Spirax-Sarco Engineering plc (OTCPK:SPXSF) Q2 2022 Earnings Conference Call August 11, 2022 4:00 AM ET
Nicholas Anderson – Group Chief Executive
Nimesh Patel – Chief Financial Officer
Conference Call Participants
Good morning, everyone, and welcome to our 2022 Half Year Results Announcement Call. I’m Nicholas Anderson, Group Chief Executive; and I’m joined here by our Chief Financial Officer, Nimesh Patel.
Regarding today’s presentation, I will start by sharing the highlights of the first half, and then Nimesh will take you through our financial performance. Later I will return to cover the operations and outlook for the full year 2022. To finalize we’ll be happy to take questions from the analysts on the call.
Moving to Slide 3. I would like to start by acknowledging and thanking all my colleagues around the Group for their outstanding efforts to meet exceptional customer demands in what has been a challenging first half year. Across the Group, we have seen continued strong demand growth, despite challenging environment and softening IP. All three businesses enter 2022 with record order books and all three have expanded their order books during the first half. We saw particularly strong demand for larger project orders as customers accelerate capital investments.
In addition to delivering increased volumes, as we ramped up our shipments from our manufacturing facilities, we have continued to actively implement price increases to offset inflation and protect margins in line with our well established practices. In Steam Specialties in ETS we saw sales growth well ahead of IP and demand growth well above sales with both businesses continuing to expand their order books beyond their record opening positions. In Watson-Marlow sales was significantly up. Demand from customers in the biopharm sector has normalized in line with our expectations and reflecting lower COVID-19 related demand. While growth from the process industries was significantly above IP. Watson-Marlow’s order book at the half year remains above their opening position at the beginning of this year. As expected CapEx has risen to record levels during the first half driven by increased investments in our manufacturing capacity to support growth, particularly in Watson-Marlow, and Nimesh will provide further performance details in the financial section.
So now moving on to Slide 4. The global supply chain challenges that kickoff in the latter part of 2021 was still present in the first half of 2022, impacting the availability of key manufacturing components, such as nylon, printed circuit boards and semiconductors. We continued to engage with our supply chain partners to deploy our litigation strategies, successfully maintaining deliveries that met customer’s requirements.
In March, we announced our decision to spend all group trading with or within Russia. And on the 6th of July, we concluded the disposal of our Spirax Sarco and Watson-Marlow operations to the Local Management for a nominal consideration. During the first half of 2022, we continued our revenue investments to support growth across all three of our businesses including accelerating our digital initiatives. We also continued investments to further expand manufacturing capacity through factory modernization and debottlenecking initiatives. These include new equipment, revised processes, additional people and new manufacturing plants in Watson-Marlow.
We have continued to make further progress on our ESG agenda, and I will provide more detail of this in a moment. Our business development teams in ETS and Steam Specialties continued collaborating to address the substantial sales opportunities arising from decarbonization, and which I will expand upon when we get to the ETS section. Also in ETS, we made good progress to address the financial end performance of the Chromalox facility at Soissons in France. And this process should be completed by year-end.
Lastly, on the 25th of July we signed a binding agreement to acquire Vulcanic for a consideration of €262 million.
So now onto Slide five. The acquisition of Vulcanic represents a significant milestone to strengthen our ETS business. Vulcanic is a European industrial electric heating group and is the largest supplier in Europe of bespoke industrial electric heating solutions. It operates a direct sales model. Has 10 manufacturing facilities worldwide and employs over 700 people of whom almost 90% are based in the EMEA region. Vulcanic has a clear strategic fit with our ETS business and it expands our platform to deploy the Group’s business model driving further improvements in sales growth and margin over time. Vulcanic has a strong complementary to with Chromalox through its existing customer’s products and operational footprints, including its strong focus on decarbonization.
It also balances our geographic footprint by strengthening ETS’s presence in the EMEA region where we expect to see the strongest amount for decarbonization solutions in the near term. Together with the actions we are taking at Chromalox in Soissons, Vulcanic establishes a larger profitable footprint in EMEA. Now Vulcanic’s performer performance in 2021 following its acquisition of EML in the USA in December of 2021 includes revenues of €89.4 million, adjusted EBITDA of €70.6 million and adjusted operating profit of €16 million. This transaction is expected to close late this third quarter.
Turning now to Slide 6 and the ESG. As I mentioned we have continued progressing our Group’s ESG agenda. Our ten inclusion commitments which form part of our inclusion plan called ” Everyone is Included” are being cascaded globally through a series of inclusion master classes, webinars and workshops to embed these commitments into local policy and practice across the group. We also formally signed the UN Women’s Empowerment Principles and UN LGBTI Standards and joined the Women’s Engineering Society to help advance our gender equity journey.
I was particularly proud that our colleagues raised £92,000 towards our total donation of £284,000 to the Ukraine Red Cross appeal. And we were very pleased to make the first awards of our newly established group education fund. We still told more than £230,000 across numerous projects globally. We have also made further investments in health and safety, including a new global health and safety management system and behavioral based safety training programs on a global scale. From an environmental perspective, we have now secured green contracts for close to 40% of our Group’s electricity supply and launched over 50 biodiversity projects globally.
We achieved a significant reduction in our absolute Scope 1 and Scope 2 market-based emissions as mentioned against the first half of 2021, and initiated implementation of Project Clear Sky to fully decarbonise our Steam Specialties’, UK manufacturing facility in Cheltenham. Every manufacturing facility has also developed their initial net zero roadmaps, which are being refined and incorporated into their operating plans, these just some of the many internal ESG initiatives of the first half. In addition to our continued work to support our customers, to improve their sustainability performance, which includes bringing to market our suite of TargetZero solutions for decarbonizing steam generation, and I’ll come back to that in a moment.
And with that, I’ll now pass you on to Nimesh.
Thanks Nick and good morning, everyone. Nick and I are pleased to be presenting another strong set of results delivered against the backdrop of macroeconomic uncertainty and challenges in the industrial operating environment. Some of which we expect to persist in the second half and beyond. I’ll explain the drivers of our financial performance, which underpin our improved outlook for the full year.
Moving to Slide 8. As always the numbers we will be discussing are the adjusted results. Adjusting items include over £15 million of costs relating to the restructuring of Soissons ETS manufacturing facility, France. And almost another £7 million of costs related to our acquisitions fee and Vulcanic in addition to our exit from Russia, further details are included in the appendix. Sales were 17% higher reflecting an organic price of 15% and operating profit was 10% higher or 9% on an organic basis. The difference between our reported and organic growth rates reflects the positive effect of currency movements on sales and profit and the adverse impact of our exit from Russia partially offset by our acquisition of Cotopaxi. These impacts are reflected in our reported numbers and excluded from our organic growth rates.
Our operating profit margin decreased by 150 basis points on both a reported and organic basis to 23.8%. In line with previous guidance this margin reduction was driven by the full year impact of revenue investments made during 2021 and continued investments in 2022. Net finance expense remained the same as the first half of 2021. We estimate an increase of £2 million pounds in the second half related to the acquisition of Vulcanic. Our effective reflective tax rate in the first half which is based on the expected full year tax rate was 26% again in line with guidance. EPS at 175.1 pence was 11% higher broadly in line with the increase in operating profit. In respect to the first half, we are proposing an interim dividend of 42.5 pence reflecting our strong first half performance and our confidence in the full year outlook. This is an increase of 10% following an increase of 15% in the total dividend for 2021. Our dividend cover will remain at the top end of our stated range of 2 to 2.5 times.
Moving to the sales bridge on Slide 9. Currency movements had a positive impact of over £11 million on sales or 2% driven by a weakening of sterling particularly against the U.S. dollar. If July month end rates were maintained for the rest of the year we would expect to see a slightly higher positive effect of around 3% for the full year. Acquisitions and disposals includes the net contribution from Cotopaxi acquired in January and the impacts of our decision to suspend trading with and within Russia from March onwards. The effect on sales was less than 1% in the first half and is expected to be similar for the full year.
The group’s organic growth in sales was 15%, all three businesses delivered strong organic sales growth driven by higher volumes as well as price increases. We increased output from our manufacturing facilities supported by prior and current investments. Although our order books still expanded from their already record levels as demand continued to exceed sales. Organic growth in Steam Specialties sales was 10% with demand growing significantly above IP. This was despite growth in Asia-Pacific being impacted by a COVID-19 related lockdown in China during the second quarter.
ETS organic sales growth was 13% driven primarily by Chromalox and despite lower sales in EMEA due to a significant reduction in output from our plant in Soissons, France. In Thermocoax, organic growth was lower than the average ETS reflecting the longer lead times on shipments of new orders to the nuclear and semiconductor markets. Watson-Marlow once again performed very strongly with organic growth of 26%. Process industry’s demand growth was significantly above IP and while BioPharm demand has normalized on lower COVID-19 vaccine related demand overall demand still exceeded sales. We expect group revenues in 2022 to reflect the typical split of around 48% and 52% between the first half and second half of the year prior to reflecting the impact of Vulcanic.
The next bridge on Slide 10 highlights the movements in adjusted operating profit for the half year. Currency movements increased profit by £3.5 million or 2% as a result of both translational and transactional impacts. If July’s month end rates were maintained for the rest of the year, we would expect to see a slightly higher positive effect of around 3.5% for the full year. The net effect of acquisitions and disposals reduced profit by £1.8 million or just over 1% and is expected to be similar for the full year. The total organic increase in group operating profit was 9%. Steam Specialties profit grew 2% organically as anticipated this was below our organic growth in sales due to the full year impact of our 2021 revenue investments and our continuing investments in 2022, which offset the benefit of operational gearing from higher sales.
ETS profit increased 9% organically with profit growth higher in Chromalox than in Thermocoax reflecting the strong growth in Chromalox sales Watson-Marlow’s organic profit growth of 21% reflected the very strong sales growth in the first half, and like Steam Specialties was below organic growth in sales due to the full year impact of our 2021 revenue investments, and the ramp-up of our new BioPure manufacturing facility in the UK. The increase in central expenses reflects increased investment to deliver on our strategic initiatives, such as sustainability and strengthening our governance in addition to higher charitable donations.
Turning to Slide 11. Our adjusted operating profit margin decreased to 23.8% in line with our guidance and which is above pre pandemic levels. And the second highest first half margin in our Group’s history after 2021s record, 25.3%. This 150 basis point reduction in margin reflects the full year impact of our 2021 revenue investments, which support the future growth of our business. When presenting our 2021 results we estimated the full year impact of these investments would have reduced the Group’s 2021 margin by less than 200 basis points.
During the first half of 2022, we have continued with our revenue investments and the ramp-up of our new manufacturing sites including: Watson-Marlow’s new BioPure facility at Dunsbury Park in the UK; and Thermocoax’s new facility in Normandy, France. And in the second half Watson-Marlow will also ramp-up its new U.S. facility at Devens. Across the Group we have also continued to successfully deploy our active approach to price management during the first half of 2022 to offset inflationary pressures and protect our adjusted operating profit margin. We anticipate the full year adjusted operating profit margin in 2022 will be similar to the first half as we continue to invest for growth, which will offset the benefits of operational gearing from higher sales in the second half.
Nick will talk about the margin performance in each business shortly.
Turning now to cash flow on Slide 12. Operating profit to operating cash conversion was 44% due to investment in working capital and increased capital expenditure. Our ratio of working capital to sales increased to 24%, up over 200 basis points from the end of 2021. This reflects a planned rebuilding of stock to meet increasing demand and mitigate supply chain related shortages of rural materials, as well as an increase in receivables. Going forward we anticipate a reduction in this ratio of working capital to sales to a similar level as reported in 2021 as shipments increase in the second half of the year. The most significant driver of the increase in capital investment relates to our previously announced expansions of Watson-Marlow’s manufacturing capacity, particularly in the U.S.
The construction of this U.S. facility is the largest project in our Group’s history with an expected cost of $106 million. The bulk of which will be incurred in 2022. We anticipate capital expenditure for the full year will be approximately 7% of sales. And as a result, we anticipate that cash conversion for the full year will be higher than in the first half but lower than our historical levels of around 90%. We ended the first half with net debt of £203 million, up from £131 million at the end of last year and net debt equated to 0.5 times EBITDA. Net debt will increase in the second half following the completion of our acquisition of Vulcanic.
Thank you. And I will now hand you back to Nick to run through our view of industrial production and our business performance.
Thank you, Nimesh.
On Slide 14, we have once again shared the sequential evolutional by-quarter of global industrial production output. As you all know global industrial production growth or IP for short is the best predictor of our markets. The blue line represents Oxford Economics’ IP forecast for 2022, one year ago in July 2021. The green line represents their forecast on the 23rd of February, the day before Russia invaded Ukraine, which we shared with you at our full year results announcements in March. The red line is Oxford Economics’ latest forecast published on the 15th of July.
Now the first point to note is the stronger than expected global IP output in the first quarter of this year, followed by the 1.5% global output contraction that followed in the second quarter of 2022. This contraction was mostly result of the heightened certainties caused by the war in Ukraine, post-19 lockdowns in China, rising global inflation and corresponding monetary policy action all of which compounded the continued global supply chain disruptions. Consequently over the past six months global IPSs growth forecast for 2022 was systematically downgraded from 4.4% to 3.5%. Given there still uncertain microeconomic environment it is plausible that these forecasts could still suffer further downward revisions. In fact, last night after this presentation was finalized we received the new update from Oxford Economics lowering the 2022 global IP forecast to 3.3% for this year. Nevertheless, our robust business model and disciplined execution of our strategies have underpinned the resilience of our performance throughout economic cycles. So we remain confident in our ability to successfully navigate the continued uncertainties ahead.
Now on Slide 15 we start the half year review of our operations with the Steam Specialties business. Steam Specialties sales were up 11% to £400.6 million or 10% up organically. Adjusted operating profit was up 3% to £92.1 million or 2% up on an organic basis. The adjusted operating profit margin of 23.9% was down 180 basis points on both the reported and organic basis; as we continued our revenue investments in supportive growth, including in our digital strategy. Demand for Steam Specialties products and solutions grew significantly above global IP in the first half of 2022 and well above sales as the business expanded its order book further from its record opening position.
Demand remains strong across all regions and most market sectors. Contributions from Cotopaxi acquired in January 2022 to accelerate digital enablement journey were more than offset by the disposal of our Russian operations. We anticipate sales growth of the full year 2022 will continue to significantly outperform current four year forecast of IP. As anticipated the first half adjusted operating profit margin was 180 basis points lower due to the full-year impact of our 2021 and 2022 revenue investments, which offset the benefits of our operational gearing from higher sales [indiscernible] recently. We expect on a similar impact on the full-year 2022 adjusted operating profit margin compared to the full-year 2021.
Moving to Slide 16, ETS sales of £104.7 million pounds were up 13% organically or 18% on a reported basis benefiting from a 5% currency tailwind as sterling depreciated against the U.S. dollar. The adjusted operating profit of £12.8 million was up 9% organically and resulted in an adjusted operating profit margin of 12.2%; 60 basis points down organically due mostly to the revenue investment for growth. Within ETS Chromalox increased its adjusted operating profit margin organically driven by continued strong performance in the Americas where margins are above 20%. The profitability of the Soissons facility in France has been addressed through a consultation process. And adjusting for losses incurred in Soissons during the first half of 2022, the ETS adjusted operating profit margin would’ve been higher than in the first half of last year.
And as I mentioned already following the completion of successful field trials, the first decarbonization solutions developed through the thermal solutions synergy project, a collaboration between Steam Specialties and ETSs are now available. Collectively known as TargetZero these new and innovative solutions are designed to help our customers decarbonize their critical industrial processes including the raising of steam.
For the full-year 2022 we anticipate ETS sales growth will be significantly ahead of global IP and similar to the first half growing above Steam Specialties. As a result of the operational gearing from increased sales, we anticipate adjusted operating profit growth ahead of sales growth in 2022 with an increase in the adjusted operating profit margin for the full-year. The Vulcanic transaction is expected to close in the third quarter of 2022, following the receipt of regulatory approvals. Vulcanic’s organic sales growth in 2021 and during the first half of 2022 was similar to ETS and we expect the full-year 2022 sales growth for Vulcanic to be similar to ETS.
Now on Slide 17 Watson-Marlow’s sales of £244.8 million were up 26% organically, while the adjusted operating profit for the first half was up 21% organically to £87 million driven by strong sales growth. The adjusted operating profit margin of 35.5% was done 170 basis points organically reflecting our continued revenue investments and the recruitment of additional colleagues for our new manufacturing facilities. Supported by increasing demand for gene and cell therapy treatments, underlying demand for Watson-Marlow’s products remain strong.
Demand from customers in the pharmaceutical and biotechnology sector normalized in line with our expectations and reflecting lower COVID-19 related demand. While in the process industries demand growth was significantly above IP. Watson-Marlow’s overall order book as the half year remains above the 2021 year-end position. Sales to the pharmaceutical and biotechnology sectors grew by close to 30% reflecting increased deliveries from the significantly large order book, while sales to the process industries grew significantly above IP. Watson-Marlow continued making significant progress in expanding its manufacturing capacity during the first half of 2022. Our newly installed capacity at BioPure in Portsmouth, Portsmouth, Watson-Marlow pumps and tubes in pharma and Aflex Hoses in Huddersfield enabled almost 40% increased production output across those four key plants compared to the same period of 2021.
In 2022, we continue to anticipate around 20% organic sales growth to the pharmaceutical and biotechnology sector or for the process industry sectors we anticipate similar organic sales growth prior to the first half remaining significantly ahead of global IP. While we expect strong sales growth in the second half of 2022, the organic sales growth rate will be lower than that achieved in the first half reflecting the strong second half comparator of 2021. We anticipate that for the full year 2022 the adjusted organic operating profit margin will be below 2021, reflecting the full year impact of our 2021 and 2022 revenue investments, as well as the ramp up of our new manufacturing capacity. However, the margin will remain comfortably above 2020.
Moving on to Slide 18. We have again added three new customer case studies that help illustrate how our three businesses improve the performance of our customers and help them achieve their sustainability targets by reducing energy expenditure and waste or contributing to a more efficient, safer and sustainable world. These case studies are in Appendix 1 to 3 of this presentation, and I would encourage you to read more about them at a later moment.
On Slide 19 with a summary and outlook. The first half revenues are up 17% to £750 million or 15% growth on an organic basis driven by both volume growth and price increases. The adjusted operating profit is the first half of this year is of 10% to £179 million or 9%, up organically while the adjusted operating profit margin of 23.8% is down 150 basis points to the full-year effect, the 2021 revenue investments and the 2022 revenue investments.
The Vulcanic acquisition strengthens our ETS business and expands our platform for decarbonization solutions. And in terms of outlook our strong first half performance together with the record order books and demonstrated resilience to economic cycles is what underpins our improved outlook for 2022. If the current exchange rates at the end of July were to prevail for the remainder of this year, there will be a tailwind impact on close to 3% of sales and 3.5% are operating profit.
Overall, we expect group revenues in 2022 excluding contributions from the Vulcanic acquisition will reflect the typical split of approximately 48% and 52% between the first half and second half of this year. And we expect the full year adjusted operating profit margin in 2022 will be similar to the first half as we continue those revenue investments for growth while remaining comfortably above those pre-pandemic levels that we discussed about.
Now, that concludes today’s presentations. Thanks for signing in and for your support and look forward to catching up with all of you in the near future. Thank you.
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