discoverIE Group plc (DSCV) Earnings Call Transcript & Summary

Good morning, everybody. Welcome to the discoverIE Preliminary Results for the Year Ended March 31. I'm Nick Jefferies and I'm here with Simon Gibbins, and we're going to take you through the results for the year. So you're all very welcome. I'll start off, Simon will then follow and take you through the financials and then we'll follow up with an operational and strategy review. And then we'll open the floor to Q&A at the end of it. So we'll now switch into the presentation, please. Okay. So to use football parlance, this was a year of 2 halves. First half was characterized by uncertainty and adapting to a new way of working, which has really become the new normal. And the second half was characterized by a recovery and a return to some kind of normality. So we saw in the second half a very, very strong recovery in orders. Orders were up 12% organically over the prior year and up 40% compared to the first half. And we returned to monthly organic sales growth by the year-end, by month 11. That resulted in us coming in ahead of -- earnings ahead of expectations. We had a strong -- not only strong finish on sales -- a stronger finish than we'd expected on sales, but also gross margin and operating expenses were a little bit better and hence the beat. We ended the year with a record order book up 15% year-on-year, that's up 11% organically. Our margins have been relatively resilient through this challenging time. We finished the year with operating margins of 7.7%, but the second half was over 8% at 8.2%. Cash generation, very, very strong. You'll see that in Simon's presentation. Gearing further reduced to 1.1, notwithstanding 2 acquisitions that we've made, which gives us plenty of firepower for further acquisitions. We acquired Limitor and Phoenix. Limitor is a Germany- and Hungary-based business and Phoenix based in the U.S. during the second half and they're both in growth. And we feel as though we've made some good progress on our strategic priorities, which I'll come on to the next slide. At the half year, we announced carbon emission reduction targets. We've made some excellent progress there in the first year, and there's more coming this year. So we'll talk a little bit more about that. And then at the end of the presentation, I'll talk about the new year, but I can say that it started very well. We're into strong organic growth from the get-go. So this is just a summary of our strategic targets. So with -- our message here is that we're on track for our FY '25 targets. So you can see at the bottom there, D&M share, our target at the bottom of that box on the left is to get the Design & Manufacturing division to account for 75% of group revenue. It's increased slightly during the year to 65%. Operating margin. Our target is to get that to 12.5% by March '25. And as I said just a few minutes ago, although for the year it's down 0.3% to 7.7%, in fact, the second half was 8.2%. So some semblance of progress through a tricky year. We continued to internationalize beyond Europe. Our revenue beyond Europe is now 28%, up 1 percentage point. Still a way to go on that one to get to 40% target. And then target market revenue. So this is the proportion of revenues derived from our target markets, which are our higher-growth markets. That has increased by 2 percentage points during the year to 70% against the target of 85%. So -- and I'll talk a little bit more about that later on. But that's just a sort of summary of where we are at a very high level. I'll hand over to Simon to take you through the finance section.

Okay. Many thanks, Nick. Good morning, everybody out there. First up, the financial highlights. As you can see, despite the pandemic, we've managed to limit the impact on the group, as you can see. So orders were actually up 1% overall as a group; revenues, only 3% lower; operating profit, just down 5%; and as Nick said, the operating margin, just down 0.3% at 7.7%. This very much reflects the tight cost control we took in -- throughout the year and also the robust gross margins, that we've managed to hold our margins, in fact, they've moved up to the highest level we've had and moved up organically as well, which is great to see. Cash, very much the order of the day, particularly in the first half, but we kept tight control of cash right through the year with working capital reducing by 13% and CapEx spend was down more than 40%. And this has driven some really pleasing cash flow numbers. You can see our free cash flow, GBP 38 million for the year, that's up 38% and is actually running at 157% of our earnings, which I think is a record even for us. And that's helped reduce our gearing. It's down to just over 1. That is the lowest it's been for the last 6 years. And in fact, we've done -- as Nick said, we've done 2 acquisitions of around about GBP 20 million in the meantime. So a very good position from cash. You look at the ROCE graph there. You can see first half, we did get hit, but actually has rebounded very nicely in the second half up to 15.6%, which is above our 15% target that we have. So all of this we feel very much reflects the model we have. It's target market-driven, it's organic acquisition build, it's a capital-light model, very much focused on cash. More on all of this coming up in the next few slides. This slide here we're looking at revenue, profit and margin. And you can see the progression we've delivered over the last 8 years. In the center chart, you can see organically sales down 6%. That splits 4% lower in D&M division, 8% lower in the Custom Supply division. Acquisitions is -- 2% contribution from acquisitions. There's 6 months contribution from Sens-Tech. If you remember, we acquired that midway through last year. And then as Nick said, we did Phoenix and Limitor this year. 1% from currency, that's an average net weakening of sterling. Sales down 3% overall, it's GBP 454 million. But importantly, it's about the second half trend and that is very much moving upwards. Strong order growth, 12% up. Sales down only 3% organically. And as we referred to, sales back into organic growth in the last 2 months of the year, which is good to see. So a really good position as a springboard for us moving into the new year. On the bottom graph, you can see profits down GBP 1.9 million. We sort of limited that impact. Margin down to 7.7%. As Nick said, it's moved up beyond 8% in the second half. 12.5% is the goal in 4 years, and we firmly believe we're on track to deliver that. Okay. This -- I think this is always a helpful slide that gives you a walk from the EBIT from last year, GBP 37.1 million to GBP 35.2 million this year. And it sort of shows how the sales impact has been cushioned. So if you work from the left, revenue 6% organically lower, that's GBP 8.8 million of gross profit equivalent. Gross margin, as I said, that's at the highest level yet and includes a small increment organically. We're really pleased to see that. And in fact, in the second half, it was up 0.5%. So a good moving trend there. So we get a positive contribution from gross margin. OpEx, we've reduced OpEx by 2% year-on-year to GBP 2.4 million. And importantly, if you compare it to the run rate from the second half last year, it's 4% down there, which is about GBP 4.5 million. So really good savings there to help us. Those 3 bars, if you're looking at organic performance, that's the organic performance. And on top of that, we have the acquisitions, GBP 3.8 million contribution from most 3 acquisitions I talked to. So profits down GBP 2.1 million at constant exchange rate, GBP 1.9 million at a reported level. And we saw across both divisions really tight initiatives in terms of OpEx and gross margin. And you can see that on the following slide. So this slide, again, you've seen this before. This is -- this shows by division, revenue, profit and margin. On the right-hand side, you can see the movement in revenue and EBIT. Firstly, looking at D&M. Organically, as I said, down 4%, lower than Customer Supply, and that's because of the target market, 75% of sales in target markets. Those markets are doing better. Also 23% of D&M sales are in Asia, and China, certainly, as Nick will show, picked up quite nicely during the year. So 4% down organically, 3% contribution from those 3 acquisitions with the sales down 1% at CER and broadly neutral at a reported level. And actually, look at the EBIT, it's actually only down 1%. So we're really pleased with that. We've managed to cushion the impact again there. Margins protected still at 12.7%. So I think -- again, it's a good springboard going into the new year. But again, the trend in the second half, very good. Strong order growth in D&M. Sales -- actually, sales growth at a reported level and actually just down 2% organically and the margin up to 13.2% in the second half. That's almost 1 percentage point higher than the first half. Customer Supply, 8% down. So less sales in target markets and also most of the sales are actually European- and U.K-based, which were more hit from a COVID point of view. The EBIT impact of GBP 1.8 million, that's 24%. It looks a biggish number, but actually if you look at the -- what we -- we look at some drop-through numbers. So that's the fall in EBIT versus the fall in sales, it's actually only 14%. So they actually undertook some excellent gross margin and OpEx initiatives to deliver that result. And again, the trend is good going into the second half. Sales were down 5%, but importantly, orders particularly strong in Customer Supply. Okay. Next slide is up is PBT and EPS. So this gives you a walk from the operating profit, GBP 35.2 million down to EPS of 26p. If you look at the movements versus last year, finance costs are down 14%. That's on the back of lower average net debt. The tax rate has gone up 4% to 24%. That's a mix of actually this year, we saw more profits in higher-tax territories, the likes of China; and conversely, there were losses last year that we were able to recognize which weren't available this year. The trend of the tax rate is certainly moving upwards as we get more profits in those higher tax territories. Shares were up 6%. That links to the Sens-Tech placing -- acquisition placing we made last year. So working that through underlying PBT, actually down 4%. And in the second half was in positive territory. So GBP 0.5 million PBT increase in the second half last year -- this year, so that's a good trend. EPS, 14% lower. The difference obviously being the tax and the shares. But -- and again, that's 4p and a similar sort of fall in terms of reported EPS down 3.5p. Okay. Cash generation. So really, as Nick said earlier, really strong cash generation. We're extremely pleased with this. You can see it from the top chart, this gives you a walk from EBITDA of GBP 48 million to operating cash flow of GBP 50 million and through down to our free cash flow level. That's cash available for dividends and acquisitions of GBP 38 million. So if you work from the left, the working capital -- we actually got nearly a GBP 12 million inflow from working capital. I've got a slide on that next so I'll take you through how we delivered that. CapEx, that's running at sort of levels more than 40% lower than last year. That's as we didn't need to sort of build capacity, obviously, and therefore, we focused down on maintenance. Operating cash flow, just under GBP 50 million. So that's up 26%, converting -- operating profit conversion rate of 141%. And we're delivering, and we talked about it before, consistently high conversion rate. You can see that on the bottom-most line. So that will show you the percentage of operating profit that converts into cash flow. And you can see, that's averaging well over 100%. We're very, very pleased with that. I think it's very indicative of what we are. We are trying to develop a strongly cash-generative business. We have -- we're buying higher-margin businesses, they have low capital requirements and they're starting to spin cash off. And you're seeing that coming now through into the free cash level, that's up 38%, 157% of earnings. And you can see on that bottom chart, the trend has seen some significant improvements in the last few years. Where we want to get to, we've talked about it before, is to get to a situation where we can be able to self-fund our own acquisitions. That cash flow has really helped bring us to -- really improve the balance sheet. Debt down from GBP 61 million to GBP 47 million. Gearing has reduced down to 1.1. As I said, that's the lowest in 6 years, and we've done those GBP 22 million acquisitions in the second half. Had it not been to those, the gearing would have been down to 0.7. The acquisition that Nick talked about, CPI, that takes the gearing to 1.25 until you can see within our range of 1.5 to 2. There's plenty of room for funding acquisitions, around GBP 35 million to GBP 40 million would be my calculation. And we still -- we've got a large facility, GBP 180 million, so plenty of headroom in terms of that, too. So working capital. You saw the inflow on the previous chart. So this shows how working capital has evolved over the last 6 years. The bar is the absolute value of working capital. And the line, if you look at the dark blue line, that is a percentage of working capital -- group working capital as a percentage of sales; and the orange line and the gray line of a similar metric from the 2 divisions. So working capital reduced by 13%, so a big inflow there. Part of that is sales reduced if you get an inflow. But around about 50% of that is actually coming from improvements in our KPIs. You can see that at the bottom there, debtor days in particular, improvement there, 4-day improvement, down to 48 days. And you're seeing that reflected in that working capital percentage coming down from 14.4% to 13.1%. And likewise, similar sort of improvements in both divisions. I mean if you look at -- actually, if you look at the D&M, it's good to reflect on that coming is -- coming down from 25% down to 17%. And that's what we typically do, we're buying businesses, we work with them, help them improve their working capital and you can start to see the effects of that coming through in terms of additional cash flow. Dividend. We resumed dividends, as you're aware, in the interim on the back of the improved cash flow that I talked about. And today, we've increased our dividend by 6% over the position it was back in the last full dividend in FY '19. Very much in line with our progressive dividend policy. It's -- you can see over that period of 11 years, we've just about doubled the dividend level. And actually, the cost of this has gone up 400%. The CAGR, it's a 7% average CAGR and the cover is 2.6. What we're aiming to do is actually take that cover over 3x and then we can combine our progressive dividend policy with our acquisition program. Finally, and certainly last but not least, the key strategic goals and the KPIs that we set ourselves. I think it's a really good reminder just to say, well, look, this is what we've done in the last 8 years as a business and this is what we want to do in the next 4 years. There are some good targets there. We think we're on track with those. Nick has talked you through the KSIs. I've actually been through those slides, you'd have picked up 1 to 6. And 7, Nick will talk about our new carbon emissions targets in his section. So it's been certainly a very resilient set of results. Very strong cash flow and our sales and profit's impact have been limited and we're in good shape going into the new year. So with that, I'll hand over to Nick for an update on operations and strategy.

Thank you. Okay. So this is the D&M division. The key points to make here are that the organic order growth was very, very strong in the second half, up 10% year-on-year. The orders well ahead of sales. We came back to organic sales growth by the end of the year, as I said at the beginning. Annual profit is 2% lower. Simon already mentioned, we took pretty stringent action on -- to contain costs and defer costs, which enabled us to achieve that. Margins, therefore, have been pretty resilient, both at gross and operating margin level. So we're pleased with that. And working capital, Simon has talked about. But during the year, despite COVID and all of the adjustments we made, we've made our commitment to expand one of our Mexican production facilities. So that work is in hand to fit out a new facility just down the road from the existing one. And just since the year-end, we've committed to enlarge one of our smaller businesses. MTC is a very successful business of ours that we've owned for about 10 -- coming up to 10 years, and we're expanding their facility into larger premises -- or planning the expansion into larger premises. So the growth planning goes on. And you can see on the chart on the left-hand side the progress of how we built this division over the last 10 years or so. This is a really important slide for D&M. You can see on the left, the proportion of revenue coming from our target markets is 75%, which is up from 72% a year ago. And on the right-hand side, that bar chart, you can see the organic growth in the target markets versus other markets. So the target markets were down by 3% organically as -- which compares with the other markets, which were down by 9%. So what that's really confirming is that both through the upcycle and the down cycle, the target markets perform better and they are more resilient than the wider markets, the wider general and industrial markets. So we're very pleased with that. That really confirms the resilience of those markets and that we're focusing on the right areas. And this chart really -- sort of really 2 things to really bring out here. The chart on the left shows the organic growth of the D&M division by region. And what you can see there is the -- although the D&M division overall organically was down 4%, you can see that there were lots of swings and roundabouts within it. So the U.K. was down 15%. Really, I think, a combination of COVID, Brexit, general uncertainty, but have got quite a significant decline in the U.K., which I'm pleased to say, is now recovering. The other big decline is North America. That really -- this was just sort of the period pre-Biden stimulus package. And what it shows is that, along with the COVID effects, some areas of our business were really quite hard hit by the general malaise in the U.S. But again, that's coming back, thankfully. Germany, down 3%. That's a really good performance actually, and the primary reason that's so resilient is that we have virtually no business exposed to the automotive markets in Germany. And so I think the areas that we're exposed to are, you won't be surprised to hear, aligned with our target markets and they're, therefore, more resilient. And then Asia, up 11%. So this is -- Asia continues to be a very, very strongly performing growth region for us. China came back sort of from the post-COVID recovery very, very strongly, particularly. And you can see that Asia now accounts for 23% of revenue of which China is the vast majority of that. And principally, that's driven by renewable energy demand, manufacturing both used in Asia and export by our customers elsewhere. But very, very strong performance. And then the middle bar chart shows half yearly organic sales growth of the D&M division. So we aim to -- our ambition is to grow organically 10% through the cycle. That's what we're measuring all of our businesses on, and you can see here that this chart goes back to Q4 FY '17, which is the Jan, Feb, March 2017 quarter and then the half year is following that. And you can see that for over 2.5 years, we had very strong, on average, double-digit growth -- organic growth through that period. And it was just starting to come off a little pre-COVID and then the last 2 bar charts shows the extent of the effect from COVID. So therefore, our priority is to bring that organic growth right back up in the periods going forward, as I said, to try and sort of counterbalance the effects of COVID during the last year. So -- but we think relatively speaking, that organic growth period -- the organic growth through those periods is well ahead of the wider industrial market, which is obviously where we compare ourselves. So this is a case study of one of the acquisitions that we made. We're often asked, what do you do to your acquisitions and how do you -- what do you do with them? And so this is an example of what we do with one of our businesses. This is the Noratel Group, which we acquired in July 2014. It's the largest business in largest stand-alone business unit in our group in the D&M division. It operates internationally with facilities in all the major continents, so it's a large business. And what you can see in the table there on the left is the revenue growth since acquisition, 7% CAGR. The return on capital employed has increased from 12% to 24%. The EBIT return on investment has increased from 14% to 21%. Working capital, as a percentage of sales, has reduced dramatically and it's one of the reasons that our cash flow has improved so much from 29% to 14%. Our target market sales have increased from 62% to 75%. Our internationalization, this is where we support our multinational customers globally, has increased from -- almost doubled from 28% to 47%. And we've made 2 bolt-on acquisitions as well, both in the U.S. So really sort of strong development on all fronts. And just on the right there, you can see a list of some of the things that we've done with it. When we acquired the business, we developed a strategic plan as to how we're going to develop it, which was obviously focused around organic growth in target markets. You won't be surprised to hear, we've invested in our production facilities. We've even created a new production facility in Bangalore and India. We've rationalized our European and our U.S. manufacturing facilities. We've made 2 bolt-on acquisitions. And over the last 2 years, we've transitioned to a new CEO following the planned retirement of the previous CEO. So to summarize all that, what do we do? We buy good businesses and we invest in them and we try to make them better, more efficient and to get them to grow better. And so we're very pleased with that outcome. Custom Supply division. So Custom Supply division is a more cyclical business. It felt, as you saw in Simon's divisional slide review, that it suffered more during the COVID, in the downturn, and it's now benefiting from a rebound pretty strongly. H2 orders were up 16% organically. But -- so more cyclical, but actually a somewhat very similar sales model to the D&M division, but it's more affected by -- there's a greater sort of coming and going of smaller customers than in D&M, which adds to that level of cyclicality. But encouragingly, the U.K. and Italy remained in growth. Germany -- so the Custom Supply division has some exposure to the Tier 2 and Tier 3 automotive customers, not the Tier 1s. And as everyone knows, that's been having a pretty tough time for the last couple of years. So Germany, which is 1/3 of the revenue here, was down by 16% and that is really what impacted the overall performance of the business. But OpEx very tightly controlled, working capital very tightly controlled as well. So in capital terms, quite efficient. Order book. Up 11% organically, 15% on a reported basis. And you can see in that chart how quickly that's bounced back. Absolutely super level that is, and that is the all-important figure for driving this year's sales. And the order book is -- and the orders are driven by design wins. So this just reviews what's happened to the design wins. So the design wins were down 15% during the year, down 19% in the first half, improving a little in the second half to 12%. But design wins and design opportunities were the area quite impacted by COVID as customers moved into emergency mode. They delayed the design projects and the design wins, and that's what's reflected in this figure here. But really 2 points to really make. Firstly, you can see the prior 2 years we've got a very, very strong bank of design wins in the first place, which are ahead of our -- well, they're about 16% of annual revenue. So that's a very high level of registered design wins, and it is those design wins that are driving the order recoveries that we're seeing now. And second -- the second key point to make is that over 90% of those design wins are in our target markets within the D&M division. So we expect that as the world is returning, that we will get very strong recovery rates in our target markets, driven by the existing bank of design wins. And what we're also seeing, it's kind of anecdotal information at the moment because it's fairly early in the new year, but since about March, we've seen a very strong pickup in project activity amongst our customers. So I expect that by the time we get to the interims at the half year, we'll be able to show some of the recovery coming through in design wins. EBIT -- this is the review of the acquisition performance, the return on investment. So this is the average EBIT return on investment. So it's the average of the EBIT of every year since we've acquired -- made that acquisition. And you can see that our target -- the dotted line on the graph is our targeted 15% EBIT ROI. And you can see that the average for the year is 16%, which was down 1 percentage point on the prior year, but still a very respectable performance. And you might all be asked -- wondering, well, which one is the Noratel one that we just talked about in that case study? Well, it's E on the chart. So our largest business in D&M is generating an EBIT ROI of 22%. And then you can see towards the right of the graph, there are just a few there that are just a bit below the target there, the more recent acquisitions will grow into those. And then M is a business that is actually performing or recovering quite strongly, but it is still coming from a low base, which was a result of some sort of subsidy changes a couple of years ago. But overall, pretty good returns and obviously well ahead of our cost of capital. Strategy. Well, no changes to the strategy. It's consistent, it's proven. We've now demonstrated the resilience of it through the upcycle and the down cycle. And our plan is to continue to grow sales well ahead of GDP through the cycle. We're moving into higher-margin businesses, both through acquisition and through organic improvement, as you saw with the Noratel example. We're further internationalizing That's where the opportunity lies. That's where our customers operate. And we are generating and we will continue to generate strong cash flows. And also, as we added at the half year, a long-term sustainable returns, whilst reducing impact on the environment. The environmental aspect of our business is now coming right to the fore and has become an additional sort of leg of the strategy. Now this is the -- so the target markets that we set up some years ago, as many of you remember, we carried out a review of these target markets a couple of years ago to see how they -- how relevant they were in the light of the sustainability agenda. And we are pleased to say they're very relevant. So our target markets are enabling us to focus on markets that have the benefit of helping to create a sustainable world. And as we focus on developing revenue in target markets, we're defocusing areas -- efforts into areas that are not aligned with this. So areas that might not be aligned with our sustainable agenda. And just some examples of what that means. So we've got -- this is -- we've got many examples and that -- this is a snapshot from the forthcoming annual report, and you'll see more in there. But this is just really 3 case studies of electrification of transportation. What does that mean? Well, the example on the left is a hypercharger, a high-speed EV charger. And the product there is -- contains a significant number of our magnetic cores and wound magnetic components. The center example is for an electric vehicle charging plug, which has a sensor to protect against overheating. And the example on the left (sic) [ right ] is pressure -- the pressure sensor for, again, for EV-related applications. So lots of examples where our component model -- what all these components have in common is that they're a critical component of the customers' end equipment. So a small proportion of their cost, but essential for their -- the functioning of the customers' equipment. So a little more on ESG. So at the half year, we announced -- or we introduced our carbon emissions reduction plan. Our plan is to reduce carbon emissions on a like-for-like basis by 50% over the -- over a 5-year period. And the chart on the left there shows the tonnes -- the carbon emissions per GBP 1 million of turnover. And what it's showing is that compared to calendar year -- this is calendar year rather than fiscal year data. But compared to calendar year '19, our calendar '20 emissions reduced by 19, 1-9 percent, which is fantastic, although it has to be said that much of that is due to the COVID effect on things like travel and production operations and the like. So the underlying reduction is about 6%. But nevertheless, a good result. We are implementing and introducing renewable energy generation into a number of our sites as we speak. We've committed GBP 1 million through various cumulatively through various CapEx projects so far, and that will come through into -- to deliver reductions in the year ahead. So as we get the bounce back from post sort of COVID effects, we're expecting that those should be more than offset by the renewable energy installations that we're making. Health and safety, accident rate has reduced during the year. And then the diversity chart there shows the head office gender split. So we're trying to lead by example, both at the Board and at the staff in the head office. And over the years, we have a -- and if you look back over more years than this, it would show that we've significantly increased our diversity. But we've got a lot more to do, not only on agenda from a gender perspective, but also from an ethnicity perspective. So there'll be more to come on that certainly in the years ahead. So outlook. So the new year has started well. We've got continued strong organic growth in orders. We have got strong organic growth in sales, double-digit growth in sales opening the year compared to last year, but we've also got organic growth compared to 2 years ago pre-COVID, which is very, very good to see and exactly what we expected. We've also made a bolt-on acquisition in the U.S. of a company called CPI, which is going to form a part of our very own cluster, similar to Limitor and Phoenix. So a good start has been made, and I think we've got some good tailwinds as well, which should continue to help us along. The order book continues to build. Orders continue to be ahead of sales. So that GBP 180 million order book is growing. We've got more acquisitions in the pipeline. And as Simon said, we've got more of our own resources to fund those. So expect more to happen on that front. So overall, we're in pretty good shape and we think we should make more good progress during the year ahead. So some things are looking quite sunny from where we stand, a bit different to a year ago, thankfully.