conversion relates to expenditure on legacy central provisions relating to environmental and property items. As we focus on clearing up and closing out these liabilities, we expect this drag on conversion to significantly reduce over the next five years. As I have already noted, following the completion of the Haniel JV, our net debt to EBITDA ratio is reduced to around two times, and Standard & Poor's continues to maintain our BBB credit rating. As well as a strong balance sheet, we have plenty of funding capacity, with over GBP 500 million of centrally held funds and undrawn committed facilities. As well as a strong balance sheet from a liquidity perspective, we also have a very well-funded pension scheme. Following agreement of the 2015 triennial valuation, the pension fund trustees returned GBP 9 million of cash to the company in the first half, and we do not expect to make any further cash payments into the scheme in the future. This three-year net debt bridge is a good demonstration of the impact of our capital allocation model. Strong free cash flow and strategic divestments have funded a transformation of the business through targeted acquisitions into a high-growth, high-margin, and highly cash-generative business, as well as funding over GBP 200 million of dividend payments with a compound annual growth in dividends of 13%. The radical transformation of our business and the impact that this has had on improved performance in revenue, profit, and cash is shown further on this slide. Our core pest and hygiene businesses now account for over 80% of group operating revenue, compared to less than half three years ago. Organic growth is some 5 percentage points higher than it was in 2013, and net operating margins are 50% higher, which, combined with the revenue growth, has driven double-digit profit growth. We have now created a platform to further compound growth in our revenue, profit, and cash performance. Andy will talk about this in more detail shortly, including our new performance guidance expectations for the medium term. Our joint venture with Haniel represents a step change in the execution of our strategy. I think it is an appropriate time for us to update our business model and strategy to reflect the transformation of our business over the last three years. Going forward, we will merge our quadrant and category reporting, focusing on our two core categories of pest control and hygiene, with our French workwear, Ambius, U.K. property businesses, and other smaller businesses reported within Protect & Enhance. We will continue to set differential investment return hurdles across these segments. Andy will discuss this further in a moment. Before I hand over to Andy, some remaining guidance for the full year. As we noted at the prelims, there is a small dilutive effect in the second half on adjusted profit before tax from the transfer of businesses into the JV of around GBP 7 million. Central and divisional overheads are now expected to be around GBP 6 million higher than 2017, reflecting the recent performance of our share price and the positive impact this has had on the group's long-term incentive plans. This is around GBP 4 million higher than previously guided. Interest cost guidance is slightly lower at GBP 40 million, reflecting the reduced level of net debt following the disposals and acquisitions in the first half. Our guidance for adjusted effective tax rate is 22.5%, in line with the first half, with cash guidance unchanged at between GBP 40 million and GBP 45 million. In other areas of the cash flow statement, I expect net CapEx now to be in the range of GBP 210 million-GBP 220 million, reflecting the Haniel transaction and foreign exchange rate movements, and working capital outflows to be around GBP 10 million for the year, in line with previous guidance. Given the first-half performance, and despite the in-year impact of the Haniel transaction on free cash flow, as I previously noted, I now expect free cash flow to be a minimum of GBP 150 million for the year. To summarize for the first half, ongoing revenue of 16%. We have had an improvement in organic revenue growth of 4.2%. Ongoing operating profit has increased by 13%. GBP 68 million of free cash flow, with a revised full-year guidance to a minimum of GBP 150 million. Our balance sheet remains robust. On the basis of this strong performance, we have announced a year-on-year total dividend increase of 15.2%, and we are confident of meeting our expectations in the second half of 2017. With that, I will now hand you back over to Andy. Thanks, Jeremy. Having taken you through the overall and regional performances, I am now going to take you through the way that we are evolving our strategy, our business model, and our medium-term guidance. I will then go through the businesses in a little more detail, and I will finish with M&A. The slide you can see on the screen there is the one that I have used in every single results presentation over the last four years, when I originally set out our RIGHT WAY plan. As Jeremy has just outlined, given the excellent progress that we have made over the last three years, there are three areas in particular that we now feel it is appropriate to update the plan. Firstly, going forward, we are not considering workwear to be one of our core business lines. We do, however, continue to have a substantial, profitable, and cash-generative workwear business in France, and I will come back to that later. Secondly, whilst the four-quadrant approach has served us very well over the last three years, and in particular, the capital allocation model, where we have used differentiated target rates of return, we now have virtually no businesses remaining in our Manage for Value quadrant, which if you recall, started out in 2013 with about 35% of our revenues in that quadrant. Therefore, we are dropping the four-quadrant model, but we are retaining our differentiated investment approach, and I will explain that shortly. Finally, in light of our performance over the last three years and the transformational nature of our Haniel joint venture transaction, we feel it is an appropriate moment to refresh our medium-term financial guidance. Our evolved strategy and model are summarized on this one chart. There is no change to the five geographic regions driving multi-local operations with over 1,800 local service teams. We cover about 90% of global GDP, about 90 of the world's 100 largest cities, and we are generating about 90% of group revenues from outside of the U.K. There is also no change to our focus on building the business on the expertise of our people, nor indeed to our leadership in digital and innovation, which all remain fundamental to the model. However, in the future, with pest control and hygiene now generating 92% of group profits and 82% of revenues, our primary focus will be on these two core businesses. The remaining 8% of profits and 18% of revenues come from our French workwear business and from Ambius and our UK Property Care business. As Jeremy has just mentioned, we have combined those into a grouping to be known as Protect & Enhance. We have preserved the concept of differentiated hurdle rates, with our key priorities being first to build our pest control business in growth and emerging markets, then growing our hygiene business with our Protect & Enhance investments demanding the highest rates of return. We have taken all of the elements of our route-based business model and our growth levers, and we have articulated them within the business into a consistent and efficient low-cost operating model that works equally well across all of our business lines. You can see that summarized on the slide. From left to right, by getting the colleague agenda right, by doing the right thing for customers, we ultimately deliver value for shareholders. And as a portfolio business, of course, this is delivered through contract growth, jobbing sales, through better price management, and through customer retention. So two final points on the new model. First, just to reinforce what Jeremy's covered, as you can see at the bottom right there, we now believe we've got good businesses and a good model in place for compounding revenue, profit, and cash flow. Taking our cash, investing it into pest and hygiene innovation, technology, and M&A, which in turn leads to good levels of growth, and in turn, further cash generation. And secondly, as you can see at the bottom of the chart, we now feel the time is right to update our medium-term guidance. We've increased our medium-term revenue growth guidance, including organic plus acquisitions, from mid-single digits to growth of between 5% and 8%. We've increased our medium-term profit growth guidance from high single digits to growth in the region of 10%, and finally, free cash flow conversion to be, on average, above 90%. So it's an evolved strategy and model. It's more focused on our core businesses and higher growth markets, while at the same time maintaining a consistency of approach across the regions through the use of our growth levers and our capital allocation model. Given there are a few moving pieces here, we've summarized those evolutionary changes to the model that may help when you take a look at it after the meeting. I'm not going to go through that now. I'll now move on to talk more about the businesses in a little bit of detail and then finish with M&A. So let me start with a very brief summary of the ongoing businesses and their performance in the first half. You'll see that pest control, which accounts for 63% of revenues and 70% of profits, delivered a strong first-half performance, with ongoing revenues increasing by 25.8%, of which organic growth was 6.5%, and profits grew by 21.4%. In our pest control growth markets, ongoing revenues in the first half grew by 22%, while operating profits grew by almost 17%. In our pest control emerging markets, ongoing revenues in the first half grew by 53.4%, and ongoing profits grew by almost 70%. Our hygiene business, which accounts for 19% of group revenues and 22% of profits, delivered an increase in ongoing revenues of 3.7%, of which organic growth was 3%, and profits grew by a very respectable 9.9%. And finally, as you can see, our Protect & Enhance businesses, France Workwear, Ambius, and Property Care, which together account for 18% of group revenues but just 8% of profits, they increased revenues by 0.6%, which was actually quite an encouraging performance, but profits were lower by around a third, in the main due to ongoing margin pressure in French Workwear. Now, I'll cover each in a little more detail, starting with pest. One of the great things about our pest control business is not just how good the Rentokil business is, but it operates in a very strong, a growing, and a defensive industry. As you can see, recent market reports estimate global pest control market growth of somewhere between 5% and 6% per annum over the next few years. That demand is being driven by population growth, increasing middle classes and urbanization in the emerging markets in particular, by rising expectations of consumers for pest-free hygiene standards. That demand is being fueled to some degree by new pest control innovation, by increasing regulation and risk management assurance, and the globalization of those standards, particularly in the food industry, by climate change and increasing pest threats, with the rising mosquito threat becoming of particular concern to public health, and by continued growth in North America, which today accounts for half of the world's pest control market and which continues to grow at around 5% per annum. All in all, a strong global market, and Rentokil are the global market leader in commercial pest control. In emerging markets, our position is unmatched by any competitor. We've got the scale, the brand, the technology, and the local experience, and these markets will be a major platform for medium to long-term growth of the group. As an example, our deal in India to establish the JV with PCI has given us a really important market position, and I'm delighted with the start that the combined business has made. Just to summarize this longer-term opportunity with one statistic, according to the OECD, by 2030, Asia will represent 66% of the global middle classes. These will be tech-enabled consumers, and they'll be demanding the same standards of public health and hygiene as exist in the world's most developed markets. I've talked in the past about our leadership in innovation and our technical expertise, and as new pest threats emerge and more regulation is introduced, Rentokil has the capabilities to lead the pest control industry. Our pipeline of innovation remains strong, and it's targeted to key product areas. This will be enhanced in September with the opening of our new science innovation and training center, which will be three times the size of our previous facility. As just one example, one of our recent launches is Lumnia. That's the world's first LED fly control unit range. We launched Lumnia so far earlier in the year in the U.K., and year-to-date sales of electric fly killers are running at approximately double that of 2016. This time last year, I showed you a video that we had produced to bring our digital vision to life, and 12 months on, we're seeing the benefits of those investments. With outstanding website performance, visits to our sites are currently running at 34% ahead of last year. We've got new tools for colleagues, such as the rollout of smartphones and apps, and a new digital learning and development program that's being deployed right across the Rentokil world. Our digital pest control services, which remotely monitor for pest activity, now have over 30,000 devices in the field, and they've sent or received 25 million messages so far. In addition, we now have 45% of all commercial pest control customers using our myRentokil customer portal for 24/7 digital reporting, and we've set the objective to have 100% of our commercial customers on myRentokil by the end of 2019. On climate change, I just want to make a couple of points. Over the last few years, as the world has been affected by increasing temperatures and changing weather patterns, there is little doubt that the threat to public health from vector-borne diseases, which are spread by insects, such as dengue fever, Zika, yellow fever, encephalitis, West Nile virus, chikungunya, and even malaria, has increased. There are two reasons for this. First, the longer breeding season, which means more insects, and secondly, the significant growth in international travel, where people affected by one disease travel abroad, are bitten again, and the disease passes on. Vector control is becoming much more important to the pest control industry, and Rentokil's expertise in Asia and Africa and Latin America, and indeed in North America itself, means that we are uniquely positioned to be engaged in the fight against these insects. There is absolutely no doubt that pest control is moving up the public health agenda. Rentokil is the industry's flag bearer for global standards, and in April, we agreed a global standards alliance with the BRC to collaborate and to move towards the adoption of common standards for pest control across the world. We also continue to build a great relationship with the Global Food Safety Initiative and its members. On the back of this commitment to global standards, our international accounts team has a sales pipeline worth about GBP 50 million, and we hope to sign our second and third truly global accounts in the next few weeks. Finally, in North America, which has been the focus for much of our M&A activity over the last three years, we are continuing to build out our high-quality business in a large and growing market. As you can see on the bottom of the chart, we have the ambition to create a business in North America with revenues in excess of $1.5 billion and margins in the region of 18%, and to do this by the end of 2020. As you can see, the opportunity to create substantial shareholder value in North America remains significant. In summary, Rentokil is the world's leading commercial pest control company. We have an unrivaled international footprint. We have the best brand in the business, strong market positions, particularly in higher growth markets. We have significant operational leverage from a proven and repeatable business model, and we are leading the industry in innovation, and particularly in the digitalization of modern-day pest control. Turning now to our second core business of Initial Hygiene. The hygiene industry doesn't have perhaps as many underlying growth drivers as pest control, but it is nevertheless an excellent business. We see the market growth in this business as typically being broadly GDP correlated, but that said, there are several trends which could potentially lead to above-GDP growth in a number of markets. The factors that we believe are relevant to the development of the hygiene market are changing demographics, meaning population growth, rising middle classes, an aging population, and more women in the workplace, increasing hygiene compliance and regulation, particularly in areas such as food retail and production, rising consumer expectations with businesses much more aware of the risks of poor hygiene standards, the impact of social media now driving businesses to invest in brand protection, sustainability with clean air a major topic around the world, but particularly so in Asia, and the importance of brand experience with organizations investing in the use of scent and design as they seek to differentiate themselves in the market. There are a number of factors that we believe are relevant to the development of the hygiene market, but our focus is our absolute laser-like focus on this operational model that I showed you at the prelims. It is a combination of our best-in-class products in each of the main market sectors, high-quality customer service, innovation and digital leadership, a really, really detailed understanding of customer and product density, and an overlay on top of that of city-focused acquisitions. In terms of the first part of the model, the best product ranges, we offer a great choice of products from the entry-level Signature range through to Reflection and through to Colour. These units are closely aligned to the key hygiene market sectors. You can see those on the chart. They are in-cubicle services, that is about 40% of the market, hand hygiene, another 25% of the market, air care, which is typically around 20% of hygiene markets, although in Asia more like 30%, and finally, floor care and other services account for about 15% of the overall market. We have high-quality product ranges, and we are well-positioned to capitalize on future growth opportunities. Turning to the final part of our hygiene model, that is product and customer density. Here is my theoretical illustration. I have shared this with you before, but it demonstrates the importance of postcode density, that is the number of customers in a particular geographic area, and product density, that is the number of products or services taken by each customer. The importance of density building remains firmly at the heart of our strategy. That is why we are beginning to incentivize our sales teams based on margins as opposed to revenue, so they can deliver this through density selling. We are also creating IT systems that allow us to extract data and to create economic models that we can then analyze and integrate those into our sales targets and incentives. Of course, it is this focus on density and building margins which explains why we are beginning to undertake a series of targeted acquisitions in hygiene in cities where we already have an existing customer base. Our acquisition of CWS's hygiene business in Italy is a good example of that. In summary for hygiene, Initial is one of the world's leading hygiene services company. We have best-in-class hygiene products. We have a deep understanding of density and the operational drivers of growth. We've got strong market positions, particularly in higher growth markets, and we've got a global footprint that's well-positioned to take advantage of some of those big demographic changes and trends taking place across the globe. Let me briefly talk about Protect & Enhance and then finish with M&A. We've got three main businesses in Protect & Enhance, Ambius, UK Property Care, and France Workwear. Each of the businesses is profitable, is cash generative, but each of them have weaker growth characteristics than our pest control and hygiene businesses. In Ambius, we've got a good business. It's mainly in America, but we've got operations in 16 other markets as well, and we have high levels of expertise and customer service. Our focus here is to protect our core office plants business, but also targeting new higher-margin areas. For example, our living walls product, which is a market that's predicted to grow by over 10% over the next few years. In our U.K.-based property care business, we've got unrivaled expertise in woodworm and damp-proofing services. We've created a national business with scale. The first half was, however, impacted by the slowdown in the U.K. property market. Our focus here is on cost and efficiency measures, whilst also sharing digital expertise from the pest control business. When the U.K. property market picks up, which it inevitably will, we would also expect to see the business returning to growth. Finally, turning to France and our remaining workwear business. Whilst we're continuing to make good operational progress in this business, the first half remained challenging, with continued margin pressure in a highly competitive marketplace. As I mentioned earlier, we have today announced an important step to improve margins in our French workwear business through the potential sale of eight break-even laundries, which predominantly supply flat linen. This, together with our focus on product and service quality and profit protection measures, means that my confidence in this business is higher than it's been for some time, and our ambition is to return France Workwear to profitable growth by the end of next year. Finally, turning to M&A, and then we'll take any questions. In the first half, we completed 25 acquisitions, 19 in pest control, which together added total annualized revenues of GBP 175 million. We continue to have a strong pipeline in place, and we would expect M&A spend in the second half to be in the region of GBP 50 million. As you know, we monitor the integration and the performance of acquired businesses very closely to ensure that they're continuing to meet our financial hurdles. For all acquisitions in the 18-month monitoring period, all but one of the deals are delivering at or above their expected returns for their respective IRR target levels. Finally, as I mentioned earlier, we will maintain this differentiated IRR approach over the coming years, but rather than using our four quadrants, in the future, we'll differentiate our return criteria by those three business lines, and they're outlined on the right-hand side of the chart. A more simpler, more focused approach there. I'm not going to go through this slide in detail, but in our annual report last year, we outlined five big priorities for the group for 2017. We are halfway through the year, so this is our report card as we see it. I think we have covered each of these points in the presentation today. I think we have made good progress overall, but there is much more to go for here, particularly in growing our margins over coming years. To finish, we had a good, strong first half. Our evolved strategy and business model gives us, in my view, a very good platform to push on from. This is now a higher-quality business focused on higher-growth markets. We have a low-cost operating model with multi-local teams covering 90% of the world's GDP. We have got core businesses of pest and hygiene. They are defensive categories in nature. They are delivering accelerated organic revenue growth. We have got a strong balance sheet. That is supporting our M&A pipeline, and that is designed to build density and to improve margins over time. Based on this, we have upweighted our medium-term guidance for revenue, profit, and for cash. With that, Jeremy and I will now be very happy to take any questions. Thanks. Andrew Finehill from Morgan Stanley. Given the growth and cash generation guidance that you have given over the medium term, can we expect any changes to structural leverage of the business? No, I do not think so. I think we have guided before, we are aiming at BBB, a sweet spot of net debt to EBITDA in the 2x-2.2x. We have clearly got some balance sheet capacity, but I think what we would be wanting to do with that free cash flow is continue to drive the compounding nature of the model. So, where we would be looking to do is drive M&A and deliver M&A that way. There is still capacity, I think, for progressive dividend growth. We have been compounding dividend growth by 13%, 15% for the first half. So, I think that the slide depicts it pretty well. It is generating extra free cash flow, continue to drive that M&A, and drive progressive dividend growth, and structurally maintain that within that BBB credit rating. So somewhere between 2x, 2.2x net debt to EBITDA over the medium term. Okay. On the sales of the French plants, can you just talk about how this may change your ability to compete, given that the density, I'm assuming, of the existing network is reduced? Yeah, I don't think it really affects our ability to compete. I think we have 36 plants across France. These eight plants are predominantly flat linen, and they predominantly serve the healthcare santé sector in France. We got out of flat linen in Germany, Austria, Benelux, over probably the last 10 years. This was our last core cluster of flat linen operations. We still have some flat linen in France. Really, what you're seeing is a move away from flat linen in our French business, and a refocusing on the workwear side of the textile business. What does that mean? It means we'll be bidding for far less hospital flat linen than we used to. That, in my view, is a very good thing, not a bad thing. Around the edges, there may be some customer accounts that we can't go for, because we're no longer in hospital flat linen. Honestly, I don't think that's a problem for us. I think it's a high-class one if it is a problem. Good morning. This is Simona Sarli from Bank of America Merrill Lynch. I have a couple of questions. The first one is on your new midterm growth guidance. What is your underlying assumption in terms of M&A contribution going forward? If you could please comment on your M&A pipeline. The second question is on your small margin dilution at constant FX in H1 2017. Can you please quantify how much of this dilution was due to M&A acceleration and how much from lower-margin product sales in pest control in the U.S.? Thanks. I'll take the first one, you take the second one. I think what we've tried to do on M&A guidance, I've said many times, M&A is a bit of an opportunistic game. You can't plan it two, three years ahead. You can only look forward to see what you've got coming up in the pipeline. Our plan, the reason why there's a range, there's a reasonable range, and maybe we'll do more than the range. One of the main reasons is we can't tell you going forward over the medium term what that M&A pipeline's going to look like a year out, two years out, three years out. My own view is there's no sign that the M&A opportunities are diminishing. The pipeline today is very strong. Our plan is, at the beginning of each year, when we give you the full-year results, we'll tell you then what our best view of M&A in the following year is going to be. I'm sure there'll be some years where there's not much going on, and I'm sure there'll be some years where there's going to be a bumper year for M&A, and that's why we're sort of putting a range on it. When we started this four years ago, we said we were going to spend GBP 50 million a year on M&A, and we've spent way more than that, and I'm pleased that we have. The honest answer is, it depends on what the pipeline looks like. We do know today the pipeline's looking strong. In six months' time, we'll tell you what we think we're going to spend in 2018 on M&A, because at that point, we'll already be able to see a chunk of the pipeline. I certainly don't think the pipeline's got any weaker. If anything, it's as strong as I've seen it. Yeah, on the margins, I'd split it into two regions. When we look at the U.S., the margins in our pure pest services business actually increased by about 1.5 percentage points in the half. I'd say the fact that margins were flat in the first half was primarily down to that increased mix of products business. Our overall strategy for driving margins in the U.S. remains unchanged, and I'm confident that as we grow leverage in the pest services business, those margins will continue to go up. In terms of acquisitions, what you see in Asia is typically we've been driving leverage of about 1 percentage point improvement in margins as that revenue growth flows through. Margins in Asia were flat in the half, and again, that was all down to the PCI acquisition and the dilutive impact of that. I think the margin performance in the first half was around mix, product mix in the U.S., acquisition mix in Asia in particular. The strategy remains, and I'm confident the model will continue to drive improved margin performance in the U.S. and in Asia over time as those acquisitions bed down and the mix reverts to more normal levels over time. I think it's a temporary first-half issue. Thank you. Morning. It's James Beard from Numis. Got a couple, if I may. Firstly, on organic growth in pest control, clearly an acceleration in Q2 to around 7.5%, I think. Could you talk through what the moving parts were there and your expectations going into H2? Will you be able to maintain that level of organic growth? Secondly, going back to that question around M&A in Asia and the PCI acquisition, if you wouldn't mind just talking through why that acquisition has been somewhat dilutive, and your expectations for the levels of margin improvement that you could see in India going forward. Yeah, I mean, I think the organic growth one is just quite simple, that pretty much every part of the business contributed, I think without exception. We saw a very strong performance in North America products, which was great to see. Overall, North America pest business delivered about 5% as well. So big business chipping in 5%. There is a big chunk of it there. Asia was growing strongly in all of its markets. Pacific had its strongest growth for some time. We also saw markets like Germany, where I think the growth was double digit, and Southern Europe probably had its strongest growth performance in a long time. So, it is difficult to give you a single explanation other than all parts of the business hitting their straps at the same time. There is always a bit of weather involved in pest control, always has been, and I think weather has been pretty favorable. I could not tell you how much is weather-related. I just know that when the sun shines, it tends to be a stronger pest season. Really difficult to give you any prediction about what the next half is going to look like. All I can say is I have not seen any of the markets indicating any change. Nobody in our monthly review is telling us that they see a problem coming in the second half. So, we would hope to see similar levels, but I cannot predict it. If they are a bit lower, it does not mean the wheels have come off, and if they are a bit higher, it does not mean we have suddenly changed the way the business works. It is the nature of the business. I think it is a pretty solid performance. All of the businesses chipping in, nobody dragging it backwards. The big market, America, with a 5% in pest and 6% overall, it is a strong performance. So, I think that is where we are at the moment. You cannot really predict the future. Do you want to cover India margins, or do you want me to cover it? Well, I think this is typical of many of the bigger deals we have done in the last two or three years. The Western business over in the West Coast of the U.S., Steritech on the East Coast. PCI is a family-run business, very strong business, but we see really strong opportunities to overlay our operating model, the kind of approaches that we have made in other countries around the world. It is less synergistic-based and more growth-based, but we would see absolutely no reason why we cannot get those PCI margins up to, first of all, Asia levels, and then beyond, given the density we have got in India and the market share. So, this one is more growth-based than some of the deals we do where we are focused a lot of the financials, at least on cost synergies, but there are super opportunities for growth and density in India. Within two to three years, we would expect those margins to be at the Asia levels and beyond as we build out the Indian business. Thanks. Morning. Jane Sparrow from Barclays. Two questions, please. The first one just on the Haniel JV. Since that was announced, obviously, we've had Elis / Berendsen also announce a recommended transaction, and they've outlined some synergy targets. Now that the deal has closed, and it looks like you have significantly greater overlap in certain territories than they do, are you able to shed any light on what you think your synergy opportunity is in that JV? Morning, Jane. I could. But you won't. In the sense that I know the answer to the question. Look, what I'd say, and the only reason I'm being slightly coy is, we're an 18% holder in the venture. We're not driving the bus. It's being driven by Haniel. I will say the synergies are very substantial. I think if you look at the Cintas, the G&K combination, which closed a few months ago, you look at the Elis / Berendsen one, you'll see the sorts of numbers that are coming out from those deals, and it would be reasonable to assume similar scale numbers. I think the combined business on day one has got net operating margins 12%, 13%, somewhere around that. Should they be at 16%, 17% over the next few years? Yeah, absolutely. Difficult for me to really talk about a business plan which isn't my business plan, and I'm not going to be held account to deliver it. But I think there's strong synergies in the business, and I think the combination of our two assets is going to be a very, very strong one. So, I am pretty confident that the value of our 18% stake will increase over the next few years. If I wasn't, I wouldn't have structured the deal in the way that we did, so. The second question sort of follows on from that, given you have the option to exit the JV in three years. That would obviously be another significant cash inflow for you on top of the cash inflow that you've just received and the improving free cash flow generation. That's a lot of money to spend on M&A, and particularly bolt-ons, obviously, there's only so many of those you can do in a year. What's your view on potential larger transactions, particularly in emerging markets where it's very fragmented, so perhaps those deals don't exist? Can you spend all of that money and get good returns? Well, we don't seem to have found any problem spending it so far, Jane. I suppose there are no major big deals in Asia, to the specific question. They just simply don't exist, or there's one or two, but they really wouldn't come to market. Look, I think that's a little bit out there. We've said we'll monetize that investment somewhere between three and five years in all probability. So yeah, there will be a payday coming down the road at that point. But we've got three years, four years, a runway ahead of us to work out exactly where we're going to put that money to work. There are some potential larger transactions out there, and as you'd expect, we have a view on every single one of them. The way we work, Jane, is that we will have, in the M&A team, we will have an existing plan, model, structure, where we've considered what we would do with any and all sizable assets in our sweet spot. If they do come along, back to this opportunistic thing, if they do come along, we're ready, excuse me, we've already worked out what we would do with them, and how we would go about those acquisitions. I think there's actually quite a lot of medium-sized opportunities out there. There's a small number of potential larger deals. They drop when they drop, and we won't work out what to do with our 18% based on that. We will just run that properly and choose the moment where we think represents the best opportunity for shareholders. If we end up with an embarrassment of riches and we've got a low gearing on our balance sheet, then no doubt we'll work out what other options we have for creating shareholder value. But the plan, as shared, is this compounding plan. Invest the money in good return-delivering assets, principally pest, then hygiene, drive innovation, drive technology, deliver more cash, reinvest in business, keep the dividend going. That's the plan for the next few years, and give or take, I think that will be broadly what we do, I think. Good plan. Thanks. Hi, it's Andy Grobler from Credit Suisse. Just a couple on U.S. pest control. You talked about an ambition of getting to 18% margin. Where are you now, and where were you a couple of years ago, and how do you bridge the gap over the next few years? Then secondly, and I suppose related, national accounts, you have the ability to bid on many more of those. What has been your success rate so far? What do you see happening over the next couple of years? Thank you. You can take the first one. Yeah, I'll take the U.S. one. U.S., I think we've improved margins from around 9% at around the time of the Western deal three years ago to just around 14% at the end of 2016. There's been a mix issue in the first half, we talked about products. The 18%, just to be absolutely clear, is a blended basis, so that's not just pest services, that's the whole of the U.S. business. What we see is, both from our businesses around the group and from looking at the competition in the U.S., that as we build scale and as we work towards that $1.5 billion in revenue, we're confident that we can get to that 18% margin delivery. As I said, in the first half, we added another 1.5 percentage points into pest services. There was a dilutive impact from the products business, but we continue to make really good progress on driving those margins in the pest services. That's the route to getting to 18% on a blended basis. You can almost linearly plot that transition from where we were three, four years ago at 8% or 9% on $500 million of revenues, through to where we are now on a billion plus, and where we'd get to on one and a half with the leverage on the head office, the leverage on the branch basis, and the returns we get through the increased density. Yeah, I think clearly there's, in that $1.5 billion, there's some assumption around M&A, but again, given the track record we've had, you can extrapolate where we've been and where we're going to get to that $1.5 billion, I think. On the national point, I'm not sure, Andy, whether it's in the context of North America or generally, but I'll try and do it quickly on both. If you think about, certainly in this country, think about whatever, I know what town you live in, whatever town you live in, think about the high street, what it was 10 years ago, 20 years ago, and what it is now. Virtually every restaurant, pub, fast food outlet is a chain. It's part of a national account or it's part of a franchise. The whole model has had to change from an SME model to a national account model. That's an exaggeration to make the point, but we see that happening all over the world. The great thing about the move to national account is when you win the national account, you win big. The less great thing is national account customers are very demanding, and typically like to pay less because they are aggregating their volume. We do see that change, and we have seen that going on now for 10 years, and that is something that we recognize that move, and we have changed the way we operate accordingly. Probably we would not have considered ourselves to be the best at national account maybe five years ago. Right now, we are really good at national account and getting better. North America, I think our view was, I think we have got about 10% of the total North American pest control market now, and we have less than 10% in the national space, but that is coming up on the rails very rapidly. We are growing our national footprint in the States at really accelerated levels, way in excess of the 5%, 6% that we are talking about organic growth. Our national business is growing strongly. I think that sector is getting bigger as well, for the reasons I have just described. But we are definitely taking share in that sector since we have had Steritech and since we have organized our business differently. I actually think, and then there is a reason I mentioned earlier, international accounts, you are increasingly seeing some global players, particularly food manufacturers, who want the same approach and the same standards and the same SLAs in all of their food factories around the world. There is really only one company that can do that, given our 70 countries that we operate in. I think national is an important change in our marketplace. I think it is one that we have embraced. I think it is one that is good for Rentokil. But there is that slight downside that when you win, you are winning at slightly lower margins, and you have got customers who are very, very demanding. That is the story on nationals. Within that, is there the offsetting balance that you may be getting lower margin for the national account, but you then build up your density? Yeah, I mean Do they offset each other? It is a really good point, and we could do half an hour density, but by the look of everyone else in the room, I do not think they are going to thank us for that. The way we think about it is, if you can, build the density first. So, if you have got a good footprint where you have got the major cities covered and you have got good density, then you can take on national account business, even though the margins are somewhat lower, and make great contribution because you have already got the density. If you go the other way around, and you start with a country and you have got very little density, and you take national account business, you will get cut to shreds because you do not have the density, so you will have a whole series of loss-making operations. We tried that model in China a few years ago, and we ended up in 220 cities in China, and not surprisingly, we did not make any money. This whole density building and how do you build it, and in what order do you build, it is actually quite a bit more sophisticated than I made it sound. It is quite scientific. But get the density first, lay on the national account, that is a good plan. You are totally right. The margin correlation, if you look at branches in North America, the correlation is totally with the density and the share of market within that branch, as opposed to what is the mix of national versus SME versus residential. While there are different margins in those sectors, the much bigger correlation in terms of margin delivery is around density. That is why we are committed to this strategy of building out that scale overall with a mixture of national, SME, and residential business. We have got to get the blend right. Great. Thank you. Hi, morning. It is Sylvia Barker from Deutsche Bank. Hi, Stephen. Just a few quick ones, please. First of all, can I just check if you have any working day impact in Q2? Do you normally benefit if people are taking more holiday? It is a bit sunny, not just in terms of pest swarming more. Secondly, just on the pest acquisitions, in the U.S., it looks like there has been quite a re-rating kind of on the sector overall. What are the multiples that you are seeing out in the market for kind of slightly bigger deals and perhaps on bolt-ons on U.S. pest now versus maybe five years ago? Then finally, just on the RLD deal, did you discuss selling other laundries, or was it always a discussion just around the healthcare? Thanks. Should I pick up the first one? Yeah, definitely. I've got no idea. We'll look into it, but not as far as I'm aware. But yeah, sometimes you get changes within the months, and I'm trying to remember when. You get some holiday changes in Asia and things like that. But as far as I'm aware, those have all worked their way through by the time we get through the- If there is, it's not material. It's not material. Otherwise, our people would have told us about it. Yeah. Because they always raise it. The RLD one, quickly, no, that was the package. We threw a rope around the sites that we thought would be the ones that we wanted to talk about. Absolutely no, not a broader deal. That's what we wanted, and that's what we've done. M&A multiples in North America, very difficult, in honesty, to talk about multiples, for the simple reason that each one of the targets looks quite different from the next one. And you can be looking at businesses that, on a standalone basis, are making very little margin at all, through to some that might be making a 15% margin, and everywhere in between. The way we think about it, and I'm not going to disclose too much of how we value them, to be honest, we look at what profit we will deliver in years one, two, and three. Jeremy's more sophisticated than me. He talks about cash returns on cash capital employed. We look at that, and we look at a whole bunch of other things as well. But we are really looking to say, "Okay, what profit are we going to deliver in year one, two, three, and how nailed on is that profit?" The vast majority of that profit delivery is coming through hard-edged cost synergies. If you're making your numbers on an acquisition through hard-edged cost synergies, your level of confidence that you're going to make your return is much, much higher. If it has to come from growth and cross-selling and all these other good things, beware whether you're going to make your numbers. We have a model. We don't change the model ever for our acquisitions, and we model every single one of our deals in an identical fashion. There's very few variables that can change the model, but our key metric that we're looking at is, once we've taken our synergy costs out, what profit are we going to deliver in those deals? Others look at it differently, I'm sure, but the key behind your question, Sylvia, nice to see you back, by the way, the key behind the question is, have prices in North America gone up? Yes, they absolutely have gone up. That's partly because we've been aggressive, competitors have been aggressive, brokers have been encouraging family-owned businesses that this is a good time to bring your asset to market because there's a good opportunity. I don't think they've got to the point that it's a problem for us. One of the changes there on the slide, I didn't highlight it, but I'm absolutely clear about it, we have changed our return criteria for acquisitions in growth markets to 13% IRR. It used to be 15, and that principally is reflecting the fact that prices in North America have increased. We will still aim to beat 15, but we're accepting that on some of the deals we've done in the last 18 months, we've had to drop below 15. Rather than calculate ourselves rich by torturing the model to give us the number we wanted, we've changed the return criteria. Prices have gone up. I don't think they're to a point that make this particularly challenging, but multiple's a bit meaningless. It's really, how much of next year's profit can you get the business for? I suppose, do you think that your pipeline obviously still seems to be very strong, but have you had to refuse a lot more or kind of not look at a lot more? Yeah, no, I think, as I tell my guys, look, we're not trying to buy every single pest control business in the world. That isn't the plan. The plan is to buy the ones that we want to buy in the cities that we want to buy, particularly the ones that are going to build our density fastest, or for whatever reason we've identified as a critical opportunity. We see a lot more deals in the investment committee than we do, so we turn down quite a few, but the M&A team are really there to make sure that the bad ones don't even get through to us. I don't think our hit rate's really changing. We don't get every deal that we want, but I'd say, we did 25 deals in the first half. I think it's a pretty respectable hit rate. I don't think it's changed much, to be honest. Prices are a bit higher in America. Other than that, the pipeline looks pretty strong. Thank you. Good. No more questions? Fantastic. Thank you very much, everyone. Thank you. See you next time.