Bodycote plc (BOY) Earnings Call Transcript & Summary

Well, good morning, everybody. Welcome to the Bodycote final year -- final results presentation. I'm Stephen Harris. Hope you know we by now. I'm pleased to be here with Ben Fidler, our CFO. And welcome to Jim Fairbairn, who is in the audience. He is due to take over from me in May. And then onward and upward as they say. Let's just move to the business of the day. We're going to go through the agenda here this morning in the normal way that we've done it in the past. We'll do a quick overview, and Ben will come up and do the financial review. I'll come back to a business review and then we'll move to the outlook. So looking at the overview here. So I'm pretty proud to say we've had another year of strong growth and margin progression. We are actually humming along here, as one would hope. Results up 8%. The revenue growth underlying is 6% if you take the surcharges out, and you can remember that those surcharges, what we imposed when the energy prices started going through the roof and the idea was just to cover the cost. And we moved those around as the energy prices moved up and down. They are in retreat at the moment and we will come to a bit more about that later. We'd like you to focus particularly on after surcharges because that's the natural way this business is going, and surcharges will be a thing of the past soon, we believe. Headline operating profit up 17%. The operating margin, we've said that we were going to get this margin moving again, should get up over 20%. If you take it after surcharges, it's 17.3%, which is 120 basis point increase year-on-year. EPS growth of 13% and our return on capital mostly up to 14.8%. Let's talk about cash flow in a minute. I think a big shout of thanks to Ben and the team here. Got us back in the cash collection game. We kind of were fumbling a bit at one point. But we're back. We're back to the kind of cash flows that this company can and will do. And I think you can be pretty confident that this kind of performance should be sustained going forward. Net cash at year-end of GBP 12.6 million, excluding leases, of course. And then the Board is recommending a final dividend of 16p. That's a full year dividend of 22.7p. And just to remind you, that makes it now 36 years of uninterrupted dividend track record moving forward in this business. Let's talk about strategic progress. I mean, one of the issues about these numbers is that they're not a flash in the pan. They've come about by us pursuing our strategic focus areas, and we're pretty much doing well on every single aspect of it. So Specialist Technologies has led the margin growth -- sorry, well, margin growth and the revenue growth. You'll remember that Specialist Technologies have high growth rates. They have margins that are extremely good and quite a large market potential. And it's been our strategy to really invest in these Specialist Technologies and grow them, and we're seeing that come through and we have for some time now. Our view is that Specialist Technologies should outperform through thick and thin, over Classical Heat Treatment, and they have done so again. Clearly, strong growth in Aerospace and Defense, up 11%. And medical, which for us, of course, is orthopedic implants, not to be confused with other parts of the medical market, up 24% and still going very strong, and we expect that to continue. We'll talk more about that again. We secured some more major projects. We talked about in the first half that we'd signed some nice electric vehicle contracts, and we've done the same again in the second half. These are pretty meaty. And when we talk about electric vehicles, just to point out, because some people are saying that electric vehicles have hit an air pocket, well, for us, electric vehicles is hybrids and battery electrics. And quite frankly, whilst battery electrics might have stalled in some parts of the world, not everywhere, of course, but in some parts of the world, hybrids are going really, really strongly. So I think we're in a very good place, and we expect that to be quite a good strong secular growth market going forward and we're doing very well in it. Improved our energy efficiency. So this is quite important, I think, not just for us but for a lot of people. So we've reduced our absolute energy by 4%, even though we've got the sales growth of 8%. And I think that's pretty good performance right there and we'll be continuing to do that into the future. So reducing energy through lots of different ways. New contracts secured through our Scope 4 scheme. Basically, we have a great value proposition where we can reduce customers' carbon emissions, one by them giving it to us, but two, we're more efficient and we use better processes than the customers. And so overall, it's a win-win. We swap carbon with them. They give us a good price, and we'll go into that in a bit more detail. Margin improvement, another step on the journey. So we're heading towards 20%-plus on the margins, eminently achievable. Notably, within this, aerospace, defense and energy margins up 410 basis points. And AGI is sustained above historic peak levels. AGI has not been this high in the past and we've held it now for 2 years and we should keep it up there. Capital deployment, a big theme for us is balanced capital deployment. And you've seen that we increased our CapEx with a great proportion of expansionary spend, so a big focus on expansion, and we'll look at where that's gone. We did complete the Lake City acquisition in January, which we worked on all through last year. Really, really good acquisition, great returns on that. And it's right in our strategic crosshairs of Specialist Technologies, and it's got this orthopedic implant specialty there as well. And then to balance it all off, we've launched a GBP 60 million share buyback. Let's just look at the margin story here. I would encourage you to look at the solid line. That's excluding surcharges and you can see where it's going. Those of you who've been around a while, you realize that prior to the pandemic, we were almost over 20%. We're just in the high 19s area. And we should keep this journey going. What causes the margins here? Well, one is the mix issue. So the more Specialist Technologies you've got, naturally, the higher the margin is. Clearly, volume helps. We get quite good drop-throughs on growth. And so those things combined drive this business forward. So natural margins should be in the low 20s. Why isn't it -- sky is the limit here? At some point, there is definitely a limit. You get into a big pushback from customers, and we don't intend to hit that brick wall because we will just invest faster for growth once we get to that point. And so volume growth, mix and improved efficiency, not to forget the efficiency improvements, which we work on day in, day out. Energy surcharges. So this has been the story over the last 2 years. We put this in place and hardly anybody in our space did this. We did it pretty quickly. You can see the energy surcharges are coming off. And in fact, now in the first quarter and what we've had so far, they continue to fall. Unless there's another macro shock out there, my expectation, personal view, is that we'll see these energy surcharges which track energy costs. We'll see these falling down to pretty much the sort of level that we saw before all this happened. Because remember, we always did have something called EEC, which is our Environmental and Energy Charge, which we used to levy on customers that were in a specific area like California where they have an energy peak or environmental cost, or in Texas, where they have a disaster with their sort of quarter inch of snow. So we do put -- generally speaking, we'll be putting very low levels of EECs out there, and they weren't really worth talking about until we put the big surcharge program in. So I would expect this going through the year, progressively towards the end of the year, to be falling. But who knows? Something might happen on energy out there. ESG, I'm not going to go through the slide. It's just to say scores on the board in every category. We're doing very well. We will come back to climate change later when I come back up here. But we're doing very well on our ESG agenda. And with that, I'll hand over to Ben.

Thank you very much, Stephen, and good morning. Just to add my welcome to Stephen's. We'll get rid of the picture of that very handsome chap and move on to look at the numbers in a bit more detail. So headline numbers just to step through those briefly. Revenues of GBP 802.5 million for the year, up 8%, excluding energy surcharges as you heard from Stephen, much more of the right number to focus on. Revenues up at 6% up to GBP 736 million. On that higher top line, we delivered strong headline operating profit progress. Headline operating profit up 17% at constant currency to GBP 127.6 million. That gave that operating margin of 15.9%, up 80 basis points year-over-year. Look through the surcharge effect on revenues, margins of 17.3%, strong performance up 120 basis points year-over-year, a performance we're very pleased with. Headline EPS, you can see there up 13% to 48.4p. Full year dividend, continuing that strong track record that we have on dividend, a 7% increase up to 22.7p. And good free cash flow improvement, free cash flow up over 45% in the year to GBP 122.5 million. Finally and then very importantly, return on capital employed. That's a key metric we focus on in terms of driving the business forwards and driving value, up 150 basis points in the year to 14.8% as we continue to drive recovery there. Let's look in a bit more detail then at the revenue progress. And the picture overall and the message overall, I think, is a year of good top line progress for the group but did very much reflect the benefit of the broad and balanced end market exposures that we have in the business. What were the key drivers of that then? Chart behind me breaks those out. Firstly, volume, price and mix added about GBP 43 million to revenue. That's that 6% growth we talked about, led by Specialist Technologies up 12%. Secondly, energy surcharges. They were up almost GBP 19 million in the year to reach around GBP 67 million. For the eagle-eyed amongst you, you'll notice all of that increase came in the first half. Actually, energy surcharges were modestly lower in the second half of the year on a year-over-year basis. In the first few months of 2024, you'd have seen from the earlier chart, surcharges have continued to reduce, reflecting lower energy input costs. Hard to predict exactly what happens, but if things go as expected on energy input costs, we'd expect that reduction trend to continue in surcharges through the course of 2024. Finally, as you'll see on this chart, fourth driver was FX, about a GBP 3 million headwind to revenues for the year from currencies, predominantly on the dollar and the Swedish krona, with quite a big reversal in the second half of the year after what had been about a GBP 12 million tailwind to revenues in H1. Headline operating profit performance was strong, as you heard earlier, GBP 127.6 million, up 17% at constant currency. Four drivers of that, that are worth stepping through and flagging. First is the nonrecurrence of the GBP 5 million energy surcharge shortfall that you may well recall we suffered in the first half of 2022, driven by the lag in implementing surcharges at the start of the surcharge program. Secondly, GBP 18 million of additional profit that came from the higher volume, the benefits of pricing and mix as well as some improved efficiencies, with the majority of that GBP 18 million led by the ADE division. We'll come to that shortly. The third driver was a headwind of around GBP 4.5 million from higher share-based payment costs on long-term incentive share schemes, as that charge in 2023 reverted closer to more normalized levels, having been lower in the previous year. And finally, another FX issue, about GBP 3.3 million of headwind from foreign exchange. Let's now turn to look at the divisions in a little bit more detail. And the message here is both divisions delivered a very good purging performance, and we're pleased with that, 20% or higher operating margins, excluding surcharges from both of them. And there still is further to go there. AGI, which as you know, is focused on our automotive and general industrial sectors, delivered revenue growth of 3%, stronger growth achieved in the first half than the second half of the year. Growth was modestly better in automotive than it was in general industrial. Stephen will lift a little on those end market trends in some slides a little bit later in the presentation. Despite some of the volume weakness that we've seen in the AGI business in the second half of the year, full year operating profit was up 1%, and margins were held broadly constant in the year of what we think is a very healthy level of 20%. ADE, our aerospace, defense and energy-focused business delivered strong growth. Revenue is up 11%, excluding surcharges, and strong operating profit performance, with operating profit up 38% as you can see from this slide as the benefits of volume, efficiency improvements and pricing improvements came through. Margins up over 400 basis points to 21% pre-surcharges and margins in that division clearly got further to go. Now turning to cash flow. Improving cash conversion back closer to historical levels has been a big focus of ours through 2023. And reflecting that focus, we were pleased with the cash flow performance with free cash flow up GBP 39 million to GBP 122.5 million. Two drivers of the improvement: firstly and actually the smaller of the drivers was the improvement in profitability, EBITDA up GBP 9 million year-over-year; secondly, and actually the much more significant driver of the cash performance, was improved working capital control with a much lower level of working capital outflow of GBP 1.7 million compared with over GBP 25 million of outflow that we had seen in 2022. The primary driver of that was receivables, collection and receivables management. It's been a big focus on that. There still is a big focus on that, and I don't think we still have more to deliver on that through the course of the next 12, 18 months. And that improved cash flow was delivered after a 10% increase in maintenance CapEx to around GBP 58 million as we continue to invest to drive efficiency and equipment uptime. As seen in the first half, cash tax was lower than normal, and that was seen in the full year numbers where cash tax was also lower than normal level, and I would expect that to step up again in 2024, but we'll -- a little bit more on that in a few slides' time. For reporting going forward, I also just wanted to flag this slide to you, which is that we will be changing a little bit how we present our cash flow statement that will bring expansionary CapEx into operating cash flow and into free cash flow. And the graphic just points you to what we'll be moving around where. It essentially better aligns us with normal market practice, I think, is fairly straightforward, and I think the reality of most of the modeling that is done out there by the sell side and the buy side probably aligns us with where you're already at anyway. As that -- as this shows, on that basis, our 2023 headline operating cash flow was GBP 112 million and free cash flow of GBP 95 million, still some very good numbers. As you know, we take a balanced and measured and disciplined approach to capital allocation. And I think 2023 was interesting in the sense that it highlighted that's not just a narrative. It very clearly played out in the actions and in the decisions we took. Expansionary CapEx was up around 25% to just under GBP 28 million. Including maintenance spend, our total CapEx was up 15%. 2023 was a year of delivering further progress on our strong dividend track record with GBP 40.6 million paid to shareholders in ordinary dividends. And in the last 2 boxes, as we announced in January this year, we successfully closed on the acquisition of Lake City for GBP 52 million, a very positive addition to our Specialist Technologies businesses and enhancing our size and scale in medical, in particular, as well as the GBP 60 million share buyback we announced in January and which commenced this morning. There's a separate announcement on that, but I'm sure you've all seen. The group's balance sheet remains in very good shape. Excluding IFRS 16 lease liabilities, the group ended 2023 with net cash of GBP 12.6 million. On a pro forma basis after the acquisition of Lake City, that's about GBP 40 million of net debt. Now probably the most exciting slide in the whole deck, I recognize, is the technical guidance slide, which I know is always eagerly awaited. So just some things to flag as we look forward here for 2024, just to point you in the right direction for a few items. Firstly on FX, look, my crystal ball is no better than yours. So who knows what's going to happen on currencies? But just to flag that if currencies were to stay for the full year at today's levels, that would be around about an GBP 18 million impact to revenue and potentially a GBP 4 million impact to profit. Secondly, as far as net P&L finance charge in 2024, as you can see here, that will be increasing year-over-year, as I think you'd expect, reflecting 2 things: the acquisition cost of Lake City as well as a full year of higher interest rates. Cash interest costs will probably be going up by a similar rate as the P&L net finance charge. Finally, cash tax is likely to be just over double the 2023 levels at around GBP 20 million, reflecting high levels of profitability as well as that nonrecurrence of the U.S. tax refund that impacted the first half of 2023. I'll now hand back to Stephen, who can take us through the 2023 performance in a bit more detail as well as moving on to talk about 2024 outlook.

Thank you, Ben. Okay, so let's move into the business review. First of all, just starting on the transition to a low-carbon economy. And I make no apologies about this. The transition to low carbon for Bodycote is a great opportunity for monetizing the projects. This is, for us, a big driver of improving our returns and increasing the profit that we make. We're naturally placed for it and we're working very hard on it and doing quite well. We can save customers up to 60% of their carbon emissions. And as well, it also reduces their Scope 1 and Scope 2 reporting, turning into Scope 3. We'll go into a little bit more of a deeper dive here. So there's a case study here, another case study. This was a project that we won in Europe. Actually, it was in France and it was primarily driven by the carbon issue. So we could actually reduce the energy consumption for the customer who was looking at a make-buy decision, to be honest here. We reduced them by 50%, 99% less processed gases, 20% better processing time, a real win-win result. They get their carbon footprint down, we get nice revenue growth with great margins. So that's the kind of business we're going for. And it's increasingly becoming a feature of our sales and marketing efforts. If we look at our internal issues on energy consumption and our Science Based Targets initiative, you can see by the graph that we're making pretty good progress here continuing to drive it down. At this stage of the game, it has been improving operational efficiency, mostly. It's not been investing in new projects. Although we have been doing that, and if you look at our capital investment, it's about GBP 12 million of the CapEx is associated with low-carbon projects. But I remind you that our CapEx there is good return on investment in the first place. It's just the stuff that also reduces the carbon. They will kick in increasingly over time. And so those projects will be helping us to drive this down. Just moving on then to Specialist Technologies, which, of course, has been something that we've been focusing on a lot. When we started building this portfolio, you might remember me saying that we thought this business could grow at 10% per year. I was clearly wrong. And when we had some pretty weak years overall, it became apparent that the real issue here is that it outperforms the cyclical Classical Heat Treatment business. And to that end, I mean, a core feature of the Specialist Technologies is that they're inherently less cyclical. And you can see that from the graph. And so in tougher times, Specialist Technologies outperform even more. But it's about 10 percentage points on average higher growth than Classical Heat Treatment. Superior growth coming from it and less cyclical. Growth supported by significant investment in additional capacity. 58% of our CapEx expansion was on Specialist Technologies. And we'll look at the specific projects later. Just looking at how they've been performing, so on the left-hand side, you can see the revenue growth. By the way, on these graphs as usual, the top left number, which is the total revenue that the graph alludes to is including surcharges. There's no adjustment for surcharges in the top left number. And then you can see the growth rates including and excluding surcharges on the right in the title bar there. On the right-hand side, you can see the spread of Specialist Technologies across the different end markets. And clearly, there's quite a lot in the Aerospace and Defense, but it's also very broadly spread over the general industrial markets. So the growth was led by Civil Aerospace, up 16%. Now that's both a combination of the rate of plane building. Don't forget our major exposure on this stuff is to engines, so the rate of plane build but also strong aftermarket activity, particularly in wide-body engines. And just sort of heading off a question that might come later. If you were in a plane with doors flying off in mid-air, that doesn't affect Bodycote. We don't do that kind of work. To the extent that there may be a sustained reduction in airframe build rates, maybe that would affect us in due course. But right now, you're not seeing anything in terms of engine build rates changing. And so we don't think that in itself is a problem. Interestingly enough, I know that Spirit has been looked at to be acquired. Remember that when Spirit was spun off, when Boeing originally had it and they spun it off, we were a supplier to them. And what happened was that when they got spun off, the new owners decided to completely change the supply chain. They actually changed the rationale for supply chain. And I will say the same thing as a lot of people who have said, it was based on lower cost as opposed to anything else. With them being acquired, if they do go back into the Boeing family, I would fully expect to get some of that revenue back. Not huge, it's not a huge amount because we don't do that much on the airframes, but we should see a handful of millions at least coming back to us. Within Specialist Technologies, general industrial revenue was up 13%. And the 2 main subsectors here were energy, and we'll talk a bit about that, and medical. So in the energy situation, what we saw was, okay, the market was reasonably strong. That benefited our subsea business, which is in Powdermet and HIP Product Fabrication. And so we had quite a nice growth in our subsea business. But the other thing that was driving here is we got major market share gains in surface technology. And the surface technology is basically in gates and seats for onshore oil production. And we really have noted a mile and we can see a long runway for that, so that's very good. That's why you've got the 33% growth here, which clearly is well above any kind of market growth. Medical, as I said, it's orthopedic implants. It's been growing at 50%. Will we continue to see that kind of growth? Well, it won't go down but we're going to be lapping quite high numbers here. So the percentage year-on-year growth, I don't think we can sustain 50% all the time. Having said that, we've now got Lake City and Lake City's firmly in this area. It's actually the market leader in this area. Moving on to Emerging Markets. So Emerging Markets, the growth is being driven by Eastern Europe. I mean, actually, overall, the Emerging Markets growth was a bit lackluster, 1% excluding surcharges. That's primarily driven by China, which shouldn't be a big surprise to anybody. But Eastern Europe up 5%. The situation in China is actually quite an interesting picture. So we've been getting good traction in terms of the electric vehicle work, which we'll come to a little bit more in automotive. But certainly in Eastern Europe, there's been very good contract traction there, and we're moving into quite chunky production. China is very interesting. So we've now been making quite a lot of inroads to the main OEs in China, which is not our traditional area where I mean in the past, you might recall, we went to China with the Europeans effectively providing them with services as they went to China. And so we piggybacked on the people producing for the local Chinese market. We're now engaged at quite a higher level with the electric vehicle manufacturers, the top guys. We're building a brand-new facility just for electric vehicles there. And part of the plan here, of course, is to do the reverse of what we did in the first place. We're quite impressed, I have to say, with the quality of the design and the price point of the Chinese electric vehicles. They are coming to Europe and we're going to come with it. So it's going to be the reverse of what we saw originally. And I think that's going to be very good for us. I can't say the same. I don't think it's going to happen in the U.S., not unless Sino-U.S. relations thaw a bit because by the time anything from China gets to the U.S., it's very expensive these days. But we'll certainly see some good work, I think, coming out of this relationship building that we're doing in Europe. And we've been investing for this. Aerospace and Defense, did I cover that? No, okay. Thought I hit button wrong way for a minute here. So Civil Aerospace is up 12%, excluding surcharges. We talked about the aftermarket and aircraft deliveries. Still some supply chain challenges. Supply chain challenges are actually, right at the very beginning, roll castings and forgings. They are starting to ease, and we should see, I think, an improving picture going forward. Defense good growth, up 10%, but it's not something to write home about because defense is not a major part of our business. Outlook remains very strong. And we can see quite a long runway, excuse the pun, in this business because our customers have very large order books. And because of our strategic relationship with them, they share their production plans out quite a few years with us so that we can get our production planning right. So we can see quite a lot in this sector. Automotive, interesting. So automotive growth up 5%, excluding surcharges. Eastern Europe, going back to what I've been talking about before and the EV world, up 24%. So quite a win there. Modest growth in Western Europe, and frankly, that's heavy truck and bus. Now that's not heavy truck and bus for sale in Europe. This is really Sweden, where they make the engines that then get exported around the world. So that's just a general commentary on the heavy truck and bus market globally. And North America, pretty low single-digit growth actually. We'll see where that goes going forward. Some of the projections in automotive offer some nice modest growth in general there. And we've got more OEM contracts on EVs, which will support that, particularly in North America, by the way, because whilst we started off with the contracts in Europe, we have, in the second half of last year, secured some nice contracts in North America for hybrids. General Industrial. So I just want to clarify something here that a lot of people get confused about. So we call everything that's not automotive or aerospace as general industrial, which really means everything else. And within what we define as general industrial, we have quite a lot of segments that really are not related to industrial production. So if you look at the graph here on the right, the pie chart, those that are in the browns and reds and oranges, for those of you that are a little bit colorblind, that's sort of as you start around the clock, they are not really related in any way to industrial production. So oil and gas, industrial gas turbines, renewable energy, and medical or orthopedic implants. As you come around the clock, you move into the more IP-related areas so industrial machinery and tooling. And in fact, it's industrial machinery and tooling that are the most sensitive when it comes to IP. And then you go on round. So it's quite a diverse area here. It's not any 1 thing. And if you just take the PMIs or the IP forecast on their own, you will misrepresent what we have and what we define as general industrial. And you can see we've been doing pretty good, pretty well. Again, energy and medical. A lot of that, of course, is what we referred to before from Specialist Technologies. But we've seen the softness in industrial machining and tooling revenues. Just a note on that, those are firming up at the moment. So I know people look at that stuff for future indication, particularly for automotive. So where have we been investing? So our investments have been pretty much for growth and they've been in our strategic focus areas. So 80%, as I said earlier, our 2023 expansion CapEx was in Specialist Technologies, Emerging Markets and the secular growth markets of Civil Aerospace and electric vehicles. Now where we put it? So in the United States, we've invested significantly in HIP capacity. So we've got East Coast and in the Midwest, they are actually coming online as we speak. We should see at the end of the quarter that capacity come into play, and it's sorely needed actually on the East Coast for sure. Nitriding, which we almost classified as a Specialist Technologies, it's got many of the features, the high margins, the one thing it doesn't tend to have is a particularly stellar growth rate or at least it didn't have until electric vehicles came along because nitriding is a preferred technology in electric vehicles. Corr-I-Dur, low pressure carburising, expanding that in the Emerging Markets. And indeed, we've got some of that going into China, as I mentioned before, in the new site. Big focus on electric vehicle demand and investing to go after that. We've also got traction in the fuel cell market. Now fuel cells, at this point in time, it very much is an exploratory market for people, but they do need to have production support and they're getting it from us. We talked about the Chinese facility, and we increased capacity in Poland, Hungary, and Turkey. We're also building at the moment a new stainless steel facility in Southern Europe -- West and Southern Europe. So coming to the outlook, and in typical fashion, I'm not going to actually read out the outlook. We published it this morning. I will, however, unusually make a comment on it. And this outlook is the planning assumption for it, the planning assumption is basically on flat IP. And to the extent that the majority of the observers out there that say IP is going to improve through the year, that's what I seem to be reading, that would be a following wind for this, at least on those IP-related areas in GI. So that's all I'm going to say on outlook. And then to my final slide, I should say my final, final slide for Bodycote, this is -- I'm quite pleased to say I think that the company is in a very good place, and Jim is going to pick up pretty stable humming platform here. We're very well positioned for the future. We've got the expertise in the company. It's very broad-based. We've got the scale, better than 40,000 customers. We've got a tremendous breadth of service supply in terms of 168 facilities. We're now in 23 countries. We're back up to 23 countries. You can see on the right that pie chart, and we're showing you through that wonderful bit of artistic interpretation there of the spectrum within GI. It's quite a lot of different markets. And of course, bottom left, the Specialist Technologies story, really, a real success story over the years. And our margins on the bottom right, and we're heading to 20%-plus and we should achieve that. With that, I'd like to say thank you and we'll move to questions.

It's Stephan Klepp from HSBC. I have 2, if I may. I think the standard one and don't be bored by it, I think everybody is interested in the momentum in machinery and tooling, yes? So it has been relatively weak in the second half. So how should we think about the business going now into the first half in 2024? And the last one, I'm just trying to get some help for me and some indications. So you're investing in new capacities and there's obviously an utilization question. And when new capacities are coming on, there's DA coming on top utilization probably in the beginning, the ramp up. So how should we think with -- how should we square investments in new capacity, capacity utilization and the margin growth that you're expecting?

Let me talk about the second point first. Thanks, by the way, Stephan. So across the network, the utilization in Classical Heat Treatment is still not very high. We've got bags of capacity. I mean, you remember that in 2020, we did a reset in the company. We decided to exit a lot of internal combustion engine work, particularly in Europe. We didn't get rid of the kit. We kept the equipment and we just repositioned it, put it in different places. So we still got that capacity. And of course, we weren't highly utilized anywhere at that point. So in our traditional areas, a Classical Heat Treatment area, then we've got lots and lots of capacity, no worries there. Where we're investing, of course, is in these higher-growth, higher-margin areas, Specialist Technologies, where the growth rates are high, Emerging Markets, the growth rates are high. Not much investment in Civil Aerospace at the moment because a lot of that is Classical Heat Treatment, and we've got the capacity. And the electric vehicles, lots of investment there. But those businesses are very, very good return on investment. So we don't have the capacity. The CapEx is going in there, but the return on investment is high. It's much higher than the Classical Heat Treatment side of the business, if that answers the question. Yes, I'll come back to the first point. So as far as machinery and tooling is concerned, the importance of this really is tooling in particular, is a lead indicator for automotive and the fact that we're seeing it firming, and Ben will give you a little bit more color on that, suggests that indeed, the punters out there that say that they expect automotive sales to be growing, there's some supporting evidence for that. Typically, we find the tooling market has a sort of 6-month-ish lead indicator on it. So that would be pointing towards, I would suggest, a second half growth in auto. But as far where it is right now, Ben, if you'd like to...

Yes. So just a word I add to that. The tooling piece, as Stephen said, has started to firm in the first 2 months of this year. Now it's always really challenging to read too much into the first 2 months of the year, particularly when one of those being January is a smaller month for manufacturing full stop, and is very sensitive to when shutdowns from our customers have come to an end following Christmas. So a little bit of a health warning there. But nonetheless, encouraging signs in tooling based on the first 2 months' performance. Manufacturing, also seen it's starting to fill the bottom, I think I would frame it like that, rather than necessarily absolutely turning at this point in what we've seen in January and February.

It's Jonathan Hurn from Barclays. Just 3 questions. Firstly, just falling back on -- following up on the prior question. Can you just be a little bit more specific on those return on invested capital rates for Specialist Technologies and also for Traditional Heat Treatment? That was the first one.

Well, I'll tell you what we say publicly, I repeat it, and that is across everything, including Classical Heat Treatment, we've got a hurdle rate for investment that's 20%, 25% depending on risk. So when we look at these Specialist Technologies, that's sort of internal rate of return on capital kind of thing. Specialist Technologies, everything except HIP, I'll put HIP to one side, everything except HIP has a better capital intensity than Classical Heat Treatment, so you have less pounds of capital per pound of sales. And so you can imagine that the ROI on that stuff like LPC and the like is very high, S3P very high, those things. The 1 exception is HIP and in HIP, you have assets that are literally 50-year assets. And in those situations, they cost a lot but their margins are very high. So their return on assets are more like Classical Heat Treatment because of the time scale is to get everything running and the installation cost and everything else.

The second question was just on Specialist Technologies. I know in terms of the overall group as that grows, that's beneficial for mix. But if you look at Specialist Technologies on a stand-alone basis, is there potential for margin improvement within that specifically?

We could but we're not going to, at least not under my watch. Maybe -- might do something different on that. And the reason is when you have -- we often get asked to break them out and we try to hide them because the margins are eye-watering and not at the crying end, the other end of it. And so in some of them, they're really extreme. And what you don't want to do is drive it over the top because as you expand margins too much, you invite people really doubling down to get into the marketplace, and then you might get more competition, plus the fact customers starting to get pretty upset. So I think we'd rather use that for OpEx investment and putting feet on the ground because the major barrier to the Specialist Technologies is actually people capacity, not physical capacity. We've got to train our own troops in this because you can't get them from anywhere else. There's no way to get them from. And this is not sales in the way that Bodycote normally does. This is what's becoming more and more normal for us, but this is often missionary selling. It's telling people about things which they didn't even dream could be done. And so they are able to redesign their products using these Specialist Technologies to make them. And therefore, I don't think, at this point in time, at least margin expansion is the goal of those technologies.

And finally quickly, just lastly, just in terms of those contract wins in automotive in H2, can you just give us a little bit of color on the size of that and maybe the phase of when those come through?

Sure. These are explicit 5-year contracts and then renewable thereafter. They ramp up over 1.5 years or so. And at peak, they're GBP 10 million to GBP 15 million per year each and nice margins.

It's Harry Philips from Peel Hunt. Just starting with that auto contract because you said at the half year that the first one, 10 to 15. So how many...

There were 2 in the first half.

There were 2 in the first half. Each 10 to 15, right. And then just the continued EV commentary. Just how, I suppose, how big is EV potentially getting in the next couple of years?

Let me just put a qualification in Harry, if you don't mind. So they were -- we don't sign contracts with guaranteed volume. So we'd sign contracts with guaranteed pricing over the life of the contract, with indexation often and the terms and conditions are fixed. And what we do is we diligence the business case. So at point of signing, our estimate was something over GBP 10 million. On the Western European contracts, let's leave the second half North American stuff on the side. But on the Western European contracts, which you remember were Mercedes and Stellantis were the platforms. They've had a big wake-up call because they've had BYD and Chery breathing down their throat. And so it wasn't long into the contract startup where they said that GBP 15 million top end, we're not going to hit that. Right, our contract signature, it was going to be very good. It's now down more towards the other end of the scale that we were thinking. So just to note that. North America, as I said, I don't think we'll see the same thing because they're going to have inherently less competition in North America. Overall, how big could electric vehicles be? I'll leave that to Jim. You can talk to them in the bar.

Then just following on from that. Obviously, you're talking about investments in EV in China. Obviously, presuming if it's domestic, it's BYD. And then...

And let me just interrupt you and just point out something which many people may not know. One of the problems that the -- certainly the Europeans and, to a certain extent, the Americans are trying in China, what they didn't understand and they're starting to understand that as you see VW going in as 1 competitor and you see Mercedes going in as another competitor. And what they're up against is a consortium of 19 competitors who all work as 1. They're government-backed, they're government-supported, they cross-collaborate. They feed information across. They feed R&D across. If you were in America, they'd all be in jail but they'd work together. And that's quite an important thing. So when you get in -- we got into this environment because we hired some local well-connected folks in China, which was necessary. They know the people. And once you get in there, you realize that they all know each other. They're all passing it around. You break into the 1 account and they call their buddies and they say, you've got to use these guys, too. And they really, really, really want us there. Two reasons: one, inward investment in China has slowed, and they like some inward investment, we're a gnat on the wall when it comes to inward investment in China. But still, we are encouraged. We used to have a problem getting sites and licenses to operate. Not anymore. You get the property, you get the license to operate, please come in and invest, they say. And then when you do that, they're also in there because they're saying, "Look, you guys know Europe. You know where you are. We need to work together." And when I say Europe, this includes down into Turkey. So this is the whole gambit. So I interrupted you, but it's not 1 guy. This is a whole very formidable group.

Just going into sort of a different area, the sort of the competitive environment. I mean, it's interesting to see Stack sell the HIP side to private equity. You've got, obviously, [indiscernible] wanting to become pure play. We can have a debate about what Albert's going to do with their assets. It's quite -- particularly as you sort of look at over the landscape now, how do you -- how does Bodycote sit into that profile? Is it still going to be primarily organic with like Lake City or...

Let's come back to the Stack one. So you recall when we announced that we were acquiring, it was 2 companies, it was Stack and it was Lake City. We completed on Lake City. We didn't complete on Stack. I mean, we had a period between signing and completion. And in fact, there was a material adverse change in that side of the business. And that is, all of a sudden to us, it became not worth it. The return on that investment would have been poor, particularly when you stack it up against buying our own shares. But it would -- it completely changed. It just collapsed after our announcement. And so actually, we were very glad to back out of that. They've sold it to them for -- we don't know the price but a very, very much a lower transaction price than -- we know that much. It's much cheaper. So that, as far as we're concerned, we're happy to see it go. It's not really a big problem for us. It was an opportunity but not essential. And it was 1 small site with 1.5 HIPs, tiny baby HIP and a big one for Stack. So that's that acquisition. As far as the speculation around the other big ones are concerned, it's like always, we don't comment on those kind of things.

And then sorry, just finally, just on the Schaeffler...

You don't want to let Andy ask a question, do you?

Exactly. Just sort of obviously now as Schaeffler the sort of launch customer, maybe just a bit more detail around that and the extent of the opportunity.

Say that again?

The Schaeffler, was it Schaeffler announced as your launch...

No, you're mixing us out with some...

Too many results. Okay, I'll leave that. I'll pass on to...

They are a big customer of ours, but we didn't talk about launch customers or anything.

Andrew Douglas from Jefferies. Just sticking on the EV bit. Is it the same products that you're selling to the EV market than you did in the first half in terms of the customer or the technologies, I should say?

Well, it's low pressure carburising. In terms of the products we're working on, the second half ones are slightly different because the first ones were battery electric. The second one is a hybrid and the configurations are quite different. And we're primarily working on the drivelines of these things. And the key takeaway, I think, is when this all started, a lot of people were saying, "Well, this is going to be the end of Bodycote because there's no moving parts in an electric vehicle. What are you going to do? How are you going to treat this stuff? You're out of the game." And in fact, as we get into it, the transmission driveline for electric vehicle has got 5x at least the work in it than an internal combustion engine. And it might have fewer parts, but because of the torque they have to look after, they need much, much more treatment. That is 5x longer at least, 5x longer in the furnaces, 5x longer in the low-pressure carburising units, and that generates revenue. So the value in EVs, battery electrics is huge. We have less competition because nobody else really has got a lot of LPC out there. And if it's a hybrid, where you get 2 bites of the cherry.

I feel like I can go back to [ 1990s ]. In terms of putting your technology into China, how do you protect the IP from a consortium of 19 big companies that's government-owned? Are you guys comfortable with that?

That's a good point. So the technology that we're putting in China is low-pressure carburising. Cats out the bag on that, all right. So the issue of LPC these days is one of knowing how to operate it.

Yes, okay. And then just 2 quick ones. The FX hit in '23 looks a bit off to me. GBP 3 million of sales, GBP 3.3 million of operating profit. Can you square that one for me?

Yes, you're right. It is an optically looks a bit curious. The issues are you really do need to delve under the bonnet of the specific currencies and the specific mix effects within those currencies because you had, particularly in 2023, some moving in some quite different directions, particularly the euro, which actually moved in a positive direction, offset against dollar, Swedish krona, and Turkish lira. So it's a mix effect and the shape within that we can take you through it offline.

It's all translational, not transaction.

It's all translational, correct.

And you gave us a little there on the surcharges in terms of underlying pricing, so just [indiscernible] you're still happy you can get some positive pricing this year?

Absolutely. Yes. I mean, we've always had pricing covering our costs ever since I joined this company. It's got a really good track record and there are lots of good reasons for that. We're quite hard to move away from once you're working with us, not because we hold you the costs, the switching costs for customers. We hold it. But the switching costs are quite high, and that gives us the ability to put prices up pretty much on a regular basis. And in this environment, when surcharges are coming off, because at the end of the day, the customer looks at the net-net, when surcharge is at their height, we were 100% increase effectively on overall price on some of these places. With them coming off, us going back with a slightly juicier price increase gets lost in the noise.

Dom, Convey from Numis. Just 2, if I may. Just in terms of Civil Aerospace, there's been a lot of sort of puts and takes over the last 3 or 4 years now, acquisitions, surcharge, et cetera. Can you give us a sense as to where you think volumes are relative to 2019?

Dom, glad you asked that because I can hand over to my aerospace specialist, Ben.

Now you brought me for real. So yes, we're now probably around about 20% below our 2019 levels. It has obviously built up if you look what we said 6, 12 months ago, we were talking more like 25% below the pre-COVID levels. We expect good growth to continue in Civil Aerospace as we look to 2024, if you think about the parameters driving that. The airframe and build rates are up around 10%. Rolls-Royce has talked about, which is another big customer of ours, as you know, in the U.K. aerospace business, around about 10% increase in Rolls-Royce OE volumes. And take the midpoint of Rolls-Royce's aftermarket guidance range for shop visits, it's about 10% growth in shop visit volumes. So yes, I'd expect aerospace growth to continue to be good this year. We'll continue to claw back. So yes, we are still 20% below, but we will get back to and exceed the 2019 levels, reflective of the fact that build rates over time are going to go above the pre-COVID levels. Supply chain constraints that Stephen talked about, we talked about in the statement. Those continue to be a little bit of a throttling effect over the pace with which that aerospace recovery is coming through. But probably no bad thing in [ truce ] because it means it's more likely to be at a more manageable pace for the industry and, therefore, more sustainable.

And just second question. In terms of surcharges, there's obviously that sort of GBP 65 million still in the numbers last year. What's the phasing of that as it comes out of the P&L and just how we should think about modeling surcharges and obviously, the impact on margin?

Do you want me to take that one? We put the slide up on surcharges. Now you can kind of, to some extent, take a ruler to the axis there, which I'm sure you may do after this meeting. You can see what that sort of optically comes out at, and it kind of you'll see it flags kind of about 6% of sales with the surcharge effects in the first quarter that we've seen so far this year compared to what was more like 9% of sales for the full year 2023. Now extrapolating the exact shape of that line as we go through Q2, Q3, Q4, I am neither bright enough nor is my crystal ball good enough to say I can predict what is going to happen to energy prices, recognizing we're operating in many different markets globally. But it is pretty likely to continue to come down. So I think I would just use some intelligence around an extrapolation around that as you forecast forward for the course of this year. But reflective of what's happened already in the first quarter, those numbers I shared with you, which you can see it's kind of fallen about 30% or so. It gives you some indication of the sort of trajectory there.

I think it's worth noting, though, Dom, that we're now at a stage in the market where the customers have really started to push back. They can see the energy prices falling, and they never did like the surcharges in the first place and they're saying, "Can't we get rid of this?" And so that is -- our counter to that is to try and build it in permanently in the prices. We'll get some of that. So whilst we might see energy prices not go down all the way, we can still see our surcharges going down faster but we'll try and build that in our prices.

The other piece I would also just add for clarity, remember that surcharges are pretty much a noise effect as far as profitability is concerned, right? I mean, there may be some timing mismatches at certain points. But essentially, it's a revenue noise effect, not a profit effect. Secondly, also, when we talk about further progress in the margin in 2024, we're talking about that on an excluding surcharge basis.

Richard Whitehead, KBC. Great set of results. Just 1 very quick question, please, really acquisitions, clearly a topic that can on be very limited on. But in terms of preference regionally, we've seen a big focus in recent history in the U.S. Do you have a focus? Do you have a preference regionally? I'm thinking more about your emerging markets, Eastern Europe? Is that on the radar or is it opportunistic for those markets? Or is there actual focus to spread...

That's something I can comment on. In the Emerging Markets, there's no ready to buy. So that's easy. Okay.

Very quick answer. It solves that all for me.

Lake City, you've only had it a month and a bit. What have you found so far that's been interesting? Are they good about and happy with what you got?

It's probably better than we thought. Seriously, it really is good.

Just people assets?

The growth people there are great. They're teaching us about the medical market. Their assets are in good condition. They really have a great customer following. The integration with Lake City is really sticking in the back office and then that's all it is. They are very glad to be part of our group. So at the moment, everything looks pretty rosy. I wouldn't expect that to change.

I haven't got another question, but on behalf of the analysts in the room and all the analysts who have been around for the last 15 and a bit years, I just want to wish you well on the next stage of your career. I've calculated it, just over 30 sets of results you've done with us, idiots asking the stupid questions that you've given good answers to. But it's been a pleasure to work with you for the last kind of couple of years. You've always been fair and very honest and open with the analysts. I seem to remember your first analyst presentation about 2008. It was a slight tricky market. You learn a lot from that. But yes, wish you well on the next stage of [ career ] and good luck.

Well, thank you very much. I appreciate that. I'm getting all emotional now. So turn the mics off, please. No, thank you very much. Appreciate it. And goodbye, everybody. I have really enjoyed working with you.