Spirax-Sarco Engineering plc

Good morning and welcome to all those who are joining us on this call and on the webcast. I'm Nicholas Anderson, Group Chief Executive, and I'm joined here by our CFO, Kevin Boyd, who, as previously announced, will retire at the end of September after four and a half years on our team. Kevin has been a fantastic teammate for me and an outstanding contributor on our positive transformational journey. While saddened to see him go, I fully understand and respect the personal nature of his decision and I am very happy for him. Also with us here today is Nimesh Patel, Kevin's successor who joined us two weeks ago. We're all excited to have Nimesh on our team and I look forward to continue building a successful future for our group with Nimesh's help and support. Regarding today's presentation, I will start by sharing the first half highlights and then Kevin will take you through our financial performance. Later, I will return to cover the operations, including our half year update on the impact of COVID-19, as well as our latest outlook for 2020. To close, we'll be happy to take questions from the analysts on the call. Turning now to slide two. The outstanding efforts and dedication of all our employees worldwide were of pivotal importance to continue serving our customers, many of whom operate on the front line of the pandemic. I'm extremely proud of all our colleagues and very grateful for their engagement and commitment. Employees' health, safety, and well-being remained our top priority during the first half of this year. with rigorous new measures implemented that help keep infection rates very low across the group. Additionally, in April, we launched a global employee assistance program in the local language of all countries in which we operate to support employees with multiple issues, including mental wellbeing. Despite the significant challenges posed by the COVID-19 pandemic, The group's operational health and safety performance continued to improve across almost all leading and lagging indicators. All manufacturing and warehousing facilities remained operational, with only a few experiencing temporary shutdowns of less than two weeks, mostly in line with shutdowns mandated by local authorities. Strategic capital and revenue investments were maintained in order to ensure we do not compromise our readiness to capitalize on future growth opportunities, despite, at the moment, implementing strong cost controls and deferring non-essential capex. I am very excited by the actions we have taken to accelerate the group's sustainability agenda and performance. These include the appointment of a group head of sustainability and making a number of environmental commitments such as achieving net zero greenhouse gas emissions by 2040 or earlier. Turning now to slide three, the strengths of our robust direct sales business model, diverse end markets, geographic spread, and high proportion of sales driven by the customer's operational maintenance spend enabled our group to achieve a resilient trading performance despite the unprecedented circumstances caused by COVID-19. Once again, we outperformed global industrial production as revenues declined 5% organically, while IP declined 8% in the first half of the year. Strong cost containment actions combined with the benefits from ongoing performance improvement initiatives mitigated the adverse effects of lower sales on our operating profit and maintained the operating profit margin above 20%. Watson Marlowe achieved good sales and profit growth. A strong demand from the biopharm sector outstripped the sales decline of other industrial sectors, which are more closely aligned with movements of global industrial production. Both electric thermal solutions and the steam specialty businesses experienced sales declines consistent with industrial production declines in the main sectors they serve. Thermocoax, that joined the group in May last year, achieved double-digit sales and profit growth on a like-for-like basis, supported by market share gains in the semiconductor sector. I'll now hand over to Kevin to take you through our financial performance.

Thanks, Nick. Good morning, everyone, and welcome to my last results presentation. Nick tells me that I will miss it, but I must admit I'm looking forward to dialing in with the rest of you in March to hear Nick and Nimesh present the prelims. Down to business, on slide five. As always, the numbers we will be discussing today are the adjusted results. Details of the adjusting items are given in the appendix. Reported sales fell by 4% with an organic decline of 5%. We saw a fall in reported profit of 8%, an organic decline of 7%. The reported operating profit margin fell by 100 basis points to 20.9%. Organically, the margin fell by just 50 basis points. On a reported basis, the margin in the steam business contracted 240 bps, whereas we saw a margin expansion of 90 bps in ETFs and 100 bits in Watson Marlowe. Net finance expense reduced by 0.2 million pounds, despite the increase in facilities in the period, and we anticipate a charge in the region of nine million in the full year. The tax rate, which is based on our assumption for the full year, decreased by 100 bits to 28% due to a change of mix in both corporation tax and withholding tax. Adjusted EPS of 111.6 pence was down 7% on the prior year, less than the decrease in operating profit due to the reduced tax rate. And we are proposing an interim dividend of 33.5 pence, an increase of 5%. Finally, net debt at the end of the period was £326 million, down from £392 million at the same time last year. This equates to 1.1 times the last 12 months EBITDA. Moving to the sales bridge on slide six, currency impacts represented a headwind of under 2% in the first half. In recent weeks, sterling has strengthened, particularly against the U.S. dollar, and if July month end rates were maintained for the rest of the year, we would expect to see the headwind increase to over 2% for the full year. In mid-May 2019, we acquired Thermocoax, The additional four and a half months of ownership this year added £15.2 million of revenue. The organic decline in the steam specialties business totalled 7%, with EMEA and Asia-Pacific down 8%, with the Americas, which experienced effects of COVID later, down 3%. Watson Marlowe performed very well in the circumstances, with the growth in biopharma exceeding the decline in industrial to give organic growth of 5%. The organic decline in ETS of 12% was driven mostly by market declines in the US, a fall in the oil price, and their higher proportion of capex-related project work. This next bridge on slide 7 highlights the movement in adjusted operating profit for the half year. Exchange movements decreased profits by £4.5 million, a decline of £3.7 million due to translation, combined with £0.8 million from transaction. We anticipate this headwind will continue, and if July's month-end rates were maintained for the rest of the year, we would see a 4% negative impact on profit. The additional four and a half months of ownership of Thermocoax added £3.1 million profit. Dental costs were well controlled, falling 10%. Team Specialty's business organic profit fell 11.6 million as careful cost containment limited the drop through to less than 50%. Watson Marlowe continued to perform strongly, delivering 3.9 million organic profit growth. ETF saw a fall in profits at an organic level of 1.9 million pounds, a drop through from sales of only 18%, as we saw underlying operational performance improvements. The total organic decline in operating profit was 8.8 million, or 7%. The chart in slide 8 shows the adjusted operating profit by half year over a 10-year period, with the margin in the first half represented by the blue column. The solid bars show the reported margin for the period, while the full bar show what the margin would have been excluding the two large, lower margin acquisitions made in 2017, which, by the way, are still on course to get to group margins by 2027. This year, we expect group reported margins to again reflect the historical phasing of being higher in the second half. The reported margin in the first half of 2020 decreased by 100 basis points to 20.9%, due in part to the effects of FX. We strip out M&A and SX. The margin fell by just 50 basis points due to operational gearing effects. In the steam specialty business, the reported margin reduced by 240 basis points to 20.5% due in part to currency. Organically, the margin was 190 bits lower as cost containment could not quite compensate for the fall in the top line. In ETS, the reported margin increased by 90 basis points aided by a larger contribution from higher margin thermal coax. Organically, the margin fell 130 lips as efficiency gains and cost containment lessened the impact of operational gearing. In Watson Marlowe, both the reported margin and organic margin increased by 100 basis points due to positive operational gearing and targeted cost containment. Turning now to cash on slide nine. Free cash flow increased by £21 million, with operating profit to operating cash conversion of 86%, up from last year's 67%. This was primarily a result of lower working capital outflow, as a traditional build of inventory was compensated for, to a degree, by lower sales and the deferral of £6.3 million of tax payments, £5 million of which will be paid in the second half of the year. On a constant currency basis, including acquisition and disposals, underlying working capital percentage of sales improved by 100 basis points to 22.9%. Investment in fixed assets was ahead of the prior period. While we postponed some non-essential capital expenditure in the second quarter, we continued with a number of strategically important programs, not least the continuation of work on the new facility for AFLEX in Yorkshire. We expect spend in the full year to be at a similar level to that of last year. Acquisitions in the half year represent the payment of an earn-out on Concave, the small technology acquisition that Watson Marlowe made in early 2018. In May, we paid last year's final dividend of £58 million, an increase of 10% over the prior year. And we ended the period with net debt of £326 million. Total committed debt facilities at the 30th of June amounted to £809 million, giving headroom of around £500 million. Net debt equated to 1.1 times trailing 12 months EBITDA, and that compares to our debt covenants of 3.5 times. I'll now hand you over to Nick to take you through the operations outlook.

Thank you, Kevin. As mentioned earlier, I will... first provide an update on our markets and operations in the first half of this year, including the impact of COVID-19, followed by a summary of the key points of today's presentation, including our latest outlook for 2020. To finalize, I will open for your questions. Turning now to slide 11. This graph tracks the quarterly evolution of global industrial production annual growth rates, which we refer to as IP. As you all know, IP is the best predictor of our markets. Today, I'd like to highlight two observations. First, prior to the advent of the COVID-19 pandemic, global IP was slowing for eight consecutive quarters and ended 2019 at virtually zero growth. In the first quarter of 2020, global IP contracted 3.9% before collapsing to an 11.8% contraction in the second quarter, which resulted in an 8% contraction for the first half of 2020. Second, this latest forecast indicates a recovery starting in the third quarter, but still resulting in a 5% contraction for the second half of the year, and therefore a 6.4% contraction for the full year 2020. As hopes of a V-shaped recovery recede, we now anticipate a slower rate of IP recovery in the latter part of 2020 than we assumed back in May, or than appears to be captured in these forecasts. On slide 12, we start the review of operations with the steam specialties business, which accounted for 58% of revenues in the first half, and where organic sales and profit declined 7% and 15% respectively. All geographic segments suffered organic sales declines, with an exchange headwind expanding the reported sales and profit declines to 9% and 19% respectively. The operating profit margin fell by 190 basis points organically to 20.5%. The strong cost containment actions were taken to mitigate the adverse effect of the sales decline without compromising the strategic capital revenue investments that will support growth in future years. Despite the challenging operating conditions caused by COVID-19, customer service indicators, such as on-time delivery, continue to improve across all geographies. We remain confident in our ability to continue outperforming our markets in all geographic segments, absent a significant resurgence of the virus. Moving on to slide 13. In the steam specialties, Europe, Middle East, and Africa segment, organic sales were down 8%, with operating profit down 23% organically. Sales decline in Northern Europe were less intense than Southern Europe, where countries have been more adversely impacted by the pandemic. Sales in the Middle East and Africa region declined significantly, while gastrop. was able to maintain sales at similar levels to the first half of the year. The operating profit margin decreased 360 basis points to 17.0%, as lower sales and an exchange headwind were only partly offset by strong cost containment actions and the favorable product mix. We believe the twin issues of COVID-19 and uncertainties surrounding Brexit will continue to suppress business sentiment and act as a drag on economic recovery in the second half of the year. Moving to the Asia Pacific segment, sales were down 8% organically, while the organic operating profit was down 13%. Sales in China were down 15% in the first half, as the severe 35% contraction in the first quarter was only partly offset by a strong recovery in the second quarter when sales grew 7% over last year. Korea achieved a strong 9% sales growth, driven by the shipment of several large capital projects for the electronic and the oil and gas sectors that carried over from 2019. Elsewhere in the region, Sales contracted strongly in Japan, Southeast Asia, and India. The new gastro sales company in China celebrated its first anniversary in April and achieved significant growth in the first half, despite challenging market conditions. The operating profit margin declined 190 basis points to 26.9%. as a significant drop in sales volumes and an exchange headwind were partly offset by strong cost containment actions and a positive product mix. Absent a significant resurgence of the virus, we anticipate a lower sales decline in the second half of the year, as the region leads the return to a more normal business environment. Turning now to the Americas, Overall, organic sales were down 3%, while operating profit was up 3% organically. All countries were impacted by COVID-19, albeit to different degrees. Nevertheless, our businesses demonstrated good resilience in this large and diverse region. Organic sales were down 8% in North America compared to a good first half of last year. Most of this decline was driven by a rapid contraction of our distribution partners in response to plant closures and falling industrial production. Latin America achieved 8% sales growth organically as our local manufacturing plants remained open and serving our customers despite the increasing challenges caused by the escalating infection rates in all countries across that region. Gesture with a smaller presence in this region served primarily through distributors, also experienced an organic sales decline against a very strong performance in the first half of last year. Reported operating profit margin was down 90 basis points to 18.5%, due mostly to the strong currency headwind. Organically, the margin was up, a strong 110 basis points. The continued severity of the pandemic across this region could potentially extend its duration. So we anticipate increased business weakness in the second half of the year. Moving now to slide 16 and the electric thermal solutions business. Revenues expanded 7% in ETS as a 12% organic sales decline was offset by the additional 4.5 months of revenues from Thermocoax. Additionally, we experienced a strong order book build in the first half of the year. Thermocoax, acquired in mid-May of last year, delivered strong double-digit sales and profit growth on a like-for-like basis compared to the first half of last year. This growth was partly driven by market share gains in the semiconductor markets they serve. As with steam specialties business, Chromalox's organic sales decline was primarily due to market-driven weaknesses. Nevertheless, continued performance improvements and strong cost containment initiatives strongly mitigated the adverse impact on profit. reported operating profit for ETS was up 16%, increasing the operating margin by 90 basis points to 10.6%. In early 2020, we initiated a process to reorganize Cromlox France in order to eliminate the losses of the European operation by the end of 2021. That process is expected to complete next week and start generating savings in the balance of this year. We also completed the sale of Protrace, a small non-core heat trace engineering business in Canada that was lost making in 2019. We remain confident that all the actions taken to improve the ongoing performance in Chromalox, plus the continued good performance of Thermocoax, and The unwinding of the order book build-up in the first half of the year will result in an improved second half for the ETS business. Turning now to Watson Mall on slide 17, where organic sales grew 5% with strong contributions from all geographic regions, while operating profit grew 9% organically. A small exchange headwind increased reduced operating profit growth to 8% on a reported basis. Sales to the biopharm sector, which accounted for 53% of revenue in the first half, expanded by a strong 18%, aided in part by an unseasonal order book reduction in the second quarter of the year. Sales to the other industrial sectors declined 6%, which is consistent with the organic sales decline of the steam specialties business. The operating profit margin remains strong and increased a further 100 basis points to 32.6%, reflecting the combined effect of sales growth and prudent cost controls. In the second quarter, production commenced, at our new £23 million state-of-the-art facility for AFLEX in Yorkshire, UK, which will be fully operational in late 2021 following multiple validation processes. Also in the second quarter, the Board approved a £24 million investment to construct a new manufacturing facility in Portsmouth, UK, significantly expanding the capacity of our BioPure connectors business that was acquired in early 2014. The strong first half performance in the biopharm sector was buoyed by some customers pulling forward orders from the third quarter in order to protect their supply chain during the COVID-19 pandemic. We therefore anticipate sales growth to be lower in the second half of the year for the Watson-Marla business. Moving now to a COVID-19 update on slide 18. As I mentioned earlier, employees' health, safety and well-being remained our top priority during the first half of this year, with rigorous new measures implemented that helped keep infection rates very low across our group. All our operating companies stepped up their community engagement activities during the pandemic. supporting the vulnerable in the communities in which we operate. On our website, you can find multiple examples of these initiatives from all over the world, which make me extremely proud of our teams. With over 50% of revenues coming from sectors on the front line of the pandemic, we worked hard to ensure our sales and service engineers could continue supporting customers, most of which was done virtually. All manufacturing and warehousing facilities remained operational, with only a few sites experiencing short shutdowns, mostly in line with local government mandates. All businesses proved resilient to the worst effects of the pandemic, with strong cost containment and performance improvement measures mitigating the adverse impact of lower sales on our operating profit. The group's risk register was reviewed to reflect effects of public health crises, particularly COVID-19. This resulted in eight of the 14 risks on our risk register being updated with special attention to the mitigation plans. Turning now to slide 19, 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. For example, by reducing energy expenditure and waste. These case studies are further examples of how our robust direct sales model, diverse end markets, and continuous investments in innovation underpin the resiliency and performance of our group. However, in the interest of time, on this occasion, we have moved these case studies to Appendix 1, and I would encourage you to read more about them at a later moment. Moving now into our summary and outlook on slide 20, we are pleased to report a resilient first half performance. with an organic revenue decline limited to 5% and reported revenue decline of 4% despite an 8% contraction of global industrial production. The group operating profit declined 8% and was down 7% on an organic basis, resulting in a group operating profit margin of 20.9%, 50 basis points below the first half of last year. If July's month-end exchange rates were to prevail for the remainder of the year, there would be a 2% headwind on the translation of sales and a 4% impact on operating profit. As hopes of a V-shaped recovery recede, we now anticipate a lower rate of economic activity in the fourth quarter. As a result, we believe that organic revenue growth in the second half of the year will be lower than we anticipated in our May trading update. However, due to the operating profit being stronger than forecasted in the first half, our expectations for full year operating profit remain unchanged. And that concludes today's presentation. So we will now be pleased to take questions from the analysts on the call. I would request that before asking your questions, please state your name and that of your organization for the benefit of others on this call.