Hill & Smith PLC (HILS) Earnings Call Transcript & Summary

Hello, and thank you for joining us today to review our 2021 Results. It's been a good period for us. We delivered record constant currency revenue and operating profit with revenue up last year by 10% and operating profit up by 29% on an organic constant currency basis. We see the strong recovery in trading across all 3 of our divisions and encouragingly, revenue was up by 4% and operating profit up by 3% compared to our record year in 2019, again, on an organic constant currency basis. And of course, this has been achieved while successfully managing supply chain headwinds, the impact of COVID, labor challenges and using our pricing power to offset cost inflation. In the second half of last year, we developed our ESG strategy. And I'm absolutely delighted today to be able to commit to net zero carbon emissions for Scopes 1 and 2 by 2040. We've continued to focus on improving the quality of the portfolio in 2021, as previously announced. We acquired Prolectric, we closed our variable message signs business, and we disposed of our security covers business, and we're currently in an exclusive process to sell the majority of our Swedish roads business. The group remains very highly cash generative with a very strong balance sheet, and I'm pleased to announce that we're recommending a total dividend for the year of 31p per share. Despite the serious geopolitical concerns, our outlook is positive with good progress expected in 2022. Now as a reminder, we operate a clear strategic framework driven by our purpose of creating sustainable infrastructure and safe transport through innovation. And our purpose naturally gives us 2 things, it aligns us with markets that will be supportive in the long term, sustainable infrastructure and transport safety. And it also ensures that sustainability is part of our everyday work. In deciding where to operate, we use a 3-step process to vet, sort and prioritize our opportunities. The first thing we look at is macro drivers, beneath that, we look at market drivers. And finally, we're using a systematic approach to application choice and to assess individual businesses, and I'll talk to you about that later on. Now this approach is changing the nature of the group, both in terms of refining our niche market choices and also broadening our technology footprint. We use our autonomous operating model to drive organic growth. It gives us great agility and customer focus. 99% of our employees are employed by our operating companies. And it's this proximity to our customers that will fuel our future innovation. But perhaps most importantly, it allows us to care about high-margin, fast-growing but small niche opportunities. Portfolio management and ESG, I'll come on to in a few moments. And I think our expectation is that we will deliver superior long-term stakeholder value through this very disciplined approach. Now we started our ESG initiative in July last year by forming an ESG team, which both Hannah and myself sit on and carrying out a materiality study, and this resulted in 3 imperatives and within them, 7 focus areas. In protecting the world, we've got 2 important roles. The first is supporting our customers' environmental programs by supplying our sustainable infrastructure products and services. And the second is minimizing our own environmental impact as we manufacture our products. Saving and enhancing lives also has 2 key elements. The first is our important role in ensuring that the public is safe when they travel and road workers are protected at work. And we have an opportunity and a responsibility to enhance the welfare of our employees and their local communities. And we do this through thoughtful employment practices, people development, leading to social mobility and community support. And underpinning all of this is our resolve to be inclusive of all members of society. Sustainable governance ensures that our plans are credible and that we've got appropriate metrics in place to guarantee that we deliver on our promises over the long term. We're committed to TCFD, and we signed up to the Science Based Targets initiative. For each of the 7 focus areas, we've taken guidance from the relevant UN SDG and developed an action plan with a key metric for each initiative, and executive directors have 10% of bonus opportunity measured against our progress on these metrics. What I'd like to do now is to take a closer look at 3 of the 7 focus areas. So last year, we signed up to SBTi to play our part in limiting global warming to 1.5 degrees integrate. And we also started the analysis of our carbon dioxide emissions. And that analysis showed that the biggest net zero opportunity we have is the use of gas to power our galvanizing bar. And in fact, that application alone accounts for more than half of Scope 1 and 2 emissions. The next step was to build our net zero carbon reduction plan. Where possible, we synchronize the upgrade to clean energy with the natural end of life of equipment. So as a consequence, most of the CapEx in our transition plan is aligned with historical norms. We do recognize that the cost of alternative fuel for galvanizing will be higher, but our expectation is that most of this will be recouped through price. And we plan to trial our first electricity fired galvanizing facility in 2023. And it's -- this detailed costed plan that's given us the confidence to commit to reaching net zero for Scope 1 and 2 by 2040. To measure our progress, we're using a carbon intensity metric. This allows us to make adjustments for organic growth, acquisitions, disposals. But nonetheless, it still ensures that we deliver net zero by 2040. You might be interested to see that the 2030 target of 0.06 equates to a 45% reduction by 2030. And this year and next, we'll calculate our Scope 3 benchmark and develop our Scope 3 reduction plan. Now we've known for a while that many of our products bring value to society, but the challenge for us has been how do we measure that. So to address that question, we started to partner with Route 2, who are an environmental consultancy. The methodology we're using seeks to calculate the financial value to society of our products by looking at their impact on 6 capitals using credible external data. Our initial study focused on 3 key products and services as a U.K. galvanizing our composite fire poles and our temporary road barrier. To bring the process to life. In terms of the supply chain, we look at 17 impact indicators, and there as diverse as land transformation, water pollution and modern slavery. And we use a database that covers 191 countries and up to 500 sectors per country. For each of those indicators, a positive or negative economic value is attributed and that's based on a specific supply chain. So as an example, think from a country with a higher risk of child labor would be valued less favorably than zinc from a lower risk country. What this also does is gives us a fantastic head start on understanding our Scope 3 emissions. The direct operations piece looks at the value to society of our own plants and operations. Factors such as poor gender equality, high water consumption or a high injury rate will detract value whereas the provision of health insurance, vocational qualifications and paying our staff, of course, adds value. The downstream impact evaluates the external value to society, and I think this is probably the most important and interesting part of this. As an example, our temporary barrier is estimated to save 2,200 tonnes of carbon dioxide per year because it's easier to transport than alternatives. But more importantly, it avoids 93 injuries and saves 2 lives. Impressively, our U.K. galvanizing business is estimated to save 460,000 tonnes of carbon dioxide per year compared to other surface treatments. So the next steps with this is to verify our application of the methodology, increase a number of our products under review and then develop metrics and an improvement plan. What I'd like to do now is to share how we put in place the leadership team to drive cultural change, increase employee engagement and most important of all, accelerate our growth. Now as a reminder, the Executive Board was formed in January 2021, when we introduced the group President role and Denise Beachy joined us from DuPont. In June of last year, Andrew Park joined us as Chief People Officer from Inchcape. And in February this year, David George joined us as a Group President from Sitetracker, which is a digital infrastructure business. And this follows his career in digital solutions with both Trimble and Ericsson. And like Denise, David will be based in the U.S. In March, Hooman Javvi joins us from ABB, where he ran their Electrical Insulation and Components business right across Europe and Hooman is relocating from Germany to join us in the U.K. Our strong team of group presidents are responsible for growing their portfolio of operating companies, both organically in partnership with the operating company MDs, but also inorganically in partnership with our corporate development team. And this role enables us to scale the group as we grow without compromising our decentralized model. In the review period, Dina Hart joined us as Group Head of Health and Safety. She's based in the U.S. And last month, Lucinda Farrington-Parker joined us as the Head of Sustainability, helping us to achieve those ESG goals as I mentioned earlier. And finally, before the half year, we're going to add a U.S.-based M&A team member, which just reflects the importance of the U.S. to our growth ambitions. These additions rightsize the central team for sustainable growth at just 31 people. In addition to ensure we've got the right people in place, we've also changed our reward structure at the operating company MD level. So last year, we changed the MD's bonus plan to reward organic profit growth and we also enrolled around 60 of our most senior leaders in our LTIP program. At the PLC board level, we've also continued to build capability through the addition of Leigh-Ann Russell, who's the EVP of Innovation and Engineering at BP. And Farrokh Batliwala, who was formerly a Divisional President of ITT. What I'd like to do now is hand over to Hannah to go through the results.

Thank you very much, Paul. The group has delivered a strong full year performance, with trading significantly ahead of 2020, which was impacted by COVID-19 disruption from the middle of March. We've seen a good recovery across all 3 divisions. And as a result, revenue for the period was GBP 705 million, 10% higher than 2020 and 4% higher than 2019 on an organic constant currency basis. Underlying operating profit was GBP 86 million, a significant improvement compared to last year and also 3% ahead of 2019 on an organic constant currency basis. And for the rest of my presentation, all growth rates referred to will be in organic constant currency. I'm also pleased to report that despite inflationary headwinds and labor availability challenges, operating margin recovered strongly to 12.2%, and 160 basis point improvement compared to 2020. Underlying profit before tax was 28% higher at GBP 79.9 million, and with an effective tax rate of 22.3%, earnings per share stood at 77.9p. Based on the strong performance, we're also pleased to recommend a final dividend of 19p per share, bringing the total dividend for the year to 31p per share. The strong performance in the year demonstrates the strength of the group's decentralized business model, our choice of resilient end markets and the international mix of businesses within the group. As you can see from the charts at the top, revenue is fairly evenly distributed across our 3 divisions, whereas the split of operating profit reflects the superior margins achieved by our Galvanizing Services division. The utilities division contributed 31% of group profits this year, reflecting strong growth in the U.S., particularly in composite solutions and a good recovery in our Engineered Support and U.K. businesses. The Roads and Security division delivered a robust performance with margin improvement reflecting portfolio management actions and an encouraging, albeit partial recovery in demand for our security portfolio. The charts at the bottom outline the geographic mix of revenue and profit. The U.S. and the U.K. remain our key areas of focus for both organic growth and targeted acquisition opportunities. And in 2021, 81% of revenue and 90% of operating profit was generated from the U.K. and the U.S. The Galvanizing division delivered a good performance, particularly in the first half with a strong recovery in demand compared to H1 2020, which was impacted by the complete closure of our French operations for 6 weeks and a slowdown in the U.K. And as a result, revenue growth was 11% and underlying operating profit increased by 18%. And I'm also pleased to report that the division continued to deliver superior margins with underlying operating margins increasing to 60 basis points to 19.9%. The U.K. group experienced a strong recovery with 17% revenue growth and record operating profit. And the U.S. business delivered a solid performance with 3% revenue growth and the business was able to maintain superior margins despite challenges with customer project delays and labor availability and this reflects the benefit of pricing actions of favorable product mix and good demand for value-added services. Our French business delivered a strong performance, supported by a good recovery in demand compared to a COVID impact to 2020. And as a result, revenue was 15% ahead of last year. And as illustrated on the chart on the slide, the division benefits from a wide sectoral spread of customers operating in resilient end markets. The medium- to long-term growth prospects for Galvanizing are supported by several key drivers in these markets. So firstly, while Galvanizing volumes were historically considered to grow in line with GDP. In the U.S., we expect the government's investments to provide a boost to growth. The U.S. infrastructure bill includes investment across a range of infrastructure areas, which are likely to benefit from 2023 and beyond, including roads and bridges, power infrastructure, railroads and public transit. Secondly, given the relatively low levels of market penetration in the U.S., we see scope for further geographical expansion and continue to seek both organic and inorganic growth opportunities the attractive U.S. market. And thirdly, Galvanizing has a very important role to play in sustainable infrastructure and the circular economy, which we set out on the following slide. So hot dip galvanizing has 3 sustainability benefits. Firstly, it's a proven steel corrosion protection system, which optimizes the service life of steel structures. And this results in maintenance savings for our customers avoids the premature replacement of steel products and significantly reduces the life cycle carbon footprint compared to paint alternatives. As shown in the illustration where the CO2 saving is estimated to be 58% over a 60-year life of a steel frame car park. Secondly, our process is designed to minimize environmental impacts by allowing us to recycle nearly all of our byproducts. And thirdly, the galvanizing process prevents rust and therefore, maintains the steel itself in a fit state to be recycled alongside the zinc when a structure reaches the end of its service life and this is why Galvanize Steel is one of the world's most recycled products. So if we turn to the Utilities division. The Utilities division delivered an impressive performance in 2021 with 12% revenue growth and 38% profit growth against robust 2020 comparators. We're also pleased with the continued progress made on margins across the portfolio with underlying operating margin increasing by around 200 basis points to 12%. And the strong profit growth was partly underpinned by a record performance in U.S. composites with high demand for engineered composite solutions, including fire-resistant utility poles, waterfront protection and mass transit infrastructure. The electricity distribution substation business faced some challenges during the year due to rising steel costs and customers delaying nonessential projects. However, demand is recovering and prospects for future growth driven by aging infrastructure remain very encouraging. In the U.K., both the buildings products and the industrial flooring businesses have experienced a good recovery trading and together delivered 20% revenue growth. And our Engineered Support businesses delivered 10% revenue growth, representing a healthy recovery in both the U.S. and India. Across the division, we see opportunities to grow our market share in attractive niche growth markets and a breakdown of revenue by end market is shown on the slide. We have a number of operating companies within the portfolio who provide products and solutions to support sustainable construction or address the challenges of extreme weather conditions. Given the global challenges of climate change, we see this as a key macro driver for future growth. In the U.S., we view electricity transmission and distribution as a focus area and key growth drivers include the requirement to upgrade aging infrastructure with 70% of the U.S. grid more than 25 years old. Increasing electricity consumption with demand forecast to increase by 30% by 2050 and the democratization of energy generation with the drive towards green energy. So an attractive growth market with the additional benefit of GBP 65 billion of incremental funding from the U.S. infrastructure bill. We have 2 businesses involved in this area, a distribution substation manufacturer and a composite utility pole operation. The case study of fire-resistant electricity transmission and distribution poles provides a good illustration of the types of fast-growing niches we look for, the benefits of customer proximity and the role innovation can play in our future growth story. Fiber Reinforced Polymers for instance, offer substantial performance benefits, including durability, safety and ease of handling, making it a better alternative to timber. And while our standard FRP utility pole also offers some degree of fire resistance, following findings that a number of the recent major wildfires in California were caused by falling power lines, our customer requires an electricity distribution pole that could withstand the extreme heats of wildfires. In response, our team developed a product that incorporates a fire-resistant sleeve, which shields the base FRP pole from extreme heat. In addition, the integration of a temperature monitoring system helps the electricity company determine the structural integrity of poles after a fire. This project has been a success with first deliveries and strong demand for the product in 2021, and we can see further growth potential, both in the state of California and in other wildfire impacted states. So if we now turn to roads and security. Revenue increased by 8% to GBP 283 million, underlying operating profit increased to GBP 19.7 million with an improvement in margins from 5% to 7%, and this reflects a solid recovery in the U.K. and good levels of demand in the U.S. In U.K. roads, revenue was 8% ahead of 2020. And during the year, we provided a range of certified products and services to support the upgrade of the strategic road network under Road Investment Strategy 2. U.S. Roads delivered 6% revenue growth, supported by strong demand for roadside safety products. And while margins were impacted by steep increases in steel input costs and freight charges, we expect margin improvement in 2022 as pricing actions take full effect, and we increased our focus on higher-margin products. In recent years, we've seen a growing demand for our tested roadside safety products in the U.S. with the introduction of new safety standards and increased levels of state and federal investment to upgrade road infrastructure. And in the second half of the year, we invested GBP 12.2 million in the expansion of our temporary barrier fleet, including GBP 4.3 million of assets in the course of construction relating to further planned fleet expansion in 2022. Now despite the efforts of the strengthened local team, the Swedish business continued to underperform in 2021 due to challenging market conditions. And as a result, we've taken a further review of the business, and we made the decision to dispose of its rental division, which we expect to complete in the first half of 2022, and we're continuing to assess options for the remaining part of the business. In security, we saw some recovery in the key markets for HVM Solutions. And in addition, demand for the U.K. security barrier rental returned in the second half with the resumption of high-profile events, including the COP26 Summit in Glasgow. Second half margins continue to show improvement and full year profits were ahead of 2020. However, as a result of the COVID-driven challenging market outlook for security businesses, we recognized a noncash impairment of GBP 16 million, which is included in non-underlying items. Now the growth prospects for the division are underpinned by supportive drivers. Firstly, Vision Zero and other road safety initiatives are gaining traction globally, including in the U.K. and the U.S., which drives increasing demand for the group's range of tested road safety barriers and complementary products. Secondly, governments in the geographies in which we operate are committed to investing in upgrading road infrastructure to support future road use demands. In the U.S., the infrastructure bill includes a 5-year reauthorization of the federal highway program and invest GBP 348 billion in highway and bridge improvements through FY 2026. And this record level of support begins with a year 1, 38% increase and growth with inflation in subsequent years. In the U.K., Road Investment Strategy 2 commit significant funds to upgrading the strategic road network. And we're going to look at this in a little bit more detail on the following slides. So our U.K. roads business provides a range of certified products and services to support the maintenance and the upgrade of road infrastructure, including rental of temporary safety barrier, supply of permanent safety barrier, bridge power pits and other safe support structures. The chart at the top shows that in 2021, around half of our revenue was ultimately attributable to RIS2 fundings for the strategic road network with the division also benefiting from buoyant levels of demand from local authorities for products and services to enhance nonstrategic and local road networks. It's also worth noting that revenue relating to smart motorway schemes accounted for only 9% of our U.K. roads revenue and less than 2% of total group revenues in 2021. Now the headline RIS2 committed spend is GBP 27.4 billion, and Hill & Smith opportunity comes from 2 spend areas, capital enhancements and capital maintenance, both of which represents a significant increase in headline spend commitment versus Road Investment Strategy 1. In addition, with traffic levels forecast to rise with increases in population, Road Investment Strategy 3 is expected to increase investment in the strategic road network beyond 2025. Investment in the rollout of smart motorways represents around GBP 4.5 billion of the overall RIS2 spend. And during the year, our U.K. business was awarded primary provider status for the provision of temporary barrier within the Smart Motorway Alliance and the first is RIS2 Smart Motorway scheme commenced in June 2021. In January 2022, the U.K. government issued their response to the transport committee review on the rollout and safety of smart motorways, which set out recommendations, including pausing the rollout of further all lane running schemes until sufficient safety data is available and the retrofit of additional emergency refuge areas. Now while we await for the scheme details, the recommendations are broadly in line with our expectations with 2022 demand for our rental fleet expected to be driven by the retrofit of emergency refuge areas, central reservation upgrade schemes and upgrades to the wider strategic road network. And finally, moving on to cash generation. The group continued to be highly cash generative with underlying operating cash flow of GBP 67.1 million. This included a working capital outflow in the period of GBP 6.8 million, reflecting the increased trading activity in the year. Capital expenditure was GBP 35.9 million, as expected, representing a multiple of depreciation and amortization of 1.6x. In the year, we allocated capital to support growth with GBP 12.2 million spend on our U.S. temporary barrier fleet, GBP 2.8 million on the expansion of our manufacturing and distribution facilities across our U.S. operating companies. And a further GBP 3.6 million on the expansion of our off-grid solar lighting and power rental fleet in the U.K. Now the group invested around GBP 1.2 million on product development during the year. And while we expect this to increase in 2022, we are still in the early stages of our innovation initiative. The group generated over GBP 40 million of free cash flow in the year, providing us with funds to support our acquisition strategy and dividend policy. Underlying cash conversion was 78%, reflecting the capital investment in growth opportunities during the year. Excluding the strategic investment in rental fleet, the underlying cash conversion was 97%. Net debt at the end of the year was GBP 144.7 million, after cash flows of GBP 21.2 million for the dividend payments and GBP 11.8 million relating to the acquisition of Prolectric. And we continue to maintain significant liquidity headroom and leverage capacity to support future growth opportunities. Net debt to EBITDA on a covenant basis reduced to 1x, and interest cover was 25.4x, both comfortably within our covenants. We use return on invested capital to measure our overall capital efficiency with a target of achieving returns in excess of 17%, comfortably above the group's cost of capital through the cycle. The group's return on invested capital in 2021 was 16.8%. The improvement reflecting the recovery in trading our disciplined approach to capital investments and the steps we're taking to improve the overall quality of the portfolio. And with this, I'm going to hand back to Paul to talk about how we've developed our approach to portfolio management.

Thank you, Hannah. Well, the first step was to select the 13 criteria that we use to determine whether a business deserves a place in our portfolio. We then run the existing portfolio through that ranking tool, which uses 13 points. And that helps us understand which businesses we could grow in the medium to long term and which we should dispose of. And this led to a conclusion that maybe around 15% of our revenue should be disposed of and to date, we've disposed or closed businesses that account for 4.5% of revenue, including the Swedish business that we spoke about earlier. And we've got a clear action plan to dispose of the full 15%. The impact on profitability is materially lower than 15%, and we will see an increase in operating margins as the quality of the portfolio improves. And finally, we use the same ranking tool to assess our M&A pipeline and you will recall that, that caused us to remove around about 80% of our prospects at the start of last year. Since then, we put a huge amount of effort into rebuilding the pipeline, and we've now got a strong list of quality targets. We take a similarly disciplined approach to how we think about acquiring businesses. So starting in the top left-hand corner with our M&A landscape, we only source targets that sit in attractive niches that we like and understand and they're colored green. Where there's an adjacent application that we like the look of, we do detailed research to verify whether it really is attractive and those are the yellow areas. And it's this approach that's broadening -- sorry, this approach that's changing the nature of our group. It's helping us refine our niche market choices and also broadening our technology footprint. We use multiple sources to find targets. They are then research and assessed against the 13 criteria before they're either considered qualified or discarded. So what type of acquisitions might you expect from Hill & Smith? You absolutely should expect us to acquire businesses at a very clear fit with our purpose and strong strategic alignment. The most likely to be in the U.K. or the U.S., and they could be across any of our 3 divisions. Thinking back to the previous slide and the M&A landscape, we derisk our approach to buying businesses in applications that we're already familiar with or adjacent applications that we've researched thoroughly. Thinking financially, our sweet spot for revenue is somewhere between GBP 15 million and GBP 50 million. However, if a business was super fast-growing or of particular strategic interest, we would go below the GBP 15 million and equally, we're not going to shy away from acquiring bigger businesses with a strong fit. And actually, around 1/3 of our current portfolio has revenues above that GBP 50 million mark. Typically, we want to acquire businesses that are growing at more than 5% per annum with strong gross margins. The organic growth is paramount. We're buying businesses for their long-term potential. The gross margin percentage is key because it's that allows us to reinvest in talent and innovation, which keeps our businesses ahead and protects our pricing power. Our group operating margin range is between 12% and 15% for acquisitions, we target businesses at the top of that range or even above the top of that range. Moving on to target characteristics. Most of our deals are likely to be with private owners, in fact, thinking about our active deals, most of them are bilateral. We're happy to acquire products all services business. We've got good experience and enjoyable experience of running both. And increasingly, we're confident and willing to buy digital and sensing businesses, although in terms of scale, they're likely to be towards the smaller end. Of course, projected returns are an important part of the mix, and we expect acquired businesses to exceed our WACC within 3 years. As previously communicated, we're happy to pay for quality. We expect most of our deals are likely to be in 7 to 10x EBITDA range. And finally, although we do have significant firepower, we could deploy up to GBP 200 million without the need to raise funds through equity. It's not burning a hole in our pocket. We're only going to do the right deals. So let's move on to talk about our outlook. Well, as I mentioned right at the start, our people are doing a fantastic job in managing the ongoing supply chain issues and using their pricing power to offset inflationary pressures. And we do expect to see good progress in 2022. Of course, we are closely following the tragic events in the Ukraine following Russia's invasion. We've got no operations in Russia, Belarus or the Ukraine, and we've got no material trading relationships within that region. In the medium to long term, our business is going to be backed by strong long-term growth drivers in both sustainable infrastructure and the safe transport arenas. With our strong M&A pipeline, we expect to add quality businesses that are supported by those very same macro trends. And encouragingly, our U.K. and our U.S. businesses are well placed to benefit from government investment programs in parallel with their own self-help initiatives. So finally, I'd like to thank you for your continued interest in Hill & Smith. Thank you.