Victrex plc (VCT) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Victrex Third Quarter Interim Management Statement. [Operator Instructions] I would like to remind all participants, this call is being recorded. I will now hand over to the CEO of Victrex, Jakob Sigurdsson, to open the presentation. Please go ahead.

Thank you. So good morning, everyone, and welcome to Victrex's Third Quarter Interim Management Statement Call. This covers the period from the 1st of April through the 30th of June 2024. Joined on the call by Ian Melling, our CFO; and Andrew Hanson, our Director of IR. I will start with a summary of the key messages and the key outcomes, and Ian will then cover the financial detail. And towards the end, we'll open up the call towards questions and answers. So turning to the headlines. I'm pleased to say that despite the mixed sentiment within chemicals and some end markets right now, we delivered growth in both volume and revenue during the third quarter versus the third quarter of 2023, with a 20% volume growth over this comparable period. This marks the first period since the fourth quarter of 2022 when we saw -- when we've seen quarterly volume and revenue growth compared to the prior year period. What this shows is that we're seeing continued momentum from the early signs of recovery we saw in the second quarter although the picture remains a bit mixed by end sector. On a sequential basis compared to the second quarter of 2024, volumes are flat. The puts and takes for Q2 -- Q3 versus Q2 mainly related to growth in VAR and Electronics quarter-on-quarter being offset by Automotive with the restocking benefit we saw in the first half did not continue into the third quarter. But we're still expecting to see growth on a full year basis in auto but not the double-digit levels seen in the first half. For the first 9 months in auto, we're up mid- to high single digits, and we're expecting to finish the year in auto around the mid-single digits or so. Medical remains a headwind for us, with the industry destocking and inventory unwind amongst major medical device customers continuing to be a headwind. This means Medical is tracking lower than our expectations for the second half so far even if we see some more encouraging signs on the Sustainable Solutions side. I should point out, though, that we are not losing market share in Medical to other key players. Our business is much more diversified than it was a few years ago and the underlying number of procedures in the various applications are growing. So what we're looking at here is purely an effect of destocking that is prevalent with a number of medical device companies right now. It's worth reminding everyone about the context of Q3 both this year and last year and how these periods have flipped in terms of the sales mix. Q3 last year was the lowest quarter for Value Added Resellers since the COVID period. On the flip side, Medical was very strong in Q3 last year as Medical revenue contribution being north of 20% for the group in its entirety. Now picture has reversed this year, with Q3 this year seeing Medical revenue below 20% of the overall group revenues and VAR much stronger year-on-year and also compared to Q2. Ian will explain in a bit more detail and give more context to this and how it relates to the average selling price. I'll come back to these points in our outlook once Ian has given us the financial details. And the outlook is largely unchanged, except for the continuing headwinds in Medical. For now, I'll hand it over to Ian, who will cover the financial details.

Thank you, Jakob, and good morning, everyone. As Jakob noted, it was pleasing to see year-on-year volume and revenue growth in what we all know has been a tough period for Victrex and the wider chemicals. Covering the financial detail, Q3 group volume was up 20% to 979 tonnes versus Q3 last year of 818 tonnes. Q3 group revenue was up 2% at GBP 74 million compared to Q3 2023 of GBP 72.2 million. The delta between volume and revenue growth is reflective of Medical remaining soft but also the sales mix that has been more influenced by the proportion of business from Value Added Resellers. On pricing, Q3 average selling prices were GBP 76 per kilogram. The change year-on-year is primarily driven by sales mix and the year-on-year movements in Medical and VARs as Jakob has noted. Remember, Medical had a strong performance last year, including a record full year, and VAR in Q3 last year was its lowest quarter since 2020. Currency is a small adverse impact on ASP, and it's worth noting that underlying pricing remains robust across end markets. If we look sequentially at volume and revenue, Q3 group volume of 979 tonnes was flat compared to Q2 2024. This reflects that auto was down on a sequential basis as some of the restock effect for auto in the first half starts to unwind. We did, however, see some sequential progress in VAR and Electronics. Q3 group revenue was down 5% compared to Q2 2024, and this reflects a similar theme, i.e., sales mix as Medical remains softer and the proportion of business from the likes of VAR increased. A quick word on end markets in Q3. Aerospace continues to show a solid performance on a year-to-date basis. Also, I have already covered the sequential impact, but we saw a solid year-on-year performance here, too, which was the same with Electronics. Energy & Industrial saw single-digit growth on a year-on-year basis, although Industrial has been soft, offset by some good growth in Energy. Medical, as Jakob noted, this has been and remains a challenge for us. Remember, Medical's high margins have a notable drop-through in the P&L. We've seen several peers and those who supply the medical device industry commenting on the destocking effect in this industry, and performance is tracking lower than our expectations so far in the second half with no improvement on the first half at this stage. We are well placed for when this destocking cycle ends, though, and remain focused on delivering the broader range of opportunities across Medical in the years ahead. Finally, year-to-date group revenue of GBP 213.3 million is 9% lower than the prior year, reflecting the softer first half and lower Medical revenues. Year-to-date group volume is down 2% at 2,716 tonnes. But with favorable comparative to come in our fourth quarter, we continue to see the opportunity of low to mid-single-digit volume growth for the year as a whole. I'd like to finish with a word on cash and then currency. Victrex continues to have a robust balance sheet, with cash generation set to improve driven by trading conditions, lower capital expenditure and progress on inventory unwind. Remember that we have continued to invest through some of the toughest times seen in the chemical industry, and that investment cycle is now coming to an end. That gives us well-invested assets to underpin our future growth. Net debt on the 30th of June 2024 was GBP 39.6 million, including cash of GBP 22.7 million. This means net debt was some GBP 10 million lower than -- at the end of Q3 than the end of the first half, and this was after payment of our interim dividend on the 28th of June. This means free cash flow improved in Q3 to over GBP 20 million in the quarter. We're focused on continually improving our cash flow position, which can support returns to shareholders over the coming periods. Our forward guidance on full year capital expenditure and inventory is unchanged. We anticipate capital expenditure will be lower in the second half compared to the first, meaning full year capital expenditure of around GBP 35 million. Inventory is tracking to reduce in line with our guidance. One other final point worth flagging quickly is on currency. As we noted in our outlook statement, currency has become slightly adverse for us in the second half as sterling has strengthened primarily against some unhedged currencies, including the Japanese yen. Thank you, and I'll now hand back to Jakob.

Thank you, Ian. So moving towards the outlook and the guidance. We are seeing continuing momentum in some end markets. Ian flagged that Value Added Resellers was an area we're seeing an improvement in. And this is usually a very good barometer for recovery even if the shape of the recovery this time around compared to previous recessions is a little bit different in shape. VAR and Electronics, our end markets, we do feel more encouraged by as we look towards the rest of the year. But we will need to see continuing signs of improvement for us. Aerospace, we remain encouraged by the evolution there, and we seem to be on a good track record to get to pre-COVID levels as it relates to our sales into this sector. In Automotive, we've covered that we're on track for growth on a full year basis. And as I said before, we are growing mid- to high single digits for the first 9 months, and we would expect to end the year in the mid-single digits as it relates to growth. Energy & Industrial, we indicated in our announcement that Industrial is seeing a slower recovery. And this is probably the sector that is most sensitive to the high cost of capital these days. But we are seeing better signs of recovery on the Energy side, and that's sort of starting to show improvement month by month. Overall, we do remain focused on our goal of delivering a better second half year. But Medical performance is tracking lower than our expectations for the second half year at this stage, and run rates have not improved on those in the first half. On volumes, our guidance is unchanged, and we continue to expect low to mid-single-digit volume growth for the full year. But headwinds, they do remain, as I said, destocking in Medical primarily. And also remember that we have signaled previously about lower asset utilization and the recovery of fixed cost in our P&L, and there's no change to that specific guidance here. In summary, we still have the opportunity of slightly better PBT performance during the second half of 2024 versus the second half of 2023. But unless Medical run rates improve for the remainder of the year, it will be challenging to deliver this now. A brief word on FY '25 at this early stage. Overall, some of the recent signs in several end markets make growth prospects much more encouraging as we move towards FY '25. We are focused on good profit growth in FY '25. But clearly, we will guide on that in greater detail in December at our FY '24 full year earnings call. For the medium to long term, strong confidence in our medium- to long-term prospects. We have a diversified core business, increasing commercialization in our mega-programmes, well-invested assets and we're coming off a big CapEx cycle in the past 3 years to a more normalized levels, as indicated in Ian's comments. We've got enhanced capability in our global team and the opportunity for substantial cash flow improvement as unwind inventories on top of the reduction in capital expenditures. We continue to invest through some of the toughest time in the chemical industry. And with the recovery in the core business and some increasing milestone delivery and commercialization in the mega-programmes, the opportunity for improvement is clear over the coming years. That essentially concludes the formal session today, and we will now hand it over to Q&A.

[Operator Instructions] And your first question comes from the line of Riya Kotecha from Bank of America.

This is Riya Kotecha from Bank of America. I've got 2 questions, please. My first one is on your internal expectations for profit growth. So at the first half results in mid-May, if I read the release, it was mentioned that the PBC (sic) [ PBT ] for the second half could be slightly better year-on-year if the run rates continued and Medical improved. Today, mid-July, you mentioned that it will be challenging to grow second half PBC (sic) [ PBT ] at the run rate. So what has the third quarter PBT done on a year-on-year basis? And is it fair to say that your internal expectation for profit growth is worse compared to May? And that leads to my second question, which is on the budgeting and the forecasting process. And can you speak about the level of visibility that you have with the Medical customers, which strikes like it would be longer than 1.5 months given you directly supply to the medical OEMs? So has the level of destocking worsened sequentially into the third quarter in Medical? Or were you maybe just overoptimistic in May with the second half profit outlook?

Thank you, Riya. I'll make a start maybe on the profit, and then Jakob can add thoughts on our visibility with the Medical customers, which is limited as across all our business, and we have relatively short lead times for our products, but I will let Jakob comment on that after I speak a little bit about the profit. In terms of our expectations for profit, I think we were pretty clear that we could see a growth H2 on H2 if Medical improved. And the thing that's different from the end of this -- the first half is that Medical hasn't picked up. We had reasons to think we might see a pickup in Medical given the strength of the end markets, but that destocking has persisted. And we don't see -- certainly here now we don't see the order book that we would need to see going into Q4 to support that, hence the change in position. I think consistency is there. What's changed is the recovery on Medical and it not coming through as early as we thought to May. Jakob, do you want to comment?

Yes, I think on the lead time side, we offer relatively high service levels here. And so the lead times are pretty short, and therefore, the visibility towards orders is actually not that long. I think the general sentiment in the industry is that this has been a very sharp inventory correction. I think what's unusual this time around is that whilst inventory corrections and adjustments and working capital adjustments have taken place in the medical device industry many times in the past, it's been highly unusual to see it so universally happening across the industry and that clearly magnifies the impact on anyone that is serving them. The sentiment [indiscernible] just started early in June with the largest CDMOs in [indiscernible] and others, it was fairly subdued, and I think they have seen a significant reduction in their revenues. And also be mindful of the fact that we don't, in most of these cases, supply directly to medical device companies. We do supply to what could be considered Tier 1s sort of mainly. So I think the consensus there is we've seen from anticipated revenue -- recovery, sorry, anywhere in the time frame from the beginning of the fourth calendar quarter into the first calendar quarter of 2025. And that should then lead to upstream demand a little bit ahead of that. But that's as good as it gets in terms of visibility in the industry. But it will also be quite interesting to see what level of working capital is going to be portrayed in the accounts of some of the large medical device companies as they come out with their half year results towards the end of July. So I think that hopefully gives you enough color on the situation as it is right now, Riya.

Yes. That's helpful. I've got one more question based on that and some of your comments that PEEK hasn't lost market share in Medical. What gives you the confidence and clarity that customers who are arguably under a lot more pressure because of the higher rate environment in the U.S., for example, on trading down to cheaper materials? Because if I -- if I look at the Medical division volumes for Victrex, the average level has been about 190 tonnes compared to your PEEK volumes in 2022 that was 6% ahead of the average. And then if I look at VAR, where we clearly saw the huge restock and the destock, your average volumes were 1.6 compared to PEEK volumes that was 30% ahead of this. So I guess what I'm trying to say is from looking at your numbers in the spreadsheet, the PEEK Medical volumes don't seem like they went through that level of destock and restock as VAR did. So what gives you the confidence that it's not just a destock and maybe a market share story or consumers trading down to cheaper materials, if that makes sense?

Yes, there's a couple of points here. The first one relates specifically to the volume question. And our Medical business is split into implantable and nonimplantable. And nonimplantable is much larger in volume but lower in value than the implantable piece. So that skews the volume picture to the effect that you've identified. And then the second part of your question was related to what gives us the confidence in the fact that we're not losing market share. And there, it's clearly the conversations with our customers. All of them are ordering, but they're ordering at a much reduced rate to what they were doing last year, as an example. And they're ascribing it to the well sort of detailed inventory reductions with the medical device companies. And I do also, and I would like to refer to the sentiment in the industry as well and the fact that actually a number of our peers have also commented on Medical destocking being a source of reduction in their medical volumes in recent times as well. But I do think this is a well-documented phenomenon. Number one, you see it in the account of the medical device companies through our conversations with customers. We know that we're not losing share, but they are simply receiving orders at a much reduced rate to what they were experiencing last year. And I think that's a pretty and a rather solid underpinning for us to state that we're not losing market share to other people.

And it wouldn't be a straightforward process to shift to a lower-cost material in Medical. There are significant regulatory hurdles to changing materials in any medical device, and that's a multiyear process and not something you can do quickly in response to a margin issue, for example. So PEEK would be a very small portion of any of these medical -- big medical device companies' cost and would offer them a pretty limited opportunity, I would suggest, relative to the challenge of changing materials for any given device, whether that be changing from one PEEK supplier to another or, even harder, changing from PEEK to an entirely different material.

Your next question comes from the line of Alex Stewart from Barclays.

You're running at an annualized volume of 3,900, 4,000 tonnes or so. A lot of your strategy in your medium-term expectations are predicated on a recovery in those volumes and improved mix away from VAR towards some of the other Industrial businesses and, of course, improvement in Medical, including the wind-down of inventory. But what's your contingency plan if we don't see a recovery in volumes, if we get sub-1,000 tonne quarters now for 2 years or so? What can you do on cost? What can you do on cash flow to hedge yourself or to mitigate the impact of that? Because it's actually looking like an increasingly plausible scenario that the industry doesn't recover in the way that we expect. So very interested to hear what your internal plans are for that.

Yes. Thanks for the question, Alex. It's pretty pessimistic picture you paint, but happy to have a go and talking about it. I think on cash flow, our cash flow is robust. We've just seen a GBP 20 million cash flow quarter. So cash flow is robust. And how is it robust? Well, we're bringing CapEx down, as we've said, versus history, versus the last couple of years, and that's starting to take effect now. We're also reducing our inventory levels with a target of getting down to GBP 100 million by the end of next year, FY '25, and we're on track to do that. So inventory reduction is there. We are hamstrung a little bit this year by asset utilization as we bring that inventory down. That situation should improve a bit next year. And even at lower volume should be an improvement in the following years as well as we get to a more steady state on manufacturing. There are choices we can make around the plants. But at the moment, having the capacity we have is important for our customers. It's important for the customers that we have tied up in the mega-programmes in terms of security of supply and being able to provide the volumes that they will require in the future. So that capacity is important to us, but we do have -- there are always choices we can make. We have a factory coming on stream in China now, which will start to improve as that business grows, and we hope to get the first commercial sales out of that plant and get it up and running fully by the end of this year such that, that is starting to contribute more significantly next year and become less of a headwind from a profit point of view. So with inventory coming down, CapEx coming down, bear in mind, we've still been a cash-generative company through all of this. I'm pretty confident that cash flows can bounce back, and we've got the flexibility to do what we need to do to respond to increasing demand. But if we need to, we can take further actions in response to reduced demand as well.

So I suppose that's a great answer on cash flow. But your P&L is optimized for -- well, it was optimized for production rate of about 4.2. That's probably moved higher with the fixed cost loading from China. So I'm actually talking more about the asset utilization penalty which you're paying or you paid during the pandemic, where you've got demand rates below optimized production rates. Is there something you can do to your fixed cost base, in other words, on the P&L side, if you find that we're going into a prolonged period of low volumes?

If you -- and it's a really good question, Alex. And clearly, we think through this in our regular strategic planning reviews. So if there is an Armageddon scenario, which, by the way, we're not anticipating based on where things are heading, I think we're seeing sort of certain sectors that have been quite perturbed, if you will, from the re-equilibrium by the various reasons, whether it's the atrocities in Ukraine or COVID in recent times, inventory correction in Medical and things like that. I think most of these markets are stabilizing, and the underlying macroeconomic drivers that are sort of a tailwind in everything we do are still there. Now if there were to be an Armageddon scenario, then there is an optionality for looking at our different manufacturing trains in a modular fashion, whether that be on the polymer side, where we effectively got 4 trains that could be considered independent of one another, or whether it's on the monomer side, where we've got 3 trains, if you will, start to be considered somewhat independent of another plus that we have built a bit more flexibility into our supporting infrastructure, particularly in the aftermath of COVID to be better able to deal with the swings that one could see in the external environment. But also being mindful of the fact that given the role that we play with many of our customers quite often being the single source, having assurance of security of supply is a big part of our value proposition. So we always have to balance the approach to situations like that and make sure that we don't take capacity out at a too early stage and, in any way, jeopardize our ability to be the reliable supplier that we've run the reputation of being. But in Armageddon scenarios, I think the modularity of both our monomer presence and our polymer presence associated with the flexibility in the infrastructure gives us opportunities to adjust, if you wish, the fixed cost base of the business were we in the need of doing that.

Your next question comes from the line of Kevin Fogarty from Deutsche Numis.