Diploma PLC (DPLM) Earnings Call Transcript & Summary

Good day, and welcome to the Diploma half-year results. At this time, I would like to turn the conference over to Johnny Thomson, CEO. Please go ahead, sir.

Thank you. Good morning. I hope everyone is well. Thank you for joining us for our half-year update today. I'm here with our CFO, Barbara Gibbes. So the agenda for today, I'll give some summary comments in a minute. Barbara will then take you through the numbers. And I will return for a business update before some comments on our prospects. And as usual, there'll be plenty of time for questions at the end. I'm really pleased with our progress in the last 6 months. We've worked hard on revenue initiative across all businesses designed to penetrate, diversify and grow organically. The contribution from the quality acquisitions we have made, Windy City Wire particularly, has been exceptional. The trading momentum into the second half is very encouraging. And we are significantly upgrading our full year expectations. We have a strong balance sheet. And while maintaining our financial discipline, we continue to review acquisition opportunities. During this period, we have intensified our environmental and social agenda delivering value responsibly. Our successful progress is wholly attributable to our people. So a few words firstly on them. The leadership in our businesses has been brilliant throughout the last year. They have been structured and agile as they balanced a great many challenges. And all of our colleagues continue to show tremendous patience and passion towards servicing our customers. We're focused on supporting their physical and mental well-being through these uncertain and stressful times. This includes ensuring we have safe working practices and environments, but also in promoting physical and mental health awareness. I want to thank all of my Diploma colleagues for their outstanding attitude and contribution in the last 12 months. Our performance in the first half has been very strong, ahead of our expectations. Revenue growth of 29% included 2% organic growth on the pre-pandemic period. Our focus on our business's revenue initiatives, rapidly increasing customer demand in the latter weeks of the half and an exceptional contribution from our acquisitions has driven this performance. Margins were a little above the top end of expectations, up 60 basis points at 18.2%, despite the global supply chain pressures and boosted by last year's restructuring, the accretive contribution from acquisitions and continued COVID-related expense savings. Our cash performance has been strong throughout the pandemic and was so again in this half. Current trading is very encouraging. We remain positive about and significantly upgrade our full year expectations, as Barbara will outline. Adjusted EPS growth was up 19%. Given this performance and our confidence in the group's trading, we are increasing the interim dividend by 25%. Now over to Barbara.

Thank you, Johnny. Good morning, everyone. We have delivered a [Audio Gap] revenue, profit, cash and better-than-expected deleveraging in the following slides, starting with revenue. Overall, reported revenues have increased by 29% in the half. Let's look at the drivers behind the revenue performance in more detail. Our underlying growth for the group was plus 2% against what was a pre-COVID trading period. This performance has exceeded our expectations for the first half. We have seen sector growth rates of minus 1% for Control, 14% for Life Sciences and minus 2% for Seals. There are 3 key factors driving this outcome. First, the success of our revenue initiatives and our focus to continually penetrate, broaden and diversify our businesses for scale. Second, the return of demand across all of the sectors. And third, the underlying growth rate also benefits from the organic growth contributed by our recent acquisitions. That is to say how much they are growing themselves under our ownership, with Windy City, in particular, performing well ahead of expectations. Now on to the next slide to current trading. We are very enthusiastic about the current trends we are seeing in the businesses. For the month of April, we have seen 45% underlying growth over last year, which is driven by the success of our revenue initiatives, the upturn in the demand curve and the strong contribution from acquisition. Momentum is improving across all the sectors, and this performance gives us confidence for the full year. Looking at the individual sectors. We successfully brought our existing Controls business, now called International Controls, back into growth by the end of the first half, and this continues into April by focusing on diversification of end segment. Windy City made an exceptional contribution for the month. Life Sciences is lapping the softest comparative. The existing business is excelling at getting product into hospitals whenever lockdowns permit, which has resulted in strong capital sales. Simonsen & Weel, a new acquisition is an ICU-focused medical equipment business and is benefiting from a COVID boost through exposure to ventilator sales. While these sector growth rates are not sustainable, we are excited about the expected acceleration in the negative surgeries in the second half of the year. Seals. Seals was the most resilient sector. We are seeing continuing strong performance at international Seals and are well positioned in North America to take advantage of the recovery in demand with our new distribution facility in Louisville, Kentucky, having much greater geographic reach. As a result of these improving underlying trends, we are increasing our full year expectation to just over 40% growth in reported revenues by financial year 2025. M&A is a core part of our strategy. We focus on businesses that have value-add distribution characteristics, strong management teams and organic growth potential. We are really pleased with how all of our acquisitions are performing and the value they have already created for the diploma group. I have already explained a strong contribution from acquisitions under our ownership to our underlying growth performance. From a margin point of view, Windy City, in particular, first half operating margin of more than 20% is exceeding our expectations, and this is having a sustainable accretive impact on the group margin. Both Windy City and Simonsen & Weel, being our largest acquisition, have grown their profits very materially under our ownership. The businesses are in great shape to deliver sustainable margin accretion going forward. We have spent just over GBP 400 million across all sectors this year so far, and our pipeline remains active. We are pleased that in the current environment of supply chain disruption and inflation, we have delivered 60 bps margin progression to 18.2%. In Controls, we're seeing the benefits coming through from the restructuring in our existing business as well as significant accretive impact from Windy City. In Life Sciences, we're seeing operating leverage and a higher drop-through to profit due to the absence of travel cost. Seals margin shows the impact from dual running costs in the transition to the new U.S. distribution center in Louisville, which is now fully operational. In the absence of these costs, together with operating leverage, the Seals margin will improve further in the second half. In the first half, we have experienced some supply chain disruption and inflation, but we have managed it effectively. We expect this pressure to continue, especially as older inventory unwinds, but are well placed to navigate this challenge through supply negotiations and customer pricing. Going forward, the benefit from restructuring activities as well as the accretive impact from acquisitions will sustainably enhance our operating margins. While operating expenses will return to a more normalized level in the post-COVID environment, and there may be continuing supply chain pressures, we expect that operating leverage will more than offset this. Therefore, we will see continuing margin improvement towards 19% for the full year. On to the income statement. I have already commented on revenue and profit. Our interest charge for the period was GBP 3.4 million, significantly up from last year as a result of increased borrowings to finance our acquisitions. Our effective tax rate is 24% for the half year and will nudge up towards 25% for the full year. Adjusted EPS is up 19%. This includes the dilutive impact from the 10% share pricing right at the very end of the last financial year. Our EPS growth will accelerate significantly in the second half due to our second half performance rating. Our policy is to pay a dividend in line with our EPS growth, and we are reinstating the interim dividend at 12.5p, which represents a 25% growth rate over last year's implied interim of 10p. We delivered a very strong cash performance in the period with a 72% conversion rate. Working capital benefited from a continued intense focus on cash collections. We have also remained disciplined on inventory and are expecting to make selective investments into stock in the second half of the year to manage our supply chain more effectively. Our cash tax rate benefits from the fact that the acquisition goodwill for Windy City is tax deductible and so has decreased to 20% from 26% last year. Our return on adjusted trading capital employed stands at 16.5%, which is ahead of expectations and driven by the outperformance of the Windy City investment, and we expect this KPI to continue to rise over time. The strength of our operating performance means that we are deleveraging quicker than expected, putting us into a strong financial position with plenty of flexibility that continue with our M&A program by retaining a robust balance sheet. While the pipeline is active, we will retain our financial discipline. So we are significantly upgrading our expectations for the full year. Our successful revenue initiatives, together with improving demand and the acquisition contribution means we now expect reported revenues to grow by more than 40% for the full year. The benefits of restructuring and acquisition accretion as well as second half leverage means we expect a continuation in margin improvements towards 19% for the full year. We expect to continue to deleverage and expect net debt to stand at less than 1x EBITDA for the full year 2021. Now back over to Johnny.

Thank you, Barbara. So a reminder of our strategy, we continue to build high-quality, scalable businesses for organic growth. We do so by focusing on core market penetration while diversifying into adjacent products and end segments. We sustain our growth by enabling the execution of our value-add distribution model in the businesses as they scale. As such, we continuously improve our core business model competencies, particularly at this time, the management of route to market, strategic supply chain and commercial discipline or pricing. This is supported by pragmatic and incremental investments in talent, technology and facility. And finally, delivering value responsibly and our ESG agenda has become an important value creator in the group's development. It's core to our strategy. While there is significant ongoing ESG activity across the businesses, we have been working hard this year to establish our group approach. First, we run a decentralized management model. And so as I've said, our people are critical to our success. Our social agenda prioritizes keeping our colleagues safe. And along with the emphasis on physical and mental well-being, we have also refreshed our health and safety policy, KPIs and reporting. This month, we are completing our first engagement surveys across all of our businesses to hear how we can continue to develop great places for our colleagues to work. Some of the outputs will also enable us to focus our diversity activity to ensure we are actively creating inclusive environments. As a distributor, our supply chain is a massive significance. We have defined the supply chain code of conduct, and we'll be engaging with our suppliers to ensure that they are responsibly managing both their environmental footprint and their employment practices. We want to reduce our environmental impact, even as our business grows. Our environmental agenda focuses on direct and indirect greenhouse gas emission, waste management and reducing waste to landfill, and opportunities to grow green revenue. By the end of this year, we will have clear definition around our group ESG priorities, our KPIs and our targets, which we will roll out in 2022. Making a difference for us is about local ownership. I'll come back to some examples of how ESG already lives in the businesses. I'm very excited about our prospects and controls. The sector exemplifies our strategy of building high-quality, scalable businesses for organic growth. We have actively sought to diversify the sector on geography, product and end segments. Windy City Wire has clearly transformed the Controls portfolio with a significant U.S. presence as well as exposure to high-growth technology-enabled end segments. We've also been working hard to diversify organically in the International Controls businesses, significantly reducing our aerospace exposure, while continuing to increase exposure to, for example, broader industrials, defense and renewable energies in the U.K. and increasingly in Germany and France. These segments are recovering well post pandemic, and we are still to benefit from the return of the aviation market, too. This has helped us to get back into underlying growth in International Controls by the end of the first half, ahead of our expectations. Margins have been very good in the sector due to the restructuring completed last year and the accretive contribution from Windy City. A few words now on Windy City Wire, whose contribution in the first half has been exceptional. Firstly, the management team and all of our new colleagues have settled seamlessly into the group. It's been a pleasure to work together with them on this exciting next phase of the journey. As I said, at the time of the acquisition, the business is exposed to fast-growing technology and segments. We continue to develop our exposure to digital antenna and data center markets as key drivers of structural long-term growth. The business is also gaining market share due to the quality of the customer servicing proposition, only accentuated further by our control of the supply chain, a significant competitive advantage in this environment. For all these reasons, the business grew by an impressive 9% on a pre-pandemic comparator. As broader market conditions improve, we expect the growth rates to accelerate in the second half. As I also said on acquisition, the team have built a fantastic, scalable platform based around seamless assembly process, a well distributed branch network and superb technology. Having made the investments in creating this scalable platform, we also now see the benefits to the margin with profit growth in the period of 55%. We're well ahead of our business case. While, of course, we can't promise this level of profit growth sustainably, we're extremely well positioned, and I'm more confident than ever in the shareholder returns from this acquisition. We continue to make great progress in Life Sciences. There are a number of structural growth drivers for the sector, which support a mid-single-digit base rate of growth. The specialty nature of our businesses in preventative segments of health care, which keep people out of beds, is consistent with our health care customers' budget priorities. On top of that, the catch-up in elective surgeries hasn't yet significantly materialized, but will do so as we move beyond the pandemic and for at least 18 months. And finally, our exposure to diagnostics will be of huge value as investments in research, testing and development intensifies after the pandemic experience. We're supporting these structural tailwinds with solid strategic progress, too. As I outlined at the full year results in November, we continue to develop our product pipeline to ensure our growth is sustainable. We also acquired Simonsen & Weel in the first half, a quality health care business based in Denmark, which builds our Northern European portfolio, adding a third dimension to the shape of the sector. Life Sciences performed very well in the first half. We have experienced some catch-up in capital sales with increased access to hospitals and labs. Over time, we should see some acceleration from the elective surgery catch up. The contribution of Simonsen & Weel has been excellent. There is some benefit to their numbers from nonrecurring ventilator sales in the half, but the sustainable business remains strong and has great prospects. The margins in the sector have also been excellent due to leverage, the accretive impact of Simonsen & Weel and COVID-related expense savings. So we remain optimistic about the short and long-term prospects for Life Sciences. There's also been great progress in our Seals sector in the half. We continue to benefit from the incremental investment in infrastructure in the U.S. potentially accelerating should the proposed federal bill will be passed into law. Further diversifying our product and end market exposures is also critical to our growth. Our international Seals businesses have been doing this successfully with, for example, significantly increased medical and renewable energy exposure. In the U.S., VSP, as an important adjacent product, gaskets to our portfolio. The transition to our North New North American aftermarket facility in Louisville, Kentucky, has been successfully completed, and we can already see the early signs of market share gains in our underpenetrated U.S. regions. The performance of the sector has recovered well through the pandemic and is back in growth at 1%. I'm encouraged that this is accelerating as demand picks up. We benefit from the more diversified end segments and product exposures, and we see the market share gains from Louisville. Margins were a little down on last year, as expected, due to the dual running investment in transition to Louisville. And this will unwind in the second half. Field is in very good shape for both the short and the long term. As I said earlier, our ESG agenda is core to our strategy. While we continue to develop the group's approach, there are many great strategic activities making a difference in our businesses today. I've talked already about some of the social initiatives. So here are some environmental examples, too. Our Seals business has become established as a leading provider to the wind turbine industry, tripling our business in this space in the last year alone. We were able to work closely with manufacturers to help them meet the demanding ceiling challenges for harsh, onshore and offshore environments. Seals has supplied over 10,000 turbines in the last year, significantly increasing our exposure to renewable energy. We have been implementing a major waste reduction program at Windy City Wire. Windy City has always been very good at recycling scrap for copper and silicone insulation. Through this process improvement and automation, we have reduced scrap by 50% over the last 6 months. And finally, in Louisville, our new state of the art facility has accelerated our sustainability journey, the high-density design significantly lowers our carbon footprint. The robots deployed in the warehouse are highly efficient. To give you an idea, a team of 10 robots on the grid uses the same amount of energy as a hair dryer. I am proud of the many ongoing initiatives and excited about developing this important aspect of our strategy. And so to summarize. We continue to navigate the pandemic successfully, thanks to the fantastic efforts of our colleagues. We've had a very strong performance in the first half. Our acquisitions are making an exceptional contribution. Trading momentum is encouraging, and we have significantly upgraded full year expectations. Our balance sheet is in good shape, and I feel very optimistic about our short- and long-term prospects. Thank you for listening, and we'll hand the line over for questions.

[Operator Instructions] We will now take our first question from David Brockton from Numis.

Two questions, please. The first one around the margins. There's clearly very good progress being made there from the efficiency savings you've put through restructuring last year. But also sort of the acquisition contribution. And just on the acquisition contribution, I just wanted to understand whether that is sort of deliberate seeking of businesses with higher margins in terms of acquisitions? Or is that just a function of the opportunities that have arisen? And then the second question actually related to acquisitions, is just to understand how the pipeline looks. You've clearly had a sort of a very active first half in addition to Windy City Wire. Just keen to understand the sort of the nature of opportunities and sort of multiples you're seeing in the market?

Yes. Okay. I'll take the last bit first and then just on the margin second. I guess what we're seeing is an active pipeline, you probably won't be surprised, Dave, to hear that there seems to be a lot more activity out there. Having said that, there are pretty high-valuation expectations, too. So while we're encouraged about what we're seeing, as I said a bit earlier, we're going to be very disciplined about how we approach it from a financial perspective. And indeed, we've walked away from a few in the last few weeks for that reason. So there's lots of great opportunities out there, and I continue to feel optimistic that we can do deals, but we just have to be cautious about the valuation environment. Just on the margins, I think what I'd say about our acquisition strategy is that we buy businesses that are focused on -- that have a really strong value-add distribution component. And generally, that does come, therefore, with strong gross margins. So we don't tend to buy businesses with very low margins. We tend to buy businesses that already have well-established gross margins. Having said that, as we scale businesses, of course, we would expect to see some margin improvements in our acquisitions, too, naturally.

We will now take our next question from Sam Bland from JPMorgan.

The first one is on this Windy City performance. I know in the statement, I think it talks about how it was helped by a higher copper price. You just talk about how important that copper price is for Windy City. I'm kind of conscious that it might turn out to be an even bigger tailwind in the second half of the year? And the second question is you talked as well about seeing an acceleration in trading. Is that sort of mostly just an impact from weaker comps now as you go into the sort of COVID comparison period? Or is it sort of more sequentially and on an absolute basis, trading volumes are picking up?

Yes. I mean just on the Windy City question on copper prices. I mean, first of all, the copper prices went up sort of, I guess, the beginning of our financial year. And it is contributing to our revenue growth, which was 9%. About 1/3 of that roughly is from copper price. The other 2/3 is from improving mix towards more of the technology-enabled data centers and digital antenna that I talked about. And some of it is also about pure volume gains as well. What I would also say is that none of it is -- goes to profits. Effectively, we're just pricing, passing on. So there 50% odd profit growth is pure performance. And then just on the trading, yes, of course, the comparison gets a lot easier from, I guess, back end of March onwards. But roughly around the same time as when we -- so an increase in customer demand, not exclusively, but almost in all of our businesses. So there's a big pickup in demand at the same time. But also as we -- as I said during my presentation, we've worked really, really hard across the businesses. To execute on their individual collective revenue initiatives. And that's really paid off as the half has progressed. So we're really seeing all 3 things happening at the same time, which is why you see such strong growth rates in April and sustaining through the rest of this year.

We will now take the next question from James Sparrow from Barclays.

Just two questions, please. First one on supply chain inflation. Could you just comment on which segments you're seeing as most impacted by that currently and how confident you are about being able to pass on that cost in product price increases? And then aside from product, could you also perhaps comment on wage inflation pressures that you might be seeing in various markets? And then the second question is on ESG initiatives. Once you've clearly defined those, do you plan to embed them in remuneration incentives, both at a group level and a senior divisional level?

Okay. Supply chain, yes. I mean to answer your question generally, to start with, Jane, what we've seen, particularly in the first half, is challenges and inflation around freight, globally. And then secondly, some raw material price inflation, particularly copper, as I've just been talking about, and we've successfully seen that off in the first half. I think that's really intensified for us in the last few months coming into the second half. I mean we are a bit longer cycle inventory-wise than some. And so I guess it maybe just taken a few months longer for us than others. But certainly a bit more intensive in the last month or 2 some raw material shortages. Some suppliers struggling, I guess, to get back to capacity, and continued freight challenges just driving some disruption and inflation. And it's pretty much across all our products in that segment. It's not really specific to anyone. j I'd say we feel pretty confident in the way we can manage it. We're obviously looking at how we change our procurement in order to drive both cost savings but also to manage lead times more effectively. We're holding a little bit more inventory, as Barbara mentioned in her presentation, and of course, we'll have to pass it on where we need to in pricing, too. So at this stage, it's hard yards in the operation, but we feel confident that we can manage it. And I'm glad you brought up the labor point, too, because it is equally relevant to how we operationalize growth in the coming months, particularly in the U.S. Sometimes the kind of leading indicators on the job market in the U.S. can be a bit misleading. And what we've seen is tightening very, very quickly in the U.S. Of course, the stimulus package, et cetera, has also, I guess, made it a little more challenging, to be frank. And so I would say, at this stage, it's a bit early for us to quantify exactly what wage inflation might look like. But we're definitely seeing the early signs of operational challenges and the start of some inflation coming through. But again, it's not anything we can't manage. We feel confident that we can manage this operationally. But again, also, it will be part of how we think about our pricing as the year progresses. And overall, therefore, when you put that together, we still feel very confident that we can deliver really strong margins. And in fact, our second half margin should be stronger than our first, as Barbara said.

Yes. And ESG question?

Sorry, ESG, I totally forgot about that. Yes. Yes, we'll be defining our KPIs, as I said, through this year and rolling them out into next year, I would -- while I don't want to -- it's really a remuneration committee decision on how we remunerate myself, Barbara, and therefore, how we cascade that in an aligned way throughout the organization. But I guess, I would expect that at some point, ESG will become part of our remuneration, yes.

[Operator Instructions] We will now take our next question from Henry Carver from Peel Hunt.

Just a follow-on from Jane. Actually, I think you covered most of it, but another one on margin. I mean you talked about the wage inflation, freight costs, et cetera. How should we look at COVID-related cost savings coming back in? Is that significant? Or I'm just wondering if we are looking at a kind of sustaining margin next year or actually, if it'd be prudent to this being a bit of a high watermark margin-wise? And then just secondly, can you just remind what the exposure to aviation is in Controls? And what kind of full return to the health of the aerospace industry, which albeit it could take a few years, but what that sort of could mean to that division and the business? Or is that not significant?

Henry, on the margin, that's a good point, as you say, we are in a bit of a sweet spot at the moment. And as we see the operating leverage come back in, some of those operational cost savings that come from not being able to travel will come back in. And then as for the long term, our ambition is to drive a very strong organic revenue growth and deliver that at a high teens margin. And so it's important that we make the organic revenue growth sustainable rather than hanging on to a very expanded margin as we are seeing in the current year. Having said that, we are very, very pleased with our margin performance in the current environment.

Just on your aviation question, I mean, I think aerospace is now under 5% of the group, I think it was 5% in November at last year's full year. So it's a bit under 5% of the group now. So massively material. It's kind of holding steady at the moment, diluting a little bit as the other segments progress and grow. But again, I don't -- for me, it's not a dead segment, right? I mean it's very, very exciting one. It's been the driver of growth of great growth for Controls over many years. So we're really, really well positioned in that end segment. And of course, it will be a plus when it comes back in the next few years, whenever that is. We're obviously not waiting for it. As I said, we're diversifying that Controls business as much as we can for now. But when it comes back, it will be nice to have.

We will now take our next question from Daniel Cowan from HSBC.

One question for me is just on the Louisville dual running costs in sales. Just wondering, please, how much that might be in H1?

Dan, that is an incremental of $1 million over last half year.

We will now take a follow-up question from Sam Bland from JPMorgan.

I just got a follow-up question. It was on the April growth you mentioned. I think 1 percentage you gave was 45% and the other was 31%. I'm just interested in exactly what the difference is between those 2 numbers? They're both described as underlying. So I think it was M&A, but I would have thought M&A had a bigger difference than 14%. Just a bit more color there would be helpful.

Sam, so this goes to our underlying growth calculation, the way we calculate underlying growth includes the growth element of businesses that we have acquired from the start of our ownership. So the underlying growth this year is particularly impacted by Windy City because that's grown organically, so very strong. So this has having come up with the underlying growth rate for the group at 45% for the month. But you can actually divide out between the existing business and those incremental acquisitions that we had during the year, and that's where the 31% comes from. So it does not include the full impact of the acquisitions, if you're with me, it's just the growth element.

Okay. And the underlying number that you report every year is in line with the 40 -- is on the basis of the 45%?

Correct.

[Operator Instructions] There appears to be no further questions at this time. I would like to turn the conference back to the host for any additional or closing remarks.

Thank you very much. Well, just a few comments. We're very pleased with the performance. We're very pleased with current trading. The acquisitions are doing really, really well. And I am very encouraged by the strategic, structural and tactical opportunities that we have for growth in the long-term across all 3 of our sectors. And overall, we feel really optimistic about our short-term and our long-term prospects. Thank you very much for joining us today.