TT Electronics plc (TTG) Earnings Call Transcript & Summary

All right. Good morning, everyone, and thank you for joining me for the TT Electronics 2021 Full Year Results Presentation. As usual, I'm joined today by our CFO, Mark Hoad. We'll run you through the presentation and then open up for your questions. I'd like to start off by saying that I'm really pleased with the strong performance in 2021. It shows we have the right strategy and have excellent people delivering that strategy. We performed really well despite the well-documented supply chain and COVID-19 challenges, all while delivering strong growth. So I'd like to take a moment to thank our teams around the world who have been genuinely amazing. We continue to win significant new business, as we work in partnership with our customers to solve technology challenges for a sustainable world. 2021 was a year of strong performance. We are pleased not only to be reporting good results but also considerable momentum across the business. Our revenue and run rate operating margins have returned to prepandemic levels at constant currency. Adjusted operating profit was up 31%, reflecting 3 things: drop-through on growth, the benefits of the self-help program and actions we've taken to offset headwinds in material costs, supply chain logistics and COVID inefficiency. We are passing on inflationary pressures through pricing, and we expect to continue to manage this dynamic throughout 2022. There was a particularly strong performance in Sensors and Specialist Components, up 82% in adjusted operating profit and GMS, up 24%. The pipeline of new business opportunities looks stronger than ever and with significant new wins on multiyear projects and new customers added to our key account list. Order intake has been excellent, growing 53% organically, with book-to-bill of 137% and an order book now 56% higher than a year ago, all providing unprecedented visibility for this year and beyond. To support our customers and maximize growth, we've also taken a decision to invest in inventory. On ESG, our products enable our customers to meet their sustainability targets, and we have made great progress on significantly reducing our own carbon footprint over the last 2 years. Today, we are making near-term commitment to deliver 50% reduction in Scope 1 and 2 emissions by the end of 2023. So as you can see, it's been a busy year with lots of progress, pointing to our confidence in achieving our top line growth ambitions and that we are making tangible progress towards double-digit margins. Now, given the strength in operational execution on the next slide, I thought it would be helpful to give you a bit more color on how this has been achieved. So yes, operationally, it's tough out there, but we've been really pleased with our execution. By having our hands on the right levers, the team have made a real difference and offset substantial material price escalation, logistics costs and COVID-driven inefficiency. So how have we achieved these results? Well, there's a lot of examples I could pick where we have operated in partnership with our customers to manage the challenges. It's definitely one of the positive outcomes from being even more embedded with our customers. Taking one of our bigger customers, they are paying us 20% more for their materials needed to produce their products. And they are now directly funding additional buying resource to work specifically on supply chain availability to keep their production line going. Furthermore, we have agreed delegated authority from them to approve price increases so we can be agile when securing parts. In a separate initiative, we have adapted some off-the-shelf software to find innovative ways through data analytics to enhance parts sourcing. And the work of our supply chain council has been invaluable here. It works across our divisions to meet customer needs through initiatives to consolidate supply, maximize economies of scale and search out scarce parts, often working together with our customers and their broader networks. In more and more situations, I and my fellow CEOs are working across businesses and supply chains to free up the supply of critical life-saving products. Cost headwinds have been largely mitigated through price increases, albeit inevitably, with some lag. In 2021, we estimate our revenues include some GBP 5 million to GBP 10 million of price increases that we have passed on to our customers. At the same time, our self-help program continues to progress very well, and we are realizing benefits earlier with the program concluding this year. It has been an important contributor to the excellent performance of Sensors and Specialist Components in 2021. The merging of Torotel and Covina is underway and will deliver incremental benefits. We plan to reinvest this back into R&D to support growth opportunities. All around, this demonstrates the strength of the TT operational team and their ability to overcome even the most extreme challenges. On the next slide, I'll focus on growth and the improving quality of the business. Our clients increasingly work in partnership with us, and we are growing the number of customers for whom we are both designing and building the product. Our aim is to be working as part of our customers' teams, with our products and services integral to their designs. This has resulted in revenues from our top 10 OEM customers, growing to 32% of revenue, up from 26% in 2018. We have secured more than 30 new material contracts this year as part of the record order intake. This is going to deliver over GBP 100 million of multiyear revenues for us, really showing the strategy and our investments paying off. An example of this was the recent win with a major defense prime in the U.K. for their army vehicle program, Boxer. The program will last for the next 10 to 20 years, with the initial contract being for GBP 5 million. We'll provide complex, high-reliability power electronics assemblies. Our divisions are increasingly collaborating and cross-selling our capabilities. As an example, in our Power and Connectivity division, our engineering team in Minneapolis has collaborated with Radwave Technologies to develop smaller, more accurate sensor coils which support new procedures in structural heart and orthopedic healthcare. This is evidence of the success in cross-selling, as our GMS business will also provide the complete system manufacturing under an exclusive 5-year contract. Investment in R&D and acquisitions is important to improve our capabilities and enhance growth potential. We continued our level of R&D investment throughout the pandemic and invested GBP 11.4 million in R&D last year. So now, I'll move on to acquisitions where we've also been improving the quality of the business through adding new capabilities. What's been good about our acquisition success is that it has added higher-margin businesses with cross-selling potential and cost synergy, creating value for TT. The examples of Torotel and Covina show we have secured new contracts, added new key accounts and had success building the pipeline of opportunity through cross-selling, especially with GMS. We've delivered cost synergies, as expected, and the Covina integration has created additional rationalization opportunities with Torotel. In January, we announced the acquisition of Ferranti Power and Control. We're delighted that they've joined the TT team. Ferranti brings further technology capability, intellectual property and scale to our power business, with highly skilled employees and valuable long-term customer relationships, primarily in aerospace and defense. We also believe the acquisitions of Covina, Torotel and Ferranti over the last 2 years mean we are well placed to benefit from increased defense spending. We continue to see an active M&A market, with a good pipeline of opportunities for the group to pursue. So with that, I'll hand over to Mark to take you through the financial performance for the year.

Thank you, Richard, and good morning, everyone. We are really pleased with the strong performance in 2021. Demand is coming back strongly, and we've delivered really good revenue growth. Operating profit and margins are well up, thanks to growth, our self-help actions and the contribution from the Torotel acquisition. And we've been investing to support our strong order book growth to manage supply chain constraints and to drive margin improvement. The business is in great shape. In 2021, we grew revenue by 10% organically. We saw good growth from our core markets, particularly healthcare and automation and electrification. Commercial aerospace demand stabilized from Q2, and we're starting to see some signs of demand improvement in order intake. Revenue growth would have been even higher but for component availability, which impacted our ability to ship some product in the last few months of the year. We've increased operating profit by almost 1/3 at constant currency, and we improved run rate margin by 180 basis points to 8.1%. This takes us back above prepandemic margins. We're on track to get to double-digit margins. And on the next slide, I'll show you the tangible progress we're making. 2021 was a year of significant investment in acquisitions, in the self-help program and in inventory to support growth and deliver our record order book. We realized GBP 9 million of proceeds from the sale of freehold properties to support this investment, and balance sheet strength has been maintained, with leverage well inside our 1 to 2x target range. Return on invested capital continues to show strong recovery. It was up by 140 basis points in the year and is now back in line with our pretax cost of capital. We expect further improvement as operating profit grows going forward. Adjusted earnings per share increased by 24% to 14.5p. Given the strong performance in 2021 and the positive outlook for '22 and beyond, the Board has proposed a final dividend of 3.8p per share, taking the full year dividend to 5.6p per share, an increase of 19% compared to 2020. We're delighted with the progress we made on margins in 2021. In any year, 180 basis points of improvement would look great but even more so, given the magnitude of the headwinds we've had to manage in the year. This increases our confidence in getting to double-digit margins. Here, you can see the key elements of the improvement in operating margin in the year. Firstly, we're getting good operational leverage on the growth we're generating, and this has added 130 basis points. Our self-help program added another 120 basis points, an increase from the first half, with the Sensors and Specialist Components division realizing benefits earlier than anticipated, as you can see in their margins. We've added about roughly GBP 4 million of discretionary costs relating to marketing and employee incentives as planned, and Torotel delivered modest margin accretion benefit to the group. All of this means we've increased those run rate margins by 180 basis points on a constant currency basis to 8.1% and adjusted margins then reduced by 0.8%, which is the impact of the cost mainly incurred in the first half to establish the Virolens product line. Moving on then to see how that revenue and profit performance has played out in the divisions. In Power and Connectivity, revenue increased by 15% on a constant currency basis and by 3% organically. Organic growth picked up in the second half and came from the defense and automation and electrification markets. The inorganic contribution from Torotel was GBP 15.2 million of revenue and GBP 1.5 million of operating profit. There was some delay in planned order intake for commercial aero products, which meant that the H2 contribution wasn't as strong as H1. This division has longer-term dynamics. It's the division that's most impacted by the commercial aerospace market, which has yet to come back, but we are beginning to see some improvement. This is also where we're investing to deliver future opportunities. Remember, here, we spent GBP 3.8 million in the year, mostly in the first half to set up Virolens. Excluding that, profit would have been up 13%. Adjusted margins declined by 250 basis points at constant currency, but run rate margins were 8.3%, excluding the Virolens costs, and we see no change in the medium-term margin potential for the division. Global Manufacturing Solutions delivered organic revenue growth of 14%. Demand was particularly strong in healthcare and in automation and electrification, and the revenue growth was highest in the Asia region, in part, thanks to take-up of our new offering in Malaysia. The order book continues to grow very nicely, and as a result, the division already has its forecast revenues for 2022 fully covered. Adjusted operating profit improved by 24% on a constant currency basis, and margins improved by 60 basis points, moving above 8% for the first time. We've said before that the quality of this division has been transformed. This is now being borne out in the continued margin progression. Finally, Sensors and Specialist Components. Here, we grew revenue by 11% organically, with strong demand in the automation and electrification market in particular. In this division, we've also had really good growth in order intake. The general tightening in the supply chain for electronic components is encouraging customers to place orders further out to secure capacity, giving us greater demand visibility. We now have around 3/4 of the year's revenues covered by orders, whereas normally, this will be less than half. We are seeing some input cost inflation, but this is being passed on through price increases. The profit performance in this division has been very strong, with really good operational leverage on revenue growth. We also realized an extra GBP 1 million of benefits of the self-help program earlier than planned. As a result, adjusted operating profit grew by 82% at constant currency, and margins are up by 550 basis points to 14.2%. Moving on to cash flow. As I said, 2021 has been a year of significant investment, as we deployed capital to support growth and to improve margins. Here, I've shown you the differences that explain the reduction in free cash flow compared to 2020. EBITDA increased by GBP 6.2 million with the growth in operating profits. We continued the investment into the self-help program as planned, with higher capital expenditure as well as increased restructuring spend. This was partially funded through the sale of surplus freehold properties that realized GBP 9 million of proceeds, including selling the Corpus Christi property in 2021, earlier than originally planned. With the growth dynamics that we're experiencing, we're investing in working capital, in particular, inventory. With the high levels of growth in the order book, increasing lead times and critical component availability challenges to manage, we've gone from a GBP 3 million working capital inflow in 2020 to a GBP 15 million outflow in 2021, hence, the GBP 18 million swing. Finally, after paying very little cash tax in 2020, this did return to a more normal level in 2021. For 2022, we expect free cash flow to step up, as the spend on the self-help program comes to an end and working capital flows return to more normal levels even if we don't anticipate the inventory position reversing in the near term. We're making these significant investments in line with our capital allocation policy. We're prioritizing organic growth and margin enhancement, with over GBP 30 million invested in the year in R&D, CapEx and the self-help program. We returned GBP 11.4 million to shareholders in dividends in the year. With the final dividend we've now proposed, we will be increasing dividends by 19% over last year. We continue to deploy capital on value-enhancing acquisitions. In January of this year, we completed the Ferranti acquisition for GBP 9 million, taking spend on acquisitions since the start of 2020 to more than GBP 55 million. And we've done all of that, keeping our leverage within our 1x to 2x target range. This capital allocation policy is supported by a well-balanced debt package. A medium-term debt with a group of long-standing relationship banks is now complemented by our long-term private placement debt, which we put in place in the second half of last year, GBP 75 million of 7- and 10-year notes with an average fixed coupon of 2.9%. Lastly, I wanted to give you an update on our self-help program that is now very well advanced. The most complex parts of the program are now complete. We've closed sites in Barbados, Carrollton and Corpus Christi, along with a small site in Tunisia that came with the Aero Stanrew acquisition. The closure of our Lutterworth and Akron sites will be completed by the end of this quarter. We've opened our new Sensors and Specialist Components facility in Plano, Texas, just north of Dallas, and we're up and running. We have a new enlarged clean room in Bedlington that's now operational. We're progressing well through the more complex product qualification, and transfer from Lutterworth will be complete in the first half. As I said before, we realized the sale of the Covina property in the first half and, in the second half, completed the sale of the Corpus site ahead of schedule. In total, we realized GBP 9 million, keeping the cost of the overall program down. We now plan to integrate Covina into the Torotel site at Kansas City, improving the overall benefits of the self-help program by GBP 2 million. We're realizing the project benefits, we're getting through the toughest execution challenges, and we will be completing the program this year, making a meaningful contribution to our margin improvement. So hopefully, that's given you a good sense that we have had a great year and that the business is in great shape. With that, I'll hand back to Richard.

Great. Thanks, Mark. Let's now take you through why I'm excited about the future of the business and the opportunities that we have in front of us. As you know, the business has changed significantly over the last few years. We have done a lot of work to position ourselves to benefit from markets with long-term structural growth. This slide provides you with the weighting and summarizes the good long-term growth potential in these markets. We've shown you this before, but I want to bring you right up to date. The future growth from these markets is driven by electrification and the need for efficiency, improved productivity and environmental demands. Current dynamics mean we have some good opportunities for these to be higher in healthcare, defense and commercial aerospace. In healthcare, electronics plays a central role in advancing medical technology. COVID-19 has had a clear impact on these trends, and the tailwinds will underpin growth. Our products are enabling the development of smaller, lighter and more precise surgical devices, which reduce the size of incisions, shortening recovery times and improving patient outcomes. It's therefore entirely possible that, in the short term, growth could well be higher than the 5% to 7%. In aerospace and defense, defense outlays have been strong in the areas in which TT has expertise: communications, radar and other defense deterrence. They've all seen strong program supported with good awards. This market is now 12% of group revenues. Current events demonstrate the need for strong defense capabilities. Western governments are already indicating they are going to increase spending. With good customer access in Europe and the U.S., we are well positioned to support this increased demand. Commercial aerospace is beginning to pick up, and we have GBP 40 million of annual program sales to come back, as build rates return. Together, this could mean we have the opportunity to exceed these aerospace and defense growth rates over the next few years. The automation and electrification market is performing well, as projects restart after the pandemic and underlying demand for electronics comes through. We believe all this clearly supports the medium-term revenue growth projections for the group and provides the possibility to exceed. Additionally, short term, we are working to build on a record order book, with demand enhanced by pricing dynamics linked to material supply chains. We're estimating the pass-through of material costs to pricing could inflate revenue by as much as GBP 15 million to GBP 20 million this year. Delivery and growth is key to business sustainability and our shareholders. Equally important to our wider stakeholder group is the role we play as a good corporate citizen. Our progress and priorities on ESG are highlighted on this slide. For environmental impact, we have set a clear target of net zero for our scopes 1 and 2 emissions by 2035. We have shifted more sites to renewable energy, and we reduced our manufacturing footprint. This allowed us to deliver a further 25% reduction last year. And as I mentioned earlier, we have also announced a short-term target to half cumulative emissions by the end of 2023. All sites have projects aimed at reducing energy consumption. In China, Mexico and Malaysia, they can't access renewable energy, and so we are looking into alternative solutions, which may require some levels of capital investment. We're already making good progress on assessing material areas of scope 3 emissions and making reductions, too. On social, I was also very pleased to have maintained strong levels of employee engagement, as demonstrated by our recent survey in October. For the second year running, we saw 85% participation levels, and we have maintained our 2-star rating, the second highest level, benchmarking the group amongst the best of engineering and manufacturing companies globally. We continue to work on gender diversity, supported by a women in leadership program and the diversity and inclusion awareness initiative that is well underway. TT's intern, apprentice and graduate programs enable us to find and nurture young talent to provide the critical skills our business needs for the future. On governance, all of this is also reflected in the way the Board is made up, undertone, level of engagement and policies from the top of the company. Now, let's turn to margin development on the next slide. The business has not only shown its resilience through the pandemic, but it has quickly recovered to 2019 revenue and margin levels. Excluding the Virolens investment in 2021, our run rate operating margin is 8.1%, up 180 basis points at constant currency. From here, we have clear steps to take us to a double-digit group margin, through self-help actions, growth and acquisitions. First, our successful self-help program, which is delivering significant benefits with more to come. The program has been an important contributor, supporting excellent improvements in margin in our Sensors and Specialist Components division. Secondly, organic growth. As already outlined, the new programs, new customers and market demand have driven a record order book, now 56% higher, underpinning growth in profit and margins. Finally, acquisitions. We're really pleased with Torotel. It's delivering new high-quality business for us, with great examples of cross-selling and cost synergies. The acquisition of Ferranti Power and Control further enhances our power business in Europe. And both the Ferranti and Torotel acquisitions will improve overall group margin. We continue to pursue a pipeline of acquisition targets, which should support a continuation of this opportunity to enhance value for the group. Now, I want to look at GMS and how we have transformed the business to be a significant contributor for the group. The progress in GMS over the last few years has been tremendous. It was a low growth, GBP 150 million business, largely industrial and receiving offload work and managing a 30% churn every year, with very low margins. It is now best in class in its markets, focused on healthcare, aerospace and defense and high-end industrial partners, with margins more than doubled. The improvement in the customer mix is one of the factors driving margin. We are working with customers who are winners in their own markets and who place a higher value on a strategic manufacturing partnership. We've consciously reduced the long tail of less profitable customers and exited any simpler PCB assembly and consumer-facing electronics. Our focus has been on moving up the value chain to produce higher value-add assemblies, where we see greater stickiness due to the complexity of the product design. And the team has also successfully navigated a strategy to be more sustainable, with a focus on Chinese customers so that we benefit from local market growth rather than being a low-cost supplier to the West. GMS delivered 14% organic revenue growth in 2021. The division is central to our cross-selling key account strategy, particularly with the Power and Connectivity division and is introducing new customers to the rest of the group. The business is already fully booked for the year, giving great visibility to growth. So the team are already working on growth for 2023 and beyond. They have now moved above the 7% to 8% target margin range we previously guided to, and we believe this business is capable of further improvement over the medium term, as it works with more of the product businesses. So in summary, we start 2022 with a record order book, giving us excellent visibility for the year. We've talked you through the levers we have to navigate the supply chain challenges. The level of new business opportunities, coupled with our order book and self-help actions underpin our ability to deliver revenue and margin growth. However, we are mindful of the evolving geopolitical situation and associated macro uncertainty. With good customer wins, strength in our target markets and the commercial aerospace recovery still to come, we believe the group is in a strong position for the future. Thank you very much. That concludes the presentation. So now, we'll open up the call for questions. Thanks.

[Operator Instructions] We will take the first question from Michael Tyndall from HSBC.

A couple, if I may. The first one, just in terms of passing through costs. Thank you for giving us a number there. I'm just curious to know: does it vary between the divisions? I'm thinking maybe incentives in Specialist Components with greater distribution, it might be more timely, whereas it might be a bit slower in Power and Connectivity. So I'm wondering whether or not there is perhaps some catch-up in Power and Connectivity and whether or not some groups are easier to pass it through versus others. And then the second question, I'm hoping you'll help me here. If I think about where consensus is for revenue for '22, if I'm not wrong, you've just told us price is going to be about 3.5%. M&A looks like it's about 2% in terms of top line. And then your base markets are 3% to 5%, but actually, with civil, it should be better this year. It feels as if consensus is too low for revenue growth for '22. It feels like we could be getting up towards the high single digit when I put all that together.

Good math there, Mike. Thanks very much. So let me start with the pass-through costs. So you're right to -- you're right to ask the question about the differences between divisions, definitely. So I think the way to think about it is that in sensors, it's principally a component division where we're selling out to the broader market, so we are and have been, on a reasonably regular basis, actually adjusting price to be as best we can ahead of inflationary pressures throughout last year and to the start of this year. So then we're -- it's a more general price increase. We do it when we think it's appropriate to do it based on the market dynamics. The other 2 divisions both have a more similar dynamics to what we're talking about, the more significant material pass-through. So they are buying components from the wider market, and it's here where we've seen the sort of more extreme individual sort of price movement. So in Power and Connectivity and GMS, we'll have input inflation from things like maybe freight or general escalation, so that will be put through general price increases. And then these individual one-offs, where in -- when we go into consultation with customers and agree a transparent pass-through of that price. So those 2 have more of that material element of the GBP 15 million to GBP 20 million that I talked about. And then on -- moving on to consensus '22. I think you're about right on the 3.5%, I think. I'm sure you're right on the M&A. And you're right to point out general market could mean that it could be -- it could potentially be higher than that. I think that's what I was indicating through the presentations. We feel we've got the right kind of markets with some good potential opportunity. When you take commercial aero, still to come back. You look at government signaling increases in defense spending, and we just acquired 3 companies to extend our scale and capability in defense markets in Europe and the U.S. So yes, I think that makes us feel optimistic that the opportunity is there. The issue right now is very hard to predict exactly where the supply chain situation is the tightest that will impact our ability to get products out the door. The teams did an unbelievable job in Q4 to deliver the product that they did to the customers and achieve the growth that was there, but it's still left probably hanging and is still the case today in the GBP 20 million to GBP 30 million range of product that is -- whether it's been ordered in lead time or we can't get a pass and then potentially to deliver above what's actually getting shipped right now. Hopefully, that gives you a sense of why we may not want to go all the way as yet. And also, clearly, we need to want that extra growth in backlog before we talk about it coming through.

The next question comes from Christian Hinderaker from Liberum.

First question is on the civil aerospace exposure and the linkage between your own revenues and OEM build rates in terms of timing. And I guess any additional comments there on how that dynamic may have changed, given the supply chain tightness and extended lead times. And then second question is about lead times again but, perhaps, more generally. Could you perhaps provide some color here across the business in terms of both the input and your own delivery times and how those have shifted over the year? I know there's been some quite aggressive increases in delivery time, say, for capital equipment in the U.S., up 28 days to around 173 days, but interested in comments as they relate to your own businesses.

Chris, so there's a bit of a -- we're clearly excited to build rates increasing now and, certainly, some of our peer group actively getting the revenues come through. We tend to be a bit further down in the value chain of the platform, down to build rate flowing through into actual pull-through of our products. So obviously, the starting point of that was customers using up inventory that was out there and then needing to restock. So it's fair to say that we have seen what we would call, sort of, the early signs of demand starting to come back in terms of the orders. And we also have some specific situations, perhaps customers have got themselves a bit out of kilter with what they should think they needed for their increase in the build rates, the ones that are [ obviously ] pulling through. So some significant in-lead time ordering and requirement of parts that is challenging, and we're working through with them right now. So I think that means we're encouraged that this is now starting to come back. But I do think, as I've said before, I think it will be over the next few years, you'll see that GBP 40 million come back. Our lead times, they extended during last year, and they're already relatively high early in the year, and then they had probably 2 or 3 extensions. Some parts are out it in 40-week plus. And that means that for the likes of GMS and Power and Connectivity, we are strongly advising customers to look well into the future and ensure that they're giving us visibility so that we can manage the situation together.

The next question comes from Harry Philips from Peel Hunt.

Just a couple of questions. The first is on GMS, where you rightly highlighted quite correctly that transformation of the business over the last 5 years has been extraordinary. I was just sort of wondering where you take it from here because you're using it to sort of interlink with other parts of the business more and more. It's very China-centric, but Richard, rather, you talked about the China-to-China strategy, which sort of -- I was just wondering how you really sort of scale it up from here. Because if GMS is going to become sort of more core to the business, both sort of structurally and what you offer to the customer, do you need to broaden this geographic base a little bit? Or is China for China or is it half? I'm just curious as to how you see that evolve over the next 2 to 3 years. And then secondly, just sorry to be tedious about Virolens, but just hope you understand where we are. In terms of your cost, essentially, we're done there, regardless of what happens with the customer and so on. And any equipment win or whatever is entirely down again to the customer, not yourself. So sort of Virolens now, as we look at it, would be a sort of net gain, if anything happens, but there's no sort of additional cost to possibly incur on the downside?

Yes, let's take that one first, Harry. Yes. I mean you've got it exactly right, though. So it's -- any results need to come from our partner and customers, and they would be a net gain to our outlooks. The cost of exacting that position, as we said, we were taking them down the second half of last year when the project is -- remains live. As I've said to people that have asked, there's been an ongoing dialogue with regulators and, more particular, regular in an output, and that remains ongoing. So the project's life, from our perspective, still has opportunities, but there's no -- we haven't had a definitive outcome from another regulator yet. And so -- and then on to GMS. Yes, thanks for mentioning the extraordinary transformation. I've been incredibly impressed with where we managed to get this business. And I think in terms of where it goes from here, though, I think, first and foremost, I'll point to growth, Harry. The growth potential is really good. They delivered an excellent 14% that they are part of the journey of expanding the large customers in the key markets, where we're focused on, and we believe there's more opportunity with these customers. The customers themselves are doing really well. The markets are doing well, as I mentioned in the presentation. And hopefully, there'll be some more from the defense market in the coming years. So you add all of that through, I think the focus should be growth. China for China was important to make sure that the team we're not reliant on being a low-cost supplier to the West. That's kind of the 50-50 balance now in the business out there, which is excellent and gives us the opportunity to benefit from local China growth. And we've also -- we did make a bit of an expansion of the team into our -- because we have the opportunity to do it in our Kuantan facility in Malaysia. And the guys in China stood that up in less than 6 months, and it's doing fantastically well already. So I think we have the capacity to grow into. We're positioned in all 3 regions. Plus, as I say, we've got the extra bit in Kuantan. So -- and the fact that they're working so well with the rest of the business, in particular, Power and Connectivity as well as most customer overlap. So I'm optimistic there's more to come there.

The next question comes from Mark Fielding from RBC.

Just a few questions from our side, I suppose. Just picking up that slide, you talked about the medium-term growth rates and the near-term potentials, which actually, in some cases, were above that. I mean specifically on healthcare, there is a reasonable exposure there in GMS. Is your order book also supportive of the idea that you kind of see growth above that 5% to 7% range in the near term?

Well, I mean, firstly, in healthcare, yes. That's what I'm saying. Potentially, yes. So as I say, just point you straight back to the supply chain situation, and those challenges are pretty extreme to make sure we can get all of the potential out the door, but it's really good to have the opportunity.

Great. And in terms of -- again, on the growth side, I think the defense side, you touched earlier on the civil aero. But defense, how quickly does changing environment actually convert through to potential demand for you guys? How do we think about that whole process?

Well, you probably -- I mean it's quite early days, isn't it, in terms of the statements that have been made about movements in budgets, but they are significant, for sure, and very material in nature. So the job we thought we had to do was position ourselves with the right platforms with the right capabilities that are in demand, generally. So I'd expect money to flow into those kind of areas when it does. And then I guess you got -- I'd probably suggest we all look at history, where governments have looked to ramp up spending and get equipment on a relatively short-term basis. They've things like -- I guess you go back to the early 2000s, right? They found ways to increase that spend over 1 to 2 years and ramped up relatively quickly. Whether we'll see that here or not, I don't know, but that's certainly capable of doing that if we want to.

Great. And separately, on free cash flow. It feels like we're heading into a period of stronger free cash flow. Just wondered if there was anything Mark wanted to sort of highlight around the sort of outlook for that. And maybe linked to that slightly, pension is obviously in a very strong place. Can you remind me, I should know this, but when is your next triennial review? Obviously, I know the comments about working towards a potential buyout as well, but how do we think about pension payments in the medium term?

Yes. So on free cash flow, Mark, you're right. We are going to have the tail end of the spend on the self-help program this year, but notwithstanding that this year, free cash flow will step up. I think consensus is somewhere around GBP 15 million to GBP 16 million of free cash flow to equity. And then, in '23 onwards, it sort of steps up again. So really healthy, clearly helping to delever the group and free cash flow yield is -- you can do the calculation for yourself. On pensions, actually, the next triennial valuation is going to be as of April of this year, which will be -- honestly, we're at a stage now where that's an interesting weighing point, but we have a very good understanding of the position of the scheme. We've been in a certain surplus on an accounting basis for quite a long time now. We've also been in surplus on a funding and self-sufficiency basis for a while. So as you say, all eyes are on the potential to get in the scheme to buy out, and the buyout deficit has gone from -- in 2016, the buyout deficit was GBP 200 million or so. In '19, it was GBP 100 million or so. It's now down around kind of GBP 35 million to GBP 40 million. So we are -- it gives you a sense of trajectory on how quickly that can move. So we're doing the work to get the scheme data in a state that is capable of being shared with insurers. And I think, we're definitely moving into the phase where we're getting at least a buy-in, so taking the risk off the table is definitely about 2-, 3-year time horizon at the outside, I would say.

Right. And just a final question on 10% margin target, maybe a bit unfair because normally what is happening in the world. But how do we think about that margin target if current inflated costs in the world are sustained for a prolonged period of time? And how do we think about your sort of timeline? Because obviously, you can't control the pass-through element. That's not in sort of your hands, but just how do you think about that? And are there other actions going on?

Yes. Well, I think that's why we try and answer that by let's exclude the pass-through thing, right. To start with, if you take this year's numbers with the self-help action and the leverage, and we expect margins to be moving up again towards 9%. And then there's more self-help next year. There's more leverage. And so we've been successful in passing on the general inflationary pressures. So we'd expect that to be moving as we'd indicated, which is broadly towards the 10% in '23. With pass-through, there could be some mathematical headwind to that calculation, if you like, but it's purely mathematical. It's not an effect of inflation, if you like, on the business. Does that make sense?

No, it's perfect.

We'll now take the next question from Vanessa Jeffriess from Jefferies.

Just a quick question on Torotel and the progress you're making there and, firstly, in the second half. It looks like if I look at the profit contribution to make half, there was quite a move in margin. Is that just similar challenges in the rest of the division or something more specific?

No. So there was some commercial aero order intake that we were anticipating in the second half that got pushed to the right, so that's really the main thing that influence things there. But Richard referred in the presentation to getting really good traction with the business there in terms of opportunities. And then clearly, we've also said that we've got this additional benefit from the self-help program from merging the Covina site into Torotel. So actually, the return on invested capital of those 2 acquisitions combined, particularly when you take account of the proceeds from the property space, well, it's going to look really attractive. So we're very happy with the position there.

And as we said when we brought the business in, we said there are opportunities to invest in growth of the business, which is supporting the pipeline of opportunities. So that has continued through that -- through H2 and with those dynamics that Mark described.

And then maybe just on broader M&A pipeline?

Broader M&A. Yes, I just don't mention in the presentation, but there's a good list. The M&A market has been definitely very active. We continue to work with targets and try and foster more opportunities. Really, the current macro situation made people think twice about what we're doing in terms of asset sales, and so we'll have to see how that develops.

[Operator Instructions] We'll now move to the next question from Richard Paige from Numis.

Just a couple from me, please. Just looking at the S&SC margin, particularly second half [Audio Gap] relatively strong. Just wondering if you could provide a bit more color behind that.

Yes, I mean so really outstanding performance across the year. The improvement year-on-year, I guess, came from 2 things. One is we actually have really good growth out of that business, more than we were anticipating at the start of the year, and they got really good operational leverage on that growth. And then also, the benefits of the self-help program there, which are coming through. And actually, they managed to realize GBP 1 million of self-help benefits earlier than we'd anticipated. So their margin is right back up to where they have been -- so peak, really back at peak margins for them. So I think in this environment, looking forward, it's all about now sustaining that, hopefully, a little bit of growth. So yes, we're actually delighted with the performance of the business there.

And just on the operational gearing, if I strip out the sort of Virolens impact, looking at about a gearing or drop in '21 that you achieved, is that a sensible place to start in terms of thinking about how '22?

So, Rich, you're dropping in and out a bit. So I'm going to -- your question is about the operational leverage we got, the operational leverage we got in '21...

Yes, I said '21. Yes, yes. exactly. Yes.

Yes. I think when you sort of strip all the noise out of it, we've obviously got self-help benefits and discretionary costs going back in. We're realizing about 20% operational leverage on the growth across the group on a blended basis, which considering that, obviously, GMS is the fastest-growing part of the group there. But I think that's pretty incredible performance in this kind of environment. So that feels like the right sort of assumption to make going forward.

There are no further questions on the phone at this time.

Okay. Well, if we are concluded on the questions, thanks very much for joining us this morning. Really appreciate it. I know these are busy times for everybody. So thanks for joining. Thanks for the great questions and have a really good day.