Porvair plc (PRV) Earnings Call Transcript & Summary

Good morning, everybody, and thank you for attending the interim results for Porvair plc for the 6 months to the end of May 2021. I'm joined by our new Finance Director, James Mills, who will take you through the numbers in just a moment. But before we get there, we're going to turn the slides that are available on the website. And just by way of strategic and other backgrounds, starting then on Slide 2. We have followed a consistent strategy at Porvair for about 16 years now. And it's one of niche positions and a focus on new product developments. And the numbers that, that produces have been relatively consistent now over a reasonable length of time. James is about to tell you about the 6 months where revenues are down 5% and adjusted EPS up 3%. And I'll talk you through some of the challenges and opportunities for the last, really, 12 or 18 months have thrown up, largely related to the pandemic. We put at the bottom of Slide 2 the 5, 10 and 15-year growth results for the group. And you will see that after the last 18 months, they have slipped by about 1 point. But as we say in the statement, actually, we think the outlook is pretty good on a 3- or 5-year view. And we -- there's no reason why the group can't get back to its long-term growth rate, which is around 8% of revenue and 11% to 12% of EPS growth. And we think we've got plenty in the tank to do that, as you'll hear in the next 20 minutes. Before we get there on Slide 3, just one slide on what we make and why we make it. So we are a filtration company, and we look for businesses that give us really 3 things: Niche positions backed by fundamental demand drivers, and we'll talk about those; and then identifiable barriers to entry. And we set that out at the bottom of Page 3, what we mean by those 3 business characteristics. And most of you have heard those before, I don't propose to dwell on them at this stage. Then on Slide 4, a simple slide on our strategic purpose and principal measures of success, which are consistent earnings growth and ESG metrics. Got a slide on ESG coming up. We talked about it at great length in February and we'll do again next February, so I will just touch on that this time around. And then what the strategy really means, which is focused on regulated markets with long-term growth prospects, customer-led product development. And then in what is a cash-generative business, we allocate mainly to organic growth and margin enhancement. And you'll see some of the margin benefits coming through with James in just a moment. The odd acquisition, we made one in this period, Kbiosystems, which joined us at the beginning of the second quarter. And then a progressive dividend. And we've announced a small increase to the dividend this morning. On Slide 5, a very quick look at the segments that we serve and what we mean by regulation and growth drivers, and a split between those divisions in terms of revenue. Again, I've covered that in previous presentations, don't propose to do so now. But I think it is worth reflecting, as we come out of a very bruising recession, that some of the aspects of our business, particularly the barriers to entry that we have talked about, have survived in difficult times. And some of the growth drivers, and we'll get on to this, likewise, even following a pretty damaging destocking recession, our fundamental growth drivers behind the business is still there. And I think that really is why the results that we're about to present are, frankly, better than we expected them to be 6 months ago. So on Slide 6, this is the key themes of the last 6 months. Well, we're about to come out of the pandemic, we hope. It has been one of, the 6 months that we're talking about, really how to manage factories in a socially distant manner. And the staff well-being aspects related to that has been absolutely at the top of every agenda for a while now. In the last 3 months, I would say that we are able to sort of see very clear order book improvement. Actually, it looks like the order book really fell sharply through about June of last year and has actually been creeping back upwards pretty consistently ever since. But we're now beginning to see that, as we look forward to the second half, some of the benefits of that. But I would also say, and we'll talking a little bit about this, I don't want to overplay it. There has been more supply-side dislocation than frankly I can remember for a very long time. The labor market in the U.S. is tight. All sorts of transportation problems. Raw material prices are going up and so on. We can talk about that. These are ordinary course issues, but they are happening more often just at the minute, and they require some quite careful navigation. And so there is a little bit of caution in [ our voice ] looking ahead for the next 6 months. It really sits in that area, and I'm sure we'll come on to that. So in terms of the key themes, you see them there, it's one of order book improvement and supply side dislocation. And we can come back to some of those issues in, perhaps, your questions. So that's it, initially for me anyway, on the background to the results. I'm going to hand over to James now on Slide 7 to take you through the numbers in a bit more detail.

Thanks, Ben, and good morning, everybody. Good to be talking with you all for the first time this morning. So as Ben says, turning to Slide 7. You will see here our usual financial summary. I hope you [ noticed ] the announcement this morning. And [ starting with ] the income statement. Revenue was GBP 69.7 million, is down 5% in total against the prior period. You see here how each of the divisions have fared, and you will note that the overall revenue performance has been impacted heavily by the reduction in Aerospace & Industrial. This was mitigated to a certain extent by the growth in Laboratory. And Metal Melt is broadly flat period-on-period. You see here that adjusted PBT is up 1% to GBP 8.6 million, basic EPS up 25% to 16.4p. And adjusted basic EPS have reached down to 14.8p. There are a number of moving parts on the performance, and I'll take you through the headlines in a moment as we go through. So moving on to Slide 8. This shows a simplified income statement on an adjusted and a total basis and how we compare half-on-half. We have a clean set of trading numbers with operating profit being broadly flat across the period despite the overall revenue reduction. The group performance has benefited, and it's fair to say, from the cost reduction actions that were taken in the prior year and also from some costs being temporarily lower than they were pre-pandemic. It's also worth noting in here the currency impact in the period. And if we remove the effect of FX from these numbers, then revenue was down 2% and adjusted operating profit is up 4% on the prior year. It benefit -- the trading results were a bit better than expected going into the half. And I'll talk about the division performance and give a bit more color in a moment. Adjusted tax was reduced slightly from the 23% that we had in the prior period to 21%, which is consistent with our last full year position. I don't intend to explain on the adjusting items here. And these are detailed within Note 1 to the interim statement. So moving on to Slide 9 and the cash flow. Again, we're showing a simplified version here, a simplified cash flow statement and net cash position on the slide at the bottom. A few things in here just to draw your attention to. The working capital outflow of GBP 3.8 million in the half is GBP 7.7 million better than this time last year. But remember, the prior period had the outflow associated with -- it was about GBP 5.1 million in relation to the gasification contract and the provision releases. So excluding the GBP 5.1 million release in the prior year, working capital is actually GBP 2.6 million better half-on-half. And as a reminder, the group typically sees an outflow of working capital in the first half of the year. We spent just shy of GBP 1.7 million in the period on the Kbio acquisition, net of the cash required. And further Kbio payments of GBP 2.3 million were made in June for contingent and deferred consideration. The CapEx of GBP 2 million is normal for this time of the year, and we'll continue to invest in the business in the second half of the year. The cash flow, when all is said and done, says that we are broadly cash-neutral in the period after the CapEx and acquisition payments. And at the bottom here, we've simplified the net cash presentation to basically show that we have the GBP 6.2 million in net cash by the end of the period. So important to note that we have GBP 2.3 million -- or GBP 2.3 million of contingent and deferred payments that I just mentioned for Kbio go out in June. So the net cash position is more like GBP 3.9 million, up from the GBP 1 million that we had at this time last year. Just a brief word on dividends. The group has a progressive dividend policy, and the Board has approved a 6% increase in the interim payout, taking the interim dividend from 1.7p to 1.8p. Turning to slide then -- to Slide 10. Slide 10 summarizes the division performance. Aerospace & Industrial revenue is down 27% on the prior period. As you'll recall, the prior period had GBP 7 million of gasification spares revenue, and it has not repeated in 2021. So like-for-like revenue, like-for-like being at constant FX, excluding gasification revenue for the prior period, was 7% lower. Within the division, Aerospace revenue down 23% over prior period. And you will recall, it was within Aerospace where most of the restructuring was carried out in the prior year to reduce costs. The Aerospace order book for the second half is looking better than it was coming into the first 6 months for this year. And I have mentioned good areas of good news within the period. Petrochemical and microelectronics part of the business have had a pretty good first half. In Laboratory, trading performance has been strong with revenue up 33%, including Kbio's maiden contribution and up 26% on a like-for-like basis if we exclude Kbio. And Kbio has had a pretty good start with the group, and integration activities are going well. Margins in the Laboratory division are at a record 19%, and all parts of the division have performed well. Seal Analytical was up 11% with stronger demand from China in 2020. And we've seen a sharp increase in diagnostic-related demand, with several new filters introduced in late 2020. The additional capacity has been added to meet the demand, and investment in this division will continue in the second half of the year. Reported revenues within Metal Melt was down 1%, but up 6% on a like-for-like basis with better demand from aluminum and automotive customers, offset by the Aerospace segment, which has remained quiet. Margins at a record 16%, partly due to the investments carried out in the quieter months of 2020 and partly because [ selling ] related costs are temporarily at unprecedented low levels in the division. But nonetheless, this is a pretty good result for Metal Melt. So those -- financial highlights. I'll hand you back to Ben now.

Okay. So one slide on Slide 11 on ESG. I mentioned earlier, we've [ full reported this ] February, and we will do so again next February. Three things to say. First of all, of course, if you're a filtration business, then largely speaking, what you make has environmental benefit. And we said that they are some of the things that we do, but mainly emissions control and so on. So we are positioned pretty well from an ESG from a product point of view. We adopted 4 metrics at the start of this year that we're going to test ourselves on in 2025. And so that -- we set them out in the middle of the page. And then the first -- last 6 months has really been about digging those metrics into the business, adopting them in sort of standard management processes through HR and through expenses and through the CapEx and risk assessment. The main emphasis in the last 6 months has been employee engagement, in terms of making sure that everybody who is no longer sort -- or is not traveling and such is communicated with well. We are listening to their comments and suggestions. We do a [ DART ] survey in all plants every year. They are encouraged to tell us what they're thinking, and we react to that. So that has been a very sharp focus over the last 6 months. And I think we'll come back to that in February next year with a much fuller report. And so the outlook then. And there's a summary in the outlook. It does feel like a recovery is underway, has been perhaps for a while. And that brings opportunities. Certainly, it's been a better start to 2021 than we expected. And it seems pretty clear that the underlying growth drivers that move us along are still there. Specifically in Aerospace, we can see signs of life. It was interesting last week, many of you would have seen big order from United for mainly Boeing but also 70 Airbuses. We are on both their trains. And it was interesting to see that United expected passenger growth of 4% to 6% over the next 5 years, which is a return to the trend growth. So underlying growth drivers, even in Aerospace, starting to reassert themselves. I think that's probably balanced in Laboratory, which has been sort of unprecedented demand over the last 6 months. And we do expect that to settle a bit, certainly in sort of COVID diagnostic component things that we make. But we don't see it returning all the way back down to where it was before. There are -- there's evidence that countries, states, provinces, all leave pandemic recognizing that they were underinvested in their analytic and diagnostics capabilities. And we also see evidence of beyond COVID research into antibiotics and other sort of existential threats increasing. So we expect demand to remain at elevated levels, but perhaps not as elevated as they are now. So then those 2 things probably balance out, the Laboratory settle, and Aerospace will need to take up some of that. And we're seeing better margins. We spent this time last year, and there's a prelim stage, going through some of the improvements to the base business that we've made, some of the investments to productivity and using the quiet time of the pandemic to improve some of the factory facilities that we've got and so on. And that's definitely coming through in the results this year. And so we think there's a bit -- there are still -- there are some opportunities. There are some challenges on the supply side. But in general, we will continue to invest, and we think that the future looks pretty positive on us over 3 to 5 years. So I think that's it from us. We'd be very pleased to answer any questions you may have.

[Operator Instructions] We have a question from the line of Maggie Schooley from Stifel.

I had a few questions, if I could. And the first on Metal Melt Quality, the pickup at order books, but reasonable for the second half. And there has been some intermit -- there's some of strength that's coming from restocking. But can you give us some indication if you think those trends are looking a bit more sustainable? Kind of balancing out the strength in automotive that you've seen versus the potential for semiconductor challenges or -- and against the pickup in Aero and as well against some of the inflationary pressures. So if we could get a feel for what you think these trends are going to look like in the second half of the year. Yes. Again, sorry to push you a bit more on Laboratory. Can you help us a little bit, more than a bit, of insight on how you would classify the positive effects of COVID?. Because these things tend to be prolonged for quite some time. So it seems to me that you've been relatively conservative when you say that the 2 should balance themselves out, i.e. the strengthen in Aerospace versus what should subside in Laboratory. So just to get a better feel for that. And then lastly, sorry, just 3. Balance sheet is looking quite good. Can you give us an update on how the M&A pipeline is looking in terms of are asset prices still very elevated? Or are you starting to see things look more attractive on that? Sorry for 3, but yes.

That's okay, Maggie. Yes, I'll take those, I think. So Metal Melt is [ absolutely ] sustainable. It feels like it. There's 3 key markets. Aluminum is strong. There seems to be quite a lot of plastic-to-aluminum switching going on, and electric vehicles have a higher content of aluminum. And those 2 things do seem to be pushing aluminum consumption along, which I mean, profits are quite high as a result. And eventually, that feeds through to the demand for aluminum filtration. So that looks pretty good. Automotive is harder to call because the microelectronic problems mean that plants are sort of stop-starting a bit. But demand for that, and in agriculture, which is very closely related, has been okay through the 6 months. But we don't have much visibility for the next 6. Aerospace, where in Metal Melt, we are exposed to passenger [ air parts ]. So we make filters for turbine blade manufacture. That has picked up from being absolutely on the floor in sort of October, November of last year. That has picked up. Not -- nowhere near sort of the pre-pandemic levels, but it -- I think we are now running a single shift. So that's promising and that has to continue to grow, I would expect. So I think, yes, there is some evidence that suggest that demand in Metal Melt, at least for the next 6 months, is sort of there. On Laboratory, I think you suggested that we might be being prudent in our outlook. And we certainly are. And as you know, we always are. But equally, I don't want you to sort of run away and think that we are sort of over-egging it. What we're really trying to say is that -- so the Laboratory revenues were up 33%. Strip out Kbio, 26%. 26% is not a sustainable rate of growth in Laboratory, that's what we're saying. And we don't know what is, but it's less than 26%. We are making a lot of COVID testing components, specifically pipette filters. And that will settle back to a level. And I think we might have won some market share in the pandemic. And we make a comment about the new product development cycle. Perhaps -- I'm sure, in extremis, people are compared to qualify new suppliers much more quickly than they ordinarily would, and we've certainly taken advantage of that. So we think they will settle back to a higher level, but they will settle back. 26% growth is not sustainable. And then your third question, Maggie, was about M&A. We are always on the lookout. Asset prices, I don't think, has fallen back, obviously not in our line of work. But we're always on the lookout. Our long-term record is 1 acquisition a year. I think that's probably about right. We might do a bit better than that this year. But there's nothing imminent at the moment. Does that answer your questions, Maggie?

It does. It does.

Our next question comes from the line of Tom Fraine from Shore Capital.

A few questions for me. If you can follow-up on that last-last question about Laboratory. If you could give us an idea of what percentage of Laboratory is driven by COVID specifically. And therefore, whether we would still expect growth. And how much of that will be sort of temporary rather than relatively sustained in the future. So that's the first question. And then one on gasification. Just wondering if you're still tendering currently for gasification contracts. And do you expect future revenue in the near-term from this area of the business of each contract. And thirdly, in regards to the margins. And some of it benefited from some temporary cost savings, but overall, the operating margin is -- has entered the teens now. Is there any reason why it can't get to, say, 15% in the next couple of years? Is there anything holding that back? And how much of the sort of temporary costs are affecting that margin? Are we still expecting it to grow? And then in the near term, have those temporary costs come back yet?

Okay. Tom, thank you. I will -- I'll answer the first 2 legs of that. I'll let James talk to you a little bit about margins. The Chairman is on this call, although thankfully, he's on [ finance credit ]. He's on the call, and he is very keen that we focus on margins, and specifically, we focus on the sort of 15% number, top. So you're absolutely right to ask that question. And I'll let James come back to some of the moving parts in just a moment. In terms of your further 2 questions. Laboratory, what proportion of that is COVID? It's quite hard to tell. I mean, the direct COVID diagnostics products of the laboratory revenues of GBP 25 million are probably only 10% or 15% of that. But then, there's an enormous amount of standard laboratory consumables that go down those same sales channels. And it's quite difficult for us to answer that beyond -- it's a reasonable percentage, but it's not by any means the whole of it. Remember that laboratory splits anyway between Seal Analytical, which is about clean water; and lab consumables. And that is loosely 50-50. So maybe 10% of the Laboratory revenues is directly COVID-related. And then your third question was gasification. It's just been a very quiet 6 months. We are not currently tendering for any new work in gasification. Oil prices have been low for a while. Have -- although they're creating back now. And new gasification contracts tend to go in step with high energy prices. So there's nothing -- absolutely nothing going on there at the moment. But the spares work is ongoing. We just haven't had a spares order run through in the last 6 months, and we'll see how we get on in the second 6 months. So I think those are the first 2 questions. James, do you want to just address margins? Are they sustainable is the question.

Yes, sure. So I mean, if you look back over the sort of last 2 or 3 years, certainly, the half year, margins have gone from sort of 11%, 12% last year and 13% this year. It's a whole bunch of stuff, really, in -- within the business that's contributing to the current year. Really, it's certainly the cost reductions that took place last year coming through. We've got volume driving through Laboratory, which is -- happened to sort of drive up the margin, as well as an element of mix. I think your question's sort of around sustainability. I mean, 15% is quite a bit of margins if we can get there, but there's an awful lot of stuff that needs to happen for us to be able to deliver that, and that will take some time. If we think about the selling, marketing costs and travel costs, those costs are quite a bit down. They're quite a few hundred thousand down on prior periods. And clearly as restrictions start to ease, that cost will start to creep back into the business. I mean, it will need to, but the challenge for us will be to contain that cost coming back into the business and trying to hold on to the margins that we're delivering at the moment. So business is on a good journey. It's a question of where we can get to in the future, and we're still working that book...

Sorry, just to be clear with it. 10% of Laboratory total sales are on the COVID diagnostics.

Yes, I think that's a good -- that's about right, yes.

Yes. And I'm sorry. If you don't mind, just one more briefly on H2. Is there any reason to think that H2 might be weaker than H1? I mean, overall, looking like things are recovering and the order book is strong. I mean, are we expecting realistically that H2 probably is going to be stronger than H1 in earnings and revenue basis?

We are cautious about H2. H2 hasn't been -- H1 has been stronger for -- in 2019 and 2020 for various, for different reasons that number there. And we are particularly cautious about what's going on in America, where we are -- where about 50% of what we do is there. Partly, just straight supply side. So raw material prices are going up. Raw material supply is just difficult. It's just hard to get inventory. Certainly, oil derivative products, which for us would include foam, is very tight supply. As is metal powder, which is important for filtration manufacture, very tight supply. Transport cost. To get a -- you've probably seen this. But to get a 20-foot container from Shanghai to an East Coast port normally between $2,000 and $4,000. Last week, it was $13,500. So just everything is difficult. And whether that's just restocking for some more fundamental changes in the supply chain, it's too early today. All of that would be pretty much ordinary course. And as raw material prices come through, we pass them on. And you have to be disciplined to do that just because you have prices on those things, that you will retain the business once you've done so because your competitor may not. So all of that is sort of all smoke and noise around that. More fundamentally is tightness in the labor market, again, particularly in the states, and it depends on which state you're talking about. But we are -- we have 7 U.S. facilities, all in different states. And minimum wages are going up. And certainly at the moment, combination of welfare and COVID support means that it's very, very difficult to find labor. Very difficult to the point where capacity is constrained in some of our plants at the moment. We are running -- vacancies quite in a relatively high vacancy, which is just new. Now whether that then feeds through into wage inflation or whether the situation eases as COVID restrictions fall away, it's just too early to say. But it seems to us to be the right approach is to be cautious for the time being on the second half. And what we -- I think we'll do this time, which we don't always do, is that we will issue a third quarter -- a brief third quarter update. And we'll let people know how the second half is going. But I think it's too soon at this stage to say that the second half will be as good or better than the first half, because at the moment, it's -- life is challenging.

[Operator Instructions] We have a question from the line of Andrew Shepherd-Barron from Peel Hunt.

Yes. 2 questions from me, if I may. One is a follow-up on the long-term margin discussion. Along the lines of -- is there anything else? Do you -- to achieve higher margin, is it just good practice, business as usual, chipping away costs and revisiting things? Or is it something -- do you need to do anything else? You need to round out the product portfolio through M&A or through particular new product development? Or do you need to rethink the plant structure and how all of that works with respect to overall product mix? That would be my first question. And the second one for me is on Kbio, which appears to have had, as I understand it, a very good start of the year in terms of revenue and profitability. Can you just talk through how that's working? Obviously, you paid out -- you're paying out the deferred. Could you give us some clue as to, if you put out the deferred, what sort of multiple do you bolt it on, on a full power?

Yes. Well, let's start with margins. You offer us 3 routes to better margin, Andrew. The first is good practice. And yes, at least half of the improvement comes from that. And that really is the benefit of some of the work that we did last year. It's very difficult to tidy up and invest in plant and machinery if it's running full tilt, but it wasn't last year. So we took that advantage of doing productive maintenance wherever we could, and that's coming through. Quite a lot of it is mix. Honestly, the more Laboratory growth relative to the other 2 divisions, the better our margins will become. And so you might imagine that in terms of capital allocation, that gets a disproportionate amount. And then the offered a third route, which is restructuring. We are not a big restructuring business. We've got 13 plants. Other management cultures might think, well, that's too many, and surely, we can do that in fewer and we'll save on costs. Of course, we look at that periodically, but it almost never makes any sense to us. And that comes all the way back to our strategic statement, which is one of consistent earnings growth. Principal measure of success: Consistent earnings growth. And it's quite difficult to achieve that if you are restructuring manufacturing facilities. Very loosely, when you pick up a press or a furnace or whatever and you put it down somewhere else, it never works quite as well as it did when it was sitting in the first place. And so you lose time and cost and customers in doing that. But good practice and better mix is the route for us to sustainably higher margins. Hopefully, James has had enough time to work out what the multiple was for Kbio. But I can -- if not, I can probably assess it for you. But James, do you want to have a crack at Kbio?

Yes, sure. The Kbio is disclosed in [ the statement here ] -- in the interim statements. The total consideration, you will see in here, is about GBP 7.3 million. That does include GBP 1.3 million for sort of cash for cash. Really, that's more working capital adjustment in there. So broadly, when you bought it now, we paid about GBP 6 million for business. The business is certainly riding the COVID wave at this point in time. It's equipment that we are supplying, again, driven by COVID demand. And that, we think, will settle down in time. I think in terms of sort of the multiple, we would look at about 6x, 6.5x on a normal run rate of revenue...

On EBIT. That's right, on EBIT.

On EBIT, yes. In terms of sort of the benefit that we've had of Kbio coming in when it did, it coincided with COVID and the demand from COVID, and that will certainly pay it off. But I think sort of normal run rate of business is about that multiple.

Okay. Great. That's -- I mean, it did look as if the revenue -- contribution to revenue since acquisition was substantial compared to what the previous full year numbers have been. So it's obviously doing very well. Yes. I mean -- but then I think it seems to have narrowed down your options for margin enhancement. I'm sure -- if there are other routes, please do share...

New products is the one I missed. Thank you. Of course, but new products tend to have better margins than older ones. But that's sort of ordinary course there.

That's ordinary course. And is that true across all the divisions? I mean, can MMQ benefit as much? Well, obviously, we'd...

Yes. Yes, absolutely. Definitely true of all the divisions, that the decision to invest in a new product program is all about do we get a better return from that product than the one we're currently making?

Our next question comes from the line of Rory Smith from Investec.

It's Rory from Investec. If we look further out, is there an opportunity for you in Aerospace from the adoption of sustainable aviation fuels, given the OEMs currently doing the work in this area, either from a sort of replacement type of one fuel or mix shift or both?

Sorry, just give me that one more time, Rory. Is there an opportunity from SAF fuels? Is that -- was that your question?

Yes, pretty much, yes. What are you sort of seeing in terms of the opportunity for your business from that?

Yes. Provided -- the answer to that is, provided aircraft -- in terms of our fuel line work, which is significant. Provided aircraft are still fueled by liquids, then it shouldn't have much of an effect. There are a whole series of filters between the fuel tank and the nozzle on a turbine, and we make all of those. And it doesn't really matter what fuel runs down that. As and when aircraft start to be supplied by electrical power and batteries, then that work, we would expect to dry up. But then all the coolant and attenuator and actuator equipment that replaces liquid fuel also require filters. So -- but that would be transitionary. And that feels like it would still be quite a long way off.

There are no further questions registered. So I turn back to the speaker for any closing remarks.

Well, thank you very much for attending, everybody. Have a very good day. And if there is anything, James and I are here all week, and we'll be very happy to answer any questions you may have. Thanks very much, everyone.