Coats Group plc (COA) Earnings Call Transcript & Summary

Good morning, and welcome to the Coats Group plc Half Year 2021 Results Presentation. My name is Victoria Huxster, and I'm the Head of Investor Relations at Coats. I'm here with Rajiv Sharma, CEO; and Jackie Callaway, CFO, and they are going to talk you through the results and outlook for the business. Without further ado, I will pass you over to Rajiv.

Good morning, and welcome to our 2021 half year results presentation. I will start with the business highlights. This will be followed by a presentation on our financials by Jackie. The presentation concludes with our outlook statement, after which we open up for Q&A. In the presentation, I will refer to Apparel & Footwear as A&F and Performance Materials division as PM. As announced in our post-close trading update, we have seen positive momentum and a strong operational performance. Our organic revenues are up above 2019 levels despite a lockdown in India during May and June. Core A&F thread sales were 2% above 2019 levels and PM organic sales were 4% above 2019. The teams have done really well despite the COVID backdrop and have continued to win new customers and new programs with existing customers, all of whom value our speed, flexibility and reliability. Coats has continued its focus on innovation and launched 12 new products in the first half. We made good progress in our sustainability agenda, especially in recycled threads where sales touched $23 million in the first half. This is more than what we sold in all of 2020. We have seen strong cash generation and our leverage now stands at 0.8. The Board is pleased to declare an interim dividend per share of $0.61. Before I get into the results, let me start with the company's purpose. It is to connect talent, textiles and technology to make a better and more sustainable world. In Apparel & Footwear, we will grow market share by delivering innovative and value-adding product and service solutions to our global customer base. In Performance Materials, we are leading with innovation, developing highly engineered products to create textile-based industry solutions for existing and new markets as well as driving operational efficiencies within the business. We are also strengthening the core of our business by becoming even more customer-centric. This means we relentlessly focus on the industry imperatives of speed, personalization, innovation, cost, quality, reliability and sustainability. We are investing in our employees so they can develop to their full potential within a safe, respectful and inclusive work space. We will maintain our disciplined use of capital to fund inorganic and organic opportunities to build scale and new capabilities. This strategy is underpinned by our strategic enablers of digital innovation and sustainability. I will give you more details on these enablers a bit later. Over the next few slides, I will talk about the market for both A&F and PM and how we have performed in the first half in each of these divisions. A lot of trends like casualization and personalization that started in 2020 have continued in the first half of 2021. Retail sales are recovering, but not yet to 2019 levels. Sports and athleisure are performing well as people work from home or focus on fitness. Other continuing trends include online digital adoption, supply consolidation, near shoring, changing customer needs for speed and digitization of the supply chain. Inventory levels within the A&F industry supply chain are lower than 2019 and 2020. We are also seeing increased commitment and action by premier brands and retailers and sustainability. Domestic demand in China is strong with our first half revenues up 61% versus 2020. End market sentiment is positive across all regions in the U.S., Europe and Asia with some weaker spots such as South America and Japan. A&F division benefited from strong customer relationships along with flexibility and agility of the supply chain. Despite recent lockdowns in India and COVID resurgent in South America, our core thread business, which is 85% of the A&F division was up 41% versus the first half of 2020 and up 2% over 2019. This was somewhat offset by a slower recovery in zips, largely due to slower recovery in high-end apparel, luxury handbags and accessories in Europe. Our global accounts program in which we dedicate customer relationship resources to our key brands and retailers delivered a wide range of customer and program wins. Our key competitive differentiators have continued to help us win new customers and increase share of spend with existing customers. These competitive differentiators include market-leading product ranges, technical services, reliability and speed of supply chain, sustainability credentials and digital technologies. Our geographical proximity to customers across sourcing locations remains a critical differentiator. This division is well placed to do well as end markets continue to recover. Let me turn to PM and start with a high-level view of the sectors served. The Personal Protection market has seen a recovery in industrial output, although military spending on apparel in the U.S. has taken longer to recover. The firefighter/PPE segment remained relatively more resilient. Energy market started to pick up with oil prices rebounding, rig counts increasing and drilling activity is forecast to increase 12% in 2021. The rebound in telecoms in the second half of 2020 has continued into the first half of this year, with optical fiber demand buoyed by Internet infrastructure investment. Transportation has continued the recovery seen in the second half of last year, although semiconductor shortages are impacting vehicle builds. The trend towards electric vehicles and light weighting is a key driver of our composite story. Household and Recreation saw strong demand as working-from-home trend continue. After a heavy impact from COVID last year, revenues have recovered well in all Performance Materials segments, except Personal Protection. Personal Protection continues to be impacted by labor availability issues in the U.S. All other end users such as Telecom and Energy, Transportation and Household and Recreation performed strongly and have seen growth in the first half versus both 2020 and 2019. We saw strong demand in Telecom and Energy, and consumer demand remaining strong in Household and Recreation, particularly in U.S. outdoor goods. Transportation saw good revenue growth from share gains in spite of semiconductor shortages that continue to impact vehicle builds. These shortages are expected to continue into 2022. Excluding the U.S. business, PM margins were 16.5%, indicating a healthy recovery elsewhere in the group. We continue to place significant focus on our U.S. operations with price and productivity actions to offset inflationary pressures. Insufficient labor availability in the U.S. have impacted sales and margins. We are investing in automation and have implemented new shift patterns to help address the labor availability issues. We have also integrated the Patrick Yarn and Pharr business under a new management team to better drive price and mix in addition to operational efficiency. As a result of these actions, it is anticipated that operating margins in PM as a whole for the full year will be in the mid-to-high single-digit range. Let me talk about our operational delivery. Despite COVID shutdowns in May and June in India and labor shortages in the U.S., we have increased our manufacturing output versus 2019. Health and safety is the #1 priority. And as you can see, we have had a lowest first half work-related recordable rate of injury on record. Freight cost and reliability have been a challenge in the first half. Despite this, our operational teams have continued to focus on delivering good customer service by implementing tactical actions and flexing the supply chain. Inflation in raw materials, labor and freight have been a headwind, but our commercial and operational teams have put in place actions with price and productivity to offset inflationary pressures. Now I will talk about our 3 strategic enablers of digital, innovation and sustainability and how they are critical to our sales and margin growth. For the first one, digital, we have developed a short video to highlight a few areas in which our digital investments help us better connect with customers. This enables more sales and impactful innovation. [Presentation]

Moving on to innovation. We continue to create innovative new solutions for our customers with 12 new product launches in the first half of the year. These have delivered incremental revenues of $11 million so far. Examples in A&F include a reflective tape with unique technology, which charges up in under 10 minutes and glows for over 8 hours. We have also launched new products in our zips and trends range generating early customer wins and stronger medium-term potential. In PM, the largest selling innovation was a new FlamePro product with lighter weight, higher performance and improved strength and protection qualities. Our innovation pipeline to deliver further incremental revenues in the future remain strong and we will continue to accelerate our innovation credentials and solutions in order to deliver tailored solutions to be customers' design requirements. Our group vitality index was 13% in the first half, which means that 13% of our total sales came from products launched in the last 5 years. A key part of our company purpose is to make a better and more sustainable world. We previously laid out an ambitious set of sustainability targets. Despite some obvious disruption from COVID during 2020, we are making progress on each of them. Let me highlight a couple of areas. Under the social pillar, one of our sustainability target is to have 80% of our employees working in Great Place to Work certified sites. Validation by external agencies builds trust across multiple stakeholders in our employee and community programs. During the first half, we added certification for India, China and Sri Lanka taking the total to 44%. During the first half, we also had our annual employee engagement survey. I am thrilled to inform you that 90% participated, which is high considering COVID restrictions. And our employee engagement score was 83% versus a benchmark of 74%. Coats continues to be in the top decile of industrial companies in terms of employee engagement. In our living sustainably pillar, we have a target to have all our premium polyester threads made from 100% recycled materials by 2024. Revenues in the first half were up strongly to $43 million against $37 million for all of 2020. We are well on track to deliver our 2024 targets in this area. During the first half, we also developed and launched EcoRegen, a biodegradable thread made from a renewable fiber derived from wood pulp sourced from sustainably managed forests. This eco-friendly regenerated fiber is fully biodegradable and composite. The launch of EcoRegen is part of a sustainable product road map to support a move towards the circular economy. Two new products to support circularity will be launched soon. As a final point, our third annual sustainability report published in March has more details. If you would like a meeting to discuss our sustainability agenda in more detail, please do contact Victoria. And with this, let me hand over to Jackie to present the financials.

Thank you, Rajiv, and hello to everyone on the call today. I'd like to start by taking you through the key highlights of our financial performance for the first half of 2021. After the significant disruption caused by COVID in 2020, we have seen strong momentum and top line sales recovery and growth during the first half of the year. This was despite some ongoing localized COVID lockdowns that we continue to see around our footprint, notably in India in May and June, but I'm pleased to say that those sites are now fully back open. With a very encouraging demand recovery in most of our end markets, which Rajiv has already mentioned, we are also seeing our operating margins normalizing towards pre-COVID levels, and this has resulted in delivering operating profit for the first half of $95 million, which was ahead of expectations. We have also maintained our strong discipline over cash flow delivering $48 million of adjusted free cash flow, which has enabled us to keep a strong balance sheet with leverage of 0.8x at the end of the period. This leaves us in a comfortable position on our banking covenants and with significant committed facility headroom. This will allow us to take advantage of the recovery with optionality to make investments in both organic and inorganic growth. Slide 18 sets out the financial summary and our key financial metrics, which clearly all show a significant improvement versus 2020 as a result of the widespread disruption last year. A comparison and to better assess the speed of recovery, we've also included the 2019 organic comparators. Let's now take a deep dive on these key financial metrics, starting with revenue. Overall, the year-on-year increase in group revenues on an organic constant currency basis was 34%, and this recovery was driven across both A&F and PM, although I note that A&F was harder hit by COVID in 2020. On a reported basis, revenues grew by 37% as a result of a small contribution from the Pharr HP acquisition, which was completed in the comparative period and a 2% FX translation tailwind driven by the appreciation of the Chinese yuan and the euro versus the U.S. dollar in the period. Against 2019, both of our businesses have performed very encouragingly with a return to pre-COVID 2019 sales levels in A&F and 4% growth above 2019 in PM, resulting in 1% organic growth versus 2019 for the group. It is worth noting that if it wasn't for COVID disruption seen in our India business in May, June, group's organic growth versus 2019 would have been around 3% for the first half. Group operating profits were up 175% on an organic constant currency basis to $95 million. Its a significantly increased volumes delivered upside margin benefits. As a result, margins recovered to a healthy 13%, and I will cover the key profit lever movements in more detail shortly. First with 2019, operating profit and margins were slightly down. This is due to the dampening effect of the lower margin Pharr HP acquisition, the disruption seen in our India business in May and June and the operational impact in our U.S. business as a result of temporary labor availability issues. Finally, on the slide, EPS and free cash flow were both also well up year-on-year due to the profit recovery we've seen as well as the lower interest charges and normalization of our effective tax rate following a spike due to COVID last year. I'll give more details on these later. Now moving on to operating profits in the next slide provides an overview of the movements in our group operating profit and margins during the year. As I said, our operating profits recovered quickly following the significant COVID disruption in 2020 as additional volumes positively benefit operating margins. We continue to offset our various inflationary pressures such as raw materials, freight and wages through price and productivity initiatives. We also saw positive mix in the period. Although this was, to some extent, reversing a trade down seen last year. Whilst we expect heightened inflationary pressures, primarily in relation to raw materials to be incurred in the second half, our early actions on price and productivity initiatives and the first half leave us well placed to mitigate these successfully. At an SD&A level and as expected, we see many of the temporary cost savings put in place last year, such as staff bonuses and discretionary costs been reversed alongside a natural increase in variable cost of selling. The above impact, but predominantly the positive volume impact, leads to a significant increase in operating margins in the period, which were up 670 basis points to an organic basis of 13%. Let's now look at segmental margin on Slide 20. Both segments saw an improvement in margins from 2020 as volumes came back to the business due to the COVID recovery. A&F margins having shown a strong recovery in the second half of 2020 continued to increase and was 15.5% for the first half of 2021, despite the reversal of some of the 2020 discretionary cost savings that assisted the 2020 recovery. These operating margins are notably ahead of pre-COVID full year 2019 levels by 80 basis points as gross margins benefited from excellent customer services along with a well-controlled cost base. PM margins were up 220 basis points year-on-year to 6.4% on a reported basis as a result of the improving volumes. However, they were notably held back by the continuing labor availability issues in the U.S. and the ongoing dampening effect of the lower margin Pharr HP acquisition. It is noted that excluding the U.S. business, we are outpacing these localized labor issues, peer margins were a very healthy at 16.5%. In relation to the U.S., we have a very close focus on driving the margins upwards, which will be helped when the labor disruption situation subside. But in addition, we are looking to drive price increases to reflect the value add we deliver and deliver self-help initiatives to drive operational efficiency. We've also integrated the Patrick Yarn and Pharr businesses under a new management team to form a Coats one performance yarn business. As a result of these actions, it is still anticipated that operating margins in PM as a whole for the full year will be in the mid-to-high single-digit range. On Slide 21, we show the bottom half of the profit and loss account, and there are 2 items I'd like to highlight on this slide. Firstly, net finance costs at $5 million was significantly lower than 2019 as a result of a few factors. Firstly, this includes the impact of a historic indirect tax claim within Brazil, which is now deemed virtually certain following a favorable Supreme Court ruling in the period, and this has resulted in a $5.1 million exceptional credit with an operating profit and a further $4.7 million exceptional interest income. These refunds date back to 2003 and the estimated tax credit amounts are expected to be utilized over a period of approximately 6 years. Also, lower interest on bank borrowings due to lower interest rates and lower corporate facility utilization and lastly, the reversal of the mark-to-market losses at the same point in 2020, largely as a result of the sterling appreciation since that point, which relates primarily to a hedging on our U.K. pension payment. Aside from interest, the other item I'd like to flag is the normalization of our underlying effective tax rate to 31% after the site that was closed by COVID last year. As profitability has normalized to pre-COVID levels in H1 2021, so has the effective tax rate as expected. Moving now to Slide 22, where we see the strong cash delivery in the half. At an adjusted free cash flow level, we delivered $48 million compared to a $5 million outflow for the first half last year. Given that our cash flows are typically more second half-weighted, this is a very strong performance. Although I note that there are some nonrecurring benefits within this number as a result of COVID actions taken during 2020, for example, the nonpayment of staff bonuses, which would usually be paid in March. The increase in cash generation was largely due to the recoverability in operating profit that I've talked about earlier, but we also maintained our discipline across the other cash levers as set out in the slide. In the second half of the year, we expect to see a normal marginal inflow of working capital due to seasonal trends. And in relation to CapEx, as we recover out of COVID, we expect to return to broadly normal run rate of spend. For the full year, we expect our CapEx to be in the range of $35 million to $40 million. Our closing net debt of $168 million, excluding leases, was lower than in the end as a result of the strong adjusted free cash flow noted earlier, more than offsetting our ongoing pension payment and our return to paying shareholder dividends following COVID. This level of net debt equates to leverage of 0.8x, which is slightly below our target range of between 1x and 2x. At 30 June, we had maintained a comfortable liquidity position with committed facility headroom of around $330 million. As with previous announcements, we have provided modeling guidance for 2021, the latest of which is set out on Slide 23. I'm not planning to go through this in detail, but we'll be very happy to arrange a follow-up call if you have any questions. I conclude by reiterating the strong performance of the group in the first half. The positive and improving momentum in top line revenues and the ongoing strength of the business and balance sheet that we continue to have. And now I'd like to hand back to Rajiv.

Thank you, Jackie. I'm now going to quickly sum up and cover the outlook statement. After that, we open up for Q&A. It is pleasing to deliver a strong operational and financial performance in H1. We are already back to 2019 levels as far as sales and cash are concerned. The margin recovery in A&F and PM outside of the U.S. has been strong. We continue to focus on winning with the winners and winning where it matters. The Board has approved an interim dividend of $0.61 per share. To end the presentation, let me talk about the outlook for the rest of the year. In the second half of the year, we will continue to drive performance by focusing on profitable sales growth, our strong customer relationships, our digital innovation and sustainability credentials and ongoing pricing and productivity actions. We issued a post-close trading update on the 14th of July, which said that our performance for the full year was anticipated to be moderately ahead of previous expectations. Thank you all for your time. And now I hand back to Victoria.

Thank you, Rajiv. We now have some time for Q&A, and the Q&A session will begin shortly. [Operator Instructions]

[Operator Instructions] Our first question is from Charles Hall of Peel Hunt.

Can I just ask a bit about the margin trajectory. Firstly, have you now done all the pricing activity that you intend to do to recover the freight labor materials costs? Secondly, the Apparel & Footwear margin, obviously, very impressive, higher than pre-pandemic. Is that sustainable at this level? And thirdly, Rajiv, if you could go into a bit more detail on that U.S. performance and how quickly you think you can start to resolve the labor issue. And my understanding is that you've got strong demand. So this is very much a supply side issue rather than the demand side issue?

Charles, could you just repeat the first question that you had?

Rajiv, I can't remember the first question now. I have done the third question. What was the first question? It was have you got all the pricing activity that you wanted to do...

Thank you. All right. Brilliant, brilliant. Okay. So let me start with that, Charles. The actions that we had to take are all done for the full year. As we get into the second half and as sort of volumes come through, we'll start to see the price realization happening. So in the first half of the year, we had about $7 million of price coming in and that's expected to more than double in the second half of this year. So as far as the actions are concerned, that's all done, and I think price is going to be pretty strong for us in the second half. With respect to the A&F margins of -- it's been pretty strong, 15.5% margins. It's been driven by a combination of customer mix, product mix. We have seen our higher-margin products growing at a faster rate than the lower-margin products. So that's been a very positive thing. Price clearly has been coming through. And not to mention that we have seen a lot of volume flow through in the first half of the year. And as a result of that sort of kind of manufacturing margins, because of the higher utilization in the factories, has all sort of resulted in higher margins for A&F. Now the question is, is this sustainable? The answer is absolutely yes. As a matter of fact, in the medium to long term, the margins in A&F could go higher than 15.5%. So we are generally quite sort of bullish about the A&F margins. Let me talk about your third question, which is the U.S. labor issue. U.S. has been facing a very tight labor market for the last 12 months, and it's not just Coats, it's across the board in the U.S. I don't expect the labor situation to improve dramatically over the next 6 to 9 months. I think we are in a tight labor market in the U.S. So what we have -- essentially, what we have been doing, Charles, is selective automation in our factories in the U.S. We're looking to outsource some of the production to the other Coats units in Mexico or Europe or even in China for that matter. But labor remains a big, big concern for us. We have seen the highest labor inflation in the U.S. in the first half of this year. Despite increasing wages and sort of benefits for the U.S. workers, it's been tough in terms of attrition and absenteeism. And we are generally running at between 65% and 75% capacity utilization in our U.S. factories. And these factories, unless you're running at 80-plus-percent, it's hard to make money in the U.S. So we are working pretty hard to make sure the customer mix changes, price is coming through in the U.S., the automation projects should start to kick in. We are hopeful that the second half of this year, we'll start to see an improved margin in the U.S. business.

And just thinking about it from that utilization point of view, say, in 12 months' time, where would you hope to see that?