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

Ladies and gentlemen, hello, and welcome to the Morgan Advanced Materials Half Year Financial Results 2021 Call. My name is Maxine, and I'll be coordinating the call today. [Operator Instructions] I will now hand you over to your host, Pete Raby, Chief Executive Officer, to begin. Pete, please go ahead when you're ready.

Thanks very much, indeed. Good morning, everyone. Yes, I'm Pete Raby, 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 2021. And I'll then take you through the business unit performance, our progress against our ESG priorities and the drivers of our growth. Starting with the summary. The safety of our people is our top priority, and we continue to operate COVID protection measures in our facilities as needed. We've delivered 4.2% organic revenue growth in the first half of the year, driven by a broad-based recovery in our end markets and the benefits of growth initiatives that are underway as part of our strategy. Operating margins have expanded 170 basis points to 12.8%, reflecting the benefits of our restructuring program, which we further accelerated in the first half and the drop-through on the incremental revenue. We've increased pricing in parts of the business where we have pockets of raw material inflation, and the combination of pricing and continuous improvement activity continue to more than offset cost inflation. Cash was very good in the first half with GBP 36 million of free cash flow, reducing net debt-to-EBITDA to 0.5x, excluding leases. Adjusted earnings per share increased 10% to 12.7p per share. Reflecting the strong momentum in the business and growing profitability, the Board has resolved to pay an interim dividend of 3.2p per share. We've also made good progress in the first half in reducing our CO2 emissions with a 17% reduction compared to the prior year. And this is a great further step towards our goal of reducing emissions by 50% by 2030 from our 2015 baseline. I'll now hand over to Peter, who will take us through the financial results.

Thank you, Pete, and good morning, everyone. Let me start with the summary financials for the period. Revenue at GBP 461 million was 4.2% higher on an organic constant currency basis. Group adjusted operating profit was GBP 59 million, with margins 170 basis points higher at 12.8%. It's pleasing to see that the benefits of our restructuring savings and efficiency actions, combined with the higher volumes, have returned margins to 2019 levels, even though we're only partway through the recovery from a top line perspective. Operating cash flow was GBP 63 million and free cash flow of GBP 36 million was a particularly strong performance. I'll cover more detail on cash in a moment. Adjusted EPS was 10% higher at 12.7p per share, reflecting the higher operating profit. The interim dividend declared is 3.2p per share compared to a 2020 interim dividend of 2p per share declared in the fourth quarter last year. As a reminder, the Board is looking to grow the ordinary dividend as the group's earnings improve, targeting a dividend cover of around 3x adjusted EPS on average over the medium term. As usual, we've included in the appendix the financial information in statutory format. The only significant adjusting item in the first half this year was a gain on the disposal of our associate. Turning now to the year-on-year movement in our adjusted operating profit chart. This chart illustrates the key drivers. We have seen significant benefits in the period from the acceleration of our restructuring program announced last year. We've continued to realize positive pricing, which, together with our ongoing continuous improvement projects, has more than offset cost inflation in the period. We have the benefit from higher volumes in the first half and the reversal of the discretionary cost actions we had in place during the uncertain period of the pandemic last year, such as salary and bonus reductions. We have a headwind from foreign exchange translation and also as guided, the impact from the business exits previously announced in Technical Ceramics. This next slide covers an update on the restructuring program we announced this time last year, which, as a reminder, primarily related to the closure of 8 manufacturing sites across Thermal and Technical Ceramics in response to the lower demand position we saw last year. We have made significant progress on this program and now only have 1 site remaining to be closed in the second half of this year. As a result, we have accelerated further benefits into this year with the current year savings now expected to be GBP 20 million with the full run rate savings of GBP 23 million attained next year for a total program cost of GBP 28 million. Turning now to our cash flow. On trade working capital, we've seen a modest working capital outflow in the first half, which reflects the growth we've seen in the second quarter of the year. On capital expenditure, this will be a rather second half weighted this year as we ramp up our engineering activities following the curtailment of CapEx last year. Free cash flow before dividends was GBP 36 million, significantly improved on the prior year, reflecting the continued focus on cash flow during the period. Included within the cash inflows on investing activities is a GBP 12 million receipt in the first half from the divestment of our 35% stake in [ Gem Tech ]. [ Gem Tech ] was our only investment accounted for as an associate of the group. Net debt-to-EBITDA, excluding leases, the measure which most closely aligns to our banking covenants, was 0.5x at the half year, and we've included in the appendix our usual summary of our funding profile. Next, on pensions, we've seen a GBP 48 million improvement in the deficit in the period, with the benefit from cash contributions and a reduction in the liabilities due to higher discount rates at the half year. Overall, we're making good progress in reducing our defined benefit pension scheme liabilities, and the U.K. schemes are now slightly ahead of the recovery plans anticipated at the time of the last triennial reviews. Finally, I've included an update on the financial framework for 2021. As you see -- you can see, we expect our adjusted effective tax rate to continue to be around 27% to 28% this year. Based on current exchange rates, we expect our finance charge to be around GBP 10 million comprising a cash interest charge of around GBP 6 million on our net debt, a noncash pensions financing charge of around GBP 2 million and GBP 2 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 20 million, the majority of which is to our U.K. schemes, as previously outlined. As usual, we've set out in the appendix sensitivities for revenue and adjusted operating profit to changes in value of sterling against both the U.S. dollar and the euro. Based on current exchange rates, we continue to expect this to be a headwind to our reported earnings. On portfolio impacts, following the divestment of our U.K. electro-ceramics business back in 2017, in June last year, we closed our U.S. electro-ceramics business following the completion of last-time buys for customers. This was a headwind to operating profit of nearly GBP 3 million in the first half of 2021. We also saw small impacts from the divestment of Diamonex business in the second half of last year and the divestment of our associates in the first half of this year, as previously mentioned. For 2021, we expect CapEx to revert back towards our more normal levels of between GBP 40 million and GBP 45 million. That covers the key financial items. So with that, I'd like to 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 progress against our ESG goals, the growth opportunities in our faster-growing markets and the business outlook. Slide 12 shows the organic performance in our major market segments. Revenues in our industrial segment grew 10% driven by European and Asian markets. Transportation was up 2% with automotive recovering strongly, largely offset by declines in aerospace in the first quarter. Chemical and petrochemical revenues declined as expected, reflecting the later cycle nature of project activity in our Thermal Ceramics business. Revenues in the health care segment grew 24%, driven by low temperature insulation products for medical transport and storage, implantable devices and medical imaging. Energy was up 26% with growth in power generation driven by the wider economic recovery and growth in wind and solar energy applications. Security and defense revenues declined by 30% with the expected reduction in ceramic armour sales in Seals and Bearings as that product line comes off the peak. Finally, semiconductors grew 10%, reflecting growth in that market for our ceramic and braze solutions. Overall, we're seeing robust recoveries in all segments with the exception of aerospace that remains well below 2019 levels. Moving to our global business units. I'll start with Thermal Ceramics. Thermal Ceramics revenues grew organically by 5.5%, driven by a strong recovery in the automotive segment, growth in health care and growth in industrial segments as those markets recover. Operating margins improved to 12.1%, reflecting the drop-through on the increased revenues, the impact of continuous improvement activities and benefits from our restructuring program. Turning to Molten Metal Systems. Revenues increased organically by 16.3% with strong demand in both the aluminum and copper segments, reflecting the wider recovery and some rebuilding of stock levels in our distribution channels. Margins expanded to 11%, reflecting the drop-through on the increased revenues and efficiency actions. In Electrical Carbon, revenues increased 10.5% organically with growth in industrial, rail and renewable energy markets, in particular, in Asia. Margins expanded to 19%, reflecting the drop-through on the increased volumes, pricing and continuous improvement actions and the benefits of our restructuring program. This was a really good operational performance by that team. Moving to Seals and Bearings. Revenues declined organically by 12.2% with the expected declines in ceramic armour. That was down GBP 12 million in the first half and then declines in aerospace, partially offset by growth in industrial markets. Margins declined to 16.6%, reflecting the drop-through from the reduced ceramic armour volumes. Turning to Technical Ceramics. Revenues increased organically by 6.6% with growth in health care, renewables and semiconductors, partially offset by a decline in aerospace. Margins expanded to 10.3%, reflecting the drop-through on the increased revenues and the benefits from restructuring actions. And this was partially offset by a GBP 3 million headwind from the closure of our North American piezoceramics business in June of last year following the completion of last-time buys. I'll now turn to our goals and progress on the environment, social and governance, or ESG. Our purpose is to use Advanced Materials to make the world more sustainable and to improve the quality of life. This purpose guides our decision-making and strategy, and we deliver on it through the way that we operate and manufacture our products and through the products themselves and the benefits that they bring to our customers. We're constantly investing in our manufacturing processes to reduce the environmental impact of our business. In parallel, we're investing in new materials and process technologies that improve the performance of our products and deliver bigger environmental and safety benefits to our customers. We've set 5 priorities that we'll be working on, and we've set targets for those for 2030. We will reduce our Scope 1 and 2 CO2 emissions by 50% by 2030 from our 2015 baseline as part of our aspiration to be net zero by 2050. We're committing to reduce our water consumption overall and in high and extremely high water stress areas by 30% by 2030, also from our 2015 baseline. We're determined to provide a safe, fair and inclusive workplace for our people. We've committed to a lost time accident rate target of 0.1 by 2030 against our goal of Zero Harm. We want our workforce to reflect the communities in which we operate, and we've set a target of 40% of our leadership population being female by 2030. Finally, we want a welcoming and inclusive environment for our employees where they can grow and thrive, and we set a target of achieving top quartile engagement score by 2030. Slide 19 shows our progress in reducing our CO2 emissions over the last several years and in the first half of 2021, which is shown here as an annualized figure. Our CO2 emissions are down 17% on the prior year, a good performance with the business growing 4% in the period. We have a broad-based improvement program underway covering energy procurement, process improvements and process and behavioral changes in our plants. In the first half, the biggest contribution has come from procurement, where we've transitioned to carbon-free energy for a number of our sites. Year-to-date, 27% of our electricity is coming from green or carbon-free sources. Turning to water. Our water withdrawal in high-stress areas is up 21%, and our overall water withdrawal is up 20% year-to-date. This is driven by the business growth and mix effects with a greater proportion of high water intensity products in the sales mix. We have projects underway to drive reductions in our water use. From a safety perspective, we've seen an increase in lost time accidents with 21 in the first half compared to 15 in the prior period. Total accidents are slightly down against the prior year. We're accelerating our training activity for leaders and employees as part of our wider efforts to improve our safety culture and performance. Finally, from a diversity and inclusion perspective, we set a goal of 40% of our leadership population being female by 2030. Our midyear position is 27%, slightly down on the 30% position at the beginning of the year with some open roles and a small shift in the population, which is impacting the figures. We've got a broad program of work in the planning stages here, and we expect that to drive improvements. I'm pleased with the progress we've made on CO2. We've got more to do to build momentum towards our other targets, executing on the plans that we have developed. A comprehensive update on our ESG goals and progress is covered in our midyear sustainability report, and that is available on our website. Together, our 4 faster-growing markets are approaching 20% of the group's revenues. And those are clean energy, clean transportation, health care and semiconductors. These markets have good underlying drivers, and we expect them to grow more quickly than our core business over the cycle. We're investing in new products and solutions to serve these markets, expand our share and increase the underlying growth rate of the group over time. Let me give you some examples. In the clean energy market, our ceramic components are used in the manufacture of solar panels. We've built close customer relationships and a rapid and interactive new product development process that allows us to develop new products quickly to meet their process needs. In the clean transportation market, we provide carbon strips to carry current from overhead lines to the train in rail and metro systems. We've invested in process technology that's reduced our lead time and shortened our new product development cycle. This enables us to modify our material formulations quickly to meet the varied needs of metro systems with different climatic conditions and infrastructure needs. Coupled with our responsive service and support model, this has enabled us to win share. In the health care market, we've developed an innovative coating technology that improves the performance of our power tube components for x-ray applications. This is providing superior performance to our customers and helping us to increase our share. In the semiconductor market, we're working with manufacturers of deposition equipment to provide very high purity silicon carbide components used to hold wafers during processing. We work closely with our customers who value both our differentiated material, which improves the performance of their equipment and our responsiveness in supporting their own product development road map. We're continuing to invest in new materials and product development and, where needed, in new capacity to win share in these faster-growing segments. We expect these segments to have high single-digit to double-digit growth rates. And these high growth rates are as a result of enduring global trends that we see today, including digitization, climate change and a growing and aging population. By increasing our exposure to these markets, we increased the underlying growth rate of the group. We incrementally expand our margins as newer products contribute to the mix and improve the alignment of our portfolio with our purpose, reinforcing our ESG credentials. So in summary, the safety of our people is our priority, and we're continuing with our COVID protections as needed to keep them safe. I'd like to thank all our people for their commitment, looking out for one another and providing great support for our customers in this challenging time. We delivered 4.2% organic revenue growth with a broad recovery in our markets, including in health care, semiconductors, clean energy and industrial and through share gains. Operating profit margins increased to 12.8%, back to 2019 levels, even though we're still below 2019 volumes, and that reflects the benefits of our restructuring program. Adjusted earnings per share increased 10% on the prior year. We've reduced our CO2 emissions by 17% despite the underlying growth of the business. Looking to the balance of the year, we've got good momentum across the business, and we expect the full year organic growth to be in the range of 7% to 9% with further increases in margins as the business grows. Thank you. That ends our formal presentation. We'll now take questions. The operator will explain the process for Q&A.

[Operator Instructions] Our first question comes from Richard Paige from Numis.

A couple of questions from me, please. First of all, Electrical Carbon, the margin -- I mean, the performance there is really strong. Margin up to 19%. And I think even in the comp you had an insurance benefit as well. So just could we dig a bit more into that? And obviously, ultimately, the sustainability, particularly on that margin side and the growth opportunity there and what's driving it, please?

Sure. Yes. So yes, really good performance, as you say. We were delighted with the progress -- the continued progress in that business and strong margins in the first half, as you say, 19%. The drivers there really, I mean, good continuous improvement momentum. We've got a very mature program in that business. That's been running for a number of years. Pricing, you can see the benefits of pricing coming through in that part of the business. And as with the other business units, we have the benefits of project -- the restructuring project that we've been running. And then across Electrical Carbon and some of the other businesses, you can just start to see some of the benefits of the new products that we've been developing coming through in there as well. In terms of sustainability, I think we'd probably say that's the sort of top end for Electrical Carbon margins. As that business sort of recovers above 2019 levels, we'll probably need to add some resources in there just to support the growth.

Okay. And then the second one, where are we with regard to aerospace? Is that now stable? And I guess could you just remind us of your sort of key platform exposures there, please?

Sure. So in terms of the position, I'd say it's improving slowly, Richard. I don't think we're seeing anything that's different to anyone else. In the second quarter of this year, aerospace was about 30% down on 2019 levels. I think that's about right when I look at global traffic patterns. I think in China, levels are back to normal. The U.S. is probably still 10% to 20% down on sort of prior period. Europe is lower and obviously, sort of wide-body long haul is still pretty depressed. In terms of platform exposure, it's very broad. Much of our exposure comes through our Technical Ceramics business there. We've got ceramic cores that go into aero engines across almost all sort of platforms that are flying. So it's a very broad-based exposure from that point of view.

Okay. Just to clarify that. So no real bias towards wide body or narrow body?

No.

[Operator Instructions] Our next question comes from Harry Philips from Peel Hunt.

So my first question on Electrical Carbon, but that was a hell of the performance. Just a sort of variety of them, if I may. Just could you remind us of the sort of body armour roll off this year? In my notes from the finals, we go from 49% down to sort of 20% to 30%. Do you have a sort of updated sort of, say, profile for that, that would be very helpful? In terms of the pension, I mean, obviously, great progress in terms of the deficit and all the other good things around that, but we still have this, just how long you have to pay GBP 20 million a year? I'm no pension experts, so apologies for the events of the question. But how long do you have to pay GBP 20 million a year for going forward? And then lastly, just in terms of energy, is it possible to split out the sort of new energy sort of solar, wind content of that broader end market, please?

Okay. Harry, it's Peter here. If I just pick up the first couple of questions. So on body armour, I think probably we're going to be in the sort of GBP 25 million to GBP 30 million range this year. So as you say, declining from GBP 49 million last year, as we expected, that continuing to decline. That will continue to decline, I think for the next year. It's probably too early to sort of guide for next year, but certainly for this year, we think we'll be in the sort of GBP 25 million to GBP 30 million range. On the pension deficit, yes, I mean, pleasing progress. Nice to see we're ahead of the recovery plan. Those recovery plans we set, I guess, based on the sort of 2019 actuarial assessments have recovery periods through to 2025 and 2027, the majority of the contributions carry on to 2027. So we've really got another -- a good few years ahead of us, Harry, in terms of continuing to put cash into the schemes.

Yes, so energy, about 40% of what we do in energy is in renewables.

Our next question comes from Margaret Schooley from Stifel.

I had 1 on M&A, given the strength of the balance sheet now. And at the full year, you did mention that perhaps you would be dipping your toe back in selectively for bolt-on M&A. Can you just give us an update on what areas you might be focusing on? And what you're seeing out there in terms of pipeline? And then potential pricing of assets?

Yes, sure. So yes, we are looking to undertake incremental M&A. We've been working on that diligently since, I'd say, sort of the back end of last year. The pipeline is developing. I wouldn't say it's super mature at this point. But we are looking, in particular, anything that can accelerate the development of our strategy. So that would be adding technology or perhaps routes to market, in particular, in those 4 faster-growing market segments of clean energy, clean transportation, semiconductors and health care. We will look at if there are opportunities to consolidate within the core as well. But in many cases, those markets are quite concentrated for us. So we're continuing to work hard on that. I continue to believe it's probably sort of a deal every couple of years rather than more frequently just given the availability of prospects we've got, but there is obviously a level of opportunism to the timing of those things. In terms of pricing, I think it depends usually on the specific asset that we're dealing with. So I don't think I can give you much insight around that until we get to specifics.

[Operator Instructions] Our next question comes from Daniel Cunliffe from Liberum.

Just regards the body armour business, if you strip out the delta on this half, it looks like the underlying business was flattish, but of course, I'm not quite sure of the FX impacts. Can you sort of help me with that? Is that sort of a fair assumption that from a volume perspective, obviously, the revenues look flattish ex that delta, but from a volume perspective, where should we think you just see the quantum on that?

If that's specifically on Seals and Bearings, I think that -- the analysis is broadly right. Obviously, we've got revenue FX headwinds this year. I think the other thing I'd just highlight for Seals and Bearings is they do have some aerospace exposure and aerospace is obviously down in the first half on the first half last year, just given we didn't really see the impact of the pandemic until the quarter of last year. So that's the other feature for Seals and Bearings.

[Operator Instructions] We currently have no questions registered, so I'll hand it back to you.

Very good. Well, thanks so much, indeed, everyone. Thanks for your time. That wraps it up.