Morgan Advanced Materials plc (MGAM) Earnings Call Transcript & Summary

All righty. Good morning, everyone. That's a very subdued good morning, nevertheless, I'll take it. I'm Pete Raby, the Chief Executive of Morgan Advanced Materials. I'm joined on stage by Peter Turner, our Chief Financial Officer. I'm going to say a few words of introduction. Peter will then take you through our preliminary results for 2019. And then I'll take you through the business performance and wider strategic progress that we're making across the group. Turning to the highlights. We've made considerable further progress with the implementation of our strategy during the year, strengthening sales capability, driving new product development, improving our operations and developing our leadership teams. And this has enabled our third successive year of organic growth in a challenging end market. The group grew revenue by 0.8% organically in 2019. We saw good growth in the faster-growing market segments that we've been focusing on, including in semiconductors, petrochemical and health care. Our good performance in these segments more than offset weakness in global industrial markets and automotive. We expanded operating margins to 12.8%, with the drop-through on organic growth and efficiency actions driving the increase, and this meets our commitment to expand margins in 2019 following the 3-year period of investment in the group. Earnings per share grew 4.9%, reflecting the improvement in operating profit. Cash performance was very good, and free cash flow of GBP 59 million reduced net debt to GBP 157 million and net debt-to-EBITDA ratio of 1x, excluding IFRS 16 impact. I'll describe our progress in more detail after Peter has taken you through the numbers for 2019. Peter?

Thank you, Pete, and good morning, everyone. Let me start with the summary financials for the year. Revenue of GBP 1.049 billion was 1.5% higher than last year on a reported basis, reflecting the underlying growth and foreign exchange tailwinds. On an organic constant currency basis, revenue was 0.8% higher than last year. Group headline operating profit was GBP 134 million, with margins at 12.8%, 70 basis points ahead of last year. Operating cash flow was GBP 164 million, and free cash flow of GBP 59 million was GBP 10 million better than last year. I'll give some more detail on cash in a moment. Headline EPS was 4.9% higher at 28p per share, reflecting an improvement in operating profit and a reduction in the effective tax rate to 27.3%. The final dividend proposed is 7p per share, bringing the total dividend to 11p per share, maintained in line with last year as we continue to rebuild dividend cover. Included in the appendix of the presentation is the financial information in statutory format. There are no new reconciling items in 2019. Turning now to cash flow. On trade working capital, we've seen an improved position this year, in particular on trade debtors. Capital expenditure is broadly similar to the prior year, with investments to support the growth in the business to improve efficiency and to enhance the safety and infrastructure across our manufacturing footprint. On the financial items, you can see the interest paid, the impact of IFRS 16, and the movement in tax paid mainly reflects the benefits in the tax benefit we had from 2018 as a result of the additional U.S. pension contributions we made at the end of 2017. Free cash flow before dividends was at GBP 59 million. The net debt-to-EBITDA ratio on a pre-IFRS 16 basis, which most closely aligns to our banking covenants, is now at 1.0x, reflecting the continued improvement in our cash performance. On pensions, we've seen a GBP 33 million improvement in the position through the year with the cash contributions and investment returns more than offsetting movements on the liabilities caused by lower discount rates. We have completed the 2019 triennial valuations for the 2 U.K. schemes, subject to regulatory approval. The actuarial deficit of GBP 120 million for these schemes will be funded by deficit payments of GBP 16.5 million per annum from 2020 onwards, increasing by 2.75% until 2025. A proportion of this payment will continue to be made to the Morgan pension scheme until 2027. This next slide sets out the progress we've made over the last 3 years in reducing our leverage. The left-hand chart shows the progress on our net financial indebtedness on a pre-IFRS 16 basis. Since the end of 2016, we've reduced net debt to EBITDA from 1.6x to 1.0x, with the benefit from the disposals we made in 2017, along with the improvements in our free cash flow generation over the period. We have also completely refinanced our debt position over this period, extending our debt maturities and reducing the interest cost. This is shown in more detail on the slide in the appendix. The right-hand chart shows the progress in reducing the net deficit of the group's defined benefit pension schemes, despite the persistently low interest rate environment. This has been achieved through our active management of the liabilities, together with the ongoing cash contributions to the scheme and through aligning the investment strategies of the schemes to better match the liabilities. Together, these 2 charts show the significant improvement we've made to the strength of the balance sheet since the end of 2016. Finally, I've included some guidance for the financial items in 2020. As you can see, we expect the headline effective tax rate to continue to be around 27% this year. Based on current exchange rates, we expect our finance charge to be around GBP 13.5 million, comprising a cash interest charge of around GBP 7 million on our net debt and noncash financing pensions charge of around GBP 3 million and around GBP 3.5 million on our interest and our lease liabilities. We expect our contributions to the defined benefit pension schemes around the group to be around GBP 21 million, the majority of which is to our U.K. schemes, as previously outlined. As usual, we set out in the appendix sensitivities for revenues and headline operating profit to changes in value of sterling against both the U.S. dollar and euro. And based on the exchange rates as of the end of January, we expect foreign currency translation to be a headwind to reported earnings in 2020. Finally on the our portfolio impacts, following the divestment of our U.K. electro-ceramics business in 2017. This year, we'll also see the impact of the closure of our U.S. electro-ceramics business around the middle of the year, following the completion of last-time buys for our customers. This will be a headwind to operating profit of around GBP 2 million this year. That covers the key financial items. So with that, I'll hand you back to Pete.

Thank you, Peter. I'll now take you through the performance of our business units, and then I'll give you an update on our wider strategic progress. So to frame the business unit performance for the year, this slide shows the growth rate in our major market segments. Our revenues in industrial markets declined 3.6% during the year, with volumes down in Europe and Asia and broadly flat in North America, and this reflected the weakness in global industrial markets. Transportation revenues were down 3.8%, with automotive volumes down 29%, driven largely by Thermal Products and reflecting the global slowdown in automotive and diesel vehicle slowdown in particular. This was partially offset by growth in the aerospace segment. Chemical and petrochemical revenues were up 9.6%, driven by later-cycle project activity in Thermal and demand for Seals and Bearings. Semiconductors grew 9.6%, with share wins in certain Electrical Carbon and Technical Ceramics products more than offsetting a decline in consumable components. Our revenues to the energy segment declined 3% with reductions in power generation partially offset by growth in wind and solar. Finally, health care revenues grew 3.9%, driven by medical seal applications in Seals and Bearings. Overall, we've delivered share wins and growth in our faster-growing segments to offset declines in industrial and automotive markets and generate 0.8% organic growth at the group level. Turning to our global business units. Thermal Ceramics revenues declined organically by 2.7%, with automotive down significantly. We supply fibers for heat shields, catalytic converter insulation and diesel particulate filters as well as fibers for brake shoes. Volumes were impacted by the sharp declines in the global automotive market. These declines were partially offset by growth in project activity for chemical and process industries, which is typically a later-cycle part of the business. Despite the decline in revenues, operating margins expanded by 0.3%, reflecting the benefits of the plant closure in Brazil in the prior year and wider operational efficiencies. Molten Metal Systems revenues were up organically 0.6% on the prior year, with growth in the aluminum casting market in North America and Asia supported by some share wins. Margins declined 1.6% from the prior year, reflecting restructuring actions taken in the first half of the year and investments in business capability to support future growth. Margins improved in the second half as expected. In Electrical Carbon, revenues declined 2.4% organically, with declines in industrial markets in Europe, North America and Asia, partially offset by strong growth in the semiconductor segment. Margins expanded 1.7%, reflecting high levels of operational efficiency delivered across the business. Seals and Bearings grew revenue 6.5% organically, with growth in ceramic armor and in the chemical and petrochemical market and with share wins in health care more than offsetting declines in industrial and automotive markets. Margins expanded by 0.4%, reflecting the drop-through on the higher volumes, offset by investments in R&D, sales and wider infrastructure to support the longer-term growth of that business. Technical Ceramics delivered organic revenue growth of 5.7%, with growth in aerospace, renewable energy and semiconductor segments offsetting declines in industrial markets. Margins expanded by 1.2%, driven by the drop-through on additional volume and operational efficiencies across the business. Turning to our strategic progress. I'll start with our purpose and how we support the United Nations Sustainable Development Goals. Our purpose is to use advanced materials to help make more efficient use of the world's resources and to improve the quality of life, and we deliver on that purpose through the products that we make and the way that we make them. We improve the quality of life. We enable medical diagnostics with our power tubes in medical scanners. Our feed throughs are at the core of cochlear implants. Our seals are used in blood pumps. We enable greener electricity generation. Our carbon brushes are integral to wind turbines and power generators. Our ceramic rollers are used to make thin film solar panels. Our insulation is used in solar towers and steam turbines. Our ceramic cores are used to make more efficient industrial gas turbines. We enable the production of more efficient and faster micro processers. We enable the digital world and all of the benefits to the environment and health that, that brings. We help to keep people safe. We provide fire protection in everything from cars to tunnels to ships to oil platforms. We enable electrification for cleaner public transport. Our products help reduce energy costs by enabling electrification in rail and metro systems and by helping those systems to run ever more efficiently. Our self-lubricating seals and bearings and our ceramic shafts reduce the energy consumption of pumps in everything from domestic appliances to power stations to chemical plants. We help our customers to minimize energy consumption. Our insulation products reduce energy usage in high-temperature processes from aluminum production to solar panel production. Our crucibles use less energy to hold molten metal for aluminum and copper casting. All of these things are made possible by our advanced materials. In delivering on our purpose, we support 6 of the UN Sustainable Development Goals through the products we make and also through the way that we make them, supporting health and wellbeing, enabling the production of affordable and clean energy, providing decent work and economic growth, supporting industry innovation and infrastructure, enabling sustainable cities and communities and taking a responsible approach to consumption and production. Today, around 60% of our revenues support these goals directly. We've got more to do to widen the set of things that we target and to establish more ambitious longer-term targets, and we're working on that. We already make a positive difference, and we're committed to doing more. In part, we achieve our purpose and support these goals in the way that we make our products. We reduced the environmental impact of our plants, and we strive to keep people up -- sorry, we strive to keep our people safe and provide a good working environment. We've worked hard on the safety of our plants, improving their physical safety, the safety of our processes and the safety culture in our business. We still have more that we can do, but we reduced our lost time accident rate by 74% over the last 5 years. Over the same period, we've reduced energy intensity by 17%, our water intensity by 27% and our CO2 intensity by 18%. In absolute terms, we generate 77,000 tonnes less carbon dioxide per year than we did 5 years ago on a business that is 14% bigger. Let me give you one example of how our highly engineered products save energy and carbon emissions for our customers. We generate CO2 in the production of our products, and as I've just highlighted, we're reducing the energy and CO2 associated with that. However, our products also improve the energy and CO2 intensity of our customers. This slide shows the impact that we deliver for an ethylene cracker. For every tonne of carbon dioxide that we produce in making the insulation products for this application, we save between 27 and 60x the CO2 for our customers over the typical 20-year life of the solution. These reductions are against a traditional insulation solution that you might find in the market today. And we're achieving these benefits by using highly-engineered combinations of materials that deliver a much more efficient insulation solution for our customers. The results come from both the better properties of our materials and our superior engineering design. And this is at the heart of what our Thermal business does. We produce engineered insulation products and solutions that save considerable amounts of energy and CO2 for our customers. Turning to our strategy. I'll briefly recap the elements of our strategy, just to frame what we're doing across the business. Our strategy is to build distinctive capabilities in 3 areas: in material science, in application engineering and in customer focus. We'll apply these capabilities to solve difficult problems for our customers where they value our differentiated products and support, and we'll apply these capabilities ethically and safely, in line with our high group standards. We'll operate businesses that are at scale and are scalable. By at scale, I mean they're among the leaders in their markets and they're big enough to be resilient and able to invest to sustain their position. By scalable, I'm talking about our ability to run these businesses on a global basis, getting synergies in technology, in operations and in sales. We'll serve markets that are growing and where we have room to grow and where customers value our differentiated products and services. This is our strategy for the group. This is how we add value as a group. Through the execution of this strategy, we aim to deliver more resilient financial performance and faster growth. We've been implementing our strategy through 4 execution priorities in 2019, and we've made good progress against each of them. Starting with sales effectiveness. We've completed sales training during the year for 80% of our sales teams. This met the target that we set at the beginning of the year and marks the start of ongoing investment in their capability. We've also continued the deployment of our CRM tool, giving our sales people easier access to the information that they need. We've completed further work on segmentation of our customers, aligning our service levels and our offerings better, and we continue to deploy our pricing tools during the year. Our new sales incentives were in place for the majority of our sales teams and those are starting to drive performance. In 2020, we'll be completing the training for the remaining 20% of our sales team and continuing the deployment of our CRM tool. We've got further pricing work underway across the business, building on the improvements that we've made over the last 2 years. We'll also be spending more time on market segment strategies, looking for adjacent growth opportunities that our business development teams can pursue. Turning to technology. We've made good progress during the year with execution of our top development projects progressing well under our stage gate process, and I'll say some more about that on the next slide. Our third priority is building our teams. We've launched development programs this year for our leaders at multiple levels of the organization. Our new leadership teams are bedding in and driving both operational execution and strategy development. In 2020, we will continue that and work with the wider employee base to increase their engagement in direction and plans for the group. Our fourth priority is operational efficiency and effectiveness. I'm pleased with the progress here. We delivered further efficiencies in the year to drive margin expansion and help to offset inflationary pressure. We've improved delivery performance across the group with deployments of lean tools and the associated visual management and daily meeting cadence. We'll continue that in 2020, looking to drive further efficiency savings across the business and improve our responsiveness for our customers. Over the last 4 years, we've increased our investment in research and development by GBP 10 million per year. These are investments for the long term to develop new materials, processes and products that improve the technical differentiation of the group. Some of these new products and process are now starting to mature, and we expect them to contribute between GBP 5 million and GBP 10 million of incremental revenue to the business in 2020. We've got new developments coming through in each of our businesses, targeting faster-growing market segments, including semiconductors, thermal management solutions, electric vehicles, renewables, health care and electrified rail. For example, we're introducing new materials into automotive pump applications in Seals and Bearings. We have new silicon carbide materials and products available for semiconductor etch and deposition applications. We're launching new fire protection materials and products in our Thermal business, which delivers significant performance improvements over the prior generation of products. We're developing a range of implantable feed throughs to support customer applications from cochlear implants to neurostimulation. We're at sample volumes with several start-up and mature customers, and we expect these investments to start to deliver this year. We continue to innovate our materials for rail applications, developing formulations that meet the precise needs of our customers in different geographies with different climate and different overhead line requirements. At this stage, all of these are individually quite small, given their relatively early stage, but taken together, we are starting to deliver return on the increased investments that we've been making in research and development. The implementation work over the last 4 years is transforming the health and the performance of our group. We've simplified our portfolio, exiting businesses where we didn't add value or where we had lost leadership positions. We've simplified our structure and strengthened our leadership teams. We're steadily improving the capability of our sales teams and deploying better systems and processes to support them. We've invested in sales, technology and product resources to target fast-growing market segments. As a result of these changes, our strategy is delivering, and you can see that in the overall performance of the group. This slide shows the average annual organic revenue growth of the group from 2012 to 2014 and from 2017 to 2019 compared to the weighted industrial GDP, which is a proxy for our markets. We launched our strategy in 2015, and since then, we have transformed the growth of the group. From 2012 to 2014, we were losing market share. By 2017, we returned the group to organic growth, and over the last 2 years, we've grown faster than our markets. As part of our strategy execution, we had a 3-year period of high investment in the business, from 2016 to 2018. During that period, we held margins broadly flat as we invested surplus returns in R&D, sales and broad improvements to our capability. At the end of that period of higher investment, we committed to expand the margins as the business grows. We've delivered on that commitment this year, with margins expanding from 11.8% in 2016 to 12.8% in 2019, driven by operational improvements and the drop-through on revenue growth that we've delivered, in particular, in 2019. This is a significant improvement in the underlying profitability of the group. We've still got more we can do to improve our business and deliver on our full potential, but I'm delighted with the progress we've made over the last 4 years, and I'd like to thank all of our people for their commitment and for their contribution. Looking ahead to 2020, we're expecting similar market conditions to 2019 with weak industrial and automotive markets persisting and geopolitical uncertainties remaining. We're expecting our revenue growth in faster-growing segments to more than offset these weaknesses, supported by the continued implementation of our strategy, the implementation of new products, further share wins, improvements to the efficiency of our operations and further strengthening of our sales capability. Overall, we expect organic constant currency revenue growth to be in the range of flat to modest growth, with the first half slightly below this trend due to the impact of the coronavirus. In summary, we've made good progress with the implementation of our strategy, and our strategy is accelerating our growth. The group grew revenue by 0.8% organically in 2019, our third successive year of organic growth, demonstrating the success of our strategy. We expanded operating margins to 12.8%, with the drop-through organic growth and efficiency actions driving the increase. And this meets our commitment to expand margins in 2019, following the 3-year period of reinvestment in the group. Earnings per share grew 4.9%, reflecting the improvement in operating profit. Cash performance was very good, with free cash flow of GBP 59 million, reducing net debt to GBP 157 million, a net debt-to-EBITDA ratio of 1x, excluding IFRS impacts. We're continuing to strengthen our group to deliver more resilient performance and faster growth for the medium term. Thank you. That ends the formal presentation. We'll now take questions, if I could ask you to wait for the microphone and state your name and affiliation. Thanks very much.

It's Andrew Douglas from Jefferies. Three questions, please. Can you just talk about coronavirus in a bit more detail? You've given us some numbers, GBP 7 million and GBP 3.5 million of EBIT. Can you just explain kind of how you got to that? Is that based on kind of what, 3 months out or 6 months out, 1 month out? How do we get those numbers? And just exactly what is going on within Morgan, if you can just help us outline that? Second one is on the efficiency chart. And can you just give us a rough idea of kind of what efficiency improvements we should be able to see through -- into '20, just so we can build our operating profit bridge? Clearly, there's quite a few things going on. And then last, but not most least, we've had another, I think, better-than-expected year from ceramic armor in Seals and Bearings, if we look back kind of 2 years. Where are we on that? And kind of when does that start dropping away? Or is it not?

Okay. Super. I'll take the first one, and Peter, I'll let you pick up the other 2, if that's all right. So starting with coronavirus. I guess, first, I should say, I mean, it's a horrible situation. It's horrible for anybody that's impacted by it. That's initially been our employees in China. I have to say I'm incredibly impressed and proud of the way that our leaders have handled it. They've done it really well. Our employees have been very calm and very professional throughout what has been a really tough position. So in China, we have 8 factories. We have 7 of those factories now open after an extended shutdown period following the Lunar New Year, and the 7 that are open are running at sort of 50% to 60% capacity, reflecting the available employee base. We've got 1 factory in Hubei province, which is still closed. The expected reopening date for that plant is the 11th of March, albeit that could still shift. So our current estimate for the impact on revenue and profitability is a GBP 7 million revenue impact and a GBP 3.5 million profit impact for the full year, and that's captured in the press release. That's a full year impact. I think it'll be a little worse than that in the first half, and we expect to see some recovery in the second half of the year. That has been built up as a bottom-up estimate plant by plant, looking at the particular customer situations. It assumes that there's a certain amount of revenue, obviously, that's gone for good, reflecting lower demand, lower consumption and some modest recovery of revenues in the second half from things, perhaps in the project activity that might slip to the right. It assumes that we get back to full output in our plants in China over the next couple of months. So by the end of April, we expect to be back at full run rate. Beyond the situation in China, we do have a global footprint. We have facilities all over the world, including in South Korea and in Italy, both countries at the moment that are experiencing quite sharp increases in reported cases of the virus. Our plant in Northern Italy is currently closed, following actions by the local authorities. Our best understanding at the moment is that the plant will be closed for a couple of weeks. We haven't estimated any financial impact from that at this stage. And so I think that's the position and I think how we got to it. I'm happy to follow-up on that, if there's anything else. Peter, perhaps you could comment on?

Yes. So if I take ceramic armor first. So we did about GBP 35 million of revenue in ceramic armor in Seals and Bearings in 2019. We think that will be a similar kind of level sustained into 2020. So we've got reasonable order coverage for this year to sustain those kind of levels. Clearly, at some point, that will reverse and go back to its sort of more historic levels. At the moment, we're assuming that's 2021. But as you rightly said, we've sort of been expecting that to drift down sooner than it has, so the orders that we've had there have sustained for longer than we expected. It's been very warm additional business, good additional cash contribution for us as we've sustained that business, and we've executed very nicely against delivering for the customer there. So ultimately, it will depend on the end customers' demand. We don't have visibility beyond the end of 2020, but for this year, at least, we think it will sustain. On the efficiency side of things, we -- as Pete said, we've still got more we think we can drive in terms of efficiency across the group. Just as a reminder, though, we do need to sort of square off the equation of pricing and cost inflation first. So typically, we're doing about 1.5% on sales price. We're typically seeing cost inflation running around 2.5%. So we need some efficiency actions to square that circle before we can get some net benefits to the P&L. But as you saw last year, we managed to do some of those, and we think we've still got potential to do more as we move forward. But exactly how much will depend a little bit on the net of pricing and cost inflation. It's a much bigger kind of net number that we're working with as we move forward.

It's Ed Maravanyika from Citi. Just on the coronavirus impact. Are there any other plants, besides your Chinese plants and the Italian plant that you mentioned, that might have been caught up with it from a supply chain perspective? Is there anything that comes from China that goes to other plants? And just on your leverage level sort of 1x now, is that aggressive enough?

Okay. Again, I'll pick up coronavirus. Peter, I'll let you go into leverage. So from a supply chain point of view, Ed, no material impact that we can see at this stage. I think the sort of internal supply chain inside of China is starting to recover. Goods and materials are starting to move between the 2 factories and between provinces. So we -- I'm not aware of any of significant shortages of material around the world as a result. Obviously, it's a fairly dynamic situation there. We need to kind of keep an eye on that. But up to date, no, everything we know is baked into that estimate we've provided. Peter, on leverage?

Yes. So from a leverage perspective, as you said, we've made good progress over the last 3 years. I think we're now at sort of more comfortable financial position. I don't think it's yet kind of inefficient, if I can put it that way, particularly given where the pension deficit still sits. So relative to our size, the pension deficit still was significantly lower than it was 3 years ago, still a reasonably significant number. So we need to continue to commit cash into that scheme. And whilst that's the case, then I think the leverage where it is, is at an appropriate level.

I'm Mark Fielding from RBC. There's actually a couple of follow-ups. So in relation to the leverage question, I suppose, the next step to that, though, is obviously you're making good progress in terms of the efficiency, the self-help side of things. Do you start to think more actively and progressively about M&A in the business and areas for expansion? And what would be interesting to you in that context? And just separately, can I go back also to the body armor side of things? And just to clarify, to be clear, it is a continuation of the existing contracts. I'm just curious if there's any new avenues of contracts or new business areas there. And if anything has changed your view on what is the normal level that it could fall back to?

Okay. I'll take M&A, and you can deal on that one. So in terms of M&A, we are looking actively for incremental acquisitions. That's an activity we've been working on, probably with some greater effort over the last 12 months or so as we've sort of stabilized and developed the teams that we've got off the business. At any given moment, we have a handful of things that we're looking at. I think nothing is in an advanced stage. And given a number of our segments are relatively mature, there don't tend to be lots of opportunities out there that are really attractive and value creating. So it's something that we're keen to do. We're looking hard. I'm not expecting that to turn into a sort of significant amount of M&A activity. I think a deal every sort of 2 or 3 years is probably the realistic outcome as opposed to sort of several per year. But obviously, there's a degree of opportunism about that depending on sort of timing and availability.

Now on the ceramic armor market, it's the continuation of the same kind of end customers' demand, if I can put it that way, so we're continuing to service that same market demand. Our view is that, at some point, that will cease when they've completed their replenishment cycle, and so we'll go back to its historic levels. I don't think there's anything that we know today that says that doesn't drop back to sort of GBP 5-plus-ish million a year in the longer-term steady state at some point.