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

Good morning, everyone. I'm Pete Raby, the Chief Executive of Morgan Advanced Materials. I'm joined on the call by Peter Turner, our CFO. I'm going to say a few words of introduction. Peter will then take you through our interim results for 2020. And I will then talk through the business unit performance and wider strategic progress that we're making across the group. I'll start with COVID-19. The safety of our people is the top priority for our business. And during the first half, we've made a lot of changes in our plants, our warehouses and our offices to ensure that we can maintain a safe working environment. We've changed the physical layer to maintain social distancing. We've introduced the appropriate hygiene and disinfection processes. We've provided additional PPE, and we've reviewed our work processes, changed them as necessary to keep people safe. And these measures will remain in place for as long as necessary, and they allow us to operate our facilities safely. We've changed our ways of working to keep our people safe, and I'm very proud of the way that all of our employees have responded during this very difficult time. It has been a tremendous effort, and I want to thank all of our employees for their support. With the rapid action taken by our teams and with the essential nature of many of our products, we've been able to keep most of our plants operating through the second quarter of this year. Wherever our customers are in the world, we've been able to maintain supply of products for critical sectors from power generation to food preparation to health care, using local capacity or our global footprint if local supply was interrupted. During the first half, we had some of our plants closed for periods, reflecting the actions of national and local governments to manage the virus. All of our plants were operational during the month of June with Mexico and India the last to reopen. During July, we've had 2 facilities: one in the U.S.A. and one in India closed a short period. And as of today, all of our plants are open. So moving to the summary. Our trading in the first half has been resilient with revenues of GBP 478 million and 8.8% decline on an organic constant currency basis. This demonstrates the improvements that we've made to the business in recent years, the impact of our cost controls and the benefits of our diverse end markets. We've taken rapid action to manage our costs and delivered EBITDA margins of 11.1% despite the sharp revenue decline. We've also worked hard to preserve cash and have improved free cash flow to GBP 26 million to give a net debt-to-EBITDA ratio of 1x, excluding IFRS 16 impact. With demand expected to remain weaker for some time, we've accelerated existing restructuring actions that we would have taken over the next several years, and we expect this program to deliver a GBP 20 million reduction in our cost base by 2022. This will allow us to emerge stronger from this crisis, trading well through the period of lower demand and enable us to expand our margins from historic levels once volumes return to more normal levels. I'll now hand over to Peter to take us through the financial results.

Thank you, Pete, and good morning, everyone. Let me start with the summary financials for the period. Revenue of GBP 477 million was 8.8% lower on an organic constant currency basis. We saw a decline of 3% in the first 12 weeks of the year, largely driven by the impact of COVID-19 in China, followed by declines of nearly 20% in April and May as the impact of the pandemic was felt across the rest of the world. The revenue decline improved slightly in June to around 9%. Group headline operating profit was GBP 52.9 million with margins of 11.1%, reflecting the lower volumes, partially offset by our rapid actions to adjust the cost base of the business to reflect the lower demand position. Operating cash flow was GBP 59 million, and free cash flow at GBP 26 million was a particularly strong performance. Headline EPS was 11.5p per share, reflecting the lower operating profit, partially offset with a reduction in the effective tax rate to 27%. We are not declaring an interim dividend with these results. We recognize that dividends play an important part of the returns for shareholders. However, at present, forward visibility remains limited, and so the Board will continue to review this position during the second half of 2020. The Board intends to resume dividend payments once we see a sustained improvement in demand compared to the position seen during the second quarter. On a statutory basis, we made a loss in the first half, driven by the impairments of assets, which I'll cover shortly. And as usual, we've included in the appendix the financial information in statutory format. Turning now to the year-on-year movement in our headline operating profit. This chart illustrates the key drivers. We've seen a significant impact from the reduced volumes, particularly in the second quarter. We've continued to realize positive pricing, which has offset cost inflation with our ongoing continuous improvement activities driving further benefits in the period despite the disruptive environment we've seen. These savings have been supplemented by our actions on discretionary cost savings, including curtailment of discretionary spend, a temporary hiring freeze for all but the most critical roles and temporary salary reductions for the Executive Committee and Board. Turning next to restructuring. As Pete mentioned in his introduction, we've launched a program to position the business for a period of lower demand. We regret that this will lead to job losses. However, this will allow the business to emerge from this crisis stronger. This program involves a number of activities. Firstly, we've seen a significant reduction in the demand in our aerospace end markets, in particular in ceramic cores and believe that this downturn is likely to be sustained for an extended period. In response to this, we've announced the closure of Ceramic Core manufacturing sites in both the U.K. and the U.S.A. Secondly, we're closing sites in underutilized production lines in Thermal Ceramics to align our capacity to lower industrial and automotive demand. And finally, more widely across the group, we are taking the steps to align our cost base to the overall lower demand position. Overall, this program will have a cash cost of GBP 30 million, comprising redundancy costs and other costs associated with the closure of the impacted sites. This program will deliver annual benefits of GBP 20 million by 2022. The anticipated phasing of the costs and benefits of this program are set out on the table on the slide. On the specific adjusting items, in the first half, we've reported a GBP 68.9 million charge. GBP 5.5 million of this relates to the initial costs incurred in association with the restructuring program on the previous slide. We then have impairments of assets of GBP 63.4 million. Within Technical Ceramics, this primarily relates to the Ceramics Cores business, where we've seen a significant downturn in aerospace demand. The impaired assets comprise intangible assets recognized upon the acquisition of the Carpenter business back in 2008 and property, plant and equipment. Within Thermal Ceramics, the reduced demand in aerospace, automotive and industrial markets have resulted in impairments. These include assets that are related to the closure of sites and underutilized production lines as well as the impairment of intangible assets recognized upon the acquisition of Porextherm in 2014. Turning now to cash flow. On trade working capital, we've seen an improved position this year, in particular, on trade debtors. We've constrained capital expenditure given the economic environment, but continue to invest in projects for health, safety and the environment as well as other select projects to improve efficiency. On the financial items, you can see the reduced interest paid following the repayment of one of our U.S. private placement notes at the end of last year, and the movement in tax paid reflects the lower profitability as well as the benefit of permitted deferrals in certain jurisdictions. Free cash flow before dividends for the year was GBP 26 million, significantly improved on the prior year, reflecting the benefits of the actions we've taken to improve our liquidity during this period. This next slide is a reminder of our strong maturity profile of our debt with no maturities due before 2023. The net debt-to-EBITDA ratio on a pre-IFRS 16 basis, which most closely aligns to our banking covenants, remains at 1x, in line with the year-end position. We also have significant liquidity with cash of GBP 122 million and undrawn headroom on our revolving credit facility of GBP 117 million. Additionally, we've been confirmed as an eligible issuer under the U.K. government's CCFF facility with a facility limit of GBP 300 million, although this is unused, and we do not have any plans to utilize this facility at present. Overall, we have a very resilient balance sheet position. On pensions, we've seen a relatively modest GBP 8 million increase in the deficit in the half with the cash contributions and investment returns nearly matching the movements on the liabilities caused by lower discount rates. This reflects the work carried out over the last few years to make the pension scheme position much more robust and to better match the assets and liabilities of the scheme in terms of both interest rate volatility and movements in inflation. And then finally, I've included an update on the financial framework for 2020. As you can see, we expect our headline effective tax rate to continue to be around 27% this year. Based on the 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, a noncash pensions financing charge of around GBP 3 million and GBP 3.5 million of interest on our lease liabilities. We expect our cash contributions to the defined benefit pension schemes across the group to be around GBP 21 million, the majority of which is to our U.K. schemes, as previously outlined. And as usual, we've set out in the appendix sensitivities for revenue and headline operating profit for changes in value of sterling against both the U.S. dollar and the euro. On portfolio, just a reminder that following the divestment of our U.K. Electro-Ceramics business in 2017, in June this year, we closed our U.S. Electro-Ceramics business, following the completion of last-time buys for our customers. This will be a headwind to operating profit of just over GBP 2 million in the second half and nearly GBP 3 million in the first half of 2021. On capital expenditure, given the constraints we've placed there, we expect this to be around GBP 30 million this year. That covers the key financial items. And 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 an update on our wider strategic progress as a business. To frame the business unit performance in the year, Slide 15 shows the growth rates of the group in the first half in our major market segments, and we've also included the second quarter impact to give you a view on the changes from the first quarter. Revenues in our Industrial segment declined 18% during the first half, with volumes down in all regions, reflecting the weakness in global industrial markets. Transportation was down 20%, with Automotive and Aerospace severely impacted by the pandemic. Chemical and Process Industry revenues were up 15%, driven by later cycle project activity in Thermal with strong demand in Asia and North America in particular. Security and Defense revenues increased 45%, driven by higher ceramic armour sales and Seals and Bearings and some other defense sales from Technical Ceramics in North America. Semiconductors declined 7%, with growth in Asia, more than offset by declines in North America and Europe and reflecting the end-of-life of some electronics product lines in the North American [ piezoceramics ] business that ceased production in the second half of last year. Health Care revenues grew 12%, driven by product sales for a variety of medical applications. And finally, our revenues for the Energy segment declined 16% with reductions in power generation and a reduction in associated maintenance activity. Overall, we delivered a resilient performance in a very challenging market. Moving to our global business units. I'll start with Thermal Ceramics. Thermal Ceramics revenues declined organically by 13.9%, with industrial markets down globally and Automotive down significantly, partially offset by growth in insulation products for the petrochemical industry. Operating margins declined to 7.7%, reflecting the drop-through on lower revenues, partially offset by cost reductions. Margins were also depressed by a GBP 2.5 million credit loss provision taken in this business. Turning to Molten Metal Systems. Revenues were down 15.7% organically on the prior year, with declines in all regions reflecting the weakness in the end market demand for aluminum primarily in Automotive and Aerospace. Margins declined 2.6% from the prior year, reflecting the drop-through on the reduced revenues partially offset by cost reductions. In Electrical Carbon, revenues declined 8.4% organically, with declines in industrial markets, rail and energy, partially offset by strong growth in the semiconductor segment in Asia. Margins expanded 3.1%, reflecting the benefits of cost reduction actions and a GBP 1.5 million one-off insurance credit relating to prior year claim. Moving to Seals and Bearings. Revenues grew 7.6% organically, with growth in the ceramic armour and health care offset by declines in industrial and transportation markets. Margins expanded by 1.2%, reflecting the drop-through on the higher volumes and the impact of cost controls within the business. And finally, Technical Ceramics. Technical Ceramics' revenues declined organically by 8.9%, with declines in industrial, aerospace and semiconductor segments, partially offset by growth in healthcare and defense. Margins reduced to 9.6%, reflecting the drop-through on the reduced revenues, partially offset by cost reductions. Let me now turn to our purpose and strategy. Our purpose is to use advanced materials to make more efficient use of the world's resources and to improve the quality of life. We deliver on that purpose through the products that we make and the way that we make them, and we use our purpose to guide our decision-making. In delivering on our purpose, we support 6 of the United Nations Sustainable Development Goals through the products that we make and also the way that we make them: supporting health and well-being; 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 already make a positive difference, and we are committed to doing more. During 2020, we're working on our detailed plans and our targets, and we'll provide an update on these with our full year results at the beginning of next year. Slide 22 shows our EHS performance in the first half. We've implemented a lot of changes quickly to keep our employees safe in our facilities during the pandemic. While doing this and working in different ways and with different facility [ plant ], we've maintained a good standard in our operations. We've seen an increase in the lost time accident rate. That's the number of accidents per 100,000 hours worked. But given the very disruptive impact of the virus, I think we've delivered a decent performance. We continue to make good progress in reducing our environmental impact with CO2 intensity, energy intensity and water intensity, all down on the prior year, and this is particularly pleasing given the inevitable inefficiency that we experienced with plants starting and stopping and running at lower capacity. And this reflects the benefit of changes that we made last year and during the first half of this year. Turning to our strategy. I'll briefly recap the key elements 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 and sustain their position. By scalable, I'm talking about our ability to run these on a global basis, getting synergies in technology, operations and sales. We'll serve markets that are growing and where we've got room to grow and where customers value our differentiated products and services. This is our strategy for the group. It's how we add value as a group. And through the execution of this strategy, we aim to deliver more resilient financial performance and faster growth. While the market environment has been very tough and has required a lot of changes in working practices, we have continued to make progress with the implementation of our strategy. We've got 4 execution priorities that we're working on during 2020. Starting with sales effectiveness. Our focus here is on [ embedding ] in the changes that we've made over the last 3 years. We've been completing the remaining training for sales and customer service people not trained last year. We've also been deploying upgrades to our CRM tool to provide a better user experience and functionality as well as embedding that tool into our review processes. And finally, we've continued to refine our pricing approaches, and that's continued to deliver benefits to profitability during the first half. Our second priority is technology. Our technology teams continue to make good progress with the development of new materials and new products, and we've seen some new materials starting to move from sampling into product successes. We have inevitably seen some slowdown in our customers' new product development cycle. That has a knock-on impact for us, and we have slowed our activity to match, but we're continuing to secure attractive new business. For example, in our Thermal business, we've developed a range of materials that provide fire protection for electric vehicle battery. In the first half of this year, we've seen our materials accepted for several platforms that will start production over the next 12 months. In our Electrical Carbon business, we've secured approval for a new wind brush and slip ring set with a large wind OEM, and we expect sales to start to ramp from the end of this year. Our third priority is building our teams, and I must say I'm really pleased with the progress that we've made here. And I think we're seeing the benefits of the work that we've done in the last few years. Our teams have switched to remote working seamlessly, and they've been able to address the many short-term business issues quickly and effectively. We've made changes to working approaches, of course, and we're doing as much as we can to keep individuals and teams connected and supported whether they are in our plants or whether they're working from home. During this year, we are working to transition our physical training programs to virtual. We ran virtual 3-day sessions for the final modules in our leadership development program, and we're taking the approach and [ lessons ] from that to our wider training activity. Our fourth priority is operational efficiency and effectiveness. We've met our target for efficiency improvements in the first half despite the disruption and lower activity levels, and this has supported our profitability. We have seen some impacts on our delivery performance with plants shut down or running at lower capacity, but we've performed well for our customers during the period. The deployment of our standard tools and approaches has continued, and we're absolutely seeing the benefit of that in our performance. Turning to the outlook. European and North American markets were weak during the second quarter as lockdown impacted economic activity levels. In Asia, we saw a steady recovery in activity levels during Q2, with China and South Korea largely recovering their Q1 decline. We saw the first impact of the virus on our order levels in China in the first quarter, and this spread to other geographies in the second quarter. Order intake has been extremely volatile in the last 4 months, and it is significantly down on the prior year. In April and May, orders were around 30% lower than 2019. In June and July, this improved slightly, with orders down around 20% on the prior year. And we expect this to translate into a continued revenue decline in the third quarter of this year. With our relatively short order visibility and the very considerable uncertainty around the outlook for the virus and the consequent impact on demand, we're not in a position to provide guidance for the full year at this point. So in summary, keeping our people safe is our top priority as a business, and we have measures in place in all of our plants to ensure social distancing and appropriate hygiene, disinfection and PPE. Our trading has been resilient with an 8.8% organic revenue decline. We've acted quickly to control our costs, and we've delivered operating margins of 11.1% and free cash flow of GBP 26 million. Our net debt-to-EBITDA ratio is 1x, giving us good headroom as we manage through this crisis. We've accelerated restructuring actions to further simplify the group and reduce our cost by GBP 20 million a year by 2022 for a cash cost of GBP 30 million. I'd like to thank our employees again for their support and their commitment to our business during this very difficult time. Thank you. Now that ends the formal presentation. We'll now take questions, and I will hand back to Hannah, who will explain the process for Q&A.

[Operator Instructions] We do currently have one question on the line from Richard Paige of Numis Securities.

Just a couple of questions from me. First of all, on the Armour side. Obviously, very good sales again there, now representing 1/3 of Seals and Bearings and obviously benefit through the margin there. Could you just update us on what the expectations are for that product looking forward on that? And just the second question on Technical Ceramics. Obviously, the drop-through there looks pretty high, GBP 5 million loss of EBIT on GBP 10 million loss of sales. Could you just give a bit more color around that? And to what extent sort of mix effect, particularly, I guess, I'm thinking Aerospace here has had the impact there, please?

Yes, sure, Richard. Yes, so Armour, it continues to be very strong for us. I have to say it's been a really outstanding job by the team, both in sort of winning the work and in, frankly, executing it flawlessly. I think we'll see -- it's probably a sort of another sort of GBP 20 million or so in the second half of this year, but we are expecting volumes to drop next year, I think, somewhere in the sort of GBP 20 million to GBP 25 million of Armour revenue next year is our current expectation. In terms of Technical Ceramics, you're right, the drop-through is a little higher there. I think I'd probably call out a couple of things. One, the particularly sharp drop in Aerospace. Volumes are down something like 50% and that's quite a difficult volume drop to sort of address in terms of cost reductions very rapidly. As Peter outlined, we are doing a number of plant consolidations within the Aerospace part of that business in order to provide a longer-term cost position that sort of matches the demand. And then the other piece there, we continue to invest in new product development and sort of new product, sort of start-up activities in parts of that business. So if you like, we preserve some costs in that business that we might otherwise have thought to remove just to make sure that we're well positioned to grow as we come out of it.

[Operator Instructions] We have a question from Anthony Plom of Berenberg.