Spectris Limited (SXS) Earnings Call Transcript & Summary

Thank you very much, and good morning, and welcome to the Spectris Q1 trading update. I'm joined by Derek Harding, our CFO, to discuss our performance in the first quarter of the year. Thanks to the continued great work of the whole Spectra scene, we given a strong trading performance to start 2022, building on the momentum from last year. The recovery in our end markets have continued, leading to a strong organic sales growth of 12% in the quarter. And this was further supported by market share gains as we focus on supporting our customers through the launch of new products and services. Our order book continues to strengthen, with like-for-like orders growing 29% in the period, maintaining a strongly positive book-to-bill ratio we have seen for the past 20 months. Book depending on the quarter was 1.35, up from 1.16 last year. The firm order book also provides confidence in continued sales momentum, supporting our outlook and positive prospects for 2022. Our aggregate order cover now extends beyond September. We continue to see the same level of supply disruption as we saw last year as well as an impact from COVID-related lockdowns in China at the end of the quarter. Consequently, our overdue backlog remains at a similar level for December. To be clear, we are not seeing any customer cancellations beyond what we would ordinarily expect from a long-run historical average perspective, i.e., remains very low. We now expect to be managing supply issues through at least the end of the year and the impact from the China lockdowns over the next few months. However, we have organized ourselves to better mitigate shortages and deal with surprises as evidenced by our Q1 sales. Looking at the performance of our businesses now in more detail. Like-for-like sales were high in the majority of our end markets in the quarter, especially in semi compound machine manufacturing, and both automotive and energy and utilities -- which were essentially flat last year, were both firmly in growth territories in the quarter. Like-for-like sales increased in all regions, with the strongest performance in Asia, particularly in China and South Korea. In North America and Europe, like-for-like sales were 8% and 12% higher, respectively, and orders also showed a similar trend with over 20% growth in Europe despite war in Ukraine. We are seeing continued input cost inflation but we are successfully offsetting these costs and deploying our pricing power and also our Spectris Business System to reduce waste, drive efficiency and increase throughput. Turning now to each of the businesses. Malvern Panalytical recorded a 14% increase in like-for-like sales with good growth across all regions. Our sales into pharma customers continue to be robust, supported by activity within small molecule development and manufacturing, and from the demand for vaccine and gene therapies, all underpinning investments. Equally, we continue to see good growth in metals and mining and for advanced materials in semi comp and advance manufacturing. At HBK, like-for-like sales increased 8% in the quarter. As I mentioned, the automotive sector grew well this quarter, supported by investment in electric vehicle R&D and production capacity. Machine manufacturing, which has been a standout performance since 2020, continued to see strong growth and order intake was particularly strong in the quarter. Industrial Solutions posted a 15% like-for-like sales increase. And here, we're seeing continued strong demand for pharmaceutical and semiconductor customers with long-term structural growth drivers, boosted by the onshoring trend. Orders were significantly up on last year versus a tough comp. And after a slight decline in 2021, sales into energy utilities continued to recover, posting strong growth in the quarter, very much underpinned by oil and gas prices. And we're also delighted to receive the Queen's Award for international trade for our Hummingbird range of sensors and Servomex. I continue to be pleased with how our strategic initiatives have supported the progress and performance. And as you are all well aware, we announced the divestment of Omega to Arcline earlier in the month. By combining their Dwyer group of businesses with Omega, Arcline will bring further scale to enhance Omega's future opportunities. Moving on to the balance sheet and capital allocation. We are clearly delighted with the valuation we achieved on Omega. The multiple achieved demonstrates the inherent value of our remaining businesses, which are of even higher quality with higher growth characteristics. The proceeds from the Omega divestment alongside our cash generation helps further strengthen our already strong balance sheet, which at the end of the quarter had net cash of GBP 133 million. This enabled us to announce a GBP 300 million share buyback, the first tranche of which starts today. We have and will maintain a strong balance sheet, given the current world events, but it still leaves significant capacity for further M&A very much aligned to our strategy and purpose. We are very clear that aligned with our stated policy, any acquisitions will demonstrate a clear path to returns in accordance with our stated capital allocation framework and financial criteria for acquisitions. During the quarter, we completed some small M&A transactions in addition to the acquisition of Creoptix that we did in January. Red Lion Controls acquired MB connect line in Germany, their high security hardware and software solutions will enhance Red Lion's industrial automation and networking technology portfolio and also provide cross-selling opportunities. And HBK signed an agreement with Dewesoft to establish a new jointly owned company called Blueberry to develop a next-generation data acquisition platform. The new platform provides a common hardware and software architecture that will enable faster time to market and accelerate the creation of an open ecosystem that other industry participants can use for the benefit of customers and also further enhancing HBK's software strategy. We also continue to make progress on our sustainability strategy and in the quarter joined the United Nations Global Compact, we'll report to them annually on our progress as we undertake initiatives, which support our stakeholders and the wider society. We mentioned in February, the work we are conducting to assess our activities across a key range of sustainability trends. Our activity on this front continues and will be a foundational element in our strategy development this year. We have strong positions in many of these areas today, such as health care, the transformation of mobility, energy transition, environmental controls, product circularity and material reuse. We see exciting opportunities to accelerate our growth, aligned to these trends, both organically and in targeted M&A. And we very much look forward to sharing more with you at the Capital Markets Day event later this year. So in summary, I am very pleased with how we started the year. We've given a strong trading performance. Our businesses are performing very well. Customer demand remains robust, and our order book has continued to expand. While supply chain issues are expected to persist, our strong order book provides confidence in continued sales momentum, supporting our outlook and positive prospects for 2022. I'm also extremely pleased with how the group is continuing to execute on our strategy and the inherent value we are creating for shareholders. Following the divestment of Omega, we are now focused on premium precision measurement businesses. with highly attractive financial profiles and growth prospects. The group has a portfolio of high-quality assets, and we are well positioned to continue to deliver on our strategic objectives, organic growth, margin expansion, and return on capital employed, very much supported by a strong balance sheet. And with that, we're very happy to open up to questions.

[Operator Instructions] We have our first question comes from George Featherstone from Bank of America.

I've got a few, so I'll just take them in turn. Maybe starting with Asia. Clearly, strong demand from a revenue perspective in Q1. I just wondered if you could talk through what the demand picture is like in China and the impact that you're having from the lockdowns?

George, so I mean, Asia was particularly strong, both in terms of revenue and orders through the first quarter. We continue to see demand being very robust in pharma and life sciences in China, also their investments in semiconductors, electronics, plus continued investments in a number of R&D themes that we have very much aligned to around electrification and energy transition and automotive R&D was also strong. As it relates to the second part of your question in terms of the recent lockdown events, we started to see an impact in March, certainly our Malvern Panalytical business, where we have a facility in Zhuhai, was impacted and likewise, Omega saw sales restricted in the latter weeks of March as the consequence of lockdowns. Since then, during April, Shanghai went into lockdown, which included our [indiscernible] facility for HBK, which has limited our ability to ship goods to customers within China, but also to export. So it's been pretty severe in terms of the impact in terms of society and businesses are completely closed. It's not as though businesses were treated as essential like they were in North America or in Europe, or allowed to continue. So we've had employees basically shut up in their apartments or even those employees who volunteer to stay on working in our facilities to ship the final goods ended up getting effectively tracked in the facility. So we've had to support them both at home and in the facilities. But we -- I think really the key issue here is going to be how fast the capacity comes back into the ports and into shipping because there's clearly now quite a big backlog, both on imports and exports into and out of China, and that's going to take a number of weeks if not a number of months to unwind. So we are -- all our facilities are fully operational again as we speak today. But clearly, there's an unwind effect that we are closely monitoring.

Maybe turning to the order backlog. Could you talk us through how this compares to this point last year, which businesses have the strongest backlog today? And how does the margin within the backlog compare to how you ended 2021 on a pro forma basis?

Yes. Well, we can deal with the order backlog. I mean clearly, we need to get back to you on trading rather than margin at the moment. But I mean all the businesses have got -- have seen a significant growth in orders. I quoted our sort of book-to-bill ratio of 1.35, 1.36 versus 1.16, quarter-to-quarter. We have seen significant growth. Now within about 29% of growth in orders in Q1, there's clearly an element of pricing within that and there's equally an element of some pull forward in terms of -- given the supply chain challenges we have had to increase lead times as many companies have. So there is also an element of pull-forward. So about 29%, you could say sort of 4%, 5% of that may be price, 6% to 8% is sort of pull forward with the remaining sort of 15%, 16%, really being sort of volumatic order growth here, true volume growth. So we're seeing absolute order growth coming in across all of our businesses. And that's serving, kind of revenue. So lots and lots of positives there.

And finally, just for me. How should we think about the decision to use the majority of the proceeds from Omega on the buyback rather than keep for M&A given your comments about having an attractive acquisition pipeline?

Yes. So George, I mean, as we always do when we're looking at the balance sheet and capital allocation and certainly when considering capital returns to shareholders, we look at the forward M&A pipeline and the potential demands on the capital. Also our ability to -- from our existing facilities. So if you look at where we start at the end of March, GBP 130 million on the balance sheet, GBP 400 million of proceeds to come from -- to come from the sale of Omega, plus clearly trading cash to come through on top of that. So as we look forward, we are certainly not short of cash, so even returning GBP 300 million leaves us within a strong net cash position with a strong balance sheet, including with our existing facilities. So we feel that gives us sufficient firepower at the current moment versus the prospects we're looking at.

We have our next question comes from Andrew Wilson from JPMorgan.

I've got two. I'll start with, I guess, probably a couple of questions actually on the supply chain. I'm just interested in terms of sort of how you see the backdrop in the Q1 and then I guess, currently to the degree that your comment versus where you were in the Q4 in terms of has it got more difficult. And I guess, probably linked to that is looking out on the balance of the year, your confidence around I guess, price cost development, but just in terms of -- it sounds in the Q1 as if price cost isn't necessarily an issue and there's obviously lots of work going on, but just given that costs have continued to go up given that we've probably got more disruption as a result of -- with Ukraine and now in China. Just your confidence in terms of, I guess, those price cost dynamics continuing to be positive.

Andy, so I think in terms of the supply chain and the sort of Q1 backdrop versus Q4, as we put in the statement I mentioned in my speech, I mean, we are seeing continued levels of supply disruption pretty consistent with what we saw in Q4, plus never -- the addition of some new factors as well. So the shortfall we saw in Q4, effectively, that has helped our Q1 sales down to thinking about the [ company ] to come in. But we've also -- that's been sort of factored out by a number of other events that's happened both in terms of ongoing supply constraints, plus obviously lockdown in China, et cetera. So effectively, we are just carrying a consistent level of overdue orders in our backlog at the moment what we saw at the end of the year. So the situation is, I would say, is stabilized, clearly lots of challenges, but the team is doing a really good job in trying to mitigate those on a daily basis. But then the other point in terms of the confidence around sort of pricing cost, as we've again put in the statement here, we have been able to offset input cost inflation through pricing and also our own efforts in terms of becoming more efficient through the deployment of our Spectris business system, taking out waste, driving efficiencies and importantly, also being used to help solve some of the supply issues, increasing capacity, increasing throughput, reducing lead times to make sure we can serve our customers the better we can. And as we -- coming into the year, we were certainly anticipating inflation to be high through the first half and then decline down to about 3%, 4% by the end of the year. That was very much in line with all the economic forecast back in January. Given that all the events that happened since then, that's still -- our current view is that inflation hasn't yet peaked. So we certainly anticipate inflationary pressures continuing over the coming months and remaining high really all the way through the rest of this year. As such, we are already considering what we will be doing on pricing at the half year. So the positive is the price increases that we put through in January, have all been accepted by customers. They are sticking. The challenge, clearly for us, is that we now have over 5 months all to cover on an aggregate level. So price is pretty much baked into that order book from previous price increases. So we're having to try and anticipate future cost inflation and input cost inflation through our pricing really looking out 5 to 6 months. And obviously, there's a balance to be struck, viewed in our judgement in terms of what's the level of pricing elasticity we can command versus that ongoing inflation. But so far, we've been able to offset and mitigate those input inflation. So we are pretty confident as we stand here today.

Great. And if I can just follow up on -- I think it's probably a nice question to ask -- it's a nice question to answer. But just when we kind of look through the statement and the end markets that you talked to, it's basically everything seems to be pretty positive. So I guess the question is, is there anywhere in Q1 where demand is disappointed, even if it's sort of against expectations or whether it's just outright still weak. I'm just interested if there's any kind of pockets where you've seen weakness or perhaps been a little bit slower to recover than some of the markets that you mentioned in the release?

I mean -- I mean, we report a position where all our end markets are in positive territory. The growth in pharma and health care has remained robust, as I said, aerospace and defense for us typically, from an order perspective, it's held up really well. We've been very strong in Q1. Sales were a little bit softer, but that was against a bit of a tougher comp. But most of our exposure in aerospace depends really in terms of space and defense rather than commercial aerospace. So that's definitely helped. Automotive is both from an orders perspective, that revenue is strongly back now in positive territory. Energy and utilities is up significantly against an easier comp. Semiconductors from an order perspective, again, orders have been very high, higher than our aggregate, 29%. Sales were slightly -- were softer than that, but that's again against a very tough comp from Q1 of last year. So it's sort of nuanced by all the end markets. But overall, pleasing to see we're all in positive territory. The 2 I guess I mentioned is machine manufacturing, which has been strong really since middle of 2020, has been a standout of our OEM centers, in particular, for HBK, the new range of sensors has really landed well. As companies looking at greater levels of position in automation, we're finding very strong customer demand for our sensors. And then in the academia markets that's up high single digits on sales in Q1, double digits in terms of orders. So overall, we're seeing a robust outlook right across the end markets.

Our next question comes from Jonathan Hurn from Barclays.

Just a few questions for me, please. Firstly, can I just come back to pricing and just in terms of Q1 performance. So if you look at that sort of 12% growth you saw in the quarter, how much of that is essentially volume? And how much if that is coming through price, if anything?

Yes. So the 12%, Jonathan, and you can [ imagine ] it depends business by business, but it's about 3% to 4% is what's in there from a price point of view. 8%, 9% is sort of true volume, organic volume growth over and above that. We have been putting our prices up progressively over the last 18 months, I mean, we did a price increase in Q1 of last year. There is another price increase in Q3 of last year. We obviously took price up again in Q1 of this year, and this is reply to Andy Wilson's question that we're certainly contemplating another price increase in Q3 of this year around the sort of summer. So it's -- we are, we're having to continually look at, as I said, the -- what we're seeing from an inflation perspective and making sure we're trying to get ahead of it. So inevitably we're seeing both price coming through in the revenue and a little bit more coming through, as I've talked about in the order book, because orders are 5 months on aggregate ahead of what we've seen from a revenue retention point of view.

That's very clear. Second one, can I just -- sorry for the topic. Can you just talk a little bit about expected sort of drop-through rates for '22. Obviously, you talked about inflation coming back. You talked about obviously continuing for the full year. How should we think about the drop? Do you think you can get to the similar levels of drop-through as you did in '21? Or do you think we're going to see a fair markdown from those levels?

Yes. Jonathan, I'm not going to answer your question directly. I mean, we are -- continue to focus very much on delivering the quality out of our businesses in terms of strong organic growth this year and margin progression. And that remains our focus. Yes. I mean I'll just add, we'll obviously give a little bit more color at the half year Jonathan, as we sort of look forward, but at this stage, it's early. There continues to be the lumpiness in supply chain that Andy was talking about, that we continue to see through the first half. But not any detail on drop-through.

Okay. So basically, the organic rate that we were seeing last year sort of mid-30s is probably hard to achieve would be a fair assumption.

I think we -- yes, I mean, we gave a bridge to give you a rough idea of where we thought some of the sort of moving parts and pieces of the full year in February. So I'll update that at the half year [indiscernible]

Okay. That's clear. And just lastly, just final one, just sort of looking to Q2, Q3. Obviously, the year-on-year comps are going to be tough there. And obviously, the issues coming through in China. How do we sort of see that sort of organic growth rate would you feel in sort of Q2 coming through?

Yes. I think, again, I'll sort of focus you on the full year, Jonathan. It's going to be -- there's always going to be a danger or risk as we look at sort of point reporting dates through the year, just in terms of even the stresses and strains that exist in the supply chain, what's happening in China currently that can impact sort of just month-to-month performance. As I said, certainly in China at the moment, we've got a lot of goods tracked in facilities and shipping at the moment, we can't get to customers so we can't recognize the revenue. And so the timing of that could influence sort of short-term results. But if we look at the full year, currently look at the full year, given our order book to cover our ability, demonstrated through Q1 to be able to execute on the order book despite the supply chain pressures, on a full year basis we are confident in being able to deliver the levels of growth that we talked about back in February at the full year results, consistent with what we saw last year.

Okay. And just to clarify that level, that was high single digits, wasn't it that was kind of sort of 8% to 10% [indiscernible] do you think?

Correct. Yes.

Great. That's very clear, guys.

We have our next question comes from Will Turner from Goldman Sachs.

So all my questions are kind of just derivatives of questions that have already been asked. Apologies if I may have just missed the answer to the first one. But could you just clarify a bit more on how much of your business within China is held up at the moment? And how much of your total sourcing comes from that region?

Right. So I mean I think in terms of revenue, we declared it on the revenue, we're about 13%, 14% of our overall group revenues is in China. In terms of the impact, as we stand today, the primary areas are really sort of fit within Omega, Malvern Panalytical and HBK. And we have the last what I saw for Malvern Panalytical -- we've got sort of GBP 7 million, GBP 8 million of revenue that we just can't recognize -- Malvern Panalytical revenue we can't ship, [indiscernible] out of our Omega facility in Zhuhai customers at the moment. So there's a backlog there. A good chunk of the sensor manufacturing for HBK comes out of our facility in Suzhou that's fully operational. And it's not -- it's both the customers that we ship because it's in China but a good element of that actually gets exported out of China, we then convert those components into our broader range of sensors in our Darmstadt facility in Germany. So that's causing delays there. And then say the only warehouses shut down for a number of weeks, which is currently kept into the backlog. So it is causing some issues at the moment. It's just as I said earlier, just how long it takes to unwind all that with freight capacity and then import and export out of various ports in China, how long that takes. In terms of our exposure from a supply perspective, I mean, it's sort of mid-teens on aggregate, in terms of overall exposure. But that's sort of skewed a little bit by the fact that we have a sensor manufacturing plant in Suzhou for HBK. So that actually increases that percentage quite considerably. It's not as though we are -- a majority of our supply comes out of China at all. We certainly buy a good chunk of goods from there, but it's not a -- it doesn't dominate in terms of our supply chain.

Great. And I can imagine so this will have an impact on sort of the sales recognition in March and April. But can you just comment on the order development sequentially throughout the quarter. Did you see any changes in order activity in March or April post the kind of macro -- the geopolitical events that happened in February?

Is that specifically as it relates to China?

No, this is for the group as a whole. More broadly.

Yes. Okay. So I mean I sort of covered some of this to Andy Wilson's point. But if we look at the end market specifically on orders, pharma has been very robust. Aerospace and defense is up higher on aggregate than our overall numbers, automated likewise, energy utilities likewise, and electronics, semicon and machine manufacturing. So we are continuing to see very robust order intake, which continues to build the order book.

Okay. Great. And then the final question I have is on M&A and the buyback. I guess should we take from the decision for the buyback to mean that -- would you ever consider -- because I know you obviously -- you've outlined the rationale for the Oxford Instruments acquisition. But should we take from the decision to do a buyback that potentially going back to Oxford Instruments is off the cards for now? Or and then in addition, has there been any -- in your decision to terminate or like not pursue the Oxford Instruments acquisition, is there some restrictions meaning that you can't look at the business again? So just would look to a little bit of thoughts, particularly on Oxford and how recent developments have changed things?

Yes. So I mean, we clearly said at the time when we sort of [ downed ] tools, that we felt the -- was very much the right transaction just at the wrong time. The world's changed significantly as we were in the final throws of sort of negotiation and diligence in the deal. My view is that Oxford remains a very sensible transaction for us and the combination with Malvern Panalytical would create significant value for shareholders. We were in the process of doing our diligence and also looking at synergies. I'm very confident that the orders would have come out with synergies of at least GBP 50 million. So we had as ever always look at the synergies and we'll just count those in terms of their deliverability to give confidence to the Board and obviously, to the market about deliverability of the value, but we certainly saw more opportunity than that. And you can see in our growth rates around Malvern Panalytical and recent statement on trading, the businesses in that sector very strongly, which supported the value. However, as I said, right deal, wrong time, being, I think, inappropriate given we are shut at the moment to sort of comment or speculate, but given that it is the wrong time, it would be inappropriate to lever it off the balance sheet at the moment. And we will be disciplined around how we approach our M&A and approach our shareholder value. Clearly, at the moment, the timing isn't right. And just to be [indiscernible], we'll continue to explore other opportunities. And clearly, we match any M&A we do as an opportunity cost as we deploy capital against that against other opportunities. We have a portfolio of quality assets, and our focus very much at the moment, given the macro is to make sure we focus on driving strong organic growth from those businesses and expanding margins and getting back to at least the previous high of 18% plus that we've talked about. That very much remains our focus.

Our next question comes from Mark Davies Jones from Stifel.

Firstly, just a clarification. It's obviously traditional for me to ask something about Omega, I'm running out of opportunities to do that. So I just wanted to double check. It doesn't actually close until Q3, but there's nothing in there that would allow the buyer to have any adjustments if that is being affected by what's happening in China, that is fixed terms, is it now?

Yes. Yes. It's fixed terms. I mean, as we talked about it when we announced the Omega sale, the closing conditions are pretty thin in terms of antitrust, et cetera. It needs an HSR review and that's pretty much it. So we'd be hopeful of closing in early Q3. But congratulations, Mark for asking this, taking the last question.

My real question was about automotive because it's good to see that accelerating nicely, but obviously, the end market is particularly affected by supply chain issues and we're seeing automotive volume numbers being revised down pretty regularly at the moment. I know the R&D piece is separate, but it's also [ partly ] funded by the health of the underlying industry. So do you think what you're doing that is specific enough that you continue to see strong automotive demand growth even in a slowing total auto market?

Yes, it's a great question. I mean, the encouraging thing, I mean, despite sort of volumes being in decline, the auto manufacturers typically are reporting quite positive profit numbers and cash generation. despite the decrease in volume and obviously, they're passing on pricing in terms of sales of new vehicles, trucks, et cetera. So we are certainly seeing at the moment continued strong demand for things like our -- actually powertrain testing around electric vehicle development. That remains very strong. Our virtual test division within HBK has got a very strong pipeline for all their range of simulators all the way through from the desktop all the way up to the full scale [ 10 400 ] simulators. So at the moment, we continue to see strong demand. However, auto is always a bit later cycle. And we saw that in 2020 with the pandemic, it held up quite well for the first few months of the pandemic and it was really only in June, July when we saw it tail off. So we are keeping a very close eye on the market trends and indicators there and certainly our order pipeline of opportunities to make sure that we're again keeping ahead of the game where we can. So I think it's eyes wide open, one to watch, but at least at the moment, as I said earlier, our orders into automotive have been strong through the first quarter of the year.

We currently have no further questions. I will now hand back over to Andrew.

Okay. Very good. Well, thank you very much for your questions. I think in summary, as I said earlier, I'm extremely pleased with how the group is executing on our strategy and the inherent value we are creating for shareholders. I'm also very pleased with our strong start to the year. Our robust order book provides momentum for the rest of this year, and we believe we are well positioned as we've discussed. Thank you very much for participating in the call today. Just as an advert, we are hosting an in-face teach-in on Malvern Panalytical at Malvern in the U.K. next month. And we'll make that presentation subsequently available on the website, but it is face to face and you're all very welcome to come and join us in Malvern for that. And of course, we'll be publishing our H1 results in August. So if I don't see you in Malvern, we'll speak in August. Thanks very much indeed. Take care.