Bodycote plc (BOY) Earnings Call Transcript & Summary

Hello, and welcome to the Bodycote Trading Update. [Operator Instructions] Just to remind you, this conference call is being recorded. I'll now hand the floor to Stephen Harris, Group Chief Executive. Please begin your meeting.

Good morning, ladies and gentlemen. Stephen Harris here. I am with Dominique Yates, Chief Financial Officer, as usual.

Good morning.

So we're going to just take you through this trading update from the top. This covers the 4 months to the end of October. And if we start off with the headlines here, basically 8% higher at constant currency for the period, and that's 7% constant currency up for the full year year-to-date. Overall, the business underlying, I think, the fundamental is very strong. Things are moving ahead. There's one bump in the road, which we'll talk about in a minute, and that's in automotive. But overall, we're seeing quite nice growth pretty much in every other place other than automotive. So let's just dive in without further ado onto the automotive issue. So we are actually looking at a modest downgrade on our automotive expectations for the full year. What we are seeing is quite a weak Q4 coming up, I believe. We said quite clearly that we thought Q3 was going to be down, but Q4 would be quite strong and covering over for Q3. And I know that in many areas, people said, "Well, why are you so confident of that." I think the issue there was that we were quite confident because we were told that, that was the case, particularly in North America. And as it's turned out, it's North America that is the weakest part of the piece. In fact, our European automotive revenues are flat. And the total problem that we've seen is actually in North America, and it's all about supply chain issues. And funnily enough, the one OE that actually told us that they were going to be strong in the fourth quarter turned out to be the weakest. Such is life. I think everybody was caught out, particularly the North Americans were with the Asian supply chain issues, particularly in Southeast Asia. And indeed, I've talked in the past about tooling sales being a leading indicator for car and light truck. And this is a car and light truck issue, by the way. It's not all automotive. Heavy truck and bus is up quite a bit. But car and light truck is where the weakness is. Tooling is a leading indicator. And indeed, we saw tooling rising. So there was -- in Q3, there was quite an expectation for sales in Q4. But in fact, it's come up short, we won't be able to catch up, and our customers are not able to catch up, particularly the one in North America. But around the piece, the rest of the automotive business is actually staying well ahead of the decline. I mean we've got flat sales pretty much everywhere there, and slight rise in the emerging markets, except for Mexico, which, of course, is the supply chain for the U.S. and there it's off 50%. Just moving into that in terms of a forward look. This is not an absence of demand. This is purely a supply chain problem. And therefore, one would expect the sales for this business actually to just move to the right. The unknown for us is when it will start picking up because indeed, that will require some resolution to the supply chain issues that are there. Certainly, customer demand is extremely strong. You've seen that with the sales of second-hand cars, for example, people just can't get new cars these days. And so it will come back and it will come back strongly. Whether we will see that, I'll call it, bubble hit into 2022 or move into '23 depends on the timing of the resolution of the supply chain issues. And that's something that we can't tell at this point in time. Moving on to the rest of the business. Actually, it's sort of lots of ticks in the box and good news elsewhere. Civil aerospace revenue is up 25%. And this activity is starting to build. It's doing quite well. And indeed, Europe is strong at the moment, but the U.S. is accelerating. It's also strong, but not as strong as Europe, and it's accelerating. General industrial, it's a very good story there. So it's almost back to 2019 levels, lots of parts of GI kicking in strongly, very few parts that are weak. In fact, just looking at it, it's very small segments for us like rail that are weak, everything else is very strong. So GI is doing well. Emerging markets, they grew 4% in total. So that's a result of the GI side as much as anything else counteracting the Mexican downgrade in automotive. And nicely, specialist technologies, they grew 10%. They are continuing to outperform the classical heat treatment side of the business. One of the big questions on people's minds, I think, has been what about inflation, and the big cost inputs for us, obviously, are energy and labor. And I'm happy to say that we're doing quite well in that area. Even though there are significant energy price increases right around the patch, we're covering those. We cover them with energy surcharges. They've gone in immediately, and we're well ahead of the game there. And labor inflation, we've got price rises going through to cover that as well. So definitely covering our costs on the inflation side, so no problems there. And our cash flows, as usual, are nicely very strong. In terms of the outlook, too early to say really what the short-term outlook is past the end of the year. So into '22, it's a bit difficult to call. But into '23, I think we're looking at quite a strong growth in the business in '23 for sure, maybe a little bit earlier coming into the second half of '22, we might get some good growth there, but we can't call that just yet. So overall, the outlook, I think, is very strong, but that's into '23. With that, we'll open it up for questions.

[Operator Instructions] And our first question comes from the line of George Featherstone at Bank of America.

My first question would be in civil aero. I wonder if you could give us some color on the change in inventory levels in the supply chain compared to H1? And if there's been any change in your expectations about when these will normalize?

Yes. Sure. George, the change in the inventory levels is something that is quite hard to call in detail because it's quite a spread out supply chain, as you would imagine. What we are seeing is the piece of the supply chain that's closest to the OEs -- so this is getting towards the final assembly side on the engines, which is the biggest exposure we have. There, certainly, production levels are picking up. They don't have a lot of stock that's starting to be eased out. There's still quite a bit of inventory at the very beginning of the supply chain, which is the raw forgings and castings and that is to be the last part of the supply chain to actually move up in terms of revenues, and they still have a little bit of stock there. But overall, it's not anywhere near what it had been like at the end of last year. And as the 737 MAX starts to ramp up here, then I think you'll start to see things moving quite quickly. It's notable, though, I think you're probably well aware of the fact that both Boeing and Airbus are both saying they're going to sell a huge amount of planes. And if you add the 2 together, it's more than the likely demand is out there. So one of the guys is going to win and one isn't. But for us, we're ambivalent. We're on both platforms. The big narrow-body platform that we're on is the LEAP and whether it's a 1A for Airbus or a 1B for Boeing. It doesn't matter who got it. In some ways, we'd rather Boeing get it because there are more LEAP engines going on to the Boeing platforms than there are on Airbus. Because the Airbus platform is shared with the Pratt & Whitney, which there's not a lot of work out-house there. They've got a lot of it in-house. hope that answers your question, George.

Yes, it does. And my second question would be on the energy costs that you mentioned earlier. I just wondered if you could remind us the proportion of your cost base that's related to energy. And I know you mentioned surcharges, but any other mechanisms you have to offset how cost inflation into 2022?

So historically, and this is an average across our business and does vary in certain parts of the business, but as an average, our utility costs, energy costs are around 10% of revenue or an 8% of our cost base.

And in terms of other ways of mitigating it. I mean, clearly passing the cost onto the customers is easy to straightforward in many respects for us as a company. I shouldn't say easy, it always takes difficult negotiations, but it is straightforward for us. In some respects, the higher energy prices drive a little bit in the direction that we were already going, which was to try and move into far more energy efficiency. It helps our carbon footprint in the first place. So that's a journey that we were already on. And the actual higher prices that are out there make a lot of the projects just that much more beneficial in terms of return on investment. So we are doing that. But that, of course, is a longer crop as it were.

And our next question comes from the line of Andre Kukhnin of Crédit Suisse.

Sorry, I have to go back to automotive just to understand the trends a little bit better there. Firstly, on Europe versus North America, looking at the at least car production rates from IHS, those saw equal sort of amount of downturn over the year period of July to end of October. In fact, I think Europe was actually a bit worse. Could you talk about what drove your outperformance in Europe? And do you view that as sustainable? Or is there a kind of gap in terms of timing between what we see in car production rates and your demand?

Yes, Andre. So yes, it is interesting. It's an interesting question. Clearly, the European performance is outperforming the background market. I will say this, actually, our North American performance is outperforming the background market, too, as is our emerging markets. So we're doing better than the background market right across the piece. It's just that the North American side is much weaker in terms of the specific OEMs that we are dealing with. So do I think it's sustainable? My belief is that this is going to start to resolve now. And certainly, the supply chain issues are slowly resolving. There's a lot of chatter about the fact that semiconductors, in particular, won't reach "market demand" until the end of '22 or into '23 even. But I think what we need to understand is that even getting towards market demand still implies growth. And there's quite a bit of growth there. It's just the market demand is so much higher than the background supply at the moment. So sustainable is not a term I like using very much. Do I see it getting worse? I don't think so. I think it's probably on an improving trend. But clearly, I've been wrong once on this. So who knows. I hope that answers your question, Andre.

Yes. Yes. And just second one on this. And I know you don't like going through monthly cadences too much, but I just wanted to understand the shape of it, what you said about tooling as a lead indicator. You said it turned up, but came short. So kind of what was the shape for you in North America? Was it kind of down from July onwards, and we are flatlining at this? And there is a lead indicator that tells us that it should tick up but not enough? Or is there a different shape to it?

No. I think they need to understand what tooling is all about. I mean, basically, the tooling is required for production, and they need to tool up before they produce. And whilst they're producing, they need to renew their tools. So we saw quite a surge actually in Q3 in tooling. So there was a big expectation that production was going to climb. And it slowed down, but we're only talking about October. It slowed down into October, but it's still growing. I mean it's still up in the reasonably high growth in October, high single digits. So there is an expectation in the OEs for sure that their production is going up. And indeed, the comments out of Mary Barra at GM, which is particularly important for us, of course, is that they expect their volumes to rise significantly in Q4. just not back to where they thought they were going to be. I think that's the big issue. So yes, the tooling is actually a judge not of output, but of the OEs and production outlook.

Great. Great. That's very helpful. And last question, just in terms of any cost action, could you just remind us where we are on that? And are you planning anything in relation to this kind of near-term demand volatility?

So I think, in some respects, this is business as usual for us. So we're always on the costs. It's a full-time job managing costs. I don't see this as anything exceptional. We're not into closing any plants down or mothballing or anything like that. This is just carrying on in terms of managing our labor and energy costs, which are the big inputs, closely. So I don't see any more restructuring if that's where you're going. And the restructuring program that's already in place is actually coming nicely to a close, and it's all as expected.

Our next question comes from the line of Michael Tyndall at HSBC.

Two, if I may. Emerging Markets, up 4%. Am I right in thinking Mexico within that was down 50%. So I'm guessing the rest of emerging markets was very, very strong. So I wonder if you could maybe point out some of the highlights there. And then the second question, I know you've mentioned to us in the past that PMI is not a good indicator of the direction of your business. And really, it's a question of looking at your business in aggregate internally. I'm just wondering if given all the supply chain issues we're hearing about, what does that internal barometer look like at the moment? Is there any sense that customers are looking to kind of start to build inventory to try and compensate for the supply chain issues?

Yes. Okay, Mike. I'll tackle the second question first, if I might, that's about inventory build, if you like. We don't have evidence at the moment of inventory build going on. I mean the inventory build would occur if people had sufficient supply to be able to build inventory. And in fact, they don't. At the moment, what we're seeing, and there will obviously be some exceptions to this, but what we're seeing generally, I think, is that people are shipping as soon as they can get enough components in to be able to build. And indeed, we've even got -- the automotive industry is the one that's suffering the most from all this, as I think, as everybody knows. And we've got supply chain members, Tier 1s and Tier 2s, actually sharing components in order to try and keep the production lines flowing of the OEs, which is a first. I've never seen that before. So they are sharing it around. And so you're not seeing a build of inventory because it just flies out the door as soon as you've got it. General industrial, more of a mixed picture, but I haven't yet seen any strong signs of anybody actually stocking up. They're still quite lean and shipping as fast as they can get their hands on stuff. Aerospace is on a build. They've got a little bit of inventory as we've always said. So I guess that's it. And as far as emerging market is concerned, I'll let Dominique take that.

Yes. So I think it's fair to say that where we were -- first of all, it's worth mentioning that 2/3 of our emerging market business is automotive. So inevitably, that business across emerging markets hasn't been immune to the supply chain issues that we've already been talking about. So China, which is predominantly automotive, the growth there was weaker. But where we have a sort of a greater balance across the business or where general industrials are a significant proportion of the business, then we've shown very strong growth and general industrial revenues in emerging markets were up 27% in that 4-month period against last year. So it's a mixed bag, but really driven by where the automotive mix is.

Just to add to that. I mean, currently, trucking in China, I mean it's up nearly 7% there. So it's weaker growth, but it's still kicking in there.

Yes.

And our next question comes from the line of Robert Davies at Morgan Stanley.

My first one was just, I think, on U.S. labor availability. Just given your order production comments, I think from Mexico into the U.S. and GM, just be wondering, is that a particular pinch point or not something that's really been a significant issue through the quarter?

Sorry, Robert, could you just explain the question on the pinch point, I didn't quite understand that.

Sorry, just in terms of your labor availability given that labor and energy are one of your 2 major costs. So just wondering how big of a fact there getting older people in the U.S. was for you at the moment.

Okay. So not a problem in Mexico right now, I don't believe. The U.S., it's quite interesting. I mean you can read in every U.S. newspaper about labor shortages. In fact, obviously, over there quite recently, just anecdotally, you drive down the road and every restaurant is hiring. But one of the things is labor is certainly very short in the U.S., particularly in people facing jobs. Less of a problem in factories as it were, where you don't have to see strangers all the time. And that's obviously a COVID effect, I would think. Nevertheless, there is a shortage of labor, but it's manifesting itself, not in the lack of people totally now, but it's eased a little bit, but certainly, we're seeing the labor inflation in place in North America and the U.S., and that is driving up wages for sure.

And then my follow-up question is, just wondering with all the sort of disruption in the market in the last 12 to 18 months, whether there are any new segments that you're looking at in terms of potential acquisition targets. Has that brought more distressed assets to the market or forced people to family owned businesses to sell? Are you seeing any change in behavior from sellers?

Yes. Initially, there was certainly a PE lunch for the market. I think that the asking prices were crazy high. So not much happened there. But as time has gone by here since the beginning of the pandemic, we are starting to see more assets coming on the market. And a couple of them seem to be relatively good, more in terms of specialist technology targets for the industrial and classical heat treatment. What's happening in the classical heat treatment side is that there are distressed assets, but the ones we've looked at are not very good. I mean there are a couple of reasonable ones out there in terms of size, but they're not very good assets, not something we would want. Anyway, somebody will buy them for sure. But as I said, some small players in specialist technologies that, who knows, with the following wind, maybe we'll close something off there. But it always takes 2 to tango in these things with acquisitions.

Great. And then maybe just one final one, if I could. You mentioned I think China order was a big exposure in that business. Just outside of auto. I don't know if you have much general industrial in China, just to be kind of interested, there've been very mixed data points recently. Just if you could shed any color on your China business ex auto, if you could?

Not a lot of color really. I mean it's GI business. Dom, do you want to add anything?

Well, I'd say whatever we're doing in China isn't going to be representative of general industrial in China in any way because it is a tiny business in the context of our overall business. So...

Our next question comes from the line of Dominic Convey of Numis.

I guess just trying to explore a little bit more about the new guidance for the full year. Statement states that H1 -- so second half revenue shortfall of up to GBP 10 million. I just wonder whether you could give us a little bit of clarity about what assumptions explicitly you're making about Q4 auto volumes relative to Q3? And thereafter, how we should think about the drop through, given that I think you said you're treating this really as ordinary course of business, therefore, no extra measures on the cost actions. And I guess an alternative way to frame this would be, where you now expect second half sales and profits to land relative to the first half?

Just a quick note on the volumes. I think we will see stronger volumes in Q4 than we saw in Q3, just not enough to make up the hole that has arisen actually. And Q3 was always going to be lower. We just expected Q4 to be higher and Q4 volumes will be higher. They are going up at the moment, albeit relatively slowly. So in terms of more detail on that in terms of the full year guidance, I'll let Dominique take it.

Yes. So current consensus is around GBP 628 million, which is more or less where we thought we would be when we came out with our interim results. So if you take GBP 10 million off that, that gets you to GBP 618 million. At the time of our interims consistent with that revenue, we were looking at a headline operating profit of GBP 100 million to GBP 101 million or so. So with GBP 10 million off that or the 50% or so drop through, you get to the GBP 95 million to GBP 96 million headline operating profit range, which is where we're now anticipating to come out at the end of this year.

Our next question comes from the line of Sanjay Jha of Panmure Gordon.

I just wanted to check whether -- in the last few months, we have seen quite a shift, especially in Europe, towards battery/electric vehicles. And I just wanted to see to what extent do you think your customer base is being impacted by that? And how do you see that panning out next year?

Yes. So the shift to electric vehicles, I mean, it is starting to pick up more for sure. We are seeing the impact of it mostly in our Eastern European business at the moment. And is it negatively affecting our customers? Not that I can see. Not at this point in time. There's too many other things going on to be able to pick that out of the mix. But our potential exposure to the EVs, when they get bigger in volume, is certainly looking quite good. We've done quite a number of requests for quotation. And these things take quite a few years before they get into production from the original RFQs. I think an interesting point, Sanjay, though, is that -- and I think it surprises me as much as anybody else, is that the size of the vehicles that are turning electric is quite interesting. I never expected to see an electric F-150. But there is, it's there. I mean, we've had a few issues in terms of helping them get their production lines going. But a larger vehicle than I expected to see at this stage of the game in EV. But yes, definitely, the trend should be positive.

Our next question comes from the line of Harry Philips at Peel Hunt.

Just a couple of questions, please. The first is just trying to get sort of some clarity maybe around 2022, and what you're suggesting at the outset, Stephen. I was just trying to interpret it. I don't have any pain points or anything, but just trying to interpret what you were saying. Basically, also a part you should see good growth, I mean, GI just kicking along well, recovery in aerospace and so on. We can look at IHS or BAS. IHS' forecasting has been even worse than mine in the last 18 months, but should we use IHS as a sort of crude rule of thumb for where auto might go? And then secondly, just particularly around LEAP. I mean, there was a big finished engine inventory with Safran for a long time. Just how do you see that. Are you actually seeing a reasonable uptick in Safran volumes of yourselves at the current time?

Harry, yes. So reverse order. First one, the aerospace Safran. So I think the answer is, clearly, the European sales are doing quite well. But we have to remember that the -- and by European, I mean the Airbus LEAP 1A sales, they're doing quite well. And I think the LEAP-1A inventories are the ones that are most down. And that's because the 737, which is the other side of the pond, is moving, but not as fast yet, but it's expected to start moving very, very fast soon. And don't forget the LEAP-1A and LEAP-1B are built both sides of the Atlantic. So the cold sections are in Europe and the hot sections are in North America for the 1A and the 1B. So the growth we've seen so far is primarily driven by the 1A with the acceleration coming quite strongly now with the 1B coming through. Inventory is declining, I think. I can't give you much more color than that, actually. The next part of your question, I think, was the automotive and the shape going into '22. And I think one could look at the fact that demand hasn't gone away. There's still a requirement for all these components that just aren't coming through the system at this point in time. So it moves to the right. And the question is, at what point do those components become available? One can imagine that if they -- fantastic, if they became available by December 31, then 2022 would be a very good year. I just don't think it's going to switch on that fast. And most of the players are talking about delays in getting enough components to really start moving here sort of in the Q1, Q2. But it is a real gambling game at the moment people don't know and because it's a global supply chain issue. And people have been caught out. They thought that the components were being manufactured and then they just couldn't get them on the containers and into the port. And then they had COVID hit the component manufacturers. So it's a very, very difficult one to call. IHS, it's not my favorite, if I can say that. Harry, I wouldn't use that, but then I have other tools. And if you could repeat the third part of your question? If there was...

Yes, it's just more generally, I only say, auto has the uncertainties around is about visibility, as you've just been outlining. But elsewhere in the business, the sort of growth prospects for '22 sort of remain unchanged from where you anticipate at the half year, and if anything, you could argue that aerospace may be a fraction ahead. I just wanted to be clear that for '22, beyond the debate around auto, nothing has really changed in your thoughts and expectations around that.

Correct.

Our next question comes from the line of Jonathan Hurn at Barclays.

Two questions from me, please. Firstly, can we just come on to margin? Obviously, you have an aspirational target of getting group margins to 20%. Is that more a '23 possibility? Or do you think there's a chance that, that could actually come through in '22? That was the first question.

Okay. Margin question. The margins are actually pretty decent at the moment in terms of where they've come from. They're moving ahead. The hitting in '22, I don't think so. I think that this 20% number that we've been talking about, it's more likely to be a run rate that we hit probably in the back end of '23, to be honest with you. So I'm not saying that we're going to be there in '23 for the whole year. But by the time we get into the second half, fourth quarter, we would hope that we'd be hitting that as a run rate.

That's very clear. And the second question is just on specialist technology, obviously, 10% growth. Can you kind of break that out where that growth is coming from? And how do we think of specialist technologies in '22? Obviously, as aerospace starts to pick up, can we expect that growth rate in specialist technology to essentially accelerate from where it is right now?

Yes, I think that's a good call. So certainly, our stainless business, S3P, is continuing to march ahead. I mean, it's astounding. It's hardly touched by any of these other issues going on, which is what you would expect in many respects. But even this automotive exposure is still marching ahead and doing very well. The HIP services, which is a big chunk of specialist technologies is the piece that is most exposed to aerospace. And indeed, as aerospace accelerates, that HIP services business will do well. HIP services is mostly on the front end of the supply chain. In other words, the real castings and forgings. So that's where most of that work is done. There is a little bit at the other end, but mostly at the front end. So that's longer to recover in terms of the turn up because you've got to burn off that inventory that's at the end of the supply chain. So the good thing about HIP services is of all of our businesses, it has the highest drop-through. It's because the costs in HIP are more fixed than the others. And so when that does turn up, that will help boost the margin that we've been talking about.

Okay. Great. And then maybe just one final one. I know it's a very small end market for you, but it wasn't mentioned in the study, just energy. What are you starting to see there? Are you starting to see a pickup coming through in where you have exposure to energy?

Yes. Well, energy for us is in 3 pieces. One is industrial gas turbines. And there is growth in industrial gas turbines. Another one is power generation, and that is in decline for us. Part of that is deliberate, of course. And we've been withdrawing from these sectors. And then the third part, which is the one that people are most focused on, is oil and gas in terms of onshore and subsea. The subsea piece, there are projects mostly for gas that are being let, and we're doing quite well in that fairly successfully. But it's a small business in group context, as indeed is the onshore oil and gas. Onshore oil and gas is actually mostly exploration exposed as opposed to production. And there, we are in decline. We've actually withdrawn from a significant part of that business anyway. But the characteristics on the energy side are that if the energy prices are high, then production is the area where there's demand. Not many people are expanding on exploration. So exploration is down quite a bit, actually. But overall, it's a small part of our business these days.

We currently have no further questions in the queue. [Operator Instructions] And the next question comes from the line of Margaret Schooley at Stifel.

Stephen, Dominique, just 2 very quick questions from me. First of all, within general industrial, which was particularly strong, is there any particular subsegments that stand out? I know medical has been quite good through the year, but if there's anything that you can highlight to us that's looking particularly of interest? And then the second question, I know we talked about M&A, but are you starting to see any traction or movement as companies stop firefighting and emerge from the crisis in terms of outsourcing. Has there been any further indication that perhaps that could be looking more bright as we move through FY '22.

Yes, the outsourcing question is pretty easy. I think everybody is so tied up with trying to get production going, they don't have time for outsourcing. Yes, they're just fighting like crazy. In terms of the general industrial sector, there's stand out issues. I'm just looking -- medical is not growing as strong as some of the others at the moment, sort of general manufacturing and machining seems to be doing quite well. And funny enough, so is agriculture. So yes, medical is doing okay, it's just that the other ones are starting to pick up, frankly, and doing very strong to step.

And as there are no further questions coming through at this time, I'll hand back to our speakers for the closing comments.

Yes. Thank you very much, everybody. Appreciate your time and hope to see you shortly.

This now concludes the conference. Thank you very much for attending. You may now disconnect your lines.