Intertek Group PLC

LSE:ITRK

Earnings Call Transcript 2018-Q2

[André Lacroix, Chief Executive Officer]

Good morning to you all, and thanks for joining us following the release of our Six Months Results this morning. We are pleased with the performance of our H1 Results, and we will give you a full briefing on how we see the trend in H1, and importantly moving forward for H2. We continue to make progress on revenue margin and cash and we are on track to deliver our 2018 full year targets.

So I'll start with the performance highlights of – to the first six months of the year, then Ed will take you through the detailed financial results, and I'll come back to give you more insight on strategy and performance moving forward. Let's start with our performance for the first six months of the year.

We continue to make progress on revenue, margin and cash. The group generated revenues of £1.348 billion, up 3.9% at constant currency, down year-on-year by 1.8% at actual currency. Our revenue performance at constant currency was driven by good organic growth of 3.4%, in line with expectations, and by the contribution of recently made acquisitions.

The group delivered an operating profit of £226 million, up 6.4% at constant currency and up 0.8% at actual currency. We delivered a strong operating margin of 16.8%, up 40 basis point at constant currency and 50 basis points at actual rates. Our adjusted EPS was 91.2p, up 6.8% at constant currency and 0.9% at actual currency. We continue to make progress with our disciplined approach to working capital management, and our working capital was down year-on-year by 6.5%.

In line with our new dividend policy that targets a payout ratio of circa 50%, we've announced an interim dividend of 31.9p, up 35.7% compared to last year. Sequentially, we saw an acceleration of organic revenue momentum with 3.4% growth at constant currency, which compares to 2.5% in the second half of 2017 and plus 1.7% in first six months of 2017.

We benefit from broad-based organic revenue growth in our product and trade divisions, growing respectively at 5.7% and 0.7% at constant currency. We saw a mark improvement of our performance in the resource business with organic revenue almost flat at constant currency. As you know, margin management is an important priority for us, and I'm pleased with the continuous progress we are making on margin.

We've delivered an operating margin improvement of 40 basis point at constant currency, benefiting from operating leverage linked to revenue growth, productivity improvement and from our portfolio strategy.

I will now hand over to Ed, who will take you through our financial results in detail.

[Edward Leigh, Chief Financial Officer]

Thank you, André, and good morning, everyone. And I'll now take you through some of the details underlying our results. Summary for the first half, we delivered good revenue, profit and EPS growth at constant currency. Margin improved year-on-year at both actual and constant currency, and our cash flow performance was strong. Total revenue growth was 3.9% at constant currency and down 1.8% at actual rates with FX translation reducing our revenue by 570 bps, driven by depreciation of sterling.

Organic revenue at constant rates was up 3.4%. Operating profit at constant rates was up 6.4% to £225.8 million, and margin was up 40 basis points. The FX affected the half year, resulted in operating profit up 0.8% to actual rates. Net finance costs of £12.2 million were 10.3% lower than last year through a combination of lower debt and with the stronger pound reducing our dollar interest costs. So overall, fully diluted EPS grew to 91.2p, being up 0.9% at actual rates and up 6.8% at constant rates.

I'll now take you through the high-level margin performance by division. The group recorded a 50 basis point improvement in operating margin in the first half, increasing to 16.8%. Margin improved by 40 basis points at constant rates, driven by strong margin accretion in products which was partially offset by the margin performance in trade and resources. The margin also benefited from the stronger portfolio mix, which contributed 20 basis points. We had a further 10 bps accretive impact from acquisitions completed in the past 18 months.

The group realized a gain from implementation of a pensionable salary freeze for the U.K. scheme, which was partially offset by other specific costs resulting in a gain of 10 basis points. Finally, and as expected, FX had a positive 10 bps impact on the group margin.

Now turning to group cash flow and net debt. So our disciplined focus on cash management continued throughout the period with working capital down 6.5% year-on-year and reducing as a percentage of revenue year-on-year. Cash flow from operations was £204 million, down £22 million due to two factors: firstly, a negative FX translation impact on EBITDA of circa £13 million; and secondly, the base effect of our low working capital exit point in December 2017.

We invested £46 million in CapEx, up from £34 million in 2017 to expand our market coverage and develop innovative ATIC solutions. Free cash flow in the period was £91 million. The over all performance in cash flow resulted in a reduction in net debt to £568 million, down £128 million or 18% versus June last year.

Now turning to our financial guidance for full year 2018. The expected net finance costs will be around £28 million to £30 million, with the increase versus previous guidance reflecting the acquisition of Alchemy. The effective tax rate is expected to be in 25.3% to 25.8% range, and minority interests will be circa £20 million. For your models, I've set out the number of shares for EPS calculation.

We are expecting the full year CapEx to be £130 million to £140 million, and based on our acquisitions in the first half, the acquisition of Alchemy and the FX effects on our U.S. debt, we have updated the net debt guidance to close the year at between £800 million and £850 million. This guidance is stated before any further M&A completions and any material movements in FX.

I'll just hand you back to André.

[André Lacroix, Chief Executive Officer]

Thank you, Ed. And I'd like to start the second part of the presentation today with a brief update on strategy. We provide independent quality assurance services that are mission critical for our clients. That's exactly what Intertek stands for in the market. We offer ATIC solutions to customers operating in three sectors of the economy, product, trade and resources. Importantly, we operate a capital-light business model, which combined with entrepreneurial culture, enables us to react quickly to new growth opportunities by following the supply chain of our customers in new geographies.

As you know, our approach to value creation for the mid- to long term is based on what we call the Intertek Virtuous Economics, global GDP+ organic growth, plus margin accretion, plus strong cash conversion and importantly, plus disciplined capital allocation. The compounding effect of our Virtuous Economics earnings model year-after-year will continue to create shareholder value creation.

The growth opportunity in our market are very attractive. The total quality assurance market is worth circa $250 billion. We see strong growth opportunity with existing and new customers, but we also see attractive growth opportunities to get access to the quality assurance work that corporations currently do in-house.

Moving forward, our future growth outlook is global GDP+ organic revenue growth in real terms. We expect our product division that represent 76% of the group's earnings to grow ahead of global GDP. We expect our trade divisions that represent 18% of the group earnings to grow at a rate broadly similar to GDP through the cycle, and the growth prospect of our resource division, which represents 6% of the group's earning, are linked to the global growth drivers in the energy sector.

The main objective of 5x5 strategy is to move the center of gravity of the group towards the high-growth and high-margin sectors in the industry. We are very focused on seizing the exciting growth opportunities in high-growth, high-margin with our differentiated TQA value proposition, ATIC. Globally, we support the existing and emerging quality assurance need of our clients through each area of their operations: R&D, raw material sourcing, component suppliers, manufacturing, transportation, distribution and consumer management.

We spend a lot of time with our clients, and each time I meet one of our clients talking about our ATIC opportunity, our clients are really excited about the broad-based approach we take to help them in their day-to-day quality assurance work. Importantly, we focus on innovations to accelerate growth and improve our margin, and our customer facing innovation is either based on digital solutions or on leading-edge technology.

I'll cover later that we get access to industry-leading solutions with our M&A activities that enable us to bring unique IPs and scale this up into the world of Intertek. I'd like to share with you now some of the recent innovations that we've launched based on the innovation work we do in our businesses, which is always starting from customer insights with our 6,000 monthly Net Promoter Score survey.

To help our customers better leverage their customer feedback, we have launched Voice Of the Customer. This is a service that use big data analysis techniques to quickly identify quality issues and deliver actionable product quality improvement for our customers. Another very strong area of growth is sustainability and we developed a comprehensive suite of services across all areas of the supply chain of our customers and our sustainability approach is industry agnostic.

We continue to expand our Inlight solutions that offers a trusted software other solution platform. Through this unique platform, customers are able to gain great visibility of the supply chain and build resilience in their global operation to reduce risks. You might have noted that we've rebranded our Cargo/AA business Caleb Brett to strengthen our service differentiation, leveraging more than 130 years of heritage in the industry where we have pioneered marine surveillance.

Another exciting example of innovations in trade business is what we've done with ExxonMobil in Mexico where we've created mobile laboratory to test fuel quality across a fast-growing network and improve the capability and the skills of their staff. Another example of a mobile solution is the unique crop quality toolkit that our experts have developed for small farmers in sub-Saharan Africa, making it easier for all of our clients to get to the highest level of quality.

Another very interesting project is what we did with Greenlink to minimize the impact on the marine environment. Our experts are providing vital support to the project, ensuring regulatory compliance. In oil industry, we've developed the only database of near-infrared spectrum analysis of crude oil in the world. You might remember that in 2017 we launched PipeAware, an industry-leading software as a solution that allows pipeline asset owners to access real-time information on their asset inspections through the manufacturing stages.

Now PipeAware too has extended its functionality and help customers track all aspects during construction Phase 2. I could get on and on with innovations happening in the world of Intertek, but let's go back to business and talk about the outlook for the group in 2018.

In 2018, we expect we have a good organic revenue growth at constant currency. We expect our good organic revenue growth to be driven by robust organic growth in our product-related businesses, solid organic growth in our trade-related businesses and stable organic revenue in our resources businesses. From a profitability standpoint, we expect to deliver a moderate margin progression. We'll continue to invest in growth with full year CapEx investment of circa £130 million to £140 million.

We are maintaining the full year guidance we gave you on currency in March. Based on the last two months' rate, the average sterling rate apply to the full year results of 2017 would provide reduction of 400 bps at the revenue level and 350 bps at the operating profit level. Let's now discuss the performance and the outlook for each of our divisions.

I'm really pleased with the continuous progress we are making on our product businesses, and we delivered an excellent performance in H1. 5.7% organic revenue growth after three years of robust organic growth, and all of that driven by broad-based revenue growth across business line and geographies.

We delivered a very strong operating profit of £172 million, up 10.3% and that enabled us to deliver a margin of 21.3%, which is up 70 basis point versus last year, a tremendous performance as we benefit from operating leverage, cost discipline and pricing power. Let's talk about each of our important business lines in our product business. Our top line business delivered solid organic revenue growth as expected, benefiting from supply chain expansion of our clients in new markets, rapid expansion of footwear sector and increased demand for chemical testing.

Our Hardline business had a very good first half, and we benefit from innovation from our customers, leveraging wireless technology and increased demand for chemical testing. I'm really proud about the performance of our Electrical & Network Assurance, where we delivered robust organic revenue growth. We are benefiting worldwide from electrical appliance innovations that provide better efficiency and connectivity to consumers. And importantly, we are benefiting from increased demand for IoT assurance services, of course, including cybersecurity.

Our Business Assurance continues to go from strength to strength and delivered a strong organic revenue growth, driven by ISO standards upgrade, increased focus of corporation supply chain and risk management, and importantly, increased consumer and government focus on ethical and sustainable supply. Our Building & Construction business largely focused in the U.S. had very strong performance, and we delivered a robust organic revenue growth in the first six months of the year. We are seeing a growing demand for greener and high quality commercial buildings and increased investment in large infrastructure projects in the U.S.

Our Transportation Technology delivered double-digit revenue growth, driven by the continuous investment of our clients in new models and new fuel-efficient engines, and importantly, the increase scrutiny on emissions. We generated robust organic revenue growth in our Food business. The Food business is a very exciting sector where we see continuous growth, driven by food innovations and increased focus on the safety of the supply chain from both the regulator and consumers.

We saw robust organic revenue growth in our Chemicals & Pharma business. As expected, we are seeing a growth of SKUs around the world, and here again an increased concern from the regulator and the consumer on product safety and traceability. For the full year of 2018, we expect the product-related businesses to deliver robust organic revenue growth.

Our Trade business delivered a solid performance, in line with expectations and organic revenue growth of 0.7%. Operating profit was £42 million, slightly down year-on-year, and operating margin of 13.4% was also slightly down year-on-year, driven essentially by country mix. Our Caleb Brett business reported a stable revenue performance as expected. We continue to benefit from the global and regional trade structural drivers in all regions, except in North America where we are seeing an industry destocking of crude and refined products.

Our Government & Trade Service businesses delivered robust organic revenue growth, driven by volume growth with existing contracts, as well as the win of several new contracts. Our AgriWorld business was in line with expectations, reporting a revenue performance slightly below last year as we saw lower level of export activity due to baseline effect in some of the largest markets that benefited from strong trading activities in 2016 and 2017.

For the full year, we continue to expect our trade-related businesses to deliver solid organic revenue growth. I'm really pleased with the performance of our Resource business that delivered an improved trading performance following several years of revenue decline. Our revenue was broadly in line with last year, slightly down 0.7% versus last year.

Operating margin was 5.5%, slightly down versus last year due to contract mix. The revenue from CapEx inspections was lower than last year. Importantly, we benefit from stable level of CapEx inspection activities i.e. the volume that we are seen from our clients has stabilized, while we continue to see price pressure in the market, again, as expected.

Good news on the OpEx maintenance service where our revenue is now stable, and we continue to see an improved level of demand for testing activities in the Minerals business that delivered robust organic growth performance, the best performance for many years. For the full year, we expect our resource businesses to deliver a stable organic revenue performance in 2018.

Our M&A strategy is focused on the acquisitions of leading and innovative solutions that are scalable across Intertek. And in the last 18 months, we've made several acquisitions in attractive growth and margin sectors, and as Ed has explained, these acquisitions have contributed to the progress we are making on margin.

Last week, we announced that we have entered into an agreement to acquire Alchemy, a leading software solution provider which will expand our global Assurance offering into People Assurance services. In case some of you couldn't join our webcast last Friday, I just like to recap the key features of the acquisition.

Alchemy focus on frontline staff and industries with high turnover where traditional classroom training is too costly and not efficient. Today, the integrated solutions impact more than 3 million frontline workers at 50,000 locations worldwide. The demand is growing for solutions that identify, monitor and efficiently close skills gaps among frontline employees.

Alchemy gives us further exposure to the high attractive food industry where demand for quality assurance is stronger than ever, driven by increased regulations and increased consumer expectations. And frankly, where operational and compliance consistency are an ongoing challenge for companies. Alchemy is a high quality business with scalable solutions that can be rolled out across many different industries and geographies inside Intertek. That will accelerate the of our capital-light and high-margin assurance business.

The transaction is value accretive for shareholders on both the billing and IFRS [ph] revenue basis. We expect strong growth for the five years CAGR of 20%. Alchemy operates a high margin business model and has got strong cash conversion above 100%. Billing EPS will be accretive in year one and we expect Alchemy's return on invested capital group WACC rate in year five.

A few concluding remarks before our Q&A session. In H1, we've continued to make progress on revenue, margin, cash and returns with our increased dividend of 35.7% compared to last year. We offer our clients a differentiated TQA Value proposition that provide a superior service.

Moving forward, we're uniquely positioned to deliver GDP+ organic revenue growth in real terms. We will continue to pursue disciplined approach to margin and cash management, and M&A will continue to focus on attractive growth and margin prospects. So in summary, we are on track on a good-to-great journey, making good progress both on performance [Call Ends Abruptly]