Bodycote plc (BOY) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Bodycote Trading Update Call. [Operator Instructions] I would now like to turn the conference over to Mr. Stephen Harris, Group CEO. Please go ahead, sir.

Thank you. Good morning, everybody. Welcome to the call. I'm here with Ben Fidler, our CFO. I'd like to say this morning that as you can see, the company is in rude health. We're humming along very nicely. We've got a great management crew in place, and we're on top of the business in numbers. I think at this point, I suggest to check that that's one of the reasons clearly that I'm comfortable at this point in time to think about hanging up my boots. And you'll see that we put out a separate announcement of the trading update this morning that says I've actually informed the company that I will be looking to retire next year, in no time soon. That would be the appropriate time once we've actually identified and selected a successor, and it will be hand overed to that person. So still around for quite a while, but the company is in very good shape. Let's move on to the trading summary itself. Clearly, a strong start to the year. The main numbers we'd like to focus on in these releases are the numbers excluding energy surcharges. So whilst we reported group net revenue up 22.1%, but the number we like to focus on is the constant currency, excluding surcharges, which is a group increase of 9.5%, and that's more indicative of the underlying trends in the business. As you can see, the -- we've stated the surcharges are trending down and that indeed is the case. It's steadily falling in each country, in each location, month by month at the moment, and we are marking the surcharges to the market almost everywhere on a monthly basis following the indices down. We don't know where or when that will happen. Obviously, it won't ever go negative. But we would expect, along with the rest of the world, these energy prices to still keep falling, at least until we get to the winter. At that point, I don't mean to say this, but it depends on the weather. It's not something that I didn't want to say. And we'll see how -- what goes into the fourth quarter with that. But generally, the surcharges are coming out. And therefore, the underlying growth is going to be more reflected in the reported top line growth. And things are looking pretty good. The margins of the business, of course, are expanding as these energy surcharges are. And indeed, as the volume comes through, we also get the [ contracts ] we normally get. So our margin progression is exactly where we thought it would be. Just looking a little bit more deeply into some of the numbers and putting out a little bit of color, I'm not going to go through the 2 businesses. You can see the specialist technologies numbers there as well. But just picking on each one of the market sectors a little bit. Aerospace and defense, so the excluding surcharges number, it's up 9.4%. I'll be honest, that's a little less than we would have expected. We were hoping that it was going to be higher than that. Certainly, it's not a bad number, but we have been seeing that some of our customers, in fact, quite a lot of them, they still got the supply chain issues, but the numbers are ticking up every month through the year. And that's something that we would expect to keep going, and that growth rate probably going higher as the year goes forward. But right now, it's just a little bit behind where we thought it might be. In contrast, automotive is higher. We were a little bit cagey about automotive because it's such an uncertain area for most people. But with 8.8% growth, excluding surcharges, that's quite a nice print. But we must remember that we've got a soft comp for that from the prior year. But the other thing to note about automotive is that one of the things that's driving it along for us is we are picking up increasingly more and more electric vehicle work. And whilst I won't go into a lot of detail today, it is something that we want to comment about more at the half year because some of the contracts we've picked up are material, and they are long standing. So that is quite interesting, and it's helping to drive that automotive growth. General industrial, it's pretty much the same as we said at the full year results earlier this year '22. We still got the 2 sectors that we referred to growth is moderating in. No change in that trend. But there are other areas within general industrial that are getting really quite strong. We're quite pleased with our medical growth, and that is picking up quite rapidly. And in medical, what we're having a lot of success with is prosthetic implants for prosthetics. So it's not just the underlying growth in the normal cobalt chromium hips and knee joints that you've seen around the years. But we're picking up quite a lot of these titanium alloys additive manufacturing work that requires HIPing and heat treating and that that's quite high value work. So that's growing from a smaller base, but it's still very nice growth. It's going on in that part of GI. And of course, the other one is energy, which we put in GI right now. We used to report it separately. But once we decided to retreat from fossil fuel extraction, we thought it was not a material part of the group, and we put it in general industrial. And the growth area in energy, particularly for us, is in what you might call energy security, securing people's energy supplies in way that is manifesting is it seems like anybody with a gas deposit off their coast is putting in wells. So we've got quite a lot of subsea gas work that we're working on, which, of course, is through one of our specialist technologies Powdermet. And that is really going very strongly. It's a small part of the group, and it's growing rapidly. Unfortunately, that business is also lumpy, but it does have quite a long time horizon in terms of the project. So we've got good visibility of that particular piece of the business right through '24. And that is quite strong. Just moving on to emerging markets. Emerging markets really knocking out there. The only slightly offsetting piece there is China. So we've got 6.5% growth in China, and we don't have surcharges in China either. So some people might think that's great. Our internal performance in China, we always reckon that we should be higher than that. We always have been in the past. But of course, China has just come out of the COVID lockdowns. I think a lot of people are finding that the rebound is not quite as fast as they thought it might be. And we get intelligence on it now every couple of weeks, things have opened up and things are moving, but it's quite an intense type of activity in China, particularly in automotive, which we have a lot of exposure to, particularly the EV market in China. And what we're seeing is lots of price wars going on and that's all the Chinese players. And that is certainly causing work to be switching around and giving us opportunities and growth. So China, I think it will be slower to grow than we might have originally thought. We never factored that in very heavily, but it still looks pretty good in the long run. Moving -- our financial position, of course, is very strong. And summary and outlook, well, we're 4 months the year-end and 8 months to go. Clearly, we're in a good place. And we're comfortable with where our expectations are. We're not going to be changing those at the moment. But let's see where we get through at the half year. With that, I'll turn the call over to questions and answers and Ben Fidler can take the questions. And I'll just give you -- yes, I'll help him as well. If you could open the call up, please, Laura. I appreciate that.

[Operator Instructions] Your first question comes from the line of Andrew Douglas from Jefferies.

Stephen, I won't wish you a retirement -- happy retirement, just yet. It feels like you've got a bit more time under your belt. Three questions from me, please. Firstly, can you just talk to us a bit more about automotive? I hear what you say about contract wins and wanting to talk more about that in the summer. But can you just talk about Eastern Europe, in particular, very strong growth there. I'm assuming that's partly moving the capacity over from the West. But that's kind of where the EV will be kind of seeing the main benefit. Is that right? Or is there more to it?

Exactly right, Andy. I'll take them one at a time, if you don't mind the questions. That's exactly right. I mean we've got significant contracts covered in Eastern Europe and indeed, the rest of the emerging market in EV work and not just the EV specific work, but also the general work such as [ dent ], brakes and steering and stuff like that. But a lot of that stuff will end up for EV, but we've also got very significant EV specific exposure that we're being contracted to do. And in fact, our investments have been geared that way for some time, and we've actually got more equipment we're moving in there now. And it helps the fact that we've got the right kind of equipment, and it's mostly our specialist technologies on hand. And we're moving that into the right locations. So sometimes we have to adjust the math of it because our customers don't always set up who we thought they would. But that's actually what that's going on Eastern Europe. And general industrial actually is also doing quite well there, too. But certainly, the move of the supply chains in general to the emerging markets is what's driving the...

And the commentary about just being cautious of or cognizant of the potential consumer slowdown in the second half and what that might mean for auto. Is that just kind of a general comment rather than anything that you're seeing or hearing?

It's my natural envelope kind of to say.

Okay. We were talking about M&A last time we spoke a couple of months back. And I sense that there was a bit more enthusiasm for maybe some newer deals that come to market, maybe some bigger deals, and some more interesting deals. Can you give us a refresh on what you're thinking about M&A? And then I've got one for Ben.

No, there's no change to what we're thinking. We wish some of these private equity companies will calm down a bit. But on that, life is where it was. There's certainly a lot of activity coming to market. And clearly, acquires a number of companies that have financial stress. So we don't see, but a lot of companies out there do, and that's bringing stuff to market whether we manage to put off a deal or not, time will tell as we get towards year-end, of course, we haven't pulled off a deal of any size and we will be sitting in a very comfortable position on the cash side. And that's where we'll be contemplating what we do with that cash with regard to shareholder returns.

Okay. Understood. And then lastly, just for Ben. Ben, can you just give us a little bit of help on the shape of this year's profit numbers? I'm working on the assumption that they're not too different to last year in terms of first half, second half split. Is that right? Or is there an update you can give us?

Yes. Thanks, Andy. So what I'd say on that, if we remember where we were last year, last year was around about 45-55 H1-H2 split looked at the operating profit level. I think this year, we would still expect to have something in the second half bias. I'd probably work on the basis, it's a little bit less pronounced than the second half bias what we had last year. But I would still plan on the basis of something for the second half bias in 2023 again.

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

I'll go one at a time. I just wondered, firstly, maybe one for Ben. Can you help us with the mechanical impact that you're seeing on margins from the moderation in surcharges in the first half? And if you got any color for the rest of the year, that would be also super helpful.

Yes. Well, look, I mean, the mechanical implications are, it clearly boost the top line. Surcharges are there rightly to recover our energy costs. We don't make money out of those surcharges. And therefore, the fact that they are dilutive to margin, but they are absolutely the right thing to do to cover us from an inflationary cost perspective. This morning, this trading segment is all around the top line. So we're not going to talk about profits. We're not going to talk about margins at this point. You'll have to draw your own views and conclusions, understanding, as I'm sure you do, the operational gearing that we have in the business to top line growth. What I would do is reiterate the comments we've made in our full year guidance, which is we do expect margins to expand for the full year as the surcharges moderate. Now the pace of moderation in those surcharges requires rather large crystal ball on both sides, your side and our side. You clearly have seen what we've been able to achieve in terms of surcharges in the first 4 months, up 7.1% year-over-year. What I would flag, as you forecast forward there, George, is just the fact that, that first 4 months does compare to the early part of last year when we had a lag in putting in place those surcharges in the first place. So I wouldn't annualize that number, the 7.1%. And building on Stephen's comments and will be made in the statement, recognizing that surcharges as a percentage do peak in the fourth quarter, they have been declining from there. And clearly, just bear in mind that first 4-month number, not working on an annual basis as you forecast through Q2, Q3 and Q4. But where surcharges are really going to land during the second half and particularly over the winter months, it's hard to predict. What I would say is, okay, that's going to cause you to modify your top line expectations, but it isn't going to cause you to modify your profit expectations because it's net neutral at the profit level.

Okay. And then maybe a couple for Stephen, just I wondered if you could help us a little bit with the subsectors that you're referring to, again, in general industrial that are sort of a bit more sluggish. And equally, I think before you're talking about some CapEx-related investment. Just wondering if that's still something you're seeing a lot of traction in those markets? Or is there any moderation to all there as well?

Okay. So I mean, the 2 areas that we've talked about, the same 2 areas that I'm talking about now, and that's tooling, which has been over the years quite a nice leading indicator for automotive. If you remember about tooling those people, tool up before they start producing and then once they start producing there is a replacement requirement but not anywhere near as much as the original tooling that they start in place where they're going to ramp up their production rates. So we saw quite a large growth in tooling back last year originally. And then it started to moderate, as you would expect, anyway if people were going to be going into production. We haven't seen the production coming through, but we did see the tool coming through as a moderated growth and that moderation has continued. What that really means in the fullness of time is automotive is going to be in its steady state, and that's just replacement, or is there going to be a bit of a defined because people are maybe worried about consumer spending. That's not something I can actually answer as to what the customers really are doing, but it's in line with, they're not expecting any massive drops, but still obviously mindful of what's coming down the pike is the economies generally go there very way. So that's just one small snippet there'll be too much into it. The other one is industrial machinery and that seems to be CapEx driven, that is long cycle. It is generally stuff that people have to invest in as they expand their production. And the growth in that was very steep at one point, and it has been for probably the last 6 months growth in industrial machinery pretty much more around the place has been slowing in it's growth. It's not gone down. And there are plenty of pieces of evidences of that, not just from Bodycote, but other places. So in the industrial machinery, particularly machine tool producers, have been talking about their growth in exactly the same way that we're talking about the kind of work that we see because obviously, we're servicing those kind of people. That's just a CapEx cycle. It's a general not so good as tool but sort of indicator about people's thoughts about the future economy. But once again, these are people's thoughts. They're not really tangible in terms of how general economies are going, which is people doing their future planning. And the trend changes in those have really been along the same lines we've talked about already, so we've been knowing this really, that's why I spent a lot of time explaining this.

Okay. And maybe just a final one on Civil Aero, which I appreciate it seems to be quite difficult to call now, given the supply chain challenges. But I just wondered if you could help us with a little bit of color what customers are saying in terms of sort of H2 levels of demand that you might see and whether or not that supply chain could be unblocking anytime soon.

I think it is unblocking and people are certainly planning it that way. But I know you directed this question of me, but actually, the aerospace expert in the room is Ben. So, I'm going to hand over to Ben.

Thank you, Stephen. So Yes. Look, I would concur with that view. We saw progressively through the first 4 months of this year that -- although some of these supply chain constraints throughout the whole supply chain is still evident, there are signs that they are progressively using. You saw that in the first 4 months, and we are expecting to continue to see that as the case. A number of our customers, we know are putting incremental capacity in both capital capacity, headcount capacity to help deal with some of the upstream supply chain challenges. So I think as far as commercial aerospace is concerned for us, that 11% growth that we saw in the first 4 months period, we would expect to see some improvement in that growth as we go through the remaining part of the year. Obviously, critically, it does depend on the exact timing of some of these supply chain constraints easing.

And I just like to add on the point on that because we don't often talk about defense and I won't spend a long time talking about it either. It is a small part of the group. But we are starting to see the budgets of the different countries rather than spending money on the replenishment, inventory restocking in the defense side of life. And so that has started to pick up. It had to come sooner or later and it is coming now. So not as fast as anywhere near the civil aerospace space, it's a healthy one.

Your next question comes from the line of Harry Philips from Peel Hunt, New World.

Again, 3 questions from myself, if we can say. Again, just coming back to Aerospace. Just one of the supply chain bottlenecks appears to be in the casting and forging side, and obviously, that takes a while longer to unwind. So maybe a little more detail if you have it around that? And then just on pricing, not just surcharging. Is pricing just good across the piece? Or are there particular pockets in specialist technologies or emerging markets where you're getting more through or getting more of your value plus into your selling price. And then lastly, I guess, for Ben, obviously, your comments around M&A and the activity of private equity and so forth. Obviously, very strong balance sheet. So maybe first thoughts maybe not the appropriate time, but I'll ask questions on the left plus also around capital allocation and the balance sheet, please.

Thanks, Harry. The aerospace supply chain, I mean, yes, I mean, you're right. People talk about the casting and forging and that is -- we start with that work pretty much on the West Coast of the U.S.A. That's where the concentration for us is. And to remember generally speaking, the castings and forgings that are being produced today end up on airplanes probably 2 years in the future. So that's the kind of supply chain latency that is there in that work. And in fact, the issue is not what it was. I mean one of the problems that people were worried about with the lack of material, there was a huge scale of uncertainty for example. And you don't share a lot of that noise at the moment. Really, it's about production capacity. And that's all about the gearing up and trying to take the production rates up, and that's proving tough. So we've got quite a lot of capacity waiting for it. And we deal mostly through like, I think, all through Tier 1s in that area that they're in the market, they're putting in their capacity. It's their capacity constraints. It takes quite a long time, laying the stuff down and it started -- they started investing quite a while ago, but it takes time to put it online. And that is coming online gradually. And some of the really dominant players not quite as fast as some of the smaller ones. But we see that moving ahead quite nicely. It's certainly they're telling us, okay, this move is coming, it's coming tomorrow. It's coming tomorrow. We get used to that kind of drumbeat. But that's where that's going. The other end of the supply chain, which is that the -- for us, the closest to getting on the planes is our thermal spray business, particularly the Ellison business that we bought. And then the volumes are coming through quite nicely. The issues on pricing, generally, the -- I don't think that you can say this is an area where we're getting better traction or not because we're very good with the pricing side. I think we are one of those businesses where we tend to get our prices through and at the level that we want. The only area where it's tougher actually, is what I've just referred to, which is in some of the major OEMs that are seeing big inflation from all over the place, and they're a bit more reluctant to raise prices, one in particular. But nothing materially would say for the group. Overall pricing very, very good, passing through what we need, what we want. And I've always said, inflation is a nice environment for [indiscernible] because we are able to do that with many other companies, so we don't have the same luxury. I hope that answers your questions.

Lovely. And capital allocation, Ben, do you have a thought?

Yes, happy to just share some thoughts with you on that. So I think the first point to frame it is that this is a high quality issue. It's high quality. I was going to use word problem, but it's not a problem. It's a high-quality issue to have. We are a business that is highly cash generative. We have a strong balance sheet. And clearly, as we progress through the course of this year, we would expect the level of debt to diminish further as we approach the year-end. At the same time, we're conscious in terms of leverage that we are operational gear and therefore as a business, we have to be mindful of the level of financial gearing that is appropriate and prudent to put in the business. Clearly, on a medium-term view, that level of financial leverage is higher than it is today, which gives us the opportunities to pursue different routes as far as capital allocation is concerned. What I would say is we will be disciplined about that. Those different uses of capital will and have to compete with one another. So those will be organic investments, dividends, M&A, and potentially supplemental distributions through either special dividends or share buybacks as and when appropriate. And they will compete with one another in terms of what the risks are, what the returns are. What I would say is I would expect -- you should expect to see organic investment and M&A to focus on very clearly support of our strategic areas. We desire to grow in specialist technologies, emerging markets and electric vehicles. And that's exactly where we are focusing more of our spend and efforts on the organic expansionary capital expenditure as well as the pipeline of M&A deals where inevitably as always in our industry, there are a number of those that are under consideration at any point in time.

That's great. It's interesting just on your M&A comments availability with another 2 executive changing or announcing has changed 10 days ago. We'll see what it all brings. Many thanks.

Your next question comes from the line of Stephanie (sic) [ Stephan ] Klepp from HSBC.

I guess there was a gender change. It's still Stephan, but anyhow. Yes, hello. There was many questions already asked and many answered. So I have only 2. So I understand your conservative stance regarding the full year. But are you currently because we are basically at the end of May, are you seeing any changes in the demand dynamics in the short term that would cast a different picture on H1.

No, we haven't thus far seen any difference if we had, you'd have seen it reflected in the statement that we've just put out this morning. It clearly was a good start to the year. That has underpinned our confidence in the report there and underpinned our confidence in the guidance that we gave in March that we're reiterating today, clearly dependent upon the trading pattern that we see in the next couple of months. And when we announce our half year numbers, we will take a raincheck and look at where things are then.

Yes, that's fair enough. Good. And then second one, it's about the strong growth in specialist technologies, so -- which is very good, obviously, because the mix shift continues to high-margin areas. And I know that you are especially talking about margins, but are there any reasons we should not assume that the positive mix shift and delivering on the energy or declining energy surcharge should have a very supportive effect on the margin?

I think you can assume it will have supportive effect on the margins, yes.

Say that again, I couldn't hear you.

I'm sorry, I think you should assume that it will have a supportive effect on the margins.

And you're not specifying anything else or any color on that?

I think that's enough for today.

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

I think my question is probably around automotive. And I know you've talked about getting a lot of new contracts in EVs. But there's probably another trend, which is clearly the Chinese domestic brands are pushing for exports. I'm trying to understand the shape of the automotive business because you still have a lot of business in Western Europe, which is clearly going to get exposed by shift to Eastern Europe and to China. So to what extent do you feel you're going to have problems in Western Europe, you already have a lot of assets there, is clearly are going to be stranded?

Well, I mean, first of all, if you recall, we did go through a restructuring program, moving a lot of those assets out to Western Europe. We did that in '20 and '21. So we have a vastly less exposure to the Western European automotive scene. That exposure that we do have in Western Europe is primarily on the platform agnostic equipment. So that is things like brakes, steering gear, seatbelt clips and all those kind of interesting things as opposed to any type of transmission type. The threat from China is probably an electric vehicle as opposed to anything else. There's a side there on that. I mean, we are resisting taking businesses of automotive today that's associated with internal combustion work. Now remember, the only ICE work that we do is not associated with the engine itself. It's associated with the parts of the transmission of the engine. And we're resisting, expanding that because quite a lot of that work is being outsourced as people tool up for electric vehicles. So that is still growing. And you might say in 5, 6 years, there might be stranded assets there, but we don't have those kind of assets in place in Western Europe. The Chinese export side, lot of written about it. But our guys on the ground, it's a real bunfight going on in China with all these guys playing in a local market at the moment. And there's talk about quite a lot of consolidation happening in China. But it clearly, I mean, they'll break out in China at some point in the future. It's not something that we necessarily would be concerned about anyway. Because we're on the ground there. And I don't think we're going to have stranded assets. One of the things about our assets if they are reusable into different segments. It's not as if something that is doing transmission system for a car today can't be used for doing wheels somewhere else on a different kind of vehicle. Same kind of processes, some of the specialist technologies that tend to be more focused on specific types of work. And on specialist technologies, they're not going to be strands, I mean things are actually focused on very high growing areas. So I would say, in general, Sanjay, I wouldn't be pessimistic about this in the U.K. if you want. But for us, we see it actually is quite an opportunity.

So are you saying that you don't expect to do any more restructuring of your -- substantial restructuring in your sort of Western European capacity.

Correct.

There are no further questions at this time. I'd now like to turn the call back over to Mr. Stephen Harris for any closing remarks.

Okay. Thank you. Thank you very much, everybody, particularly to those people that have been sending me messages this morning. It's a little quick to congratulate. And the office to buy me a beer, double pint yet, because it will get very warm by the time I leave the office. So looking forward to seeing you in time as we go through the results at the half year and the full year. Thank you very much for listening.

Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.