Diploma PLC (DPLM) Earnings Call Transcript & Summary

Hello, and welcome to Diploma's Q3 and Acquisition Trading Update Call. My name is Laura, and I will be your coordinator for today's event. Please note this call is being recorded. [Operator Instructions] I will now hand you over to your host, Johnny Thomson, Chief Executive Officer; and Chris Davies, Chief Financial Officer, to begin today's conference. Thank you.

Good morning, everyone. Thanks for joining. I'm here as usual with our CFO, Chris. We have 2 RNSs out today, one on our quarter 3 trading and a second one on an exciting European Fluid Power acquisition to update you on. So I'll say a few words now on both of those. And then, of course, we'll open up to questions as usual at the end. So starting with the Q3 trading, we've had another strong quarter. Our year-to-date organic growth is now 9%. Importantly, as we said at the half year, remaining volume-led principally. As expected, the growth is still strong but moderated a little as comparators get a little tougher. And all factors are trading well, the underlying trends being similar to what we saw in the first half. Reported revenue growth year-to-date is now 21% with a good 8% from acquisitions and still a 4% benefit from foreign exchange to the 9 months. Our operating margins have remained very, very good in the period, again driven by, as we talked about in the seminar a few days ago, the differentiated value-add business model, benefits of scale, some good management around price and costs and of course, the support of some accretive acquisitions, too. So that's why I want to stay on the trading update for now. I'll come on to talking about DICSA, our new acquisition. We're delighted with it. Strategically important, market-leading, European fluid power aftermarket distributor for GBP 170 million. It's a very strong value-add proposition based on specialized products, broad range of product, technical expertise, speed to market, in many respects, similar to some of our other steel businesses that we like, Hercules aftermarket in the U.S., R&G in the U.K. So we're pleased with that. It's got an impressive track record. Organic compound -- organic growth of 11% over many, many years and margins above 20%. Strategically, it's important for us, and it gets us into Continental Europe part of the white space that we showed you at the seminar a few weeks ago. Around 30% of DICSA's revenues are in Spain, followed by France, Germany and across much of Europe. And what this is really the quality business with small shares of very big markets and therefore, huge potential to keep growing at these historic rates. It ticks all the boxes that we look for. I'd say, first of all, it's an aftermarket business, which, as I mentioned earlier, is a model we like. You can see the quality of the value add and the strong margins over 20%. It's got a great organic growth track record. A high-caliber management team. We spent a lot of time with them, getting to know them. CEO, Daniel Carmen and his team. We've been really impressed there. Our kind people, I would say, and we're delighted that they're all going to be staying on with the business under our ownership. On top of that track record, it's interesting to note that we see some synergies across the group on the basis of the DICSA acquisition. There's some revenue opportunities, particularly cross-selling, some of R&Gs products into Europe through DICSA's platform, and that might be particularly seals and gaskets. We also see that DICSA has a small presence in the U.S. that we can leverage, obviously, our businesses, Louisville, et cetera, to help them accelerate their growth in the U.S., too. And I think, finally, there'll be a bit of cost synergy as well with some product read across between R&G and DICSA. So there'll be some nice synergies that we can see over the medium term as well. We believe we've got a good deal here. We captured discipline. The purchase price is a multiple of 9x '23 EBITDA, which we think is a great value for a business that's going to be accretive to our organic growth and margin. And of course, there will be the synergies on top of that, which will help us accelerate to a faster 20% return on capital. So in summary, it's a great acquisition for us, strategically accessing European markets, attractive fluid power markets, exciting growth track record in its own right but with some opportunities to add to that with synergy. Last words on what all of this means Q3 and DICSA, what it means for our outlook for this year. Obviously, we have a strong Q3 trading, which really just emphasizes our confidence in the guidance we gave you at the half year for the full year. The acquisition of DICSA covers our cost of capital straight off the bat in year 1, and we expect it to add around 5% to earnings in its first full year. Clearly, a little bit of that will be this year, and most of it will be into our next fiscal year. The balance sheet remains strong. We expect net debt to EBITDA of around 1x at the year-end, assuming no other acquisition. Returns will be strong and high again, probably around the 18% mark. And the acquisition pipeline is active. But as you would expect, the bar is raised given the current environment, so we'll keep very, very disciplined. All in all, therefore, a good 3 months trading. We've made a good strategic acquisition, and we're feeling very confident about the outcome for this year and our prospects to carry on, delivering quality compounding in the future. And I'll take questions.

[Operator Instructions] We'll now take our first question from [ analyst, Wenlin ] at Morgan Stanley.

I have two questions, please, both on then on the deal. So firstly, on that 11% organic CAGR over the last decade, you talked a lot at the investor seminar about unlocking further growth potential from your acquisitions. Would you say that's the case here as well, given some of those synergies that you've outlined? Or could it be more limited to that sort of, I think, 15% you gave at the seminar given this is already a business of quite significant scale? And then secondly, again, at the seminar, you talked a lot about structural growth drivers for -- across the business, be it sustainability or infrastructure spend, automation, et cetera. So how does that -- how does this business that you've acquired fit into those things? And how could it benefit from them?

Well, I'll take the last one first, if I can. I mean, I think the good thing, as we've seen with our other fluid power businesses is that the end markets tend to be quite diverse. So that has tended to make our fluid power businesses pretty resilient through cycles, which is great. However, on top of that, there is clearly some upside that we see from increasing infrastructure spend. We see that very clearly, of course, in the U.S. as a massive opportunity there. But sometimes we forget that there are significant initiatives in the U.K. and Europe on infrastructure investment, too. And I have no doubt that, that will underpin great growth in DICSA as well. I mean, your first question -- I mean, I suppose let's start at the beginning and say, if this business, as we think it can do continues to deliver 11% organic growth, we'll all be very, very happy, indeed. That will be fantastic. But as we're indicating, we think there's opportunity for us to add to that. So I'm not going to sit here and give you a committed number as to what that might be, but I think compounding double-digit growth in the foreseeable future is definitely something that we'll be aiming for.

And we'll move on to our next question from Kean Marden at Jefferies.

Just before I get to the acquisition, can I just check the inevitable Q3 organic revenue growth math. Obviously, there are dangers with sort of trying to back at the first quarter due to rounding and others. But would that math gets you to about 7%? Is that a sensible calculation, first of all? Then just looking at DICSA. So it's got an EBIT margin of 23%. I think I'm right in thinking that R&G's EBIT margin was sort of low teens, maybe mid-teens, so maybe you can help us understand the reason for the differential between the two. And then secondly -- sorry, finally, on DICSA, if you get to looking at the sort of the ROATCE calculations. My initial math and apologies because there's quite a lot on this morning, but I think your EBIT from DICSA might need to increase to about GBP 55 million to get to a 20%, ROATCE, unless there's anything you'll do with the denominator there, which looks quite a step-up from sort of the GBP 20 million business delivered in December '22. Just hoping you help me understand the math on that. And if it is going to grow that rapidly, what the drivers are to support that, please?

Shall I take 1 and 3?

Yes, go for it.

Kean, yes, look, it is hard to back out Q3. It's closer to 6 than 7. It's pretty high 5s, low 6s. ROATCE. I saw your notes. Look, year 1 is higher than you've got it. It's double digit off the bat. I understand your question, but obviously, we are driving to get to 20%. The number is the number. But this is a business. When you do the math on the compounding the double digits, it does grow quite heavily, and there are synergies that we will deliver elsewhere, e.g., in R&G that would frankly be capped as a part of that. So I'm not going to give you years to 20% ROATCE but we can see it, and it's not a million years away. This business can grow rapidly.

Maybe to help with that bridge. Do you have an insight into what it's tracking to deliver for December '23? I think you've given in December '22 numbers in the statement. That might help us understand the bridge get better.

Yes. We're not going to give that out at the moment, and it's -- you kind of infer actually, Kean, from the notes. '23 profit growth is decent. It's kind of mid-single digits. But what you've got there is there's a little bit of up-front investment like-for-like profit growth would be much stronger than that. This isn't about the first year, though. As you really think about the compounding model, this thing accelerates like Windy City, like any of our acquisitions.

I'm not sure I recognize the GBP 55 million number, Kean. But what I would say is that our typical acquisitions would get to our kind of more strategic acquisitions as they would typically get to returns in the kind of 3% to 5% range. I think what we're saying here is that with the synergies, we can expect that to be closer to 3% than to 5%.

Okay. I'll follow up on this. And then just the reason between the margin difference between R&G and DICSA.

Yes. I mean there's a slight difference in the -- at the moment in the route to market inasmuch as DICSA is a bit more like our U.S. aftermarket business, Hercules, with a kind of platform out at Zaragoza that kind of feeds the market in from Spain and France. R&G is a bit less mature and is still building with smaller businesses around the country, which over time, we will be able to bring together. And therefore, when we bought R&G, the margins, as you said, were around 15%. They're already significantly higher than that after 1 year and will continue to grow. So I think what you're really identifying is the opportunity within R&G to expand the margin.

[Operator Instructions] We will move on to our next question from David Brockton at Numis.

Two questions, please. Firstly, I just wondered if you could talk about the process to buy DICSA. How competitive was it? And how important was the sort of the Diploma proposition to them? The second question, just picking up on that last question about the sort of the platform the business offers here, can you just touch on how well invested you feel that platform is and sort of room for growth that it still offers?

Room for growth. Sorry, David, can you just ask that last bit again? I missed the room for growth.

Just -- yes, how much before you would need to sort of further invest in the platform to deliver the growth opportunity?

Yes. Okay. No. Okay. That's fine. I mean I'll take them in order. I mean process-wise, look, it's a family business. We've known of it and tracks it for many, many years. In fact, I'm aware that before my time, there was a few conversations between us some years ago. So it's been kind of on the radar. The family for various personal reasons no longer directly involved in running the business. And with a few other personal interests, they want to pursue and decided that this was a great time. They have run a competitive process. I don't know everything about the others involved, of course, but aware of the fact that it was principally private equity as it normally the case with us. What I can say regardless of pricing, et cetera, is that we very, very quickly form a very, very close bond with them. I'm fairly familiar with Latin environments and with Spain as is Chris and our CEO of International Seals with the Seminar Alessandro Lala, Italian, not the same thing. Is it -- but we've been able to build quite a bond with them. And clearly, there's some read across which they can see an opportunity as well as us. So we're very, very happy with the relationship that we've built, and we think it's going to be a great partnership. In terms of the platform, it's fairly well invested. I mean they've got a facility in Zaragoza in Spain, which basically distributes direct across Spain and France. And they've got some small facilities in Germany and Italy, which help them with other European markets. So I think it's -- and they've got very good technology. Their technology is actually attractive parts of the proposition as far as we're concerned, both e-commerce and logistics technology, which we really, really like. So they have put quite a bit of money into it. And we certainly don't see in the short to medium term any significant capital obligations as a result of doing this. I think what will happen is that we'll probably end up putting a bit of investment behind accelerating growth behind some of the synergies I was talking about, making sure we can access markets like Germany a little better, for example, making sure we can put a bit of sales resource behind how they accelerate in North America, for example; some resource to support the cross-selling between R&G and DICSA, for example. So I think there's some great opportunities for us to just put a bit of selective investment in to realize the potential here. And as I said a little earlier with Kean's question, I really feel that this is one that for different reasons, like Windy City, we can see accelerated return on capital.

We'll move on to our next question from Ben Wild at Deutsche Bank.

Two for me. Just firstly, the integration process of this business. Clearly, you're talking about synergies, which I don't think you've done before in your time at a company during previous M&A or acquisitions. What does the integration process here look like? Is it different to previous deals that you've done? And then secondly, on the capacity for further deals. Obviously, the balance sheet is in great shape, but connected to the first question, you spent a lot of time at a seminar talking about the disciplined approach to the compounding model. How do you think about management capacity for further M&A going forward and allied to that with the pipeline? Maybe I'll leave it there and follow up if there's any scope too.

Management capacity. Okay. Well, look, the first one on integration. We don't have -- at this kind of strategic level, this is more of like a platform for us. You saw the white space chart in the seminar. We don't have anything really in Continental Europe. So this is a platform for us. So of course, there's the usual of bringing them into our financial systems. But outside of that, there isn't any heavy integration. Where I was just talking on the last question about was actually putting a bit of resource into helping them accelerate in some countries or some spaces where we think we can help, but that's not really integration. That's about driving cross-selling opportunity. And actually, you're right inasmuch as it's not been necessarily a material part of acquisition strategy that we've signaled in the past. However, as we said at the seminar, that doesn't mean we're not doing cross-selling in the businesses we buy. I mean we talked to the seminar about VSP, for example, which is a relatively recent acquisition, and we're cross-selling seals and hoses and other things into that. So we aren't doing it. It's just that, I guess, and we're highlighting that in this case, there could be a very significant upside. The point on management capacity, again, there isn't a heavy integration. Of course, this will consume quite a bit of time for our International Seals CEO, Alessandro Lala. And -- but we feel there's plenty of bandwidth for him to be able to focus on that along with his team within the sector. He has no other acquisitions ongoing. And as we said at the seminar, we're very careful about the acquisition pipeline. I'm very happy that the pipeline is a healthy spread across and geography and sector because it allows us, therefore, to make sure that there is no undue strain on any one part of the business. And therefore, quite obviously, you wouldn't expect us to be doing another big international seals acquisition any time soon for that very reason. So we feel pretty comfortable from a management bandwidth perspective. If you think about it, it's a long answer. But if you think about it, the only other strategic acquisition we've done this year, TIE and automation very different part of the group in the U.S., in controls, under David Goode's very different area of the group. And so of course, we consider it, but we're not worried about it.

Great. And maybe just a follow-up. If there's scope for this business to replicate the R&G bolt-on model that, that business has been so successful driving, and is there any history of that kind of process in DICSA's past?

No. DICSA's development has been all organic, which is part of the appeal. I wouldn't say that there's no 0 potential for bolt-ons in DICSA. But I think, first and foremost, given the platform that they've established, I can see that they can access the market organically, and therefore, while the R&G model, it's very, very attractive at 3 or 4x multiples. And accessing these markets with a little bit of sales investments, infrastructure investment will be even more attractive, I would suggest. So I don't think it's either or, but I think in this case, it will be predominantly organic.

And we'll take our next question from James Rose at Barclays.

I've got three, please. First, could you share with us how Windy City Wire has performed during the quarter? Second, on the acquisition, can you give us some idea of the mix of the customer base, please? And then lastly, I mean on the website, DICSA talked about manufacturing capabilities, technical and commercial assessments, quality management systems. Could you sort of bring to life what sort of value add beyond normal distribution there for us?

Okay. I'll let Chris talk about DICSA's customers value add in a second. And I'll just answer on when Windy City. I mean Windy City had another good quarter. I mean I think as we indicated at the half year, the volume growth has moderated during the course of the last 12 months for all the reasons you would expect and principally driven by incredibly strong comparators. So volumes moderated, still positive but moderated. However, their profitability and profit growth is still very, very strong and a bigger contributor to our performance with excellent margins. So it's been another very, very good quarter, and we're very pleased with how it's progressing.

Yes. So DICSA, I mean, they've got very, very large customer base, as you might imagine. There's about 4,500 customers. They split broadly into little distributors, kind of like the people that R&G feed and then repair shops, kind of like of people that Hercules aftermarket feed. Slightly different proportion in different markets, but the biggest customers kind of -- the top 15 is 8%. You've got no customer concentration, and you've got the types of customers we've been in R&G and Hercules. In terms of this, I do think you're right. From their website, they do talk quite a bit about manufacture. They've got a bit of like assembly and manufacture as part of their value add. So they do make custom stainless steel fittings, which are very high-quality and then they do some assembly, which is hoses with those fittings. They have some sort of patented drawings that they then outsource the manufacture of, but it is very much in the same way as a Windy City Wire or some of our other businesses. It's light manufacturer to guide and drive the value add of the distribution model.

And we will take our next question from Oscar Val of JPMorgan.

A lot of my questions have been asked, so just one from my side. Can you talk, I guess, Q3 organic by division? You've given some color on Windy City. Can you just touch on Life Sciences and Seals? Are they growing in line with that 6%-ish that you talked about Q3 at a good level or below or above that?

Yes. I mean, I think as I said in the -- at the start of the call, it's broadly speaking the trends are quite similar to what we saw and what we talked about at the half year. If I can give you the balance around the portfolio, I suppose the OEM destocking that we talked about at the half year is still happening. And it just moderated some of our growth rates in those OEM businesses in the U.S. and Europe, particularly, at Seals. So probably, we see seals is a bit below that 6% average at the moment. On the flip side, as we know, this is a very resilient -- revenue resilient business, increasingly so. So on the flip side, Life Sciences is doing very well in a strong quarter and prospects for another strong quarter in quarter 4. It may be a bit lumpy over the short to medium term, but it definitely picked up over at the last quarter and into next quarter. So Life Sciences is now acting as we hope as a good support. And on top of that, on the control side, I've talked about Windy City doing well, but more broadly across controls. We've got some very good tailwinds still supporting us in things like energy, defense, aerospace, et cetera, et cetera and new acquisitions in controls is doing well as well. So the control sector is very, very good, too. So they would probably be slightly above the average. So I mean that just gives you a bit more color, not that different from what we saw at the half year, same kind of trends.

There are no further questions in queue. I will now hand it back to Johnny Thomson for closing remarks. Thank you.

Yes, we're very pleased with the quarter. We're very pleased with the way we're trading. We're extremely happy with DICSA. We think it's a quality business right in the sweet spot in our aftermarket fluid power space, accessing Europe as we wanted to. So overall, we think we're progressing well, and we're very positive about the full year performance. I'm excited about our prospects, and we thank you very much for joining the call.