SGS SA (SGSN) Earnings Call Transcript & Summary

So welcome to the Q&A of our Capital Markets event to all of you joining online and in person. Our CEO, Geraldine Picaud; our CFO, Marta Vlatchkova; and the entire Executive Committee will answer your question.

As this session is webcast, may I ask you to wait for the microphone, to state your name [Operator Instructions] many thanks, and we're going to take the first question now. Analyst from Morgan Stanley.

Annelies Vermeulen from Morgan Stanley. Two questions, a slightly longer one and a shorter one. So on the additional CHF 50 million of savings from procurement, how much drop-through do you expect from that into margins? I realize today, you've said you've gone from 150 basis points of margin improvement to more than 150. So can we assume some of that is from that procurement? And of the CHF 40 million that you've done already, the remaining CHF 90 million from the CHF 150 million, what would the phasing over '25, '26, '27 look like? And then secondly, Marta, I think you said this morning that you retain the option to do a scrip or cash dividend. Is it safe to assume that, that will be the case for full year '24?

Yes. Thank you, Annelies. I will take your second question about the scrip, if you don't mind. I think the first thing we need to have is the results of 2024. And this is when we will take the decision about another scrip and the dividend. So let us finish the year on a bright note, and then we'll come back to you with that in due course. That will be the right time. I will give the floor to Marta on the efficiencies of CHF 150 million now. It's fair to say that we're ramping up and we're delivering as fast as possible. And the goal is to get the run rate by the end of 2025. So maybe on the drop-through, do you want to take it? Basically it's...

This is 100% flow-through. Of course, for the lean operating model, the restructuring part, the CHF 100 million, they are restructuring costs, but they are below the adjusted operating income. So that portion to an extent, yes, will compensate for the year '24 and '25. But the payback is below 1 year. The payback of the CHF 100 million program is below 1 year.

And I think it's fair to say the uncertainty is the ForEx, and we've put it clearly because we are doing guidance in reported terms when it comes to margin now. So that's why we wanted to completely assure you about our commitment to deliver this 150 basis points at least by 2027. But obviously, we don't know what we don't know when it comes to ForEx, but we want obviously to plan and to deliver or over-deliver on our margin improvements.

Suhasini from Goldman Sachs. So my first question is on the M&A program. I think it's very clear that you have an accelerated strategy to do the bolt-on M&A, adding 1% to 2% growth per annum. But can you maybe talk about how the pipeline looks in terms of larger transactions and the choices that you can make over there? And in relation to that, I suppose, is this flexibility to use scrip dividends to basically fund deals? How will you go about making that choice? The decision between, let's say, choosing the scrip dividend, is that more reserved for larger transactions? Or is it also going to be for bolt-on M&A?

I think we do have in our pipeline that's quite large and it's just the beginning. We do have midsized or larger deals that are potential. We focus on the bolt-ons for the moment. And obviously, we want to go as fast as possible. So growth could mean effectively scrip in order to fund and grow faster and accelerate the delivery of Strategy '27. So that's clear. But we do have larger deals. And in due course, we will consider them at the right time and with the right level of synergies and return, which large deals should bring.

It's Pablo Cuadrado from Kepler Cheuvreux. I only have one question, which is focused on pricing. Clearly, you have kept the, let's say, the organic growth for the next few years, 5% to 7%. That's unchanged. I think we have seen this year a little bit of a ramping up process with the pricing, looking H1, later on slowing down a little bit on the Q3 results. If you can update us how you are seeing the developments there? Do you think that pricing still is going to be phasing down, let's say, next year, but how do you think it's going to be for the years of the plan to 2027?

It is a bit difficult to plan the, I would say, the mix volume and pricing to 2027. What is sure is we want value for pricing. And you've heard how the team wants to continue to innovate and develop the best service, and that will always have a price, and we want to continue on our commercial excellence to be able to increase our prices, not only with inflation, but also for the service and the quality of the service we are doing. And that's key. And the commercial focus is really back on. And then volumes have to be there. It's obvious. Marta, do you want to give more color on '24...

On the comment, which is the component of inflation pass-through in pricing, obviously, this portion will slow down because inflation is slowing down. But in opposite to that, we have the focus on commercial excellence and driving the mix up.

It's Rory McKenzie from UBS. I appreciate the clear targets to add the CHF 600 million from Sustainability, CHF 200 million from Digital Trust, doubling North America. And I appreciate there's intersectionality within all that. But that does suggest your outlook for everything else in the group is probably low single-digit CAGR at best. So what's weighing on other parts of the group? Are there any contract exits or business reductions that you're evaluating as you think about cleaning up that portfolio? So yes, discussing the wider group would be great first. And then secondly, very clear on the accelerating M&A plans. I'm surprised there wasn't an equal discussion about accelerating CapEx given your growth focus and the very good payback you've illustrated on some of those projects. So can you talk about that CapEx plan as well?

Sure. Sure. We had -- you remember on that last point, we had a clear slide by end markets, and we showed where we allocate capital. And the allocation of capital is obviously bolt-ons, yes, but it's also CapEx. So here, you have the answer with regards to CapEx and where we want to focus our CapEx investment. We maintain a 4% on sales, which is also a lot. And you see where we're going to have the focus in terms of CapEx allocation with the slides that I presented this morning. So it's true that M&A was stopped in terms of bolt-ons for SGS. So it's relaunched, and that's also the reason why we wanted to assure you that we are fully at speed, that we execute. And that's part of the strategy because as we explained in the breakout session, and as I said this morning, we are in a fragmented industry. So we need to play an active role in consolidating the business. And the bolt-ons bring synergies. And that's why we have this double-digit ROIC year 5. It's because you have synergies. This is the story of bolt-ons. You bring synergies, you ramp up and execute the synergies with accountable business leaders and you get the value and you get a fantastic payback and value. So this is something key and is something that really was important also to showcase. But -- I mean, the labs -- we still do labs, and we still have CapEx within maintenance or greenfield or brownfield. I think during the visit of the lab and the mass flow lab yesterday, you could see that -- I mean, depending on your group and some groups, they were already talking about the next machine they would like to buy and the extension they would like to do and putting this here and there. So no worries on that. There is a lot of appetite. The point is to, as I said, organization more efficient and focusing the resources where we grow faster, where they are accretive and where it's accretive to our margins as well. So that's really the focus.

On the question regarding how we have modeled in the growth by '27, if you put aside the growth driven by Sustainability and Digital Trust services, the remainder of the business is 5% to 7% growth, including bolt-on, both organic and bolt-on.

Himanshu from Bank of America. When you think about Strategy 2027, what are some of the risks that you see in terms of execution? And also on FX, because it has been a topic and has been a headwind to the margins. Is there something that you can do about it to maybe hedge the FX risk?

So on the FX, this is something that is a translation, a currency translation effect. So there's no hedge that you can do. What you can do is continue to invest in the right geographies, which is what we do. So this will -- hopefully, by 2027, we should have a lower impact when it comes to ForEx as we convert all our results into Swiss francs. And the other question...

The risks in terms of execution.

Well, look, you've got the Executive Committee members here. They are all fully committed collectively, individually, with us. So risks that are under our control are monitored. The risks that are not under our control, it's -- obviously, it is for every business. But think about SGS as a company that is present in so many end markets that it is its strength. SGS is a super resilient company. It is not cyclical. It is recession-proof. So there's no reason why we will not deliver or over-deliver actually, that's my goal, Strategy '27.

It's Arthur Truslove from Citi. Two from me, if I may. The first one was just on the ForEx within the bridge on Page 31. Obviously, it's quite a big block in terms of the margin bridge, almost as big as the organizational efficiencies. So I was just wondering kind of how big it actually is in terms of basis points in terms of what you've modeled and what the assumptions are for that? And the second question, I guess, talking to the operational leverage side, I get really is if you think about your lab footprint, I know it's sort of quite difficult to answer, but to what extent do you feel that it is optimized in terms of where you are? And how much further is there to go in terms of optimizing that network?

Marta, do you want to take the first question about the FX bridge? I know you're a cautious CFO, so you can explain...

Well, the ForEx is there. You have seen the impact last year, you have seen the impact in H1. It's fair to say that the appreciation of the Swiss franc, even though it's still there, has slowed down after the U.S. election when the U.S. dollar went up. But yes, we have been, I would say, on the safe side because we are cautious to deliver on our promises and restore the credibility.

Okay. And then about the operational leverage optimization, I think you've been through the breakout session where you've seen all the initiatives that are ongoing. So yes, there's more to be done. It's a constant exercise. I think that's what Malcolm explained. It never stops. We're always in an optimization mode, whether it is to transfer task to our shared service center in [ Merida ] and in Bogota or whether it's about gathering volumes to a hub-and-spoke model. So yes, there is still some efficiencies, some operational leverage to optimize. And this is what we are doing as we speak. That's ongoing.

It's Karl Green from RBC. My first question is just around the issue of the double-edged sword, which is regulation and net zero transition. I mean, clearly, some markets like the U.K. and Germany are at the sort of receiving end of some of the more negative consequences of that at the moment. So I guess the question is in terms of a global business like yours, are you kind of seeking out those countries and those verticals where you see that the balance is better in terms of supportive regulatory dynamics, but it's not happening too quickly. So just thinking about how you would allocate, say, CapEx or sales and business development resource. That's the first question. And then the second question, much more prosaically, just around working capital. I think you said you'd like to keep it at around or below 3% of sales. And I think historically, SGS has done in some years much better than that. So is there something sort of fundamentally happening on the working capital side in terms of payment terms or perhaps linked to procurement that we should be thinking about in terms of modeling working capital?

Thank you very much for the question. I'll let Marta on the working capital, and then I'll take the first one, actually.

Yes. So looking at the working capital, remember our pillars of growth, remember, we want to double North America. So this comes with payment terms that are payment terms of mature markets. So keep that in mind. Nevertheless, working capital below 3% of sales is very healthy and best-in-class.

So we're taking care of the payment terms. Yes. I do think that, as I said, you've got regulations and a regulation framework, and it continues in several countries. As we have a global network, we benefit automatically from that, whether the supply chains are moving, whether there is announcement about less regulations in a given country. If you listened to Steven this morning, he said basically Trump administration, the big winner is going to be Asia without China, so his regions. Wherever the supply chain is going to move out of China, he's going to capture it. So I do think that our global presence allow us to really capture growth. [ Jonas ] was asking me, how are we going to face Trump yesterday? And I said, well, actually, this will stimulate investment and economic growth in North America through the tariffs, the tax, the investment schemes he's putting in place. And that's a super fantastic opportunity for us as we are also investing in North America, doubling our sales there, and it will produce even more business for us.

It's Neil Tyler, Redburn Atlantic. I wanted to ask a question about the comments you made regarding commercial excellence. You've given us lots of examples of measures, both existing and new that are strengthening this. But can you please explain some of the details of how price negotiations with customers might have changed or need to change to make sure you get paid appropriately for the excellence and the value that you're bringing? Because I'm not necessarily sure that, that was always the case.

Well, look, I can answer generally. I can give the floor to one of the Ex-Co members. Maybe, Derick, you can comment also on what you're doing on your region to accelerate the commercial excellence. We are focusing by determining exactly the pricing impact, the volume impact in labs for each segment, each geography to sensibilize really, have you done the work, in inflationary countries, it's just a must do, a must do, a must follow up. So we have started beginning of the year when I arrived to put emphasis immediately on that, on the necessity of passing on inflation where they need to be. And then you have to have training programs. You have to visit customers. This is not something that happens by decree and things don't come from the sky. You have to have teams that are incentivized properly with motivating incentives program. We had a very good sales team in China with a very good reward scheme. And we expanded it out of China to the Asian regions under Steven. And we also did it in North America. Derick, do you want to add things on that? Steven can complete as well, how good we are on our sales programs.

Yes. I think part of what we normally or traditionally do, and it is not just in North America, and if you look at what we do with the global accounts as well, it's a package offering on a commercial approach. So our commercial teams are driven to see how they can best tailor-package a service offering to a client. And it's a case of bundling services as well. I gave an example during the North America presentation. As an example, in North America, we have a lot of minerals clients, a lot of mining clients. We also have a big tag along with our environmental services that are tagging along with our minerals clients. So you tag that along together, and it gives you a better leverage. I think in addition to that as well, in the North America presentation, we spoke about the latest acquisition we did, which is Beta Analytic. So those are premium services. We are a market leader in a sector that commands us to drive a better pricing. So commercially, our teams are also driven to better understand how can we differentiate ourselves in offering a service where we can get some better or more advantageous commercial offering.

Well, thank you, Derick. Steven, you want to say how your tigers in China are getting the volumes and gaining market share?

Yes. I think it's on top of the price. The most important, as Derick mentioned, that we should really differentiate ourselves. You offer the value to the customer. At the end of the day, we help our customers to export their products. I quote an example during the breakout session that in the past, the Chinese or the Asia exporter, they are quite happy with the European, U.S. market. But nowadays, they foresee the challenge from U.S., right? They wish also to diversify their markets. Now they come to us other than U.S., Europe, they're asking for the solutions in Latin America. They're asking for the solution on SEAP countries. And as long as we are able to offer them the solutions, -- in the past, we received 1 sample, we test for 2 markets. But now we receive 1 sample we test for 3, 4, 5 markets. That's also why we can really not only keep up the price, but we even charge additional for offering them better solution.

Thank you, Steven. So we really make sure we have value for pricing. You want a service in express, double the price at least, right, guys? So we are very commercially focused.

It's Will Kirkness from Bernstein. Two questions, please. Firstly, on the CHF 600 million uplift in Sustainability. I know you detailed sort of 4 pillars to that. I just wondered if you could quantify the uplift you expect maybe by those pillars or by region, if it's more useful. And secondly, just thinking about capital allocation and funding of the capital allocation. So you can sort of self-fund through free cash flow, divis and bolt-ons. But if in a couple of years, you're looking at something more strategic, how would you feel about balance sheet capacity at that point in time?

Well, thank you. Look, on the capital allocation, we'll see in due course. I think it depends on the size, the magnitude of what we are talking about. So let us start. And when we'll have the strategic, we will see where we stand in terms of balance sheet, what the firepower of our balance sheet, how much we can absorb, and we'll see in due course. I think it's too preliminary to express how we're going to fund the strategic where we stand today because it really depends on the timing. We have still 3.5 years to get to our Strategy '27. So let us start, and we'll come back. We will have a better balance sheet, and it depends on the size of the strategy. Basically, if it's CHF 500 million, it's okay, if it's CHF 1 billion, that's the thing to be seen. You said quantifying the 4 pillars. So we know our baseline by pillar. And now what we want is to get the CHF 600 million. We will regularly report on that because we say you can only manage what you can measure. So Marta and the team is already focusing on putting the right measurement and how fast, effectively our services, our Sustainability services are growing. We're very confident. It's a fast-growing demand here, and we want to monitor that. So today, it's too premature to give you this sub-segmentation in the Sustainability services that, again, cover all end markets and all geographies. One question there.

It's Karl Green here from RBC. Just a quick follow-up. Really interesting seeing a lot of the automation in the laboratories, the mass labs, in particular. Could you just indicate roughly what proportion of the lab network is on the mass flow basis compared to the sort of more specialized site-based laboratories, et cetera, just in terms of thinking about how much more automation we could see across the group?

Yes, it's very -- it really depends on the regions, on the end markets, some are more advanced than others. But I would say a good half easily is already on the -- largely.

Himanshu, just a follow-up. Geraldine, you joined 10, 11 months ago, you presented to us an initial assessment at the beginning. Since then, over the last 10 months, have you found or discovered anything, any more surprises that could basically be positive or negative? If you can talk about that. And also, we know the cost savings are tracking ahead of the plan. So should we expect probably the remaining CHF 90 million to come also sooner than expected, maybe first half of next year?

Well, we'll do our maximum to deliver Strategy '27 even faster than we are doing today. Be assured of that, Himanshu. With regards to the surprises, I would say they've been only good surprises. I've been -- I'm surrounded here by my Ex-Co fellows, my Ex-Co members, and they're all very committed individually and collectively. And this sense of commitment is actually all over the company. We want to succeed. We want to perform. And I hope you had this sense when you were interacting during these 2 days with our people and our management team. We're all focused on performance and delivering.

Arthur from Citi. Just a couple of follow-ups from me. The first one was just following on from an earlier question about the scrip dividend. So I know you're not going to sort of say what you're going to do in respect of 2024. But I was just wondering if you could talk through the thought process that you sort of go through when you decide what to present to the Board in terms of your recommendation. The second question I had was, obviously, in one of the slides earlier, you talked about sort of shifting supply chains. I guess some people obviously think there's a risk of some shifting out of China. In terms of your thinking, are you expecting any shift away from China to be sort of faster in terms of geographical shift than you've seen in the past? And does that present risk to kind of utilization of labs in China, for example?

Look, I'm happy to let Steven comment on the rapidity of the move of supply chains out of China. But I would just tell you, China is the factory of the world. It is a fact. China represents 60% of the industrial capacity of the world. This is a fact. So nothing is going to change that fast, obviously, to me. But Steven, do you want to comment a bit on that?

Yes. As Geraldine said, we don't really see if there's any supply chain migration is going to happen overnight, right? And also when I shared with the -- during the breakout session that as long as the consumer keeps buying, the product needs to be manufactured somewhere. I assume the majority will still be in Asia Pacific. If we look into the China specifically, most of the company or the manufacturer, they are keeping the China Plus strategy rather than just shut down the China and moving everything outside to the other countries. So as long as we maintain our presence in China, the additional capacities to be built in other countries, most of the case, again, in the Southeast Asia, some of them may be in Mexico. But to me, again, we see this as opportunity rather as a threat.

Thank you. Yes, the nearshoring is a great opportunity for us. You mentioned about the scrip. Obviously, final decision, as I said, will be made when we have done the full year 2024 account. I think you heard me, I said our priority is growth, and our priority is growth. So I think it's fair that at this stage, we intend to propose to our Board to include a resolution for a scrip dividend to be voted at the next AGM.

Tom Burlton here, BNP Paribas Exane. Just a question regarding the operational leverage piece of the margin bridge. Can you help us just get a sort of framework for that? I guess, a, what have you assumed in terms of drop-through in that bridge? And then b, when you think about 2027 and your kind of vision for when the business is sort of operating at full clip, what's the right level of operating leverage and right kind of drop-through we should think about this business when it's operating at full pace?

Look, again, the operational leverage is something we work at all times. When I talk about -- and Marta will complete, obviously. But when we talk about commercial excellence, we're also talking about increasing the volumes and therefore, improving the operational leverage of each of our labs because in the testing business, it is a fixed cost structure. So you need to manage your lab with a utilization rate. So your question basically, it's really depending on which region we're talking. Utilization rates are not the same everywhere and some are already 100% utilization rate, and some are not and need to be obviously optimized with either proper and more efficient sales team or a restructuration in terms of hub and spoke. So it is really a case by case. But as I said, we still need to optimize our network, and it's a constant effort. There's still some room for improvement, as you've seen in the bridge of Marta.

Yes. And what I just would like to add is the way we see it is that operational leverage together with a better mix should be at any point of time able to offset headwinds from ForEx, at least, more than offset, yes.

Michael Foeth, Vontobel. I have one question regarding your digital strategy. You talked a lot about revenue opportunities from Digital Trust. But my question is more on how much you have to spend yourself on digitalization and IT in your 2027 roadmap? Is that portion rather increasing or decreasing? How much is it split between CapEx and OpEx?

It's -- look, this is a good question. So it's what we say AI for tick instead of tick for AI. So how much we can digitalize and optimize our process. And as you've seen in the lab, even though the lab, you visited yesterday, it's fully digitalized, there's -- it's a constant progress to optimize and robotize. So there is a bucket of CapEx in the 4%. That will be always dedicated to optimize our labs. As Marta said, any CapEx has got a payback below 3 years. So it means that even when you put a software in place or you put a new system in place in your lab, you need a business case. You need to have the lab manager, the country manager committing to say, "Okay, I'm having that, I'm going to have some depreciation in addition of this CapEx that are going to hit my margins. But in exchange, I will more than offset that by having staff reduction or more volumes for the same fixed cost basically." So you need to have that business case, and this has been set since the beginning of the year. We need a precise business case and someone accountable to deliver. So there's no free lunch, if you will. But this is a constant exercise that we are doing. Marta, do you want to add something on the quantum of CapEx on IT or something? I think it's...

No. I received quite a lot of questions during the breakout sessions on that. All I can say is -- and the difference, it was also to compare with previous statements we have done. What we do is it's a controlled investment, yes. It's a committed investment. We track of the payback. Depending on the maturity of what we want to implement and what we want to invest, there are clearly cases where the payback is attractive, we go for it. And there are clearly cases where we do not follow a dogmatic approach to say, yes, we have to have 100% coverage of specific system or software rather than do it in a phased manner when the maturity of operations is there to be able to pay for it.

[indiscernible] [ Lazard ]. I just wanted to ask, given the scope of growth and the opportunity that you have, as you go through the strategy to 2020 (sic) [ 2027 ], can you imagine a situation where you will be more comfortable with higher leverage?

It could be. It could be. We'll see. It depends on the opportunities we are going to have along the way to end of 2027. But in any case, that would mean to recover as fast as possible because I believe in a strong balance sheet, and I believe in a strong credit rating. So if we have to go along the way, again, at the right timing when it's -- when we keep our strong balance sheet to go a bit more leveraged, it would mean that we have the clear synergies, obviously, and we have a plan to assure our credit rating agency that we are back on track ASAP, right? So that's very important that we recover as fast as possible our balance sheet.

[ Guillaume, ] [indiscernible] if the FX is not the headwind you were expecting, what will be the strategy there, pushing on the margin or reinvesting some of it in the business?

So a good question, [ Guillaume. ] We'll see in due course, when we're there. But obviously, we will reach at least the 16.2% that Marta showed this morning. That's the first objective to get there, to feel comfortable there, and then we will decide if it makes sense to reinvest or to continue. It depends on the quality of what we reinvest to. So it could be either/or. It's too early to tell.

Himanshu. Sorry, can I just clarify one of the answers, Marta? You mentioned at any point of time, the operating leverage and the mix should be able to more than offset the FX headwind. So does it mean the operational savings of CHF 150 million drops through to -- all of them accrues to the EBIT margin in '26?

Yes, it means that, Himanshu. But to the provided -- I mean, you have the FX, which is an unknown. You have seen that in the chart of Marta, right? So that's -- except if you put out the ForEx, we can assume that we should reach that probably, yes, by 2026. But we stick on our guidance on 2027. Don't push Marta. Okay. Well, Ariel is telling me it's time. So fine, we're going to have the fun part now with the drone, right? Cool. So look, we were really delighted to host this capital market event with you. I would like to invite all the Executive Committee members to stage because it's not a one-man show as you've -- one-woman show, as you've seen. It is a collective effort. It is a team effort. And here is the team with me, with Marta, with us. And now I would like to say thank you very much for your attention. Thank you very much for your participation. You can be assured we're all there, committed to deliver on Strategy '27. And again, we are executing at full speed. So thank you very much.