Smiths Group plc (SMIN) Earnings Call Transcript & Summary

Good morning, everyone, and thanks for joining us. As we typically do, I'll provide a short recap of our first half results and then turn it over to Clare to walk us through the numbers. I'll come back and update you on our progress with respect to strategy and operations, and then we'll open up for your questions. Before we get to results, though, let me say a few words about today's announcement regarding our CEO transition. As you will have seen, I am leaving Smiths to take a new role in the U.S., and our Board has appointed Roland Carter as my successor. The last 3 years have been a period of strong progress for Smiths. We completed a transformative portfolio action in FY '22, we delivered record performance in FY '23 and we've now posted 11 consecutive quarters of growth with, as we'll cover in just a moment, significant momentum for the second half of FY '24 and beyond. Roland is the right leader to build on all this momentum. Clare and I will cover results in Q&A today, but I did want to take this opportunity to introduce and personally congratulate Roland. Roland, over to you.

Thank you very much. Hello. I'm Roland Carter. I am delighted to have been appointed as CEO of Smiths Group. I'm a chartered engineer, and I have been at Smiths for over 3 decades. In this time, I've had the opportunity and the privilege to lead many parts of this company. This has enabled me to develop an in-depth operational and strategic understanding of Smiths and its fundamental growth drivers. For the past 6 years, I have been President of Smiths Detection. Prior to that, I was President of Smiths Interconnect and Asia Pacific. I've worked for Smiths in the U.K., China, France, Germany and several other places. And I'm responsible for some of the acquisitions that form part of Smiths and also for some of the divestments that have reshaped us. Smiths is a fantastic business with great people and a wonderful culture. It has a hugely exciting growth potential. I would like to thank Paul for all he has done for Smiths. We are making great strategic progress and our operational and financial performance has improved, with Smiths well-positioned to deliver on its significant potential. Thank you.

Thank you, Roland. And again, congratulations. Okay. Having covered the CEO transition, let's now turn to our first half results. I will open with a short recap of our first half performance before turning it over to Clare to walk us through the numbers. I'll then come back and update you on our progress with respect to strategy and operations. And as always, we'll have plenty of time at the end for Q&A. We delivered 3.9% organic revenue growth in the first half, building on a record year in FY '23. We've now posted our 11th consecutive quarter of growth, extending our track record of consistent performance, driven by strong underlying demand in energy, security and aerospace our orders grew 16.5% in H1, providing good momentum for the second half and beyond. Our execution focus and Smiths Excellence System are delivering further tangible benefits. Organic operating profit increased over 5%, resulting in a 20 basis point increase in operating margin and a 50 basis point improvement in ROCE. Our balance sheet remains strong, and cash flow is much improved. Operating cash conversion increased 26 percentage points to 89% and free cash flow more than doubled. As such, we increased our dividend by 5% and have announced a new GBP 100 million share buyback program. With respect to people, we continue to actively develop our global talent. For example, we more than doubled our investment in leadership development and our wave 1 cohort of Black Belts and Master Black Belt are now completing their assignments and reentering into high-impact leadership roles across our company, backfilled by an even larger cohort of Wave 2 talent. We're also continuing to make good progress on advancing our sustainability strategy as the Science Based Targets initiative, SBTi, validated our net zero targets and plans last December. In support of our communities, I mentioned the launch of our new Smiths Foundation on our FY '23 call in September. I'm now excited to share that we are making our first wave of grants in support of charitable causes that linked to our purpose of improving our world through smarter engineering. In summary, we're off to a successful start in fiscal 2024 and carry strong momentum into the second half. And as such, we are reaffirming our full year guidance of 4% to 6% organic revenue growth with continued margin expansion. You are familiar with our Smiths Value Engine, which connects the 3 components of our success: our purpose, our strengths and our priorities. For today's presentation, we've also added our financial commitments to the slide to illustrate how our strategy is purposefully shape to deliver the financial commitments we make to all of you. Let's turn to those now. Clare will provide details on each of these in just a moment. So I'll just hit the high points. It was yet another period of strong well-balanced performance for Smiths, 4% organic top line growth and 6% with M&A. Good operational execution, turning this into 4.5% EPS growth or 11% on a constant currency basis; and improved capital efficiency, resulting in a significant increase in operating cash conversion and more than doubling free cash flow. As all of you know, when this business grows as it has now for 11 straight quarters, it generates a lot of profit and cash. And with that as an overview, I'll hand it over to Clare.

Thank you, Paul. As previously mentioned, organic revenue growth for the half was 3.9%. Acquisitions added 2.2% and there was a negative 5.4% FX impact bringing reported growth to 0.7%. We grew our operating profit to GBP 246 million, up 5.3% organically. And we improved margin by 20 basis points while at the same time, investing for growth. This operating profit growth, combined with the net impact of the previous share buyback program and FX contributed to EPS growth of 4.5%. We increased cash conversion by 26 percentage points to 89%, with improvements in working capital. ROCE was up 50 basis points to 15.7%, reflecting increased profitability. In line with our progressive dividend policy, we're announcing a 5% interim dividend increase. And I'm also pleased to announce a new share buyback program of GBP 100 million. We launched the initial tranche of up to GBP 50 million to be completed by the end of September. We continue to extend our track record of delivering growth. Now having grown revenue on an organic basis for 11 consecutive quarters, with growth in the first half against strong comparators last year. Notably, 8 of those quarters were in or above our medium-term target range. H1 performance reflected growth in our 2 largest divisions: John Crane and Detection and was delivered despite softness in certain end markets at Flex-Tek and Interconnect. Our portfolio helps provide resilience when end market performance is variable, underpinning a more consistent growth performance for Smiths. We converted revenue growth into 5.3% organic operating profit growth. On the positive side, acquisitions added 10 basis points and pricing more than offset inflation, leading to a further 20 basis point expansion. Benefits from the Smiths Excellence System together with the 2023 savings projects added 130 basis points. Volume in John Crane, Detection and Flex-Tek together contributed 100 basis points. The market-driven sharp volume contraction at Interconnect compressed margin by 80 basis points. And to support the elevated activity at Smiths Detection, we invested in additional field service engineers, increasing the number of engineers by 11% and this impacted margin by 30 basis points. We also invested 120 basis points to support future growth, primarily in John Crane, reflecting additional hiring and operations, together with increased spending on marketing and systems. In summary, we delivered a 16.3% operating profit margin, a 20 basis point expansion and in line with our full year guidance for continued margin improvement. For the half, the primary drivers of EPS growth were growth in operating profit and the benefit from our previous share buyback program. FX netted EPS growth down to 4.5%. However, on a constant currency basis, we delivered 11.3% EPS growth. Cash conversion in the first half was 89%, a 26 percentage point increase from last year. driven by working capital improvement. Our medium-term target is 100% cash conversion, and we look to make further improvements in the second half toward this level. We increased CapEx 5.6% to GBP 38 million, representing 1.5x depreciation. This included capacity expansion and investment in automation at John Crane. Finally, operating cash performance translated to GBP 112 million of free cash flow, more than doubling year-on-year. Now turning to each of the divisions. John Crane delivered organic revenue growth of 12.7% with a particularly strong performance in the first quarter, and this was against a strong comparator last year. Growth was broad-based by end market and in both original equipment and aftermarket sales. This revenue growth translated into strong operating profit growth and 110 basis points of organic margin expansion. Pricing discipline offset the impact of cost inflation and SES also drove performance. And we delivered this margin progression while also continuing to invest in growth to service the strong demand we see now and in the future. This encompasses additional hiring and operations to support the strong growth, together with increased spending on marketing and systems. Order intake grew 10.9% in the half, and the sustained high order book supports our positive outlook and expectation for continued growth through the second half of the year. And John Crane is playing an increasingly important role in helping our customers improve efficiency and reduce emissions from their operations and is now present in more than 100 hydrogen and carbon capture projects. We'll talk later about some of these recent contract wins. Smiths Detection delivered strong organic revenue growth of 8.9%, with growth in both aviation and other security systems. In aviation, we continue to have strong demand for our CT airport checkpoint scanners, and we continue to secure new contracts with multiple wins across the globe during the first half. We estimate that the industry is only about 40% of the way through the checkpoint upgrade. Importantly, these OE sales secure an attractive aftermarket for us that we expect to continue to contribute to margin expansion over the medium term. In other security systems, aftermarket revenue growth was particularly strong at 34%. We expect growth overall to remain strong in the second half. Operating profit growth was 10.3%. Margin expanded by 20 basis points, reflecting the positive benefits of SES and cost actions and the investment we made in increasing our field service engineering team by 11% to support our record activity. Orders were up more than 38%. Order intake in defense was particularly strong driven by a multiyear contract for an initial GBP 88 million award from the U.K. Ministry of Defense for the next generation of chemical detection equipment. This followed an earlier award from the U.S. Department of Defense to supply chemical agent detectors. Orders in detection are for multiyear deliveries with around 1/3 of the order book expected to contribute to revenue this year. In summary, Smiths Detection is delivering on its growth potential, and we believe SES benefits, increasing aftermarket revenue and the impact of new contracts will support margin expansion in the coming years. Now let's look at Flex-Tek where revenue declined 4.1% organically. Flex-Tek's Industrial segment declined 7.6% in the first half, as expected, mainly in HVAC and due to soft U.S. residential construction. Offsetting this, aerospace sales grew more than 12% linked to new aircraft builds. Despite the overall lower sales, organic operating profit increased 2.6%, and we expanded margins by 140 basis points. The margin expansion resulted from tight cost control plus positive mix impacts reflecting new industrial contracts. This was supplemented by the contribution of HCP, the acquisition we made in Q1, where integration is ahead of plan. Looking forward, we expect our HVAC sales to improve as the U.S. construction market recovers. Combined with continued strong aerospace sales, we anticipate that Flex-Tek will return to growth in the second half of the year. Turning now to Smiths Interconnect. Organic revenue contracted 13.7% in the first half as a result of challenging semiconductor and connector end markets. Although importantly, the market backdrop improved through the half. In Q1, Smiths Interconnect had double-digit organic revenue decline. And in Q2, this improved to flat. Order activity has also improved. We had order growth in the second quarter, and we now have a positive book-to-bill ratio. Reflecting lower sales, organic operating profit declined by 1/3 resulting in an operating margin contraction of 370 basis points. Despite the challenging first half, we maintained R&D investment to support our new product pipeline with recent product launches in medical, space and defense markets. Our orders have returned to growth, and the market backdrop is showing signs of gradual improvement, underpinning our expectation for an improved second half and underscoring our confidence in our medium-term outlook. Now to our capital allocation framework. Our first priority is to support organic growth, and we invested GBP 83 million in R&D and CapEx in the first half. We supplement organic growth with strategic acquisitions, and we've spent GBP 90 million on 3 bolt-on acquisitions since the start of 2023, most recently Flex-Tek's acquisition of HCP, which we announced in the first half. We'll maintain a disciplined approach as we actively look for further additions to complement our portfolio. And at the end of the first half, we sold around 1/3 of our stake in ICU Medical, raising almost GBP 70 million and have flexibility on future monetizations. Our third priority is returning capital to our shareholders, and we're increasing our interim dividend by 5%. And given the strength of our balance sheet, we're also announcing a new GBP 100 million buyback program with an initial tranche of up to GBP 50 million to be completed by the end of September. Our leverage at the end of the half was 0.9x net debt to EBITDA. So we have the strength and financial flexibility to execute our growth strategy and to continue to deliver against our medium-term financial targets. Finally, with respect to our guidance, we're well positioned for the remainder of the year with record order books at John Crane and Smiths Detection and expected gradual market recovery in semi con in U.S. construction and our new product pipeline, we expect growth to improve in the second half, and we reiterate our 4% to 6% organic growth guidance. We also expect to see continued margin expansion. With that, I'll hand back to Paul.

Thank you, Clare. I will now give an update on some of our strategic and operational progress, beginning with growth. Building on what Clare said earlier, underlying demand remained strong in 3 of our largest end markets: energy, security and aerospace; while 2 other markets, construction and semiconductors contracted in H1. In the interest of time, I'll touch on current dynamics in just 1 end market for each business, beginning in the top left with energy for John Crane. Energy was our fastest-growing market in the first half, where we grew 17%. Energy volume is a key metric for John Crane as it determines capacity needs for our customers, which in turn drives demand for both OE and aftermarket services for our products. As you can see from the chart, energy output continues to climb steadily, a trend we expect to continue throughout the second half and beyond. Moving counterclockwise to Flex-Tek in the lower left, our construction sales in H1, around 15% of total Smith were down 10%, consistent with the housing start data that you see here. We track a number of indicators in this part of our business: housing starts, permit applications, mortgage rates, builder confidence, et cetera. And some of these factors, for instance, housing permits and builder confidence are trending positively. Others, however, like U.S. mortgage rates still have further to go before a sustained construction uptick can confidently be expected. Now as Clare mentioned, in total, we expect Flex-Tek to return to growth in H2 behind continued momentum in aerospace and industrial electrification alongside gradually improving conditions in HVAC. Moving to the lower right, you see semiconductor market growth over time. Semi Test represents just under 3% of group sales. And after bottoming out in the spring of last year, this market is now showing signs of recovery. As such, we expect semi test specifically and interconnect more broadly to also return to growth in the second half. Finally, for detection in the top right, revenue passenger kilometers, one important metric for our business, were up almost 30% in the half. Regulatory mandates are another important driver such as required checkpoint CT upgrades, which are underway across the globe, and of which I'll say more in just a moment. The strength of these and other dynamics underpin good ongoing growth for Smiths Detection. One final item to note on this chart is the clear benefit that comes from a balanced portfolio. H1 softness in Flex-Tek and Interconnect was more than offset by strength in John Crane and Detection. You'll remember that the exact opposite took place in FY '22, when Flex-Tek and Interconnect both grew double digits, while Crane and Detection were still recovering from COVID with a well-balanced portfolio balanced by market, balanced by geography and balanced between OE and service, we're now demonstrating that we can deliver profitable growth as well as stability. Let me now say a few words about our near-term progress accessing longer-term megatrends. Energy transition describes the world's multiyear, multitrillion-dollar commitment to moving from fossil-based to low carbon fuels. As we covered in some detail at our H1 Capital Markets event, John Crane is uniquely positioned to support our customers along this journey. We continue to see strong growth in this part of our business with a number of new contract wins in H1, 2 of which you see here. On the top left, a contract to supply dry gas seals for critical compressors in a large-scale blue hydrogen project in Texas and in the lower left, a significant contract to supply wet seals for an electric battery facility in Tennessee. The scope and diversity of these wins further demonstrates the breadth and depth of John Crane's capability in energy transition. With respect to supporting the world's insatiable demand for data and connectivity, Smiths Interconnect is similarly well positioned. Our orders in satellite communications grew double digits in H1. Further bolstering momentum here, we received a GBP 2 million grant from the U.K. Space Agency to expand our space qualification lab in Dundee, Scotland, a major satellite manufacturing hub for Europe. And on the right side of the chart, Smiths Detection plays a central role in protecting our world from ever-rising security threats. During H1, we secured 2 awards to develop and supply next-generation chemical detector systems, one from the U.S. Department of Defense and the other from the U.K. Ministry of Defense. These multiyear awards will contribute accretive growth in H2 and beyond. As mentioned on the previous slide, mandated upgrades of airport security checkpoints are now well underway. 40% of the roughly 6,000 checkpoints around the world have thus far ordered new machines. Smiths Detection has won more than half of all awards, and we were particularly active in H1. These are just a few of the many growth programs underway across our company. At our Capital Markets event in 2022, we discussed our strategy of building pan-North American coverage for our highly successful HVAC business headquartered in South Carolina. This is a great business for us, one where geographic proximity to customers is especially important due to freight costs, cycle times and regional product differences. The first step in our expansion several years back was opening greenfield locations in Florida and Arizona, 2 of the fastest-growing states in America. In 2021, we acquired Royal Metal Products in Georgia, another fast growth state, further bolstering our position in the Southeast. In 2022, we opened our third greenfield site in Texas, strengthening our coverage in yet another top 10 housing market. And earlier this fiscal, we acquired heating and cooling products in Ohio, a market leader in important Midwest and Northeast states. While we are now able to competitively serve customers across North America, we'll continue to look for additional organic and inorganic opportunities to deepen our penetration in markets where our customers need us most. Having covered a few of the many growth initiatives underway, let's now turn to execution, where Smiths Excellence System is at the core of our strategy. As we did on the full year call, today, I'll share another example of SES in action, this time in Smiths Interconnect. Let me quickly set the stage. In partnership with a major global health care customer, we designed a custom medical connector, leading to a GBP 10 million contract. As the size of the program necessitated more than a tenfold increase in line capacity, we charted a Black Belt project to map the value stream, optimize line layouts and implement visual management systems enabling our team to respond in real time. The results of the project have been encouraging for both our customer and for Smiths. This project delivered a 5-point improvement in gross margins and a follow-on order for an additional GBP 4 million with line of sight to still more opportunity down the road. Let's now hear from Allyssa Skidmore, one of our senior engineering managers. [Presentation]

Thank you, Allyssa and Team. Another 50 or so projects like this are currently underway across the company, and we're on track for GBP 20 million in SES contribution for the full year. Consistent with this, our Smiths Excellence Awards, which we celebrated last fall, recognized distinctive contributions in support of the highest priorities you see here. They are organized around our strategies for growth, execution and people. The excellence awards are one of a broad array of initiatives that continually reinforce and advance our high-performing and inclusive culture. You've seen a marked uptick in Smiths performance over the past 3 years. The many actions we've taken across this time, for example, strengthening our leadership team, revitalizing our new product engine, improving our portfolio and embedding SES and the Smiths leadership behaviors are all interconnected building blocks of a much broader, stronger and more stable foundation for Smiths. It is our culture of continuous improvement that underpins our sustained performance. And it is this foundation that will provide continued success as we move forward. I'll close my comments on H1 with a quick update on people and culture before wrapping things up with a look forward to H2. With an eye to supporting all stakeholders, we launched the Smiths Group Foundation last summer. Across the first half of this fiscal, employees from around the world nominated close to 100 different causes for funding consideration. And after a rigorous selection process, the first wave of grants are now being made. We've asked Hannah Constantine, Group Director of Legal Operations and Chair of the Smiths Group Foundation to say a few words about how we're advancing our purpose and supporting stakeholder success. [Presentation]

Thank you, Hannah. Exciting to think about the positive impact that these grants will support. Now just a few comments by way of summary, and then we'll open it up for your questions. double-digit order growth in H1, coupled with gradually improving market conditions has us well on track to deliver our full year organic growth guidance of 4% to 6%. The operating leverage that comes with us alongside additional benefits from SES and other productivity initiatives has us reaffirming our guidance of continued margin expansion. And on the back of our strong balance sheet and much improved cash flow, we're announcing a 5% dividend increase and a new GBP 100 million share buyback. In short, a good start in H1 and with even more to come in H2. Our wonderful people make all this progress possible. And I want to recognize my colleagues around the world for doing what we do best, improving our world through smarter engineering. In the same way, we're grateful for the strong support that we enjoy from customers and shareholders. And with that, I'll ask the operator to please open it up for Q&A. Thank you.

[Operator Instructions] We will now take the first question, it comes from the line of Lushanthan Mahendrarajah from JPMorgan.

I've got 2, I think. The first is just on margins. And I guess, going back to that operating bridge you showed in terms of both the 80 basis point headwind, I think from Interconnect volumes and then the 30 basis points from Detection and sort of field service engineers. I guess how do we think about both those moving parts going forward, presumably, interconnect that reversed in the second half, perhaps not fully. And in Detection, I guess, how much do you have to go in terms of the field service engineers. Is that going to be an incremental headwind going forward as well? Or have you sort of done that?

Thanks for the question. Let's see, with respect to margins, you asked about interconnect and detection. Let me take the 2 in sequence. For Interconnect, yes, your hypothesis is correct as that business gradually returns to growth here in the second half. Margins will gradually return as well. You'll remember that was an 18% margin business in FY '22. And as it gets back to the same sort of volume levels, that same ballpark is about right for what you should expect. With respect to Detection, we're clearly prioritizing growth over margin in that business right now, and that's for 2 reasons. First, we're as interested in operating profit growth as we are in operating margin for Detection. It had double-digit operating profit growth, both in '23 and in the first half. Just that the top line is growing so quickly that the margin percentage probably isn't as pronounced as you would typically think with that much top line growth. The second important thing is the market share piece for detection. The world is going through an upgrade of all checkpoint systems from 2D to 3D scanners. Those machines will be in service for 10 years and the gross margin on the service is better than 2x what it is on the OE. So we're pleased with our market share performance there. As I mentioned in my earlier comments, the world is maybe 40% through the total upgrade, and we've won better than half of all tenders. So the NPV of those awards will generate a lot of value moving forward.

Okay. Helpful. And the second one is just on sort of the orders, which are very strong in the first half and for some of these divisions a bit more obvious than the others, but it would be helpful just to get a reminder in terms of the sort of timing of orders and sort of for each division in terms of when that sort of leads to sales and also particularly for Interconnect and Flex-Tek, what percentage of revenue is -- do you have visibility on orders? I guess I'm just trying to get an idea of H2 and the underpinning there that order growth you've seen in H1.

Yes. Let's see, a couple of questions in there. Let me see if I can remember them. The first is orders were up 17% in the first half, and we expect roughly half of that to convert to revenue in fiscal '24. A little bit different business by business. The largest percent of order book conversion or the shortest cycle time is in John Crane. Almost all of their double-digit order growth will convert here in fiscal '24. Probably the lowest number would be detection. Those are typically multiyear contracts. In particular, the 2 large defense contracts, those are 8- to 10-year contracts. So maybe 1/3 of Detection's record order book will convert in this fiscal and then it's about half for Flex-Tek and for Interconnect. Let's see, you asked how much of Flex and Interconnect is covered by orders roughly 1/3 of Flex-Tek is order-driven and roughly 2/3 of Interconnect.

We will now take the next question coming from Mark Davies Jones from Stifel.

Can I ask a bigger picture one to start. Paul, as you're first to part. Firstly -- sorry, to see you go, but can you tell us any more hints about where you're heading to? And can you give us a little reflection on where you think Smiths is relative to that U.S. industrial peer group operationally. I know you did some benchmarking when you turned up, where are we now, do you think? Because obviously, there is still quite a big valuation to get.

Yes, thanks for the question, Mark. So as I mentioned in my introductory comments, I'm going back to the U.S. to lead a U.S.-listed company and doing so principally for personal reasons. I come from a big and close-knit family and our kids, our siblings, our parents are all in the States, and this is just a great opportunity to be closer to them. With respect to U.S. versus U.K. industrials, I took this job, and you and I talked a lot about that when I did because I saw an opportunity for a fundamentally good company to perform at a higher level. In line with Smiths vast potential. And as I reflect back on the last 3 years, that proved to be even more true than I imagined at the time. And my second reflection would build on that for all Smiths has accomplished over the last 3 years. I haven't a shred of doubt that our brightest days are still ahead. I don't see any meaningful performance difference between the high-performing U.K. industrials and our peers in the U.S. I think you're accurate, though that there is a valuation different in aggregate, but there isn't in specific, the highest valued U.K. engineering companies trade at multiples as good or better than what they would trade in the U.S.

Can I ask one slightly more specific one around Flex-Tek, very impressive margins there in the period. You talked about mix within industrial. What's driving that?

Our industrial business is 80% of total Flex-Tek. Of the 80%, 2/3 of that or 60% is HVAC and 20% or 1/3 of it is other industrial and a big part of that is our process electrification business. So the mix comment we made there would be specific to process electrification. In particular, we talk about the H2 green steel project, that very high margin. The last 20% then of Flex-Tek is aerospace and of course, that is margin accretive as well.

We will now take the next question coming from the line of Christian Hinderaker from Goldman Sachs.

Can I just ask firstly on the interconnect business in terms of the mix, 19% semi-test 26% other industrial, 40% safety security and the rest aerospace. I think the semi-test and Sat-Com dynamics made a bit better understood. Can you just remind us of the technology applications and growth dynamics for the other parts? And then also maybe add some color on which of those areas drove that sharp inflection in orders in the second quarter.

Yes, you set the table well roughly half of all Interconnect is connectors. I'll come back to that. Maybe 1/4 is Sat-Com and then 1/4 is semi-test. You're also right that the dynamics are well understood. Sat-Com market strong, double-digit growth and no signs of softening. I spoke about semi-test earlier. Gradually recovering, we expect it to return to growth in the second half. Now for the connectors part, there's a couple of different pieces to that. We have a industrial connectors business, a typical application would be rail. Our connectors are good in high vibration environments. So the connectors between 2 railcars is a typical example. That market is still in recovery kind of up and down. We have a medical connector business that we gave an example of the SES project for. That's going well because of these big contracts that we're winning. And then we have a small defense electronics piece of that as well, connectors that go into those applications. And as you would expect, that market is growing, but they're typically forward-dated contacts.

Well, I've got 2 now on the capital allocation. I guess, the buyback, GBP 100 million and how we think about that in the context of the GBP 70 million proceeds from the IC state sale. Should we assume that 1 sort of spurred the other? And how do we think about the remaining equity stake in ICU?

Clare, do you want to take that?

Yes. So thanks, Christian. The decision to initiate a new buyback program reflects our improved cash conversion and also our commitment to return excess capital to shareholders. So we took that decision looking holistically at our anticipated sources and uses of cash. So we took into account, firstly, our first priority for capital allocation, which is organic investment. We looked at our anticipated acquisition. [Audio Gap]

And maybe just if you could add to that, what are the sort of views here in terms of comfort levels on leverage, I think, 0.9x net debt to EBITDA today. And then in terms of the M&A piece, are there particular priorities across the portfolio that we should be thinking of?

At 0.9x net debt-to-EBITDA, we're sitting very comfortably. We feel that, that is a balance sheet that allows us to pursue all of the organic and inorganic opportunities that we have in our site. It's a very comfortable place for us to be. In terms of our M&A pipeline, I would describe that as active and growing. And you have seen the successful acquisitions we've made recently since the start of FY '23, we deployed GBP 90 million for acquisitions, the largest of which was HCP and Flex Tech which is performing ahead of plan, and we're really happy with that integration. We would love to do more acquisitions like that.

We will now take the next question from the line of Jonathan Hurn from Barclays.

Just 3 questions from me. Firstly, I just wondered if we can just come back to the margin rich for '24, but sort of take it up to a group level. Maybe clear, could you just give us a little bit of color about how we should think on a full year basis, the impacts from mix some investment on growth? And also, what kind of tailwinds on a full year basis we could see from price cost in SES, please.

Yes. So when you think about the full year, we reiterate our guidance for continued margin expansion. We will continue to save where we can in order to spend where we want. And that is what you see when you look at the group level margin bridge. We will continue to achieve more in price than in input inflation. We intend to continue to deliver SES benefits. We have almost 50 Black Belt projects in flight. You saw 1 of those described here today that will continue to deliver benefit. We also have the full year benefit of the savings programs that we put in place last year. And then on the other side, we will, of course, have the benefit of the order books coming through in Crane and Detection and gradual recovery in Flex-Tek and Interconnect, which will improve volume and operating leverage. And as Paul mentioned, though, we're going to continue to lean into growth. And that's where you saw the investment in field service engineers for Detection. You also saw the investment, primarily in John Crane, in commercial aftermarket support and systems and marketing because we have momentum, and we want to continue to build that momentum.

Okay. But just on a sort of a basis point impact, is it going to be any significant difference full year relative to what we saw in the half year bridge?

It will not be significantly different.

Okay. That's very clear. The second question was just on, obviously, the defense contracts that you won. I think you sort of alluded to them being mix beneficial. Can you just talk a little bit about the margins of those defense contracts, please?

Go ahead.

I was going to say, we certainly don't talk about margin by contract, but that segment, the Defense segment within Detection is margin accretive.

Okay. And is that significantly above where the current margin for Detection is in terms of relative to those defense contracts?

Yes. Jonathan, these are chemical detector contracts to develop the next generation of lightweight mobile chemical detector to be used in defense and civil applications. Again, 1 is with the U.S. DoD, 1 is with the U.K. MoD. So the first piece of it is development revenue that tends to be high margin, and then it turns into production units. Those units are also accretive -- margin accretive to Detection.

Okay. That's clear. And just finally, just maybe on John Crane. Obviously, you talked about the order book and most of that being delivered, not all of that being delivered in the second half. If we look to John Crane to next year, FY '25, I mean, obviously, you're coming up against tougher comps. How do we think about that sort of growth of that business? Do you think it starts to slow down to sort of mid-single digits growth? Or do you think next year could be another year of high to maybe double-digit growth for John Crane?

I'd say 2 things. First is, we don't see any evidence in the market data that we get in our order book or in our customer behavior of near-term slowing in that market. Both the traditional energy side and certainly the new energy side are buoyant right now. With respect to the second half, as I mentioned, half of our order book -- of our total order book for Smiths will convert in FY '24, but almost all of the John Crane order book. So we have good visibility to the second half. Rolling into FY '25, it's a little early to provide guidance on that. We expect the market to remain strong. we expect John Crane to be accretive to group growth. So if the group is going to be at 4% to 6%, we expect John Crane to be at the north end of that or a little bit higher.

[Operator Instructions] We will now take the next question coming from the end of Andrew Douglas from Jefferies.

Three questions from me, please. Can you talk about the kind of broader investments in the group? You got 30 basis points and then 120 basis points headwinds this year. We got Flex-Tek recovering clearly. We've got John Crane staying strong. Is this business under invested. What's the rationale behind putting a 150 basis points of cost into business or is it -- last year? On cash flow, can you just talk about the building blocks going towards 100%, you double free cash flow is a good improvement in the first half against the low base. But can you just talk about how we get to that 100%? And then second -- and lastly, sorry, on the M&A buyback debate, buy back is a little less than 2% of your market cap. You've probably got over GBP 1 billion of firepower, yet you appear Clare to talk about kind of more bolt-ons in terms of future M&A. Is that right? Or is there any kind of maybe on transformational, but kind of large-scale M&A that could be happening. Otherwise, I don't quite understand the GBP 100 million.

All right, Andy. Let me take the first one, group growth. Clare to handle cash flow. And then I guess you called it a debate between M&A and buyback. I'm not sure there's a debate. I think our allocation strategy is clear, but I'll let Clare answer that one. Investments in growth, the answer to your question is embedded in the question itself. Market demand is so strong in 70% of the company right now. John Crane and in Detection and in the aerospace part of Flex-Tek that I think would be silly not to be investing in that growth. I mean all of these businesses have a combination of an original equipment in a higher-margin aftermarket component to it and capturing share now from an NPV perspective is the easiest math you'll run. So taking advantage of that opportunity to us seems like a value accretive decision. That's why we're doing it.

Does that continue into '25, Paul, sorry?

Will that continue into '25?

Yes.

If the market dynamics continue to give opportunity, we will continue to prioritize growth. And along with that comes not just top line growth, Andy, but the operating profit growth. Over the last 3 years, the company has a compounded annual growth rate of operating profit of 14% alongside the 7% CAGR on organic growth. So we're getting strong top line growth and converting it to even stronger profit growth. We're very pleased with that dynamic.

And then, Andy, in terms of your other questions, as we look to the second half, we do have the opportunity to continue to improve working capital. We also specifically have the opportunity to improve inventory and our inventory turns. So that's why I said that we do believe as we go to the second half, we will continue to improve upon the 89% operating cash conversion. From an M&A perspective, primarily what we look at are what you would describe as bolt-ons, consistent with what we've done in the past, most recently, HCP and Plastronics. Of course, we look at opportunities for all of the divisions across all geographies. We're always looking to see if there are new technologies that enhance our core or strengthen us in adjacencies. We do, of course, look at larger for opportunities when they come along, but our primary focus continues to be on bolt-on opportunities. And then finally, in terms of your question around the balance sheet. Prior to the sale of medical, we ran the balance sheet at around 1.5x leverage. We're now at 0.9x. So we have ample headroom if we were to find an interesting and larger acquisition. But right now, I think it's a very comfortable place for us to be. I think it allows us to execute on what we've consistently communicated as the priority ranking: Organic first, M&A second and then returning excess capital to shareholders.

There are no further questions on the phone at this time. I would like to hand back over to Paul for closing remarks.

Okay. Well, thanks, everyone, for tuning in today. As we mentioned, we're with the start to FY '24, good top line growth, again, converting to even higher EPS growth on a constant currency basis. And the very strong order growth in the first half leaves us confident of continued margin expansion and acceleration in the second half, causing us to reaffirm guidance of 4% to 6% for the year. So with that, well, thank you for your kind attention, and I will leave it at that.