Bodycote plc (BOY) Earnings Call Transcript & Summary

Welcome to the Bodycote's trading update. [Operator Instructions] Just as a reminder, this conference call is being recorded. Today, I am pleased to present Stephen Harris, Group Chief Executive. Please begin your meeting.

Good morning, ladies and gentlemen. Stephen Harris here. I am with Dominique Yates, our CFO. We'll make a few introductory remarks on this trading statement, and then we'll go into question-and-answer mode. So just to state from the outset, I think it's fair to say that times are not boring at the moment. It's really exciting place to be. We are performing in a fairly resilient way, which I hope by now you've got used to coming from us. We're charging our way through the situation we've got there. I don't think it's true, though, our small competitors that we have around in our local regions are faring as well as we are. Certainly, I've been in this business for a fairly long time now, and I've never seen so many small businesses that compete with us at the edges closing their doors for good. It's probably been more in the last year than I've seen in the last 10 years. So it's pretty tough out there, especially if they've leveraged themselves up to invest. So we are picking up a little bit of share here and there, but it's not a huge amount. It won't move the needle particularly. As far as the energy challenges that we're facing, it's quite useful, I think, to look at us now as more or less an energy intermediary. We update our surcharges on a monthly basis, so we're right on top of that. Our price increases, which are really destined to cover wage inflation, that's done on an annual basis, and our wage rounds are coming up into the new year now, typically starting around April. But that's sort of the way that we're dealing with the inflationary situation. And it varies quite widely, as we noted in the trading statement, depending where you are in the world. Hopefully, as we see energy falling a bit, now as we go forward, that gives us an opportunity to do a little bit of arbitrage because you will recall in the first half that we did have a lag. That lag is now gone. But hopefully, we'll get as little bit of a lag in the other direction, as energy comes down to help compensate some of that. Overall, as I said, really quite an interesting time and I think we're navigating it well. Undoubtedly, people are going to want to ask us, well, what's it look like for next year? And Dominique and I, we're listening to a learned economist the other day, who told us that from his standpoint, that the projections for macroeconomic future in the next year or 2 in the globe is probably the widest range of outcomes he'd seen in the career from the upside to the downside. So it's quite difficult looking forward to decide where we're going to be going in that. All I can say is that we have capacity. So if the world gets a bit stronger, we're ready and willing and can take very easily more capacity and more work into our capacity. Equally well if life gets a bit more miserable out there, we are very flexible and we've got flexibility on the downside. So I think we're pretty well set no matter which way it goes next year and the year after. We've got some mega-trends in there that are kicking in well. I think everybody is aware of the aerospace growth. We've got general industrial, which takes a long time to turn in general industrial and it's growing fairly well. The only 1 that's a bit negative or was flat really is automotive. That's not as good as the others. But overall, we've got some nice trends in there. And all things being equal, we should be taking advantage of whatever comes our way. With that, I will hand you back for questions and answers.

[Operator Instructions] Our first question comes from the line of Michael Tyndall at HSBC.

A couple of questions for me, if I can. Just thinking about the price variances that you've seen in the industries. And I guess from the statement, it sounds like it's very much a process issue as in where there's more energy, there's more price increases. But are you seeing any differences or variances in terms of how hard or easy it is to pass through energy costs in one industry versus another? And then just on the auto side of things, you're saying volumes were flat, but certainly, the sense was that production on a pretty weak base was recovering in Q3. So I'm just trying to reconcile your experience, what perhaps broader light vehicle production is doing?

Let me take the pricing discussion first. So obviously, geographically, prices are varying quite widely. We differentiate between surcharges and actual price increases. So I think your question was really geared towards surcharges rather than absolute price increases. In the surcharge realm, they do vary widely by geography and indeed by customer because it depends on the type of process the customer is actually using with us, so which plant and what process the customer is using depends -- that drives the surcharges. Is there 1 industry that's more difficult than the other? First of all, I would say you remember that we have some long-term agreements in place. Clearly, most of the time, that means that we're delayed. One or 2 of them, we've actually managed to negotiate quite an increase in those because it was becoming ridiculous. And so the agreement's actually been put to one side for now in terms of the surcharges. So we do have some of the long-term agreements that have become current in terms of energy surcharges. But as an industry in total, I mean, the toughest buyers are always in automotive in my experience, and there certainly are in this environment as well. But it's really a matter of time because it comes to a point where you just say, well, we're not going to keep going like this because the surcharges. If you don't get them, they do put you into a pretty difficult situation. So we've got virtually everybody here, there's probably 1 or 2 out of the 70,000-odd locations that we ship to that are still playing silly. But pretty much everybody is paying through on the surcharges. And of course, they're watching the indices closely because we've pegged our colors to the indices out there. And when the industries come down, no doubt, they'll be banging down our doors to get our surcharges down. But it has been more difficult in automotive. But overall, we're doing pretty well, I think. As far as the second question is concerned, Dominique will take that.

Yes. So I mean, overall, automotive volumes are flat. I mean, to your point, Mike, they're a little bit ahead on the car and light truck markets and a little bit behind on the heavy truck and bus. So within that, there is slight positive uplift in volumes in car and light truck. I think the other thing I'd say is in a relatively short 4-month period, comparing against wider industry volume movements in the equivalent period, there's always going to be some differences. I think the key point that we are trying to get across is that we're not seeing any significant movements. We're certainly not seeing any significant decline and that volumes are more or less flat on what we were experiencing in the first half of this year and again second half of last year.

And our next question comes from the line of Jonathan Hurn.

Just a few questions for me, please. The first 1 was just, obviously, on the guidance. So if we sort of take that H2 revenue run rate and add it to H1, it kind of gives you a number sitting above where consensus revenue is sitting. But you're saying, obviously, your overall expectations for the year are in line with consensus. So can you sort of bridge the gap there a little bit in terms of first, what you think expectations are for the year? And secondly, just give us a feel for profitability in the period because, obviously, you haven't really made any comments about that? That would be the first one, please.

Well, in terms of full year expectations, the consensus figure is currently at a headline operating profit of GBP 106 million, which really isn't very far off what you would do if you doubled first half headline operating profit and added the shortfall that we had for energy service charges in the first half. So I think in that regard, what we're saying is very much in line with that expectation.

Yes. One thing on that, Jonathan. Don't forget that the business in the -- right in the last couple of months slows a bit from seasonality. So if you did a straight-line projection through November and December, you'd end up with a slightly wrong answer, I think, that might be where your gap is.

Well, that's fair. That's clear. Second 1 was just on sort of obviously the strength in general industrial. Can you sort of talk a little bit about the moving parts there, where you're seeing the strength? And also just how that played out through the 4-month period? Was it pretty consistent in terms of sort of revenue per month? Or did we maybe see a slight slowing towards the end of the period?

No, I think it's pretty consistent. And there's so many moving parts in that. It's -- just it changes very, very slowly. So in this period is only 4 months, you won't see anything really moving. The fact that we've now put energy into GI because it's only 7% of sales is -- that makes a little bit of a difference because that's the 1 piece that did move up, as you would expect. But the rest of the stuff is just a continuation of the trend and that's what it's likely to be going forward. It will change slowly over time, as it always has been, but it's not going to knee-jerk in the space of 2, 3, 4 months.

I think just to add to that, I mean, as we've said before, the subsectors, if you like, within general industrial, where we've been seeing the strongest performance now pretty much since the second half of last year are those that are more geared towards capital expenditure projects -- capital expenditure. And we've certainly seen that trend continue into the second half of this year.

And maybe I'll just squeeze 1 last 1, just in terms of obviously the -- just focusing on labor, obviously. Can you one -- just talk a little bit about availability? Are you still seeing sort of some stress points within the business in terms of labor availability? And the second 1 was just in terms of like you say, when you get to sort of next year, there's going to be a price increase to cover your labor costs. What kind of magnitude of increase are we going to see in '23 for pricing for labor, I should say?

Okay. So in terms of labor availability, I would say that it's starting to ease a little. We would expect it to ease further into next year. Clearly, there's more labor coming available. People -- in this situation, people who decided to hang up their boots and maybe not work anymore, decided to change their mind. So we've got people coming back into the workforce certainly in a number of our locations. We've got an easier situation. So that's positive. In terms of the wage inflation, it varies quite significantly. I mean, we've got some places in Eastern Europe where the local inflation CPI is around 17% and wage inflation is around 10%. That's sort of similar in some of the higher inflationary areas. U.K. is not exactly the cheapest place for inflation right now in terms of labor. I can't give you 1 blended rate across the whole group, but it's not the 2% or 3% that we've seen in the past. It's certainly above that. And I think that the customer base in general, what they just want to know is forewarning from us, what the price increase is going to be rather than screaming about them because I think everybody is facing the same situation. So we are trying to get quite a lot of warning to our direct customers so that they, in turn, can build in their price increases into their -- further on to their customers. So it's quite a range, I would say.

Our next question comes from the line of George Featherstone at Bank of America.

My first 1 would just be trying to get a little bit more of an understanding on the general industrial trends. You talked a lot about this more capital investment being undertaken or that's where the growth is. I was wondering if you could provide some more specific details on the exact end markets that, that is, and basically, your expectations for the sustainability of it, given the wider macro context?

When you say sustainability, you're not talking about carbon there, are you?

No. In terms of the demand.

Yes, I thought, yes, because we've got a very good sustainability story actually, but we're not going to go into that right now, I don't think. In terms of how sustainable -- in terms of time, the general industrial trends are going to go, I mean, I'll say again what I often say. In the round, general industrial tends to track industrial production around the world. And so that's the sort of the longer-term proxy for GI. And it splits down between OpEx and CapEx. And Dominique was just talking about the CapEx side a little bit. And so some of the sectors which we look at -- which are CapEx-orientated are industrial machinery, for example, machining operations as well alongside that. General manufacturing, tooling, that tends to be associated with the buildup in capital. Those are the main kind of areas that we're talking about.

Okay. And maybe turning to Civil Aero. I just wondered if you could give us the volume growth component of that sort of period and then maybe talk about some of the dynamics in narrow-body versus wide-body.

Sure.

Well, the volume component of Civil Aerospace is up 13% against the equivalent period last year.

Okay. Narrow-body versus wide-body? Do you have to give some context on that?

I don't have that split, but it's -- no, I don't have that split right easily in front of us. We can get back to you on that.

Okay. And my final 1 would just be maybe a more sort of wider conceptual comment. I just wondered if you did any work on right now at this stage, how more efficient you are versus your customers' in-house production?

Great question. And we are working on that now at the moment in terms of providing some, what we call, white papers and case histories to customers so that we can actually show that because we are significantly more efficient than most of our customer base on a like-for-like basis because our utilizations are much higher than they are. There are -- typically they have to be, by definition, the way these systems run. But I don't have those at hand at the moment. So the numbers that we've calculated in the past still hold. But we're going to be more specific so by customer and by process. We'll be able to talk about that in the future. It's an ongoing work in process.

And just to come back on your narrow-body versus wide-body question, looking at the geographies of Civil Aerospace, I would say, it's not very different between narrow-body and wide-body in that 4-month period.

The only thing I could add to that actually is -- you didn't ask this question but I'll put it a different way. Where is the growth in Aerospace? The 1 place where there is less growth is at the raw material and the raw -- forgings and castings. And that shouldn't surprise anybody because that's where they've had production difficulties and production capacity issues. And that isn't necessarily a big problem for today. But if it holds like that, it will be a problem in 18 months, 2 years because they do need to get those raw materials and forgings -- castings and forgings starting to flow at a greater rate. And so right now, it's further down the supply chain in terms of near the plane assembly that an engine build that things are really growing, but it's still not going very strongly at the raw material end yet.

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

Three questions, if I may. Just firstly in terms of profitability, can you confirm that on the volume element within that revenue growth in the 4 months that you're still getting a drop-through of circa 50%? Secondly, just in terms of tooling, I think at the half year, you're saying, you've seen a pickup, and that typically pointed to a recovery in automotive volumes on a 3- to 6-month lag. Maybe just give us an update as specifically what you're seeing in the second half and how we might think about auto transitioning into 2023. And thirdly, obviously, we've had this energy shock in Europe. Are you seeing any change in customer behavior or trends yet? Or is it just too early to evidence that?

Uncharacteristically, I'll make the comments about profitability and on the volumes. So we have not seen any margin squeeze on the volume part of the business. So if you put the surcharges to 1 side, the underlying health of the profitability is quite good. So that's sort of 1 way of answering your question. As far as the tooling is concerned, actually, it's pretty flat from where it was in the first half in tooling. It's just in the roundings, but these are fairly small numbers for a 4-month period, so nothing we can read out of that. It's not accelerating, which would suggest that whatever -- as you were asking, it's sort of -- it's a leading indicator often for automotive, particularly. It doesn't suggest that the tooling up for a big surge in automotive at this point in time. They tooled up a bit, and that is just keeping us at a flat rate. So we're still waiting there. In terms of customer behavior, I think, yes, there has been an evolution of customer behavior during this period that we've seen. I mean, when we started this exercise, which was right at the end of last year in terms of going after the inflation and then progressively in the first quarter, there were a large amount of customers, in particularly, the big customers that were just in a state of denial. And it was very tough at that point, and then -- that's where we had our lag. Now I think there's -- I know there's a much more sense of realism. Most people, though, are not prepared to just take a number. They just want to say, well, what are you putting it to? Which is where we've gone to sort of referencing external indices because we didn't do that originally. We just said well this is what we need. And so there's more sophistication about it, and it's become more of a business-as-usual issue really, unfortunately. So that's where we're going as we go forward. The interesting thing, I think, is going to be on long-term agreements, particularly those that are laxing next year, and we have a number of small ones because they have to be renegotiated. And that will be quite interesting because the customers are going to be seeing a pretty different cost base when they originally signed their LTAs. And the indices that are in the LTAs have not been reflecting the cost increases. And so they've benefited quite a lot in the past. So I don't know what the outcome is going to be, though. It's not a huge part of our business, the ones that are coming up very small, but it will be an indication as to how customers behave those particular customers, which are aerospace customers, by the way when those LTAs come up. I hope that answers your question, Dom.

Very clear.

Our next question comes from the line of Maggie Schooley at Stifel.

I just had 2 questions. Following on from Dominic's question slightly, Specialist Technologies was growing quite nicely during the period, which is logical, given [indiscernible] But are you seeing any pickup in other areas seeking out that technology, given the lower energy consumption versus the benefits of that technology in terms of what it does for the product? The second question I had is, given that you mentioned that businesses are struggling, you're starting to see small market share gains -- has always been a focus for you given your strong balance sheet. But are you -- can you just give us an update on what you're seeing on the willingness of buyers, but more importantly, expectations on price? And are we starting to see any movement on that front?

So on the Specialist Technologies question, there are people switching faster because of the lower energy consumption. To be honest with you, I haven't really looked at that. I have to ask the question. We're doing -- so many other things going on, I haven't seen that. I would doubt it in the very near term here because most people are [indiscernible] water in their businesses rather than looking for optimization right now. It will probably start over the next year or 2 if the energy prices remain high. There will be an added impetus to go to the Specialist Technologies. There might be some, but at the moment -- but I'm not aware of it overly. I couldn't quite hear you on your second question. Were you talking about M&A?

Yes, sorry. So you mentioned a lot of the smaller players were struggling. I know that's they won't move the dial for you in terms of M&A or something of that nature. But are there any larger businesses that are now coming to the same conclusion? And are you starting to see price expectations or the pipeline looking more attractive than it has in the past?

Yes, I think the answer is yes to that one, Maggie. The ones that are shutting their doors are not businesses that we would have gone for in the first place actually. I mean, they're not there. But some of the other businesses, certainly, the price expectations are lower in some instances. But the really, really good ones that are out there, which are not necessarily in classical heat treatment, it's more of a case them coming to market than the prices being low. And previously, they just wouldn't come to market. So we're seeing more opportunities to go after things. And then -- luckily we'll have some success at some point here because we've certainly been trying hard enough.

And we currently have 1 further question in the queue. [Operator Instructions] That next question is from the line of Harry Philips at Peel Hunt.

Again, just a couple of questions on Emerging Markets and Specialist Technologies. In terms of Emerging Markets, there's a big increase in revenue and obviously, big increase from the surcharge and price element. But are you seeing your customers, particularly the larger OEMs sort of switching more production away from Western Europe into other regions and you're just reflecting that trend? And a sort of a similar theme around Specialist Technologies, again, lovely improvement. But are you still getting the decent margin and that margin mix is sort of holding up, if not improving structurally going forward? And then actually, just 1 final question. The comments around Civil, I'm presuming the engine side is sort of mirroring the comments from the customers and the cost should be fairly straightforward there?

Yes. So Emerging Markets, are customers moving more to Emerging Markets? I think in Eastern Europe, the projects that were already started are certainly moving fast and accelerating. So particularly in electric vehicles, we're seeing some pretty nice business being set up for electric vehicles that we're part of in Eastern Europe. There is a little bit of retrenchment where there are items that can be sourced back in the west. And that's mostly because the energy inflation in Eastern Europe has been much higher than in the west. So you're seeing some people saying, okay, well, we will do it back in Germany for the moment or back in France because it's just a little bit cheaper. So there's been a little bit of backflow. But that's only stuff that can be easily moved. The general trend and the investments is still ongoing into the emerging markets, in particular, Eastern Europe down to Turkey. And that's going quite strongly as sort of long-term trend. Mexico is doing fairly nicely. The 1 area where, obviously, there's a little bit of a mix going on is in China. It's a huge market. So for as far as we're concerned, there's still plenty to go for. There's miles and miles and miles to go for. But it is quite confusing in the Chinese market, particularly from the property side, and that affects us when we're looking at expansion in greenfields, which is something that we do in China fairly regularly. And that's making like a little bit more interesting, if I put it that way. So the property market in China is certainly deflating somewhat. The next question was on civil engines, I believe?

Yes. That's right. I mean, obviously, sort of uptake's been pretty decent at the moment. And I'm just assuming that you're sort of mirroring that level of uptake, if you like, and the sort of inventory within the system is largely being worked through.

Yes. I think that's really true, Harry. And don't forget that we do have aftermarket as well. And our aftermarket is, quite heavily biased towards Rolls-Royce. So whereas the Rolls-Royce engine build is not so high in terms of their tick-up, I mean it's a slight tick-up from small numbers. There is aftermarket work there. We do, do aftermarket for the LEAP engines and CFM56 to a certain extent that's mostly LEAP now. But the percentage of the business that is aftermarket on LEAP is much more, one, it's the new fleet; and two, it doesn't actually need as much aftermarket because the GE and Safran approach life is to repair more, whereas the Rolls-Royce life approach is to replacement. We win on the replacements, and we don't win on the repair. So the percentage of the LEAP that we would see in the aftermarket will be lower anyway on a smaller fleet. But still, you do have the aftermarket that moves the numbers in a different fashion from the new engine build. But in short -- that was a long answer. In short, our numbers are meeting or exceeding the engine build rates at the moment.

And we have 1 further question on the line, that's from the line of Andrew Singh at JPMorgan.

It's actually Andy Wilson at JPMorgan. I've got 2 questions. If I can just start, just I think possibly clarifications on previous comments. Just on the auto volumes. I guess I'd expected them to be a little bit stronger. Now notwithstanding sort of Dominique's comment around it's a 4-month period and that's very difficult even to kind of read across or read more broadly, but is that a sort of inventory in the chain at the sort of through the auto supply chain that you think is having an impact or is this just simply a timing thing? I just wondered if you could help in terms of thoughts around inventory in the chain potentially and that may be improving.

We thought you'd changed your name for a minute there, actually. But yes, the automotive story is a little bit difficult. I mean, car and light truck is a little bit up. But it should be, in some ways, it should be up further because you are seeing the easing in terms of the supply chain, and there's still quite a bit of demand out there. But can't really answer as to why it isn't up a little stronger. I don't know, but it is a short period that we're seeing here. We are, in fact, seeing -- the OEMs are more bullish than the Tier 1 and Tier 2 suppliers. I will say that, so much so that the supply chain going into Christmas, they're talking about taking an extra -- going an extra day -- sorry, taking a day early or 2 days early in terms of the Christmas closed, which is -- it's not a huge amount of impact on that, but it does show you they are a bit more conservative than the actual [indiscernible] they're seeing the demand picture still very strong. But there's a little bit of a reluctance, I think, in the supply chain to stock up now, having run their inventories down a little bit too far. They're not really moving the inventories up yet. I don't know if that answers your question at all, Andy?

No, it does. It's helpful. I mean, like I said, I'm not trying to overlay, but on a very short period, I appreciate, but just it's helpful to get the context, given obviously how broadly exposed you're going to be. My second question was on price and surcharge. Can you split what's being priced and what's being surcharged, appreciating that it might be different by region and by market? I guess my question really or what I'm trying to understand is, is this the right way to think about 2023? You've talked about expecting price to come through to cover, I think, labor inflation. Would we expect surcharges to just naturally reverse and, therefore, there is a difference in the impact that you're going to see next year potentially on price can still be up but surcharges, at least on the sort of headline revenue number, would be a headwind? I'm just trying to understand, obviously, what are quite big effects if you can help me a little bit.

Yes. Well, let me just say 1 thing. It varies by plant, by customers, so there are huge differences around the place. So we can't -- giving you a blended number would be not a good idea. Dominique?

I think first of all, we're not splitting it because it's commercially sensitive between the price and surcharge. But if we just come on to the sort of the logic, I mean, the first thing I'd say is energy cost today might be off their peak over the summer, but they're not below today what the average has been through this year. So I'm not sure that one should necessarily assume that energy costs next year will be below overall where they've been this year, albeit clearly, it's a volatile market and that picture could change. More generally though, the logic that you described is absolutely correct. To the extent that energy costs are lower, and therefore, our surcharges come down, that would reduce our revenue expectation, revenue growth next year and correspondingly improve our margin, which this year has been hit by the surcharge-fueled revenue growth.

Important to note on that is that the surcharges don't cover a margin increase. They are straight pass-through of energy. The price increases are different. They actually include a margin as well. So the more price we've got, the better the margin picture. The less surcharge we've got, the better the margin picture.

That's very helpful. That's exactly what I was looking for.

And there's no further questions from the line, so I'll hand back to our speakers for the closing comments.

Yes. Well, thanks very much, everybody, yes. And obviously, if you've got any questions, just call us directly. Thanks a lot. We'll say goodbye now.

Cheers.

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