Spectris Limited (SXS) Earnings Call Transcript & Summary

Good morning, and welcome to the Spectris Quarter 3 Analyst Call. My name is Carla, and I will be your operator for today's call. [Operator Instructions]. I will now hand over to your host, Andrew Heath, CEO, to begin. Andrew, please go ahead when you are ready.

Thank you and good morning, everyone. I'm Andrew Heath, Chief Executive Officer of Spectris. Welcome to the Spectris Trading Update Call for the Third Quarter of 2023. I'm joined this morning by Derek Harding, our CFO. As you have seen in our press release earlier this morning, we continue to make excellent progress. Our strategy for sustainable growth is really working for us. We are enhancing our capabilities, which is enabling us to better shape our future as we focus on structural and dramatic market trends, solving our customers' toughest challenges, investing for growth and driving operational excellence. In Q3, we achieved another period of double-digit revenue growth with increased sales across all regions. The launch of new products and services underpinned by customer-backed R&D as well as sustainability drivers, helping us to outperform our end markets. And I'm personally delighted with the progress that we continue to make on margins, particularly in Spectris dynamics, which reflects not only our sales growth, but also our focus on driving operational excellence from organizational efficiency through to the maturing use of the Spectris Business System. And this performance clearly builds on the momentum of the first half and provides further evidence of the improved strength and quality of the business. Importantly, it also represents another step towards meeting our medium-term targets as we set out last year. Additionally, the strength of our balance sheet provides us with the flexibility to compound growth through itself M&A. We'll also complete the buyback program before the end of the year, if not sooner. And we completed 4 acquisitions in the period, very much aligned with our strategy to compound growth and further bolster our offering to customers. Now I know you want to hear about our end markets. So let me provide some color on what we are seeing and also hearing from our customers. Firstly, we remain encouraged with the strength of our sales pipeline and that strength continues. We continue to see high levels of interest and opportunities for our class-leading products and services. Although, as I said at the half year, it has been taking longer to convert interest into orders as markets have normalized. However, we believe we are coming to the end of the normalization phase with our order backlog and lead times returning to more typical levels. And given this context, it is really pleasing that our book-to-bill remains very close to 1, which demonstrates robust underlying demand. Order intake in Q3 was in line with the first half, i.e., only down 5% and this is despite lapping a very tough comp. Also, our order book visibility remains towards the top end of our expected range of 4 to 5 months, which is significantly higher than pre-pandemic levels due to the portfolio rationalization that we've delivered over the subsequent period. Environmentally, we see normalization happening that really sort of completed earlier in this year with order intake since that being relatively stable. And say, there are potentially signs at the start of the upswing in the next cycle and with pharma, we see it being relatively latency cycle also. Demand year-to-date for our range of instruments for Advanced Materials remains robust, and we continue to see order growth in aerospace and defense prime materials and also academia. While automotive was softer than the first half of this year, that returned to positive growth in Q3. So machine manufacturing is the only market where we are still seeing some normalization happening, and that's mainly in China. By default in China, in particular, order intake in all of our other key end markets in China was actually up in the third quarter. So what does this mean in terms of the outlook? Well, while we remain vigilant to the broader macroeconomic environment, the continued execution of our strategy for sustainable growth, combined with good odomentum, our leading product portfolio, broad end market exposure and our strong self-help story gives us the confidence in delivering our updated guidance for 2023. We now expect to deliver organic sales growth of around 10% for the full year, representing a third successive year of above-market sales growth. We also anticipate to report strong progress on margins, adjusted operating profit is now expected to be in the upper half of our guidance range of GBP 250 million to GBP 265 million. And then looking ahead 2024, we expect another year of progress with improving profitability and further margin expansion, demonstrating the group's resilience. So I would like to take this opportunity to thank all of my Spectris colleagues around the world. They're really delivering for our customers. They're improving our business. They're aiming high, and they're achieving some fabulous results. As I said, we are building a stronger and higher-quality business. We are also building a more resilient business. Our strategy sustainable growth is clearly working. We have good underlying momentum, we have broad end market exposure. We have a strong self-help story, and we've got a strong balance sheet. With that, we are now very happy to take your questions.

[Operator Instructions] Our first question is from Rory Smith from UBS. Rory your line is now open. Please go ahead.

It's Rory from UBS. I have 3 short ones, if I may. Firstly, on growth, 11% like-for-like, could you just break that down between volume and price, please? And then maybe within the volume piece, what was underlying demand and maybe what you saw coming in from new products and/or market share gains?

Rory, thanks for your question. So I'll take you back to what we said at the interims of the half year. When we came into 2023, we were sort of getting about 60% volume points in price through last year. We said that the full year results in February that we anticipated that to sort of invert through this year. For the half year, we're still getting about 60% volume, 40% price. We were very pleased with that. Clearly, the volume was growing faster than we thought. But through the second half since -- sort of June, we have started to see that ratio start to invert. So we sort of stand today, it's near a sort of 50-50 adding slightly more towards price than volume, but still getting good volume coming through. And your point on new products and market share, as you've seen, we continue to launch new products. We've been investing for growth significantly over the last 2, 3 years on targeted end markets where we see real sort of structural thematics where we can have advantage positions and establish leading positions or maintain our leading positions. And through those new products, we typically get higher margins of the new products that we launch and see that important to driving R&D spend at our vitality mix up.

Brilliant. And then second for me, just on China. I don't think you'll surprise anyone that some of the softer -- shorter cycle end markets are softer. But could you just be a bit more specific on what the sort of areas of strength were? And then within China and also within Asia holding up that agent growth number in line with the group?

Yes. So I mean if you just look at the period in Q3, I mean, we had, as I said, positive order growth in all of our end markets, except for machine manufacturing. Automotive was particularly up in the last 3 months in China. Semi electronics has been a strong point in China all year actually for us as how sort of [indiscernible] R&D. In the third quarter, we were pretty much flat on our Pharma Life Science sales in China as well. So it was softer in the first half that we talked about at the half year. We were -- I think along with lots of our peers, a little surprised that China see more of the bots coming out of local towns at the end of January, February time. And this sort of initial bounce in scientific around some of the Pharma, Life Sciences part of the business sort of in Q1, but then that sort of dissipated. But it's encouraging to see China order intake in Q3 being so positive.

Great. And then finally for me, just on M&A. Could you talk to the different rationales maybe across the 3 smaller acquisitions since the half year-end. And it seems like 2 of them are technology add-ins, which looks good. But is the vertical integration in PMS. Is that an opportunity or a necessity with that particular business?

Yes. So -- I can quickly walk you through them. So the 3 acquisitions and investments, I mean the [indiscernible] minority investment, double digits investments really to help position us into an early stage business, and that's a great technology for [indiscernible] in sort of biologics, biopharma space. This adds to our Creoptix acquisition we did about 18 months ago. So we continue to focus on that sort of biologic department of our pharma offering as well as more broadly across [indiscernible] scientific. The MicroStrain acquisition we have talked about it previously. But I mean, that's a carve-out from Parker that really adds some further sensing technologies and some smart capability in sensing to bolster our center offering process offering for the Dynamics division. And then the primary carve-out of the technology through there is to really help to strengthen and bolster our offerings in the semi-conductor wafer analysis. So really looking at sort of metrology for semiconductors, silicon wafers in particular to how to operating with more [indiscernible]. And then lastly, the EMS business is a distributor in the U.K. and Ireland for our PMS, Particle Measuring Systems business. They indicated that they were interested in being acquired and our strategy was talked about previously is to sort of go direct to our end market customers as much as we can. And we thought it's a good opportunity to integrate a key disputer in the region. And all of those 3 acquisitions will bring incremental revenue as part of our compound growth strategy, which just I think should be slightly sharp about 2% revenue for next year or so. I think it's nice to see we've got a good spread of acquisitions across all the businesses actually in the last period. We continue to populate our pipeline and nurture our pipeline as we look into sort of 2024. I would hope that the market will shift it to be more maybe a buyer's market and it has been more of a sellers market over the last 3 or 4 years. So we continue to focus our efforts on trying to find good acquisition targets.

Our next question is from George Featherstone from Bank of America.

First one would be, it's not typical for you guys to typically provide an outlook on the coming year at this stage. You still got the largest quarter ahead of the current year and you obviously commented that backlog is normalized. So I just wondered what the -- what's driving the confidence really in that outlook statement 2024, which is quite encouraging on face value?

George, thanks for your question. I mean, yes, I mean it was a very conscious decision to make reference to 2024. I think it's a testament to the first thing I said, really, in that we are -- we certainly we're very much a changed business. Our strategy for sustainable growth is really working for us. The focus on sort of the key sustainability trends, secular growth trends in our end markets really posing our R&D investment on helping to solve some of our customers' toughest challenges. We're certainly putting wind in our sales. And despite the market normalizing through this year, we're very pleased that we're coming out year-to-date with the book-to-bill of 0.97x. We're at the upper end of our sort of revised guidance [indiscernible], which is much higher than it was pre-pandemic, as we've changed the mix of the businesses within the portfolio much stronger businesses. And as we look at that old momentum, then we certainly feel we can make progress this year, and we felt it was right to say so. So that's progress both on the top line and in terms of margin.

And then if I think about the guidance for the remaining of this year, it implies for Q4, you're expecting flattish revenues compared to last year. Appreciate you've got a tough comparator. But given the supply chain improvement and the higher pricing you've already commented, you started to see come through in H2. Is there not so upside risk to that? Or should we infer that more of your order book is ultimately for 2024 delivery?

Yes. I mean clearly, with 4 to 5 months of order ability at the top end of that range and clearly, quite a bit of the order book now is actually going into Q1 for next year and into Q2 even. And because again to the mix of business, we are a bit longer dated. But I think I wouldn't read too much into it. I mean we have said around 10%. We could potentially do better than 10%. It just depends on just how customers and ourselves execute over the next 2 months for a number of our end markets in terms of recognizing the revenue, we need to complete the orders and that make customers need to take a seat in store and commission. And sometimes, we can see delays. So it depends, which is why we said around 10% is a good guide. And we'll certainly feel that we've got enough orders in the tank plus and even that we will absolutely come in with adjusted operating profits in the top half of our range, as we said.

Okay. And then final one would just be on the other businesses, which continue to progress well. Are these businesses now performing in line with your expectations? And given the strong response to your actions, can you provide an update on your broader strategy for these companies, please?

Yes, so in terms of I don't know if you can go [indiscernible] with another. I mean, we've changed the management teams out last year. Both businesses have really responded well to the new presidents driving a real focus on operational performance. You saw that coming through very strongly in the first half. Although as we said at the half year results, it was some slightly flattered by Red Lion's ability to really execute on a very strong order backlog. It was held up last year because of all of the challenges around electronic supply chain. They were semiconductors and electronics freed up really from January onwards. They've done a phenomenal job to get you on that backlog. And we saw all of that come through in the first half. But even so, second half performance is still very good. And Servomex continue to get better quarter over the quarter. So your point in terms of -- is there more to go. Certainly, we continue to drive operating forms and all our businesses and would look for both red lines and Servomex we feel there's further potential for both of them. And in terms of -- I don't know what a second part of your question was that...

Yes, broader strategy of the company is that's possible.

So in terms of the broader strategy, I mean, we've never come out and sort of be definitive around any of the businesses in terms of sales processes, et cetera. But I think it's really quite clear that both businesses are sitting in other. We are looking for them to improve their performance. If we feel that we can get them to the right at performance and we're the best one, they will stay with the group. If we don't we're going to be the right, then ultimately, one or more would leave. So our position in the land remains the same. But that's the same for any of our businesses, frankly, they all have to earn the right to stay in the portfolio.

Our next question is from Lush Mahendra from JPMorgan.

The first is just on some of the comments you made on semis and pharma sort of the normalization is largely done, I guess. What's giving you the confidence there? Those orders already started picking up? Or just sort of what are you seeing in terms of -- to give you some confidence for those potentially for the worst ?

Yes. So as I briefly mentioned, let me take it in turn. So the [indiscernible] markets we started to normalize towards the back end of last year through Q1. Order intake in both markets has been consistent since around the March time frame. Within semis, one of our gas plant will maybe analyzers and [indiscernible] systems, we track it as an early cycle product. So it gives us certainly visibility in terms of where the market is moving. And in the last quarter, we have seen a significant upswing inquiries from customers and also orders for that particular analyzer, which is normally important to the start of an investment cycle in the fact build out. So we are hopeful that we've seen the bottom of the semi cycle and actually we're starting now to enter into an upswing. And clearly, one quarter doesn't make a trend. But as we go through to the year, we are hopeful we'll start to see that [indiscernible]. And listening to the market commentary and listening to our customers, that certainly seems to be the direction of travel. So that's a positive sign. And then I think in pharma, we certainly feel that pharma is getting later in the cycle. I think the industry commentary that we sort of followed suggest that this may be a sort of an H2 recovery for next year. And yes, we'll wait and see but certainly, if you look at our sort of pharma order, say, over the last 6 to 9 months, so it's been pretty consistent. It's not been going down. The market normalized last year, then it's flattened up since then. And so again, we were at the bottom of that cycle.

Okay. And then just on the book-to-bill for Q3 itself. I guess what was that? And if the comp orders have sort of jumped around a little bit last year. I think it was a tougher comp in H1 and then easier in the second half. Just I guess, sequentially, what have orders done versus Q2 as well? That would be very helpful.

Yes. So I mean our order intake, I said earlier year-to-date, we're down 5%, which is exactly where we were at the end of the first half, and we feel pretty good about that because markets have normalized. We're always expecting the backlog to come down as lean times came down. We're now in sort of the range that we expected to be next 4 to 5 months, but still at the top end of that range. So 0.97x book-to-bill year-to-date followed with Q3, it was 0.93x. So we did see a little bit more slowing, but we anticipate that. And again, quarter-to-quarter, [indiscernible] end, if you look at the book-to-bill in Q4 last year was 0.9x for instance. It depends on just the level of revenue we're generating with booking versus the ability of revenue we're actually shipping. So it will move around it, but we look towards the end of the year, we have actually confidence in the order book and all the momentum going into next year.

Our next question is from Jonathan Hurn from Barclays.

Just a few questions for me, please. Firstly, maybe just one for Derek, in terms of the cash conversion. Obviously, that was very strong in the first half. I think it's about 112% conversion. Can you just talk about how we should think about that sort of cash conversion for the second half, please? That was the first one.

Yes. I mean simply Jonathan, it will continue to be strong, I think, for the remainder part of the year.

Okay. Okay. And then maybe just following on for that, I was just coming back to pricing. Can you just sort of talk about how you think about that 24%. I think historically, normally, you sort of get about 1% to 2% growth every year from price. As we kind of look at that, sort of, I suppose, organic numbers for '24. Should we think that the price can contribute that kind of sort of contribution again?

Jonathan, that's probably right. I mean, we are certainly come at the normalization rate. Clearly, prices were put up significantly during 2022. During this year, we've seen -- we're not fulfilling price much. Equally, our suppliers happen either. And so as we go into next year, we don't anticipate a significant sort of pricing tailwind for next year. So your assumptions are broadly correct.

Okay. And then just finally, just obviously, you talked about FY '24 and further margin progression. Obviously, that's quite dependent on the volume that comes through. But in terms of the sort of I suppose the bottom-up stuff, can you just maybe give us a little bit more color on what you think possible contribution could be from ERP to group margin in '24? And also maybe just from the Spectris Business System, how much more can that get to the margin in '24, please?

Yes. So in terms of sort of ERP for next year, it really is not going to sort of shift the dial. Next year is all about implementation. It goes live in more analytical in Q1 and then progressively through the second quarter and then we go to HBK and start to do the same process there. So in reality, we're not going to see a huge -- or anything really material for next year in terms of the benefits coming through. We start keeping in 2025 and then coming in full in 2026, with 150 basis points to -- it's really -- it's a 26 number. We get that progressively now and then. But then from an FBS perspective, we [indiscernible] benefits from FBS in 2022. We're running at sort of similar higher levels this year, and we will continue as we sort of mature our FBS journey, we'd expect to sort of that pencil tick up as well, encouraging you to as part of that mature journey in the Spectris Business System. We have our internal report going to gold. So we are now at the point where we are starting to sort of internally certify our sites from bronze, silver to gold standard. We get into first sites on bronze shield as we already achieved that milestone that we want to go through the end of the year. And as that matures, and we go from a bronze, silver to gold over the next 3 to 4 years, then that will really solidify and mature out our capability. But importantly, we'll take out cost, drive efficiencies to remove waste, reduce lean time, introduce work in progress, and will contribute. But I think the best way to sort of think about it model it is really -- we use it to help offset as much as we can sort of input cost inflation and particularly labor cost inflation to by driving efficiency. So you can't sort of necessarily to sort of take a GBP 10 million, GBP 11 million that straight to the bottom line because it's also looking in a new part. But we're using a saying, just with mitigating offset some of the investor pressures and drive that productivity and efficiency across our business.

Sorry, can I just clarify on the ERP? Maybe it's just me, I thought that 150 basis points improvement will fully come through in '25. Am I wrong in thinking -- or has it sort of been pushed out a little bit?

No, no. So it's come through in '25, Johnson, but not '24. I think your question was the benefit in '24.

Yes. No, but I think Andrew said the 450 basis points have come through in '26 in his comment, maybe I misheard it. Is that correct?

Well, I mean it will be -- I think we've always said we're not going to give a point-by-point timing. So it will come through. I mean the bulk of it, the systems will be live in '24. So we should start to see the bulk of that benefit in '25. There may be a bit that then comes to '26. But I mean we're on that journey to 20% plus, which we're focused on targeting 150 basis points is the key point of that. Obviously, it will depend on how the world is sitting over the next 2 years, but there won't be a big boost in '24, so a good chunk in '25, and we should continue to benefit from that in '26.

[indiscernible] full run rate benefits will get in 2026. So '25 entering that transition. We've got a lot of the benefits coming through '25, but we'll complete it everything we needed to do any restructuring 2025. So 2026, we'll get the full run rate effect of kicking into those results.

[Operator Instructions] Our next question comes from Mark Davis Jones from Stifel.

And 2 for me, please. Firstly, encouraging that you're saying most of the margin gain is coming at the dynamics. Is there any specific part of that? Is that mix related? Is it just volume going through some big cost savings benefiting? And the secondary and perhaps related questions on auto. Why do you think we've seen some mostly acceleration in the other country to the run in the market? You said China was strong. Is it a specific part of the EV in testing work, which is driving that demand?

Let me take the first one, Mark. If you look at the margins and dynamics, if you recall last year, we had a dip due to the timing of pricing and volume that we said would always reverse. And that is reversing as expected. So as pricing comes through and the cost base doesn't increase as much as it did last year, we're seeing that margin benefit come through. So that is definitely one part. There is volume coming through in Dynamics as well as the business continues to focus having kind of structured itself now that its 3 core product lines that's driving benefit. And we are also taking cost out of the business again as a result of our focus on some of the restructuring we did in the first half of the year. So it's actually a combination of all 3 of the things you talk about, the previous one being the recovery on the gross margin following the price volume change that we suffered last year.

And Mark, your question regarding auto why we're sort of outperforming. When a company comes back to sort of a theme of our strategy, which is to make sure we're focused on those parts of our end markets, which are growing most strongly and where we are most advances and then making sure we have the right tool solutions to customers to satisfy the challenges they're facing. So in particulate it's all the new model launches, new platforms around EVs, battery technologies around electrical powertrain testing, the capabilities that talked about, particularly at sort of the Dynamic Capital Markets Day in May over the year [indiscernible] test. So the solutions that we're coming up with enhanced capabilities that we're developing are allowing us to then make sure we're targeting those areas that are in markets that are growing more strongly. And that's -- we clearly see that in automotive as well, which is allowing us to outperform.

Our next question is from Bruno Gjani from BNB Paribas.

I just had a clarification on the scientific order development for Q3. So H1 orders for the division was slightly up year-over-year. So preorders are down 5%, adding price at Scientific is down around 10% in Q3 in that dynamic was up. Is that implicit down 10% driven by semi and pharma? Or are other markets also declining on a year-over-year basis?

So yes. Certainly I think broadly, we are correct or not quite as much as that, but broadly, let's say, your analysis is right. But it is predominantly the fact that we sort of pharma and semi order intake is normalized. As I said, it's consistent, it's flat. But against a very tough comp from Q3 last year. That's the primary reason. We get on see the positive progress that was made on all this in Q3 as well.

Understood. And am I correct in thinking that you're yet to trade the softer pharma and semi orders or scientific [indiscernible] the top line something is to grow at a very high level at a very rich way. So basically, you have a mix headwind that we might have to digest or we should be mindful of saying Q4 perhaps in 2024 as the balance of business shifts towards other end markets has been scientific or not so much?

No, I think to scientifically what's really pleasing is that the broad end market exposure that we have as pharma and semi normalized. Then prime materials maybe picked up. Academia maybe picked up and the advanced materials where we're selling insurance into development things like catalysts for and go into sort of the petrochemical market, but also to [indiscernible] transition. So it's a bit that [indiscernible] transition of energy mix through to [indiscernible], et cetera, et cetera. That has remained very robust, and particularly around [indiscernible]. We see significant [indiscernible] whole market, very good U.S., Europe and in particular China, where you know there's a lot of work going on in to fashion world. So I think as you look at Scientific, there has been -- we saw there was some early cycle advantage of semi, pharma coming in to the sort of post-pandemic times. And then the other markets are then really compensated. And if you look at it from revenue line, you won't see as much of that as we still have a very strong backlog of semiconductors. We never seem to be on the revenue semi-conductors backlog was a point in 7 or 8 months. So that helps off from a revenue perspective.

Got it. And just finally on M&A, on thinking to the flurry of smaller deals that you carried out over the last quarter. Does that change your asset, do you have large deals at all or not so much?

No, I don't think we use that. I mean as we said over we look at anything for early-stage investments, technology IP and investments through to small medium sized bolt-ons tend to get to larger scale transactions. I expand to say that the pipeline is more skewed to the smaller loans at the moment. That's just sort of where sort of market takes and valuation ships and what we're nurturing as we stand here today.

We have no further questions registered. So with that, I will hand back to your host, Andrew, for final remarks.

Great. Thank you very much. And again, thank you, everyone, for joining the call today. Look, as I said, our strategy and our purpose, I mean, we will clean out [indiscernible] is really working for us. I hope in terms of our press release this morning, post the core and the questions that we've answered, it's clear that we have continued momentum right across our business. That's underlined by a very strong performance in Q3, double-digit organic sales growth and strong margin expansion. We've got all the cover at the upper end of our new normal 4 to 5 months. And all that despite demand is now broadly normalized with backlog and lead time to typical levels. And as you see, we continue to execute on our compound growth story to M&A with 4 acquisitions since the half year. As we look at the full year, our order book gives us the confidence in terms of our adjusted operating profit guidance being at the expense to be in the upper half of our guidance range. I think our resilience and strong self-help story also means that we expect further progress in 2024, in particular sort of margin expansion. And I hope you got from this call, we remain excited by the significant opportunities that still lie ahead of us. So thank you very much for joining and look forward to catching up with you all soon.

This concludes today's call. Thank you all for your participation. You may now disconnect your lines.