SGS SA (SGSN) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the SGS 2024 Q3 Sales Update. My name is Ariel Bauer, and I'm in charge of Investor Relations, Communication & Sustainability. I'm here with Geraldine Picaud, our CEO; and Marta Vlatchkova, our CFO. Please note that this call is being recorded and will be available for replay on the SGS website. [Operator Instructions] I would now like to turn the conference over to Geraldine Picaud, CEO of SGS.

Thank you, Ariel, and good morning, everyone. I am very pleased to share our Q3 sales update with you this morning. I am also very excited to speak about the highlights and the sales performance of Q3. And then I will pass over to our CFO, Marta, who will give you more details on the numbers. So let's start with the highlights of our Q3. We have recorded a strong performance this quarter again with the sales growing organically by 7.3%. Taking into account the negative -- the limited negative ForEx impact, the total growth of the sales amounts to a good 3.8%. Beyond the sales members, over the past few weeks we have focused on our sustainability offerings. And I'm excited to share that we are now ready to launch IMPACT NOW, a platform of services and solutions dedicated to help our clients to reach their environmental goals. In parallel, we have also continued to develop and promote our strong leadership on PFAS testing. And now on the M&A side, we have accelerated on bolt-on acquisitions with 4 more companies about to join our network. These achievements in sustainability offering and in M&A are key milestones in the execution of our Strategy 27. I will be happy to provide further insights during our Capital Markets event next month. Now we are well on track with the plan, and I confirm the outlook for the year. Let's look at IMPACT NOW. We are launching in the coming days the IMPACT NOW offering, which brings together all of SGS' Sustainability services under one platform. It's based on 4 pillars in order to address all of our clients' sustainability ambitions. We propose testing services in the field of climate change, including greenhouse gas emissions measurements, for instance, but also in circularity and nature protection, where we are targeting forever chemicals. Finally, we are also providing a solid offering in assurance, including ESG reports. Let's go to PFAS. Within the sustainability offering, we have developed a strong leadership in PFAS testing. Indeed, we have the most extensive suite of services and accreditations. This is a fast-growing market in which we invest to reinforce further our position and be able to capture the demand of today and tomorrow. As an illustration, we are currently quadrupling our capacity in North America. After organic growth initiatives, let's now look at external growth through bolt-on acquisitions. Deals are now sourced locally, executed with financial discipline and dedicated teams make sure that we execute the integration plans and extract the identified synergies. Since January, we have signed 9 acquisitions, which represent total annual sales of approximately CHF 70 million. This is about 1 percentage point of additional growth as of now. This month, we are completing 4 acquisitions. Let's start with Beta Analytic, Beta Analytic is a leader in hydrocarbon dating and bio-based carbon testing. As an increasing number of products and packaging move from petroleum-based to bio-based materials, carbon testing is a unique solution to validate product claims and prevent greenwashing. This market is growing 20% annually, boosted by increasing regulation. Then Hazgo and Express Solutions are both based in Belgium. They have 36 employees together and are specialized in supply chain services for sensitive products such as pharmaceuticals, chemical samples and dangerous goods. Finally, AMA Analytical Services based in Maryland with 21 employees is a specialist in environmental testing with a focus on asbestos, metals and microbial analysis. I really take the opportunity to warmly welcome the members of these companies in the SGS family. Let me now give you more detail on our end markets. And let's start with Industries and Environment, which delivered organic sales growth of 7% for Q3. The double-digit growth in Environment was fueled by further expansion in PFAS testing, notably in North America, where we are quadrupling our capacity. Our portfolio and capabilities have also been strengthened by the acquisition of AMA and Beta Analytic. We also saw strong demand in safety-related services in Asia Pac and Latin America. We had a high single-digit growth in technical Supervision & Advisory, mainly driven by transportation and energy projects in Latin America. For example, we supported major railway development projects in Mexico. The growth of Industries & Environment was partly offset by the completion of low-margin contracts in nondestructive testing in Asia Pacific and in the Middle East. Let's now move to Natural Resources, which delivered solid organic sales growth of 6.9%. Double-digit growth in Laboratory Testing was led by increased activity in energy, chemicals and on-site projects with notable wins in Australia and Africa. We also experienced a double-digit growth in Metallurgical Testing. This was driven by Latin America and continued momentum in battery metal testing in North America. Trade & Inspection had a solid growth despite the soft start of the new crop season in agriculture. The solid sales performance was partly offset by the exit from low-margin minerals contract in Latin America. Organic sales growth in Connectivity & Products, you can see here it continued to accelerate in Q3. It was supported by sustainability and regulations globally, and it generated a strong organic sales growth of 8.4%. Double-digit growth in Softlines continued to benefit from lower inventory levels and new opportunities in sustainability driven by increased customer awareness. Connectivity delivered another strong quarter with high single-digit growth, supported by improvement in wireless and automotive. Hardlines achieved high single-digit growth with new regulations in food contact materials, notably banning the use of bisphenol, PFAS and more harmful contaminants leading to increased demand for testing services. Finally, Trade Facilitation Services remained broadly stable. Let's move to Health & Nutrition, which delivered organic sales growth of 8.2%. It benefited from strong organic sales growth in Food and cosmetics globally and early signs of recovery in Health Science. Food delivered another strong set of results in all regions, mainly driven by regulation and increased demand for microbiological analysis, allergen testing, pesticides testing, food authenticity and nutrition testing. High single-digit growth in Cosmetics, led by increased clinical testing in North America. Health Science returned to mid-single-digit growth, driven by early signs of market recovery, which led to strong performance, in particular, in drug development in Europe. We are seeing positive trends in Q3 in Health Science on the back of favorable comparables. Lastly, let's review Business Assurance. We experienced double-digit growth in Certification, a strong growth in Certification supported by medical devices and digital trust services. There was also a high single-digit growth in Sustainability led by ESG Assurance, social audits and energy certification. These strong results were partly offset by a slowdown in Training and unfavorable comparable in Consulting. Now with that, I will now hand over to Marta, who will present our sales performance. Marta, floor is yours.

Thank you, Geraldine, and a good morning to everyone. In Q3, we continued to deliver strong sales performance in both organic and reported terms. We grew organically by 7.3%, equivalent to CHF 119 million. The scope over the quarter was minimal. The powertrain testing disposal in Q3 last year was largely compensated by the acquisitions of ArcLight in May and Gossamer in August this year. The Swiss franc continues to appreciate against all major currencies, translating into a moderate 3.5% negative impact. This led to Q3 sales of CHF 1.7 billion, up 3.8% compared to prior year. Let's now drill down into our sales growth. In the third quarter, our testing and inspection division grew organically by 7.4%. Growth in Europe continued to improve and reached 5.4%, benefiting from early signs of recovery in Health Science. Asia Pacific increased by 4.8% organically. China maintained high single-digit growth, supported by strong Connectivity & Products, Food and Cosmetics. This was partly offset by the end of low profitable contracts in nondestructive testing. North America growth accelerated to 8.8%. We achieved strong double-digit growth in Food, Environment and Connectivity & Products as a result of major contract wins, including supporting one of the largest renewable energy projects in the U.S. history. We have also been recently selected to partner with several major consultants and industry groups to provide analytical support for sediment investigations for one of the most high-profile and industrialized stretches of river in the U.S. Latin America expanded organically by 17% with double-digit growth across all business lines. Eastern Europe, Middle East and Africa grew by 11%, supported by double-digit growth in Industries & Environment. Our Business Assurance division delivered an organic growth of 5.9% with double-digit growth in certification of management systems and a strong performance in ESG Assurance and Sustainability audits. These strong results were partly offset by a slowdown in training and weakness in Consulting, where the high basis of comparison will continue to impact growth for the rest of the year. Let's now move on the next slide, where we can see the sales evolution by quarter. We started the year with an organic growth of 7.1% and highly unfavorable ForEx leading to a net decline of 2.1%. In Q2, we expanded organically by 8.9%, while ForEx eased, leading to 5.1% reported growth. In Q3, the strong sales performance continued with 7.3% organic growth, corresponding to 3.8% in reported terms. This led to sales of CHF 5 billion for the 9 months. And now let's move on the next slide, presenting the 9 months sales bridge. We achieved strong 7.8% organic growth year-to-date, translating to CHF 383 million. This was partially offset by the negative scope and currency translation effects, leading to a reported growth of 2.3%. The scope of minus CHF 21 million reflects the prior year disposals of the automotive asset assessment business and the powertrain testing operations. The acquisitions of Nutrasource in May 2023, ArcLight in May 2024 and Gossamer in August 2024 partially reduced the impact of those disposals. The negative currency translation effect of 5.1% continues to be driven by the appreciation of the Swiss franc against all major currencies compared to the same period of last year. With that, I hand it back to you, Geraldine.

Thank you, Marta. Let's now go to the outlook. So to conclude this presentation, I would like to confirm again our 2024 guidance, mid- to high single-digit organic growth, a full M&A program relaunched, improvement on the reported adjusted operating income margin on sales and a strong free cash flow generation. We are fully on track to deliver and to achieve our targets, and we are confident that we are doing the right moves to deliver Strategy 27. Thank you for your time and attention, and I hope to see many of you in a couple of weeks at our Capital Markets event. Marta and I are now ready to take your questions.

[Operator Instructions] The first question comes from the line of Daniel Bürki from Zürcher Kantonalbank.

I would have 2 questions. First, on profitability. How do you see the moving parts developing? Obviously, currencies, mix effect and as well the restructuring program. That's the first one. And the second, regarding China, it's quite astonishing you have high single-digit growth there despite a very tough macro environment. If you could elaborate a little bit on the Chinese market, please?

Sure. Thank you for the questions. So look, on the profitability, you're right, there are several moving parts. We are -- we do see the ForEx having a negative impact on the margin, but I would say as usual. The mix effect will be flat to slightly positive. And then we will have operational efficiencies, and we will have as well the renew plan fully -- I mean, in full execution mode, obviously. And that we will give you more colors when it comes to our Capital Market event in 2 weeks now. So be a bit patient on that. With regards to China, you're totally right. China has done a fantastic performance. They have really done well to increase their service profile for the domestic market requirements and that's something they're really progressing very well. You've seen they maintained a high single-digit growth. So we are very, very happy about the strong performance of China.

The next question is from Sylvia Barker from JPMorgan.

A couple of questions, please. Firstly, on your Consulting business, can you just remind us kind of the magnitude of that? And just maybe go through again why the comp is so high. I guess, the restructuring you've been doing in that business, and how long will this year-on-year impact persist for? And then second, on the Health business, clearly that was one negative impact on the margin. Can you maybe talk a little bit about how you think about the operating leverage into that Health business as the growth is now recovering?

All right. Thank you. Look, the Consulting business represents an average, I would say, around 10% of the total Business Assurance sales to give you a bit an idea, but still a very important business. We have had some headwinds throughout the year with notably some deals that were a bit postponed and pushed into next year. We had a one-off with the management changes that really have meant that we've seen reduced projects and reduced conversion from analysis, if you will, to engagement this year. But the important point is that this will change next year as we have built a new team and we have a new sales structure already in place, and we are already sitting on quite a very strong pipeline for 2025. So I think the important message is to look forward. This will be also quite accretive to our margin as we go to 2025. So we will regain what we've lost and do even better as we go to 2025. Then on the Health Science, I think, was your second question. The increased sales in Health & Nutrition effectively is a good thing. It's a good thing for our growth. It's a good thing for our margins as well, as you can imagine. And I would say that we see that continuing now as we go into Q4 and 2025. So it's really fueled, if you will, by a lot of drug development in Europe and that is accelerating, and you see that in the numbers already in Q3.

The next question is from Arthur Truslove from Citibank.

A couple from me, please. Firstly, if you think about the Wireless business within Connectivity & Products, my understanding is that's just come back to growth. Should we expect to see operational leverage there? And is that potentially a positive driver for margins? Second question, what are you seeing -- or what do you think you're going to see in terms of the kind of Softlines and Hardlines element within the fourth quarter? Obviously, there's been some discussion about how comps get tougher in the fourth quarter in those kind of lines of work so I was just wondering if you could talk about trends that you're seeing now and possibly exit rates as well. And then I guess, finally, how are you getting on in terms of people leaving the business under the restructuring plan? Is that all going to plan? And in what circumstances could we see more than the CHF 9 million of savings seen in Q2, in Q3 and/or Q4?

Okay. Thank you, Arthur. So look, yes, you're right, we see early signs of recovery as it comes to Wireless and that's a good thing for our connectivity business. It is -- and we continue to always expect incremental margin improvement because this is effectively also a volume business. Most of C&P is also driven by volumes as far as our growth is concerned. So it's good early signs and the recovery has started as we speak about Wireless. You mentioned Softlines and Hardlines, and here, we had a very good organic growth, a strong double-digit growth in Softlines, high single-digit growth in Hardlines as far as Q3 and that is also obviously producing a good operating leverage because, again, it's mainly composed of volumes when it's about C&P and Softlines and Hardlines. So that's all good. We see that continuing as we go into Q4. That is not something -- we don't have, as we speak, a tough comp when it comes to these 2 activities. So we do see continuing to grow. You mentioned the savings. Yes, we did CHF 9 million savings as it comes to Q2. We will give you exactly where we stand when we go to the Capital Market event. But as I said, we are fully on track when it comes to our restructuring plan.

The next question is from Annelies Vermeulen from Morgan Stanley.

Two questions, please. So I just wanted to come back on the moving parts of Business Assurance. I appreciate you've got tough comps in Consulting, but as that's only, as you say, 10% or 20% of the division, I think you also had those tough comps in the first half. So given the ESG tailwinds in this segment and the parts are growing double digit, I'm slightly surprised that the growth has moderated as much as it has in the third quarter. You touched on a stronger pipeline going into next year. So in 2025, can we assume that the Business Assurance reaccelerates to one of the higher growth parts of the business? Any comments there, please. And then secondly, you've done quite a few deals this year. You mentioned the M&A pipeline remains very strong. When we think about financing those deals, is it safe to say that you are considering offering the dividend in scrip again in February to allow you to capitalize on those deals?

Thank you, Anne. Look, again, the Consulting part of our business is accounting for only 10% of the total Business Assurance business, just to repeat that. It's a project-based business. And when I say we've seen postponements of projects, that has impacted us. I think it's fair to say the comparison base is stronger when it comes to Q3 and Q4 than Q1 and Q2, much stronger, okay? Then we had this change -- complete change of leadership and organization that started in '23 and impacted the business. But again, the important thing is that we have, the strong pipeline. Here, we're not talking about Sustainability consulting. This consulting part I'm referring to is the main point business that was acquired in 2021 -- well, 2022. And it's a business that's mainly serving the private equity on procurement and -- it's a kind of procurement control tower. So you do have effectively some business that is recurring, but it is mainly project driven. And some -- a lot of projects post-COVID bounced back and then it was affected when we had this management change. Now the good thing is that there's a new management in place. There is a practice leadership in place. And we do see a very strong pipeline. I will give you more color on the Capital Markets event on this topic as well, and we will discuss that deeper. But yes, we do see 2025 accelerating again and recovering on the traditional level of Business Assurance that you are used to. So that is something we have to go through for Q3, Q4, probably Q1 and then we're going to get back to the proper level of BA, which is a strong and fast-growing and good margin division. So we're going to fully recover as we come to 2025, definitely. Then you mentioned about financing the deals. We're talking here about bolt-ons. I have presented at the high level the capital allocation when we introduced Strategy 27 back in January. It's too early to talk about scrip or dividend at this stage. We will give more color on the Capital Market event and obviously, in due course, give the detailed capital allocation. But yes, we will continue to grow. And yes, we will have the firepower to finance all our deals.

The next question is from Allen Wells from Jefferies.

Three for me, please. Firstly, just I noticed in I&E and Natural Resources there are some comments around exiting and ending some low-margin contracts. I mean, is there anything to read into that in terms of how you guys are thinking about kind of contract portfolio rationalization as a way to support the margin? That's my first question. Secondly, in Health & Nutrition, there's good recovery there. You called out some recovery in pharma in Europe. Obviously, this is in slight contrast to one of your peers from earlier in the week that's slightly disappointed in its pharma business. I just wondered if you can add a bit of color there. Is this growth recovery more market-wide? Are there some company-specific issues in there that you're benefiting from? Or is it just some market share gain? And then, finally, just on PFAS, which you called out. Could you just help us just understand the size of PFAS in the business? I appreciate you probably don't want to give absolute revenue numbers, but any way to kind of quantify PFAS and where you see that going? And then maybe anything you can kind of expand on your leadership claims there because I think anyone that's exposed to that within the testing space seems to suggest that they're a leader or that they have leading capabilities. But I wonder if you could kind of rubber stamp where SGS is in terms of its leadership position.