IMI plc (IMI) Earnings Call Transcript & Summary

Hello, everyone, and welcome to the IMI plc preliminary results [ presentation ]. My name is Nadia, and I'll be coordinating the call today. [Operator Instructions] I will now hand over to your host, Roy Twite, Chief Executive Officer, to begin. Roy, please go ahead.

Good morning, everybody, and welcome to IMI's 2022 preliminary results presentation. Next slide, please. So this slide covers the key messages from the presentation. And the first thing to say is that it was another strong performance in 2022. There is great momentum in this business and we delivered 10% revenue growth and the group order book was up 14% with a critical order book, a particular highlight, up 18% at the year-end. Growth Hub is getting stronger and stronger, creating a customer-led entrepreneurial culture, and it's really helping to drive the better whole growth that is right at the heart of our strategy. We delivered GBP 52 million worth of orders from Growth Hub last year, and I'm going to give you some exciting examples later on. This cultural change is reflected in our customer satisfaction scores. We are now achieving industry-leading benchmarks across our company. We completed 3 acquisitions in the year, all in attractive, better-world growth markets. Our adjusted operating margin increased by 80 basis points as we made further progress towards achieving our through-cycle margin target of 20%. Employee engagement remains a top priority for the Board and for the exec. And with that, I am very proud to report record scores and a significant reduction in health and safety incidents in the year. Finally, I am pleased to report that we are increasing the final dividend by 10%, which reflects the Board's continued confidence in the prospects for this business. Okay. So with that, I'm going to pass over to Dan, please.

Thanks, Roy, and good morning, everyone. I'm pleased to be able to take you through our 2022 results today. So next slide. So an overview of revenue and operating profit. First, as Roy already said, really solid results, organically up 4% on revenue and 8% on operating profit. All 3 divisions are up on the top line and increased their margins in the year, with the group margin up 80 basis points to 17.8%. We continue to manage corporate costs closely. And although the figure is slightly higher than last year, you'll recall there was a one-off property sale in 2021, which helped us by about GBP 1.5 million. For 2023, corporate costs are expected to be around GBP 26 million. Adjusted EPS increased 15% on last year to 105.5p at the top of our previous guidance. Operating cash flow remained strong, and our net debt-to-EBITDA came in at 1.8x, in line with the guidance we gave in November. So next slide, please. Since the launch of our Better World strategy in November 2019, we've made real progress in transforming the organization, putting the customer at the center of everything we do and enabling a culture of sustained profitable growth. You can see on this slide how through a combination of strong organic growth and targeted bolt-on acquisitions in attractive market segments, we have delivered 3 consecutive years of profit and margin improvement. Adjusted operating margins have increased by 360 basis points since 2019. Next slide. We increased our margin target last year to 20% through the cycle. And as this slide shows, given the progress already achieved, we have a clear pathway to deliver on this commitment. Firstly, our complexity reduction program is progressing well and is expected to provide a further GBP 42 million of benefits over the next 3 years. Secondly, Jackie and team are continuing to drive growth in the aftermarket within Critical Engineering, providing margin support for both the division and the group. And then finally, continuing our growth in our attractive end markets will provide further margin support. Next slide. So looking at the income statement. As expected, the interest charge has increased to GBP 19 million, reflecting the increased rate environment and the funding for our acquisitions. We also show a pension finance credit in 2022. But due to the final buy-in on our U.K. scheme, we expect a small charge in 2023. It means the overall finance charge in 2023 will increase to roughly GBP 25 million. Our adjusting items are broadly in line with last year, with lower restructuring costs and a hedge gain offsetting higher intangible amortization and the impact of our exit from Russia. And finally, taxation. Our rate returned to roughly 21% after getting a one-off benefit in 2021. We expect the rate to increase, largely due to the U.K. rate increase and new minimum tax laws coming into effect. We currently are forecasting a 22% rate for 2023. So next slide, please. So next, an update on our complexity reduction program. As you saw on the previous slide, we have delivered sustained margin improvement since 2019 and complexity reduction has played an important role. In 2022, we delivered a further GBP 13 million of benefits ahead of plan, taking the total incremental P&L benefits since the start to GBP 84 million. The charge in 2022 was lower than presented at the half year. This is a result of some phasing changes in Critical with certain project announcements now planned for this year rather than last. There have been no changes to the total costs, and overall, the program remains on track. As you can see, we expect to complete the projects and deliver the lion's share of the remaining benefits in the next 2 years. But as you know, we will always look for and execute on opportunities that will enhance the long-term competitiveness of the group. Next slide, please. So continuing the cash flow, where you'll see an improvement versus last year. Working capital was higher with debtors reflecting our top line growth and inventories increasing to support both the significantly higher critical order book and customer service in Precision and Hydronic. Both Hydronic and Precision reduced their stock levels in the second half, although we still are experiencing supply chain challenges within certain parts of these businesses. We will continue to manage our position closely and reduce levels further when conditions enable us to do so without adversely impacting customer service. CapEx of GBP 71 million is about 1.2x depreciation and includes investments to support growth and our sustainability initiatives. We continue to see good opportunities to deploy capital into our core businesses to drive further performance improvement. Our net debt has increased to GBP 812 million at the year-end, reflecting in-year acquisitions, but also an adverse FX movement of around GBP 50 million due to our U.S. and euro debt positions. Net debt to EBITDA remains within our target range, and we continue to develop an attractive pipeline of bolt-on acquisitions. Next slide. Okay. So getting into the division performance. Precision had an excellent 2022. Adjusted revenue was up 18% with organic growth up 5%. Profits are 23% higher and margins improved by 70 basis points to 18.5%. Running through the sectors, Industrial Automation's organic revenue was up 7% with the integration of Bahr progressing really nicely. Process Control organic revenue was up double digits at 16%. Life Sciences revenue was down 8% organically. Although do remember, we had the last of the ventilator surge sales, about GBP 12 million in the first few months of 2021. Life Sciences grew organically by 10% if you exclude those surge sales. Now adjusted revenue is up significantly due to the Adaptas acquisition, which is performing very strongly. Its order book at the end of 2022 was GBP 16 million higher than at the start of the year, a 66% increase and the growth opportunities being identified from the collaboration between Adaptas in IMI's existing Life Science businesses are significant and growing. Commercial vehicle revenue was down 1% in the year, with positive results in Europe and the Americas, offsetting Asia which was heavily impacted by China's COVID lockdown. We still see business being held back by component shortages, but maintain our strong relationships with OEMs, which position us well to meet demand when these pressures ease. And our Rail business continues to trade well, delivering 12% organic revenue growth in the year. We are tapping into very good growth opportunities, particularly in Asia where our solutions significantly enhance the safety of passengers during their journeys. Before moving to outlook, I wanted to highlight the important evolution of Precision's business since 2009. Our sector businesses have grown from roughly 30% of revenue to over 50% now, reducing our exposure to the cyclicality of general industrial production. In addition, Beth and the team continue to build out Industrial Automation's aftermarket, which now represents about 40% of IA revenues. So finally, the 2023 outlook. Based on current market conditions, including the softening industrial production environment, we expect Precision Engineering's organic revenues to be lower than 2022 with margins slightly higher. So next slide. So Critical had an outstanding 2022 with strong order intake, continued organic growth and margin expansion. Orders were up 12% in the year led by a 16% increase in aftermarket. The energy end markets, particularly upstream oil and gas, including LNG, delivered well. New products are playing a big part in Critical's growth with GBP 43 million of growth of orders in the year. Organic revenue was 2% higher than the prior period and 3% higher on an adjusted basis. Margins are up 90 basis points and now at 19%, reflecting the division's actions to reduce complexity and its continued evolution toward a more aftermarket-intensive business. You can see on the top right how aftermarket orders have grown at an 8% compound annual growth rate since we launched the strategy in 2019. Critical ending order book is up 18%. We saw significant new construction activity in the second half of the year. And given longer lead times, we expect much of those orders won't ship until 2024. Therefore, on outlook, based on current market conditions, we expect 2023 organic revenues to be up high single digits. Margins are also expected to be higher. Next slide. And on to Hydronic Engineering, a solid performance from Phil and the team with 4% organic growth against a stronger 2021 comparator, given the installer catch-up activity post COVID. We continue to see strong demand for our energy saving solutions, like our HALO-B thermostatic radiator valve, which Roy will highlight shortly. Although we cannot fully quantify, we know there was some distributor destocking in the second half of last year. Hydronic's on-time delivery remains consistently above 90%, which is excellent performance, but does mean our customers can get comfortable holding less stock. Operating profit is up 5% organically, and the division continues to invest for the future while remaining a 20% plus margin business. In terms of outlook, based on current conditions, we expect Hydronic Engineering's 2023 organic revenues to be higher, supported by demand for our energy saving solutions. Margins are also expected to be higher supported by the Heatmiser acquisition. Next slide. Now we have brought the pension slide out of the appendix as there are some news, 2 things, really. First, we completed a final buy-in of the remaining U.K. pension liabilities in December last year. This has fully derisked the DB U.K. scheme. Many of you will remember when we started this journey back in 2014 with an overall U.K. liability of GBP 1.3 billion. Through a series of buy-ins and buyouts, we have managed the position and the risk down. We will now assess the merits of a final buyout in 2023, which would remove the remaining U.K. asset and liability from our balance sheet. Second, as a result of this buy-in and the adequately funded position, we have stopped the previously required GBP 7 million annual cash contributions. So we are seeing an immediate cash flow benefit of GBP 7 million going forward. The overseas schemes will be the focus of the team going forward, where we will continue to look for opportunities to reduce our outstanding liabilities. Next slide. We also thought it was a good time to remind everyone about our capital allocation principles. We look to maintain a very disciplined approach to capital deployment. Given the diversity and resilience of our businesses, we target a debt-to-EBITDA position of between 1 and 2x. The cash-generative nature of our businesses means our leverage level should reduce by about 0.5 turn during 2023 unless we are successful with additional acquisitions to accelerate our performance. Capital investment continues to be an important driver of sustainable profitable growth. We focus on better-world opportunities and expect to continue to spend at a level above depreciation. Operating expense investment is equally important with R&D expenditure exceeding 3% of sales in 2022. And this figure still does not fully reflect all the growth of activity around the group. It truly is embedded into everything we do now. On acquisitions, we will continue to pursue those that help us move further into attractive markets, and we will execute that within our strict return guidance, delivering IMI's cost of capital by year 3 and to not be materially dilutive to the group's overall ROIC by year 5. And finally, we manage our debt position to minimize both the interest rate and liquidity risks, maintaining roughly 75% of our debt at fixed rates, which are currently fixed at about 3%. And we have spread the maturities of this debt over 6 years starting in 2025. Now the final slide before I hand over to Roy, the group outlook statement. Based on current market conditions, we currently expect adjusted EPS to be around 111p in 2023. That's considering a net interest charge of around GBP 25 million, a 22% tax rate and assuming FX creates a tailwind of around 2%. So with that, let me hand back to Roy to take you through the strategy update. Thanks, everyone.

Thank you, Dan. This next slide clearly shows how our strategy is delivering sustainable improvements in our financial KPIs since the strategy was launched in 2019. Revenue has been growing at 3% CAGR. Our operating margin is up 360 basis points at 17.8% and adjusted profit before tax has been growing double digits at the 11% CAGR. ROIC has improved by 130 basis points to 12.7%, and adjusted EPS has increased from 73.2p up to 105.5p. Next slide, please. So I want to provide a quick refresher on our strategy. At the heart of the strategy is our purpose: Breakthrough Engineering for a Better World. This is an incredibly powerful driver which has unleashed the tremendous energy of our people to solve key industry problems, helping our customers become safer, helping them become more sustainable and more productive. And really, there are 3 key pillars to our strategy. The first is customer satisfaction. We provide world-class engineering expertise and excellent service to all of our customers, alongside deep sector knowledge and know-how. Our focus is on solving our customers' problems. We have market-leading brands, and we are achieving industry-leading customer satisfaction scores across IMI. The second is market-led innovation. Our innovation incubator, Growth Hub, supported by selective M&A enabled us to develop breakthrough solutions to support our customers with their most challenging and complex engineering problems. And the third is complexity reduction, and we continue to simplify and improve our global manufacturing footprint and demonstrate a resilient supply chain to support our customers. Next slide, please. Our 3 divisions are aligned to attractive growth markets. And we have a portfolio that is supported by global macro trends. The long-term fundamentals in each of these markets are strong, and we have the ability to make a significant positive impact. I'm going to highlight a few examples. In Life Sciences, the global health threats that we face, along with the rapidly improving approach to diagnosis and treatment presents a huge opportunity for us. We can empower our customers by helping to automate their processes to diagnose disease early and support highly tailored, patient-focused critical care. In indoor climate, the global drive to net zero, along with increased energy prices means that more than ever, our customers need to reduce energy consumption, improving building comfort and to combat climate change. And Heatmiser, of course, is a really exciting acquisition for us in this space. Next slide, please. Growth Hub remains absolutely at the heart of our Better World strategy, and I'm really pleased to report that a record GBP 52 million of orders were run through Growth Hub last year. Pipelines remain really healthy across all 3 divisions and more and more employees are getting involved and taking the knowledge that they gain back and applying it in our core business to create more value today. And whilst there were 9 growth projects that delivered over GBP 1 million of orders last year, I would like to highlight 3 specific Better World projects that really demonstrate the commercial mindset and the customer-focused culture that Growth Hub is fostering within IMI. Firstly, our focus on hydrogen as a sustainable fuel is leading to a number of exciting early project wins. Our HydroGreen team are actively supporting the development of hydrogen refueling infrastructure with solutions that reduce the cost of operating refueling stations and they secured GBP 3 million of orders last year, and we expect that to double this year. Secondly, you might remember that we introduced aerosol at our Capital Markets Day back in 2021. Aerosol is an innovative solution that prevents steam erosion in process industries, minimizing plant downtime and extending plant life, improving efficiency and return on investment for our customers. It is now a significant driver of growth, and we secured GBP 17 million of orders last year. Finally, our HALO-B thermostatic radiator valve is a great energy-saving new products. You might be aware that Germany had issued a regulation limiting the temperature of municipal buildings to just 19 degrees Celsius this winter. And this is a very effective way to save energy. On 1 degree Celsius decrease in temperature can reduce energy consumption of the building by around 6%. And after seeing this policy announced, our team quickly developed the HALO-B Valve, which helps limit the temperature in building to 19 degrees C. This has been a great success in Germany, and we secured GBP 4 million worth of orders in the year. So hopefully, these examples provide you with a good feeling of how our Better World strategy is really accelerating organic growth. Next slide, please. As you know, we have completed 4 strategic acquisitions since December '21. And on this slide, I'd like to provide a very quick update on how things are going. Adaptas has traded very strongly since we acquired it in December '21. We continue to see a great opportunity to cross-sell Adaptas' leading mass spectrometry technology into our existing OEM customer base and vice versa. Adaptas has now been further complemented by the acquisition of Core Solutions, another Life Sciences business where we are already seeing very strong customer demand and a significant opportunity to scale up. The integration of Bahr is on track. We are actively progressing with our plan to rapidly scale Bahr's high-added-value products and systems through our Norgren sales network. And finally, we completed the acquisition of Heatmiser, the U.K. leader in smart thermostatic control in December '22. Heatmiser provides a unique opportunity to accelerate our growth in smart buildings, and we are very excited to scale Heatmiser's predominantly U.K.-based business right across Hydronics core markets. All 4 acquisitions present the opportunity for significant synergies and are on track to deliver growth and financial targets. Next slide, please. I also wanted to take this opportunity to give you an update on our ESG progress and provide an overview of our new sustainability framework, creating a better world. This framework sets out the most important priorities for our business, and it has been developed in collaboration with our stakeholders who are part of our materiality assessment. There are 3 pillars to this framework. Firstly, empowering people. We develop and empower people to make an impact and to create a better working world. We have made great progress in the year with employee engagement now at record levels, and our recordable accident rate improving by 38%. We are also making good progress on gender diversity and are benefiting from the strong female representation on our Exec Committee and our Board. Secondly, sustainable solutions. We engineer solutions for our customers that are safer and more sustainable. Every day, our people are helping to improve energy efficiency in buildings, improve analytical devices to save lives and reduce emissions in both oil and gas and in trucks. Thirdly, climate action. We play our part to address climate change and protect the planet by minimizing the environmental impact across everything that we do in IMI. We continue to see great progress in reducing our CO2 intensity with a 9% reduction last year and a 25% reduction since 2019. We are committed to a net zero target for Scope 1 and 2 by 2040, and we are very pleased to announce a target to be net zero for Scope 3 by 2050. Next slide, please. To summarize then, the key takeaways from today are: first, that our purpose-led strategy that we set out in late 2019 continues to deliver with 4% organic revenue growth, 15% adjusted EPS growth and the order book up in all divisions. At the heart of our strategy is our Growth Hub, which is going from strength to strength and delivered a record GBP 52 million of orders in 2022, while fostering a customer-led entrepreneurial culture. Third, we have completed 4 strategic acquisitions since December 2021, all of which are in attractive better-world markets and present opportunities for growth. Fourth, as Dan said, we expect this year's EPS to be around 111p and remain on track to deliver our ambition of sustainable profitable growth and a 20% through-cycle operating margin. Okay. So with that, I'm going to stop talking and turn over to the moderator, please, for the Q&A.

[Operator Instructions] And our first question today goes to Andrew Douglas of Jefferies.

I've got 3 questions, 2 should be really quick and hopefully 1 also be quick. On Precision, I'm just interested in your commentary on the outlook for industrial automation. I know that you're historically a PMI business. But 1 or 2 of your peer group, who's also PI correlated talking about reasonably healthy growth in IA. Can I just double check? Is this a typical IMI conservatism? Is there any kind of market share loss that we kind of need to be aware of or any help that you can give us there? It just feels like that's potentially a little bit soft, but then I'll leave you to discuss that. Secondly, on pricing, clearly, lots of ups and downs when we think about the whole pricing equation. Can you just give us a view on whether we should be modeling prices up this year and whether that's kind of an annualization of last year's numbers or are you putting more prices through this year? And last but least, on Growth Hub, clearly, GBP 52 million of orders is great. Are we looking to expand that in the current year? And if so any guidance there would be helpful.

Great. Well, thanks, Andy. Yes, Precision. So on Precision, we certainly don't feel we're losing market share, Andy. Our customer satisfaction scores, for instance, are now industry leading, right? So we use Net Promoter Score. We're up there in the 40s so we definitely don't feel that. I think with us, Andy, we will pick a forecast that we think is absolutely achievable with IA, what we've done is look at PMIs, we looked at previous recessions, and we've used that. And it's very important for us as we manage the business to make sure that we get our costs in line. And as you see, although we are forecasting Precision to be down in terms of sales, we're forecasting it up in terms of margins. So managing our cost base very, very important for us and making sure that we can show the benefits of the restructuring as we have done since 2019. And as Dan said in his presentation, delivered over GBP 80 million of benefits. And as you can see, profit since the 2019 result and the strategy presentation, up nearly GBP 100 million in that 3 years. So yes, that's how we run the business. We want to make sure that the costs are in line. The other people could well be right. I mean, it's certainly early trading. January, February is solid, right, within Precision. So they could well be right. But for us, we don't want to rely on any sort of better outcome. We want to make sure that if we do get a better outcome, Precision, of course, is a high added value business. As I've said many times, I was managing it as we came through the -- through 2009 through the other side, and we got tremendous drop-through in terms of the profit. So -- and that's the way we want to run the business, right? We want to make sure that we are prudent, we're careful. We don't rely on any sort of second half recovery. I think some of the peers have got a point -- and again, it's not clear to us because we get a mixed picture. Obviously, out there right, our labor costs are high, right? And labor is difficult to get hold of and that is making people think about automation. There's no doubt about it. So the question will be, does reduced consumer spending because of inflation and energy costs and everything else mean that capital starts to come down, capital spend starts to come down? At the moment, as I said, Andy, we're solid. And we really hope that everybody else is right, but we don't rely on hope. We make sure we get our costs in line. And if we get that extra sales, we'll be obviously absolutely delighted and I'm sure everybody will be. So that was the first question. I think Dan, do you want to cover...

Yes, sure. Andy, yes, I mean we did get good pricing. And I think last year was a lot around managing the input cost commodities and components and got that nicely and you saw the result on the margins. We probably have about 2 points -- 2 percentage points of carryover. And as you know, there's probably a bit more pricing in Hydronic and a bit less in Critical. And off that base, our expectation is we will need to move pricing further in 2023, and that's more down, as Roy already just mentioned, the labor pressures and labor inflation. So we'll look to make sure we manage that and clearly use all of the productivity as well to manage that as well. So looking for further price movement as we get through 2023.

Yes. And I'll just add to that, Dan. I think Dan is absolutely right. I think pricing this year will be mid-single digit, Andy, and it will be obviously predicated more on labor inflation. Last year, it was more material inflation. And as Dan said, probably at least 2% of that is carryover. And actually, most of the rest of it is now agreed. So we're pretty sure that, that is going to come through. And then Growth Hub, Andy, that was your last question, yes. I mean, first of all, delighted with what's happening with Growth Hub. I think it's really cultural, Andy. It's the most important thing, right, because we can look at those orders and the they're important from those teams really, really important to us that we can generate market-led innovation that we can go out, solve customer problems, create solutions quickly. And as I showed some examples, I love that HALO-B example because the teams reacted so quickly. The German government said 19 degrees in municipal buildings because they need the energy saving. Our team, we actually scaled up more than 10x. It was a bit like the ventilator challenge in my mind. The team is so responsive, so market-based. And that's what's key. And actually, even that HALO-B order is about GBP 4 million. It's not even in the Growth Hub numbers, right, because it wasn't done through all of the Growth Hub techniques, but it's another indication of how the culture is changing in the company. And that's why I'm actually trying to move away a little bit, Andy, from just Growth Hub target because I want the whole company to react like that, right? Be deeply cultural, deeply based on our customers' needs, not on what we've got and trying to sell that, much more on we can solve your problem, we react to you. And that's why obviously the Net Promoter Scores, customer satisfaction are going up. And that culture for the company will lead to higher growth. And that's what we want to keep accelerating that overall growth level, Andy. So yes, no, really good news. And yes, we're pleased with it. Does that answer your question, Andy?

Yes, that's great. Great work.

And the next question goes to Christian Hinderaker of Goldman Sachs.

Just wanted to come back to the margin expansion that you see across all 3 of your divisions. That's obviously encouraging. We know about the GBP 20 million of restructuring savings, and you've talked a little bit about pricing. But I guess just to narrow in on that a little further, you mentioned wage inflation. Some companies here in the sector are talking about 5%, 6%, 7% cost inflation on the labor line. What do you see in terms of that inflation rate? And also more broadly, are there any considerations in the bridge to think about with regard to, say, M&A in terms of those margin expectations? And then I'll come back to the other 2.

Yes. Thanks, Christian. Yes, I think obviously, we're seeing similar levels of labor inflation, right? We want to keep all our best people. We want stability in our workforce and broadly, that's what we've got now. And we want to keep that. It's very, very valuable to us. So yes, similar levels, as I said, pricing matching that, though, we expect to win the overall inflation equation. We are seeing a bit of relief on some materials, and that will help us compared to the high levels of inflation last year. So that's good news on the materials side. Roughly, our P&L is sort of just over 30% labor, just over 30% materials. So that's pretty equally balanced. So a bit of a leap on materials is good. And of course, we've got our own efficiencies that we're driving as well, plus the GBP 20 million from the programs. The good news on the programs is the vast majority of that is now done for the GBP 20 million which is great. That was 3 big site consolidations in Precision. And I think Beth and the team have done a great job in terms of making sure those projects have been done on time to budget. And we're starting to see the savings coming through in the P&L already. So that's encouraging, Christian. So I think overall, in terms of inflation, the bridge, yes, it will be helped by, obviously, the accretive margins on the acquisitions. But in the overall scheme of things, that's relatively small. Heatmiser obviously does help Hydronic. Probably that's the big one, really, Christian, in your models and that is worth about 100 basis points. So for Hydronic. Hydronic, it's obviously not for the group. It's not that big, unfortunately. But yes, Hydronic is worth 100 basis points. So Dan, anything I missed in that bridge?

No. No. I mean that's why I presented it. I think we see a clear shot to getting ourselves up to that 20% through the cycle. I think also that gives us, as we continue to deliver close to that, the opportunity to continue to invest in the business to drive the top line growth as well organically. I think that's the key for us. As we approach that number and get there, we'll want to make sure we're continuing to invest in the Growth Hub teams but across the business in the better-world segments.

It's a really good point actually, Dan's point I should have made. We've improved profits by nearly GBP 100 million over the last 3 years despite a lot more investment in our business, despite the fact that 800 people have been contributing over that period of time into Growth Hub, despite the fact that R&D as a percentage of sales has gone up from just over 2% to just over 3%. So yes, I mean, we are investing heavily. We want this business to grow faster. I mean that's our main activity. And that obviously contributes towards achieving those 20% margins.

Okay. Maybe just turning to you mentioned ongoing supply chain issues, I think, in Critical and Precision. I just wondered if you could elaborate on that in terms of magnitude, whether it's specific product categories or any regions in focus. It seems that peers in the market have seen a better situation in supply relative to, say, 6 months ago.

Sorry, I sort of missed the early part of that question.

Just elaborating on the supply chains. I think yes, yes. Certainly, the boats are moving a lot faster around the world now and the ports have kind of caught up. We're not necessarily seeing lead times come down across all the elements. And well, I would say though that in certain parts of our business, our customers have started to destock as they get confident because of our performance. And as you know, Christian, we are moving more and more towards a local-for-local supply chain. We continue to look for ways to bring our products and produce them in country. So I suspect we're continuing to watch it. It's still within, I'd say, elements of Hydronic, some components that we do take out of China into other parts of the world. And in Precision, there are some elements that do cross the long-term borders. It is improving, but we're not going to declare victory just yet, and we're going to continue to maximize and focus on giving the customers, the right-on-time delivery of the right performance. But having said that, I suspect as we go through the year, subject to all of that, we'll look to bring some of those stock levels down and deliver an improved cash conversion for 2023.

Yes, completely, right? Does that come at...

Yes, just so it's not specific to say, to commercial vehicles within Precision or particular end markets having shipping issue. Is that right?

Yes. I'd say electronics are still the most affected components, right? So as Dan said, that affects parts of Hydronic, parts of Precision. And outside of that, as Dan said, lead times generally from supplier -- transport lead times have come down, no doubt as Dan said, the boats are definitely much better, right? Transport costs have come down. But in terms of supplier lead times, we are not seeing a dramatic reduction in supply lead times yet. Some suppliers are still reporting hard to get hold of additional labor, but they are also reporting that they would like to start quoting for more new business as well, right, which is always a sign that they think capacity is going to get freed up in the -- in say, the short-term future Christian, right? So I think what we're going to say I'm certainly talking to one of our lead supply chain directors, he was thinking sort of end of Q2, Q3, we probably start to see the effects of shorter lead times. But he did put one proviso in which is that China opening up, which is obviously a good thing in terms of markets doesn't suddenly soak up a load of capacity. So that's the only rider on that, Christian.

And then third and finally, Dan, you touched on cash conversion. I just wondered what level of free cash improvement we might expect along with the margin expansion this year. I think you've had around GBP 136 million of cash out from working capital in the past 2 years. And then prior to that, an inflow of around mid-teens in terms of the GBP 1 million mark. What would be a reasonable expectation for working capital improvements as we move through this year?

Yes. I'm going to shy away from giving an absolute target number. What I can say is we delivered 80% cash conversion this past year, and again, continue to put the stocks in to cover off the supply chains. I'd expect as we go through the year and based on what we see today, the cash conversion for 2023 is going to be kind of in the 90% range. Again, we are going to make the investments also on the CapEx side and continue to deploy capital that way as well. So yes, and I think that's probably where we wanted to get to. So we make sure we're continuing to invest in the business. So yes, so a targeted cash conversion kind of as we -- as everything normalizes at around the 90% range feels about right. And that's what we're targeting right now, Christian.

And the next question goes to Andrew Wilson of JPMorgan.

I'll stick to two. I wanted to start on -- maybe a follow-up to a couple of comments you made, one in your, I guess, prepared comments and one to Andy Douglas' question. But just on Hydronic in terms of the destocking, which you talked about, can you talk about where you think customers are in that? And if you've seen any change? And I guess linked to that, have you seen any of the same effects in Precision because I'm conscious that clearly, that can have moved around a little bit, and maybe customers had restocked earlier in the year. So just trying to get a sense of kind of both of those dynamics, please.

Yes, good point, Andy. Yes. So I mean Hydronic, you saw Hydronic slow significantly in the fourth quarter. That was certainly wholesaler destocking. We've always had conversations with those wholesaler and their own cash targets to achieve. Dan actually met personally with one of those wholesalers. So we've got pretty good data on what happened. And the good news, Andy, is that as we come to January and February trading, that has clearly stopped now. So I wouldn't say it's definitely all done. But as far as we can tell, the vast majority of the destocking in Hydronics is done, which is obviously good news. As Dan said, Phil and the team just done a tremendous job. I mean, they kept on-time delivery pretty much throughout COVID at around 95%, always over 90%, and that was partly because of what they did operationally. And you'll remember they consolidated 3 warehouses into 1, which gives us better stock profiles, better coverage but also operationally, they're doing a fantastic job. So very, very good. That's where we want to be. The Net Promoter Scores are fantastic, customer service scores are fantastic. But obviously, that means that our wholesalers can take stock down and be comfortable that we'll still deliver. So that's definitely what happened in Hydronics, and that definitely reduced Hydronics growth last year. And I would think, Andy, a similar thing has happened in Precision. Obviously, Precision way up in IA in the first half last year, pretty flat in the second half. And because we're a component supplier, we're on the end of the supply chain, and it always happens if you look at Precision's history on the way up, we'll get better growth. On the way down -- remember, part of what we do, particularly in IA is through distribution, and they will tend to adjust stocks accordingly when they see tougher times are coming. So yes, I think you're absolutely right in terms of what's happened there, Andy.

And in terms of Critical and just thinking about the outlook for '23, obviously, you provide some, again, have provided very helpful comments by sort of end market last year. I'm just interested in terms of the thought processes in terms of the big end markets for Critical in terms of orders? Because clearly, there was a very, very good momentum in '23. How sustained -- how sustainable is it in the year of growth, if we think about specifically orders obviously sells very well underpinned, but orders for Critical in '23.

Yes. I mean our plan is for all this -- all things being equal to be up again this year on last year. And again, Jackie is winning. I mean, you could see fourth quarter is super strong, right, which is why we think sort of sales up this year high single digit rather than the full order book because obviously, as you know, a lot of those orders will be 12 months, bit longer fall into 2024. So we think Critical is in great shape. Aftermarket strength as well, Andy, really coming through very strong. Part of that's on the back of the growth up work that Jackie has absolutely driven and actually improved. That's what I love about that team is that take the concepts and actually take them forward very, very quickly. So yes, we actually think orders will be up this year. Clearly, you can see it's oil and gas strength. Talking to Jackie, he feels that this year will be another strong year for LNG upstream. Similar to last year, there's projects out there, we're getting high hit rates. And then what normally happens is, and I think Jackie is right in this, is that you then get downstream strength, right? And that sort of follows on for the period after that. So as you know, we're strong in both areas, and we feel pretty good. There's also actually a lot of conventional power going into China as well over the next 3 or so years, and we're well placed with that because that's going to be the most sophisticated sort of power stations where we're very competitive, as you know. So yes, our installed base went up last year. Parts went up. And that -- I think we're doing about GBP 250 million now worth of parts business a year very good margins, as you know, Andy. So yes, all in all, I think we feel good about Critical, and we feel good that orders shipped should go up again this year.

And the next question goes to Mark Fielding of RBC.

Just actually, can I just follow up on -- we're talking with Andy there about the Critical outlook. And I suppose I'm curious on a bigger picture. I mean your Capital Markets Day a couple of years ago, obviously, it was the lowest of the 3 growth targets you set for the division. The world has obviously taken a significant shift since then in terms of energy crisis, et cetera. Just thinking about how you think about the sort of medium-term growth dynamics of that business now? And then maybe a more specific question on that, which is, if the OE orders that are coming in now and things are more about 2024, Just, I suppose, how do we think about the margin dynamic over the next couple of years? Because at the minute, as you said, a big part of your lift to 20% margins or one part of that lift is the Critical aftermarket growth, but there is this period where not a bad thing in any way, we might accelerate ahead of the aftermarket?

Yes, it's a good point. Yes. Yes, I think -- well, first of all, in terms of Critical outlook since the Capital Markets Day, yes, as [ James ] said quite fundamentally, I think energy security has risen to the top of the list for many, many countries. And obviously, LNG as a cleaner transition fuel has become a fundamental part of that, and one of our real strengths is LNG. So I think, yes, you'd have to say the outlook for the medium term is good actually. I've seen some numbers from one of our big peers projecting huge increase in LNG capacity up till 2030. And it's hard to sort of disagree with that now. So yes, I think if we were doing that Capital Markets Day, again, Mark, we probably have a slightly different view. But -- so I think where Critical is, it's great. I think beyond the medium term, Critical strategy is to really make sure that we win in the installed base. And that's what they've done fantastically. I mean aftermarket orders last year, up 16%, as you know, Mark. So I think that's still a fundamental thing. And we drive so much of the future profits of that business from the aftermarket that if we can grow that way beyond any next oil and gas surges on new construction, then that business has got, I think, a fantastic future because we think the installed base will obviously be there for decades, right? And that's got to be good news. The other thing I would say is that the factories are in really good shape. And during Mark's time, as you know, we focused heavily on the batteries. And within Critical, we consolidated the number of factors. We basically halved it, right? We went from sort of 30% to about 16%, I think it was. And the 16% we put it in were the better factories. Obviously, they were more operationally efficient. They're better at continuous improvement. They're more customer-focused. And as we drop new construction business in there, it will flow through to the bottom line. And I don't see a massive dilutive effect from that actually. What I do see is an accretive effect from the increase in aftermarket. Plus, as you know, we talked about this year's GBP 20 million worth of rationalization benefits. Actually, remember that in total, we've got about GBP 42 million to come, as Dan said, when he presented his chart. And a big chunk of that second GBP 22 million is going to come in Critical. So -- and we see that really starting to kick in next year to really underpin their margin performance as well into the future. So no, I think we feel good about Critical, and we feel good about a 20% plus margin target in Critical through that medium term. So yes, I think it's in a good place.

And actually, can I just ask a sort of slightly related follow-on in terms of the wider restructuring plan. I mean, it feels like you stuck out another roughly adding in the 2022 and the out years about another GBP 5 million of extra benefits from the plan in the announcement today. I suppose, do you feel like once you get to the end of this '24, a little bit of '25, but always there's obviously continuous improvement. Will that be largely it when we're thinking about to restructuring benefits and also restructuring costs?

Yes. I think as you know, we set out a plan and we've increased the margin targets and we increased the spend beyond that plan. But fundamentally, it was the plan we set out back in 2019, and that will dramatically reduce the complexity of the business. So as I said, in terms of the number of sites, right? So putting it into our best sites does so much more than deliver those benefits in the P&L. It massively reduces our complexity. And I can remember a chart back in, I think it was 2013, showing our supply chain now, much of that is being consolidated. That big German plant that we've just consolidated into Brno was a huge part of that supply chain complexity. So it's much more than about those short-term benefits. It's about the long-term growth and success of this business. But we -- as Dan said, we will always look for opportunity. I don't think they'll be up. We'll be spending the sort of money that we've been spending per year. But could we spend something like, I don't know, GBP 15 million mark on a project that would again give us more benefits? Of course, we could do that. And we wouldn't walk past it because, again, we want to grow faster. I want to keep taking the complexity out of the business. But largely, this particular program will be done here.

And I'd just say as we go forward, M&A sometimes gives rise to further moves as well. I mean in the Adaptas case, we acquired a wonderful, wonderful business and a wonderful campus. And we've actually been able to move some of our activity into Palmer, Massachusetts, that's gone really, really well. So that's the other caveat, I'd say, Mark, as we bring further bolt-ons into the family, that could be another option.

If they're multiple site, I mean the ones that are single site, obviously, we're buying them for their tech and for their growth. Heatmiser, we absolutely want to build on that site and invest in it. It's just fantastic in terms of smart buildings. So yes, but multiple site, those sort of complex acquisitions, we'd certainly look at the opportunity here.

And the next question goes to Jonathan Hurn of Barclays.

I have 3 questions, please. Just 1 on Industrial Automation and then 2 on Critical. Firstly, just on Industrial Automation. Can you just talk about the 40% of sales that are taken from aftermarket? And essentially, how that sort of aftermarket sort of trades through the cycle? Is there a lot more resilient for you versus the OE? That was essentially that.

Yes. No, Jonathan, absolutely, it's higher margin, and it's definitely more resilient rate. So you definitely find that our people are obviously keeping their own kit running. They're not necessarily involving investing in new production lines. They continue to buy all the spare parts, absolutely. And so that 40% is part of the reason that we think that Precision would be a more resilient business this time.

That's very clear. And the second question is just on Critical. Just coming back to the margin there. I think if you look at the chart that you put up on Slide 8, obviously, you've got about a GBP 15 million savings to come through from that over the next few years. If you kind of put that into Critical, it would kind of imply a margin of around about sort of 21%. But I know your target is 20%, but I think the ultimate question is, is that basically can Critical be a 21%, 22% margin business over time? Is that a feel -- what you feel can be achieved?

I mean, Jackie is now listening, he's probably going to kill me, Jonathan. I mean, it spends on the cycle as well, right? You need a bit of help from the markets, but we're not putting a lead on margins, as I've said on previous calls, right? And as aftermarket strength continues, as it delivers the complexity reduction, of course, and if the markets are good, of course, margins can go up plus 20%. There's no doubt. And we -- as I said, we will continue to invest in the businesses for growth. And I don't want anybody to think that we're not going to be doing that. We're certainly going to be doing that. So that will obviously constrain margins in the short term slightly. But can we do 21%, 22%, you certainly couldn't rule it out, Jonathan.

Okay. So basically Critical is a 20% margin, a 20%-plus margin sort of business rather than the sort of, I suppose, the 20% target that you have out there really...

Precisely. And I think we've already said that, Jonathan, actually, I think, 20% plus here.

Yes. And then thirdly, just a final one, just coming on -- well, just carrying on with Critical. I just wonder if you could talk about sort of nuclear. Obviously, there's a lot of refurbishment activity out there. If you look at your orders in FY '22, they were sort of plus 1. Can we see a sort of a step up in terms of that activity coming through? And just can you talk about the dynamics of sort of nuclear aftermarket? Is that really sort of high margin for you? Is that maybe your highest margin segment? Or is that not the case?

Yes. I mean, it's high margin. I mean, when we do an upgrade valve in nuclear, which is obviously aftermarket, that's good margin. The parts are very good margin, obviously. The issue on nuclear is always new construction because everybody knows that the aftermarket parts stream is good. And you need it to be good because the new construction margins are as competitive outside on. But on the aftermarket side, it's good, yes, and we do see some potential for nuclear. Timing is always tricky on nuclear because these projects always take longer, whether they're upgrades or new construction, as you know, right, in anybody that follows, well, any of the big projects, those that it can take longer. But the U.S., for instance, is prolonging the life of its nuclear power stations. And I think we'll see more and more of that. I think France is obviously dedicated to nuclear and is, at the moment, talking within the EU about making sure that nuclear is counted as a green fuel. And they made some progress on that. They're still obviously talking with Germany about that. But I think -- so for us, yes, we see nuclear upgrades as profitable. We see the parts as very profitable, and we do, yes, see some good opportunity there.

[Operator Instructions] And our next question goes to Aurelio Calderon of Morgan Stanley.

I've got 2. The first one is on Hydronic. And historically, if we look at the division, it's been more -- and correct me if I'm wrong, but it's been more of a balance between growth and margins. I think now for the first time in several years, we can talk about renovation, we can talk about a structural or a secular kind of uptick in that business. So how do you think about the margin profile going forward? Is it a matter of growth versus margins? Or can you get both in the cycle?

Yes. I mean, I think Hydronic -- I think since 2019 has grown about 5%, I think, despite COVID and everything else I said. So I think Phil and team doing a fantastic job. I also think really externally energy savings definitely come up the agenda right for lots of reasons. One is it's got a lot more expensive, energy. Secondly, because of commitments, carbon commitments by big companies by governments, right? So I think to me, it's in a really good place versus where it was 3 years ago. And as we look forward, I think energy carbon saving is going to stay fundamentally important, as I said in the presentation, the German government is doing faster legislation around energy saving, for instance. I think 80%, 90% of that business is Europe as well. And the business -- the culture in the business is fantastic. They actually got our highest employee engagement scores in the group, which is great. And what we do, cost the customer about 2% or 3% of the cost of their HVAC system, but it can save them 1/3 of the energy costs, right, because we help them design the system. We help them actually sometimes reduce the number of pumps in the system. We certainly help them with the way that the whole system is balanced and require less pumping cost. So yes, I feel like that business is in a good place. And as we said at the Capital Markets Day, we expect sort of 5% growth long term plus, and we expect 20% margins. And that was before we acquired Heatmiser, which gives us another 100 basis points. And again, I'm not trying to constrain the margins. They'll go 20% plus, but we are committed to fully investing in that business, again, to help it grow faster earlier. So yes, yes, I think it's in a good place, that business. And the outlook is healthy. I think mid-single-digit growth again this year, margin improvement again this year. So yes, we feel good.

That's super helpful. And the second question, I'm sorry to labor the point on Critical margins, but I think it's one of the key highlights in my view. I guess if we go back to 2021 at your Capital Markets Day, you were talking about kind of 20% to 30% of the Critical business that didn't have margins that were attractive to you. I guess the question is more on kind of M&A strategy going forward, especially for Critical. Can we -- one is, do we see any obvious parts of the portfolio that need to be taken care of? And second part would be, can we find a Heatmiser for Critical?

What a brilliant question for you.you know what? It's almost like you were listening to a conversation with Jackie in one of our business meetings because we would obviously -- aftermarket is going great, right? But if we could even take it to the next level, it will probably be via instrumentation, digital, exactly as you say, right, the Heatmiser equivalent. So we would love an acquisition like that to accelerate our progress in Critical aftermarket, yes, fantastic. So as we think about Critical, the 30% that we had under review, I think you know, I mean, the margins are barely dilutive now on that 30%. And that's a testament to those teams and to Jackie, because what they had to do was absolutely flipped to get much more aftermarket business, and they've done that. I mean and I visited both of the major parts of that business in the last 6 months. And that seems are great, right? They're focused on refurb, focused on driving upgrade valve just like we've done in the rest of Critical. So I'm really excited about the prospects for that part of the business. But acquisitions, as you say, would tend to be more instrumentation and certainly more at driving aftermarket for the long term, that sort of growth.

And our final question goes to Mark Davies Jones of Stifel.

A couple, if I may, both on Precision on some of the moving parts there. Firstly, on CV, what's the view for '23? Obviously, China was very weak last year should be reopening, getting better. But conversely, supply chain is still very tight. Western cyclical markets a bit weaker. So how does that balance out, do you think this year?

Yes. Mark, I think you just described it perfectly. It's exactly how we see it. We should get a rebound from China, Western markets, we think, well, let's say, flat to slightly down as where we got it. So we've got the whole thing up flat to slightly down within our 111p. Again, let's hope that things improve from there, but that's exactly how we've got it.

Okay. Great. The other bit was Life Sciences about which you are sounding quite excited and clearly Adaptas is going very well. Can that become a much more material bit of the division? And if so, they're fairly niche businesses, do you need to enter more niches? Is that a big focus of M&A?

Yes. I think -- I mean, certainly, we can grow this Life Sciences further, yes. There's some good opportunities and Beth, Martin and the team are doing a cracking job. And I think the talent in that team and the opportunities they're opening up. I mean, Beth told me about another couple of contracts that we've won by that test team. So just literally the other day, Mark. So I feel really good about Life Sciences, yes, the funnel is good in terms of opportunity. We're trying to do more of what we did with Heatmiser. Well, we did it with core solutions. I know it's a lot smaller. But yes, they tend to be quite niche, technically very, very capable. And what we look for is obviously acquisitions that have already established good product market fit. We obviously chat with the customers. We know most of those customers pretty well now that it's a technology or a product that's really going to get some traction. So it will just take a bit of time. It is a very selective process, but the funnel has got some interesting opportunities in it, yes.

Presumably that part of the Precision portfolio should be still growing nicely in '23.

Absolutely, Mark, yes.

We're past all the valve surge stuff now, so that falls out of the comp.

Yes, that's out of the...

Yes, as you saw, I mean, underlying, that grew about 10% last year and yes, we're past all the ventilator valve stuff. Having said that, we've actually had an order in January to support China on ventilators, quite a large one. So yes, I mean, in terms of -- the real noise, the big stuff. I think we're past it, yes.

We have no further questions. I'll hand back to Roy for any closing remarks.

Brilliant, I think from my perspective, it was a good solid set of results. The strategy that we announced back in 2019 is clearly working really well. Customer satisfaction is high. Employee engagement is high. We've added, as I said, almost GBP 100 million to profit since 2019. I think we've got great momentum in this business. And actually, as we sit here today, we feel reasonably optimistic about this year. So thanks for joining us, everybody, and all the best. Thank you.