discoverIE Group plc (DSCV) Earnings Call Transcript & Summary

Well, good morning, everyone, and welcome to the Half Year Results Presentation for discoverIE plc. I'm joined here by Nick Jefferies, the Group CEO; and Simon Gibbins, CFO of discoverIE. As I take over as Chair at discoverIE, having been sat on the board for a few years, I'd first like to just thank again my predecessor, Malcolm, for handing over the company in such good shape. And then also, just as an introductory remarks, I'd like just to reassure Nick and Simon that I'm not going to steal all of your thunder and present the half year results and then hand over to you. But what I'd like to do is just take a few minutes to reflect on some of the key themes that I see as underpinning the long-term performance of the discoverIE Group. And the first theme that I would pick on is resilience. And I think if we reflect back over the last 5 years, we've seen some pretty tumultuous times in world's economies and markets. And over that period, the discoverIE Group has actually put in pretty solid performance of 10% per annum organic revenue growth over that period, which I think is pretty impressive. And I think when you reflect what is it that's allowed them to achieve that, I think it's a clear business model where there -- where we are focusing on the target markets, which themselves are showing long-term growth. And within that, a lot of hard work as well. So it's not just the markets that we're supplying into, but it's a real focus on design wins, making sure that we're supplying those essential products to customers and over the long term, being their preferred partner of choice. So resilience as a theme, and I think you'll see that coming across in the half year results. Second theme would be compounding, and this is something which I've been involved with over many years. But it's that ability to actually accelerate the growth of the group by finding these selective value-enhancing acquisitions, which actually contribute to the group and start getting some of those cross-selling opportunities and clustering opportunities within the group. And what I would say is that it may from the outside seem to be a very easy trick to pull off, to continually bring along these acquisitions. But it is hard. You've got to be very selective. You've got to pull back from the market when the conditions aren't right, you've got to take the opportunities when they're there. And that's only the start of the journey. You've then got to put in additional investment. You've got to help make sure that those entrepreneurial teams still are enthusiastic about continuing to grow their businesses. And that's what discoverIE has done very well over the years. The third theme I would pick out is just the clear strategic direction that the group has had. And I always feel that strategy doesn't really have a value and that, that is translated into some real strategic objectives that you have that you're tracking and monitoring and just making sure that you're following that course. And I think that's been impressive over the years with discoverIE. They've set ambitious and stretching KSIs, key strategic indicators. And I think what's been impressive is that they've not been afraid over the years to actually recognize they're getting quite close to achieving one of those, whether it be operating margin, target market sales or whatever. And then actually pushing it forward and stretching the management team even further, and you'll see that today in terms of the movement of those KSIs. And then the final theme that I would pick up on is sustainability. And I think that's very much what everyone is talking about. But there's a lot of lip service there. But what I see in discoverIE is a real commitment to that, a real feeling that this is something which is of value to the community, it's a value to the employees. But very importantly as well, if you get that right, it's a value to all of the stakeholders, including the shareholders. And again, I think what you'll see today, again, as I was talking about the KSIs moving forward, there's a more ambitious target there in terms of Net Zero. And I think what people are very much realizing is that, that doesn't have any value unless you have specific actions along the way that take you to those targets. So that's really all I wanted to say just in terms of introduction, and let me hand over to Nick to bring it back down to the half year's results and the near-term outlook.

Thank you, Bruce, and good morning, everybody. Great to see you all. Thanks for coming. Well, you know Bruce, you know Simon, many of you know Lili, I can't see where Lili is, at the back. But I'd also like to introduce Paul Hill, who is our Group Commercial Director. Paul joined us just over a year ago as the CEO of Antenova, one of our acquisitions. And when we reshuffled the business at the beginning of the year, he became the Divisional Director for the Sensing & Connectivity division. So he's your man for difficult questions. I'll move on to the summary of the results. So very strong set of results this period. We're very pleased with them, needless to say. Sales up 23%, of which 14% organically, order book up 21%. But I think almost more importantly than the growth is the efficiencies that we've been able to eke out of the business. So the EPS is up by 37%, and that's really on the back of strong margins and operating leverage. And as Bruce said, sales CAGR since 2018 now is 10%. We always talk about trying to achieve 10% through cycle organic growth. And we're now -- we've now got to the position and where we're doing that. And now the challenge is to keep that going. Carbon emissions have reduced by 40%. This is our carbon emissions intensity. We announced a 50% reduction plan in 2019, and we're making very, very good progress on that front, to the extent that we've announced our Net Zero plan this morning with a separate press release, which I'm sure you've seen. And finally, on this slide, H2 has started very strongly. So we're still seeing very strong growth. We're on track for expectations as we would expect to be. So we're in good shape. These are the 4 key strategic targets that we have that Bruce referred to. So operating margin on the left, we reported 11.7% operating margin, which is up 1.4 points, 140 basis points from last year. Sales beyond Europe is now 41%. Our target is 45%. That's really about internationalizing the business to serve our international customers. So good progress there. Target market sales, we'll show you some more data later on this, but target market sales is now 77% of total group revenue, and carbon emissions I've talked about. So we're making -- continuing to make progress on the key directional strategic targets. So Net Zero. So we are announcing a science-based targets initiative aligned Net Zero plan. So we're committing to Scope 1 and Scope 2 Net Zero by 2030 and a 65% reduction by 2025. Additionally, Scope 3 Net Zero by 2040. So this is obviously a big commitment for us, but as Bruce said, a very important one. And you can see here at this pie chart on the right, you can see that 78% of our emissions come from -- linked to our electricity sources. So the primary focus of our Scope 1 and Scope 2 plans is to -- is changing the sources of electricity. So we are installing solar panels in various plants around the world. We're switching to renewable grid sources, et cetera. And then you can see in this chart, this -- you can see this is our sort of planned reduction, and we're committing to 65% reduction of Scope 1 and Scope 2 by 2025, so 2 years out. So pretty ambitious, but we believe, certainly doable. So just to recap, really, I mean, many of you know this already, but just to recap it, we think that we are very well positioned in this changing world and global environment. The products that we make are essential for customers' applications, but they're a small proportion of their cost. That means we are able to retain stable gross margins as things like raw materials and FX change. We've got a very broad geographic footprint internationally. So as customers -- and we've been seeing this for several years, sort of regionalize and localize their production away from just sort of one single base of production, we're able to follow that production and make it locally and supply them locally. So we're well positioned to move as they move. We have efficient supply chains, as you've seen through these results or you'll see through these results and last year's results. We have some turbulence from the supply chain, but we've done pretty well relative to some others. And that's because we buy raw material -- most of our products is based on raw materials and base materials that were -- base components that we buy in. So we don't buy in loads of semiconductors, for example. We buy some, but not too many. And then finally, sort of topic -- very topical point. Our production is low energy intensity. So we have a high proportion of manual, skilled and semi-skilled labor with some automation, but we don't have big energy-intensive production factories. And so therefore, the rising cost of energy is not a major problem for us. Our energy costs overall are less than 1% of group revenue. With that, I'll hand over to Simon to take you through the numbers.

Thanks, Nick. Many thanks Bruce as well, and good morning, everybody. So first up from me will be the financial highlights. As you can see from the chart, it's been a really good period of progress, another good period of progress, strong growth in sales, growth in profits and EPS. The EPS, as Nick said, that's up 37%. Operating margin also up strongly 1.4 percentage points to 11.7%. And that's driven on the back of stable gross margins and operating efficiencies. And I'll talk about those more on one of the next slides. Operating, in terms of cash flow, our cash flow has been good again, that's given the conditions, given the strong growth, given some of the supply chain headwinds. So I'll talk about that. Balance sheet, we -- strong balance sheet. We've got gearing less than 1. So plenty of headroom for acquisitions. And as you can see on the chart at the bottom, the ROCE is now above our 15% target. And you can see a trend that we're achieving back over the last 5 or 6 years. So I think all of these actually show our strategy at work. We're about selling a bespoke differentiated product to industrial customers, it's good organic growth into our target markets, which Nick will talk to. It's about -- it's a capital-light model, and it's about cash generation. So it's very much our model at work. On to sales. So sales, GBP 220 million in the period, that's up 26%. You can see that's driven by 14% organic growth. That sort of follows on from what we delivered in the previous periods. And that splits between 8% of that is volume growth and 6% is price. And you can see this is very much building on the strong growth and momentum that we've achieved in the last period. So we've achieved 19% compound growth over the last 5 years, and it's up 31% since H1 '14. And all of this growth is continuing to drive strong profit growth and margin, which you can see on this next picture. So profits up 42%. That's up GBP 7.6 million, up to GBP 25.8 million. And it's continuing that growth trend that you're seeing. So we've delivered 30% compound growth over that 5-year period. And look at the operating margin, again, that's up now to 11.7%. That's a record for us. And that sort of building on what you're seeing in the previous period. It's up 3.6 percentage points in the last 5 years. It is up nearly 10 -- well around 10 percentage points since April '14. And we're well on track to deliver that target that we set ourselves to 2025 of 13.5%. Next, this is a bridge. I think you'll find this helpful. It walks you from last year's profit of GBP 18 million through to GBP 25.6 million this period. So the first 3 bars that you can see, that's the organic performance. So you've got strong sales growth, you've got stable gross margins and you've got operating efficiencies. We've invested 9% in OpEx, but we're delivering 14% of sales growth. So that translates into a 19% drop-through, that's 50% of the gross margin. We're really pleased with that. That's a good target to achieve. So GBP 5 million coming out of organic growth. That's more than 2/3 of our overall profit growth from the organic performance. So that's really good to see. Importantly, in there is the gross margin. I talked about that, it's stable. And that's very much about the products that we're selling. We're selling bespoke products. They're smaller products, but they're critical parts to the customer. And that's helping the customer differentiate his products, but it's a small cost relative to the overall build. So that puts us in good shape in terms of maintaining those margins, as you can see. Added to the organic performance, we've got GBP 1.9 million from acquisitions. There's 4 acquisitions in there. There's Antenova, Beacon, CPI and CDT, which we acquired this year. But at the end, you can see there's some benefit we've got from FX, and that for us is the impact of the weak sterling against dollar, it's GBP 0.7 million there. So it's a good performance. I think you can see, again, it's sort of crystallizes what our model is about. It's about good organic growth, operating efficiencies with complementary accretive acquisitions. Next, on to the 2 divisions. So you can see both. What you can see here is revenue, profits and margin for both divisions on the left-hand side. On the right-hand side, you can see revenue growth, you can see the order growth, and you can see EBIT growth. Both divisions are performing well. In terms of orders, orders last year, if you remember, were very strong. We're up 68% last year, up 36% against a pre-COVID period. So actually delivering orders broadly in line with last year is a great result. They're well ahead of sales in both divisions. We've got a book-to-bill in M&C of 1.06 and 1.11 in S&C. So both those divisions exited the half with record order books. In terms of M&C, sales up 26%, that's driven by 17% organic growth, that's widespread growth particularly across India and across Europe. 9% from acquisitions. That's the acquisition of Beacon we made last year. And that's driving some really strong healthy profit growth. That's up 35%. That's GBP 4.7 million up to GBP 18 million with a margin lifting up nearly 1 percentage point to 13.2%. If you look at S&C, that's a higher-margin division, another good performance, so 11% organic growth, augmented by 8% from those -- the 3 of our acquisitions that are in that division. So 19% growth at constant exchange rates. And again, that's delivering 20% profit growth and margin. We've held -- the margin is slightly up at 16.3%. So good performance from both divisions. And if you recall last year, I'll equate again, we think both these divisions are capable, have the opportunities to grow both organically and by acquisition. So we'll see how that develops over the next few years. On to PBT and EPS. And here, you've got a walk from the underlying operating profit of GBP 25.6 million down to the EPS of 17.8p shown versus last year. If you look -- the interest rates, it's 10% higher in the first half, that's going up. So I put some guidance there in terms of interest rate sensitivity. So I sort of see the interest -- the base rates being overall, and we sort of borrow in -- we borrow broadly evenly in sterling, euros and dollars. And I assume the average sort of base rate for those 3 going up by 2.5 percentage points in the second half. And I see that -- looking forward to next year will be another 1 percentage point above that H2 rates. So interest rates going up, so need to be factored into your models. I think you guys are doing that. After interest rates, PBT, you can see, that's up 46%. Below that, you're seeing slight increases in tax rate. We're making more profit in some of the higher tax territories like Germany, like India. Shares are up. They're up 6%. That's on the back of -- looking back, it was a share issue we made at the time of the Beacon acquisition. So taking those into account, EPS up 37% at 17.8p. And you can see on the graphic, that's sort of helping again drive up the EPS, which has seen us deliver 25% compound growth in the last 5 years. And just at the bottom, reported EPS, that's EPS including acquisition, amortization and acquisition costs, that's making great progress as well. So that's up 65% on last year. Okay. On to cash flow. The chart at the top gives you a walk. It's the last 12 months. We always show last 12 months at the half year. A walk from the EBITDA for that period down to free cash flow. You can see that we've invested GBP 14.5 million in working capital during that period. GBP 8.5 million is to support that strong sales growth I've talked about. GBP 6 million we've invested into inventory, given the supply chain constraints the market is seeing. I don't expect that to start reversing out in the second half. If you look at the chart below, despite that, we delivered operating cash flow of GBP 37 million, free cash flow of GBP 24 million, and they're both up 11% on last year despite the working capital. And if you look at the bottom -- the line at the bottom, we've got a good record here. It's a capital-light model, and we're delivering capital -- cash conversion rates up at sort at near 100% level over the last 10 years. And we hope we can sort of continue those sort of -- that level of momentum. And look, if you also look at the top chart, capital expenditure of GBP 5.7 million over the period. That's sort of 1.4% of top line. Our guidance is around 2%. But either way it's a low level of investment making our capital -- the nature of our model allows it to be a capital-light model. In terms of balance sheet, GBP 45 million of net debt on the balance sheet, it's a 0.8x gearing. Our target range, we're still in the -- we're 1.5x to 2x. So plenty of scope for acquisitions there, and we've got a large credit facility, so plenty of funds to be able to support acquisitions. I've added a slide here on -- this is on capital allocation. Hopefully, you'll find this useful. Our policy is pretty simple, really. We invest in organic capital projects as they arise. We play a progressive dividend. And any sort of the remaining free cash flow is allocated into acquisitions. You can see on the top chart, we show -- that shows capital we've utilized over the last 5 years, GBP 350 million of capital we've used in that period. And nearly half of that, you can see, is coming out of free cash flow. The balance is coming out -- GBP 130 million out of equity and the balance is coming from debt and the proceeds of disposals. And if you look on the left of that chart, GBP 27 million into capital, GBP 40 million into dividend and nearly GBP 250 million into acquisitions, there's 11 acquisitions we've made during that period. And if you look at the bottom chart, we're well disciplined in terms of the balance sheet. I talked about the range. We've had it for a number of years, 1.5 to 2x gearing. And you can see on the chart there, we keep nicely below that level. There's no need for us to overstretch the balance sheet. Finally, on to dividends, we've increased the dividend. You'd be probably not surprised, up 6%, again, that's in line with the progressive policy. We've sort of seen us double the level of dividends, more than double the level of dividends in the last 10 to 12 years. And that policy will continue. The cover that we achieved last year was approaching 3x. We expect to sort of take it up and beyond that 3x level to allow both the dividend policy to continue but also to have more self-funding of acquisitions. So it's been a good year of progress for us. Strong growth in sales, profits and EPS, a good firm increase in operating margins on the back of stable gross margins and operating efficiencies. We've got a record -- we're exiting with a record order book. We've got a low -- a strong balance sheet, and as Nicholas talked about, a good acquisition pipeline. So hopefully, we're well set for the future. So with that, I'll hand over to Nick for the operational review.

Okay. So just a bit of a recap. So this is just a sort of summary of the group. So we've got 31 manufacturing sites now in 18 countries. The important thing within that is that the world and our customers are regionalizing and localizing, and our international footprint is very much geared towards that. So we're really positioned well to take advantage of customers as they move stuff around. 20 acquisitions made since 2011. We're always expanding capacity somewhere, production capacity, that is, and we're currently expanding one of our two sites in India with a greenfield site just around the corner from our current one. We're doing a greenfield expansion of a business in Germany, about 1.5 hours west of Munich, business that we bought 11 years ago. And we're also doing expansion in the U.K. in -- up near Newark, one of our businesses there is expanding its electronics production facility. I won't go through the attractive financial profile, partly because you know it and partly because Simon's covered it. But I will just touch on these two charts at the bottom. The one on the left here is a bar chart of organic growth over the first half. And really two things to say is, firstly, most regions are in sort of strong organic growth, 10% to 20% range with two exceptions; China minus 3% and India plus 53%. Actually, the two aren't related. The China slowdown is as -- partly the effects on the Chinese market of some of the COVID lockdowns, but also, it's the effect of production starting to move elsewhere. So for example, one of our large European-based multinationals has really moved a proportion -- recently moved a proportion of their production to Europe for reasons of speed of availability and supply chain flexibility. India, on the other hand, is all about the growth in India, Modi's India First program. Our customers are Western-based multinationals, they're making there, and they need components that are made there to qualify for the India First program. So we're seeing strong demand on that front, hence, the 53%, so really coming up strongly. And then this chart on the right here is the organic growth record going back to H1 fiscal '18. And you can see the organic growth by period and then the COVID period and then the recovery since. So pretty stable, but not perfectly stable, good levels of organic growth. You know all this. We focus on selling into sustainable markets. The reason our organic growth is strong is because 3/4 of our revenue are in these high-quality structural growth markets, renewable energy, medical, transportation and electrification and industrial and connectivity. These are great markets with fantastic short-, medium- and long-term prospects. And we focus intently on getting design wins and creating new revenue streams organically in these markets, and it's paying off. To the extent that if you look at the 6-year organic growth here on this chart on the right, you can see that our revenue organically in the target markets has grown 12% CAGR over that 6-year period, whereas other markets have grown by 7%, giving a total of 10%. But some interesting data within it. If you look at this year, this half -- the pointer isn't working. But the first bullet point below, consistent growth in target markets in this period, they grew by 14% organically. But renewables slowed by 6% for the first time in some time, interestingly, offset by the other target markets, which on aggregate grew by 20%. Renewables slowed. We saw it predominantly in the wind sector, where all of the manufacturers seem to slow to some degree. And we think that's sort of a consequence of them changing their production priorities perhaps in light of the sort of well-publicized difficulties that they've had more recently. But then also the other markets grew by 17% organically in the region. So they are the markets that dropped off very sharply in COVID, and they're rebounding sharply. So much more cyclical, but there's been an element over this period of all ships floating on a rising tide. Just a little recap of the divisions really Magnetics & Controls division. I mean the key points are it grew 17% organically as Simon mentioned, with the 13.2% operating margin. This is where the effect of the sort of slowdown in demand in China, most felt Asia and Rest of World where China is a big part of that, obviously has slowed, so pulling that down. But very, very strong U.K. and European growth. And then the Sensing & Connectivity division, similar in many aspects, 11% organic growth, 16.3% operating margin, but strong growth in Asia. Here, predominantly, actually, China has been fairly resilient here because that's predominantly Chinese solar demand. Most of the solar equipment in the world is made in China, whether it's a Western-based multinational or a Chinese-based multinational. Design wins. So obviously, these are very important drivers of -- or this is a very important driver of our organic revenue. We put an awful lot of focus on this. And in the period, we achieved design wins with an estimated lifetime value of GBP 154 million, which represents a little under 20% of our current revenue on an annualized basis. So very simply, if we're aiming to go 10% organically, we need to be generating design wins and new business to at least that level plus a bit more to allow for end of life of existing projects. So achieving a level of around about just shy of 20% is a very high level. And 85% of the design wins are in our target markets. So this is a super important parameter. It's what's created the strong organic growth over the recent years. And as we head into slower growth environment over the sort of a year or so to come, having a strong base of design, bank of design wins is very, very important. It also drives a strong order book. So the order book continues to strengthen, GBP 257 million, up 21% organically, representing approximately 7 months of sales. It's a record high, both in terms of the absolute value and in terms of its proportion of sales, very, very strong indeed. And this is order book based on confirmed delivery. So this is what we confirm to customers we're able to do. These are firm orders. They're not cancelable. We allow very little bit of rescheduling, but not a wide amount of rescheduling because we're a build-to-order business. So this is a very, very solid order book. Indeed, as we saw -- have seen through recent previous down cycles, such as COVID. But that said, we expect that this is going to start to normalize back over the months ahead. And we'll -- we expect to see that happening and when we do, we'll report on it. So this is the slide on our acquisition performance. We've made 20 acquisitions, GBP 355 million in consideration. And this is the track record of all of the acquisitions over 2 years old. We are targeting a 15% EBIT return on investment within about 3 years, maybe perhaps a little longer in the U.S. And this shows that overall, we've achieved a return EBIT ROI of 21% in the period. And you can see how that has panned out. So it's kind of slightly -- probably obvious to you, but the two on the left are our first two acquisitions. They were small, they didn't cost a great deal and they're performing very, very strongly indeed. And then our largest ever acquisition was -- is the 43% one. So that's very important. Obviously, it's a bit like ballast on the ship. So that one needs to perform well, and it is. These two here, N and O are the businesses that are suffering from supply chain, semiconductor shortages, and we have one slightly problem child, which hopefully we'll be able to report more on the full year. But overall, we're pleased with that. And this is an example of one of those businesses. This is a business called Foss, which is based in Norway and Slovakia. It makes fiber optic components. It's within the pool Sensing & Connectivity division. So we bought this in January 2015. You can see here that it's grown 6% CAGR revenue over that time, but operating profit has grown by 14%. So the operating margin has increased from 12% to 19%. ROCE has over doubled from 16% to 36% and the EBIT ROI from 19% to 46%. Working capital has reduced. This is a very low figure. This business is very, very efficient and great progress. Not all our businesses are this efficient, but this is a great figure. And it's got a very high proportion of revenue coming from its target markets. And the way we achieve this, and you may remember, we've shown similar examples for different of our acquisitions in previous results presentation. But when we buy a business, pre-acquisition, we agree a 3-year business plan with the business, which is basically 10% per annum growth plus operating leverage target. We then aim to get more revenue coming through from the target markets. We invest in expanding capacity. We've expanded both the Norwegian facility, and we've moved them to a new Slovakian facility in this case. We've also made a small local -- acquisition of a local supplier, which is proving very lucrative. We've invested, in that we often change or upscale the finance function, and we've done that here. We've invested in new sales resource. So we've got a very strong top tier in this business. We put a very strong focus on working capital. I think I'm right in saying that every acquisition we've made, we've made the working capital more efficient. And then we put in place all of the group risk and controls and internal audit procedures to sort of put the strong control framework in place. And now we're putting in place the ESG policies as well. So just to move to the outlook. So the second half has started well. We've got strong organic growth, sales growth continuing. As I mentioned earlier, the order book is a very solid order book, and we expect that, that will drive the second half performance. But we do think that the order book is going to start normalizing. As we see supply chains internationally generally easing a little, we think that will lead to a little bit of easing in the order ahead period that our customers are placing and so that could naturally lead to a slight rebalancing or normalizing of the order book. The design wins are strong. They underpin our future growth. We've got a very good pipeline of acquisition opportunities. So we've got somewhere between GBP 70 million and GBP 100 million of acquisition firepower. So you could see that if we deploy a good proportion or all of that, that will make a meaningful contribution to next year's performance. And there's no doubt that we're -- as we're looking ahead, we're anticipating a slower organic growth period and a greater contribution from acquisitions than we've seen in the previous year. So having that low gearing and firepower is very important. And we're very confident in delivering a good close to the rest of this year as well. So we think the business is in great shape. We're very pleased with the performance, but we're focused on driving the second half and delivering further growth next year in a more challenging environment. So that concludes the presentation formally. I think we'll now go over to Q&A. So perhaps Simon will take our position.

Andy from Jefferies. Is ESG now part of your LTIP and your general kind of bonus? Or that's always been the case, isn't it?

Well, yes, it's become increasingly so. So they're not part of the LTIP measure, but they are part of all of the bonus schemes.

And then just two questions on the guidance. You talked about margins in the first half going up 140 bps, which is hell of a performance. Your second half guidance implies a little bit of a slowdown in that margin. Is that just conservatism? Or is there something in that first half margin that maybe doesn't repeat or something which we're aware of?

Yes. I think the former hopefully.

Good. And secondly, I know that we have a lot of moving parts in the debt line. But if you have GBP 5 million of interest on a net debt of GBP 40-odd million, that implies a pretty high interest charge. And we've got lots of gross credit...

You've got to break it down. You've got amortized costs of GBP 0.6 million, IFRS of GBP 0.6 million as well. And then you've got the commitment charge on the unutilized balance that's at sort of roughly 0.5% on the unused balance. So if you sort of take that out what you're paying is 1.25 percentage points margin plus base rate or whatever the equivalent is on year or whatever on the things. So that's how -- and that 1.25 slightly ratchets up, depending on your gearing. If it's sub 1, it's 1.25. If we've gone up to sub 2, it would be 1.75. So there's a little bit of ratchet up in there. So if you break it down into that, of course, within the -- you've got the net debt, you've got a level of what we call sort of trapped cash, you call it. So you're probably running around GBP 60 million drawn facility with GBP 50 million of cash. It sort of sits in places like China, so you have to get out and you're not netting off against. So it's slightly higher than the pure if you apply the interest rate against GBP 45 million. Does that makes sense?

Absolutely 100%.

Mark Davies Jones from Stifel. If I can start on your closing comments around M&A. What are we looking at in terms of valuation expectations from sellers versus higher financing cost per year? Is that net balance moving more positive? Or is it still people waiting to squeeze more value out?

It is moving more in our favor because there's been quite a big readjustment to more normal levels. The reason we haven't done many acquisitions over the last year is because they will wear off in our view, way too high valuations. So there were some quite well publicized sort of transactions in spaces allied to ours that we're going at sort of 18, 20 EBIT multiples, which is not -- doesn't work for our model because we don't make a whole bunch of immediate operational synergies to justify that. So we're seeing valuations coming down to the 8 to 10 range typically, which is sort of where we're comfortable operating.

Excellent. And can I just ask on supply chain? Clearly, still tough, but getting a little bit easier. Where do you think you are both in terms of your own working capital and sort of inventory through the wider system?

Well, so we built GBP 6 million of additional inventory in addition to the -- there's the pro rata increase in working capital in relation to the higher sales, and then there's this extra GBP 6 million. And we think that, that will just gradually unwind, just burn off through the second half. And our expectation is that by the end of -- around the end of the second half, that will have burnt off completely, interestingly. So there's no rapid adjustment. It's just that we will just adjust the incoming rate of inventory to allow that to burn off, which is what we think customers are going to be doing with us and our order book. And so we're kind of behaving in the way we expect our customers to behave.

You talked about organic revenue growth and you split it out both volume and price. And I think you said price increase was 6%. Just wanted to understand how much of that is just mix related? And how much of that is pass-through of cost? And how easy is it to pass through higher costs at the moment?

Well, it's never easy to pass costs through, but I think a lot of it is passing that cost. You can see in our gross margins, we've achieved that. Gross -- if you look at that chart, the waterfall chart, organic gross margins were pretty flat. That sort of demonstrates we've managed to pass that cost through. But it's definitely not -- the businesses will say it's not easy, but they have achieved -- they've done a good job. And I think as I spelt out, it's very much the nature of our products that allows us to do that.

And that price? The 6% contribution was purely the pass-through, it wasn't mix related?

Yes. In fact, the semiconductor shortages that we've had relate to some of the higher-margin things -- areas and higher-priced units. So in fact, there's probably been a little bit of a headwind on the price -- the underlying price might be a little bit more than 6%, but it's 6% basically related to inflation pass-through.

Okay. And just looking at your revised ESG targets, so you've kind of tougher targets that you set yourself, how does that influence the M&A pipeline, the companies that you're looking at?

So there will be an -- there is an ESG diligence stream now. We've got lots of due diligence streams these days. We've got IT ones, we've got, you name it, we've got -- and so we've got one of those. And we will -- it's -- there's a lot to do, but actually, it's quite clear what needs to be looked at. And so we have a -- it's not too onerous to do it. So we will -- as we go through the DD process, we form a view as to how we're going to deal with that aspect and what we will do. And so with every acquisition we make, we have a pre-acquisition completion pack, which summarizes all of the -- lays out all of the initiatives of the business and everyone has defined areas of responsibility and an action plan and ESG is one of those now.

So it's not reducing your pipeline at all, then it's not -- there are other companies, okay.

No, no.

But also that's one of the nuances about the new ESG target is that acquisitions will come in. So previously, our previous target was sort of a baseline in 2019 of the existing business. Now the Net Zero is all about including the acquisitions as they come in. So we've got to make them work as well.

David Hawkins, Panmure Gordon. I'm going to refer to a couple of the previous questionnaires' questions in a way. Firstly, on the inflation story. I mean, obviously, as you pointed out, many of your products actually are made of sort of base materials, the price of which, in many cases, has been coming down recently. So are we sort of shortly going to be facing a situation where you are having almost the reverse conversation with customers about what the right price for your product is rather -- disinflationary rather inflationary? Question one.

Yes. There will be some of that. Yes, I don't know how much yet, but certainly, copper's down. I mean it's recovered a bit in the last month. But copper and aluminum, some of those base raw materials are down, and some of our customers will want some of that back. What we don't really have a clear view on yet is how widespread that will be, but...

But it also -- yes, you're netting off also against other things that are still going off. Nick talked about here, the energy cost is not a big part for us, but we'll also look to put that on. There may still be some residual wage inflation that comes on. So we'll be looking to pass those costs on as well.

Yes. Almost feel like I'm your customer at the moment. I'm listening to your explanation to maintain prices. I'm jumping around a little bit here. Sri Lanka, so in the statement, you're talking about putting sort of panels on the roofs there. And of itself, did I misread this, that could contribute 15% improvement in your figures towards the 65% number?

No, I think that's...

Well, it's around the total.

I think it's 50%. I think it's a reflection of our total energy bill. It's our biggest plant. So we've already done -- we've completed -- it's a 3-stage process because there's three buildings, and we did one last year, and we've got two that are in progress. Yes, that's correct. It's not such a big bill. The overall bill, as Nick said, it's not a massive cost for us compared to others.

And it has a very good payback.

We're doing another one in Thailand, yes.

Okay. Last one for me. I think you're talking about the sort of the design wins and it's a good story. Did I pick up in the statement, you actually mentioned the words very good about 3 lines later about the pipeline?

Yes. Well, it's not bad, yes.

So what's the difference between good and very good from our perspective?

Beauty is in the eye of the beholder. Yes, I mean it's a 6% increase, which is okay, but it's a lower proportional increase than some of the other figures where we've seen very big increases, which is driven by -- largely by customers have been extending some of their project -- existing production life cycles because of concerns over component availability. So why launch a new product if the existing one will do, if you can get the products for it. So there's been a bit of that, which has delayed things. But the very good relates to this -- it's about 19% of estimated -- bear in mind, these are estimated numbers, but of estimated annual value. So if we're trying to grow 10% and we're generating design wins with 19 or so percent, that's very good. But that's what we need to do. We just need to keep layering it up, and that's what keeps the engine going.

Sorry, being greedy. A couple more from me, if I may. Interesting figures on China and India and the shift there, and you've been talking about that for a while. It's interesting to come through the numbers. But can you give us any indication of absolute scale? Because obviously, that is coming from a rather different starting point. So how big is India for you now?

Well, India is about 40% of China now, which is a proportion that almost roughly doubled over a year.

And then on your comments around renewables. Obviously, those wind companies have got themselves in a bit of a mess on production and profitability. That doesn't look as though it's being resolved in the short-term. So when do you think that picture might improve? I guess the concern is the more cyclical bits have been driving quite a chunk of growth, those may slow. When does renewables come back?

Yes. Hard to say. And it changes quickly within the wind sector. surprisingly quickly, the situation changes sometimes. We've just won a very big design win in one of our customers. So I think we feel -- we're feeling that it's more -- the risk is more to the upside, but I'm not sure, really. It's hard to get a really clear steer.

James Bayliss from Berenberg. Two questions, I think, from me. So on India, if we just picked that up a bit further. Obviously, coming off a low base, you're investing quite a bit of production capacity into the region. Where do we think that gets to kind of on a medium-term basis in terms of sustainable growth rate, I guess, kind of holistically relative to some of the other regions? And then on the M&A pipeline, can you just elaborate a bit more on the kind of the sourcing you're seeing, how much of that is coming from customer referrals or existing companies kind of going out in the work or even inbound inquiries through your website?

Yes. So India growth rates, yes, interesting. I mean where will that settle out? I don't know. I suspect it feels a little bit as though India is really getting moving. So what we've seen in China over the last good number of years is sort of we saw sort of circa 20% organic growth or high teens to 20% each year. I wonder whether perhaps we've got high growth rates now from a low base, but I wonder whether that might ultimately settle off in the sort of the healthy teens rate. We'll see. But certainly, the underlying -- we're supplying customers that -- it's a western-based multinational customer base, but they're installing in India. So it's -- I think at the sort of broadest terms, it's related to Indian infrastructure build-out. So -- and I suspect that's probably got a good few years to run. On M&A, we've got -- well, we source them everywhere. We've got a page on the website for entrepreneurs, which always pulls in -- we get a couple of inquiries a month coming in there. We have advisers. We have all of our opco management are incentivized to identify targets, and we have stuff that just comes in through auction processes and the like. And we have a very clear framework of what we -- of what fits the discoverIE acquisition model, both in terms of geography and product and the like. So when these opportunities arise, we're able to screen them very quickly, in a matter of minutes, really.

Dom Convey from Numis. Just a couple of follow-up questions, if I may. You referred to residual wage inflation. I wonder whether you might give us a little bit more color there, the level of wage inflation you expect, not just sort of through the second half, but into next year as well? And to what extent does that prove just a little bit more sticky on the pass-through, particularly perhaps a more deflationary environment for other input costs? And then my other question would be around the design wins and obviously the ELVs, you said a good indicator for forward business. But delving into that a little bit, what's driving that? Is that increased capacity, more design engineers? What sort of lead indicator could we look for within that number itself?

So on the -- I'll go first and Simon can add. On the wage inflation, I think we're going to see -- we'll see teens levels in Asia and the low-cost countries, but kind of that's a continuation of what we've been seeing there for a few years. In the sort of higher salaries sort of western-based economies, we're probably -- we'll see where we are, but we're probably in the sort of the high side of the mid-singles. So -- but that's on a much higher base. But the thing to remember is that our labor costs are a much smaller proportion of our component cost than the raw materials. So we take a pretty just clear line. It's almost a state of mind. If we have higher production costs as a result of higher labor costs or even higher energy costs, then we will pass those through. That is what we will do. And we took that view very firmly on raw materials and it was passed through, and we will do the same on labor. So I don't think it will be more of a sticking point than raw materials actually. In terms of the design wins, well, early the leading indicator is design wins. I don't -- I think we're quite good at disclosing that data. I don't think we're going to go one step further up the chain. It gets less and less. I mean the design win data is not reconcilable, it's estimated data based on what customers say and what we think they will do versus what they say. And so the further we go up that sort of line, the less precise it gets. So -- but what we do internally is we focus very heavily on what the design wins are and then driving the activity that leads to the design wins.

The reason on the question, I think if I remember rightly, some time ago, you were pointing out that you specifically invested in that design capability. And that was very clearly showing rewards. And so I'm just trying to understand to what extent of the increase going forward now is simply more throughput? Or are you actually seeing bigger projects coming through and better quality design wins, if you like, on the same...

Well, so the makeup of the projects is at an overall ever, it's broadly unchanged. You can't have 3 started. You have lots of the sort of small to mediums sort of the ramp, which is a sort of bank of good size, mid-value accounts, then you get the few bluebirds every period like one of the big renewables that we've just got, but we get one of those every couple of years. And that hasn't really changed much. But having said that, in some of the businesses, we've made our design win processes and our engineering resource more focused. So some of the businesses have analyzed the returns on the design wins that they've been generating and they've cut the tail of some of the projects. And that's freed up, certainly in one of our businesses, particularly, they took a very tough line on it. And they basically freed up their capacity -- their engineering capacity by about 1/4, maybe even a bit more with the same resource. And that is leading to higher ELV, high lifetime value opportunities, and that's yet to come through. We haven't -- that's only really been done over the last 12, 18 months.

Okay. We've got a question from the webcast. Given the decline in China sales and customers are relocating productions, what are your views on the long-term prospects of the China operations?

Yes. So I mean I think you have to put China in context. So 20-odd years ago, there was this rush to get everything made in China from the West. And what we're seeing now is the end of that era and it's kind of rebalancing back. That said, we still got some very big Western multinationals based in China, and we've got Chinese multinational customers. And we see that for demand in China and sort of in the locals in that region, that demand looks set to remain. So we're moving from a China for the world kind of production and demand environment to sort of China for China and the region, and a more decentralized region elsewhere. So China will remain important for us for that reason. And indeed, we've got 2 plants and over 700 people there. So it's a key market for us, and it will continue to be so.

Further question. If the market does enter a down cycle, what will be the core pressure on the company's business model? And how will you react to this?

Well, we've been through a few cycles now. And cash and cost is what we focus on in the down cycle.

No further questions from the webcast just now. So I'd like to pass it back to Nick for closing remarks.

Thank you, Scott.

Katherine Thompson from Edison. Looking at your focus on the target markets, I just wanted to understand a bit more of how much of that is an active versus passive? So how much of the growth in target markets versus the nontarget is just kind of an attritional thing where the nontarget markets grow more slowly so they fall as a percentage, and how much of it is an active rebalancing of the focus within each business?

Well, we -- so we focus the businesses on doing more in the target markets. So we want them to get more design wins in those markets and layer up, and then you get an element of more, if you like, natural decay in the nontarget markets. That's kind of the way it works. So it's not that we stop doing anything in the nontarget markets. We just focus more clearly on the target market areas and that's generating real growth. I mean, that's -- we do more design wins in more customers. And the example we showed in this pack of Foss, fiber optics business, is the same across most if not all of our businesses. After sort of 3 or 4 years of acquisition, you see that the proportion of revenues in target markets goes up, the organic growth rate goes up, and that's because we generate better revenue streams from those markets. And so it's -- I would say it's active. It's very much more about putting more focus on those areas. Okay. Well, thank you, everybody, for attending. We're obviously very pleased with where the business is. Our focus now is on keeping it going as we move into a lower growth environment, but we've got a good acquisition pipeline to add to that. So we look forward to a good second half and a good year next year, and we look forward to seeing you in 6 months' time. Thank you for coming.