IMI plc (IMI) Earnings Call Transcript & Summary

Good morning, and welcome to the Interim Management Statement. My name is Charlie and I'll be coordinating the call today. [Operator Instructions] I now hand over to your host, Roy Twite to begin. Roy, please go ahead.

Thank you, Charlie. Good morning, everybody, and thank you for taking the time to join us today. I am joined here as usual by Dan, our Finance Director. I'm just going to take a moment to summarize the highlights from the IMS before we take your questions. So to begin with, I'd like to thank all of our employees for their excellent efforts in continuing dedication to our strategy and to our purpose, Breakthrough Engineering for a Better World. It has been another strong performance as we recorded our seventh consecutive quarter of organic growth. Group revenues were up 10% versus the third quarter of last year and up 4% on an organic basis. While year-to-date margins continue to increase, versus the same period last year, the organic order book is up 8% at the end of the quarter. We continue to see great momentum in our Growth Hubs and sprint teams right across the divisions and we now expect to deliver over GBP 40 million of orders from these projects in 2022. Our restructuring program continues to reduce complexity, and we remain firmly on track to deliver the expected benefits. Precision Engineering delivered organic revenue growth of 3%, led by our Precision Fluid OEM business, which delivered strong organic growth of 9%. Adjusted revenue in Precision was up 16% and we are really pleased with our recent acquisitions, Adaptas and Bahr, which are integrating well and contributing positively to the division's performance. You will also have seen our announced acquisition of CorSolutions last week, which nicely complements our analytical instruments offering in life sciences. Critical Engineering had another excellent quarter with organic order intake up 21%. Momentum in the aftermarket continued with 24% growth, and we also saw a pickup in new construction activity. The order book is 11% higher than the same period last year, reflecting strong demand in LNG, Oil & Gas and Power. Hydronic Engineering organic revenue was up 3% as we continue to see demand for our energy saving products. I'm extremely pleased to announce the proposed acquisition of Heatmiser. It's one of the U.K.'s leading smart, digitally enabled HVAC control manufacturers. Heatmiser will become part of IMI Hydronic Engineering and provides an opportunity to accelerate our growth in smart buildings. Adjacent to our existing HVAC product offerings, Heatmiser will provide an attractive entry point into connected residential thermostatic control, which is a fast-growing market where Heatmiser is already a U.K. leader. The demand for smart temperature controls is growing rapidly and is expected to accelerate further with more than 200 million buildings in Europe requiring renovation to upgrade their heating and cooling systems. There are significant opportunities to leverage IMI Hydronics' strong brand and market presence to scale Heatmiser's offering across Europe as well as leverage Heatmiser's proven connected technology capabilities across both our existing and new products. We expect to generate significant synergies as a result and of course, exceed IMI's strict acquisition hurdles, delivering attractive returns for shareholders. We expect to close the acquisition before the year-end. Given the continued momentum in the business and based on current market conditions, we are upgrading our EPS guidance for the full year, from about GBP 1 to now be in a range from 103p to 106p and we remain confident in delivering our Group growth targets of 5% plus and operating margin target of 20% through the cycle over time. With that, I'm going to hand you back to Charlie, who's going to manage the Q&A for us. Thank you, Charlie.

[Operator Instructions] Our first question comes from Max Yates of Morgan Stanley.

Just my first question was around pricing. And if you could give us any indication for what pricing looked like and maybe particularly in the Hydronic divisions, trying to understand whether volume or to what extent volume growth was still positive there? That would be my first question.

Yes. Thanks, Max. Max, so we're obviously not going to give too much detail on pricing because, as you probably appreciate, it's pretty commercially-sensitive subject. But what I will say is that our pricing across IMI is now slightly above single mid-digit across the whole piece. And it is slightly higher in Hydronics. So you can deduce from that, the Hydronic volume's slightly down versus the same quarter last year. But remember, in Q3 last year, volumes in Hydronic were 9% up because obviously, there was a bit of a rebound from COVID and installers were working weekends and flat out not taking holidays to compensate or [ offset ] COVID. The other thing, Max, is we are getting a little bit of wholesaler destocking in Hydronics as well. So I think that's probably slowed their overall unit growth. I think we had a bunch of customers last week in Sweden, and the overriding message was that versus 2 years ago even that energy saving's right up the agenda of our customers. So actually, I think Hydronic is in a pretty good position.

Okay. And just a quick follow-up on Precision. I mean if we think about kind of the changes that you've made to the business, there's obviously been quite expensive kind of restructuring across the group and in Precision. I guess when you look at the division and you think about potentially seeing sort of growth negative in 2023 and potentially sort of industrial recession, how do you think about the changes that you have made affecting the sort of margin resilience of the business and sort of your ability to defend margins? Maybe if you could just comment a little bit if we do see a sort of minus 5%, minus 10% for Precision next year, where would you think that margins would trough out? And do you think what you've done has made the business more resilient?

Yes. I think firstly, the restructuring has obviously improved IMI's margins from sort of 14% to 17% plus, right? So I think it's clearly dropped through to the bottom line. Typically, our cash paybacks have been less than 2 years and what we've done principally is consolidate some of our poorer performing sites into our best-performing sites often in low-cost countries. So we put proper structural cost savings into our business. I think as you sort of indicated that Max, on top of that, it hasn't just been about cost because the sites we've integrated into had higher employee engagement, they have higher customer Net Promoter Scores and a higher customer service ethic, culture. And undoubtedly better lean systems, which I think is one of the real positives of the last sort of 8 years is the lean systems and how that's gone into factories like our ones in Brno, Mexico, Shanghai, Czech Republic. So I think right across the 4, those factors were consolidated into are more flexible, they are leaner, they are able to react better to a reduction in volume. So if that does happen, I do feel better placed. I think the other thing you want to remember, Max, is that our restructuring is on budget, it's on time and that will deliver GBP 20 million of savings into next year, GBP 15 million of which will go into Precision, which would help to cushion if volumes do indeed come down in Precision.

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

A couple of questions from me then, please. First one, just on PE to follow on a little bit from Max. So I wondered if you could give us a bit of regional color? And I guess, in particular, thinking about IA commercial vehicle a little bit more of this, I guess. But thinking about IA, it looks like you slowed pretty materially in the quarter. And I just wondered if you could give us a little bit more color around the drivers of that, perhaps both regionally and even end market. And then the second question, just on Heatmiser, I appreciate you've given us an EBITDA implied margin, which looks to be in the 40s. Is there much in the way of D&A in the business? And can you give us any steer on PPA?

Yes. I'll do the easy one on Heatmiser, which is actually EBIT is very, very similar to EBITDA. There's very, very little in terms of D&A in that business, Alex. So I'll let Dan take the complex PPA one after I've taken the other one on IA. But yes, it's very, very fast. It's a good margin business, and that's principally because it adds tremendous value for its customers. I've actually got the Heatmiser system probably in a few years ago, and it's tremendously in terms of making sure that you're not wasting energy within a building that you hit the temperatures that you're comfortable with at the exact time of day that you want them which right now is more important than ever, I think. So yes, no, it's a high-margin business. It's been growing double digit. It's in a nice space and I think you explained the plan in the notes reasonably well. So -- so nice strategic acquisition. On PIA, I would say that the U.S. is -- so overall, IA Precision is doing pretty much what we expected. We've got slower growth in IA and IA does sort of follow the PMI. We do want to break that trend over time, obviously. But for the last couple of decades, IA has pretty much follow PMI. And that's pretty much what we expected it would do. U.S. is still slightly more positive than Europe, Alex. So Europe is pretty well flattened out. I think it just slightly -- I might have been minus 1 or something in the quarter, again, pretty much what we expected. And then China is the other issue, obviously. And the China lockdowns has hit both IA and our CV, our truck business in the quarter. So -- so I'm not going to predict what's going to happen in China on lockdowns. I've noticed today that the incidences of COVID are increasing again. I hope that they can find a different way through this, obviously, and we and the business will pick up again. But that gives you the overall geographic position. So Dan, do you want to comment on PPA?

Yes, Alex. Yes, we're obviously just getting into that fund accounting activity, but -- as we look at it, my expectation is it will follow very similar to the acquisitions we've done earlier this year. We'll go through the exercises. There will be some intangibles that we'll put on, there will be goodwill but it will match similar ratios of the deals that we did like Adaptas.

Okay. Great. And if I could just follow up quickly. Any kind of indication of what -- how much you would attribute to China and China lockdowns sort of hampering the business in the quarter just so we can get a better feel perhaps for the underlying business?

Yes. I think it's -- APAC for us was slightly negative for IA. And about half of IA is China for us, which has been the major drag on that, Alex. Just to give you a sort of overall feel. And normally, Asia for us is obviously growing mid- to double-digit. So for our overall growth trajectory, normally, it's quite a significant change.

[Operator Instructions] Our next question comes from Jonathan Hurn of Barclays.

I just had a few questions on Critical, if I may. Firstly, you just obviously understand the order book at the end of Q3, obviously plus 11% for the year. Can you just sort of break out how we think about that order book going into '23 but put it in terms of growth? That was the first one. I'll just take the other 2 as well when I'm here. Second one is just on the aftermarket, obviously, good strength. But can you just give us a feeling of how that's breaking down? Is that the done upgrades coming through? Or is it parts and labor, which is the main sort of driver there? And then the third and final question, just wondering if you could just give us a little bit more color on the trends you're seeing in LNG and Power? Obviously, [ U.K. has been relatively seeing its strength up ]. How long do you think that's going to go on for? Have you seen a lot of sort of upgrades coming through in Power? Just a bit more color there would be very helpful.

Yes, Jonathan, right. So the Critical order book obviously up 11% and strong aftermarket growth in aftermarket now up 19% year-to-date, and total orders up 10% year-to-date. So yes, we feel good about the order book, and we feel good about the quality of the order book. We did pick up a couple of larger orders towards the end of last year. So I'm not quite sure if we're finished at plus 11% for the year. But as you know, Jonathan, I'm not going to make too many predictions about next year. I don't think wise people are doing that right now. But in terms of Critical, we do have a 9-month order book. And so that order book strength does bode well for next year. And I think if there is a recession, that affects Industrial Automation in particular, it's nice to see that Critical is doing what it normally does, which is countercyclical and shows a real benefit of the portfolio of the Fluid Control businesses. So -- so it's a good position to be in, and it was a good strong quarter on top of a previously strong quarter. I'd say that -- and this sort of goes into your next questions really, but -- we're not yet seeing the investments that will come as a result of the Russian invasion of Ukraine. Because as I said on the last call, we won't really see that until about the second half of next year, just because of the way the lead times work on even new LNG compression plants. So this is good news, and it's a continuing trend in our aftermarket, obviously, heavily supported by the growth projects, Retrofit3D, aerosol, the ones we presented at the Capital Markets Day. So I'm really pleased with that. In terms of the nature of the aftermarket, it's pretty broad-based actually, the strength in the third quarter. And we're seeing good strength in upgrades, skills. So upgrades in the quarter were up 29%, Jonathan. The very profitable parts were up 19%. So it's pretty good. And you know that we get that annuity from the parts business from achieving the upgrades. Obviously, once we've got the installed base there, those parts flow at very good margins. So I think you get a rough calculation the other day, and now over 50% of the profits in Critical are coming from the recurring revenues of the parts business, which is -- obviously bodes well as that goes into the future. Just in terms of LNG, well, as I said, we're not really seeing the benefits yet of any recent investments. But LNG strength, I think, is going to be the well, certainly for the medium term, we think LNG is going to be strong, certainly for the next 3 to 5 years and potentially well beyond that. And Power in China, China is putting some more conventional power in place, and will be doing that over the next few years. And as you know, we're well placed in the severe service applications on turbine bypass on those power stations. So yes, I think certainly versus even probably 6 months ago, the outlook for Critical over the next sort of medium term is actually pretty good out there.

Our next question comes from Mark Davies Jones from Stifel.

Two unrelated questions from me. Firstly, maybe one for Dan. Obviously, the acquisition today slightly muddies the water in terms of the cash flow performance for the year. But can we just check are the expectations for working capital working down through the year-end as they were or any change to that? So that would be my first one.

Yes. Mark, yes, we're seeing some reduction in working capital. I think we're -- I don't think we'll be back to an overall normalized level. I suspect we'll see that come out as we watch the supply chain into next year. But in the note, we kind of gave a guidance with the Heatmiser acquisition, putting ourselves around a [ 1.8 ] -- so if you run the math there, you'll see that's supported by some working capital coming out in the second half.

Okay. And then the other one was around Hydronic. You've mentioned the energy efficiency focus, which is clearly very topical. But how does that offset against what are some quite sharp slowdowns in construction activity and forward expectations in the construction market, particularly in sort of core Europe? And do you think the specifics of that energy play can offset the broader slowdown in construction and RMI?

Yes. I think that's the million-dollar question, isn't it, Mark? And we are absolutely focused on growth in Hydronic and have a very strong plan B in place. I think -- my obvious detailed memory is 2009 when industrials were dropping 10%, 15%, and Hydronic dropped 4%. And actually, its profits increase because the price of the raw materials that it uses dropped significantly. And obviously, it's got very strong pricing power. So I think what tends to happen, and again, meeting with these customers last week is that they very much switched their focus during a recession to refurbishment because they are still being hampered by a lack of other products to finish their projects. So things like heat pumps, for instance, still on very, very long lead times. And that is -- that means the pent-up demand for the projects they're doing that will tend to move to refurbishment. I think in 2009, the vast majority of what our customer spend was refurbishment because obviously new construction, certainly by 2010 and pretty well ground to halt. So I think that's one effect. The second effect is, obviously, governments and certainly, these customers are to the saying, this is what they expect to happen this time, governments incentivized energy-efficient refurbishment on top of the existing sort of legislation because one, it drives local employment, obviously, all these people are working within their own countries until obviously, they want the energy efficiency, particularly now. So yes, I expect Hydronic to be reasonably resilient even if things get tougher in terms of consumer spending next year, Mark.

[Operator Instructions] Our next question comes from Bruno Gjani of Exane BNP Paribas.

I just wanted to follow up on Mark's question on working capital, specifically at the [ list inventory ] rebuild. So in H1, you saw inventory right quite notably. And I think at the time, you said that reflected supply chain strength and also a conscious effort also to build the stock of some components. I guess could you provide just some color on how inventory levels developed in Q3? Whether you started to see that unwind and how we should be thinking about H2 overall? And then I have a slight follow-up on the back.

Yes. Bruno, yes, we did start seeing some of that come down. We're [ in the position to ] focus on [conferring with ] the customers and [ on-time delivery ] in good shape. So we're managing that as we go through. But we did see some cash come off the balance sheet in terms of that, and we expect that to kind of come through like it did last year, if I'm perfectly honest. If you look at the trends last year where we did build stock in the first half and then draw that down, that's part of the seasonality of some of our businesses. And again, if you back- calc against the leverage position, I think you can see that that's going to come through. And we will also see some benefit from debtors coming down again. That's also some seasonality there as well.

Got it. And does it sound you're thinking about the need for cost reduction to [ pre-entry ] levels? How should we think about that? Is there any risk as we look towards next year, particularly in the weak macroeconomic backdrop that you might have to underproduce to perhaps clear some inventory and the implications that might have for margin development or not really?

Yes. I think -- this is Roy. Thanks for your questions. Now obviously, we will match production at the appropriate levels. I think some of the stock that we've got, some of the excess stock is around the site moves as well, Bruno right, which is obviously the sensible thing today. As you know, we're consolidating 3 sites at the moment in Precision. And that is what's going to generate that GBP 15 million of savings for next year. So as we're doing that, effectively, what you're doing is moving people or jobs, I should say, from one site, typically in a high-cost country to a low-cost country. And simply, we'll employ less people in those low-cost countries to match the production rate required for the appropriate stock level. So I think there's plenty of opportunities still on working capital. I think as Dan said, we described the sort of what's going to happen this year and plenty of opportunities still for next year depending on how global supply chains perform as we -- as Dan said, we will always prioritize customer service and growth. but it still remains a nice opportunity for us, I think, Bruno.

Got it. And I just wanted to follow up on the acquisitions. So it's great to see Hydronic allocated its impacts. I think velocity of significance might have been in '07 with pneumatic. But likely [ not ]. The acquisition, it seems -- it seems a thematic a question around on line with the big things around energy transition. So I was just wondering if we can expect more capital to be allocated towards Hydronic going forward? Does this market that change in divisional capital allocation priority that has been taken by you or is this just reading too much into it?

Yes. I think -- I mean I was actually running Hydronic, when we did the last 2 acquisitions. I and Phil actually, the other day -- I think and the team, I think seriously now Phil and the team have done a fantastic job. We bought this company through the relationship with the family. It's a wonderful family, the [ K ] family and I was really pleased that their strategy to expand across Europe fits exactly with what we wanted to do. And what we talked about at the Capital Markets Day and many, many times Bruno, right, which is find company with a really fast-growing product that has limited distribution across our core markets where we can really expand that distribution preferably in the connected smart space because that's the bit that's growing the fastest. And this company absolutely as we've been following it for a long time. There's more exciting opportunities in the Hydronic funnel. Yes, over time, you can definitely expect more acquisitions in Hydronic. And I think this is the start of that trend reawakening, if you like, for more than a decade ago. And we're really excited, same as you are, about the trends on energy saving and buildings, particularly but not only in Europe now. I think the U.S. is starting to take it seriously. And as I said earlier on the call, certain, customers are really -- our customers are really feeling that pull out in the market. So yes, we -- I will expect over time, more capital to be allocated to growing Hydronic, yes.

And just following up, I was just wondering if you could perhaps put some numbers around the revenue synergies that you're targeting? So it's a growing U.K. business, but where do you think you can take this in say, 3 to 5 years? What are you coming for?

Yes, we expect it to earn above our cost of capital, which we've obviously revised up given what's happening in the economic systems, but we expect to be above that in 3 years, and we expect it to be fairly dilutive. We've moved our overall ROIC. So we moved the whole incentive system for IMI top management to ROIC. And in ROIC, obviously, in the denominator, we've got all of the goodwill of the investments that we made. We put that in the annual report, as you know, and we've moved back from I think it's 11.3% roughly from memory to over 13% in the last 2 or 3 years, Bruno. And we don't want to be dilutive on that number. We are incentivized on that number. So certainly, within a sort of 5-year period, we expect Heatmiser to be contributing at about our overall returns rate, 13%.

Thank you. At this time, we currently have no further questions. I'll hand it back over to Roy Twite for any closing remarks.

Excellent. Well, thank you very much for joining us today. Yes, for me, the absolute highlights were obviously, Critical orders and the order book in Critical, which I think sets us up well for next year. The growth of momentum, I think the fact there now going to go over the GBP 40 million of orders. And clearly, that is contributing to Critical aftermarket success as well. I mean, obviously, the acquisition of Heatmiser is another absolutely strategic acquisition for us that will help accelerate that growth within the Hydronic division. And then, of course, lastly, raising the guidance upgrading again. So really appreciate everybody joining the call today. And I hope you have a great closeout for the rest of the year. Thank you.

Ladies and gentlemen, this concludes today's call. You may now disconnect your lines.