TT Electronics plc (TTG) Earnings Call Transcript & Summary

Good day, and welcome to the TT Electronics Plc Interim Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Richard Tyson, Chief Executive Officer. Please go ahead, sir.

Thanks, Kyle. Good morning, everyone. I hope you've had a chance to, at least, go and listened to and looked at the presentation we put up first thing this morning. And thanks for joining us here virtually. Clearly, this is quite a different set of results as well as the format that we're doing it in. And so before we get into Q&A, let me just summarize the main points for you. The team has responded exceptionally well, both operationally and financially. And TT has entered the pandemic in better shape, thanks to the actions we've taken over the last 5 years. And we don't have any meaningful trends yet, but the business has stabilized and is returning to normal. We expect to see improvement from here in the second half, and we have plenty of opportunities, and we are confident of our medium-term outlook. So on to Q&A. I'm going to hand back to the moderator, Kyle, who's going to facilitate questions from you. So I'll just hand back to Kyle. Thank's.

[Operator Instructions] We'll take our first question from Andrew Douglas from Jefferies.

You guys did a great job on operational gearing in the first half. I think you said 26% or 27%. Can we just have a quick walk through how that evolves into the second half? Clearly, we'll have some temporary costs unwinding and some permanent costs coming on the way. So I'm just trying to figure out if you can give us some help on the second half. But I guess also importantly, next year, again, we're going to have the same thing happening again where we have some temporary costs kind of coming back in, some permanent costs coming back out. So I don't know how you want to play it kind of like a gross number or a net number. Or just if you can give us a feel for that. And just secondly on -- or thirdly, on civil aerospace. Clearly, that's going to be tougher in the second half and probably into next year. Can you just give us an indication of how you're seeing that market, your thoughts, I guess, some form of guidance, and when do you think we can get back to '19 levels?

Sure, Andy, yes. So obviously, I should -- I've got Mark in here with me. So again, Mark can cover off the gearing point. As you say, we've been very pleased as well that gearing finished in the first half. So let me do civil aero first. So civil aero was 15% of the portfolio at the end of last year. We are anticipating the overall market to be in the range of 30% to 50% down. And that's obviously a blended factor of wide body and narrow body, with narrow bodies faring a bit better. I think as you know, we're more Airbus-focused than Boeing from the narrow body perspective. And so what we've done is essentially, we're really -- tried to move really quickly with the customer base to get the production lines reset and reed, and we're taking the costs out accordingly. So we're clearly, therefore, expecting civil aero to -- in the revenues, to be lower through H2 and then be at a kind of run rate effectively as a kind of Q2 exit run rate through H2, and then that will be the kind of sort of proxy for next year in our minds. Don't expect much recovery next year based on our -- the platforms we're on. And then a steady recovery from there through to -- we're anticipating back to '19 by kind of '23, early '24 kind of time frame. So I guess -- well, first, we've rebased, got the capacity lined up against that and expect it to be a decent sort of slow-growing market from here.

And sorry to just interrupt you. On next year, I'm assuming that it's going to be down a bit in the first half, up a bit in the second half. Is that kind of trajectory correct?

Yes. Yes, really, Andy. Obviously, it was better in Q1, right, so you have a bit of that comparative to work through, yes. But essentially, our production -- our run rates are now where they should be and the customers' sort of demand in order book stabilized.

And in terms of sort of costs and drop-through, Andy, so obviously, at these higher levels of organic decline, you get -- you have a higher drop-through effect. I think the way to think about it is, in this year, the drop-through sort of before any discretionary cost savings or the projects that you start to get in the second half would be in the order of around 40%. The cost savings that we've sort of -- that we've delivered in the first half to mitigate that is there for the order of GBP 5 million. That will be more like another GBP 3 million in the second half, something like that. And we get a couple million pounds of project benefits start to come through in the second half of the year. And then next year, all other things being equal, some of those discretionary savings will start to have to get layered back in, but it wouldn't be the full GBP 8 million from this year. It's probably GBP 4 million or GBP 5 million, and then a bit more than next year. Clearly, how much we allow to go back in will depend on the rate of recovery.

Okay. And will you guys put costs back in ahead of revenue? Or is it revenue first and then you'll kind of put cost back in?

No, it's...

It would be revenue visibility first, and it's probably right [ to put cost, yes ].

And then only other thing is, we're clearly not expecting a V-shaped recovery. And therefore, the drop-through we would see going forward on the growth, because the growth will be not at 14%. It's probably more like 30%, 35% as things start to come back.

We'll take our next question from Mark Davies Jones from Stifel.

A couple of questions from me, please. First, can you just remind us the time line on the -- achieving the savings is quite a protracted one. Obviously, there are some site closures involved, which I imagine is part of that. Is that also a question of relocating production? Why is it taking out to '23 to get the full benefit of what you're doing? Do you want to take that one first and I'll come back for a second?

Yes. I mean, as you say, because it involves site closures, it involves some aerospace products that require recertification, that sort of thing. So obviously, you've seen in the slide, we've set it out. There's the benefits to accrue a reasonable rate and we get the bulk of it by 2022.

Then could you talk a little bit about your industrial end markets? Because those sometimes are the least visible and the most complex in some ways. So what should we look at there in terms of the balance between the better bits and the more struggling bits? And in terms of the indicators that we should be watching for improvement, is that [ PMI ]? Is it industrial CapEx? Machine tool orders? What do you think is most meaningful as a guide of the trajectory of recovery there?

Big picture, PMIs. But I would be watching CapEx, industrial CapEx. And to some degree, tools. So anywhere in -- certainly in robotics. So I think -- I don't know if you had a chance to listen to the presentation this morning, but I talked about -- we've certainly seen continued strong demand for our optical sensors all the way through. And that's circa 25% of Sensors and Specialist Components. And the semi business is going well, GMS business for semi customers, as do the sensors guys. So that is -- that has been definitely robust to strong. And then the broader market general demand is really on economic dynamics and also the stocking dynamics in the distributors. So at the moment, [ broad line ] kind of distribution is holding up reasonably well, I'd say. So it's only 15-ish percent off where it was last year. So I think that's a reflection there's actually is a reasonable amount of destocking that started to happen.

Great. And if it's not greedy, can I just ask one final one on working cap? That was, I guess, the one number that didn't look quite as strong in the first half. But Mark, I heard your comments about inventory. What do you think we should look for, for cash conversion at the full year stage?

So I mean, we're definitely expecting working capital improvement in the second half of the year. Whether or not we'll get it all the way back to neutral is clearly a number that can vary a bit, but that would be our aim. But I think we're probably neutral to small outflows is a reasonable assumption. That means that sort of cash conversion would be certainly back into the 90% plus territory.

We'll take our next question from Rory Smith from Investec.

Two questions from me, if I may. Just within the 22% of revenues from aerospace and defense generally. What was the split between civil aero and defense in the first half given sort of recent acquisitions, maybe more on the defense side? And how is that different across the divisions? Could you remind me, please? And the second question, just on visibility, what's the sort of level of visibility now across the divisions? And also, as a second part of that question, what are you seeing in terms of customer inventory levels and how that might impact demand, sort of through Q3 into Q4?

So in terms of the split, Rory, for the group, aerospace -- commercial aerospace is 10% and defense is 12%. But obviously, that's sort of swung around compared to last year. Everyone understands the weakness in commercial for us. Defense has been very strong. Obviously, we've added a bit through acquisition, but actually, organically, it's been very strong for us as well. Which is why, in total, is still up at the 22% level. Across the different divisions, you've got Power and Connectivity: 19% aerospace, 24% defense. GMS is 4% aerospace, 10% defense. And Sensors and Specialist Components is broadly aerospace. There's very little defense in that.

So in terms of visibility, Rory. So I guess, sort of visibility for I think what we described earlier on today has an expected improvement through H2 is looking okay. Across GMS, it's kind of, what I call it, sort of normal levels. So not much left to book subject to no customers moving any more order book around. And then in the other 2 divisions, there's sort of -- there's a bit more book-and-shift dynamics in both Power and Connectivity and Sensors and Specialist Components. So we've still got probably 2 to 3 months of the second half to book. Obviously, a bit of that will come in, in July. So it's still a bit of -- that's why I sort of said there's still a bit of a range of outcomes on the year. But actually, those visibility dynamics are what I'd call reasonably normal to the assumption that we will improve revenues in H2. And then I think you asked about customer inventory levels. So we had destocking happening in the distributors last year. That was still -- we're still above what we would call the norms when we went into the crisis. That's come down a little bit, but not all the way down to where we would have been sort of full run rate. So there could be a little bit more to go there. And people are obviously, constantly looking at their overall demand pattern in their inventory. So again, that's another sort of dynamic that it's got some moving pieces potentially. And we have civil aerospace customers who are working through, clearly, more inventory that they would have been carrying for higher run rates. So we have got a couple of larger customers in there that will -- that could be up to 60% down this year. So that's an inventory effect as well as the updated run rate for platform build. But there's other areas where people are building up for strong demand. So defense has been excellent. I think as Mark has sort of referred to there, we've had customers placing 2-year demand in one go. Biggest order we've got a hold on was the -- were in the [indiscernible] in North America. So some really good stuff in there.

[Operator Instructions] We take our next question from Richard Paige from Numis.

A couple of questions from me, please. North America performance looks very strong in terms of the sales numbers you've provided back there. I know there's obviously some benefit from acquisitions in there. Could you just talk through, sort of, dynamics in -- over there, please? And then secondly, on the medical side, you've obviously highlighted those deferrals in terms of installations into next year. You obviously also had benefits from some of the COVID-related measures. Can you just, again, talk about the sort of timing dynamics on both sides of that equation, please?

Do you want to take that?

Yes. So, Rich, in terms of North American growth, as you say, we have added some stuff into acquisition. But organically, America was up 5% in the first half. The growth there is in Power and Connectivity and in GMS. So Power and Connectivity, Richard just referred to some of the wins we've been having, getting some really good growth there from the businesses that we've acquired over the last couple of years, which I think is really demonstrating the strategy there to grow our power electronics capability in North America is really gaining traction. And then GMS was the other area where we saw real growth in North America. We talked last year about them having a number of sort of contract wins, and that they were ramping up in the first half of the year.

Yes. So a couple of those contract wins have come with specific customers that I think we've talked about in the results presentations that we've been focused on and targeting on those key customers, improving [ price ] and giving us more work. So that's been really nice to see. On the medical front, Rich, the -- we have -- so it's been multiple dynamics going on in this market in the first half. So we've had some super strong demand for urgent operational needs for frontline, well-trailed, well-publicized ventilator stuff, but not just U.K. but an awful lot of it in the U.S. as well, where we do a bunch of parts. And we took part in a whole range of those projects in the U.K. in cross-sector project teams. But it's not just that, it's also things like refrigeration units, with the testing that we do as well that was really strong. So the guys did a fantastic job reconfiguring capacity to ensure we can deliver all of that. But then offsetting that is we also did quite some stuff in oncology, life sciences, big pieces of customer equipment, where installations have been just not possible through COVID. So either hospital reprioritizing to deal with COVID or just the fact thing to shut down. So those are clearly moving into next year and beyond. But that just means, for us, we think this was a good market for us to be in, good growth dynamics. And I think this gives us even more confidence in that going through '21 and '22. And in addition, we're still working on things, a few projects and to see how they've come along with the sort of the latest things that are needed to fight the next phase of COVID. So there's definitely been opportunities that have come out of this for us. And customers who did not know TT and have not seen our -- my team in action have really been pretty impressed, and we're getting stuff coming out of the other side of that.

We take our next question from Mark Fielding from RBC.

Just in terms of the cost reduction program and the savings program, you mentioned in the presentation GBP 10 million to GBP 15 million of end-of-life revenues. Just curious about the time line on that, are those profitable today? Just how do we think about that phasing in. Maybe [ take that ] one first.

Yes. So I mean, they are profitable, but it's part of -- I guess, it's a mixture of something that's a slightly lower margin and something that we just have to do to access the overhead reduction savings. The lion's share of that would come out next year and then maybe a little bit in the following year. So obviously, that will put a slight break on any other growth -- against the growth that we'd otherwise see next year.

Yes. So -- and that's -- it's an ongoing evaluation, while it's not an estimate at this stage. But we're taking the opportunity to remove stuff that is also less profitable to us and it's just not worth us moving to other places.

Great. And then just separately, obviously, good cash flow performance remain well within your target range. What's your thought process on acquisitions from here in this slightly unusual backdrop that we're in? And how is the pipeline looking?

Well, so on acquisitions, I suppose the first thing to say, and we tried to convey this morning in the sense of the releases, things stabilizing the business through Q2 from a March, April time where it was very focused on operational execution. And we've really been on the front foot looking forward opportunities since the back end of Q2, really looking to drive out the other side of this situation. As we just said, acquisitions that we brought in are performing well. We feel like we've got the bandwidth now to go against. So if I then talk about the pipeline, I would describe it as being more active than it has been. And there's more things coming into it, which feels like it's the dynamic that's one that's a result of the crisis. There's more assets potentially becoming available. It's still like who knows at what specific timing, but there's more conversations going on and we're encouraged by that.

Yes. I mean -- and then just to deal with the kind of capacity point, we've talked before about being comfortable in principle going up towards 2x -- up to 2x levels. At this point, in the evolution of all of this, I think where the balance sheet is today is where we are is where we are comfortable. And I think as things evolve and as we hopefully get greater clarity and certainty over time, we would gradually become more comfortable within -- we're moving back up through the range. So -- I mean the amount of M&A capacity that we'll have will clearly, therefore, be dependent on when things -- if and when things come to fruition. You know that we take a relatively prudent view of the balance sheet. And therefore, we will we would evaluate the opportunities as they come up and think about the best way to finance them at that point in time.

[Operator Instructions] We take our next question from Harry Philips from Peel Hunt.

Again, looking at the capital allocation slide. Obviously, Mark has just asked a question about M&A. So I suppose some commentary around your dividend comments today. And in the new world, what does progressive actually mean?

Yes. So I mean, what we're basically saying today, Harry, is that our focus has been on the strength of the balance sheet and making sure that all of the actions we're doing to retain that. And -- but we're obviously mindful that the dividend is an important part of the investment proposition and our capital allocation policy. So what we're indicating here is clearly that there is still some uncertainties around us and how the pandemic will evolve in H2. But assuming things continue as they are, we feel it's the right time to consider the dividend is at the end of the year once we've seen the outcome. And it's our intention to get back on the dividend-paying trail.

Yes. And I think, Harry, when it comes to progressive, obviously, that in normal circumstances that means that with growth, you'd expect growth in the dividend. I think that, that remains, in principle, our view. I think the other thing I would say though is, yes -- and also that, ideally, we like [ they ] didn't cover 2x plus. That said, we've demonstrated in the past that we're prepared to look through cycle, so we're not -- we won't necessarily slavishly be tied to 2x cover.

It appears there are no further questions at this time. I would like to turn the conference back to you, Mr. Tyson, for any additional or closing remarks.

Okay. Kyle, thanks. Well, thanks, everyone. Really appreciate you joining us this morning to hear what we've been getting on. And I guess, as I said at the start and summarized that by we came into the crisis in a much improved position. The team we've got here has executed really well operationally and financially, and we're in good shape and we're on the front foot. So thanks all. Look forward to seeing you again soon, hopefully in person.