Bodycote plc (BOY) Earnings Call Transcript & Summary

Welcome to today's Bodycote 2021 Full Year Results Presentation. My name is Jordan, and I'll be coordinating your call today. [Operator Instructions] I'm now going to hand over to Stephen Harris, Group Chief Executive, to begin. Stephen, please go ahead.

Thank you, Jordan. Hello, everyone. If somebody would've told me even a month ago, this -- in this day and age, we would be witnessing what's going on in the world right now, I would have questioned their sanity. It brings to mind that song back in the 80s, live on TV, you can watch them die. Watching this tragedy unfold right before our eyes makes it deeply personal, and our hearts go out to everyone touched by it. Let's move on to the business of the morning if we can. From a business perspective, just let me clarify, Bodycote has no direct exposure to Russia, Belarus or Ukraine. And at least some of our customers are likely to be impacted, and I will try to bring out those relative items as we go through the presentation this morning. Dominique and I will be taking you through the business. I will try and cover what we believe may be on top of shareholders' minds first, then Dominique will take you into the financial review. And then I'll come back, we can look at the business. Finally, we'll open it up for Q&A. So if we go to our highlights, I think it should be no surprises in these numbers. If there are surprises, they should be pleasant surprises. Basically our revenues are a little bit less than we told you that we were probably going to get to the trading update last year. and our margins are a little higher. And all in all, that brought us to headline operating profit pretty much on the button as to where we suggested it would be. Very good free cash flow, as you can see, and we've got closing net debt to GBP 52 million. Now on this highlights slide at the bottom, because of the relevance of this in the world today, I'll just clarify for everybody, when we talk about emerging markets, what emerging markets are for us. And they are arranged in order of size down there at the bottom of that final slide. In terms of dividends, I'm pleased to say that we are -- actually got an increase in dividends. It shows our confidence in the future. And we're basically going to be recommending that we have a total year dividend of GBP 0.20 with an ordinary dividend of GBP 13.8. Now the strategic progress bullets on this slide we'll be covering as we go through this presentation. So you'll see these items coming out as we move forward. So let's move to the first item that I -- well, Dominique and I believe are the kind of things that you're interested in. So we'll go to the strategic progress items first. So if we look at what we've been doing in the year, our energy and carbon reduction program is gathering pace. I'll remind you that Bodycote is primarily an energy and people manager. This is what we do every day. Our restructuring program completed successfully in the year, a nice result, and we refocused our Western European business on the higher-quality opportunities. And in doing that we've transferred equipment around our footprint, both within Western Europe, but also into Eastern Europe. And what we've done is target the capacity where business is more flexible and prospects growth is stronger. Just to point on our capacity, we've preserved our productive capacity. We have less sites but our productive capacity has been preserved. And if you see what we had in 2019 and the fact that we were -- only in 2019, we were only at somewhere about 60% utilization. We have a lot of spare capacity, and that's quite important, and I'll come back to that later on in the presentation. In doing this, we've increased our focus on emerging markets' investments, particularly on the automotive electric vehicle projects -- and we opened 3 new facilities in the year, one in emerging markets. And basically, the one in emerging markets was in Hungary. If we look at the -- by the way, they're all in the early ramp-up phase, so they aren't generating profits at this point in time. Moving on to Specialist Technologies. So we've continued our investment in that. Two of the main points of that are, we've got a major expansion of 1 HIP plant. That's in North America. And we also have 1 new HIP plant nearing completion, that's also in North America. And the final point, we did actually make a small acquisition in December. That, in fact, is a HIP business, and that's in Switzerland. So let's move on to something that a lot of people have been asking us in recent weeks is what about inflation. So let's talk about what we do in Bodycote day in, day out. The cost inflation in 2021 was passed on successfully. And we have the usual lags. And so let's go through the mechanics of this. So Significant cost inflation in energy and labor impacted Q4 profitability, and we think that will continue into early 2022. If anybody's got different opinions on that, please let me know. But that's what we think. So the way we deal with energy cost increases is that we use them with surcharges, particularly when the highly volatile energy market. Or we've got contractual indexation. So about 20% of our business is managed by a long-term agreement that has built into a long-term agreement contractual indexation for labor and energy. Those are there and some of them will last next 15 years or so. What it means is that there's no chance that the inflation won't be passed through. It's just a question of timing. Labor cost is a little bit different. So when you get labor costs, when the company sees that -- certainly the major form is when the pay reviews take place. And basically, in our business around the world, those pay reviews take place between first of January and September with the vast majority being in April and May. The labor cost inflation, we address through price increases or contractual indexation. And so we know when the labor cost is going to hit us, and we go to customers and we ask for price increases. Typically, we buy energy forward a quarter in advance. This is what we do every day. surcharges and price increases typically take effect in 1 to 3 months. You can't just immediately tell a customer -- sorry, your surcharge is now, whatever it is, you have to give them some leverages. So typically, if you give them a surcharge now, there'll be a 1 month delay on that. And price increases, when you notify them on the price increases, they typically need 3 months for those. And that's important because the price increases are something that we have notice on because it's trying to cover our labor and the surcharges are things we don't have notice on. Just to make sure everybody is aware, we started with surcharges and price increases back in September. So we're already in motion in covering this current period of probably the most volatile inflation we've seen in a long time. And just going back to contractual indexation, that lags cost impact by about 6 to 12 months. It varies, but on average, it's 6 to 12 months. Going on to our ESG strategy. So very timely in some respects. So the biggest impact for Bodycote in ESG is climate change. One, because we use energy and two, that managing climate change in energy and carbon is actually good for business. So we have committed to the Scientific Target initiatives, and we intend to publish our 5-year targets later in the year. Our environmental strategy is based around reduction of carbon emissions as we have got no other emissions in that. We are not only reducing our own footprint. That's something that is fairly straightforward to do. But we're also helping other companies with their footprint. And the reason for that is, as a specialist in this area, Bodycote is effectively, as I said before, a manager of energy and a manager of people. And we've got inherently high utilization and more energy-efficient processes than typically captive or in-house facilities. So customers who outsource their work to us often get a 40% reduction in their carbon footprint and read Energy. So with that, I'm going to hand over to Dominique, who is going to walk you through the financial review.

Thank you, Stephen, and good morning, ladies and gentlemen. Chart 9 summarizes the group's financial results. So revenues grew 3% at actual rates, up 7.1% when you take foreign exchange movements into account 7.1% at constant currency. And it's not on this chart, but stripping out Ellison, which was acquired in April 2020, organic constant currency revenue growth was 5.2%. I'll come on to discuss the increase in profitability in our cash flow performance later. In the meantime, I think it's worth noting that margin increased significantly from 12.6% to 15.4% at group level. And again, I'll come on to look at the divisional margins in the slides to come. Return on caps employed also improved reflecting the improvement in profitability. Again, the increased profitability and earnings, the Board has decided to recommend an increase in the final dividend from GBP 13.4 to GBP 13.8. And bringing the total dividend for the year to GBP 20 and the final dividend will be paid out as usual in early June. Chart 10 shows the headline operating profit bridge. Stephen's just taken you through the impact on our business of the cost inflation that we are currently experiencing. Overall, for 2021, we, again, recovered the impact of inflation across our business through pricing and this is in spite of the price lag effect on our business that Stephen has already described and which was certainly having an impact on our results towards the end of last year. Organic revenue grew 5.2%, which translates into GBP 30 million last year. But with good drop-through and cost savings from restructuring, this translated into a GBP 43 million contribution to operating profit. And the chart also shows that having canceled our bonus in 2020 as an immediate cost saving measure in the face of the pandemic. Variable pay returns to the P&L in 2021. Chart 11 shows the divisional split. And unsurprisingly reflects in part the different experiences of the 2 divisions in terms of revenue development with AGI revenues up, while ADE's revenues were down versus 2020. Analyzing this a bit deeper on Chart 12, you can see that we've juxtaposed here the 2 divisions' organic revenue and operating profit development since 2019. Looking first at ADE. While we saw positive development on civil aerospace revenues in the second half of the year, overall revenues for 2021 was still below 2020's. Nonetheless, cost savings from the restructuring program and other efficiency gains allowed for a 3 percentage point increase in margins. As revenues come back, we would expect to see good drop-through and strong profit and margin development. Looking then at AGI. You can see here that AGI's revenues have already partially recovered during the year. Consequently, with the positive drop-through from this revenue increase, combined with savings from restructuring, positive revenue mix and other efficiency gains, AGI margins were up 7 percentage points. And profits were actually above 2019's levels. On Chart 13, once again, we had strong cash flow performance with free cash conversion at 111%, which is excellent and working capital levels back to normal levels back in '21. The next Chart 14, looks at how we use our free cash in order of priority. So it's there to support profitable organic growth, primarily then paying our ordinary dividends. investing in acquisitions, aligned with our growth strategy; and finally, returning any excess cash to shareholders. On Chart 15, then taking a look at the balance sheet. Net debt is at GBP 52 million. That's after we paid GBP 49 million of dividends in the year and the remaining GBP 58 million for the Ellison acquisition. We've got plenty of liquidity and more than 4 years still left on our credit facility. And our headline tax rate at 22.3% is in line with guidance. Finally, based on current exchange rates, today's exchange rates, we would face all things being equal, GBP 2 million negative headwind on the headline operating profit from the strength of sterling versus last year during 2021. And now back to Stephen.

Thank you, Dominique. I'm just going to change the slides here go back. Thank you. So we're on Slide 17. This slide I've put up there is really just a summary slide, and it shows you the comparative shapes of the revenues and sizes across our main areas. And you can see the general industrial slide there heading north. I can remind you that general industrial of all our areas covers pretty much everything. We've actually lumped the energy in there for now because energy is so small, and you'll see that later on. And the general industrial curves, they move quite slowly. They don't move quickly, and when they keep going, it takes a lot to turn. That's not to say there's not a lot going on right now. Automotive, you can see a smaller amount. And then aerospace and defense, you can see what's happening there. So let's go to general industrial first. And here, you can see that general industrial makes up 49% of the total revenues of the group and 8% of that is energy. Year-on-year change, 10% increase. And the pleasing thing about this is that, as I said, General Industrial does not move quickly. It comprises so many different segments. And the exit rate for the year is already above the pre-pandemic levels. Initial recovery was actually funded out of the operating expenditures as customers' production lines switch back on. Some people don't realize that there's a significant part of our business that actually is OpEx related. And now we're actually seeing additional revenue growth as the CapEx cycle ramps up, and that's what I'm going, and that's very pleasing. Just a point to note here that if anybody needs to move in a hurry in the next 2 years, because that's how long it takes to lay down capacity in this business in this industry, but if they want to move in a hurry in the next 2 years, they have to go to where the capacity already exists. And Bodycote has a lot of capacity in the world. And I have to say we've got spare capacity and lots of it. Moving on to Automotive then. This is quite an interesting situation. You can see the shape of the curve there in the sequential downturn that we've been seeing in Automotive. And of course, everybody is pretty aware of the supply chain issues there. And for short time, people been saying chips, semiconductor, but of course, we all know it's not really just chips. This is supply chain issues right through the supply chain. And it's all kinds of stuff. Yes, I think everybody can remember the ships on the West Coast of the U.S. lined up for hundreds of miles trying to get into port to bring in product after the pandemic freeze down and trying to get the supply chains moving again has been a laborious effort. And what we see today is that those supply chains are actually easing. In fact, we've got quite a few indicators that supply chain is starting to be available. Some people might say, well, does that matter in the current environment? Well, we watched this area a lot. We have various signposts that we look at, including stuff that's published to the general -- the outside world, which I'm sure you folks are all familiar with, plus also, of course, the information that we get directly from our large customers. And I have to say that even as we sit here today, the signposts are indicating, particularly in North America, that Automotive is moving north, which is a staggering thing. But if you all recall, it might be somewhat different the kind of crises we're in today. But back in the pandemic, we've been through sort of sharp changes in Automotive. And the indicators we got then were very accurate. Are they going to be different now? I don't know. All I can tell you is that one thing the price of gas here at the petrol pump in the U.S. was similar to the prices a little bit lower that's similar to the prices that we have today. the amount of gas guzzling 4x4s and pickup trucks didn't even dent. And right now, the indicators are that, that's carrying on. So moving on to the growth in China. So we had very good growth in China and all throughout the 16%. And as a result, China is now 10% of our Automotive revenues. A reminder that our Automotive these days it's either platform agnostic or we're targeting electrical vehicles. And we've got -- most of it is platform agnostic it doesn't matter what kind of vehicle it is, you still need to have steering gear and running gear. I mentioned the significant pent-up demand for new vehicles. Now the semiconductor situation isn't completely out of the woods yet, clearly. But it's quite interesting to see what's happening in terms of new car build because there's a tremendous demand for secondhand cars or has been up to now. And the OEs -- the OEMs what they've been doing is taking all the extras out of the car. So you can't get the heated seats or your heated steering wheels maybe. And they're basically offering standard systems so they can conserve the amount of electronics and semiconductors they have available and put them into the vehicles that are best use. So you still got a lot of productive capacity in automotive, and the real question is do people want to buy it. And it would seem to be, at least in North America, the answer is yes. So in total, the automotive business, our Automotive business, we spent the last 2 years really streamlining it and positioning it for growth, particularly in electric vehicles. And I think we're in a very good place on that. So aerospace and defense. This is a very interesting at least for me, area. So we've seen progressive improvement through the year. but it's still down 34% compared with 2019. Civil aerospace revenues in the fourth quarter were up 37%. What we've seen is improving narrow-body new build, and we thought that would happen. I think the shock for us, if it is a shock is how strong the wide-body aftermarket has been. And it's been much stronger. I mean, for a market up to now, they're not really been building new platforms. The widebody aftermarket has been very strong and we can talk about -- a little bit about why that is maybe later, but I'll just mention the fact that you have had a case delayed or deferred maintenance when all these planes were grounded. And as they'll be coming into the air, that's happening. There are sort of so-called hot swap engines, numbers are bigger. And you've also got more flying hours. So -- and it's flying hours that matter in terms of spares. Remind you for everybody, our spare sales and our new build sales are the same thing. We do the same components. There's no difference in price, there's no difference in margin. It doesn't matter if it's new or an aftermarket. And the aerospace and defense midterm revenues, we still believe will climb well about 2019 because of our higher platform content. Then we just pause on this and draw out the fact that, well, what happens if you can't get any titanium. What happens if the price of nickel has gone up a lot? So titanium is used these days primarily in the platform, the plane platforms, you can't build these model planes without titanium. And the primary reason for that is that if you overlay carbon fiber onto aluminum, the aluminum corrodes. So you need something that is not going to be subject to that, and that's electric corrosion is going on. And titanium was the answer. Titanium is very light, very strong and you can use carbon fiber on it. So the majority of the titanium being used is in the [ airframe ]. Nickel on the other hand is actually used in the engines in terms of nickel alloys, tiny amounts of nickel and steel, but they go into the engines. And just so that we understand the situation, I'm told that Boeing bought forward a year supply of titanium. So they already have a year supply of titanium in stock. And Airbus, of course, as we probably know has bought up Aubert & Duval to integrate their titanium supply chain. And the interesting thing about Aubert & Duval is that they have the only real scale recycled titanium facility in the world. So we don't necessarily need them as much we need the titanium So there looks to be about a year's worth of titanium in the pipeline. And of course, the stocks inventories and the supply chains here in aerospace and defense -- they're pretty full anyway. So the immediate impact in terms of building things is not here this year, but it does beg the question if the price of nickel is so high and the price of fuel is so high. Are you going to build 2 narrow bodies? So if you can only have enough titanium in '23 to build one plane, would you build a wide body? I have no idea. But the paradigm that we were back on narrow-bodies versus wide bodies may have fundamentally shifted to the [ mid-term ]. I don't know the answer to that. The nice thing about it is we've got great exposure on wide bodies, and we've got very good exposure on narrow bodies. So whatever comes, comes. And that's really an interesting thing on aerospace and defense. Moving to emerging markets. So the growth for our emerging markets has been held back by revenues in Mexico. And once again, I've put it at the bottom of the slide here, our particular emerging markets where we are, and those are the only places we call emerging markets. And China, of course, is a big contributor to this. The reason Mexico held us back is that Mexico is fundamentally the supply chain for North American automotive. So a lot of the components that go into North American automotive are manufactured in Mexico. And during the supply chain problem that we saw last year, Mexico didn't fare very well. And our customer in Mexico -- customers in Mexico are Tier 1s. So -- that's an interesting [ twist on like that ]. Outside of those areas, automotive revenue grew 20% elsewhere in emerging markets. So good growth in automotive in the emerging markets ex-Mexico. And importantly, general industrial revenues were up 30%. So quite a nice progress going on in emerging markets. So just a word on Specialist Technologies. You can see there, I'm not going to go into much details, but they continue to outperform their Classical Heat Treatment sort of neighbors, if you like, or comparators and doing quite well. They will continue to do that as we go forward. And then just going to a summary, on Page 23 -- Slide 23. So in summary, we finished our restructuring program. We've actually had GBP 30 million of permanent cost savings occurring in 2021. And in 2022, we will see a further GBP 10 million from the program in terms of the full impact. The overall quality of the business and the mix in the business has been improved. And by that, I mean the quality of the business. So to be clear, I'm not suggesting for any moment that we produce poor quality. It's actually the quality from a financial perspective, and we've improved that. Our margins have improved to 15.4%, and this is just carrying on the journey. We've said now that we expect our margins to be over 20%. The only question is when? It may be sooner it may be later. And then cost inflations being successfully passed on, albeit with the usual lags. Automotive is doing -- is recovering quite well, but there are supply chain issues. Importantly aerospace is now accelerating, but there's supply chain volatility ahead, and you can see that from nickel prices and the like. The other thing that's interesting that's going on is, of course, unsurprisingly, the aerospace and defense area, we're seeing a very large growth in demand, which for us, we're not a big company, but for us is quite material. This is people wanting to quite quickly turn around additional capital, frankly. And that means they need capacity. Whether we get it or not is a different question, but there's clearly some acceleration, and this is mostly in North America. And in our strategic focused areas, I think we've done quite well. We're moving ahead forward -- well. And we would expect, as our revenues grow, we will get strong margin and profit improvement. And then finally to the outlook. You've seen this in the press release. I don't intend to talk through it. What we will do at this point in time is throw the meeting open to questions, and we'll try and take your questions if we can, as you ask them.

[Operator Instructions] Our first question comes from Andre Kukhnin with Credit Suisse.

I'll go one at a time. And if we could start with the energy prices first, please. Could you give us some numbers around what sort of level of inflation you're facing now so we can take it to calculate how much of a price increase you pushed through?

Okay. Andre, I'll take that one if you don't want to start with and Dominique might give you a bit more information that you're asking a very difficult question. First of all, it varies country by country. And in North America, it varies sort of region by region. There's no one answer for this. And the biggest issue with the energy prices, it's all different and it's highly volatile. So for example, if you've got hydropower, which is particularly in the Nordic areas, Sweden and Finland, then their costs aren't going up very much and things are far more stable. Don't forget, we're not exposed particularly to oil, and the oil to gas linkage was pretty much dislocated. What we use is gas and electricity. And if you don't use any gas and you're only on electricity, most of the electricity markets are regulated in some shape or form and they're fairly steady for a year. Not so in deregulated markets like the U.K., but most of the world is not like the U.K. So in France, for example, the price is set from the year ahead. And on electricity, there's not really any volatility in that. In some markets, we bought forward a year ahead. Not that we were pressured into it or anything, it was just the right thing to do at the time. And so we don't see volatility there. But there's a huge variation around the world. There is no one answer Andre on this. Suffice it to say that price increases is not a function of energy inflation, that's surcharges and what happens with surcharges is they go up and down. And so what happens is that when we see energy go up, we'll put the surcharge on, notify the customer. And when it goes down, at some point, we'll put it down as well, but it doesn't necessarily mean it goes down the second that the price goes down or the cost of electricity. Gas, slightly different matter. And there -- that situation is also covered by surcharges, but it's far more volatile and where that's going, nobody knows. So asking me or Dominique for a number, I'm afraid, Andre, our crystal balls aren't that good.

No, I appreciate it. There's great degree of volatility and variability there. I just wanted to kind of have more math behind -- sorry, can you hear me?

You cut out completely. What we might do, Andre, is come back to you later. Because [indiscernible] lots of ...

Can you hear me now?

Yes, Andre, you're breaking up. Can we come back to you later? We will come back to you but I know you're right. We'll come back around to you later. So when this question is over, if you put your hand up, again, we'll come back and pick you up, okay? Can we move on, please, to the next person in the questions?

We don't have a question currently from Andy. Our next question comes -- Andy just registered.

I'm quite sure [indiscernible] . Can you talk a little -- briefly about Ellison, how that's progressing? I just want to make sure that that's progressing as we would have thought given the aerospace evolution. You've answered my questions on GI and the CapEx cycles. I'm assuming that's quite difficult to unwind once you start kind of firing that up. But whereabouts in GI are we seeing restocking? I think there's a comment in the statement regarding restocking? And slightly similar to Andre, but hopefully slightly easier answer -- question to answer. What kind of labor inflation should we be thinking of for the year? I'm assuming it's kind of around a 3% or 4% level. I just want to make sure that's broadly right.

As always, Andy, your guesstimate on labor inflation is pretty close to the mark. Although, I mean that's a weighted down return. To be clear, in some markets, we're seeing much more than that. So for example, in Turkey, we're going to be doing probably 2 increases per year. In Turkey, given the kind of labor inflation there. But a blended rate across the group, we have put some in the air because, of course, we're not there yet. We've got to wait until we get closer to pay raises. And 3% to 4% is not a bad guess. And I'm sure you didn't guess it, you probably worked that out. In terms of the areas of restocking, the -- it's a small amount. I mean we haven't seen a lot of restocking, frankly, in the areas that are starting to restock. That means that there is still a lot of the GI sectors where we still have stock. And the areas -- I think it's easier to analyze is where we're seeing the capital expenditure happening. And that's interesting because it's the longer cycle stuff. This is machine tools. This is heavy truck and bus. This is a marine those kinds of markets that we're seeing the CapEx turning up. And in fact, we saw this happening. We just recently seen some corobrity, corroborate, I can't say the word, some other evidence that says exactly the same thing where we're seeing across different geographies that the CapEx cycle is moving up and that's good news for us because once that starts going, it doesn't change very quickly. So we've got GI in general, and the CapEx cycle means that they won't change in a heartbeat. And of course, I've no doubt that the energy markets, which are those only 8% of our business today, clearly, they're going to be moving up pretty fast in terms of the oil and gas. And interestingly enough, probably subsea gas as well, which is something that we have an exposure to that would be quite nice of that group. So I hope that answers your question Andy?

Yes, definitely. And Ellison?

Ellison, yes, Ellison all things are relative, right, when to buy a company, right at the top of the cycle. Ten out of ten for that. But actually, the Ellison business is moving ahead quite nicely. I mean it's quite clear that we've improved the margins in the Ellison business, as we said we would and they're very good. What will happen is as the aerospace business moves up, Ellison will move with it. And they've got a big exposure. It's North American only they've got a big exposure to both narrow-body and wide-body and indeed defense work in Ellison. So I think their future looks pretty good, actually, one way or another, but not quite where we thought it would be at this point in time. But as you get a pandemic and the current situation, what more is left to surprise us really. Does that cover it?

I'd have to think yes, that does. I just -- 2 quick small follow-ons, if I may. Can you give us the rough sales for the HIP acquisition? I'm assuming it's not material, but just in case. And there's quite a big pickup in bonus and employee share plan cost. I'm assuming that's the big correction and we should think at more of a normalized level year-over-year. Is that also fair?

Yes. So the HIP acquisition, GBP 7 million roughly is the turnover that they had last year. And on the bonus and bits, yes, effectively last year's number reflects a much more normal level of bonus and long-term incentives than what we saw in 2020.

Our next question comes from Michael Tyndall with HSBC.

Couple of questions, if I can. Just thinking about the recovery in A&D and the exposure to Specialist Technologies, am I right in assuming that is far more exposed to specialist tech. So if you like, that recovery will be far more margin-rich than perhaps the other areas of the business? And then I guess touching on the inflation, the pricing, can you just give us a reminder of what your services represent in terms of your customers' bill of materials? In other words, if we're thinking that putting all through these prices, maybe you'll get some pushback. Can you kind of give us a sense of when it comes to building something at your customers, how much Bodycote contributes to the costs thereof?

Thanks, Mike. Very good questions. I shouldn't say that. But for me, that's a question I like. So just talk about Specialist Technologies in aerospace and defense. The primary reason why it's focused -- the largest portion of Specialist Technologies is in aerospace and defense is our HIP services business. And you're absolutely right. It's one of the reasons why we're quite confident in our North American position. is that the drop through that you get on the increased revenue in HIP services is very high. And it is, one would expect as revenues move up that we would -- that would be margin rich. When or how they move up? It's not something I can actually sort of be clear on. But your analysis is very true. If we move on to the bill of materials question, -- so let's go back to the pandemic. You might remember that during the lockdown or as I like to refer to it [ data ] the freezeout that happened in the pandemic. Bodycote was actually -- was classified as a critical service. And the reason for that is people can't actually do things without the services we provide. We're a little bit like a telecoms company. You can't run your business unless the telephone company gives you a line. The cost of the telephone company is -- telephone line is tiny compared with what you're doing, and that's indeed our pace. So even in our Specialist Technologies, they are a tiny proportion of the bill of materials. So when a customer is seeing double, triple, quadruple even on their material prices, which they have seen. Our percentage of it is a tiny, tiny piece. It doesn't stop the buyer community sort of moaning and groaning and saying, "Oh, this is too much money" and everything. But at the end of the day, if we put it up and they want to use our services, they pay us. It's a bit like the telephone company. You need the telephone company, you don't cut the telephone company off. So we are not necessarily popular sometimes, but we're a tiny proportion of what people do. And that's the reason why we're able to pass our pricing through. This is an unusual time, who knows what will happen. But I can tell you this that people who want to move fast and do things in the next 2 years, they need the suppliers they've already got. I hope that answers your question.

I'll just add the numbers. So Civil Aerospace is 15% of our Classical Heat Treatment business. And to your point, it represents 22% of our Specialist Technologies revenues.

Got it. Just one quick follow-up on the energy side of things, and it's just an understanding question for me. I mean, so your pricing is pretty much set at the local level because I guess it depends on the energy source at a local facility that will determine pricing. Is that the right way to look at it?

That's absolutely correct. And indeed, it's the same energy price input cost input that our customers are seeing because we're local. So in some territories, they move the industrial price of electricity up, for example, once a year and then everybody gets at the same time. And if you've already had a surcharge put on your plate maybe a month before, it's pretty hard to argue actually, because at the end of the day, we're not trying to rip people off, but it's all priced locally.

Our next question comes from Jonathan Hurn of Barclays.

I just have 3 questions, if I may. Firstly, can I just come back to the outlook, obviously in the outlook statement you talk about high profit drop through over the long term. How do we think about that? Is that at the 50% level? Or is it potentially higher than that 50%. That was the first one. The second one was just on automotive. I'm just wondering if you could talk us through the margin of EV, essentially where it was in 2019? And ultimately, what you think it can get to because obviously, you do reference strong growth in margin there? And then thirdly, just coming back to Aerospace and HIP. Can you just talk about the HIP capacity is everything you have there back online? Or is there still more stuff to come on?

Let me address the first 2. So in terms of profit drop-through, we talked in the short term about a 50% or so profit drop-through for volume-related revenue growth. Clearly, this year where we're going to see a lot of inflation-related revenue growth, there is no drop-through to the bottom line because all we're doing is recovering our costs through our price increases. But in terms of volume-related revenue increases, 50% drop-through in the short term is the right number to go with. Now just to caveat on that, it is -- that it is -- that's a general statement. If we're talking about Specialist Technologies where we already have some very good capacity utilization and therefore, to grow our business, we will need to invest further building additional facilities and adding equipment, the marginal drop-through tends to be more like the average margin. So while the average margin in Specialist Technologies is very good, the incremental drop-through as one looks out, it's probably somewhat below 50%. And so it really does depend on where exactly a similar story for emerging markets where we, again, have been growing and have quite good capacity utilization. So it really does depend where the revenue drops through. Question then on automotive margins and where we're going to go on that. Yes -- obviously, we're already above where we were back in 2019, where we're already above where we were on profit. And that's not just Automotive, that's Automotive and -- well that's AGI. So that's wider than that. But clearly, as Stephen has already indicated, we've got plenty of capacity in -- across our business and as the Automotive revenues do come back, then that will have a very healthy drop-through and improve our AGI margins, in particular, as that revenue comes back.

Taking your hit on the...

Can I just, sorry, can I just ask just on that Automotive just it's more specific on the EV side rather than automotive generally. I just want to know essentially where the EV margin is now roughly? And ultimately where it can become or where it can go? So it's just more of an EV focus rather than the general auto.

Okay. So the EV focus, so this is the generic work sort of steering gear and steering joints and stuff like that, which [indiscernible] . And the margins for us on that is exactly the same in terms of [ production ] stuff. So the EV, very specific content, so this would be sort of engine casing, which is [indiscernible] casings and stuff like that. Today, our current work that we're doing there is very small. And the reason for that is because it's just not that much stuff relatively speaking. I mean in terms of -- I know we all get excited about electric vehicles, but the number of vehicles being built in the world as a percentage of the total as yet isn't that large. Most of our progress in EV is actually currently in the situation where people have said, right, I need x million of capacity in such and such a country. Our go-live date is 2023. Let's all get that all sorted out. So you're in the moment in round up phase. And that's some of the things in the new facilities, but also in existing facilities. So to quote an EV-specific margin, at the moment would be difficult. I would fully expect because the technologies that are used on the EVs and not the pieces that we're talking about here is something that we really have a great market share in and there we're talking about low-pressure carburating, which we've talked about many times, gas nitriding. We're the large gas nitrider in the world by a factor of 3. Corridor of a proprietary process of [indiscernible] those are the primary technologies that people want to use, in which we can go into why that is at some point, but I've said it many times before. And so there, I don't -- those 3 that I just mentioned are Specialist Technologies. So one can imagine the margins on the electric vehicles for us are going to be pretty nice. So does that answer your question on electric vehicles?

Yes. That's great. Very clear.

HIP capacity, which is the other one that you asked. So the North American HIP capacity is by no means anywhere near 100%, particularly because we're just moved a very large HIP in from Europe that we had to deploy it into North America because we saw the opportunities in North America to be slightly better than there were in Europe. And we've also commissioning a new facility there, which has been ongoing for some time. So as of where we sit today, we've got substantial capacity because our existing facilities were only at sort of 80% or whatever maybe a little lower even. And we've got new capacity coming online. So in terms of capacity in North America. In Europe, slightly less, but we've got this nice facility that we acquired in Switzerland. It's not a huge capacity, but it's useful and that gives us some extra capacity there. So we've got -- we've got capacity around the place. And I don't think it's pressed. And as Dominique said, if you don't have capacity, then you'll just see the margins drop-through. If you're full, in HIP services, we would expect to see the margins increase because we're going to be filling up existing capacity and you'll get drop through from it.

Our next question comes from Christian Hinderaker with Liberum.

I've got 3, maybe best in turn. I guess, firstly, a follow-up to Andy's question. Just remind us of the split in terms of CapEx versus OpEx led business within your AGI business and whether there's any mix considerations and we can come on to the other 2.

Say again, please, Christian.

Apologies. Could you just remind us the split in terms of CapEx versus OpEx led business in terms of your AGI revenues and whether there's any mix consideration there?

So no mix consideration in terms of profitability. It's all the same profitability because it's quite interesting. Our processes are really the same between all these different sectors. It's not like we've got a process that's specific for a particular sector. So the processes determine what the margins are and the price is pretty much the same across segments. So there's no real difference in available margins or contribution margin. What does change is what's the capital intensity of it and where we've got poorly utilized facilities or we've got poor customer quality. So in Germany, for example, we were -- we had poor quality business because we were priced into commodity business that there were no real barriers to come in and out of, and that's what determines the pricing. Where we are today, is far more robust situation where you don't have the quality pricing so the prices [aren't the same ]. And it doesn't matter which market segment we're in. So there's no profitability difference in the market segment. In terms of our OpEx, CapEx split, that is a very difficult question to answer. The reason we know CapEx cycle is going up is because there are some sectors which I mentioned already, which we, from history know, they are CapEx driven. And they're the ones that we see going up. But if you wanted us to be specific in terms of what the percentage is, I have to tell you we're not that precise, Bodycote is not a precision machine on those kind of things. And the reason is that there's just the thousands of customers that we have and the fact that they're all buying pretty much the same stuff, which just has a different label on it. And we charge the same kind of pricing. We don't price discriminate by what they do. We price discriminate on the basis of how much money we think we can get out of an individual customer. It sounds like a bad thing to say, but it's to do with what costs we provide for that customer. And if we can't get the margins, we've got to find another customer. So no real exact answer for you I'm afraid on this one, but it gives you just an indication of the issue.

Okay. maybe secondly then on aerospace, just interested, your [ RNS ] talks about no evidence of supply chain disruption. But then in the presentation and I think just now you're talking about some volatility in supply chains ahead? I presume it's linked to recent events, but just great for some clarity there.

Yes, you're absolutely right. I mean up to now, literally up until yesterday, which is when we checked last time, we see no issues there. But we've done a deep dive into who is going to have problems knowing that you would ask us this kind of question, who is going to have problems and that's how come I know that Boeing, for example, has bought a year ahead of titanium and that I think the price of nickel yesterday was about $101,000 a ton. That's pretty expensive. So the guys that are going to have the volatility and the problems there, that's what we're talking about. Personally, and I might be 100% wrong, I think we'll see civil aerospace pretty much carrying on okay because they've got the stocks and because they've already bought the products. 2023 will be a call at that point as to in civil aerospace will have things stabilized. There's plenty of nickel in the world. The only problem we've got with nickel is its volatility in pricing. Titanium is clearly an issue in the longer term. And that's what I was alluding to, is to what planes will you build in the future if you've got titanium in such shortage because I think it's 40% of world's titanium comes out of Russia. So defense that seems to be very robust. But right now, today, nothing. Do we expect it tomorrow or the day after for the rest of this year? Yes. But will it affect sales of the actual platforms and engines in 2022? I'm not sure. I couldn't call it your way, but I'm not sure. So it's a very difficult time to call anything because things -- there are pluses and minuses out there. There are opportunities and clearly there are problems. And the only thing that I can take some hope in is we're sitting here, we've got the capacity, people need us. And if anybody needs to do things, we're here. But we certainly don't have any sort of psychic insight.

Fair enough. And then just my third question is on Automotive. You had 9% growth, I think, despite a negative contribution from Mexico. I believe you highlighted 20% growth from the rest of the year. I'm just interested in the impact therefore from Mexico in particular. And also given that perhaps supply chains are improving, but the U.S. automakers have been a bit more bullish than others in terms of their expectations and in some cases, have had to sort of grow back. Just curious as to the level of sort of optimism or rather -- sorry, the level of conviction in that optimism.

I'll take the conviction point. So I find it staggering the fact that things roll on in North America, seemingly irrespective of what's happening in the rest of the world. I mean the -- it would seem that North America is insulated from other things happening. And the indicators are still very strong in North America. It's very hard to get any real sign posts in the rest of the world because they're changing every day. And it's not really semiconductors, okay? In North America, it's not really semiconductors that's been the supply chain issues. And they are very bullish. Now we got completely stitched last year by listening to them. as you all know. So we aren't necessarily listening to them, but they are very bullish. As far as the rest of that is concerned, Dominique?

Yes. So you're probably right. Mexico was holding back the emerging markets business, as we outlined in the presentation. Mexico, I think it's important to understand, is effectively or our business in Mexico is very much tied in with the whole U.S. auto supply chain and the customer that Stephen was just referring to there is a big customer of ours in Mexico, and that's what was impacting our Mexican business. So as those issues resolve themselves, then we absolutely will expect. We expect our Mexican business to come back strongly.

Our next question comes from George Featherstone with Bank of America.

I'll go one at a time if that's alright. I just wondered, initially, given what's going on in the world, whether your investment decisions have changed or been deferred at all for this year and perhaps anything you're planning for 2023. I think in particular whether you're going to accelerate any further investments in any regions like China maybe to diversify.

So yes, so I don't think we can claim to really have changed our minds about what we're doing. And to be honest, that's nothing more than we haven't had time to catch up breath yet. This has all happened so quickly, and we don't change our investment decisions with a knee jerk. We'll be evaluating it when we're seeing it. I'm happy that where we are is a good place. I'm happy to see that we embarked on this carbon and energy management to focus that's going to serve us very well going forward. Although that's more about energy and carbon because it would appear that a lot of the word has decided that climate change is being postponed for a decade. But as far as we're concerned, getting energy management in place and getting customers to come to us to get their carbon footprint [ out ] is a win-win, and it's just a win-win. So I think where we're going is right, and we will evaluate and maybe in due course, we might have a different priority. Up to now, I've been thinking that we should be going much faster in China. China is becoming more and more self-reliant in terms of production. And they are going to be buying locally. And we in China, we are local. We're not -- everywhere we're local. And so having more local support in China, if it works out in the geo politics of the world, would be great for business. But we need to sit back and think about it. We need to sit back and consult with people, but we're not going to change our investment decisions overnight if that's clear.

Then a couple just kind of clarifications or maybe add-ons to other questions that have been asked. Just coming back to Civil Aero, I wondered if you'd changed your view on whether this market will have fully recovered by 2023?

Changed my view or changed our view? I don't think we know at the moment. And I would say -- I don't know -- I have no idea. Who knows what's going to happen. If it recovers, it's not going to be to the kind of recovery we thought it was going to be. I think this is very sure that it's going to be in a different shape, but our wide-body aftermarket earnings are very strong, and we make the same amount of money across all this stuff. So in terms of our revenues, we might be doing okay, but I couldn't tell you. I just don't know.

Okay. And then maybe just trying to put a little bit of context around how you see the phasing for this year in your outlook. Obviously, there's tougher automotive comparatives in the first half of the year, going to be higher cost pressure given the timing differences you've already talked about in the first half, but then you've got the restructuring benefits. So I just wondered if there was anything we need to consider about the seasonality and the delivery of the operating profit this year that you'd like us to incorporate into numbers? Is it particularly H2 won't tick a bit? It appears that way so far?

Well, as you indicated, we're up against stronger comps on Automotive in the first half of the year, but then our general industrial business was doing well through last year, and therefore, we'll be up against stronger comps effectively in the second half of the year. And similarly, with civil aerospace towards the back end of the year. I think the other thing that's worth highlighting is Stephen mentioned the lag effect on our business as a result of our contract long-term agreements where price increases are based on contractual indexation and also the fact that surcharges take 1 month -- typically with a lag against the cost inflation that we're seeing. That undoubtedly has an impact on your P&L when you're seeing the biggest inflation hike. So I would anticipate as we're looking at things now, that that will be a first half impact rather than the second half impact.

Our next question comes from Dom Convey with Numis.

Just 2 questions, if I may. You've talked again about the excess inventory in the supply chain for Civil Aero. I just wonder whether you could give us a bit more color as to when you would think that if Boeing and Airbus hit their publicly stated targets for the A320 and for the MAX. When you'd expect that to be burned through and then see that acceleration in your own demand? And secondly, defense spending is now very much back in focus. Could you just remind us what your exposure is here? I'm thinking specifically any key platforms and it would also be helpful just to understand that spec tech mix within the defense revenues.

Let me take the defense revenues. So it's never really been a big focus that we talk about. But from -- with predominantly flying assets, that's why we have defense revenues. They have, in the past, not been affected by conflicts around the world because the amount of wear and tear and the rest of it has been pretty steady in terms of the percentage of what they do anyway day in, day out in terms of exercises and the rest of it. But I think we're looking at a period now where that's different. The key programs that we're on -- we're not normally on what most defense contract is called sort of really good sexy things, if you can call this stuff sexy. But we are on the F-35. We've got content on the F-35. We have content on -- and I don't really want to go into a lot of details about it, but on various land platforms. But mostly, they're all geared towards flying assets and that's the kind of thing that we're into. And so that stuff is -- I mean the F-35 program, I see is just being ramped up by an extra 25 I think it is F-35s this year, that's big, it's a big input. But I'm sure you can read the relevant press and have a much better view than I do of that situation. In terms of where the inventory is. So it was mostly down at the front end, so this would be castings and forgings and then progressively getting lighter and lighter and lighter, until you get to the plane final assembly. And when would that -- all other things aside, how long will that have taken to get rid of that inventory. It typically would take 1 to 2 years for the inventory to actually normalize. We are in a different world though, so that front-end casting and forgings, they are titanium forgings and castings. They are high nickel alloys. So next year, there is going to be a casting and forging shortfall because they can't get their raw materials. So next year, I think the front end of the supply chain if they don't already have access, there will be a problem. And in fact, we will be seeing some European suppliers basically squeezed out of the market because they don't have access to raw materials and the largest supplier in the market in that casting and forging area, which is in North America. And I'm sure you're aware who it is, a big customer of ours. They're basically they've got what they need and their prices are what they are because they can. So the whole world will -- of aerospace is going to move dramatically. We supply the largest North American company in this area. We tend not to supply the smaller ones so much. And in Europe, where we supply everybody. And some of that is owned by the same European, same North American entity and some is by a different North American entity, but the raw material availability is going to affect how much inventory there is in the system at that front end. But that will be a '23 problem. And who knows where we'll be at that point. And all I can tell you is that today, obviously, the big users of titanium are moving [ less projects ]. So this is not a forever problem without moving their supply chain. And this idea that you can recycle titanium has been pretty much poo-pooed by most people apart from Aubert & Duval and they've actually got some quite good technology. So who knows where that will go. But that's the sort of metric that you're looking at. And I'm sorry if it's a little bit cloudy for you, but believe you me, it's crazy for us as well.

And just on the Specialist Technologies, Classical Heat Treatment split for defense Stephen mentioned that defense is an important sector for Ellison. But overall, across our business, they are similar percentage -- very same -- very similar percentages of both Classical Heat Treatment and Specialist Technologies.

Our next question comes from Andrew Wilson with JPMorgan.

Hey Conrad, could I ask you to get Andre -- sorry, can I just say to Conrad, could you get Andre Kukhnin back because we did put him off. So let's not forget him, please. So Andrew, carry on.

Just a couple, I think, probably relatively quick ones. Just on the GI recovery and the CapEx elements that you spoke to. I'm interested if that includes spending from auto customers on CapEx for things like tooling, et cetera. I seem to remember that, that's reported within GI. And obviously, interested in terms of how that's developed in specifically.

Yes, because that's a leading indicator for Automotive for us. We don't include that in CapEx believe it not, we include that in OpEx and that's because -- it sounds counter intuitive but a tool is a consumable in the automotive industry. And so that's really OpEx it's not CapEx. And that's not included in what we've just said. So now the question you've got is, what are we seeing in tooling. And if I can just pretend to read you mind. And the answer is, it is pretty flat. And Dominique can actually contradict me if I read wrong numbers we've got as pretty flat.

It's very flat, very similar revenues first half, second half through last year. Okay?

Very clear. And then just maybe one for Dominique probably. Just on CapEx in 2022. I'm interested, obviously, a number of times you mentioned around the capacity, and I appreciate there's always projects going on in terms of reallocating assets, et cetera, and obviously, making sure you've got the right footprint that you want, but just interested in terms of CapEx guidance, I guess, for '22 within that context.

Well, we split our CapEx up between 2 elements: There's the maintenance CapEx element and then the expansionary CapEx elements. And I think your question is more focused on the expansionary CapEx element, but let me just make sure we're all on the same page on the maintenance CapEx element. I mean that spend last year was GBP 43 million, and GBP 45 million the year before. It's roughly 60% of the depreciation cost, and we would expect a similar amount in 2022. As far as the expansionary CapEx is concerned, that is a little bit how long is a piece of string. We have a number of projects underway and we will spend money on those projects. But it's difficult to be certain at this stage. At this stage, I think, best to guide somewhere around the GBP 25 million to GBP 30 million range. But it will depend on what projects we have come through and how quickly we can get them up and running.

Our next question we've reconnected to Andre Kukhnin of Credit Suisse.

Can you hear me okay?

Certainly.

So just to close off on the energy price inflation. You said you started implementing surcharges and price increases from September last year. Could you give us some idea of how much of price up or surcharges together you're carrying into 2022 already from what you've already done during the end of 2021?

Sounds like a CFO question to me, Andre. And I think the answer is no, we don't really want to give you an idea of that. And first of all, it's commercially sensitive depending on the different areas we are. And we -- Stephen highlighted what we're doing is we're looking at our costs. We're typically, certainly in the current environment, hedging around about a quarter out. And based on where we're ending up on the different markets and the different areas for gas and electricity, that's how we're [ discerning ] surcharges in each market. And I don't think it will be -- I don't think I can give you much more color than that.

Okay. Got it. I mean, the reason I was asking is that, obviously, we discussed the sort of mid-single-digit impact. And I was just trying to get sort of sensitivities around it. And when you pass through cost increases, which we have no doubt of you being able to do that, but through raising price, obviously, it still carries a margin impact. So it just helps us to calibrate. That's the reason I was kind of pounding on that. But I'll move to the couple of more interesting questions. I think in the past, we discussed that with this kind of higher steel prices, there is scope for customers to maybe generate savings by moving to a lower grades of material but use more of your services to bring the output quality up. I just wondered if that's -- if you've seen any of that starting to happen now that we've had well over a year of steel inflation of higher steel prices.

Yes. And of course, that is true. I mean, when you've seen such huge steel prices, there have been people moving to lower grades. It moves slowly though, Andre, because if you change material, you have to -- you then have to recertify it and takes maybe 6 months or 9 months. So we were seeing that going on, and it could well be that we'll see that going forward. But then there are countervailing forces as well. I mean one of the interesting things is the labor areas. I mean if you -- let me tell you how difficult the question is. If you look at stainless steel, it's a high nickel alloy. There are thousands of tons of stainless steel in the world. We process up, I think, it's 0.00-something percent of stainless steel in the world. So there's lots of stainless steel out there. But if the price of stainless steel has gone up, which it has and it will do because of the nickel price, you're only going to see it in those very high-end applications, which just so happen to be the ones that we're on. And things like medical work. So the stainless steel side, ironically, the price is up, you might see more people moving to it because they actually reduce the labor content and the reason I say that is the amount of processing post op process that we do goes down. So overall for the customer, they typically have a lower cost input than they would in total, then if they stay with their other material because they're not putting coats on all that kind of stuff. -- by coatings, I mean, like organic coatings and the like. So these things move in different directions. But yes, in terms of the bulk Classical Heat Treatment, Classical Heat Treatment is used to turn poor quality, tough poor quality steels into high-quality steels. So all kinds of things that you can make use of if you do the thermal processing and heat treatment correctly, but it requires more of that. So one might expect in due course here, if the price of steel has gone up, that we would see a push towards it. And in fact, that's the case of all these rising prices. The higher the prices go, it's the volatility that's bad. But the higher the prices go of raw materials, of which we don't have any or energy, which we do have, but which we actually -- we know how to manage, in the long run, it just makes us more competitive. It means people want to use us more.

Yes, exactly. I was going to ask on the energy side as well, but I guess it's a little too early, right, to see any evidence of customers making decisions based on that yet. Right?

Well, we are seeing projects being brought to the left, as they say, being brought forward and indeed in a number of areas, not just in energy, I think you'd be surprised if the amount of semiconductor stuff that's being brought forward with fairly large expenditures going on because they want it now. And so they need to move in a hurry and they're bringing it forward and they're chunky contracts. But for everyone that comes forward, there are others that may be cancelled. So trying to divine the future right now is a little difficult.

And just very last one. We talked about some of your own initiatives for efficiency improvement at your operations. And I just wanted to check whether for 2022, is that all fully captured in the 50% drop-through ratio that I think you suggested we should be applying and the GBP 10 million of restructuring savings coming on top? Or is there anything else we should think about outside of that?

No. I think those are the numbers that you should look at. Obviously, our objective, our drive is to do better than that. We did do better than that over the last couple of years, but it's not something that I think one would want to bake in forever and a day. So 50% drop through plus the GBP 10 million restructuring benefit, I think, are good numbers to use.

[Operator Instructions] Our next question comes from Cloey Schooley (Sic) [ Maggie Schooley ] of Stifel.

It's Maggie. One quick question from me. Even though you have [ ample ] capacity in the world, we're starting to see energy increases and labor increases. When we balance that against the ESG benefits that you offer your customers, are you starting to see increased inquiries for outsourcing? Or is this still -- it comes when it comes.

Maggie, could you say the first part because we didn't quite hear it properly, please?

All right. I was just going to say, given that you have ample capacity and could probably quickly absorb further business, are you starting to see increased inquiries from customers looking to outsource?

Yes.

Could you expand a bit on that? Or is it just going to happen when it happens.

No. You asked me a question. Are we seeing increased inquiries, and the answer is yes. I can't give you a number, that would be -- but we are seeing them. And we are...

Is it just a material...

No, it's not material. It's not material. Not yet.

It's not material. Okay. Just as usual, but a slight increase.

We have no further questions on the phone line, so I'll hand back.

Well, thank you very much, everybody. As always, we're here if you've got further questions, and the first number to ring, of course, is Dominique Yates. Thanks a lot. Goodbye, and we'll talk to you in the future weeks here.