Diploma PLC ($DPLM)

Good morning, and welcome to the Diploma Trading Update Conference Call. I will now hand the call over to CEO, Johnny Thomson. Please go ahead.

Thank you. Good morning, everyone. Thank you for joining us at late notice. I really appreciate that. Wilson and I are here together in our pajamas in the U.S. And hopefully, by now, you will have seen that we issued an upgrade to our trading expectations for the year. Half 1 has been very strong, and we're confident in our momentum into the second half too. So for the year now, our organic growth guidance has increased from 6% to 9%. Acquisitions for now remain at 3%. Our margins are up from 22.5% to 25% for the year, and this equates broadly to a 13% increase to consensus operating profit. A little bit of color. Peerless continues to trade very well. The positive market dynamics are sustainable, and we're winning share. Half 1 is looking incredibly strong again. And as we previously said, it will moderate a little in the second half against the strong comparator, but we will land into very good revenue and profit growth. I'm really pleased with progress elsewhere. The group's growth, excluding Peerless, is running at high single digits, well above our model. Some of the controls businesses, IS Group and Clarendon don't often get the limelight, but are doing brilliantly in energy, defense, aerospace markets, both delivering double-digit growth and meaningful margin improvement. Windy is also having a great year. Their exposure to data centers and digital antenna systems supporting strong growth and good momentum into the second half. Seals is running fairly consistent with last year. North America doing well with support from infrastructure and early progress in nuclear. On the international side, particularly RNG in the U.K., it has still been pretty tough, and that will hold the sector growth for half 1 broadly in line with the full year last year. And finally, Life Sciences is continuing stable at mid-single-digit growth. It is pretty tough in health care at the moment, but I'm really pleased with the work the team are doing, and we'll deliver market share gains to sustain decent levels of growth. Overall, across the group, margins are strong, supported by peerless performance, of course, but also by good incremental leverage and performance improvements across the rest of the group. We've had some great new businesses join us over recent quarters, as we've talked about in January, 8 acquisitions for a total spend of GBP 130 million, and the short-term pipeline looks very healthy. So with these upgraded numbers, we're expecting earnings to be up again this year by over 20% at strong returns on capital, another year of sustainable quality compounding. I'll hand over now for your questions.

[Operator Instructions] We will now take our first question from Annelies Vermeulen of Morgan Stanley.

I have 2 questions, please. So firstly, on the sort of what sounds like relatively broad-based strength in controlled beyond the ongoing outstanding performance in Peerless, which parts of controls have performed particularly stronger than you expected relative to the start of the year? You mentioned IS, Clarendon, et cetera. And I'd love to hear what's behind that. So what's driving that better-than-expected performance? And then secondly, more of a topical question while we have you. So on what's going on in the Middle East. I appreciate you don't have any exposure there, but are you seeing any change in tone of conversations with your customers or any signs of -- early signs of your suppliers planning to raise prices as a result of higher energy costs, perhaps anything to call out there?

Thank you, Annelies. I'll take them in reverse order, if I can. Of course, we're conscious, obviously, of what's going on in the Middle East. I mean it's worth just underlining that for us, there's no direct impact, if you like. We don't have any business into the Middle East, and we have minimal sourcing out of the Middle East. So there's really no direct impact for us. And of course, we're very diversified, as you know, by our kind of end market exposures, which gives us some protection in these scenarios. So at the moment, we don't really see anything particular. We're obviously keeping our eye out, particularly for us to make sure that the supply chains and logistics are operating normally and to see whether there's any pricing inflation coming through on the back of increased energy costs. We can see a little bit of the latter, but it's very, very patchy at the moment. And of course, we feel well positioned to be able to respond to that. from a pricing perspective, we've been able to pass on prices pretty effectively in the past based on our customer service model, et cetera. So at the moment, there's not a lot to see, keeping our eyes on it and expect to be able to manage it. On the first question, yes, we're really, really pleased. I just want to kind of highlight a bit more the fact that I suppose I feel like it's easy to think that Controls is all about Peerless and Windy City. And of course, they are a big part of it have done very, very well. But sometimes some of our other bigger businesses in Controls don't quite get the limelight that they deserve. We've got a big business, interconnect business, IS Group, which has been doing very well actually for a number of years. This year, particularly well with double-digit growth and great margin progress. They've got really good exposures into energy transition, into defense, a little bit of aerospace in the U.S., the U.K. and Europe, and that's, of course, helping them, but they're winning some great market share as well. So very, very pleased with IS Group. And then Clarendon, which is another fasteners business into aerospace, they've been progressing really, really well and growing double digit for a number of years now. They're principally into aerospace, again, into Europe and into the U.S. great organic growth. We've just done a couple of small bolt-ons in the last year to support their growth as well, and that's all going very, very well. So there are 2 pretty big businesses and controls that are having a great time right now.

And we'll now take our next question from David Brockton of Deutsche Bank.

Look, very impressive update this morning. I'd like to ask a Peerless question, please. Just keen to understand your sense of what the market looks like. And I guess it's broader as well for Clarendon as well in terms of outlook and whether this is share gain or market strength and any different trends in contract or spot we should be aware of?

Yes. Thank you, Dave. Look, I think from a market perspective, broadly speaking, the themes are very, very consistent from the last few times that we've updated. The demand environment remains very, very consistent and thriving. Of course, as we know, there's a big backlog of new builds, and there is consequently a significant refurbishment market as well. The supply chain constraints, if you like, haven't really changed. And I think we've also been saying to you for some time that we don't expect that to change anytime soon, and that remains the case. We're looking out at 1, 2, 3 years and not really expecting any change in the supply chain. So overall, the market dynamics are very favorable and we believe sustainable. For us, this isn't just a market story, though. Of course, we've got a great business with a great team in a very good, strong market. So that's a great place to be. But the team are doing a fantastic job to deliver market share gains for us as well. And there's lots for us to go for, which makes me excited about the sustainability of the Peerless story. For example, there's more market share potential for us in the U.S., and we're investing behind that. The Peerless team already do some business into the aerospace supply chain, but we're looking at how we can invest behind that and do a bit more there. We're looking also to help them broaden their end markets with defense and space opportunities and even some product expansion as well. So there's loads for us to go for, and the team are very focused on that. And that will give us not only a favorable market, but even more market share gains in the future, too. So doing incredibly well. It's going to be another fantastic first half of the year from them and very, very confident that as it moderates through the second half that it will moderate into a very, very strong, consistent long-term performance.

And we'll now take our next question from Virginia Montorsi of Bank of America.

I actually had 2. One is on your exposure to defense. Could you talk -- because we always talk a lot about civil aerospace, but could you talk a little bit about how much of the growth we're seeing in your Aerospace and Defense businesses is actually driven by stronger performance on the defense side. I know you're building a facility in Czech Republic to sustain the demand on the Eastern European side. So could you just give us a sense of how to think about that for the second half of this year? And then on Life Sciences, could you give us a little bit more color on the market and how to think about your market share gains potentially and the performance in MedTech?

Yes. Okay. I'll take those in order. So I think a general observation at [ MedTech ] Virginia is remember that the group is incredibly diversified. And that's one of our strengths is that while we have really exciting exposures to lots of end markets, there's nothing binary in all of this. So the likes of the defense market will only be a few percent of the group's revenue, albeit a big opportunity. But one of the exciting things is that we have so many end markets, and that makes our opportunities here to drive into these markets, not binary, but kind of diversified and therefore, very, very attractive. On the defense side, we've been in defense for some time. So we have established some expertise particularly in the U.K. But over recent times, we've been expanding that. And actually, I should mention it's the kind of the background to this has really been through the IS Group business that I was talking about earlier, but it's now starting to expand into some of our other businesses, too. We put -- as we said, I think at the full year, we've been putting a bit more investment into some of these end markets. And David Goode, our CEO of International Controls has been leading the charge on this, and we put some investment behind some qualified expertise in the defense sector that's helping us to access new market share opportunities, which is great. We have, as you said, just opened a new facility in Czech Republic. I was down there last week having a look at it, and that's really helping us to get into the supply chain, into European defense, and we're making good ground with that. So I'm excited about the future there. And we also bought one of the 8 businesses I mentioned, we bought a business called Spring Solutions, which is principally a defense-based business in the U.K., but expanding itself out into the U.S. and Europe, too. So a small percentage of the group, but a very exciting part of our end market focus and give us great tailwind for the future and a lot of resilience. So we're pretty pleased with how we're progressing on defense. Life Sciences, yes, it's obviously a smaller part of the group. But I'm really, really pleased with the way Life Sciences has been progressing. 3, 4, 5 years ago when post-COVID markets were tough. We put a lot of time and effort, and we developed our management teams and developed our business development capability. And I think we're seeing the fruits of that. The markets are still quite hard yards. So we're having to win quite a lot of market share to remain in that kind of mid-single-digit territory, some good market share gains in MedTech, seeing some really good progress in IVD in U.K. and Ireland, particularly in this half. But overall, very, very happy with what the team are doing, the business development that we're working on and the market share that we're seeing coming through. You should expect somewhere around 4%, 5%, 6% type of percent for the half year.

[Operator Instructions] And we'll now take our next question from Jane Sparrow of JPMorgan.

Two questions, please. Just first one on organic growth, the 3 percentage point increase in your guidance there. Can you just confirm that is primarily coming from a better volume environment? Or is there a bit of pricing in there as well? And then the second one on M&A. You obviously feel fairly optimistic about that this year. Can I just ask what is driving that optimism? Is this people who deferred decisions last year, deciding they just need to get on with it? Or is that your own actions to fill the pipeline with more opportunities paying off a bit?

Yes. I'll answer the question on M&A, and then I'll let Wilson answer on the organic growth point. Look, we're feeling pretty good about the momentum on acquisitions. I suppose a bit of a general comment, but I suppose we felt the market conditions over the last 12 months or so have been better suited to the small kind of bilateral diploma style deals that we've always done. And we've seen very good momentum on that. As I mentioned earlier, we did 8 at the back end of last year and into quarter 1 of this year. So that was a good start into the year. And we're feeling very confident about that short-term pipeline ahead of us as well. So we've got very, very good momentum on that smaller stuff. And it just really, really helps us accelerate the growth potential in and around all of our businesses as they get into the right end markets or penetrate geographically or expand their product capability. So we're excited that there's more of that to come ahead of us. I suppose on the slightly bigger stuff, it has been a quieter time for the last whatever a year, 18 months, perhaps. Maybe some signs that that's easing a little bit. So we'll see if that turns into anything more tangible. I'm always very conscious of making sure that we evolve the way that we do things in a competitive environment. So -- we do have well-established team processes, capabilities, et cetera. But we're working very, very hard, particularly around the origination to make sure that we've got a very, very big pipeline, lots of optionality, ability, therefore, to be discerning and do high quality, not just high volume of deals. And so over the months ahead, I feel pretty confident about it. But over the longer term, we've still got fragmented markets and a good pipeline. The processes, as I say, we're constantly sharpening. And I feel we've got a good competitive advantage as a home of choice. So our prospects, I think, short and long term on the acquisition side are pretty encouraging, Wilson.

Yes. So thank you, James. So on the organic growth, absolutely, Diploma, as you know, is a volume story. And the organic growth that we've seen so far and will continue to drive will be volume led. Just an example, even on Peerless, we said that we would moderate the prices of spot volumes, and that has generated a lot of volume for us as well to make it into a sustainable business going forward. So yes, it's a volume story.

And we'll now take our next question from Colin Grant of Davy.

I just have one question to do with -- it's probably one more for Wilson to do with the shape of organic growth as we work our way through the year. You've obviously moved from a 6% guidance on a full year basis to 9%. And I'm just wondering about the shape of that in H1 and H2. If you give us a kind of a sense of what's moving. Is it moved from 9% to 11% in H1? Or are you leaving your kind of H1 assumptions unchanged and the upgrade effectively relates greater optimism for H2? If you could just give some color on that, it would be really helpful.

So, that would be helpful here. So obviously, we're still in the process of going to H1. But all I can say is the momentum that we've seen from Q1 has continued into Q2. When we originally guided, we said that this year, because of the tougher compares in H2 last year that H2 this year would mathematically moderate, and that will be sort of the same shape of the year just everything being raised effectively.

And we'll now take our next question from Sam Dindol of Stifel.

Congratulations on the update. Just one question for me, please. On the operating margin increase of 25%, if we assume no more M&A, is that a sustainable level going forward? Or is the momentum is that slightly higher than you'd expect over the medium term?

Right. So I'll take that question. So maybe just to put it into context, I understand why you're asking that question. So in the last few years, we've seen quite a significant step-up in our margin, and that's driven by very good operating leverage as we continue to scale the group. We've also acquired a few very good quality companies that have been accretive to margin. So that's established us a very good margin that we're guiding to today. Going forward, I think the algorithm continues with regard to the operating leverage, but we will sort of see a bit of moderation from the Peerless margins, albeit just to qualify that absolute profit will still continue to grow. Specifically to your question, we can't be expected to continue to only acquire companies that are over 25% margin. So we would expect some dilution from future acquisitions going forward. But overall, what do I think? I feel like the margin is at the top end at the moment. But regardless, going forward, we are a sustainable quality compounder, and we do expect absolute profit to continue to grow in the future regardless of the margin.

With no further questions on the line, I will now hand it back to Johnny for closing remarks.

Thanks again, everyone, for joining at short notice. The group is in very good shape. It's looking like a fantastic year and the prospects ahead for sustainable quality compounding are very encouraging. Thank you again. Have a good day.

Thank you. This concludes today's call. Thank you for your participation. You may now disconnect.