Coats Group plc (COA) Earnings Call Transcript & Summary

Good morning, and welcome to the Coats half year results presentation. This morning, I'm joined by Rajiv Sharma, Group CEO; and Jackie Callaway, the Group CFO. This morning, after the results, we'll take Q&A. Please follow the online instructions to ask your question.

Good morning, everyone, and welcome. Today, I'm going to take you through the highlights for the half year and then hand over to Jackie to present our financial performance. After that, I will take you through the divisional performance and strategic update before closing with the outlook. Following this, we move to Q&A before concluding the results presentation. As we predicted, there has been a strong revenue growth in the first half with reported revenues up 7%. The expected recovery from the destocking cycle is underway, and there has been an improving revenue trend in the first half across all 3 divisions. In constant currency terms, revenues increased 8% for the group. This was driven by a 14% growth in apparel and 7% growth in footwear. Performance Materials continues to be impacted by customer phasing issues in some U.S. end markets. However, the division has had a quarter-on-quarter improving revenue trend. I'm very pleased that we have yet again outperformed the industry, increasing our share of the global apparel and footwear thread and structural components markets. In Performance Materials, which operates across a number of different end markets, we have continued to secure contract wins in vertical with 2 large automotive OEMs. These continued gains are testament to the commercial strategy we are pursuing and the hard work of our teams. Part of the reason of our market share gains is our first-mover advantage and continued global leadership in recycled products. We have registered a 141% growth in our recycled products with revenues of $159 million in the half. As such, we are on track to achieve in excess of $300 million of sales in full year 2024, which is a significant milestone. I'm very pleased to report that we delivered 18% adjusted EBIT margin in the half. This is 250 basis points up and the best margin delivery since we got rejoined the London Stock Exchange in May 2015. In March 2022, Jackie and I committed to delivering 17% EBIT margin in 2024. We have delivered on our commitment in the first half. This strong margin performance in the half has been supported by a pickup in sales volumes as well as a result of a number of self-help actions, which include an effective pricing strategy, the achievement of further significant procurement savings, ongoing integration synergies from the 2 2022 footwear acquisitions, good cost management and cost savings from our strategic projects, which is now updated to $75 million by 2025 as some further footprint optimizations have been identified. We have also delivered a healthy $59 million adjusted free cash flow on the back of the market recovery and improving operating results. The Board has increased the interim dividend by 15% to $0.93 per share, reflecting confidence in the business strategy and the ability to deliver a strong margin and cash through the cycle. Slide 5 shows the key areas that enable a strong margin and cash performance in the first half and reinforces why we are well positioned for the future. Some of these actions are structural, making the company fitter and stronger while others are based upon more tactical actions that form a part of a playbook to win through business cycles. I would like to highlight the strength of the business as we have continued to gain market share and win in a very competitive market. We have aligned ourselves with key growth brands with our strategy of winning with the winners at the most attractive segments of our market. As a result of our actions over a number of years, Coats is the #1 supplier globally of sewing thread and footwear structural components. We're also #1 or #2 in every supply market that we operate in. As the market continues to recover, we should see further improvement in performance. I will give you more details after Jackie have presented our financial performance. Over to you, Jackie.

Thanks, Rajiv. Let me begin by summarizing the key highlights of our financial performance for the first half of 2024. We are pleased to have returned to strong top line growth with improving momentum in all 3 of our divisions, resulting in 8% constant currency revenue growth. This revenue growth, along with continued benefits from our strategic projects and acquisition synergies has resulted in us delivering an 18% EBIT margin in the first half. This is above our previous margin commitment of 17%. This strong operating performance has translated into a 27% earnings per share growth, and we've also continued to deliver healthy cash generation with $59 million of adjusted free cash flow in the period. We've continued to make further positive progress on the funding position of our U.K. pension scheme and remain in a fully funded position on a technical provision basis. This allowed us to trigger the off-switch mechanism agreed with the pension trustees and turn off monthly payments to the scheme of GBP 2 million per month from January 2024. This provides a sizable $30 million per annum free cash flow tailwind. We also remain actively engaged with the insurance industry over a buy and policy for the remaining 80% of uninsured liabilities. Lastly, on highlights, I note the proposed interim dividend of $0.093 per share, which is a 15% increase on the 2023 interim dividend and reflects the Board's ongoing confidence in the medium term of the business. Slide 8 sets out the financial summary and our key financial metrics. Let us now take a deep dive on these financial metrics, starting with revenues. Overall, the year-on-year increase in group revenues on a constant currency basis was 8%, which has shown further positive momentum since our trading update in May, where we reported 7% growth. This return to strong growth was driven by the apparel and footwear divisions. The apparel division saw constant currency growth of 14% as it exited the destocking cycle first and footwear saw growth of 7% as it remains a few months behind apparel in the recovery. In both divisions, it is pleasing to see customer buying patterns returning to more normal behaviors. In Performance Materials, we also saw encouraging momentum with month-to-month improvements. Although revenues remained slightly behind last year, the division has returned to growth in the second quarter. Group EBIT was up 26% year-on-year at $133 million as we benefited from the volume tailwinds and apparel and footwear and further benefits from our strategic projects and acquisition synergies. Overall margins were up 250 basis points to 18%. And as I said earlier, this is in excess of our previously committed margin target for 2024 of 17%. At a reported level, the constant currency sales and EBIT growth was once again primarily impacted by hyperinflation accounting in Turkey, which requires us to translate results back at the period end rates. Adjusted EPS of $0.45 per share was significantly up year-on-year as the growth seen in our EBIT translated to the bottom line through well-controlled interest tax and minority interests. On Slide 9, we look at the details of our excellent EBIT and margin performance. After the period of prolonged industry destocking during 2022 and 2023, volumes have now recovered to more normalized levels, and we, in turn, benefit from the resulting efficiencies in our plants. In relation to inflation, we've seen some further deflationary benefits on raw materials as we lap higher pricing comparatives. These year-on-year deflationary benefits are expected to subside in the second half. Elsewhere on inflation, we've seen a return to relatively normal levels of inflation in other areas such as labor and energy. Together with successfully holding price and ongoing business-as-usual productivity benefits, we have comfortably offset these overall inflationary dynamics again. As mentioned earlier, we've continued to see benefits from our strategic projects and acquisition integration activities come through. I'd also note that as we return to growth, we have started to make some targeted reinvestments back into our SD&A base, which are intended to support further future growth in the business. The above impacts have led to a very strong EBIT margin in the period of 18%. This was 250 basis points up year-on-year. And as I mentioned, this was above our original 2024 group margin target of 17%. Moving on, let us now look at segmental margins on Slide 10. Before I comment on the divisions, I should note that to help year-on-year comparability and underlying performance, we've also shown some pro forma numbers for the apparel and Performance Materials divisions. Starting off with our apparel division, we saw strong margins of 19.1%, up 310 basis points year-on-year. On an underlying basis, which removes certain one-off benefits such as transactional FX gains, margins were 18.4%, well in excess of our original 2024 margin target. The division benefited from a return to significant volume growth post destocking as well as the ongoing benefits from strategic projects and procurement savings. And footwear margins were at 24.1%, again comfortably meeting our 2024 margin guidance of greater than 20%. This division also benefited from a return to volume growth, albeit slightly later than the recovery in apparel as well as $22 million of annualized integration synergies, which is well ahead of the original target of $11 million savings. In relation to the Texon and Rhenoflex acquisitions, this has enabled us to increase the EBIT margins from 12% pre-acquisition to 18% in the first half of this year. In Performance Materials, reported margins in the period were 8.3%. However, excluding around $4 million of under absorbed overheads as part of the U.S. to Mexico footprint transition, margins were 10.5% on a pro forma basis. Outside of the Americas, peer margins remain a healthy double digit, and so delivery of the 13% to 14% margin target for this division relates largely to the ramp-up of the Toluca plant in Mexico and volume recovery in our markets. On Slide 11, we show the bottom half of the profit and loss account, and there are 3 areas I'd like to cover off on this slide. Firstly, exceptional and acquisition-related items of $15 million, which includes $4 million spent in relation to our strategic project initiatives, $1 million of footwear integration costs and $11 million of amortized costs mainly in relation to our acquisition of Texon and Rhenoflex. As anticipated and as we near the completion of our strategic projects and acquisition integration, the exceptional costs incurred in relation to these are now significantly lower. Secondly, our finance costs were slightly higher than last year. This reflected well-controlled debt levels around the group with a slight increase being driven by a lower P&L credit in relation to pensions and a non-repeat of certain FX gains we saw in the first half of last year. The third item is the underlying effective tax rate of 28% for the first half. This is slightly below last year but reflects certain timing benefits in the first half. We continue to project an effective tax rate of 29% for the full year. Moving now on to Slide 12, where we see the very healthy cash generation in the period. At an adjusted free cash flow level, we delivered $59 million compared to $51 million last year. This performance was supported by improving operating results but has also been underpinned by returning to normalized levels of working capital with targeted investments and inventory to support growth. This is whilst continuing to spend on the most value-add capital expenditure opportunities, including expanding our footprint and growth productivity opportunities. We expect to spend our previously guided $30 million to $40 million capital expenditure for the full year. Closing net debt of $381 million, excluding leases, was below the end of 2023 as we benefited to the tune of $15 million from the switch off on pension payments from the start of the year. This level of net debt equates to leverage of 1.4x, which is towards the lower end of our target range of between 1 and 2x and leaves us in a strong position to pursue strategic opportunities as they arise. On Slide 13, we lay out the latest funding position of our U.K. pension scheme. We remain in a healthy funding position with a small surplus on the scheme, which means that the off trigger for our monthly pension payments remains in place. This equates to an annual tailwind to free cash flow for the group of around $30 million. The 2024 triennial valuation, which has an effective date of the 31st of March 2024, has progressed, and we expect it to confirm this fully funded position when it's finalized. Aside from the funding position, we continue to work collaboratively with scheme trustees, and we share a continued ambition to derisk the scheme of fall by removing it from the group balance sheet in a cost-effective manner. Since we last updated, we've remained in constructive discussions with the insurance industry over the spinal derisking and we'll provide updates and due course on this progress. On Slide 14, I wanted to take this opportunity to remind you of our approach to capital allocation. In short, we see many attractive opportunities to reinvest our capital to drive growth, both organically and via M&A, where we continue to follow a strict investment criterion. We will also continue to focus on supporting our pension obligations, as we have previously disclosed, and we will consider prioritizing a one-off payment, which fully derisks the U.K. pension obligations. This can be achieved in a cost-effective manner. We also remain very mindful of the need to deliver a progressive dividend to all of our shareholders as has again been demonstrated today with 15% growth year-on-year in the interim dividend payment. We will do all of this whilst maintaining a strong balance sheet of between 1 and 2x leverage. As I've mentioned previously, the Board will revisit this capital allocation policy once we fully derisked the U.K. pension obligations. Lastly, from me, and as with previous announcement, we've provided future modeling guidance for the rest of the year, the latest of which is set out on Slide 15. I'm not planning to go through this in detail, but we will be happy to arrange for up calls if you have any questions on this. I conclude by reiterating the stellar financial performance in the period, a return to strong top line growth has benefited margins alongside our continued delivery of our strategic projects and synergies. Our cash generation continues to be excellent and our continued progress on the U.K. pension scheme funding and derisking strategy. Finally, and before I hand back to Rajiv, I'd like to take this opportunity to thank him on behalf of the whole company, the Board and personally. Coat simply would not be the company you see today without Rajiv. Over the last 8 years, he has led the reshaping of the portfolio using our clear strategy, improve the operational and financial performance and positively change the culture for the benefit of all stakeholders. We are far better placed for it. It will be very sad to see him leave later this year, but we wish him all the best for the future. Over to you, Rajiv, and thanks again.

On Slide 17, we can see evidence of the ongoing recovery in apparent markets as customer inventory and buying patterns have returned to more normalized levels during the year. We expect to see this gradual recovery continue through 2024 and into the first half of next year. Our apparel division grew 14%, and we believe we have again outperformed the market. This continuing ability to outperform consistently comes from a range of premium products, global presence, supply chain agility and customer responsiveness alongside our ability to offer technical services. In the first half, we increased our revenue from newer, faster-growing brands as well as making share gains with more established brands. Our range of premium quality products includes the widest range of sustainable products in the market, being the clear global market leader in the sale of 100% recycled threads. This is another reason why we have been able to consistently gain market share. Our tried and tested pricing strategy has been executed well. With some input costs moderating after a period of high inflation, we have defended prices well. We continue to execute well with our playbook of winning with the winners, which means we proactively align with growing brands in the most attractive segments and geographies. We have also seen strong growth in China and India domestic markets. The Apparel division increased its EBIT margin by 320 basis points to 19.1%. On an underlying basis, which removes certain one-off benefits such as FX, margin was at 18.4%. This is a very good result, and we're proud of the entire apparel team. Early last year, we said that the footwear destocking cycle started 6 months behind the apparel destocking cycle, and hence, the footwear recovery will also be a bit behind that of the apparel recovery. We are fairly certain now that the majority of the footwear destocking is behind us. This is reflected in the footwear division returning to growth as we saw more normalized customer buying patterns and inventory levels in the second quarter. In footwear, revenue increased by 7%. Like apparel, we are pleased to have outperformed the market and gained market share. For footwear, part of this is our ability to cross-sell a broad range of complementary products to customers following the 2022 acquisitions of Texon and Rhenoflex. The consolidation of our 3 footwear businesses enables customers to simplify and optimize their supply chains. In the first half, we were successful in cross selling our products to 2 large European sports brands. Our ongoing customer discussions increases our confidence of further cross-selling and upselling in the future. In footwear, we have many of the same positive attributes as in apparel. This includes market leadership, global scale, technical expertise and a focus on innovation and sustainable products. Our focus is to grow with premium brands in the most attractive parts of the Sports and athleisure segments. Our initial estimate is that we have continued taking share in the first half. We are pleased to deliver good growth and EBIT margin. In the period, adjusted margins increased 340 basis points to 24.1%. This is another record and significantly above our 2024 margin target of 20-plus percent. This result is in part due to the continued benefits from acquisition integration synergies, and we are on track to deliver $22 million of savings cumulatively, which is well ahead of our initial guidance of $11 million. We are not sitting still, and we are maintaining a focus on streamlining our operations, including footprint actions, which I will discuss later. Slide 19 covers Performance Materials, in which there was a 3% revenue decline in the half. The division continues to be impacted by the previously disclosed customer facing issues in some U.S. markets as well as destocking by some U.S. telecom customers. However, the business has returned to year-on-year growth in the second quarter of 2024, and all 3 subsegments of the division, which are personal protection, composites and performance threats are delivering improving revenue trends. We have seen sequential quarter-on-quarter revenue growth in H1, and this is expected to continue in the second half. At our full year results, we said that our second new plant at Toluca, Mexico has commenced [indiscernible] production. This plant is now operational. And despite some operational challenges, output is steadily increasing. In the period, Performance Materials adjusted EBIT margin was some 70 basis points lower than H1 2023 at 8.3%. However, the margin would have been 10.5% were it not for the under-recovered costs related to the production transition between the U.S. and Mexico. Our strategic projects have positioned the division for higher quality growth, and there are some efficiencies yet to come through. Outside of the operations in the Americas, margins remain at a healthy double digit. Within Asia, where we have seen strong growth, margins are over 20% and in Europe, margins are in the low teens. Delivery of the 13% to 14% margin target for the division continues to depend on volume recovery in the U.S. and Mexico. Slide 21 covers the progress of our strategic projects. We originally announced these projects in March 2022 with expected total savings of $50 million by 2024. In March last year, we expanded the scope of these projects to increase the expected savings to $70 million from a cash investment of $50 million. We have identified some further footprint optimization projects across our portfolio, and we now expect to deliver $75 million savings from a cash outlay of $50 million, leveraging our ability to bring in these strategic projects at less than original budgets. These projects will be actioned in the second half of the year with the additional savings being delivered by the end of 2025. These projects have continued to deliver accelerated savings with $7 million delivered in the period and $64 million in total. As set out in March 2024, our latest project was the transfer of production in footwear from an underutilized U.K. facility into our existing site in Indonesia. This move delivers a number of benefits, including bringing us closer to customers, lowering production, freight and energy costs as well as reducing CO2 emissions. This factory is now open and is our first fully integrated production facility. We will now play a short video. [Presentation]

Slide 23 covers sustainability, which remains integral to what we offer our customers and how we conduct our operations. At our results announcement in March last year, we announced ambitious new medium-term sustainability targets for 2026. We set out on this slide the main areas of sustainability in which we are targeting additional improvements. We have come out of the blocks very quickly against our December 2022 baseline and delivered improvements against each one of these targets in the half. Beyond this, we have continued to work hard. In May this year, the science-based target initiative validated Coats near- and long-term emissions reduction targets. Our efforts to drive sustainable operations and products have received further recognition as we have been included in the Europe Climate Leaders list by the Financial Times. In addition, an achievement that I'm very proud of and which reflects our commitment to fostering an inclusive culture at Coats is an outstanding engagement score of 85% from the Your Voice Matter survey. This is an internal survey of all employees where we assess engagement and satisfaction levels across the business. This outcome is 11 points above the average external benchmark. Participation rates from the survey were exceptionally high at 94% of our global workforce. So now turning to recap the highlights for the half year. Performance in the first half has been strong as the recovery from the destocking cycle is underway, and we have seen improving trends in each of the 3 divisions, in particular, within the apparel and footwear divisions, which have now returned to growth. We have continued to gain market share and grow our recycled thread sales. We have delivered significant savings and integration synergies, and this, in part, has enabled us to increase our group adjusted EBIT margins to 18%, ahead of our 2024 margin target of 17%. We also generated strong free cash flow. All this means we can look to the future with continued confidence. During my 14 years at Coats, 8 years of which as Group CEO, the company has undergone transformation to become a stronger, better and more agile 100% industrial B2B business. The changes we have implemented have been far reaching and deep, and I believe I'm leaving the company in a better strategic and financial shape than the one I joined 14 years back. It's a company with a positive culture, a growth mindset and confident teams. As shown on Slide 26, the business has been significantly strengthened since it was relisted on the London Stock Exchange in May 2015. As part of this transformation, we have focused the business on the most attractive markets and customers. We have implemented a growth strategy underpinned by innovation, sustainability, digital, technology, acquisitions and greater technical capability. These acquisitions include our recent large footwear acquisitions, which has made us the leading player in footwear threads and structural components. We have deepened our relationship with customers, improved our operational efficiency and divested from those markets and geographies where we did not have leading positions or real differentiation. These actions have contributed to 850 basis points margin expansion since 2015. We have worked hard on all aspects of sustainability, which makes us both more efficient and more relevant to our customers who require a compliant supply chain and increasingly more amounts of sustainable products. We have also worked hard on the culture of the organization, and this culminated in 2023 and Coats being named as one of the "Top 25 World's Best Workplaces by Fortune" and "Great Place to Work". We have done all this while delivering good cash generation, and we have a strong balance sheet which gives flexibility and optionality. The work led by Jackie on the defined benefit pension scheme has significantly derisked the balance sheet and has left us in a stronger financial position. It has been a privilege to lead Coats. I'm proud of all that we have collectively achieved. My gratitude to all employees and Board members, past and present that were part of my 14-year journey at Coats. It has been a privilege to work very closely with 3 Chairman and the previous CEO. They are Gary Weis, Mike Kasper, David Gosnell and Paul Forman. My best wishes to the incoming CEO, David Paja and the Coats team as they write the next chapter of Coats. Slide 27 contains the key elements of our outlook statement. Following a strong first half, we are expecting to make good, continued progress, and the Board's full year expectations are now modestly above current market expectations, which is of an adjusted EBIT of $261 million for FY '24. This encouraging trend is underpinned by the ongoing evidence of recovery in apparel and footwear and an improving recent trend in Performance Materials. The recovery and our continued investment in sustainability and efficiency should enable strong profit growth and cash generation over the medium term. This concludes today's presentation, and we will now commence the Q&A session.

Our first question from Charles Hall with Peel Hunt Charles, your lines now.

Well done on excellent set of numbers and particularly well done to Rajiv on a very impressive tenure at Coats.

Thank you very much, Charles. Appreciate that.

Could we talk a little bit about the shape of sales growth in H2? Obviously, mindful that the comps get more challenging as we go through the period?

Okay. Do you have some more parts to the question, so we can take it all together or...

It's on a different subject. So let's do that one first.

Okay. So I think what I mentioned 12 months back, actually more than 12 months back, is that we will see quarter-on-quarter improvement in absolute sales numbers. So we saw that trend in 2023, where every quarter was slightly better than the previous quarter. We have seen that same trend in the first half of this year, where every quarter is slightly better than the previous quarter. And I would expect that same trend to continue into the second half and also into the first half of next year. So it will be a slow, gradual recovery, but each quarter slightly better than the previous quarter. As you rightly said, while there is improvement in absolute dollar terms, I think on a percentage basis, the comps get a bit harder in the second half, but overall, it's trending in exactly the same direction that we said 12, 18 months back, that the recovery is going to be like a Nike push a slow gradual recovery.

Perfect. And then secondly, on sustainability, really impressive number in the first half. Have you seen a change in emphasis coming through on sustainability? Is it sort of linked to the destocking cycle? Or is it because particular brands have started to adopt it in greater numbers? And also, you've got some ambitious targets for sustainability products by 2026. What do you need to do to be able to deliver on that target?

Yes. So Charles, I think if you look at the first half sustainability results, $159 million of sales, 141% growth. I think that can be attributed to roughly 70% of those sales have been market pull in the sense it's driven by market specifications, market requirements. And within that, I would say that 2 European brands who have come back very strongly at the start of this year are the ones that are driving a lot of our sustainability growth in the first half. The other 30% is more of a material replacement that we are doing proactively as a company, and that will continue. With respect to meeting our targets for 2026, so we have unlocked a lot of supply in terms of high-quality recycled materials as far as polyester is concerned. I'm not too worried about whether we will miss the 2020 cities target. I think that seems to be robustly on track. The challenge for us is beyond 2026. And that, to a large extent, depends on technological breakthroughs in terms of biomaterials. So that's something that our teams are working on very proactively. And as we have more news, we will inform you in the course of time. But in the short term, nothing to worry at this stage.

And just one follow-up. How much competitive advantage do you think you've got in sustainable products? And how does it help on pricing?

So we are miles ahead compared to our competition. The distance has increased so significantly. We don't even bother looking back to find what's happening with the next 10 competitors. It is a big, big advantage for us. It is a big source of market share gains. And the 70% where it is market pull, which is driven by brand specifications, et cetera. We do get a slightly higher price. So it does help us on the top line also. But let me just hasten to say here, overall, as a portfolio, sustainable products are margin neutral to the group because the input costs are slightly higher than Virgin Polyester, even though that spread has been coming down over the last 18 months. But overall, it's margin neutral. And my expectations are that at least for the next 4-6 quarters, it will continue remaining margin neutral.

Thank you very much. Our next question is from Joe Spooner with HSBC.

Rajiv, just to add my congratulations to you for leaving the company in better shape. I have 3 questions if I can. Firstly, I think you mentioned some targeted reinvestment needed in the cost base. Can you just give a sense of kind of what's needed on that front? And secondly, there's the customer phasing in the Performance Materials area, when does that kind of unwind and kind of annualize through? And then just finally, and the further footprint optimization savings that you've spoken about. Is there anything kind of specific is that going to extend that into new geographies? Or is that kind of finding more opportunity in areas you're already working on?

Okay. Well, thank you, Joe. Thanks for your kind words. Your first question around targeted reinvestments. So it's gone into 2 areas. One is around the commercial resources that we have. So it's largely the boost of frontline and also for investments in commercial excellence programs. We really want to make sure that as the recovery continues, we have the best frontline across the industry, and that's where the investments are going in. The other investment which is happening is it's more from a cash standpoint, that's an inventory. We want to make sure that we have the best service levels to our customers. One of the things that we have had a competitive advantage in the first half of this year is as the issues around the Red Sea continue into the-- or continued from last year into the first half of this year, that creates a positive momentum for Coats because of our large global footprint, and we are able to manage those disruptions with our customers seamlessly. And that, again, has been a small source of market share gains for us in the first half. But broadly, the answer to your question is investments are going into the commercial area and into inventory for better service. On the customer-facing question around the Performance Materials business, it's essentially 2 customers in the U.S. I think the U.S. in general is on a wait and see. I think they want to get through the U.S. elections by the end of the year and we should start to see positive momentum happening probably in first quarter next year. So that's when I expect things to start looking better there. Just on the Performance Materials, I think this question might come up. I think it's important to note that while we have 2 factories, 1 in the U.S. and 1 in Mexico, Toluca on the performance yarn business, it's important to note that we haven't lost customers during this period. What we've been experiencing is challenges in the ramp-up in our new factory in Mexico. And those challenges are largely people related. So we have the machines, we have SAP. We've got the controls, the infrastructure in place. It's more around the people, the behaviors, the training, et cetera, where we are experiencing challenges. And that's the reason why we haven't fully closed one of our U.S. factories and that continues to operate at full speed. So while we haven't lost sales, there is a profit impact because the cost of manufacturing in the U.S. is higher than the cost of manufacturing in Mexico. So that was a little bit additional color on the Performance Material part of the business here. Your third question around footprint. So I can't give you any specifics because internally, we haven't announced that project, Joe. But again, it's a project where we have an underutilized factory far away from customers. It has higher cost; the cost of shipping and CO2 emissions is not really favorable from the factory. So the whole idea is to move it closer to the customers, bring down the production cost and improve the service level. So we will talk more about this at the next results announcement, but this is the project that we will start executing in the next couple of months.

Our next question is from Bruno Gjani with BNP Paribas.

I just had a follow-up on Charles' question initially. I thought it was quite interested when you talked about the gradual improvement expected in H2 of this year. That also follows through into H1 of next year. I was wondering where we might end up to after those gradual improvements in, I guess, volume over the next 2 halves. Is the expectation that by H1 2025 volumes return to a 2019 baseline? Or are you able to contextualize that or put that into some context for us, that would be very useful.

All right, Bruno. Thank you very much. As always, a very, very deep and forward-looking question. So I'll try and not skip around some specifics here. But let me tell you what I can say with confidence that this year, given our outlook on sales and volumes, we will still be down compared to 2019 volumes and 2021 volumes. So just broadly, we'll be 2% down versus 2019 and 6% down versus 2021. I expect that we will cross the 2019 volumes next year, but probably getting back to 2021 volumes might happen in 2026.

Okay. That's very, very clear. And I had another question just on the Performance Materials margin, more of a medium-term, longer-term question around it because it's acted as a drag in recent half. I appreciate a large bulk of this is market related, some company specific. I was wondering when you expect the margin to recover. And given a part of it is volume related. I was wondering where volumes need to recover to in order for the Performance Materials margin to enter that 13% to 14% range? Because it seems as if you've done a lot of work internally. So perhaps volumes don't need to return to, say, for arguments sake, a 2019 level to support that margin. Is that sensible? I guess just any color around where volumes need to return for the Performance Materials margin to get to where you'd like it to be?

Okay. So just overall, in terms of the Performance Materials division, if I break it down into the 3 regions, in Asia, we've had a very strong performance in the first half. We had 22% operating margins in the PM business in Asia. So that continues to do well. In Europe, it was in the mid-teens in terms of operating margins. And clearly, the issue role in U.S. and Mexico, which have been articulated over the past 18 months. The volumes need to get back to 2019 levels for the overall PM deviation operating margins to get to 13% to 14%. When would that happen? It will not happen this year, we should start to see the trend line or the exit run rate of those volumes happening in the second half of next year.

Our next question is from James Bayliss with Berenberg.

Two questions from my side, please. So once that final piece of the strategic initiatives and footprint optimization finishes, can you just remind us where that would leave you from a capacity and utilization perspective? I guess if we're thinking about heading into a continued sustained recovery in volumes, any sense on how you think you'd be comfortable there before we potentially need to see a step up in growth CapEx going into the business? And then my second question, I see you've launched EcoVerde Ripcord into the telecoms market. Can you just talk a bit around the demand patterns for sustainable products you're seeing in Performance Materials overall specifically? Just trying to understand how appetite there might be evolving, especially in the face of a bit of a longer piece of ongoing destocking specifically in telecoms itself?

Right. So in terms of the strategic initiatives, I think after this one project that we're going to be working on, we have pretty much, I would say, Jackie, we are majorly towards the end of strategic projects. We will have enough capacity to manage the volume growth over the next 3, 4 years. So I don't see any new factories being built with one exception. We are starting to see the footwear structural component quite of it starting to look stronger and stronger. So there is a possibility that we might end up expanding rather than building-- I think expanding within our existing site, more capacity for structural components in India. But beyond that, I think we're in good shape from a capacity standpoint. I don't expect the overall CapEx guidance to change significantly over the next few years, which still operate within that $30 million to $40 million. And I don't see any new factory being built over that period. The other question around EcoVerde Ripcord. So this is essentially material substitution. This is not something which has been generated by a customer pool or a market requirement for sustainable products. I think overall, within the performance portfolio recycled products at this stage don't have too much of a relevance because a lot of the applications are safety critical. And I think those will be the last ones changing in terms of materials.

Our next question is from David Farrell with Jefferies.

Rajiv, congratulations again. Great to see you're leaving with the share price at an all-time high, it appears. I'm going to direct my question to Jackie. I just wanted to get a sense in terms of kind of when we look forward, what you think the right level of cash conversion would be for Coats. Clearly, we've made significant progress on the pension, the costs associated, whether it's your DC projects we'll be exiting. So what do you think that right cash conversion level would be?

Thanks for the question, David. No, you're right that we are making good progress in terms of our cash flows. You would have seen that with our first half year results in terms of what we've seen with strong cash flows in the first half off the back of good operating profits. And as you rightly point out, our cash generation post switching off of the pension is also very good. I'd say in sort of thinking about cash conversion going forward somewhere between the sort of 80% to 90% as we would be looking to land on a go-forward basis.

Okay. And just maybe kind of a follow-up question around the margin I get that you're not going to want to put out a new target. But can you just kind of talk through the potential for you to actually benefit from operational leverage as the volumes recover back to 2019, 2021 levels. I appreciate there are costs that need to go back in, but presumably, there will be an offset from operational leverage, which suggests that margins higher than 18% could be attainable?

Yes, you're absolutely right with that, David, there's certainly potential to move the margins off the back of operational leverage. On average, we see about a 30% drop-through. That's probably a current assumption. Clearly, we just balance it with putting some costs back into the business as Rajiv has already talked about today, particularly into those functions such as commercial and inventory which are supporting growth.

Our next question is from Kyle Summers with Redburn Atlantic. Kyle, your line is now open. Please go ahead.

Just one question from me, please. Just wondering if you could comment on the Vitality Index and what you're seeing there on a divisional basis?

Yes. So in the first half, Kyle, the vitality index was about just under 12%. It was 11 point something. Most of the new products are coming in through the Performance Materials business. And it has been our ambition and this, I would say, ambition underlined is that we need to get the vitality index for the group between 15% and 20% in the medium term. Performance models will be always around-- should be between 18% and 20%. But overall, for the group, between 15% and 20% would be a good place to be in.

Our next question is from James Zaremba with Barclays.

And restating other sentiments, Rajiv of wishing you well to start. If we take the footwear acquisitions associated synergies and the strategic cost saving programs, the combined contribution is well over GBP 100 million. But I guess if I look at kind of FY '25 consensus, it's only about GBP 75 million higher than FY '19 before these actions took place. Obviously, you aren't giving guidance effect at this stage. But can you talk about how we should think about some of the key moving parts in the delta, and your comments that volume should be back at FY '19 levels next year?

So is it specifically related to the footwear acquisitions, James or are you talking about the group overall...

Yes, I was sort of saying, I guess, FY '19 EBIT was about $200 million. Your strategic initiative has been about $75 million footwear, and its synergies maybe contribute $40 million to $50 million, which I guess gets you to somewhere above $300 million taken together. I suppose what's the key delta between that and I guess, where we are today?

I think the key deltas of PM and FX.

And also, I'll just comment on it. Clearly, we're taking a bit of a cautious view as Rajiv has mentioned, we see this as sort of a Nike push recovery. So we're also a little bit cautious at this point on 2025 numbers.

Thank you very much. We've got our next question from Maggie Schooley with Redburn Atlantic. Please go ahead.

First of all Rajiv, thank you very much for all your help for me over the last few years. I really appreciate it, and I wish you well in your future endeavors.

Thanks, Maggie.

A few questions. The first being the experience in this recovery versus historical patents. Clearly, it's very different given the unprecedented consumption we had from COVID. But you specifically in the presentation highlight this is a brand-led recovery. And I recognize there's increasing fragmentation in the end markets. But can you explain other than volumes, how this recovery is different than in the past? And if you have seen anything fundamentally changed with brands and brand behavior that we should be thinking about in the future?

Okay. So Maggie, thank you for the question. Just for the benefit of others in the previous decade before the pandemic, destocking cycles would happen every 2.5, 3 years, destocking would last 6 months, and that will be followed by reshaped recovery. So broadly, all within 12 months will be back to normal. Post the pandemic, what we have seen is it's been a much deeper destocking and it's a very slow gradual recovery. So things are taking longer. We're also in a very high-interest rate environment. So brands are more cautious in building inventory. That's the other factor here. But what we are seeing at a customer, or a brand level is that there is-- previously in the previous decade, you be tell a story around various categories. And by that, I mean, denim is doing well, or sports is doing well, or casual is doing well, things got that. I think it is much harder now to explain what's happening at a category level because of the fragmentation and now it's all company specific. So trying to explain the story gets more complex because within the category, you've got some brands that are doing exceptionally well and some brands that are struggling. So it becomes really brand specific. Broadly, I would say that if I just give you some very high, high-level numbers globally, probably in apparel and footwear, there are about 5,000 brands. At any given time, there will be about 1,000 brands across the world that are doing extremely, extremely well. There'll be about 1,000 brands that are struggling and 3,000 in the middle that are trying to navigate through all these fashion changes and challenges that they all have. So our strategy has always been to find those top 1,000 brands and move with them, and that's how we see the growth happening. What we are seeing right now is when opportunities emerge, you have to move very quickly to seize those opportunities. It's no longer like in the previous decade where you had time to calibrate and time to move. So I think things are moving at a much faster pace, and it's very brand-specific rather than region or category specifically.

That's really helpful. And then my second question, if I may. Clearly, Jackie talked about increasing cash flow. The balance sheet is continuing to deliver. I appreciate there's a capital allocation question in terms of the pension. But also, can you remind us, footwear still a very fragmented supply chain. And clearly, you have a growing and ingrained position in the shoe. But can you also tell us what other parts of shoe or what other areas in terms of either organic investment or M&A you could do in footwear that aligns with the 1% to 2% cost of the product and growth categories. So what else could you do either organically or inorganically in footwear to continue to support that higher growth segment?

Yes. So Maggie, let me give you a generic answer and then give you a more a little bit more granular answer here. So our strategy and acquisitions has been to move into adjacencies and new technologies. That's the Texon and Rhenoflex have been sort of about examples of that. As a matter of fact, during my time, we have done 8 acquisitions, and none of those 8 acquisitions have got anything to do with threads. So we have been time to diversify the portfolio of products from threads to threads plus other products. And that's worked out pretty well for us so far. In threads, we continue to take market share, and that's going to be our strategy. Within the shoe, we have a position on structural components and threads. When you start looking at where else, what are the other categories within shoes, you have got the uppers, you've got laces, you've got the soles, different kinds of soles or going to be interlining, you've got different kinds of uppers. So for us, it's about finding the most profitable component that we can within apparel and footwear and then trying to figure out whether we can add value, bring value to that sort of component. There are components in footwear there are components in apparel that we are looking at. I don't want to get specific around that. But all I would say is that we will continue to explore the profitable categories within footwear and apparel beyond threads and structural components.

Thank you very much. And we've got our next question from Kevin Fogarty with Deutsche Numis. Please go ahead.

And best of luck, Rajiv, well done for the new comp so far. Just if I could, just within footwear, if you kind of step back in those kind of end markets, it feels like there's a bit of a kind of sort of shift in market share amongst the kind of big brands. I guess it doesn't overall sort of feel like it's impacting your development there given the sort of numbers today. But I just wondered, are they sort of potentially asking anything more of view or perhaps promotional activity underway? Or is there any sort of change in behavior there among some of the big brands in footwear would be useful? And then just second question on potential pension fund derisking. Just in terms of kind of next steps from here, do you sort of need to wait until the outcome of the review, the triennial review is completed before you think about next steps? Or are there kind of triggers we should be thinking about to alleviate that sort of pension risk going forward?

So Kevin, thank you for the question. I'll take the first part and then Jackie can answer the second one. The one thing that has changed in the last 3 years in the footwear segment is almost every brand is pushing more for innovation. So that is something that they're trying to push down into suppliers because they need suppliers to help them with their new product innovations. And if you look at the most recent example of Nike, we have lost share in the running market to the challenger brands on running [indiscernible] and a New Balance because they were a bit slow on the innovation side. So I think overall, it plays to our strengths, everyone wants more innovation and more technical services, more simplification, and that's what we offer. So beyond that, it's more of the same, I would say, better service, reliable service, sustainability, compliance, supply chain, transparency. So we generally play very well. These are all trends that help us in the medium to long term. But I am personally very excited about this new thrust around innovation across the entire of the industry.

And then Kevin, during the presentation, we are in a fully funded position on the pension. We expect triennial valuation to confirm that. We don't say we don't need to wait for the triennial evaluation, but we are certain that, that will confirm that we're fully funded. I think what's interesting in the insurance market is very busy, but the work that we've done collectively with the pension trustee over the last 2 years, it's got us in a very good position. So we've done a lot of data cleansing and actually, we are in the market at the moment talking to the insurers, and that has been-- we're getting good engagement because we're in a good position. So look, I think we would hope to have some news potentially in the second half of this year. So it's kind of a wait and see at this point.

We currently have no further questions. So I will hand back to the management team to conclude.

Okay. So can I take this opportunity to personally thank all of you, the brokers, the analysts and the wider community of advisers and the banks. I think all of you have been partners in the journey. The last 14 years that I've been around, and I've learned a lot from each of you, and thank you for pushing us, challenging us being-- asking those tough questions we certainly learn from them. The company today is in a better position because of some of the tough questions that you asked, I will personally miss all of that, but thank you for a wonderful service to Coats, and I wish you all the best going forward. Okay. So I guess on that note, we will end the call. Thank you very much.

Thank you very much. This concludes today's call. You may now disconnect your lines.