The Weir Group PLC (WEIR) Earnings Call Transcript & Summary

Good day, and welcome to The Weir Group PLC Q3 IMS Conference Call. Please note this call is being recorded. [Operator Instructions] I will now hand the call over to Jon Stanton, CEO. Please go ahead.

Thank you, operator, and good morning, everyone, and thank you for joining us for our third quarter trading update. As usual, I'm joined by our CFO, John Heasley. And after a short overview from me, we'll be delighted to take your questions. First, though, let me talk you through the group's performance for the third quarter. We delivered strongly, and the momentum that I talked about at the time of our half year results continued. We saw this in our orders, which on a constant currency basis were up 19% year-on-year; and also in execution, where we are delivering significant year-on-year revenue growth and continuing to mitigate the impact of input cost inflation. Conditions in our mining markets were positive through the quarter and continue to be so with our customers focused on maximizing oil production driven by continuing strength in commodity prices and increasingly tight physical inventories for key metals. In infrastructure, conditions in our largest market of North America was stable, although demand in Europe continued to weaken. Across the group, high levels of mining activity drove very strong demand for our aftermarket spares and expendables with constant currency orders up 21% year-on-year. Original equipment or OE orders were up 12% year-on-year. And here, demand predominantly came from debottlenecking or small expansion projects as miners focused on expanding production from existing assets. Complexities in permitting meant large projects remain slow to convert, but demand for our expanding digital and sustainability solutions was encouraging. The group's book-to-bill was 1.02, reflecting growth in our order book, which is at record levels, and strong revenue growth across both aftermarket and OE. Through the period, we continue to successfully mitigate the impacts of inflation with gross margins maintained. Encouragingly, we saw challenges in global supply chains starting to ease, which will further support our operating momentum and focus on execution as we progress through the fourth quarter. I'd now like to give a little bit more detail on the performance of both divisions, starting with Minerals. Here, orders in the division grew 21% year-on-year and reflected typical seasonal patterns following the booking of some multi-period orders in the second quarter. Demand was particularly strong in aftermarket, which was up 25%. And this reflected very strong volume growth and also price increases, which had a mid-single-digit year-on-year impact. Demand was strong across all regions and especially strong in North America, where the general trends to reshore mineral production in the U.S. continued. And oil prices remain supportive of increased activity in the Canadian oil sands. In South America, we saw strong demand for spares for our Warman slurry pumps as miners focused on delivering year-on-year growth in copper production while managing the ongoing offsetting effect of declining grades. Aftermarket orders also included some commissioning spares as production commenced at a number of recently installed OE projects particularly in Central Asia, further growing our installed base. In OE, as I mentioned a moment ago, demand was driven largely by small expansion projects, solutions to debottleneck existing mines and sustainable solutions. We expect this to continue in the near term. And in the absence of new projects, miners are likely to accelerate production from existing assets to meet demand, which, of course, plays to the Weir's sweet spot of integrated solutions. In the quarter, we continued to grow our installed base in forward-facing commodities, including GBP 16 million of orders booked to provide equipment to high-grade nickel applications in Indonesia. And this reflects a growing trend as other parts of the world increased nickel production to compensate for the expected absence of Russian supply. We continue to work in partnership with our customers using our differentiated technology to help them address their biggest challenges and make mining smarter, more efficient and sustainable. One of our most recent innovations is our Terraflowing technology, which improves water recovery from tailings, making them easier to transport and store. In the quarter, we were pleased to see continued traction for this sustainable solution with a GBP 6 million Terraflowing order for a customer in Mexico, where the technology will eradicate the need for a tailings dam. From an operational perspective, the Minerals division performed well, and we saw evidence that supply chain challenges, which have been impacting the timing of some OE shipments, are starting to ease. We expect this will continue to improve through the fourth quarter with significant improvements in freight capacity and container pricing now giving more certainty in operational planning. The division's book-to-bill was 1.04, reflecting order book growth coupled with a focus on operational execution as revenues grew strongly year-on-year and also sequentially from the second quarter. Turning now to ESCO, where constant currency orders were up 13% year-on-year. This included an increase in volumes from mining customers, a contribution from acquisitions and the year-on-year impact of price increases which were at similar levels to minerals. In mining, orders were up year-on-year and also ahead on a sequential basis as the division benefited from the mining production trends, which I outlined earlier. So similar to Minerals, demand was strong across all regions and particularly in the Americas. Through the quarter, we made good progress on our geographical expansion initiative with net conversions and market share gains in South Africa and Australia as customers continue to recognize the production and total cost of ownership benefits of our proprietary Nemisys ground engaging tools. Progress on our mining attachments initiative was also encouraging with high levels of customer interest. Orders included bookings for existing GET customers in North America as miners recognized the benefits of our packaged solutions. In infrastructure, North America accounts for around 3/4 of ESCO's exposure, and we saw activity in this market remaining stable at high levels. Elsewhere, infrastructure demand in Europe continued to decline, reflecting the trend which we saw in the second quarter. We remain delighted with the acquisitions of Motion Metrics and CIS, both of which made a good contribution to orders in the quarter and which continue to perform ahead of the expectations set out at the time of acquisition. Operationally, ESCO also performed well. We continue to use pricing to mitigate the impacts of inflation and maintain gross margins, while our digitally enabled supply chain and selected use of air freight meant we delivered for our customers while managing the residual effects of supply chain complexities. As with Minerals, the impact of these reduced through the quarter, and we expect further easing as we progress through the balance of the year. The division's book-to-bill was 0.97, reflecting strong year-on-year growth in revenue, which also grew sequentially from the second quarter. Now a brief comment on net debt, which was higher than that reported at 30th of June 2022, reflecting the impact of translational foreign exchange on our U.S. dollar-denominated debt and typical seasonal patterns. As we expected, our leverage ratio was in line with that reported in our half year results. And given the better visibility mentioned earlier, we continue to expect this to reduce over the balance of the year as our free operating cash conversion reaches 80% to 90%. Before I close and turn to Q&A, I'd just like to say a few words on our strategy, the outlook for the balance of the year and on the broader market environment. The long-term fundamentals for the mining industry are highly attractive underpinned by the technology transition to make mining more sustainable and increased demand for metals as the world drives towards net zero. As a focused mining technology company, the drivers of our business are therefore strong and clear. And our unique capabilities and focused strategy give us confidence in achieving the through-cycle revenue growth and margin expansion targets which we outlined at our recent Capital Markets event. And at the same time, our large installed base of equipment which supports our aftermarket-focused business underpins our through-cycle resilience with revenues driven by oil production, which is largely inelastic to CapEx cycles and day-to-day commodity price fluctuations. Turning to the current year, we're going into the fourth quarter with a record order book and strong operating momentum, so our guidance for 2022 remains unchanged. We expect to deliver strong growth in constant currency revenue and profit, operating margin expansion and 80% to 90% free operating cash conversion. We know that everyone is trying to look ahead to next year, and the current macroeconomic and geopolitical environment is complex and hard to predict, and we'll all have better visibility in a few months' time. But what we do know is conditions in mining markets remain positive. Our customers are maximizing production to meet demand and address falling levels of physical inventory, and therefore, it remains to be seen if the broader environment will impact mining. In our base case scenario, we expect mining markets to remain supportive with aftermarket growth rates consistent with our through-cycle targets and demand for OE continuing to be driven by small expansion, debottlenecking and sustainability projects. In infrastructure, we expect market dynamics to remain largely unchanged with demand in North America remaining stable and the demand environment in Europe continuing to decline. So to close, let me just summarize the key takeaways. We had a great third quarter delivering significant year-on-year growth in orders with particularly strong demand in the aftermarket. Through the quarter, we've executed well, managing the impact of inflation and growing revenues significantly versus the prior year. We're carrying a record order book and good operating momentum into the fourth quarter, and our 2022 guidance remains unchanged. And finally, we remain convinced that we have huge potential to deliver long-term value creation in line with our equity case. And in our base case scenario, we assume that mining markets will remain supportive in the short term as well. So thank you for listening. John and I will now be happy to take any questions you have, so if I could return to you, operator. Thank you.

[Operator Instructions] We will take the first question from Andrew Douglas from Jefferies.

I've got 3 questions, but they're all cash or balance sheet related. I think you've covered most of the trading stuff in your remarks. When we talk about covenants for year-end, can I just double check? I believe that your covenants are average FX in the P&L or the cash flow -- and on the cash flow as well. So in previous downturns, we've had kind of 3 things happening at year-end in terms of year-end debt numbers on the balance sheet. So can I just confirm that? Secondly, on the cash flow guidance, how fourth quarter heavy is your guidance in terms of that 80% to 90%? Do you guys have got a room, like treasuries, to get to that 80%? Or have you had a good third quarter performance, which means the fourth quarter ask isn't too much? And then last but not the least, there's been some negative comments about your ability to refi your -- refinance your USPP going forward. Have you guys got any indications of what that kind of rate might be relative to the 4.3% you're paying at the moment?

Thanks, Andy. I'll let John answer those questions, and then I might come back with an overall comment at the end.

All right. Andy, in terms of your 3 questions on the covenants, absolutely, average FX on both the debt and the profit numbers, so that's been well embedded in our financing documentation for many years. So no change on that, no surprises. Secondly, in terms of the phasing of the cash flow then, as you saw from our statement, debt was higher at the end of September relative to the end of June. That was mostly FX. But what I would say is that normal seasonality applies, which is the third quarter typically does have a little bit of build of working capital in preparation for a big push towards the year-end in terms of shipments, et cetera. So seasonality consistent in third quarter as expected, and therefore, we do expect, as I said at the half year, a significant inflow of working capital through the balance of the year. And consistent with what I described then, we've got really good visibility -- actually, better visibility now than we did at the end of June on the basis that you remember it's about getting those minerals projects and getting the supply chain -- the third-party supply chain components received. Those were delayed through the early part of the year for supply chain reasons that we all know about. As Jon described, that's easing, so we're starting to see and continuing to see those components come into the business. We've got that all mapped out in a very granular basis. Those are flowing through our shops now. So we have really good confidence in how that is going to unwind through the fourth quarter, which, again, underpins the 80% to 90% cash conversion leverage coming down and, likewise, working capital as a percentage of sales coming down. In terms of the third question on USPPs, yes, we have $200 million of USPPs maturing in February. That's currently paying interest at just north of 4%. I would remind you that in May last year, we did a bit of advanced refinancing, so we issued an $800 million sustainability-linked public bond. That was when 5-year treasuries were 79 basis points. We had a margin of 140, so that is a fixed rate for 5 years at 2.2%, which effectively has, to a large degree, prefinanced that $200 million that is maturing in February. However, to double emphasize that, we're sitting with more than GBP 600 million of liquidity. Clearly, as we go through the fourth quarter, that will increase further. If we do choose to refinance, then we'll choose the appropriate time for that to ensure that the rate is attractive. But overall, the key takeaway, Andy, is that there is no need to refinance that just now if we don't want it because of liquidity. And secondly, given the refinancing with the private -- with the public bond last year, our overall interest rate is coming down relative to previous PPs and is fixed on a 5-year basis.

Yes. So I'll just comment at the end there. So I think that the Weir finance team has done an amazing job and an impressive job in terms of the refinancing that we did, both the sustainability-linked notes but also the RCF earlier this year as well. So we feel we're in a really good place from a balance sheet view. And I think as I think about the cash, I want to reiterate we're absolutely focused and committed on delivering the cash conversion targets that we've set out. As I characterize the year, first half of the year was quite challenging for us as for many and for reasons that I won't reiterate. You know them all. But I feel that we got a real grip on it through the third quarter. And we go into the fourth quarter with real visibility on what needs to be done, what are the moving parts, and the business is intensely focused on that. So hence, we feel very good about our ability to meet those targets.

The next question comes from Klas Bergelind from Citi.

Jon and John, Klas at Citi. So the first one I had is on the revenue growth. It looks to be above 30% like-for-like in the quarter when we back out from the book-to-bill. And I don't know if you could comment on what kind of growth level you expect going into the fourth quarter. Supply chain easing implies more conversion out of the order book. I'm wondering if you could perhaps comment a little bit more the fourth quarter implied growth. Then my second one is on FX and pricing versus the GBP 10 million guide that you've guided for before. I guess we're talking another GBP 5 million to GBP 10 million on top. If you can comment on what you see now. And then on pricing, would you think pricing in the P&L will be greater than the mid-single-digit level that we've seen here over the last couple of quarters and orders has converted backlog further? And then finally, on construction, I guess this is mainly European weakness, but is there any change through the quarter and into the fourth in terms of deceleration, whether that is getting worse?

Okay. We'll come back to John for the FX question, and I'll take the other 3. Look, in terms of revenue growth, clearly, significant sequential momentum into the third quarter, which is good. What we're expecting for the full year and I think is reflected in consensus is really the sort of typical seasonal balance that we normally have, sort of 45%, 55% split in terms of revenue. So I would say that's what you need to look at as you think about the fourth quarter. From a pricing point of view, our last increase was in July. And since then, as we've said, I think, if anything, input cost inflation, particularly freight, has -- and some of the commodities has moderated. So we feel we're in a very good place from a pricing point of view. I think that mid-single-digit guide is right for the full year. We're 3 quarters of the way through. That's what we've delivered. And as I said earlier, that's truly offset input cost inflation and more such that our gross margins are maintained. And I think, yes, on the construction point, Klas, I think the U.S. economy remains strong. And I think that's what we're seeing reflected in activity high at stable levels at the moment. Europe is continuing to be weak. And as we sit here today, we don't think either of those things are going to change in the short term. So that's how we're feeling about that from -- in terms of the construction and infrastructure exposure. And on FX, John?

Yes. So you'll remember at the end of June, from a profit perspective, I said that we were expecting around a GBP 10 million operating profit tailwind year-on-year in terms of translational FX. That's driven by -- or that was driven by the fact that roughly 50% of our operating profit is U.S. dollar denominated, the other big currencies being Chilean peso, Aussie dollar and Canadian dollar. Clearly, since then, we have seen Sterling weaken against the U.S. dollar, which is going to be positive if that continues for translation of revenues and profit. Actually, the other 3, the Chilean peso, the Aussie dollar and the Canadian dollar, haven't moved that much. So if we were to assume for the balance of the year that we do stay on cable around the 1.14, 1.15 mark that we seem to be bumping around that, then relative to that GBP 10 million tailwind I said before, there's probably somewhere between another GBP 5 million and GBP 10 million to come if rates were to stay where they were today.

The next question comes from Andre Kukhnin from Credit Suisse.

Firstly, just a follow-up on cash. I just wanted to ask whether your level of confidence on the 80% to 90% conversion has changed at all versus the end of June. Secondly, I wanted to just dig a little bit deeper into the Terraflowing. Could you give us any idea on the kind of TAM potential there and what your market share is in this specific offering? And maybe finally, just on ESCO performance when looking at the like-for-like growth rates and a small decline in OE, could you elaborate a little bit more on that and whether that's kind of market-driven or is there anything else going on there?

Okay. Yes, I mean, I think, hopefully from the initial comments on cash, we remain highly confident of delivering on our target, and that hasn't changed. If anything, we feel probably better today than we did in July in terms of that, so we feel we're in a good place. In terms of Terraflowing, look, it's something that we -- technology we developed for a specific application and piloted it. You might recall a company years ago, we talked about projects in Australia where we piloted it. We're now in a sort of phase with it -- I mean, it's early days in terms of the technology and the product line, but we're now in the sort of phase of sort of taking that technology that we developed for a specific project and broadening it out across other applications. And the GBP 6 million order that we talked about this morning is a perfect example of that. So in a specific application there, it's a complete integrated solution, a sort of modular project that slots into this particular customer's tailings circuit, which is going to eliminate the need for a tailings dam because of the dewatering capability that we've been able to build. So it's really early days but a really, really good reference site for us. And we're working on a number of other different types of applications and opportunities across the world on that as well. So it's just -- it's a good example of something -- a new technology, a novel technology that we developed and we're starting to get traction with, so really, really pleased with that. And then, yes, as far as ESCO is concerned, I think we're very, very pleased with the progress that we made in the quarter. Sort of underlying sequential trends are obviously the negative in infrastructure that we've talked about in Europe, but the underlying mining GET has grown sequentially, reflecting, as in the case of Minerals, the focus on production at large mining sites at the moment. So net-net, I think we're very happy with the ESCO performance. So I think -- hopefully that answers your question.

It does.

Great. Thank you, Andre.

We will now take the next question from Vlad Sergievskii from BofA.

Yes. They will be all related to cash flow and debt. First of all, you mentioned net debt increasing in Q3. Would you be willing to provide the magnitude of this increase? Is it GBP 50 million, GBP 100 million, more than that? Secondly, you mentioned that not all increase in debt was driven by FX, the majority of it, and highlighted working capital build as well. Are you able to disclose where the free cash flow was actually positive [indiscernible] in Q3 alone? And finally, also, would you be willing to share whether utilization of your working capital financing facilities have increased or reduced during the quarter?

Vlad, thanks for your questions. So in terms of the net debt increase in the quarter, as we said, that was mostly due to FX. You can see clearly and sort of do the calculations on how the dollar has moved. So as you know, the majority of our external debt is U.S. dollar denominated. The dollar-Sterling rate at the end of June was $1.22. That clearly at the end of September was in the sort of $1.13 sort of range. So when you look at that as a $0.10 move, which in terms of the level of our gross debt is around 100 million, so that's the FX impact broadly. And Q3, in terms of the free cash flow in the period, that was around breakeven, so very strong operating cash flow. And then clearly, we continue to invest in CapEx and pay tax and various things like that, so broadly neutral. But again, as I said previously, that as expected, that's normal seasonality, that there is no surprise in that for us, and that's still consistent with the -- with us getting to 80% to 90% cash conversion on a per-year basis. In terms of your third question, no, I mean there's absolutely nothing out of the ordinary in terms of invoice discounting or supply chain financing. We give full disclosure on that in our annual report and interim statements. That's in the ordinary course of business where we utilize invoice discounting in certain parts of the world. Like Latin America, for context, at the end of 2021, that represented less than 3% of our overall receivables for the group. And on a supply chain financing basis, similarly low levels but no change and no anticipated change to any of that.

[Operator Instructions] We will now take the next question from Mark Davies Jones from Stifel.

If I can stick to cash, maybe on a slightly more positive tack, given how strong the revenue trends are and how bullish you are on the outlook for your core markets, what does that mean in terms of your own investment? Both in terms of CapEx requirements to expand organic capacity but also on M&A, recent deals seem to have gone very well. Is that an area that you're focusing more on as you release more cash from working capital?

Mark, thanks for the question. Yes, look, I think we're in a good place. The focus obviously through the balance of the year is that we delever and we move the net debt-to-EBITDA ratio down to the sort of range that we would like to be in through the cycle, which, as a reminder, is 0.5 to 1.5. So we'll be there or thereabouts by the end of this year, I think. From a CapEx perspective, yes, in terms of what we need from a capacity point of view, that is really baked into the cash conversion targets that we set out for this year, next year and beyond, where, if you remember, after 2023, we expect we'll be up to sort of 90% to 100% cash conversion. We've got the large foundry expansion for ESCO running through CapEx this year and next year as we expand capacity. And then we'll be sort of reverting to 1x depreciation after that. And there's plenty within that for us to continue to add capacity as we need it, but we're in a very good place at the moment. One of the things that we've done, I think, extremely well over the years is to use CapEx to create more and more capacity from our existing roof line. And just as an example, I was in our foundry in [indiscernible] a couple of weeks ago. And there, just by the underlying CapEx that we've -- and the expansions we've done in that facility, we're now -- we now have got threefold the capacity we had from about 7 or 8 years ago. So it's just an ongoing process within The Weir Group. And as we think about acquisitions, yes, you know the strategy, I think we've got a very, very clear organic growth story going forward. We know where the sort of whitespace and the technology, organic opportunities are between the book ends of our business today. If we can accelerate those plans through select acquisitions that meet our criteria and specifically are accretive or consistent with our business model and we can deliver the returns, then those things are going to be of interest. But obviously, the priority for the rest of this year is to deliver on the cash, as we've spoken of quite a lot on this call.

If I can then squeeze in a second market question, for a long time now, you've had the situation of little in the way of greenfield builds and a lot of pressure on squeezing what you can out of existing mines. How sustainable is that? Are we going to reach the point where to meet the capacity requirements, we're going to have to see bigger greenfield work because, obviously, that has implications for your mix, particularly margin?

Yes. I don't think in the long run it is sustainable. There is not enough extra copper and nickel production slated for us to get to net zero. That is a fact, and it is increasingly being picked up in the media at the moment and that all of our customers are talking about that. We need to -- how we're going to get to more copper and so on. So I don't think it's sustainable in the long run. What you're seeing in Minerals at the moment, and we expect this to continue, as I said in my prepared comments, is that, that intense focus on maximizing production from existing mine sites will be a very, very strong driver for us and for where I talked about it last time as being a win-win. It's great for us if the greenfields come in due course and we get extra new installed -- big installed base from that. But in the meantime, we are going to benefit from our position that we have with our customers, the fact that we're deeply embedded within their operations, with their -- on the mines trying to help them debottleneck, drive the expansions. And I think that's going to be a consistent theme for some time to come. But I think we're probably waiting for more of a price signal. And if you look at the tightness in copper markets, for example, the price of nickel and lithium, it feels to me that, that might come before too long. But I think that's probably needed before you see more conviction on greenfields just given the macro uncertainty at the moment on top of the long-standing permitting issues.

The next question comes from Jonathan Hurn from Barclays.

I just have a few questions, please. First question was just about order intake and what we can expect in terms of the order intake for Q4 and how that sort of plays out sequentially versus Q3 both for OE and aftermarket. And then secondly, obviously, you've commented on FY '23 in your outlook. Are you still committed to 17% margin target for '23? And if so, what are the potential risks if there are any there? If you could just sort of elaborate on that. And then thirdly, just in terms of '23 again, just in terms of order book coverage for the revenue there, can you just give us a feel of kind of where that's sitting across sort of minerals [indiscernible]?

Okay. Jonathan, so I think as we think about aftermarket trends from here, the sort of phrase that we used in the statement is that we expect aftermarket trends to be broadly consistent with our through-cycle guidance on aftermarket. If you look at Q4, clearly, we saw a big pickup in the fourth quarter last year, so that's a tough comp, so that we're going to see another 25% print. But reverting to those through-cycle type growth numbers over the balance of the year, I think that's sort of consistent with what we would expect to see next year at this point in time. And I think -- and it sort of relates to the margin point as well. So if you think about next year, the underpins for that are the things that we always talk about in terms of production growth, declining grades and so on. But I think the extra underpin we've sort of got for next year is really around the growth in installed base that we've got coming through. The Iron Bridge Project, as you know, is commissioned at the beginning of next year starts operating. That's roughly GBP 15 million a year of additional aftermarket for us. We sold a lot of big circuit pumps this year. A lot of those will be coming into action through the course of next year. So there's a lot to suggest confidence in continued strength in the aftermarket. Back to the fourth quarter, I think the original equipment pipeline is looking very good. We'll see how it converts. But I think that focus, as I talked about earlier, on debottlenecking, trying to get more out of the existing mine sites, increasing traction with sustainable solutions, that's all playing very well at the moment. And I think the other -- just the other comment I'd make on FY '23 is the orders that we've seen in the third quarter give us a really decent underpin to the first half of the year. Obviously, it remains to be seen how things play out. We don't have visibility to H2 yet, but -- so I think we'll feel good going into the year. And that strength of the aftermarket and the momentum really underpins the confidence that we still have in that margin target. So we see the building blocks, the momentum is with us, and we feel good about delivering that.

That will conclude today's question-and-answer session. I will now hand back over to Mr. Stanton for closing.

Okay. Thank you very much, operator, and thank you, everybody, for the questions. Obviously, we're available through the day if there are any follow-ups. I just want to leave you with a reminder. We also highlighted in the press release our next Capital Markets event on the 30th of November in the afternoon, which will be a virtual event where we'll be focusing on our sustainability strategy, the technology road map that flows from that and how we're going to help deliver smarter, more efficient and more sustainable mining in the future. So we look forward to interacting with you on that. But thanks again for your questions this morning.

Thank you. That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.