IMI plc (IMI) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to today's IMI Plc 2020 Preliminary Results Call. My name is Jordan, and I'll be coordinating your call today. [Operator Instructions] I'm now going to hand over to Mr. Roy Twite to begin. Roy, please go ahead.

Good morning, ladies and gentlemen, and welcome to our 2020 results presentation. I am joined this morning by Dan Shook. I'm pleased to report 2020 results that demonstrated both real operational resilience in testing times and the early promise of an evolving and ambitious business model for growth. The energy, the enormous commitment of our employees continues to make me very proud to be a part of IMI. A more customer-focused organization, the restructuring projects to reduce complexity and our rapid response to the temporary surge in ventilator demand helped us to improve our overall profits by 9% and improved margins in all 3 divisions. We continue to invest for the future, particularly with our growth accelerator initiative, which is building a culture of market-led innovation right across IMI. Based on the current conditions and assuming no worsening impact from coronavirus outbreaks, we would expect IMI's adjusted earnings per share to be between 75p and 82p for 2021. Okay. Let me now pass over to Dan to take you through the financial detail.

Thank you, Roy, and good morning, everyone. I'm very pleased to be able to take you through the full year results today. Our results reflect another resilient operational performance with cash delivery particularly strong. We continue to reshape and invest in the business for growth. You will see on this slide the detail of our results on both an adjusted and organic constant currency basis. Regarding the impact of foreign exchange, although volatile during the year, FX had a relatively limited impact on our overall results. We did benefit from the full year of ownership of PBM, which we acquired in September 2019. On an organic basis, group revenue of GBP 1.8 billion decreased 4%, reflecting the weakness in some of our end markets during the year, which was only partly offset by the surge in ventilator valve sales. Including the full year of PBM, revenue declined 3%. Adjusted operating profit of GBP 285 million was 5% higher on an organic basis versus 2019 or 7% higher when including PBM and currency. Corporate costs of GBP 29 million were flat versus 2019 due to the structural and temporary savings achieved during the year, being offset by costs in support of our growth initiatives. The group's profit margin for the year at 15.6% was 140 basis points higher than last year, with margin improvements achieved by all 3 divisions despite the extraordinary market conditions. Regarding temporary cost savings, our total benefit for the year was GBP 25 million as the improving market conditions in the second half meant a reversal of some employee cost savings from the first half. Our expectation is that in 2021, roughly GBP 17 million of the GBP 25 million will come back into the business. So moving to the detailed income statement. Our net interest expense decreased by GBP 4 million as a result of our reduced borrowings and rates as well as a one-off interest credit in the year related to a tax refund. Restructuring costs, including impairment losses, totaled GBP 38 million in the year, and I'll provide more detail on the next slide. There were no special pension events in the year but we continue to actively manage our positions in both the U.K. and abroad. I've included in the appendix, our summary pension slide, where you'll see that the U.K. scheme increased its surplus position further during the year to GBP 69 million. The acquired intangible and other acquisition charge decreased to GBP 19 million, following the first year one-off charges from the recent PBM acquisition. This slide provides an update on our restructuring activities as we continue to make the investments necessary to reduce complexity and reposition the business for growth. Benefits of GBP 33 million in 2020 were ahead of what we expected, largely driven by better delivery within Critical. For 2020, our charge, excluding corporate, was slightly below expectations of GBP 39 million, driven by better execution and some deferral of activity into 2021, mostly due to COVID. For 2021, we currently anticipate a charge of roughly GBP 59 million, which includes the continuation of precision activities and additional actions now planned in Critical. Benefits in 2021 are estimated at GBP 15 million. As you can see on the slide, we continue to expect our overall activity to deliver a payback of inside 2 years. So moving to operating cash flow. You will see that we delivered another year of good working capital management in 2020. The inflow of GBP 15 million is supported by reduced trading, but also reflects our continued focus on debtor management, where our team successfully worked down age receivables. Debtor days improved by 4 during the year. Inventories were increased slightly to protect customer service in light of the current market uncertainties and to ensure we are prepared for any rapid demand increases in our end markets. Capital expenditure of GBP 51 million was significantly lower than 2019, reflecting a conscious effort to preserve our cash during the pandemic. We continue to see good capital investment opportunities within our existing businesses, as they progress the growth agendas. So expect CapEx to return to historic levels of between GBP 60 million and GBP 70 million going forward. Overall, adjusted operating cash flow was up 12% at GBP 335 million. Regarding net cash flow, you'll see that our operating cash enabled IMI to more than cover its investments and other commitments during the year. This includes absorbing an adverse currency impact on our debt, largely due to the December year-over-year strengthening of the euro versus sterling. Our cash outflow for adjusting items increased to GBP 37 million in 2020, in line with restructuring activity. The cash outflow for dividends reduced to GBP 92 million as a result of the decision last year to reset the coverage ratio and preserve capital for growth. Net debt decreased to GBP 316 million at the end of December, which, combined with our improved business results, meant that our key financing metric net debt-to-EBITDA improved versus 2009 to 0.8x. So getting into the detailed performance of each division, starting with Precision. Revenue of GBP 877 million was 3% lower on both an adjusted and organic basis. Our Motion Control and Commercial Vehicle businesses saw declines in the year of 11% and 25%, respectively, following the underlying market indices. Both business units delivered sequential quarterly improvement in sales and orders in the second half, again, following their respective indices. The Fluid Technologies business grew by 24% in the year due to the crucial work done within our life sciences team to support the production of life-saving ventilators around the world. Overall, the ventilator valve surge provided GBP 94 million of incremental sales in 2020. At the close of the year, there were about 10 million of extraordinary ventilator orders remaining for shipment in 2021. So the expectation at this point is for Precision to have a net GBP 84 million revenue headwind in 2021 as the ventilator market normalizes. Operating profit of GBP 151 million was higher than 2019, reflecting the impact of rationalization benefits, which offset the effects of lower volumes in the year. Overall, margins increased by 100 basis points to 17.3%, solid results for Beth and the team. In terms of outlook and based on current market conditions and no worsening impact from COVID, the revenue gap from ventilators is expected to be largely offset by growth within the Motion Control and Commercial vehicle businesses which will lead to a slightly lower revenue in 2021. Margins are expected to be flat to slightly down as rationalization benefits will be offset by the reversal of 2020 temporary savings and the mix effect of reduced Life Science sales. Next up is Critical Engineering. Order input for the year at GBP 659 million was 8% lower on an organic basis as both new Construction and Aftermarket field service activities were adversely impacted by the effects of the pandemic. The division was able to deliver good growth in Aftermarket upgrade valves by focusing on solving identified operational problems being experienced by both existing and new customers. These orders provide good initial margins and then added to our installed base and future parts opportunity. So looking at each segment individually, Oil & Gas orders of GBP 134 million were up 9% and were supported by GBP 58 million of new construction LNG orders as well as double-digit growth in parts. Refining and Petrochemical orders of GBP 177 million were down 20%, reflecting reduced new build activity and constrained maintenance budgets in the year. Power orders of GBP 190 million were up 5%, with new construction growing by 24% as a result of project wins in gas-fired and concentrated solar power stations. Note that new construction coal orders totaled only GBP 16 million in the year, now less than 3% of division order activity. Our Aftermarket was slightly lower as reductions in field service due to COVID offset growth in gas parts and upgrades. Aftermarket orders for coal parts were largely flat in the year at GBP 37 million. We continue to benefit from our installed base, of which over 60% is located in favorable geographies. We expect resilience in this business given our footprint is skewed toward larger, more efficient plants, mainly in Asia. Marine orders of GBP 33 million were lower than last year, which was expected as a result of the multiyear order received in 2019. This remains a highly attractive part of Critical's portfolio which will provide long-term growth, given its expanding product offering and geographic reach. Nuclear orders increased 38% in the year to GBP 78 million. Over 90% of activity here is Aftermarket. We are benefiting from investment to install the latest technologies into older nuclear power facilities to significantly extend the lives of those assets. Again, great upgrade wins, which extend our addressable Aftermarket. Overall, Critical ended 2020 with an order book of GBP 522 million, which is up 1% compared to the beginning of the year. Margins in the order book are 140 basis points higher than the prior year, largely due to a further mix shift toward the higher-margin aftermarket, in line with the strategy. So looking now at revenue, Critical sales of GBP 643 million were 4% lower on an organic basis, and when including the impact of PBM and currency, 1% lower on an adjusted basis when compared to 2019. New Construction sales of GBP 309 million were 7% higher, as strong growth in LNG, downstream and petchem and marine more than offset the decline in coal power. Aftermarket sales of GBP 334 million were 12% lower, reflecting the impact of site restrictions, on-field service and some maintenance deferrals, particularly within refining and pet chem. Despite the revenue fall in the year, operating profit of GBP 107 million reflected a 14% increase on an organic basis. Jackie and his team delivered significant structural improvements to the division footprint during the year. They also continue to shift engineering expertise toward more attractive markets and opportunities, including some developed through our sprint teams. Margins in 2020 were 16.6%, an increase of 280 basis points versus 2019. In terms of outlook, given the opening order book and based on current market conditions and no worsening impact from COVID, the division expects to achieve broadly flat revenue and profits during 2021 when compared to 2020. Turning now to Hydronic. Revenue of GBP 305 million was 4% lower on an organic basis. Growth was achieved in Hydronics core German market, which was offset by declines elsewhere. In the year, the division effectively managed both the sharp decline in volumes in Q2 and a rebound in activity thereafter, as construction site access and installer activity were heavily affected by the pandemic. Like Precision, Hydronics saw a sequential quarterly improvement in the second half. Good progress has also been made within Hydronics simplification project, which is on track to deliver benefits of GBP 3 million by the end of 2021 as well as a significant improvement to customer service and delivery. The main elements of this project have already been executed. Operating profit of GBP 56 million was slightly lower than last year as the division limited the drop-through impact from lower sales to 25% plus got a little help from currency. As a result, margins improved by 30 basis points to 18.3%. You'll recall that the division's margins were 15.9% back in 2017. And since then, Phil and his team have successfully refocused the division toward profitable growth. Regarding outlook, based on current market conditions and no worsening impact from COVID, we expect some organic revenue growth in the year with margins slightly higher than 2020. So before turning to the outlook for the group, I'd like to quickly point out a few more slides in the appendix of this presentation. Along with the pension slide previously mentioned, you'll also find our normal currency ready reckoner summary as well as a reconciliation of 2019 full year Precision sales and Critical orders based on our 2020 classifications. We also included a simple indicative earnings bridge to remind you of the main moving parts between 2020 and 2021. With that, let me finish with the outlook for the group for 2021. Based on current market conditions and assuming no worsening impact from COVID, we expect the group to deliver 2021 adjusted earnings per share of between 75p and 82p. Within this is an expected 3% headwind on sales and profits from currency based on forecast average rates for 2021 of [ $1.37 ] and EUR 1.14. So let me now hand back to Roy for an update on strategic initiatives.

Thank you, Dan. This next section of our presentation explains how IMI's business model is evolving. It's becoming ever more customer-focused and creating much more market-led innovation. As a reminder, in 2019, we launched our new purpose, breakthrough engineering for a better world. In 2020, we added our new values, which underpin everything we do. In many ways, these values build on our past while looking to the future, specifically, the new values of customer intimacy, one big team, plan to win and integrity. All of these values are a statement of intent, an intent to create a business that competes on differentiation, adding real value to our customers by solving their problems and generating a high-margin, high-returns business model for IMI. We are also addressing how to generate growth. IMI certainly remains capable of growing faster than its markets. In addition, some legacy markets that have previously slowed progress now offer far less downside risk than they once did. The common characteristics across every part of IMI include a collaborative and engaged team, focused on delivering for our customers. This is an organization with real depth of knowledge of fluid and motion control engineering, underpinned by strong ESG motivation and credentials. What has become clear is the opportunity to increase the level of engagement and collaboration at every single level of the business. The latent potential that is being unlocked is very encouraging. Our business model is evolving to enable IMI to create both value today as well as value tomorrow, both, of course, are absolutely crucial to us. For IMI, value today is all about excellent customer service, reducing complexity and relentlessly improving efficiencies. Value tomorrow will come from market-led innovation, mainly from our new growth hub initiatives. These include the Foresight and Growth Accelerator sprint teams in each division, developing new products that are focused on solving acute customer problems. This next slide illustrates how the divisions are creating value today, improving our customer service, sharpening our competitive edge and improving returns to investors. Precision created the Friends in Adversity campaign for customers including those customers who are struggling to find high volumes of micro proportional valves for ventilators or struggling to find the engineering capability within their suppliers to design and build fluid control manifold systems for their latest analytical equipment. Precision engineering solved those complex customer problems in 2020 and also ramped up ventilator valve production 10x, saving lives and broadening its business relationships and business opportunities in the process. To reduce complexity, Precision consolidated 4 factories in the last 18 months, reducing manufacturing costs and helping to deliver GBP 20 million of structural savings in 2020. Critical enhanced its digital configurators, slimmed down the new construction project offering and increased best cost country sourcing to cut its cost to serve for customers. The effect on the division has been significant, improving margins and sharpening competitiveness, which in turn has maintained Critical's very high win rates and increased the installed base for the future. Hydronic also restructured in 2020, stripping out complexity by combining 3 European warehouses into one, moving assembly to its Polish sites and closing manufacturing in Slovenia. Reducing this complexity is improving returns and will facilitate growth, while the digital customer club built during the COVID lockdowns has improved customer loyalty and provided insight for new products. All 3 divisions have also invested in creating value for tomorrow, allocating more time and more resource than I can remember in my more than 30 years with IMI. Precision found that thousands of machine shops are incurring inefficiencies due to long machining setup times, slow part changeover times and large space requirements for fixture storage. To solve the problem, Precision have invented a brand-new way of fixturing parts packed with IP. That solution promises significant efficiencies to our customers who adopt it. The Critical Foresight team led the group investigation into the hydrogen value chain and found many potential applications for IMI, opportunities that are now being investigated by Critical, by Precision and by cross-divisional teams. Critical also delivered GBP 6 million of high-margin orders from its growth accelerator program in 2020. Please remember that Critical are about 12 months ahead of the other 2 divisions with this growth accelerator program and now believe that they can deliver about GBP 20 million of new business from this program in 2021. So this is starting to become very significant for our future growth. The Hydronic team have created a new digital smart valve, which is at the heart of their system to enable customers to achieve an optimum level of comfort and energy efficiency through much greater digital connectivity. We are building our digital capability right across IMI, creating digital customer communities, building intelligence into our products and generating better reliability and higher productivity for our customers. While we are pleased with these individual examples, the most important thing is that we are creating a culture of customer focus, a culture of market-led innovation and ultimately of growth. This next slide is our usual bridge to our margin targets. All 3 divisions are executing well on their restructuring programs with the benefits dropping to the bottom line. Precision has now consolidated 4 factories, reducing complexity to accelerate the division's future growth. We have clear sight in Precision of the GBP 14 million of additional annual savings that are still to be delivered to hit its GBP 35 million target. Once Precision has completed their GBP 80 million restructuring program, the division will be very well positioned to deliver 20% margins at the top of the next cycle as opposed to the 16.7% margins it produced at the top of the last cycle in 2018. Critical made excellent progress on its cost base in 2020 and took a significant step towards its 17% to 20% margin target. As I said at the IMS in November, I'm now confident that we will get towards the middle of that range for Critical. The restructuring plan for Hydronic was completed successfully, and we now have 1 European warehouse instead of 3. We also have a much more consolidated manufacturing base. We expect a GBP 3 million benefit from this supply chain optimization program and for Hydronic to show further progress towards the 20% margin target in 2021. We are also building on our strong ESG foundations. In 2020, accidents reduced by 9%, and we received our highest ever employee satisfaction score for keeping our people safe in COVID at 85%. IMI is an organization which is getting stronger. It's getting more inclusive and more diverse. Last year, we hired our most graduates ever, 35 future leaders from 10 countries, with over half of the intake women for the very first time in our long history. I'm sure that you know that IMI is already AA rated by MSCI. And today, we are announcing our commitment to halve the carbon intensity from our factories by 2030. So in summary, 2020 was clearly an incredibly challenging year, but also a year that revealed the very best in IMI. It was a year in which IMI has demonstrated resilience, demonstrated ambition and an absolute commitment to supporting each other, our customers and our wider communities. Employee engagement and customer satisfaction scores are improving. Profits were up 9% in 2020, and margins improved in all 3 divisions. At the same time, we are increasing our investments in growth. IMI Critical is picking up early orders from the growth accelerator program, and we now have over 20 sprint teams working across IMI to create more innovation in attractive markets. And finally, we expect further strategic progress in 2021, continued complexity reduction, enhanced customer satisfaction and an acceleration of our growth accelerated program of market-led innovation. Okay. With that, I think we are now ready to take your questions, please.

[Operator Instructions] Our first question comes from Max Yates of Crédit Suisse.

My first question was just around the portfolio. And I just wanted to get an update on how you're thinking about the 20% to 30% of Critical that was under review? Whether you think there's potentially a solution and a potential disposal there in 2021? And maybe more broadly, do you think, given the progress you've made towards the targets that it's maybe the right time to start thinking a bit more broadly about the portfolio and whether there's any sort of areas that, that review can be extended? I just want to get your views on those. That was my first question.

Thanks, Max. Yes. Yes. I think let's start with Critical, right? Well, first thing to say is that Jackie, the whole Critical team have just done a fantastic job and a huge step forward to getting Critical back into the sort of 17% to 20% margin range. And I think the most important thing is when you think about the 20% to 30% of Critical that was under review, clearly, their sales profits, their margins and crucially, their order books, they've all moved sharply in the right direction. And obviously, they're far less of a drag now on the Critical division than they were. So overall, I think, especially given the restrictions that were in a COVID year, where our people couldn't travel as much, customers couldn't travel to our sites to do their normal approvals as much, supply chains were disrupted, I thought it was just tremendous progress. Still on the 20% to 30%, the jury is still out. They're still not at the 17% to 20% margins, although they've made fantastic progress. And I know that Jackie has still got them under intense review, and we'll see how they progress from here. In terms of the broader portfolio, no, I'm generally pleased. We had a very broad-based improvement across all 3 divisions. Again, given the issues around COVID and everything we had to deal with, I was pleased with all 3 divisions and what they managed to achieve last year. So I would say, no, in terms of the rest of the portfolio, I'm actually more confident that we're going to achieve the margin targets than I was. And beyond that, what we're looking to do as you know Max is really generate growth through the market-led innovation program. And we had a review yesterday even of 3 teams, 3 sprint teams. And some of the areas they're looking at within hydrogen, hydrogen carrier, hydrogen use actually and dispense using the regulation technology within Precision. But then more broadly, in terms of [ future foods ], in terms of areas like district heating, the use of digital. I mean, it's just tremendously exciting. And as I said in the presentation, we've now got more than 20 teams across IMI, all working in attractive markets. And the early proof of that is the GBP 6 million of new orders within Critical last year, which, as I said, we expect to build to more like GBP 20 million just within Critical this year. So I hope that answers your question, Max?

Yes. That's helpful. And maybe just a quick follow-up. Obviously, order book is -- the order book has held up well in Critical. Could you just comment on how you're seeing pricing and margins in that order book as we go into 2021? And do you see kind of as we think about the areas in Critical orders that are likely -- more likely to pick up than areas that aren't? How could that affect the average margin in the order book, i.e., are more profitable areas likely to pick up in 2021 as you see it today for Critical?

Yes. I mean, the short answer is, yes, Max. What we see is 3 areas really of growth in Critical, in terms of orders I'm talking about now for this year. The first is Aftermarket. And as I presented back in November 2019, the strategy for Critical very acute focus on the Aftermarket, driving aftermarket in terms of new technology, as I explained on the last call, using 3D printing to get in there and do upgrade valves on the installed base, which then generates more parts business. But a real focus on upgrade valves. And upgrade valves actually were up again last year. So we do see more opportunity in the Aftermarket, to grow the Aftermarket and as you rightly said, that's a huge profit driver, both immediately, but also in terms of the future revenues that we generate from that installed base from the parts business. That's the first one. The second one is Marine. That Marine segment has gone from GBP 20 million a year. This year, we'll do about GBP 50 million in that. That's a nice profitable business, complex technology going into nuclear submarines. So we're pleased with that. And then the third area, of course, is a rebound because downstream oil and gas had a tough year in terms of orders last year as you can see from the slide that Dan presented. And we do expect that to come back this year. Obviously, oil price is recovering, customers are starting to look to spend a bit more, and we think downstream will be a good area of rebound. So the short answer is yes, we see some good growth opportunity in Critical. And as I also said, we also expect that the innovation program will move from sort of GBP 6 million of orders last year to more like GBP 20 million this year as several of those projects are going into their scale-up phase. We've got the value proposition. We've proven it because we've got orders, but now it's about scaling it up. So the short answer is yes, Max.

Our next question comes from Alexander Virgo of Bank of America.

Just if you could give us a little bit of color on how the year has started in Precision, I guess, ex the ventilator business, we're obviously trying to understand how strong or how much the motion control and truck businesses can compensate? So any comments and color you can give around that, particularly regionally, would be really helpful?

Yes. I mean, I think, Alex, certainly the year -- we finished well. Let's start with that in terms of Commercial Vehicles, right? We actually went into growth year-on-year in the fourth quarter, which was obviously a big sequential build. And I know you guys have all got the public numbers for CV. So yes, CV responding quickly. It's interesting, isn't it because obviously, last year, we were managing costs very tightly in the most recent reviews with Beth in Precision. It's all been about looking through supply chains, making sure we're ahead of the bottlenecks in CV and making sure that we're ready to respond, and we are responding effectively. So CV coming into the year, I would say, strongly, Alex. Motion control was about minus 7%, I think, Dan in the fourth quarter. But building strongly in terms of demand. And that's why, Alex, we think that if you take the ventilator surge, we'll probably be on ventilators GBP 80 million to GBP 85 million down in terms of sales this year because of that surge last year, but we think that nearly all of that will be recovered through Commercial Vehicle and Motion Control.

Our next question comes from Andrew Wilson of JPMorgan.

Maybe just a couple of quick ones. Just on the Critical margin, Roy, you kind of -- yourself and Dan talked a little bit around some of the drivers of that, but it was significantly better than certainly I was expecting. I guess interested if you can provide us a little bit more detail on kind of some of the specifics? And also, I guess, whether it was a surprise from your side as well, i.e., sort of Jackie and the team, I guess, delivering ahead of even where we were planning kind of quite late in the year by the looks of it?

Yes. Thanks, Andy. Yes, I mean, COVID environment Andy in a project-based business is super tough, right? Because I think, as you all know, the last thing you normally have to do on a project is get the customer to validate the final test. And for that, normally, they have to visit your site. Obviously, we adapted as many customers as we could to using video digital technology to do the sign-offs. But not every customer is prepared to do that. And traveling became, as you know, a major issue. COVID cases went up a lot, particularly in Europe and the U.S. at the end of the year. And it was a really tough environment with a lot of uncertainty. Despite that, Jackie and the team managed to ship over GBP 100 million again in December. So yes, it was, if you like, a pleasant surprise, it certainly wasn't our middle case -- our base case, call it, Andy, but they absolutely delighted us. And I can't thank the Critical team enough for in a very tough environment doing what they did. So I would say that is good news. On the margin front, I mean, Critical, has remember, consolidated from 26 factories, including some ones that weren't the best in terms of customer service and culture down to 16 and 16 pretty much first-class factories with good process. Most of them have now got, vast majority, have got one instance of ERP, which we put in at a rate of 2 factories every 6 months, we were going for it. And Jackie has really taken those investments and he's maximizing productivity and efficiency and project management effectiveness from those investments. So it is a really good, I call it, a first-class project management business. And of course, what he's now done is really focused on the Aftermarket as well using the CRM system to really drive Aftermarket activity. And of course, Aftermarket orders, despite all the disruption and certainly, field service being under pressure last year, ended up flat on the year with a very strong fourth quarter. Obviously, there's some catch-up in there. But you all know that, that Aftermarket mix and that platform is so essential to strong margins in Critical. And on top of that, they delivered every single pound of the restructuring benefits to the bottom line. So I think all of that, plus there was a -- overall mix was obviously adverse in terms of Aftermarket, as you can see from Dan's presentation. But in terms of the rest of the mix, it was positive because, a bit back to Max's question, we had shipped most of the water orders, which we took those orders to pay for overheads, but we've been completely transparent. So they weren't great in terms of margin, but those orders have been replaced with Aftermarket orders, with good quality LNG orders, as you know, Andy, and with a much stronger order book in terms of areas like Marine. So the mix actually did help offset some of the costs that came through. So yes, first-class performance all around, I would say, Andy.

Maybe, I guess, a follow-up a different question, a different area. But in terms of the various initiatives, which you talk about, whether it be the sprint teams, et cetera, and driving the growth. How should we think about the necessary investment to drive some of that activity? I mean, is this incremental investment? Or is this similar levels of investment that's being used perhaps more effectively than they were historically? Just trying to sort of gauge where we are in terms of necessary additional investment or not, I guess?

Yes. I mean certainly, the first phase has all been about using our existing resources much more effectively. So instead of creating incrementally better products. So taking a precision valve and incrementally making it better. Of course, we need to do that. We need to do value engineering and those things. And all of that continuous improvement continues. But this program is more about solving fundamental customer problems through engineering. So the 3D printing example in Critical is an excellent one. So that team, they first found a piece of customer insight. And that's the way it works. Find a customer problem. And that particular customer problem was that, believe it or not, 92% of outages in power plants in North America were unplanned. And obviously, a fair proportion of those were caused by cavitation, vibration problems in the system that we can solve. Obviously, that's what we do, right? Fluid control at very high pressures, very high temperatures that critical engineering capability from the valve doctors has absolutely been a core competence of Critical engineering for decades. And so that's an example of where we then applied a new technology to solve a problem and have created a whole new value stream, and that's now scaling up. And I think it may hit -- they might have been GBP 2 million, GBP 2.5 million, something like that will be orders of the GBP 6 million the Critical goal. So that has been applying teams that were doing incremental work to what I would call breakout engineering -- breakthrough engineering for a better world. That's what it's all about. Over time, what I've always said, Andy, is that once we get into those margin target areas, we're not going to look to expand the margins much more. What we're going to do is put back the extra drop-through that comes from increased complexity reduction. So there are more opportunities to take more complexity out of the business that comes from extra volume drop through. We're going to look to invest that back into more sprint teams and increase the growth rate further. So that's the overall game plan. We still see opportunity to pay for the sprint teams -- more sprint teams through things like general SG&A reduction, some more transactional SG&A reduction, particularly in Precision. So yes, plenty of opportunity to refocus the money that we're spending in higher growth activities.

And Roy, I think we're already starting to do it as those temporary savings we got this year as they come back, some of that will shift. Some of the marketing and those aspects get away from the traditional and more into the digital and some of the areas that will really support those sprint teams.

Yes. Yes, absolutely. I mean you mentioned in your presentation, Dan, but things like the digital customer club, the Hydronics built, I mean first class, and that is really generating both customer stickiness, but also getting us faster customer insight in terms of being able to generate new growth programs, Andy.

Our next question comes from Jonathan Hurn of Barclays.

Just 2 questions, please, on Critical. If I look at the order book margin within that, you're saying it's up 140 basis points. Got sort of GBP 7 million of rationalization benefits coming through to that division in 2021? And also, you're saying that Aftermarket is starting to see a recovery, particularly in field service. So on the back of that, why is the guidance profits flat in 2021? Surely, you should see a little bit of improvement. So just a bit of color there would be helpful, please?

Yes. No, it's good, Jonathan. I'm glad it's nice to speak to you. Haven't seen each other for a while. But no, don't forget you've got GBP 7 million of temporary costs coming back in. So you probably remember, Jonathan, from the last call, we thought that the sort of temporary savings last year would be around GBP 30 million. They actually ended up a bit lower because the fourth quarter was so strong in terms of activity. So they ended up at about GBP 25 million when we did the final books. Of the GBP 25 million, GBP 17 million are coming back into this year, which is all reflected in our outlook and all compensated for through other activities. Roughly, Jonathan, GBP 7 million is coming back into Precision, GBP 7 million into Critical and then the balance obviously into Hydronic.

That's clear. Okay. And then the second question was just on -- the second question was just on sort of the LNG side of that business. Obviously, GBP 58 million of revenue from that in 2020. What's the outlook going into 2021 for that side of the business, please?

Yes, it's interesting, isn't it? Because LNG, yes, I think our orders were up over 50% last year. So that was really good. Our win rates were really good, Jonathan. Pleased with what we're doing on LNG. I am -- this year is going to be interesting because there are definitely projects that you know about. One is in the Middle East, on the Compression side, the export terminal side, obviously, but also in China, on the receiving side, China is still building receiving terminals. So there's quite a lot of activity going on. I think our orders this year in LNG will depend on how fast those projects progress. And it's a bit early days, but there's some that could -- orders that could fall into the end of this year, which would leave our orders, I would say, reasonably flat on last year or they could just drop into the first half of next year. And I think we'll have to sort of update you throughout the year, really, Jonathan, to give you that. But yes, there's certainly LNG activity ongoing at the moment, which is quite encouraging, I would say.

Our next question comes from Robert Davies of Morgan Stanley.

I had a couple. One was, again, just on the Critical business. I noticed across, I think it was oil and gas refining and your power businesses. OE growth was much stronger than Aftermarket. Just wondered how much of an influence that's going to be on sales this year in terms of the mix plan between the 2 parts of the business versus savings? Just if you could kind of walk us through the makeup of that margin guide for Critical would be helpful? And then the second one was just sort of a bit more of a big picture view and thinking about Hydronic and the broader portfolio. What's your sort of latest thoughts on Hydronic where it fits? I know it's sort of sort of blowing in and out of favor and there's different sort of long-term trends and the EU Green Deal and all this kind of things? What's your sort of big picture view on Hydronic going forward?

Yes. I'll talk about Hydronic, and then Dan can do the Critical bridge. Otherwise, I fell like I'm doing all the talking. On Hydronic, I mean, Hydronic has never ever fallen out of favor with me, but I think you know that, Robert, right? I mean I ran it for 3 or 4 years, back in the sort of mid-2000s. And it has fantastic characteristics, that business. It's got fantastic brands. Customer stickiness is very high because we train those customers for decades in terms of why our products are the best, how to apply them. We've obviously got the Hydronic college, which is full of people that can actually design and help design the hydronic system, heating and cooling system within complex buildings. And that creates pull, obviously, through the whole system. On top of that, Hydronics obviously saves something between 15% and 25% of the energy in a building by correctly balancing the building, using the thermostatic radiator valves. If you set all that up properly, you'll get a more comfortable indoor climate and you get the energy savings. And we can do that while saving capital costs because, again, if you balance, you need less pumps, you need less other parts of the system. So to me, it's just a fantastic business that we can definitely build on and Phil is creating a fantastic culture with the sprint teams and some of the young graduates that are coming in are now using digital technology. And one of the sprint teams, you will see, over time, has created not only a digital valve now. In fact, I've actually got [ air ] Robert, because Phil believe it or not sent it to me last week. So this is the first mockup of it but it's fully digital for the first time, is at the heart of its digital system. And it will enable the optimization and further energy savings within the circuit. So that, combined with the EU Green Deal, which all our modeling says it will provide a tailwind over the next few years, leaves us in pretty good shape. So I think super strong brands, our ability to bring through proper differentiated new product that really solves the customer problem, in line with the increasing legislation means that not only is this a 20% margin business, but it's going to create growth over time. And yes, certainly, it's in full favor with me, I would say, Robert.

And Robert, Phil's Smart, he set me one, too, so he's got me fully backed as well. Now it's great, great, great product. On the Critical side, I mean, Roy already mentioned the ins and outs of the temporary cost savings plus the restructuring and in terms of the orders and how that's going to play out, I think there's the element of field service that was definitely lower in 2020, which we're expecting some of that to come back. We're watching that book to ship level as well. And that mix element as we go through the year because a lot of that -- because a lot of that will play through will -- potentially, will hold the margins back a little bit. And that's why we're calling kind of margins flat despite the margins and the order book being up. As you know, it's a big book to ship gain there as we go through the year. So we'll watch and we'll update at the half year.

Maybe I could just squeeze in one more just for Roy. Maybe kind of taking a sort of a 5-year plus view, just be interested in what your sort of thinking would be in terms of the makeup of that Critical business? I know you've mentioned moving some parts out of that portfolio. But just I guess for some of the emerging technologies and things you're thinking about over a longer period of time, what would that Critical business look like in 5 years' time if you were to look forward?

Yes. Thanks, Robert. Yes. I mean, it will be more Aftermarket. So the energy part of it, which is the bulk of it today, will be more Aftermarket. There's no doubt about it. In the gas installed base, in the LNG installed base, which you know, is nice profit streams for us. And the winning new construction, but also now and more importantly, really, doing what we're doing with the upgrade valve business. So that we not only win the installed base, but we get the parts afterwards. It will be the energy part will be much more focused on the aftermarket and therefore, more profitable, which is what gives me the confidence that it will step up to sort of between 17% and 20%. And then, of course, the new areas will be 5 years around that time, Robert, let's just say. Obviously, Marine will be growing. There's huge opportunities for us to grow in that business. The pharma part will be a much bigger part of that, and we see good development plans within pharma. And then beyond that, and I don't know whether it's 5 years, where it's material or it's 7 or something like that. But certainly, as I said, Jackie is leading the hydrogen initiative for the whole of IMI. And just yesterday, we had 3. So right at the beginning of our new process, effectively, we've got 4 site teams, right? And they do the initial work to really work out is there an opportunity in here for IMI in an attractive market space. And we have 3 just yesterday. And so I can see that hydrogen over time will obviously be a lot more significant for Critical than it is today. So I would say they're the areas that it will move towards, while still maximizing its opportunity in the Aftermarket.

Next question comes from Will Turner of Goldman Sachs.

Hope you're all doing well. I just want to ask on Precision Engineering and your outlook. And then just some more specific questions. When we look at the division, we take your comments around the life sciences, the GBP 85 million of orders for [ ventilator valves ]. And then also look at Commercial Vehicles, which the read across from some of the truck manufacturers points towards, you're going to have a pretty -- you should have a pretty good year in that business, at least in line with maybe 2019 and 2018. How come you're not guiding towards more sales growth? Are you expecting this division to grow organically? I assume it's one with quite big FX headwinds. And that's my first question. And then also just related -- because the difference is mainly going to be in the industrial automation part. When you look at that business, how do you think it sits competitively? From the sound of things, it hasn't significantly outperformed peers? What do you think you can do to improve the organic growth of that business?

Yes. Good questions. So Will, I think just to answer your questions, obviously, it's early days. You know that Precision has a 3-month order book. There's a lot of volatility still out there, right? I mean certainly, in terms of our -- we measure our performance against our peers. And in terms of trucks, we're totally comfortable that we're well up with the peers. So there's certainly not an issue there. In terms of motion control and how we're going to grow that business? Well, Beth's coming in at number one, the sprint teams that we've got, as I said, we've got over 20 across IMI, and obviously, a big proportion of those are in Precision. And I have talked previously about, for instance -- and I don't want to get into too much detail because it's commercially sensitive, right? And I don't want to share all of these things before they've had a chance to have a real run at the market. But we have got some very clever industrial automation fixturing. It's unique. It's very flexible. And we will scale that business. And that's just one example, right? There's more digital. There's lots of excellent work going within the Precision sprint teams now. So that's for the longer term. And that will be highly differentiated innovation that, obviously, does not directly take on our bigger peers. It basically enables us to move into, let's call it, fast-growing market adjacencies with some very differentiated technology. In the shorter term for us, as I explained in November at the strategy presentation, for Precision and Motion Control, it competes on customer service, right? So its ability to quote faster, produce specials faster using applications engineering. That is right at the heart of its competitive age. And when you look at the win data in Precision, that supports, that's exactly how it wins. And so what Beth is doing on that front is sharpening our ability to compete in that way Will. So yes, we'll -- Precision has fantastic end markets. And absolutely, we'll outgrow those markets over time, definitely. I have no doubt about that.

I think you mentioned the currency as well. We'll watch and see if -- we did our numbers based on a 3% headwind, where currency is right now, might be more like 4%. And if you look at the truck indices, Will -- they were down 40% and up 40% year-over-year, but that doesn't get us back to 2019 levels, at least the way we see it in both the Americas and Europe. So it will recover, no doubt. But I don't think we're going to get back to truck production back to 2019 levels in 2021.

Good point, Dan. We're certainly not modeling that. We might get back there. We hope we do, Will. But we're not modeling. ..

Yes.

We're not putting our outlook based on that yet.

I'm doing my part with Amazon orders, but we'll see.

Yes. No, that's does. And then just a more broader kind of question. I mean, I'm quite encouraged by -- obviously, you're taking a strong focus on organic growth, and you've mentioned quite a few things that you're doing. So can we assume -- and for at least the time being, unless, obviously, a really attractive opportunity comes up at a reasonable price. But M&A is kind of taking a little bit of a back burner amongst your strategy at the moment in potential [indiscernible] ? Or are you still active in that space?

Yes. I think, Will, the way I'd sort of characterize it is pretty much as we laid it out in that November presentation, right, that we wanted to get margin momentum, get the returns in the business moving in the right direction. We put, as you know, a pretty strict measure around total returns on invested capital. Nice to see that go back over 12% now. And as I've always said, the margins are a good internal, nice, simple measure for people to understand the sort of business that we want, the depth of customer relations we want, the level of differentiation in the technology. That's the business we want to be the high-quality business. So you can see that in that last 14 months, we -- every single update to you guys, we've been able to say we're making progress in those areas despite COVID and all of the disruption that's bringing. But then beyond that, the next thing is all about how do we really generate organic growth, has to be through market led innovation. That takes some time. But as I said, the early signs are, that's encouraging, as evidenced by Critical where we think Critical is going to go this year. And then the other 2 divisions, about 12 months, something like that behind. So yes, absolutely. We have also looked at acquisitions, but we absolutely stick to our hard lines on it, that we are not going to do things that won't at least achieve the cost of capital by year 3, right, at least. And well look at PBM, right? I mean, Jackie again has done a superb job with PBM. And actually, its returns exceeded our cost of capital in year 1. And that -- but that just shows you how disciplined we are even in a COVID year when obviously, volumes are under pressure for PBM because its customers were busy concentrating on things like vaccines quite rightly. Even with the volume reduction, it just about exceeded its cost of capital in terms of -- by year 1, right? So I'm delighted with what's happening there. And we always maintain that discipline. We are not going to buy things that are going to dramatically dilute our ambitions in terms of ROIC. So yes, but if some really good bolt-ons that could really accelerate our strategy that meet those financial conditions, then absolutely, we'll do them Will, yes.

Yes. And that's across all 3 divisions, Roy. They're interesting possibilities across all 3.

Absolutely. We have at least a whole series per division that we're interested in. As I said, if they're available and at the right price, we'll definitely do it. Yes.

Yes.

Our next question comes from Edward Maravanyika of Citi.

Just had 2 questions, please. Just as you talk about Critical being sort of being weighted towards Aftermarket, say in the next 5 years, what percentage currently of new construction do you win in terms of the aftermarket? And secondly, on refining and petrochems. I think it was a headwind last year. How have activities started this year? Has there been any response to the improvement in oil prices?