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

Hello, everyone, and welcome to the Morgan Advanced Materials Half Year Financial Results 2023. My name is Nadia, and I'll be coordinating the call today. [Operator Instructions] I will now hand over to your host, Pete Raby, Chief Executive Officer, to begin. Pete, please go ahead.

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 2023. And I will then talk through our growth drivers, our business unit performance, progress against our ESG priorities and our outlook for the full year. Starting with the highlights; we've made encouraging progress following the cyber incident in January, with the business recovering steadily through the first half. Organic revenue growth was 2.6% overall with 5.6% growth in our faster-growing segments. Our planned expansion in the semiconductor market is underway with semiconductor demand remaining very robust. Financial performance for the first half of the year reflects short-term impact of the cyber incident in January. Subsequent recoveries well progressed, and it's in line with our expectations. Adjusted operating profit margin was 9%, with pricing measures continuing to more than offset inflation and return on invested capital was 18.7%. Cash generated from continuing operations was GBP 12.9 million, with a temporary working capital outflow from the cyber incident of around GBP 45 million. We expect this to be substantially recovered by the end of the year. The balance sheet remains strong with net-debt-to-EBITDA of 1.3x. And we've maintained the interim dividend at 5.3p. We've also made further progress in reducing our Scope 1 and Scope 2 CO2 emissions with a 19% compared to -- a 19% reduction compared to the prior year. I'm pleased with the progress we've made in recovering from the cyber-attack with the impact largely contained to the first half. We've got good momentum and a strong order book going into the second half, and our outlook for the full year is unchanged. So just turning to the cyber incident; on the 8th of January, we experienced a significant cyber-attack on our business. And in response to that, we shut down many of our systems, and we compartmentalized the network to protect the business. During the first half, we progressively restored key infrastructure. The recovery is going well with our core ERP systems online and remaining applications being steadily recovered. We've accelerated our IT modernization program, which includes changes to our network design and the deployment of additional security tooling as well as the acceleration of our group ERP program. Our factories have operated throughout the disrupted first half. Our teams have worked closely with our customers to manage their deliveries and customer demand has remained robust during our recovery. Output improved steadily through the first half as we expected. Overall, we saw a volume decline in the first quarter and volume growth in the second quarter as our factories recovered, leading to a net volume decline for the first half of around 5%. The volume decline and inefficiencies from the cyber incident led to an operating profit impact of GBP 23 million in the first half. Our expectation for exceptional costs in 2023 related to the incident is unchanged at around GBP 15 million. I'll now hand over to Richard to take us through the financial results.

Thank you, Pete, and good morning, everyone. I would like to start with an overview of the financial results to the 30th of June 2023. Revenue at GBP 553.9 million was 2.6% higher than prior year on an organic constant currency basis. This was driven by a volume decline of around 5%, offset by pricing benefit of around 7.5%. We made the point in the previous announcement that revenue growth in our second quarter was around 10%. This is certainly very encouraging but does reflect a degree of catch-up in invoicing as a number of our new ERP systems started up during the quarter. Group adjusted operating profit was GBP 50 million with operating margin of 9%, driven by the cyber incident. We have seen further inflation this year, which we continue to offset through pricing measures. Cash generated from operations was GBP 12.9 million and free cash flow and outflow of GBP 37.1 million, both lower than last year due to lower profitability and increasing capital investment and higher working capital. Adjusted EPS was 9.9p per share, reflecting the lower operating profit. The proposed interim dividend is 5.3p per share, in line with last year, reflecting our expectation that we will pay a dividend of 12p per share for the full year despite a lower consensus operating profit. As usual, we have included in the appendix the financial information in statutory format. Slide 28 shows specific adjusting items of GBP 13.4 million, representing costs principally relating to [indiscernible] which we continue to expect to be around GBP 15 million for the year. Turning now to the profit bridge; this chart shows the main drivers. Firstly, we expect pricing has more than offset inflation benefits of approximately GBP 11 million. We have also increased our IT spend by a run rate of around GBP 10 million per annum, which includes investments in a more secure infrastructure as well as the rollout of our ERP system. And there was an increase of GBP 6 million in other overheads, mainly in sales and R&D as we continue to invest in the business' growth. We have then estimated the 2 principal impacts of the cyber incident. Whilst all our sites, we were able to keep manufacturing throughout -- some were capacity [Technical Difficulty] through not having access to their systems, which led to the 5% volume decline and a profit impact of around GBP 8 million. We then estimate that the cost of inefficient running amounted to a further GBP 15 million to give a total estimate of GBP 23 million. Moving on to cash flow; I would highlight the following points. We have seen a temporary working capital cash outflow of GBP 45.2 million. Very approximately GBP 26 million of this can be attributed to volume with our systems recovery leading to a spike in invoicing later in the second quarter. The balance can be attributed to the period of inefficient operation, for instance, where sites had to operate with our planning systems impacting their inventory management. We do expect to achieve a substantial reversal of this working capital increase by year-end. Capital expenditure was in line with expectations of GBP 24 million, a small increase compared with the prior year and reflective of the fact that our growth investment has continued at pace. Free cash flow before dividends was therefore an outflow of GBP 37.1 million for the half. Net cash flows from FX, interest and other items comprised exceptional costs of GBP 12.6 million and net interest payments of GBP 5.6 million. There were no pension contributions in the period. Net debt was GBP 208.5 million, excluding lease liabilities or GBP 257.7 million with them included. Excluding lease liabilities, net-debt-to-EBITDA was 1.3x. We have included our usual summary of our funding profile in the appendix. On this next chart, I have included an update on our technical guidance for 2023. This has not changed from that published 3 months ago. In summary, we expect our adjusted effective tax rate to continue to be around 27%. Our finance charge to be in the region of GBP 13 million to GBP 15 million and cash contributions to our non-UK defined benefit schemes to be of the order of GBP 3 million to GBP 4 million. As before, we expect capital expenditure to be in the range of GBP 70 million to GBP 80 million. By the end of the year, we expect to have committed or spent at least GBP 35 million of the Semicon capacity investments of GBP 60 million we have communicated in December. Our dividend policy remains to move towards a cover of around 2.5x over the medium term, albeit that cover will be lower this year as we hold dividends in line with last year. Finally, I've included here of our updated financial framework that we introduced at our December 2022 Capital Markets event. We are continuing to accelerate our investment plans to take advantage of the substantial growth opportunities in our end markets, allowing us to deliver 3% to 6% organic growth through the cycle. We expect to return to this level of growth in our second half. In December, we stated our intent for operating margin to be sustained in the 12.5% to 15% range. We made good progress in 2022, achieving 13.6% and would expect to be back in our target range during our second half of the year. Following our excellent return on invested capital outcome in 2022, we would expect our capital investment to have a slight dilutive effect in the short term, but we still expect to sustain it in the target 17% to 20% range, which is well above our cost of capital. We also expect to keep net debt in the 1x to 2x range. Our ambition, therefore, remains to drive enhanced growth and adjusted EPS through accelerated organic revenue growth, a continuous focus on margin, accretive M&A, then enhanced returns to shareholders as appropriate. That covers the key financial items. So with that, I'll hand you back to Pete.

Thank you, Richard. I'll now take you through our growth drivers, the performance of our business units and an update on progress against our ESG goals together with our current positioning and the business outlook. Turning to slide 12; we have leading differentiated market positions across our business, which we segment between faster-growing markets and our core. In our faster-growing segments, semiconductors, healthcare, clean energy and clean transportation, we typically have a smaller share and an emerging position. These markets have good underlying long-term growth drivers, and we expect them to grow more quickly than our core markets over the cycle. We also expect higher margins in these segments as our products are typically newer and more differentiated. As we announced last year, we're investing in new capacity in our carbon and ceramics businesses for the semiconductor market, including to support customers making silicon carbide power electronics. Demand here has increased during the first half, and we're accelerating our capacity additions to meet that demand. Healthcare demand is also high, and we're increasing capacity in North America to serve that market. In the first half, these markets represented 21% of our sales, up from 20% in the prior year. Our core representing 79% of the business is the more mature markets where we typically enjoy strong market position, leading or among the leaders. We've got a strong brand, well-established and deep customer relationships and a global position. We're continuing to invest in our core to maintain and win share and introduce the new technologies and products that our customers need to become more sustainable. For example, we have additional capacity coming online for our aerospace customers in the second half to meet the strong demand for our cores in the latest generation of engines. Slide 13 shows the organic performance of our major market segments, split between our faster-growing segments and our core. As a reminder, these growth rates were suppressed by around 5% due to the cyber incident in the first half. Within our faster-growing segments, semiconductors grew strongly again in the first half, up 16% on the prior year. This reflects both positive market momentum and share wins as a result of our new product and capacity investments. Healthcare was up 2% with growth in vacuum insulation and medical seals. Clean Energy & Transportation were down 8% as cyber impacts reduced revenues, together with some destocking of collector strips for the European rail market. Moving to the core; Transportation grew 8% driven by Aerospace as traffic volumes recovered further. And as I remarked, we have additional capacity coming online in the second half to meet the growing demand. Chemical and petrochemical sales grew 1% with slightly higher thermal project activity in Europe and in Asia. Security and Defense grew 4% with modest declines in Armor volumes, more than offset by growth in wider defense sales. Conventional energy markets were down modestly, broadly tracking the flat industrial markets. And finally, our industrial and metals markets were flat, with growth in the U.S. offset by declines in Europe and in Asia. I'll now run through our Global Business units. For each of these, there's around a 5% volume impact on the revenues and a 4.2% impact on the margins from the cyber incident. I'll start with Thermal Ceramics. Thermal Ceramics revenues grew organically by 2.1% with modest increases in petrochemical and industrial revenues, partially offset by declines in metals. Operating margins declined to 6.8%. In Electrical Carbon, revenues increased 3.7% organically, with the main drivers being very strong growth in the semiconductor segment and growth in Transportation segments. Operating margins declined to 17.2%. Turning to Molten Metal Systems; revenues decreased by 8.4%, with weakness in the metals markets. Margins declined 7.3%. Moving to Seals and Bearings; revenues declined organically by 1.6% with weakness in industrial markets and a modest decline in Armor. We expect Armor sales of around GBP 20 million to GBP 25 million for the full year. Margins declined to 8.1%. Turning to Technical Ceramics; revenues increased organically by 7.1% with growth in Semiconductor, Industrial, Defense and Aerospace segments, reflecting a combination of volume growth and pricing. Margins declined to 9.6%. I'll now turn to our goals and progress on the Environment, Social and Governance, or ESG, shown here on slide 19. 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 we operate and manufacture our products and through the products themselves and the benefits 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 goal to be Scope 1 and 2 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've committed to a lost-time accident rate of 0.1 by 2030 against our goal of [ 0.05 ]. 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. And finally, we want to welcome an inclusive environment for our employees where they can grow and thrive. We set a target of achieving a top quartile engagement score by 2030. Slide 20 shows our progress in reducing CO2 emissions since 2015. Our CO2 emissions in the first half were down 19% on the prior year, reflecting underlying improvements across the business and some benefit from the 5% volume decline. We have a broad-based improvement underway covering energy procurement, process improvements and behavioral changes in our plants. In the first half, we improved our energy intensity price adjusted by around 9% and continued the transition to carbon-free energy for a number of our sites. In the first half, around 2-thirds of our energy came from green or carbon-free sources. Turning to water, safety and diversity on slide 21; our water usage is down 8% over 2022 H1 levels, driven by the volume decline in the business and water efficiency actions. Our water usage in high and extremely high stress areas reduced 14% in the half, with good progress on water efficiency across those sites. Looking at safety, our lost-time accident rate, the number of lost-time accidents per 100,000 hours worked is slightly down on the prior half. And we're continuing to work very hard on this across the business. We're deploying our refreshed take 5 for safety tools to help our people think through the risks before they undertake a task. We also have wider training underway as well as extensive leadership reviews and safety tools within our plants. From a diversity and inclusion perspective, our half year position is 29% of our senior leaders being female, unchanged from the year-end position. And we have a broad program of work underway to drive improvements here, making change in everything from policies to training to our recruitment processes. Turning to the outlook; our recovery from the cyber incident is progressing well, and we're investing further in our IT infrastructure to improve our resilience. Order intake has been relatively robust during the first half, and our outlook for full year organic revenue growth is unchanged at between 2% and 4%. We expect operating profit to recover in the second half as volumes and efficiency improve. We expect to continue to offset cost inflation through price increases and continuous improvement. Our profit expectation for the full year is also unchanged. And we're accelerating investment in capacity and capability in our faster-growing segments to accelerate the growth and further increase our exposure to those markets. In summary, our employees have been at the heart of our response to the cyber incident, and I would like to thank them for their commitment and their support during a challenging period of recovery. Customer demand for our products and technology remains robust, particularly in the faster-growing segments. We're accelerating investments in capacity and capability there to drive organic growth. Our balance sheet is strong, and that underpins organic and inorganic investment opportunities and additional shareholder returns. We continue to make good progress against our ESG goals. We're confident in our strategy and financial framework as we outlined in the Capital Markets Event of last year. Thank you. That ends our formal presentation. With that, we'll now take questions, and I will hand you back to the operator who will explain the process for Q&A.

[Operator Instructions] And our first question today go to George Featherstone of Bank of America.

I just want to start by looking at your operating profit bridge for the first half because I guess it implies that you feel absent the cyber incident that volumes would probably be flat year-on-year. So I just wondered if you could provide some color on this because I guess it also suggests that given you've got the faster-growing markets that probably are outperforming the group from volume terms, that would probably mean that your core business is probably showing some softening in volume terms in the first half on an underlying basis. So if you just help us with that that'd would be super helpful.

Sure, George. Yes, I think that's probably right. I guess, the market position that we're seeing, so the U.S. has held up really quite well from a sort of industrial markets perspective. But Europe and Asia have been relatively soft during the first half. And indeed, Europe has been, I think, weakening as we've gone through the half. So that leads to a sort of probably flat or slightly down position absent the cyber incident. It's obviously a little bit difficult for us to estimate precisely given we can't say for sure what revenue we might have achieved. But I think that is a reasonable view on the market. And we've assumed that that sort of flat volume position continues for the second half, and it's really a similar picture so faster-growing market is probably performing a little better. Core, probably a little bit down in volume terms with the U.S. holding up much better than Europe and Asia.

Okay. That's super helpful. Then maybe just thinking about those order trends. You said they've been robust. I just wondered if you could talk maybe as you look into the second half now, just how much visibility you have on that from what's in your order book?

Sure. So I mean we can typically see about 3 months ahead. We normally go into a quarter with about sort of half of that quarter in the order book. The balance is going to be sort of orders coming in on frame agreements, if you like, from repeat customers that haven't necessarily placed them several months in advance. Once we get beyond 3 months, we are into sort of dialogue with customers about their expectations. In some cases, they'll give us forecast in other cases, they won't and then our sort of wider judgment on the macro. So sitting here today, we're looking, if you like, through the third quarter. I think we're well covered from an order perspective there. We've still got some catch-up to do, and that's giving us a little bit of strength in the order book. And as I remarked, we have seen order intake slowing during the first half, in particular in the second quarter in Europe and Asia has been relatively soft through the first half, and we're expecting that to continue into the second half.

Okay. And the final one is on the outlook you've given a consensus range on operating profit. So I just wondered where you see yourself relative to that range in terms of your full year outlook.

George, we've probably seen ourselves sort of roughly in the middle of that range. There is a little bit of currency adversity creeping in. So it points us to somewhere around, say, GBP 123 million, GBP 124 million, that sort of range, I think, which is roughly in the middle.

And the next question go to David Farrell of Jefferies.

I think I've got 3. So the first one would be around kind of the GBP 10 million run rate investment in the IT, does that kind of endure through into 2024 or at some stage will that step down and therefore, provide quite a nice boost for margins? My second question was just in terms of pricing. Are you feeling the need to carry on pushing up pricing or is the pricing that's come through, is that just annualization of former price rises? And then my final question was on the Clean Energy, Clean Transportation figures. You obviously bought out European rail destocking. I think if we went back to full year results, there was an issue with Chinese rail. At what point do you actually think that might switch around and actually become a positive contributor to the organic revenue?

Sure thing. It's just -- I'll take IT, Richard, you take pricing, and then I'll come back on Clean Energy and Transport. So on the IT side, yes, we expect to be at elevated levels of spend for '24 and '25. And then notionally that starts to drop back after that. I guess we'll see where we are in 2026 on that. Pricing?

David, we pushed through most of this year's pricing at the start of the year. So at the moment, we're not expecting material pricing activity in the second half. So you wouldn't see a sort of material change between the 2 halves. There is, of course, also some degree of carryover from last year because the number of price increases went in through the year last year. So I think you're seeing an impact from both of the drivers that you were thinking of.

And then to your question on Clean Energy & Transportation, yes, we're a little bit, David, it's sort of the law of small numbers. It's probably GBP 25 million in sales in the first half, so it doesn't take much to move it one way or the other. And at the moment, for us, it's dominated by rail to our sort of collector products for metro and main rail and wind where we're doing sort of brushes for onshore wind turbines. We've got a number of other prospects we're working in things like energy storage and we'll sort of see how those mature. So I think the underlying markets are going to continue to grow. And I'd expect us to get into sort of more sustained growth as some of our earlier stage opportunities start to mature.

And the next question goes to Edward Maravanyika of Liberum.

My question is just on the growth you're seeing in the faster-growing markets. If you were to rank them or if you were to just maybe talk qualitatively on where the market share gain is across the different markets in the faster growing segment?

Sure. So yes, I think we're winning share in Semicon and in Healthcare. And I'd say we're probably -- we want to say -- yes, we're winning some share in wind. I think we're probably holding in, in rail as I go across those 3 markets.

And no sort of near-term headwinds in any of those 4 markets?

So Semicon is very robust for us. A lot of that is driven off sort of silicon carbide power electronics. Those are going into electric vehicles and into sort of grid power conditioning. That's very robust, as I commented, I think, demand there, if anything, is higher than it was at the back end of last year. And we don't see any near-term headwinds at that part of the Semicon spend. The balance is then in sort of wider processes and memory, albeit typically the sort of higher-end products. And again, that's held up pretty well for us. And if anything, I think we might see some acceleration there as sort of wider Semicon comes out of the trough. On Healthcare, I think that's pretty steady, to be honest. And unless there's some -- so for example, of pandemic, we saw some shifts between elective procedures and sort of emergency activity, and it would take something like that, I think, to make a big difference. On the sort of energy transportation piece, some of those rail volumes depend a lot on sort of, if you like, economic activity in the various regions. So maybe some headwind if we see China slowing, for example, as we go through the balance of the year or Europe continuing to slow.

And the next question goes to Ben Bourne of Investec.

Three quick ones. Firstly, what revenue capacity do you now have facing the semiconductor market? Obviously, you can speak in broad terms, perhaps? And then secondly, ability to further reduce fixed costs number of sites? And then just lastly, really the M&A pipeline, any change in vendor expectations, please?

Sure. I'll take the first 2 and Richard, perhaps you could pick up the last one. So revenue capacity, we're pretty much maxed out in Semicon and we're adding capacity as fast as we can Ben. So the sort of GBP 60-odd-million worth of investment we announced back in December last year, we're accelerating that. So we're trying to bring that capacity on more quickly. I'm expecting us probably to have added, I don't know, probably 50% to our Semicon capacity over the next 3 years, something like that. In terms of the site footprint, we don't have any specific plans at the moment. If you look back over time, we've typically sort of exited perhaps a site a year through either sort of merging it into a different platform or a divestment. I think we've got sort of that sort of potential as we look forward, and we'll continue to work that through.

Ben, as we said last December, we have been actively looking at our whole pipeline of M&A opportunities. We're still doing that. We did slow down slightly probably during the Cyber incident, but we picked that up again now. So we're looking very hard. I don't think I'm seeing any relaxation of ambitious vendor valuation expectations, but let's see what happens.

[Operator Instructions] And our next question goes to Harry Philips of Peel Hunt.

Just again the obligatory 3 for myself as well, please. Just looking at the performance of molten metals just looks -- I appreciate, obviously, the cyber impact and what have you, but it just looks to be sort of harder hit than might have been expected near 100% negative drop-through. If you could just maybe talk through that a little bit more. On the opposite side, technical ceramics is really strong. Obviously, Semicon coming through. What sort of expectations for growth should we sort of bear in mind there? And then just lastly on working capital, just in terms of the mix between the core businesses and the faster-growing businesses, I think you're answering my own question here, but I'm just imagining there's sort of greater working capital required in the fast-growing businesses purely as a function of inventory or is there a sort of structural uplift as well on top of just simply growth, please?

Sure, Harry. Yes, there's fairly a little bit more of an impact from volume there than we saw in the other global business units. I think partly you've got just a reflection of sort of market specifics for them. So you've got some automotive volumes that were a little bit softer there. But also, we have been doing some sort of tail management with our pricing expertise. So we expected some degree of volume decline in that business and then the cyber impact is a little bit sort of site-specific depending on particular systems and the sort of planning impact for those. On Technical Ceramics, I mean we haven't guided for particular growth rates by business unit, but they've got a bigger share in the faster-growing markets as has sort of electrical carbon. Those faster-growing segments, we've guided to sort of 7% to 12% through the cycle. I think we're hoping that we're at the sort of top end of that in the next year or 2 or 3, just given the very high momentum that we see in Semicon.

Harry, I think if I look through the cyber instance, I don't see growth in the faster-growing markets, structurally changing working capital. So I think the answer is no to a structural change. And as we've indicated, we expect to substantially reverse that temporary working capital increase by the end of the year.

We have no further questions. This now concludes today's call. Thank you all for joining. You may now disconnect your lines.

Thanks very much, everyone.