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

Hello, and a warm welcome to the Morgan Advanced Materials 2022 Half Year Financial Results Call. My name is Lydia, and I'll be your operator today. [Operator Instructions] It's my pleasure to now hand you over to Pete Raby. Please go ahead when you are ready.

Thank you, Lydia. Good morning, everyone. I'm Pete Raby, the Chief Executive of Morgan Advanced Materials. I'm joined on the call by Richard Armitage, our CFO. I'm going to say a few words of introduction. Richard will then take you through our interim results for 2022, and I will then talk through the business units' performance and growth drivers and our progress against our ESG priorities. Starting with the highlights. The safety of our people is our top priority, and I'm grateful to all of our people for how they've looked out for each other during the first half of the year, keeping each other safe while increasing output rapidly to meet customer demand. We've delivered 11.2% organic revenue growth, with 15% growth in our faster growing markets and a 11% growth in the core. I'm pleased with the further progress in our faster growing segments, reflecting the focus and investment that we've been making. Operating margins have expanded to 13.7%. We've seen inflation increasing during the first half as expected and we pass that on to our customers with higher pricing. The impact of pricing and continuous improvement more than offset the cost inflation that we've experienced year-to-date. The strong growth in revenues and profitability has delivered a 22.2% return on invested capital. Earnings per share of 15.9p is up 25% on the prior year. We saw a modest free cash outflow during the half and we ended the half with net debt to EBITDA of 0.5x. We've also made further progress in reducing our CO2 emissions with an 11% reduction compared to the prior year. I'm very pleased with the further progress that we've demonstrated during the first half. We've delivered strong revenue growth and expanded margins as planned in a challenging supply chain and labor environment. We've done much to strengthen the group over the last 6 years and that's underpinning our performance and it gives us confidence as we face into the uncertain environment over the next couple of years. I'll now hand over to Richard to take us through the financial results.

Thank you, Pete, and good morning, everyone. Let me start with an overview of the financial results through the 30th of June. Revenue at GBP 530.2 million was 11.2% higher than prior year on an organic constant currency basis. Group adjusted operating profit was GBP 72.5 million, with operating margin 90 basis points higher at 13.7%. Inflation to date has been recovered in full, with further margin expansion achieved through efficiency savings and higher volumes. Cash generated from operations was GBP 45.2 million and free cash flow, a small outflow of GBP 1 million, both lower than last year due to an increase in working capital that I will come back to shortly. Adjusted EPS was 25.5% higher at 15.9p per share, reflecting the higher operating profit and slightly lower tax rate. The interim dividend proposal is 5.3p per share. 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 have included in the appendix the financial information in statutory format, and there were no significant adjusting items in the period. Moving on to the profits bridge. We can see the year-on-year movements in our adjusted operating profit with the key drivers. We can see, firstly, the benefit from higher volumes in the year. This growth has been broad-based with all business units seeing growth of between 18% and 21%. We are benefiting from the final savings from our restructuring program, which will amount to an additional GBP 3 million for the 2022 full year, bringing the total to GBP 23 million as previously communicated. Our aim continues to be to offset inflation with pricing, which together with our ongoing continuous improvement projects has more than offset cost inflation in the period. There has also been some investment in additional overheads, particularly in R&D and sales in support of our ongoing growth programs. Finally, we have benefited from a small tailwind from the weakening in sterling, which has improved operating profit by just under GBP 3 million. Moving on with the cash flow. We have seen quite a substantial increase in working capital, driven principally by 3 factors. Firstly, revenue growth has added a bank of GBP 10 million of working capital. Then we have seen an additional increase in inventory of around a further GBP 10 million as a consequence of needing to increase safety stocks at a number of sites in response to supply chain concerns. Finally, the effects of a weakening in Sterling has accounted for much of the rest of the increase. I would note that the quality of our debtor book has remained stable with no particularly material bad debts or changes in customer payment terms arising. Capital expenditure was in line with expectations with GBP 22.5 million, an increase of GBP 13.9 million compared to the prior year. Free cash flow before dividends was, therefore, a small outflow of GBP 1 million for the half. It is worth noting that net cash flows from other investing and financing activities in the prior year benefited from the proceeds of the sale of the [ Gemtech ] business in 2021. Net debt was GBP 76.3 million, excluding lease liabilities. Net debt to EBITDA, excluding leases, the measure which most closely aligns to our covenants was 0.5x at the period end. We have included our usual summary of our funding profile in the appendix. Finally, I've included an update on the financial framework for 2022. As you can see, we expect our adjusted effective tax rate to continue to be in the range from 26% 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 6.5 million on our net debt, a non-cash pensions financing charge of around GBP 1 million and around GBP 2 million of interest on our lease liabilities. We would note that the IAS 19 deficit in relation to the group's pension scheme has fallen further at GBP 29.2 million since December. We expect our cash contributions to the defined benefit schemes across the group to be unchanged at around GBP 20 million for the full year, the majority of which is to our U.K. schemes, as previously outlined. Overall, the group's balance sheet remains strong, giving us a range of options for the deployment of capital in the medium term. As usual, we have set out in the appendix sensitivities for revenue and adjusted operating profit to changes in the value of sterling against the US dollar and the euro. For 2022, we expect capital expenditures to be around GBP 55 million as we invest to support continued growth in the business, in efficiency projects and in our infrastructure and ESG projects. That covers the key financial items. So with that, I'll hand you back to Pete.

Thank you, Richard. I will now take you through the performance of our business units, the growth performance in our faster-growing markets, an update on progress against our ESG goals, together with our current positioning and the business outlook. Slide 10 shows the organic performance in our major market segments. Revenues in our Industrial segment grew 14%, with broad-based growth across the major industrial economies. Transportation was up 5%, with growth in aerospace offsetting a decline in automotive. Chemical and petrochemical revenues grew 15%, with strong sales of Seals and Bearings components, together with modest growth in thermal insulation projects. Semiconductors were a standout, with 50% growth year-on-year, reflecting the strong demand and share growth following the investments that we've been making in this sector. Revenues in the Healthcare segment grew 4%, with strong demand for medical imaging and implantable products, offsetting a decline in low temperature insulation sales for vaccine transport. Energy was down 6%, driven by declines in the solar market with carbon felt sales to Asia down on the prior year, impacted by COVID in China and freight cost. Security and defense revenues declined by 4%, driven by a decline in ceramic armor sales as we expected, as that business reduces steadily from the 2020 peak. Moving to our global business units. I'll start with Thermal Ceramics. Thermal Ceramics revenues grew organically by 11.1%, with good growth in all the major industrial markets and growth in energy markets. Operating margins declined to 11.3%, with our pricing and continuous improvement actions offsetting but not exceeding inflation, hence compressing the margin percentage. Turning to Model Metal Systems. Revenues increased organically by 20.6%, with strong demand and share wins in the aluminum segment. Margins expanded to 14.9%, reflecting the drop-through on the increased revenues and efficiency actions. In Electrical Carbon, revenues increased 8.4% organically, with a very strong growth in the semiconductor segment, together with growth in wind energy projects. Margins expanded further to 20.7%, reflecting the drop-through on the increased volumes, together with pricing and continuous improvement actions that more than offset cost inflation. This is another very impressive performance by the team. Moving to Seals and Bearings. Revenues grew organically by 7.8%, with a reduction in armor as expected, offset by growth in aerospace and petrochemical. Armor was down slightly at GBP 12 million in the first half, and we expect armor sales for the full year to be around GBP 20 million to GBP 25 million. We have seen some additional orders here for shipment this year, given the situation in Ukraine. Margins declined to 15.2%, driven by adverse armor sales mix. Turning to Technical Ceramics. Revenues increased organically by 13.3%, with growth in industrial, semiconductor, healthcare and aerospace segments. Margins expanded to 13.6%, reflecting the drop-through on the increased revenues and the benefits from our restructuring program. Over the last 4 years, we've increased business and product development activity in 4 faster-growing market segments: clean energy, clean transportation, semiconductors and healthcare. These markets have good underlying long-term growth drivers, and we expect to grow more quickly than our core business over the cycle. In the first half, these markets accounted for 21% of the group's revenues. I'm pleased with the further rapid growth in these segments in the first half, with organic growth of 15% ahead of our core markets, which grew 11%, reflecting the benefits of our investments. The semiconductor segment was, again, the standout. Organic growth of 50% was a broad-based success, with share gains at existing customers and wins with new customers, increasing our exposure to the semiconductor manufacturing process. We expect these faster-growing segments to have high single-digit to double-digit growth rates through the cycle. These high growth rates are a result with the enduring global trends that we see today, including digitization, climate change and a growing and aging population. We're continuing to invest in new products and solutions to serve each of these markets. By increasing our exposure, we increased the underlying growth rate of the group, 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. I'll now turn to our goals and progress on the environment, social and governance, or ESG, shown here on Slide 17. 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 have 5 ESG priorities that we'll be working on, and we've set targets for those for 2030. We'll 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. We're also 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 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've set a target of achieving a top quartile engagement score by 2030. Slide 18 shows our progress in reducing CO2 emissions since 2015. Our CO2 emissions in the first half were down 11% on the prior half year, a good performance with revenues growing 11%. We have a broad-based improvement program underway covering energy procurement, process improvements and behavioral changes in our plants. In 2022, the biggest contribution has come from procurement, where we have transitioned to carbon-free energy for a number of our sites. 49% of our electricity now comes from green or carbon-free sources. Turning to water, safety and diversity on Slide 19. Our water usage is up 10% over 2021 first half levels, driven by the growth in the business and some shifts in product mix towards more water-intensive products. Similarly, our water usage in high and extremely high stress areas increased 6.3% in the year, also driven by the growth in volumes, partially offset by improvements in water intensity. We have projects underway to drive reductions in our water use across the business, and those will start to deliver on completion in the second half. Looking at safety, we've seen an increase in our lost-time accident rate, that's the number of lost time accidents per 100,000 hours worked. Our rate increased to 0.29, up from 0.22 at the end of 2021. We're well underway with the refresh of our thinkSAFE behavioral safety program during the year, with training now completed by around 80% of our employees. We're reinforcing our training, increasing safety tours, safety discussions, near miss reporting and root cause analysis of all of our lost-time incidents in any significant near misses. This is a significant focus for us as we look to improve our performance. From a diversity and inclusion perspective, we set a goal of 40% of our leadership population being female by 2030. Our half year position is 31%, slightly improved on the 29% position at the beginning of the year. We've got a broad program of work underway to drive improvements here, making changes to everything from policies to training to recruitment processes. In summary, we delivered 11.2% organic revenue growth with a broad recovery in our markets and through share gains. Together, clean energy, clean transportation, semiconductors and healthcare grew 15% in the year. Operating profit margins increased to 13.7%. Our pricing actions, together with continuous improvement more than offset inflation during the first half of the year, and we expect to do the same in the second half. ROIC increased to 22.2% and earnings per share were 15.9p, up 25% on the prior year. Free cash flow was modestly negative, and net debt to EBITDA is 0.5x. We've reduced our Scope 1 and 2 CO2 emissions by 11%, despite the underlying growth in the business. We're pleased with the performance and the momentum in the first half of the year. As we previously indicated, we are expecting a moderation of growth in the second half of the year, reflecting challenges in the wider economy. Nonetheless, we expect our profitability for the full year to be around the top end of analysts forecasts. We've made a wide range of significant improvements to the business over the last 6 years. The business is growing more strongly, margins are at much higher levels and the balance sheet is strong. We're well placed to navigate the potential economic challenges in the near term and deliver a resilient performance. Thank you. That ends our formal presentation. With that, we'll now take questions. I'll hand you back to Lydia, who will explain the process for Q&A.

[Operator Instructions] Our first question today comes from Scott Cagehin from Investec.

Just 2 quick questions, please. Maybe the first question might be a bit longer. But could you just go into a little bit more detail on the growth in semiconductor? You talked about market share gains and product innovation, et cetera. Could you just give us a little bit more color on that, where it's coming from? Is it different regions, more products specifically? And then the second question is, given where the balance sheet is -- sorry, for the obvious question, but is there any update on acquisitions? Are you doing more work on that? Are you seeing any changes out there that gives you more encouragement that you may be able to do some in the future?

So yes, on the growth in semicon, yes, I'm really pleased with the performance. Much of the sales for our semicon products go through Europe and the US, which is where the OEMs tend to be. So the end markets will be fabs, which are obviously global, but probably with a heavier weighting in Asia. But a lot of -- even our aftermarket products go through the OEMs to the end market customer. The growth really is across the whole sort of semiconductor manufacturing process, so crystal growth. We've seen strong appetite there for some of our carbon products, deposition, etch, ion implantation, a lot of -- again, a lot of activity. I think the semiconductor market in general is strong, and we've continued to win share with some of the new products that we've introduced over the last 12 months to 18 months. In terms of sort of balance sheet and M&A, you're absolutely right, the balance sheet is robust and we are actively seeking M&A prospects. We continue to work diligently on that. I would say, we haven't seen at this point, much moderation in sort of price expectations from sellers. We've looked at a number of things during the first half of the year and unfortunately stepped away either on the basis of a strategic fit or a sort of price expectation that wasn't realistic. That is something we're absolutely upping the intensity on. We're very keen to do incremental M&A that can accelerate our strategy and Rich is actually going to take the lead on sort of driving that on behalf of myself and the Board to push that through a little bit faster.

Our next question today comes from Maggie Schooley of Stifel.

I have a few, if I may. It's evident that price increases have been successfully implemented in the first half numbers, and will have been well understood by clients given the current climate. But as you look forward, is there any sign that price elasticity maybe more challenged, particularly perhaps in the core as opposed to the faster-growing markets? So just an understanding of what you're seeing there? And then secondly, in energy, you called out solar market is more challenging. I assume this is because of some of the tariff issues in the US. But there was recently an executive order to get a 24-month bridge or reprieve for some of the solar imports in the US. So are you starting to see that market potentially pick up as you exited the period? And then lastly -- sorry for the third one. Just a follow-up on Scott's question. Just very basically, on the electronics, can you split that? Are you able to split that end market spend between what you would consider CapEx-driven versus consumer-led electronics exposure if possible?

Sure. So let me comment on pricing. I'll let Richard pick up on that a little bit as well, just perhaps to give his perspective. I don't think we're seeing any signs at this point of difficulty passing on price increases to customers. Clearly, we are seeing high levels of inflation across the board. And I think that's well understood by customers. I assume, as we head into 2023, those high levels of inflation will drive some level of demand destruction in the wider economy and probably my central case is that leads to some level of recession in sort of Europe and the US. And there may be a pricing impact in due course as sort of capacity utilization declines a bit. But certainly at present, we're not seeing anything. I don't know, Richard, do you want to add anything on the sort of just the pricing we've seen in the first half and how you're thinking about that?

I think my assessment would be the same as Pete's. I think, for us, I'm very focused on what we can do about it. And the only thing we can do really is just to ensure that we are as transparent as possible, having delivered a good performance in the first half. We are preparing to be able to respond quickly to whatever might come along and aim to continue that performance. And then we'll see what happens, I guess.

To your question on energy and solar, Maggie, there are couple of sort of specific things for us. So, there were some one-offs in our sort of solar numbers last year. We've done some project activity with some of our customers, which we didn't expect to repeat and they haven't. So that just impacts the comp a little bit. And then you're right, some of it is Asia related. We do export. It's one of the few things we do export from the US into Asia, some carbon felt products that are used in solar panel manufacturing or solar cell manufacturing today. They are a combination of sort of COVID impacts in China in the second quarter, together with just freight rates around that, have depressed that part of the business. It does tend to vary a little bit according to sort of demand levels and sort of landed costs in the region. But those are the sort of the headwinds. The rest of that's sort of renewable energy side in terms of wind, et cetera, has been robust. And then on electronics and semicon in terms of the mix, I can't give you a direct split, in part, because we don't know it. In many cases, we're supplying products to OEMs and it's not clear to us whether they sell it as an aftermarket sale or as a new equipment sale. What I would say in general is the products we're supplying are consumable items. And so it is likely that the majority of it, just given semiconductor manufacturing volumes is consumables rather than sort of CapEx related. So certainly for us, we pay close attention to sort of semiconductor build rates as well as the CapEx cycle.

[Operator Instructions] We have a question from Harry Philips of Peel Hunt.

It's Harry Philips from Perham. A couple of questions, please. The first one is just in Technical Ceramics. And I think possibly Scott's question around semiconductor is partly answered. But the margins have taken a big leap forward probably to the highest level in quite a long period of time. Is this sort of level now sustainable? And is it driven by a better mix helped by the likes of semiconductors? The second is just the growth rate in Electrical Carbon, which is extraordinary when you consider that a few years ago, Electrical Carbon was seen as a mature aftermarket-driven business and it's now got 20% margins and growing. Again, is that growth rate not so much the margin, but the growth rate sort of feasible and sustainable? And then lastly, just on the ceramic armor, just 1 million drop, I think was the sales impact in the first half, but we're still looking for GBP 10 million as logic obviously say GBP 9 million, GBP 10 million in the second half to fall away in that period, please?

Harry, probably need to give up the goal I don't tip will be my advice. On the Technical Ceramics piece, so yes, I'm really pleased with the margin progress there. I mean, I think we've commented over a number of years that the margins in that business would pick up as we rebuilt the sort of pipeline at the front end and saw sort of newer products coming through, which had a higher margin profile. It also benefits from much of the restructuring program benefits this year. So, those are coming through fully. The last of the plants that we closed were in Technical Ceramics in the second half of last year. So, that's supporting the margins there. In terms of sort of sustainability, yes, I think our expectation is that, that business sort of heads towards a mid-single-digit margin position through the cycle. So obviously, we'll have to see what the market brings in the coming months, but that's certainly what we're aiming for. In terms of Electrical Carbon, yes, very pleased, as you've pointed out with both the growth and the absolute margin position. A lot of work has gone into sort of new product areas in things like wind energy in semiconductors, as well as looking to sort of redevelop some parts of the core business where the original sort of DC business, DC dry business is going away, and we've been looking to find new applications and things like aerospace to support that. So I'm encouraged there. I think the forward growth rates ultimately sort of depend on the market, but I'm certainly optimistic about our ability to continue to grow in those faster-growing segments in that part of the business. In terms of armor, yes, we're assuming that's going to slow some in the sort of second half of the year to sort of GBP 20 million to GBP 25 million. It's a little hard to judge. As you know, we've, I think, probably been too pessimistic over the last several years around the sort of the armor position, but we don't get particularly good visibility from our customers. And the situation in Ukraine is obviously having an impact on that and there's some uncertainty around what requirements might be and when orders may get placed. But our working assumption is GBP 20 million to GBP 25 million for the full year.

And finally, we have a question from Richard Paige of Numis Securities.

A couple of questions from me, please. The Q2 growth rate, given the organic growth stayed at 11% from Q1 suggests momentum is still very strong in the business. Have you seen any signs of slowdown at all, just given the guidance you're providing? And then secondly, obviously, big working capital investment like many others in the space in the first half again. Could you just give us an update on what you're seeing in terms of supply chain issues, both from your perspective and customers' perspective? And then ultimately, sort of, I guess, a million-dollar question. What sort of contingency are you now going to be building into your own supply chains in the future even as those supply chain issues ease?

Sure. Well, I'll pick up with growth and let Richard comment on sort of working capital and the supply chain. So in terms of end market position, I think it varies a little bit, Richard, but I would say, overall, we are seeing some, I'd say, early signs of slowing. So things like domestic appliances in Europe have been a little softer, perhaps of late. I think that's been reflected in some of the other results that we've seen around the market as well. We do sort of seasonally see a slowing of order intake in Europe as we head into the summer. So it's a little difficult to disentangle some of that. But I think there is some underlying softness starting to come through in Europe. The US remains pretty robust, pretty resilient. And then turning to Asia. China has been quite weak as expected, given the kind of COVID situation they had there during the second quarter. At this point, there is not yet signs of that improving and I think there are some sort of wider structural challenges in that economy with the whole sort of infrastructure housing challenges, plus the ongoing challenges around COVID. So, I think that also looks a little bit sort of more challenging again in the second half. And I think that spill through into some of the other regional economies in sort of South Korea, for example, again, is a little slower for us in the sort of back end of the first half. Richard, I'll pass to you on the second question.

I think in terms of supply chain, it's not really possible to call out one or 2 big very material things that have happened. I think this has more to do with a number of sites having concerns about perhaps raw material supplies or freight or backlogs at ports, all those sort of things that are happening. And therefore, making sure that they're maintaining safety stocks when necessary just to ensure that we can sustain our customer service. I think that we've probably done what we need to do in that respect and as far as it affects working capital. So in other words, I wouldn't necessarily be expecting another GBP 10 million of increase needed, but we'll see how we go. And at some point, we would expect to reverse some of that. But I don't think we're going to call out when the timing of that will be because for the time being at least, there are still concerns about some aspects of global supply chain.

[Operator Instructions] We have no further questions on the line. So, I will hand back for any closing remarks.

Super. Thanks, Lydia. Well, just -- thanks very much, indeed, everyone. And with that, we'll close the call.

This concludes today's call. Thank you very much for joining. You may now disconnect your lines.