Essentra plc (ESNT) Earnings Call Transcript & Summary

So let's rock and roll. Good morning, ladies and gentlemen. Welcome to the half year results for Essentra plc. I'm joined by Jack Clarke, our new CFO, who is making his debut. Quite a set of results to start with, Jack. And then Scott Fawcett. Scott is the MD of our Components division, and will answer questions on the detail of components. I was just mentioning to Charles Hall that sobering realization this is my 40th set of plc results, which is very, very depressing. There we go. So I'm going to give you some highlights and talk about the strategic review. Jack will take you through financials. Scott and I will do divisional update and then I'll round up with the ESG and outlook. Overall, a very positive 6 months, I think. Two key highlights. The first is progress made on the strategic review, and I'll give you some detail there. And secondly, very strong growth underlyingly in the continuing businesses, 14% revenue growth, 44% sales margin increase. And we are entering H2 with a 22% growth in the order book. Both our ESG and our commercial progress is continuing and we will be looking to return a portion of the proceeds to shareholders after we have done both strategic reviews. Divi goes up 15%. So the sale happened in June. We expect after clearance that it will complete in October. After that, we will have a small net cash balance, so that gives us optionality. And as I mentioned before, the intention of the Board, once we know what happens to filters, is to return a portion of the packaging proceeds to shareholders. For the half year results, packaging has been counted as a discontinued operations. So we apologize for the complexity of the results. As I say, hell of a start for Jack and well done to him and the team. But underlyingly, if you look at the continued business, very, very strong and encouraging progress. Filters, we continue to twin track, looking at both potential financial partners and a demerger option, and we should know that by the end of Q3. So that's a brief introduction. So I'll now allow Jack to tell us about the numbers.

Good morning, everybody, and thank you, Paul. As Paul said, this is a complex set of accounts. However, the ongoing business is performing extremely well. And you can see that straightaway in that revenue, as Paul said, is 14% up, profits 43%. Earnings up. Debt has increased, and I'll explain the reasons for that. The cash conversion is quite low. But again, I will explain the reasons for that. But a strong set of operational results and a ROIC of 16.4%. As I said, the revenue is up significantly. It's driven by both volume and by pricing, 6% and 8%, respectively. On components, you can see that we're up 18% -- sorry, 14% on a like-for-like basis, and that's driven 10% by volume and 3% by price. Filters is up 15%. The majority of that is driven by volume some 13% and 2% by price. The order books, Paul has said, is up significantly. Most notably, filters is up 45% period-on-period H1 versus H1 last year. So a terrific result there, and that's driven largely by the outsourcing work but also by the developments of some new products. So the Filters division is in great shape. Europe has seen a particularly strong performance in -- for components and we see good prospects going forward for the rest of the year. If I turn now to the adjusted operating profit, you can see both divisions -- both ongoing divisions had very strong performances in the period. Components was driven by a better product and customer mix by the strong performance in Europe as I mentioned. Filters had a significant improvement in its gearing -- its operational gearing. As the revenues rose, obviously, the incremental profits increased. And both divisions were able to pass through pricing increases to more than offset the cost increases experienced. A significant point about Filters, the China joint venture turned profitable in H1, which is great and ahead of where we thought it would be. You'll note at the bottom, the packaging had a relatively -- sort of very average performance in H1, and that was driven by we did not get the pricing through as quickly as we had hoped for. That is now through, and that division is back at the planned levels that we anticipated. You'll notice in the results, there is a significant amount of adjusting items. Just to take you through those, GBP 12 million relates to the Discontinued, the sale of the Packaging division, that's consultant costs and other transaction fees. GBP 181 million relates to the difference in the goodwill carrying value of the business, the business as usual and the actual sales proceeds. It was a very competitive process. We believe we've got a very good price, but there's a book loss as a result, just a book loss. SaaS, that is the ongoing. That used to be capitalized under the accounting rules. Now it's expensed. When we started the project, it was capitalized, so we've continued to show it as an adjusting item. And the GBP 13.1 million is other costs related to the Components business, or the cost of the strategic review related to the Components business and to the Filters business. So that's the adjusting items. Turning then to the income statement. You can see that there's a big increase in the finance charge this year from GBP 6 million last year to just under GBP 12 million this year. That's driven by two factors. Interest rates have obviously gone up. So the RCF interest has increased. But also because we've now concluded on the packaging sale, then the facilities fees that would normally get amortized over the life of the facility, they've been accelerated, and we've had to incur about GBP 3 million of those in this period. So that's a one-off type effect on the financing. On the tax rate, again, 6.2%. We've got an effective tax rate of 26%, which is a jump from the 21% we would normally see. The underlying rate actually is 21%. It's affected again by the packaging deconsolidation that moves the effective tax rates because there's some very low tax jurisdictions within packaging. There's also some adjusting items in there and there's some costs that we incurred last year, deferred tax charges, that we don't have this year. The underlying rate is 21%. In terms of the cash flow, on working capital, we've been building the business back up post COVID. So inventories have increased, both in Components and in Filters. We've obviously got revenue increases. So there's a tail there where you build up your receivables as your revenue grows. Much of that will reverse in H2. So that's really the biggest difference there. And we expect a big improvement also. This is the continuing business. Packaging used to have a much proportionate lower net working capital than the other 2. So it looks slightly higher. But in terms of debtor days and inventory days, all of those metrics are pretty good, and that will reverse in H2. On the debt, debt's increased, but there are a couple of big significant reasons to explain it and to take some comfort. So there's a movement in ForEx. As you know, sterling to the dollar has depreciated over the last 6 months. It's gone from $1.35 to $1.21. That has about a GBP 27 million effect on our USPP debt that we carry. It's a -- again, it's a book movement, but it does affect the debt. We do offset that with a derivative that we took out for just that purpose of about GBP 11 million, but not in total. And then, of course, we have the outflow of the adjusting items being the transaction costs of some GBP 30 million. Those, of course, will reverse when we get the proceeds in H2. So what you see now is the low point. As the proceeds come in for the 2 divisions, in H2 hopefully, then you will see we will move to a net debt position probably cash positive. So the dividend, as Paul mentioned, it's gone up 15%. The Board believes in a progressive dividend and return to the shareholders. We are confident in our liquidity to be able to do that. It's a very pleasant increase and something that we're very encouraged by. The ROIC for the underlying business has moved up to 16.4%. Again, we're seeing that continuing trend upwards in the margins, very much in line with the plan that we have for the ongoing businesses. So in summary, it's a very strong set of results for H1 with some strange moving parts that will largely flow back in H2, but the health of the business, it's in very robust shape. So with that, I shall hand over to Scott -- sorry, back to Paul, sorry.

Thank you. Just worth pointing out that ROIC has gone up materially in 2 years, and it's about double of WACC depending on. So that's quite a healthy position. So we'll now talk a bit about the 2 divisions. I'll hand over to Scott to give the detail. But Components, as Jack's already mentioned, has had against pretty tough comps a very strong first half. So well done Scott and the team, with good margin expansion, 200 bps, and strong revenue growth. So you can dimensionalize your success over the last 6 months, Scotty.

Okay. Morning, all. Thank you, Paul. So as Paul said, we had a very strong first half, so over 18% total growth for 13% like-for-like growth and some good margin expansion. And that margin really driven by the pricing activities that we've undertaken over the last 12 months. We're probably a little bit late last year with pricing and we're a little bit behind the curve this time last year, but we caught up by the end of the year and have had a very positive first half from a price management and offsetting those input costs that we're seeing at this point of high inflation. We are continuing to invest in our service. So we pride ourselves in being a hassle-free supplier of products. So service is very important to us. We have put some inventory into the stock model this year, as Jack referred to earlier. But we are seeing the improvement in both the OTIF, on-time delivery metrics and also the Net Promoter Score. We have our big Net Promoter Score coming up in November when we do the annual survey, but we do poll customers every month and that trend has been positive through this year versus last year. So encouraging to see our service coming back to a more normal level. We're continuing to invest in the digitalization of the business, so continue to invest in the web front end. We're pretty much rolled out globally now, but we do have this monthly agile release process, where we continue to make improvements to the website, both the product data and the functionality of the website. So that's working very well. And we're investing continually in the BPR program. So this is the replatforming the new ERP for the division. Jack referred to it as the SaaS accounting change that we've had there. So the investments continued through the first half. If you remember, this time last year, we went live in Spain. We have had some challenges in Spain, but we spent the time stabilizing the Spanish performance, understanding the system and rebuilding some of that ready for the second half. So we're expecting to continue roll-out as we go through the rest of the year, and we have kicked off the program in the Americas as well in recent months. Good progress on our sustainability goals. So working alongside the rest of the group on waste -- zero-waste-to-landfill and energy, all making progress. And where we are focusing, in particular, is this use of recycled content. So we've committed to achieve a 20% use of recycled content by 2025, and we continue to make progress towards that with Kidlington probably now our showcase site. And then finally, M&A continues to be an important part of our strategy going forward. And we have an active and strong pipeline with a number of ongoing conversations. So again, that will hopefully bode well for future periods. We could give more updates in the next 6 to 12 months. So that's it from me. Thank you. I will hand you over to Paul, who will give us an update from Filters.

Thank you. Filters, in short, a really strong first half and extremely well set 15% growth. Those of you who remember back, Charles, you will too, the strategy presentation we did in middle of 2017 it was, and we talked about the game changers. I think to achieve 15% growth and 45% growth in order book speaks to the validity of the description game changers because I think for a tobacco stock to get levels of growth like that really is a game changer. And in those days, we highlighted 3 levers, one of which is outsourcing. We are now very much well entrenched in growing that. China, the JV, as Jack's already mentioned, is now in the black and is performing very strongly. And then third, product innovation, particularly the next-generation products are now biodegradable or ECO filter. So all 3 game changers are changing the game. Clearly, when you get that level of operational gearing, it helps margins. So we've seen that. And it's noteworthy of the 15%, as Jack mentioned, the vast majority is actually volume growth. But where we've had to increase price to mitigate cost, we have done so. The operations are truly world-class. We measure our [ folds in parts per million ] and I think -- and the CFO of the division is here; I think it's either 2 or 3 a mere, isn't it, something like that. And OTIF languishes at 99.6%, sometimes 100% in a month, which is quite remarkable. And the Tapes business has now reached its own landmark. It's always been quite related and dependent on the tobacco industry. As of now, it is now more than 50% nontobacco, mostly through growth in things like Rippatape for Amazon. ESG permeates everything we do. It's in our DNA. We've heard some of the achievements from the environmental side, particularly the bottom 2 there with the products from Kidlington being 50% recycled and the ECO filters where we now have 4 live customers and 340 live discussions. So quite a few there. If you look at the process, we had a target of 25% GHG versus 2019 by 2025. You can see we're already 21%. So we will comfortably beat that. Major increase in renewable energy. Good progress with recycled content, as Scott's mentioned, and half our manufacturing sites are now zero-waste-to-landfill So really encouraging progress there. People have always been at the heart of not just what we say but what we do. I hope our colleagues in the room agree with that. And we are making very good progress. We're proud of how we, I think, treated and looked after our people during the pandemic. Clearly, there's a lot of change going on at the moment. So we're trying to offer as much support as possible there. That's also, I think, reflected in our Board. So if you see at the bottom there, we have this Voice of the Employee sessions where the NEDs go and visit, and we have not got 1, not 2, but 3 NEDs actively involved. So you can see how important it is to them as well. And in terms of governance, obviously, we've got Jack on Board now, who will bring his Liverpudlian rigor to everything. But also the GRC, Group Risk Committee, which I chair, continues to monitor risk and there are a few around at the moment. So finally, summary and outlook. Very good margin expansion, very good like-for-like revenue growth, packaging on track, Filters in line with where we expected it to be, and we will communicate before the end of September. We have both coped with the physical availability but the cost of supply chain challenges well. And clearly, it would be naive of us not to expect, particularly for Components, some greater headwinds in the underlying industrial production arena. But we continue to monitor those, and we have mitigation plans in our back pockets. In terms of looking ahead, I've already mentioned that the order book is 22% up as at the end of June. So overall, very good. We will have a ungeared or marginally cash positive balance sheet. And for Components, the journey is about continuing to cross-sell. Filters, it's about driving the JV, the ECO filters and outsourcing contracts. So versus our internal expectations as a Board and as you can imagine, as we shed businesses here, well, it's a bit of a moving feast. But as you can hopefully tell by what we're saying and if you like, what Scott has also said, we're confident that OP will be in line with where we expect to be at year-end. That is it. So I believe we're time for questions. I think for those of you in the cyberspace, if we can handle the questions inside and then, Owen, I believe you're going to then feed them in from outside, yes. Andy?

Three questions, which is technically 3.5, but 3 questions. Can you give us the impact of the China slowdown or lockdowns in the first half on Components? Because clearly, you had a really good performance, but had China been "normal," it could have been even better. You've talked about the ECO pipeline, you talked about 3 major customers. Can you just give us a feel -- sorry, 4. Can you give us a feel for kind of what's in the pipeline and kind of how that might progress over the next 6, 12 months? And then on price, do you -- are you still playing a little bit of catch-up in terms of the annualized benefit or you've got more to come in the second half?

Yes. There's a lag.

Yes. And I guess one of the questions that we're asking all our companies at the moment is how sticky do you think these price rises are if we were to see raw material inflation to unwind as and when that might be, I don't know, but do you expect these prices to kind of stay where they are and the cost structure to go back to normal?

Okay. I'll start then on Components. You improve and expand maybe if you'd be so kind, Scott. So this has been a business, because we are low on the bill of materials, because service is more important than price, et cetera, where in a very frankly blunt way we have always put pricing through. You remember our IP plus 4, is IP plus 2 to 3 and 1 to 2 in market share gain. So yes, now clearly, we can't just keep putting things up indefinitely, but a bigger driver of our satisfaction and our pulse surveys each month continue to show an upward trend, Andy, and that's more closely linked to availability than it is to price. So availability has got better engagement or NPS scores have got better. It's a pulse, so it's not as holistic, but price has also gone up. So there is a lag on price. So it's annualized now and who knows what's going to happen to cost. But overall, I think we'd be confident that it would be pretty sticky.

Yes, absolutely. I mean we are seeing some normalization in raw materials, but raw materials are only part of obviously our cost base. The labor costs are unlikely to fall. Freight costs are flattening, but not decreasing. Energy costs are only going to go one way. So overall, we've got a good argument with customers that, that pricing isn't going to reduce, although the rate of expansion of pricing will clearly not be the same as it has been in the last 12 months. So we are looking to make more pricing actions in the second half, but lots of the big pricing moves we did around this time last year are now annualized effectively.

And with that growth, Andy, if we've been really alienating our customers, we wouldn't have seen that level of growth. On -- what was your question on filter, sorry -- the ECO.

Actually 3 or 4, kind of think where we are kind of...

Yes. So we have live, if you like, experimental projects going. And I think there's 345 ongoing at the moment. It's something like that, it's between 340 and 350, isn't it, Claire? We are operating both in the combustible space, Andy, but also in China in the heat-not-burn space, and it makes sense if you think heat-not-burn is a bigger residue, so to make that biodegradable is actually more leveraged. And we have actually had sales -- marginal sales with 2 Chinese customers in that space as well. So we have had 2 MNCs, 2 independents and 2 Chinese customers. Another MNC is looking encouraging. And so I think we've pretty much hit where we expected to in terms of coverage. We are in our second wave of product development. There will be a third coming up as well. Our strategy is not to try and just protect through IP but constantly, now that we have clear leadership in this, to work on just constantly innovating and innovating. What was the other question?

China impact on components in the first half?

So China is around 10% of the divisional revenues, and we've had an impact of a few million pounds that we think are probably delayed or lost sales in the first half, mostly due to customers being shut down more than the actual direct impact on the site itself. We had one of our sites closed for 8 days, but actually it's the customers that have been unable to receive goods that have been the biggest challenge for us. We are seeing some signs of encouragement in recent weeks. Last 3 or 4 weeks have started to pick up again. So we're hopeful that by the time we get to October, November, it's back to a more normal pattern, but it really depends on the China government policy around COVID management.

So we'd have been into the 20s otherwise, but perhaps a 4% growth impact. And filters also has had some impact. So it would have been even better than it was now in China. James, hi.

A couple of questions, please. Firstly, on working capital, just wondering if you can talk to some of the dynamics in terms of receivable days, inventory days, particularly on the component side of the business? Because obviously, you've said a fairly sort of sizable sort of inventory and receivables build there. So just want to get some feel for the trends? And then secondly, on Components, again, as we sort of progress through H1, I think we saw pricing remained very strong through that period. Volumes did slow in the second quarter. So just wondering how that dynamic is playing out across Q3 so far?

So I'll -- you provide the detail, but essentially, James, particularly since continuing operations are growing 15%, you're going to expect a quantum growth in the absolute amount of working capital. Net working capital as a percent of sales was, as mentioned, below 15% this time last year and as mentioned above, but broadly, NWC as a percent of sales has shifted 50 basis points. But -- and there's quite a few movements there. So Jack maybe disaggregate it.

Yes. So receivables this year and last year are in the mid-60s to 64, 65 days. So they just tracked in line with the volumes. Obviously, they're higher because we had higher sales, but they're in line. Inventories have increased in Components year-on-year. However, if you go back to pre-COVID, they're very much in line with both inventory days and inventory turns are in line with pre-COVID levels, and we need that to satisfy our customers. So they're at where we would like them to be. However, in H2, we will see that cycle. We see that receivables kind of fall off a bit and we recover the cash and so the net working capital will improve. But like-for-like, debtor days, inventory days in returns and indeed payable days are broadly in line with where they've been previously.

Thank you, Jack. Scott, do you want to take this?

Yes. So as you say volumes have -- volume growth is lower in Q2 than in Q1; pricing broadly similar. I'd expect as we go forward the volume growth to continue, probably in line with Q2; pricing slightly lower than Q2 as we've annualized, as we talked about. So far in Q3, that's the type of pattern we're seeing. Everybody is actually very nervously waiting for the great recession and declines. It's not happening yet. We're watching and keeping an eye on daily sales and forecast. Obviously, in August, it's always difficult to read. But at this point in time, July was a solid start to Q3 for us.

Yes, September is going to be critical.

September is the key, yes.

We expect industry to come back in September after August. He says incisively, as he regularly does. I think if anything, I don't want to try and overanalyze it, but those customers perhaps more on the consumer product base is showing a bit more softness than the intermediate capital goods and things like that.

Yes. And automotive continues to be hampered, but whether that's actually demand or just supply chain challenges in automotive, it's still a difficult market. When you say white goods are starting to slow versus that very high peak, we saw during COVID when everybody was doing home repairs and home spending, but intermediate goods probably better and some sectors, HVAC, renewable energy, some sectors are very, very buoyant still and will remain so given the trends associated with them. So a mixed picture, but no signs of panicking at this point in time. And let's watch out for September. As Paul said, it will be a really important month for us.

And to anticipate a follow-up question. Geographically, other than the -- what we said about China, we're not seeing any huge differences in trends generally. They are moving in lockstep geographically. Charles? You always get the gold medal, you know you got the bronze today.

Slower to mark, back of the queue. So on the filter side, really impressive order book increase. Is that sort of a culmination of months, years of work starting to come through now? And the outsourcing contract in particular, it sounds as though those must be really driving through. And how much is it product development and catch-up post COVID? Or is it that your -- you've sort of got a new paradigm and the halo effect coming through from all of the work on ECO?

I think that it is a result of a clear strategy that's been followed and getting the basics right, like world-class operations, getting our innovation right. We didn't really see a marked decline in filters, if you recall, during COVID, Charles. So it isn't a kind of soft comp issue. It's genuine. I think one of the biggest levers has been the outsourcing where we're probably getting, I would say, about GBP 50 million more sales through outsourcing than we were, say, in 2019 as a baseline, that order of magnitude. I think, Claire, that would be ballpark, wouldn't it? The ECO is not yet delivering big sums, Charles, but as a Game Changer with a capital G and a capital C, it could be phenomenal. And we also have seen what we call business continuity planning support. So with all of the nasty tragic events going on east of here, quite often customers have had to reconfigure their supply chains. And so that's quite good margin business. And because of the trust we've built up by helping them out in COVID when sometimes they had supply chains that are exposed, and we help them out, plus, as I say, the best probably quality product and service in the industry bar not including their internal supply chains and the innovation, I think we've definitely transitioned from being a supplier to a partner in their eyes.

And should we think about some of that outsourced business as temporary while they reorganize their supply chain? Or is this a long-term contract and they're having to fundamentally shift supply chains?

Well, I think they've had 2 stark warnings in the last 2.5 years about the risk of single point of failure for supply. Obviously, we had the pandemic, then we had events in Ukraine. So if they don't kind of get the point and the value of putting 10%, 15% of their volumes to us or somebody else, but there's nobody really else, then I don't know what would make them. So I do think that it's embedded. That will be -- I mean I talked about our risk registers that will be doing exactly the same thing. And it'd be foolhardy for them not to contemplate second supply. So I think it is a paradigm shift, yes.

And what's the scale of the order book? And how quickly does that translate into additional sales?

The order book is over 2 months' worth of sales now. And a lot of it isn't necessarily 2 phased. So it basically underpins Q3 and the start of Q4. And you'll remember that H2 is historically stronger for Filters than H1, which is the reverse for Components.

And just thinking on the Components order book, obviously still comfortably ahead of last year, but last year you had a backlog of business. So the order book was effectively enhanced because you couldn't deliver.