IMI PLC

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Earnings Call Transcript 2019-Q1

[Operator]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's IMI Interim Management Statement Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Thursday, 9th of May 2019. I would now like to hand the conference over to your speaker today, Mr. Roy Twite. Please go ahead, sir.

[Roy Twite]

Thank you, Ron, and good morning, everybody, and thank you for taking the time to join us today. I have with me, Mark Selway, Dan Shook, Massimo Grassi. And hopefully, you've had a chance to look at our IMS this morning. I will summarize the key points before we take your questions.Critical results were as we anticipated. A 12% fall in revenues in the first quarter is consistent with our previous guidance, and we remain confident that the full year will reflect less of a decline in sales given the order backlog and the order phasing. Our confidence in the full year is also helped by strong orders in the first quarter, including an 11% increase in aftermarket bookings, which will clearly support margins for the full year.Precision results reflect a very similar trading mix to the final quarter of 2018. In other words, some slowing in parts of Industrial Automation, a mixed result from commercial vehicles geographically and continued growth in our other segments, including Rail, Life Sciences and Energy. Both lead indicators like the PMIs and our own recent trading experience suggest that demand in Industrial Automation and Commercial Vehicles may continue to slow as we move through the balance of the year. We are naturally being a little more cautious about the demand outlook for Precision on that basis.Hydronic revenues were 8% higher in the first quarter but please do remember that, that was against 2018 when revenues fell 4% as we renegotiated contracts and refocused the business. Most importantly, the division is showing that the margin improvement delivered last year is sustainable.In conclusion then, we remain mindful of continuing global political and economic uncertainty as well as some of our own recent trading, but do expect that our full year results will be in line with current market expectations. However, if markets do weaken further, we can and we will respond.Okay. With that, we'd be delighted to take your questions, please.

[Operator]

[Operator Instructions] And our first question comes from the line of Max Yates.

[Max Yates, Research Analyst]

If I could ask just a couple of questions. The first one is, if you could just give a little bit more color around the aftermarket order growth. Obviously, 11% is very strong. So just what exactly is happening there? How sustainable that is? And whether you could sort of talk about any particular trends in any of the end markets that were really driving that?

[Roy Twite]

Yes. Thank you, Max. Yes, I'll take that. So aftermarket growth was pretty broad-based actually. In fact, Oil & Gas aftermarket was up 28%. The Petrochem aftermarket was up 39%, and the Power market was up 11%. And obviously, bits like some of nuclear and some of the other parts were down. But it's a nice broad-based growth, which was encouraging. You probably know, Max, that we have really gone after upgrade valves. So this is where we target our own installed valves out in the field, and we also target our competitors' valves that have known problems in terms of leakage or steam escape, look after those and upgrade them. So that's been very, very successful. I don't think 11% growth we're going to see that year in, year out in terms of sustainability. I think we are obviously fighting against decommissioning in power in the U.S. and in Germany and other parts of Europe as well. But I think what we are proving is that if we really drive the aftermarket part, then we can get some nice profitable business.

[Max Yates, Research Analyst]

And maybe just my second question. Obviously, the -- you have your order book in Critical. It was sort of a slow start to the year in terms of revenue growth, but I presume for the full year, we're still looking at something like minus 5% to minus 7% organically for Critical. But if you could just comment on what is giving you confidence that margins will be able to hold up in the context of that organic revenue decline? And if you do think based on the order book as revenues feed through for the rest of the year, whether it will be reasonable to think about Critical margins as flat for the year and given the internal measures and mix in the backlog.

[Roy Twite]

Yes. Good question. Yes, absolutely, we guided the full year results given the orders were about 12% down in the first half of last year, that will be a reasonable guide for sales for the first half of this year and we're still absolutely in line with that. I think for the full year, as you said -- as we said that because the order book was about 7% down at the end of last year, the sales for the full year this year will be about 7% down. And we actually think, yes, that's still about right. It'd probably be a bit better than that now, as you said, sort of minus 5% to minus 7%, somewhere in that range for this full year. The reason we're confident that the margins will hold up is because we've got a very detailed analysis of our own order book, and the order book margins are up on the back of the increased aftermarket mix plus a bit of pricing improvement that we're seeing in the aftermarket. We've been seeing now probably for something like 12 months. So that's one big reason. The second reason is, of course, the restructuring that we're doing. I'm sure you remember that we are very close now to closing our Swedish engineering center, and we are moving more manufacturing from Germany to the Czech Republic. And because of those 2 reasons really, the phasing of the order book, the improved margins in the order book and the restructuring, we think that we can hold margins this year in Critical Engineering.

[Max Yates, Research Analyst]

Okay. And maybe just one very quick final one. Obviously, you've had a bit of time now to maybe think about how you're going to take the group forward. Are there any kind of initial comments on the portfolio? Any opportunities for potential pruning within the group that we maybe should think about? And do you think this will be sort of a part of your broader strategy? Or do you think it's very much focusing on the assets that you have in the current portfolio?

[Roy Twite]

Good question. Thanks, Max. Well, Max, you'd be please to know I officially take over today. So obviously, I've been transitioning with Mark. Mark is with me here, and Mark as usual has done a very thorough job with the transition. We worked through with everybody, the executive and with the Board. And we had the Board meeting yesterday, and what we've done is lay out a very clear process where the Board will get plenty of chance in July, September and December to input into the strategic process. What we will be doing is testing the market, the attractive markets that we can move this business into to create real, long-term sustainable growth. And we'll be doing that for each division and obviously looking into adjacencies where we see some good opportunity. Having done all of that work and really tested it, then obviously in February next year with the full results, I will be presenting the plan, the strategic plan. I think what I would add to that is that we're clearly aware of the levers that we can pull. I'm sure you know, Max, that I've run each division during my 30-year career with IMI, and we will be pulling the levers in the short term that we can pull to make sure that we're absolutely optimizing financial performance while we're building that strategic plan.

[Operator]

And our next question comes from the line of Ryan Gregory.

[Ryan James Gregory, Research Analyst]

Just a couple on Precision, please. The first one, just wondering how things progressed during the quarter. And then how April has compared to Q1. And then secondly, just given it's quite a short lead time business and your visibility levels are quite low. I'm just trying to -- if you can give a bit more color on kind of your thoughts for the full year? And why you think the current weakness will probably continue into the second half? How much of that is just, say, the weaker PMIs? And how much of that is discussions that you're having with your customers?

[Roy Twite]

Excellent, Ryan. So I'm going to let Massimo comment on the customers in a minute. It's great to have Massimo with me here today. Yes. Just thinking to -- obviously, we feel happy about the guidance, Ryan. And we've put a lot of effort in and really gone through the -- all the dates that we've got. We actually rechecked the PMI correlation as well because during my history with Precision, which again probably goes back almost 30 years, it's always correlated with about a 3-month lag on the PMIs and correlated in quite a close way. It's about 0.65 correlation. And we retested that, and it's still broadly through. This -- it's slightly less correlated than it used to be, but there's still a strong enough correlation to say that when Germany's PMI gets down to 44, we're going to save it. And if you look at the areas of softness in Precision so far this year, it is Germany. Asia has been a bit slower. And it won't surprise you to hear that in-plant automotive, which is our fairly small U.S. business, has also been hit fairly hard because obviously that's directly connected to investment in new products in Detroit. So that's what we've looked at in terms of weakness. We've looked at our moving average order numbers, and that's why we changed our guidance to Precision being slightly down over half year rather than full year. But with that, I'll let Massimo add a bit of color around customers and what we're seeing in April.

[Massimo Grassi]

Yes. Thank you, Roy, and good morning, Ryan. So with -- your first question was about Q1, and I would like to remind that if you look at our regional sales, half of our sales are made in Europe, and Germany is the largest country for us in Europe. And obviously, the economy is not healthy at all. And when will look at the mix in terms of verticals, Industrial Automation is almost 60% of the overall business. So when Industrial Automation is affected by tariff-related issues and Germany is also, from an economic point of view, slowing down, clearly this is the largest contributor to our business. If we look, the other regions and the other vertical outside Europe and outside Industrial Automation, we are doing a reasonably good job. If you look at growth in CV, it's 4.1% with 2-digit growth in America. Energy, it's almost 10%, and Life Science and Rail continue the positive trends. So I would summarize that it is quite volatile, but specifically driven by Industrial Automation and mainly in Europe, particularly in Germany. With regard to your second question in April and the rest of the year. So sales in April continue to reflect same mix fortune across different sectors. So we don't see for the moment any major difference in regards to the order intake trends. So we started to experience some turbulences back in Q4 and of course through Q1 and in April, this has been concerned -- confirmed, again more specifically, for Industrial Automation. And with regards to the full year view of 2019, based on the global industrial outlook, including external business confidence surveys, we now expect organic revenue margin in both the first half and the full year to be slightly lower than the comparable period in 2018.

[Ryan James Gregory, Research Analyst]

Okay. Just one quick follow-up, which is on the inventory levels. In your release, you expect building some inventories due to Brexit. But I think in Precision, you've also been building inventory for the last 2 or 3 quarters. I just wondering your thoughts on that in the context of a weakening demand outlook. Are you expecting to have to reduce those inventories as you go through the year?

[Roy Twite]

Yes. Let me just say that we're absolutely right. We put in GBP 4 million of inventory, Massimo, on the back of Brexit, which I think, it was a sensible thing to do to protect our supply chain. Aside from that, Ryan, yes, obviously as demand slows, we'll be carefully managing inventories throughout the remainder of the year or managing them down absolutely.

[Operator]

Our next question comes from the line of William Turner.

[William Turner, Research Analyst]

Just one from me. So obviously, order intake in Critical Engineering was strong. Can you give a little bit more color on the original equipment orders? And what are you expecting for the full year? Given the strong aftermarket, you could probably imply that, that could even be flat and still overall for the division be strong, so a little bit more color that would be useful.

[Roy Twite]

Yes. So new construction orders were up 25%, William. So yes, you ought to be careful in new construction. I'll always say this whether they're up or down, it's a very lumpy business. But good news, we're 25% up. And actually, we -- the strength came was in Petrochemical and Naval. So you're aware that we've actually dramatically increased the amount of product we're selling into Naval over the last 12 months really. And Oil & Gas held up. That was 4% up as well. Clearly, Power was down, I think, as you'd expect. We've see our new construction power business not surprisingly come down a lot. I'm sure you've seen what's happened to GE and Siemens, and that was actually down 45%. But in overall terms, new construction business was up 25%, William, in the first quarter.

[William Turner, Research Analyst]

And are you confident that, that's strong growth? Or the high growth like that will continue for the rest of the year?

[Roy Twite]

No. I don't think we can expect 25% growth in new construction for the year. I think that the markets are still tough. I think as I said, fossil power market is still tough. You'd probably know that we're transforming this business. It was a fossil power business. So I think it was just about 12 years ago, only 4% of this business was Oil & Gas and Petrochem. Today, that's moving to well over 60%. I think we're probably at 65%. So we're transforming from a fossil power business to an Oil & Gas business and Petrochem business. And it will be lumpy as we go through. The good news is that we've proven that using Value Engineering by becoming much more competitive. We can move into new sectors, we can use our engineering skills even in places like large-scale water, which traditionally we've not been able to compete in because the margins have just been too skinny. At lower margins, we've been able to get into some of those areas and to make sure that we can transform as fossil power, new construction has dropped dramatically, William.

[Operator]

And our next question comes from the line of Mark Davies Jones.

[Mark Davies Jones, Associate]

Firstly, a very simple one. Obviously, the Precision guidance has come down a bit, but the group guidance has remained where it is. So in terms of the offset and what is a little bit better than you would have thought back at the beginning of March, is that margin mix within critical? Is that Hydronic? Could you comment on that?

[Roy Twite]

I think you just answered yourself, Mark. You are bang on here. We're really -- let's just talk a little bit about Hydronic because we're really pleased with Hydronic. Phil has done a cracking job in there. And really all of those renegotiations that Phil did last year with the big wholesalers, you've got to remember, Mark. I know you know this, Mark. That is a cracking little business. The brand's strength, the strength in terms of the market positions, all of that has been brought back to life under Phil, renegotiated. We are taking a fairer share from the wholesalers in terms of the value, and those margins are coming through nicely in the first quarter, and we see no reason why that isn't sustainable for the year. So, yes, Hydronics is part of that. The other part is critical exactly as you say. And with 11% up in aftermarket orders in the first quarter, that clearly has strengthened our margins in our order book. Nice also to see that extra bit of pricing coming through, and all of our projects in terms of the big rationalization projects are being executed extremely well in Critical. So we've put all that into the mix. Dan and I obviously did very, very detailed reviews with each of the divisions, and we feel that on balance we can hold the market consensus. Market consensus also came down a little bit, just to be fair, Mark, because of FX -- mainly because of FX. And that took about at least 1 pence out of EPS. So that was part being in the mix as well.

[Mark Davies Jones, Associate]

Great. I then just one more detailed one. Can you update us where we are on the big CV contracts? New stuff coming in, old stuff coming out, the timing and the phasing of those?

[Roy Twite]

Yes, absolutely. Massimo, I think this is one for you.

[Massimo Grassi]

Yes, absolutely. Good morning, Mark. In CV, as mentioned, we delivered 4% growth in Q1, but clearly the market expectation for 2019 are less vulnerable than what we had experienced back in 2019 (sic) [ 2018 ], where we had 2-digit market growth across the globe. We still have some of our contracts that are coming to an end. And this year, this will impact us for about GBP 4 million to GBP 5 million, but we still have positive expectations. So we believe we will be able to offset this and continue on a growth trajectory. As already mentioned, in Q1, with the exception of Europe, where we are slightly negative, we are still growing at 2 digits in Americas, that represent about 40% of our business. And in APAC, we are growing very close at 2 digits, even if APAC represents only about 10% of our business.

[Operator]

Our next question comes from the line of Andrew Wilson.

[Andrew J. Wilson, Analyst]

It's a relatively quick one, I think, from me. I just wanted to get an update on what you're seeing in terms of customer indications on the LNG side. I think you were talking a little bit more positively with the result, which is consistent with, I think, some of your peers. And just interested as to sort of how those conversations have moved on.

[Roy Twite]

Yes. Thanks, Andrew. Yes, we're tracking 26 LNG projects, total value of over GBP 500 million over the next 3 to 5 years and certainly activity is very healthy, Andrew. So what we're looking for, we're literally over the next, I would say 4 weeks, looking for another project to come through. So the timing of the big projects that is hugely complex, I think one of the problems certainly talking to somebody very senior and one of the end-users, one of the problems is that having difficulty to find enough skilled people to make these projects move as fast as I want them to move once they've approved the final investment decision, once that's gone through, Andrew. So there's going to be some bumps in the road. Timing's not going to be actually crystal clear. Clearly, LNG gas prices have come down a bit as well, so we're keeping an eye on that. But in terms of activity, it's very, very strong.

[Operator]

Our next question comes from the line of Ed Maravanyika.

[Edward Maravanyika, Vice President]

I just got 2 questions. Just firstly, on Critical, just on the Oil & Gas side of things. Could you maybe just give a little more detail between OE and the aftermarket? Just what the growth trends are looking like there? And then on Hydronic. I know you mentioned the sort of self-help benefits that are starting to come through, but how much of that is also a supportive underlying market?

[Roy Twite]

Good questions, Ed. So in terms of Oil & Gas, Oil & Gas OE was up 4% in the first quarter. And in the aftermarket, we're up 28%. Now again, Ed, it's a really lumpy business, right? So I don't try and trend that. But I would say that in Oil & Gas generally, we are seeing more opportunity to do upgrades than we are in new construction. LNG is a bit different because there's a lot of activity there. And we would hope that we'd start to see, as I said, some LNG orders, smaller ones in the first half, larger ones in the second half of this year. And I'll stand by my previous guidance, which we would hope to double last year's LNG new construction orders. And I think there were about GBP 18 million to GBP 19 million last year, but today's exchange rates we would hope to get about double that. So LNG is a bit different, Ed, but that gives you the numbers in terms of new construction versus OE. On the Hydronic, yes, it's mainly been self-help plus rebound. That's what I was clear about. We are against a low comparator for last year. Last year, we were at minus 4% on sales in the first quarter because we were doing very tough negotiations with the wholesalers, and that clearly created a bit of turbulence. This year, we are at plus 8%, and we're seeing rebound. We're seeing the effects of the price increases on the back of the wholesaler negotiations, and we're seeing a bit of growth from the balancing the TA side of the business. So I would say that in radiator valves, not much help from the market. It's a pretty flattish market. In balancing, a very small amount of help from the market, very small. I'm talking 1% or 2%, Ed.

[Operator]

And our next question comes from the line of Jonathan Hurn.

[Jonathan Hurn, Research Analyst]

And just a couple of questions for me. Can I just come back to that Hydronic growth of 8%? Can you just be a little bit more specific, please? Just kind of split out, within the 8%, how much of that is actually volume? And how much of that is actually the price rises that you've been pushing through lately? That was the first one.

[Roy Twite]

Yes. Good question. Good morning, Jonathan. So the price is probably about 2%, and the volume is the rest. But if you split the volume down, as I said, 4% reduction last year is a very easy comparator on the volume, and we don't expect that to continue, Jonathan, all right? So the full year, we still expect to get volume growth, and we expect to keep the pricing to stick, but you've got to be careful with that first quarter in terms of trending.

[Jonathan Hurn, Research Analyst]

Great. Okay. Fantastic. The second one was just on Critical. I think if we kind of look back at utilization, that business was around about 50%. Obviously, you're taking out some of the capacity. Where are we kind of sitting in utilization within that business because obviously that's quite important for the margin growth going forward?

[Roy Twite]

Yes. It's interesting, Jonathan, actually because we've got all the good lean programs and Mark's just been down to Asia. And seeing that, we've now got really 4 first-class factories across Asia, 1 in India, 1 in China, 1 in South Korea and 1 in Japan. And the great news is the lean program continuously frays our capacity because continuously, you're improving change over times, you're improving cycle times, you're improving efficiency of the factory, so you're constantly freeing up capacity. So even though that we've managed to consolidate from 24 factories down to 16, and it was a question from the Board actually to me is what's going to happen to your overall capacity at the end of it? I still think we've got about 50% utilization today, Jonathan. It might be slightly higher, but it's not much higher. Now of course, you've got to be careful because the market's never come uniformly at you. We're never going to see a doubling up of everything. We're going to see Power coming down, and we're going to see LNG rising. That's my central base case, and we're going to have to manage that mix within our factories. But I'm entirely comfortable that we can manage this next LNG wave, that we can manage a return to growth in Oil & Gas. From where we see it at the moment, we got plenty of capacity, Jonathan.

[Jonathan Hurn, Research Analyst]

Okay. Great. And just the final one, just coming back to the order book in Critical. I think historically, you've kind of given some indication of where that order book margin is sitting relative to the division margin. I think previously, you said it's plus 1. Can you just kind of give us a sense of the magnitude of where that order book margin is sitting right now relative to maybe last year's divisional margin, please?

[Roy Twite]

Yes. Absolutely, Jonathan. So again, be careful with this, right? Because there's lots of moving parts in there, right. The aftermarket order book is obviously a lot shorter than the new construction order book, and you've got to marry all those things in. But to give you an understanding, we're just over 1% up for the moment. That's being driven by aftermarket mix plus aftermarket pricing. New construction margins are sort of about 1.5% down still, so we still got a lot of competition on new construction, particularly as we push into new spaces. But that gives you a rough idea of where the overall order book is at the moment, Jonathan.

[Operator]

And our next question comes from the line of David Larkam.

[David Alexander Larkam, Analyst]

Couple from me. Just Roy, I think you said that your review will -- won't end until sort of next March. So given that you've been there for 30 years and the diligence of your predecessor, and all the information [ pieces ] that are on the background and the positioning, I'm sort of surprised we won't hear anything a bit sooner.

[Roy Twite]

Yes. No, it's a fair point, David. I think the diligence of my predecessor is in no doubt whatsoever. Let's put that on the table. I think, David, the update in -- at the half year, I will give you a good flavor of the process that we're going through. I will give you a good flavor of where me and the DMDs think that the attractive opportunities might be, and I'll give a good flavor of the sort of process, because I am super excited, David, about using a very customer-focused commercial approach, a team-based approach to customer-based innovation. And we started to put that into Critical. We're seeing the early results of that, and I'll give you a good flavor of it, David. But quite rightly, the Board wants the opportunity over the period of the 3 Board meetings to really test the strategy, test all the aspects of it. I was told yesterday, we're going to throw the net wide. We'll bring it back in. We'll focus, but we'll throw the net wide in terms of really looking at what our options are as IMI. There will be no sacred cows. That's for sure. We will look at absolutely maximizing long-term profitable growth, but we'll do the process thoroughly as well. And that's why we're not going to wrap it up until the results next year, which will be in February next year. But as I said, in the meantime, we will be putting the financial levers necessary to optimize performance. And as you would expect after 30 years, I've got a pretty good idea of what those levers are, and I'm pretty excited about what we can do, David.

[David Alexander Larkam, Analyst]

Okay. And good luck to Mark on his retirement, and good luck to you tonight.

[Roy Twite]

Thank you very much.

[Mark W. Selway, Executive Director]

Thanks, David.

[Operator]

[Operator Instructions]

[Roy Twite]

Great. Okay. Well, I think with that, I'd like to thank you again for your time today. I'd like to thank Mark for his tremendous support and thank Massimo for coming along and answering some of the questions on the call today, and I look forward to seeing you at the half year results. Thank you very much.

[Massimo Grassi]

Well done. Thank you.

[Roy Twite]

Thanks. Buh-bye.

[Operator]

Thank you, and that concludes our conference for today. Thank you all for participating. You may all disconnect.