Good day, ladies and gentlemen, and welcome to the Vesuvius report and trading update. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session through the phone lines, and instructions will follow at that time. I would like to remind all participants that this call is being recorded. I will now hand over to the CEO of the Vesuvius plc, Patrick André, to open the presentation. Please go ahead.
Good morning, everyone. My name is Patrick André. I'm the CEO of Vesuvius plc. With me this morning on the line is Guy Young, our Chief Financial Officer. I will start by giving you the highlights of our trading performance since the start of the second half. After that, as always, we will be happy to open the floor for questions. The first message is that it's quite a resilient trading performance which we have over the past four months, which now lead us to plan for our 2022 results to be somewhat above expectations of the market.
You may know that the range of analyst consensus for 2022 was between 194 and 209. We now expect to be somewhat above that for the year. What are the reasons for this quite resilient trading update? Not that much in the markets, unfortunately. The markets have been weakening more or less as we had planned it would be when we had our latest update. There have been some regional differences from one region to the next. The trading market environment in Europe has been even a bit weaker than what we thought.
Conversely, the market environment in other regions than Europe has been a little bit better than what we thought. Overall, when you take all the world together, our trading environment, our market environment has been more or less as weak as we had planned it will be. The reason why our resilient results performance are manyfold. First, we have continued to make market share gains in all of our divisions and, in particular, in Flow Control in all regions of the world.
The second reason is that we have continued to have an efficient pricing management, and we have been able to continue to increase prices to continue to offset all cost increase, be it energy, labor, raw materials, that we are confronted with. At the same time, we have engaged into an important cost-cutting program, as we always do when markets start to weaken, and they are. We have been able to start reducing our costs there, and we will continue to do so as much as necessary in the coming months in case markets will continue to weaken.
Two other points, we have also benefited from a bit better than expected tailwind from forex exchange of a GBP 14 million, as Guy will detail to you or me to any if you are interested. Even if our inventory has been declining, we have been able to reduce our inventory, but we have reduced our inventory a little bit less than what we planned at the time of our latest trading update mid-year. The negative fixed cost absorption impact, even if it has been significant, is a little bit less than what we planned in our last update. All these reasons together have combined to help us achieve better results than what we initially planned.
This is what is supporting now our forecast of results somewhat above expectations. Our cash performance has also been quite good so far since beginning of July. We have started to reduce our inventory, even if it is a little bit less than what we would like. Clearly, our inventory has started to reduce. As a consequence, we continue to generate good free cash flow, and we expect our net debt ratio or net debt to EBITDA ratio to be significantly down end of the year as compared with mid-year. We were at 1.3x middle of the year. We expect to be on or around 1x at the end of the year.
At the same time, even if our markets have been weakening, the fundamentals of the market have been sound. We continue to be absolutely convinced that our market, both steel and foundry, are growing long-term. For these reasons, even if we are cutting short-term costs. First, we are absolutely continuing at the same pace all of our investment for the future. It means first investment in R&D. We are continuing to increase our R&D spend, which, you know, is fully expensed. In the way we are accounting for it's not capitalized. We are increasing our R&D spend because we believe that is what will help us to continue to gain market share going forward.
Our expansion, our investment in capacity expansion, in particular in Flow Control to help us, continue to grow and gain market share in the fast-growing region of India, Southeast Asia, Turkey, Middle East, Africa, Latin America. Our investments are continuing at pace, and our new investment, in new capacity in Flow Control will hit the market progressively between the end of this year and the end of 2023, beginning of 2024. We believe just in time to enable us to fully benefit, from, the market recovery when it will be there. We have also, finalized a small acquisition, small thing but important for us from a strategic point of view. A small, company in China, called BMC, which is a producer of, basic monolithic, refractory material.
It has been a partner of BMC for many years, and it's a small company, GBP 14 million turnover, but important for us strategically because it will enable us to extend our presence in basic monolithic, not only in China but also in North Asia and in Southeast Asia. Now that we are fully 100% owner of this company, we'll be able to introduce our latest critical, which we could not do before, for IP protection reasons. This will support our growth and market share gain in all these China, North Asia, and Southeast Asia region going forward. From a sustainability point of view, we are continuing to make our progress.
We will be in 2022, our CO2 emissions will be 20% lower in 2022 than they were in 2019. We are very on the right track to reduce our CO2 emissions. All the effort that we have been making in terms of sustainability over the past few years are now clearly recognized also by external agencies, because MSCI has been upgrading a few days ago our rating to AA, which is the second highest rating available for all companies worldwide. We are very pleased with this result. Looking forward, we expect that markets will continue to weaken in the coming months.
I think we should have no revision on that. Both steel and foundry markets are on a weakening trend, so we expect the next few months to continue on that trend, especially in India. There is nothing new there. It's more or less as we have planned, it will be. It's, I would say, typical downturn. We are fully prepared for that. The year 2023 for this reason is uncertain, and we will refrain from giving guidance as we said, because there is a high level of uncertainty about when markets will go the other way, when will be the inflection point, and when markets will start to recover.
What is clear to them, you may have seen the ArcelorMittal trading a bit a few days ago, is that a significant part, especially in India, of the weakness that we see on the steel market is due to de-stocking. Apparent consumption, which is what is important for term for us, is relatively down. Real consumption for most probably not down as much as apparent consumption. At some point, there will be a rebound. This rebound is very difficult today to know if it take place in Q2 next year or end of next year. This explains a very wide range of consensus for the results of the business in 2023. The range of consensus today is anywhere between GBP 167 million-GBP 218 million.
We are relatively comfortable with that trend because we don't have a crystal ball ourselves, so we will refrain from giving guidance. Most probably the upper end of that trend corresponds to a very optimistic, probably too optimistic assumption regarding when markets will recover. It will ensure that markets will recover already till 2022 next year, which we do not see as the most likely scenario out of cautiousness for the time being. The lower end of that trend will assume that markets do not recover till the end of 2023. For the time being, it's too early to give our own opinion about where we fit in that trend.
We believe that for a few months, and at least probably during the course of H1, we will be confronted with weak end markets, both in steel and foundry. That at some point in time after that, our markets will recover and will resume their long-term growth rates. I will end there, and I propose to open the floor for questions, and Guy and I will be very happy to answer.
Thank you. If you are dialed into the call and would like to ask a question, please signal by pressing star one on your telephone keypad. We will pause for a moment to assemble the queue. We will take our first question from George Featherstone from Bank of America Merrill Lynch. George, please go ahead.
Morning, everyone, and thanks for taking the questions. First one would just be kind of a little bit of a follow-up on your last comments there, Patrick, around normalization of inventory. Maybe starting with the Vesuvius itself, where do you see your working capital percentage of sales ending this year? And then where do you expect it to trend in the first half of 2023? And then how much of the wider channel inventory do you expect to normalize and kind of when, by you know, how much destocking have you been able to quantify against how much destocking you expect to see in the first half of next year?
Thank you. I will then hand over to Guy to give you some figures, but as far as our own inventories are concerned, we have already clearly started to decrease not only because markets are declining, also logistics and supply chain are improving. We don't need to keep as much buffer and safety margin as we had built over the past 12 months, 18 months due to the disturbances in the trade market in particular. Things are clearly getting better. It opens new possibilities for us to reduce, so we have started to reduce. We had initially planned to completely reduce what we believe a normal level by year-end.
I don't think we'll be able to do that. We will significantly reduce, but not as much as we wanted to initially. We will still have some unwinding of inventory during the first half of 2023. Already this year, and this is the reason why we are already generating good cash flow, we have started to unwind our inventories. That's for us, and I think hand over to Guy to give you some more figures. Regarding the team inventory, it's clear that if you remember, during the actual results, I had indicated that we had the availability for that team inventories were too high, clearly too high.
They have clearly started to unwind, and we have the perception that they are reducing relatively rapidly. It does not mean that the reduction is over, not yet, but especially in Europe, there have been significant reduction in production of steel in Europe and also in other places. We believe that steel inventories are now relatively rapidly reducing. It will probably take another a few more months for them to reach the level at which the reverse trend will start, but we are on a good track to reduce excess steel inventories also.
Somewhere in H1, we will have simultaneously both the reduction in excess manufacturing inventory and in excess steel inventory will have been achieved sometime in H1 next year. Guy, maybe you can give some more numbers regarding the working capital intensity.
Sure. Thanks, Patrick. Morning, George. I think the trade working capital to sales for 2022 is probably more likely to be between 23.5% and 24%. We should see about half of our expected underrecovery or underabsorption rather of fixed costs flowing through into next year. But our trade working capital overall should be declining back towards its trend of around 21% as soon as supply chains and markets normalize, which I would expect to be happening through 2023 and 2024. Up to 24% before coming back down to 21%, George.
Okay. Thank you very much. That's really useful. I just wanted to touch on the cost-based reductions. I just wonder if you could give a bit of color on where that's been targeted. Also in that context, you've mentioned good pricing traction covering the cost inflation that you're seeing on labor. On labor, what are you seeing as the cost inflation potential for next year? Is that part of these cost-based reductions that you're targeting? Can you raise prices again to offset that in the context of the volume declines you're expecting?
It's a very good question. We are trying to reduce costs everywhere. What we are already doing is, of course, travel, external professional fees. Everything is being reduced, but we have already started to put some of our people on furlough. As we are reducing production in many of our plants, we have started furlough in several places to reduce our fixed cost base. This is already helping us in our results. We will continue this as we've done during the pandemic. This is, in fact, we are applying exactly the same methodology that we've done during the pandemic to confront the drop in volume.
We are doing that now. This is contributing to maintaining part of or mitigating the negative impact of declining markets. Labor costs are increasing and will increase. Now we are in an inflationary context. First, we are being extremely reasonable in our labor negotiation. At the same time, we are treating our people normally well, but we are also reasonable in the way we are doing so. We have a lot of discussion with our people to agree together. We have always been able to agree so far on reasonable labor cost increase and since we are taking. Yes, for us, labor is a cost, as is energy, as is raw material.
Our pricing management is adapted to cover all of our costs, all the cost components of our cost structure, meaning of course raw materials, freight, energy and labor, which are the four most important. Labor is taken into account in our pricing strategy.
Okay, thank you very much.
Thank you. The next question is coming from Andrew Douglas from Jefferies. Andrew, please go ahead.
Morning gents, and well done for getting your technology to work. Can I ask a couple of questions, please? Firstly, going back to George's question on cost outs. Is there anything different in this cycle compared to prior cycles, in terms of the levers that you have to pull, if you do need to take additional cost out? And in terms of what needs to happen from your end markets for you to kind of take those decisions, or is it similar to prior cycles? Secondly, just wanna touch a bit on the small acquisition in China. I know it's small, but I also wanna kind of understand your thought process going into next year, with a healthy balance sheet, just regarding M&A.
Whether there are kinda more targets out there that are coming loose. Third, a slightly later question, but one for Guy. Do you guys have any refinancing to do next year? It looks like there's only a small, I think it's $13 million, to refinance. And if so, would you just kind of roll into your RCF or do you have any other options? Thank you.
Thank you, Andy. I will let Guy answer on the refinancing, but clearly we have a very solid balance sheet and a very little refinancing in the years to come. Guy will give you more flavor on that. On the first two questions, the first one is very similar. We are, as you said, battle hardened now and, as you can imagine, so taking costs out, we are weathering. It's very similar to what we have been doing regularly over the past few years each time we had a downturn. This downturn is obviously a temporary one. I don't know how long it will last, if it will be six months, one year or 18 months, but it's not five years.
We are now well equipped to make the distinction between those costs which we can and should cut to adapt to this temporary downturn without negatively impacting our long-term strategy. Conversely, those other costs which are absolutely key to our long-term strategy and which we never touch during a downturn, including a non-classical downturn like the pandemic. I'm thinking mostly about R&D. R&D, not only we are not cutting R&D, but we are continuing to increase our R&D expenses because we have very good projects. We have plenty of ideas of new products that we can put on the market in the coming years, and we don't want to slow that down because this is the key for us to continue to gain market share.
Other costs, there is no sacred cow. All the other costs which can be reduced short-term without impacting our long-term strategy, we are doing, and in a very decisive and proactive way because it is the only way to do. Regarding BMC, it's small, but it's very important for us strategically because it will really help us accelerate our development in China and Northeast Asia and Southeast Asia, which are very important areas for us. Yet we have an appetite because we have a strong balance sheet. We have an appetite for other similar bolt-on acquisitions. We are currently looking at other opportunities, mid-size opportunities, order of magnitude of CCPI, Universal, BMC, although slightly same order of magnitude.
We have the balance sheet to do it, to absorb it, and we like them because they are generally a high level of synergy. Integration risk is low. They are not stretching management teams. We still have an appetite. There is no guarantee that any of those will happen. We are proactively looking for other opportunities going forward. Now, Guy, if I hand over to you to give some information about refinancing.
Thanks, Patrick. Morning, Andy. Yes, you're absolutely right. We've got very little in terms of refinancing requirements. We've got a small USPP note that's due for redemption at the end of 2023 of around $30 million. Yes, again, you're right, our intention is to utilize either internal cash resources or some of the RCF in order to do that redemption. No major refinancing requirements during 2023.
Okay. That's really helpful. Thanks, guys.
Thank you. The next question is coming from Bruno Gjani from BNP Paribas Exane. Bruno, please go ahead.
Thanks for taking the question, guys. I was just wondering if we could go back to the underproduction in H2, and if you could isolate and quantify the impact that you expect underproduction to have on H2 profitability. And further, if you could expand on that and touch upon production expectations for next year. Are you reducing production in H1 2023 to a level that is below the Q4 level? So is it another sequential cut, or are you simply holding production at a lower Q4 level for longer? Thank you.
I will pass it over to Guy to complement with some numbers. Qualitatively first, we are producing less than what we sell. That's how we reduce inventory. That's also why. We are producing less than what we sell during H2 this year. We will continue to produce less than what we sell in H1 next year. What we sell in H1 next year, I don't believe it will be lower than Q4. Q4 is a very low quarter. I think it's more or less everywhere the same. I don't see us. Again, I have no crystal ball, unfortunately.
I consider it unlikely that production and sales of Q4 lower than Q3. It's normal. Always like that with the cycle, in such a cycle. I would, at this stage, expect H1 to be a bit lower than H2, but higher than Q4. Now, if I may hand over to you, Guy, to put more flesh on this.
Sure. Bruno, we spoke about a potential range of impact with regards to the under absorption of fixed cost at H1, and we estimated it to be impacting us by between GBP 8 million and GBP 10 million in the second half. My expectation at the moment, although we've obviously still got two months to run, and we are still looking to continue to reduce inventory, but my expectation is that about half of that under recovery or, sorry, under absorption will flow into next year, so between GBP 4 million and GBP 5 million.
Okay. That's helpful. Thanks, Guy. I was just wondering if you could talk about perhaps why you're giving us that larger production cut in H2. Is it perhaps because demand surprised positively and market share gains were more pronounced, or is it to do with more favorable cost dynamics, say perhaps contracted energy costs being lower this year for you? Or did it just make sense to spread some of that burden that underproduction presents on your margin over several periods and actually coincide that with the cost saving that might flow through to just perhaps some color around why not a larger cut in H2 and get it out of the way?
I think it's a very good question. Believe me, if we could reduce production even more in H2, we would do it. Sometimes, for example, when we put our people in furlough, we need to negotiate with our people first. We don't announce them from Monday to Tuesday that we put 80% of people in the plant in furlough. We need to negotiate with them to do that in a responsible way, because we want to keep our people. I insist on that. Now, it's not like we are shutting the operation and thinking that we'll never restart it. We want to keep our people.
We are very qualified blue collars in particular, also white collars, but we have a very qualified team, including blue collar, which, we want absolutely to keep because they are key to the quality of our production, the quality of our operations. When we reduce production in the plant, we don't do this in a gung ho way. We discuss, we explain why we are doing it.
We take the time to I would never dare to say convince, because people are never happy to listen on furlough, but at least I think it's important to take the time to explain because in the few months from now we will start again, and we will need to have those people fully motivated, fully ready to ramp up production again, with the best level of quality for our customers. The way we do the ramp down is very important for the quality of the ramp up later on and speed of ramp up later on. We are doing as much as we can. We are reducing as much as we can.
Considering the decline in the market, it has not been, especially in India, it has not been as quick as we would have liked it to be. That's the reason why our ramp down of inventory will be serious, significant, but not as much as we wanted it to, we want it to be during the second half this year.
Got it. That's very helpful. Thank you. Just a last one on pricing. I was wondering how pricing has developed sequentially. Q3 over Q2. Are prices stable or have they started to moderate lower already?
It has moderated obviously, and if you compare the quarter-over-quarter evolution, it has moderated because our cost base has moderated. Our prices are still increasing because our cost base has still been increasing over the past few months. It may well start to decline sometime in the course of next year. When it does, as we have always said we would, we will pass this through to our customers. For us, raw material in particular will pass through. For the time being, our pricing has been between stable and slightly increasing, depending on the region because of course this has not started to decline yet.
Okay. Just to follow up on that. This year you would have seen very significant price increases to the tune of, I'd say, what, 16%-17%. As you look forward to next year, how much of that do you expect to give back to customers, or any indication, or do you expect to hold it all, or what are your thoughts on this?
It's too early to predict that because it will depend on what will happen on the cost base. I don't believe labor will decrease next year. I am skeptical about the fact that energy will decrease. There are several schools of thought and as you can imagine, I don't have a crystal ball about the cost of energy. I don't consider it seen from today, but it could change one month or two months from now. Seen from today, I don't consider it as the most likely scenario that energy prices will decrease on average significantly next year as compared with what they are today. Not as compared with what they were two months ago, but as compared with what they are today.
Freight is declining as we speak. Our freight is continuing to decline, so this is a positive factor in terms of cost base decline. Raw materials are not declining that much. Raw materials excluding freight today are not declining that much. At least the raw material we are using, industrial minerals, they are not declining, actually, in fact, for the time being. It's a mixed bag. It's very difficult at this stage, and I will refrain from doing so, to predict by how much the costs could decline next year. All in all, I hope it will decline a little bit, but it's too soon to tell by which percentage. We will follow.
This is something we are revising literally every month. We are following that every month, if not several times a month. We will adjust our pricing if and when we observe a real factual cost decline in the market. Again, it's not the case for the time being.
Got it. Thanks for the clarification.
Okay.
Thank you. Just to kindly remind you, if you would like to ask a question, please press star or one on your device. Thank you. We will take the next question from Dominic Convey from Numis. Dominic, please go ahead.
Good morning, gents. Thanks for the questions. Just a couple if I may. Just following up on Bruno's point really around the inflation expectations for next year. Two-fold really. What wage inflation next year, how would you characterize your expectations? Would you say sort of mid-single digit or perhaps mid to high single digit next year? Looking at it another way, as things stand, what level of price increases do you expect you will be required to put through next year to fully recover that weighted average cost increase? I'm just conscious that to date we focus very much on our pricing models for 2022. Now is the sort of good time to review and just get our revenue line in shape for next year.
Third question, just in terms of shape, implied within the new guidance for this year, what is your expectation in terms of the performance of the last two months of the year relative to what you've already booked in the four months to October? Thank you.
Regarding your first point, we do not have, as you can imagine, a single wage expectation for all countries anywhere in the world. It's interesting because we see relatively large variations. There are some countries where we forecast wage inflation to be low double digits. There are some countries where we are forecasting wage inflation to be low to mid single digits. It's a wide range. We are looking country by country at the specific situation, the evolution of the currency, the specific level of inflation in such and such given country. We have very significant variation.
You still have countries, as you know, where inflation is still on the rise. You have other countries where inflation may have already peaked. This also creates a difference in the dynamics of negotiations of discussions we have with our employees. We expect a relatively wide range of outcome from low to mid single digits to low double digits next year in terms of wage inflation. It's really a case-by-case basis, and we are looking at it on a case-by-case basis with our local managers being empowered to adapt their decisions based on local circumstances. This is not something we are running from the headquarters and we trust our leaders locally.
In terms of price increase, our price increase or price evolution. Again, it's too soon to answer this question because even if wages is relatively, I wouldn't dare to say predictable, but you can make some forecast in terms of wage. Wage is only one of many elements of cost base. Raw materials, freight, and energy are also important ones. This is changing literally by the day or by the week. We are adapting our pricing nearly every month. Will other elements than wages more than compensate? Will the decline of other elements more than compensate the decline in wages, the increase in wages?
We think it's possible. It's not guaranteed. We will monitor this. We are monitoring this on a regular basis and we will adjust our pricing strategy accordingly. But again, unfortunately, because I don't have a crystal ball, I cannot tell you what will be the resulting evolution of our prices. We will see that when it's done going forward. To answer your question, we do not have, and we are not planning, to have a lower unit margin in the latter half of this year than what we have so far. Volumes are lower, so we have fixed cost absorption impact.
In terms of unit margin per unit, we are not planning to have a lower profitability than what we have so far.
Thank you.
Okay, thank you. There are no further questions on the conference line. I will now hand over to the management for closing remarks.
Thank you very much to all of you for attending the call today. I wish you a nice day and we are looking forward to seeing you when we announce our full year results at the beginning of March next year. Thank you very much.
Thank you, everyone. That concludes your conference call for today. You may now disconnect. Thank you for joining, and enjoy the rest of your day.