Intertek Group PLC

LSE:ITRK

Earnings Call Transcript 2022-Q2

[Andre Lacroix, Chief Executive Officer]

Good morning to you all and thanks for joining us on our call. I have with me Jonathan Timmis, our CFO; and Denis Moreau, our VP of Investor Relations. There are five takeaways in our today's presentation. The first takeaway is that the group delivered a robust financial performance in H1, notwithstanding the impact of lockdown restrictions in China, we delivered at constant currency a revenue growth of 9.5%, like-for-like revenue growth of 4.9%, and EPS growth of 6.7%, a robust free cash flow, and an excellent ROIC.

Outside of China, the group delivered like-for-like growth of 7.1%, one of the best like-for-like performance for many years at Intertek, a double-digit operating profit growth, and importantly, a 20% -- 20 basis point margin accretion.

The second takeaway is our business in Shanghai has been operating as normal from July 1st as expected and we expect our China business to deliver good like-for-like revenue growth in H2.

The third takeaway is our acquisitions are performing extremely well in revenue and margin. We are really proud of having SAI and GLA in our portfolio, two major acquisitions in high margin segments. And this morning, we've announced an agreement to acquire CEA, a market-leading independent provider of quality assurance in a very exciting fast-growing solar energy sector. As we all know solar energy is the future for the world of energy.

The fourth takeaway is for the full year. We are targeting robust like-for-like revenue growth at constant rates. And given the impact of the lockdown restrictions in China in H1, the expected divisional mix and the investments in growth we are making, we expect margin to be slightly below 2021.

Our disciplined cost management remains, of course, in place and we'll continue to leverage our strong pricing power to manage the higher-than-expected inflation in several markets where we are investing in capability. Net-net, we expect the group to deliver at constant rate a robust earnings growth in 2022.

And the fifth takeaway really important for the future of the company, the ATIC quality assurance market is growing faster post-COVID. The expectations of all stakeholders in quality, safety, and sustainability are much higher and this is great news for our ATIC portfolio.

So, let's start with our performance highlights. The robust financial performance of the group in H1 I just discussed demonstrating the strengths of our high-quality growth business model.

In the first six months, we delivered a revenue of £1.5 billion, 9.5% up year-on-year at constant rate as I said and 13% actual rate. Our group operating margin was resilient at 14.6%. Earning growth was 6.7% at constant rate and 10.6% at actual rates. Our free cash flow of close to £96 million was robust. We've announced an interim dividend in line with what we paid in the last three years and our ROIC was excellent at 16.8% with organic ROIC 21.4%, 20 basis points higher than last year. And of course our balance sheet remains super strong.

We've delivered a broad-based mid-single-digit like-for-like revenue growth of 4.9% Product up 4.3%, trade up 5.7%, and Resources up 6.4% [ph]. Our robust like-for-like revenue growth was driven by progress both on volume and price. You heard me talk about it for many, many years. We believe in good like-for-like revenue growth getting both volume, price, and the benefit of mix.

Outside of China we benefited from an acceleration of demand for ATIC solutions with a like-for-like growth of at least 7% in each of our divisions, a performance that Intertek has not delivered for quite a while. So, I'm really proud of this like-for-like performance given the acceleration of demand for our solutions in the market. And of course, we are pleased to see the acceleration in terms of like-for-like revenue momentum in the May-June period for our Trade and Resource businesses.

In H1, we saw a margin reduction of 70 basis points at the group level, driven solely by the impact of the COVID-19 restriction in China. Outside of China, we delivered a good margin performance with a margin accretion of 20 basis points. We benefited from our strong pricing power as we executed the price increase we had planned to take in the first half and of course, as we remain very disciplined on our cost management.

I'll now hand over to Jonathan to discuss our H1 results in more detail.

[Jonathan Timmis, Chief Financial Officer]

Thank you, Andre. In summary, in half one 2022, the group delivered strong revenue with a robust EPS growth. Total revenue growth was 9.5% at constant currency and 13.2% at actual rates as beneficial movements in FX rates impacted our revenue by 370 basis points, driven by the weakening of sterling. Like-for-like revenue grew 4.9% at constant rates. Operating profit at constant rates was 4% -- was up 4% to £217 million, delivering a margin of 14.6% down year-on-year by 70 basis points. Diluted earnings per share were £0.865 growth of 6.7% at constant rates and 10.6% at actual rates.

I will now take you through the high-level operating margin performance by division. Products performance was impacted by lockdown restrictions between March and June in our China business, especially in Shanghai, which represents 25% of our China business. Margins were 19.3%, which adversely impacted the group by 110 basis points. Trade operating margin grew to 7.6% and contributed a 20 basis points increase to the group margin, while a decline in operating margin in resources to 4.7% had no year-on-year effect at group level.

Finally, our recent acquisitions had a positive 10 basis points impact on group margin. The group delivered adjusted free cash flow of £95.8 million, down year-on-year by £26.8 million. A good increase in operating profit was offset by an increase in working capital. In half one 2022, we invested £41 million in CapEx in line with prior year.

We finished half one 2022 with financial net debt of £859 million, which is up year-on-year due to the acquisition of SAI and represents a financial net debt to adjusted EBITDA ratio of 1.3 times. We have a robust financing structure in place. We have a good average debt maturity of 4.5 years with an even spread of maturities. 83% of our debt is at fixed interest rates with an average rate of 2.7%.

Now turning to our financial guidance for 2022. We expect net finance costs to be in the range of £34 million to £38 million. We expect our effective tax rate to be between 26.5% and 27%, our minority interest to be between £20 million and £22 million, and CapEx investments to be in the range of £125 million to £135 million. Our financial net debt guidance excluding future changes in FX rates or M&A is updated to £730 million to £780 million as a result of the weakening pound against our predominantly US denominated debt.

I will now hand back to Andre.

[Andre Lacroix, Chief Executive Officer]

Thank you Jonathan. And let's now discuss the performance of our business lines starting with our Products business. All comments that we'll make as usual in this section are at constant currency.

In H1, our Products business delivered a robust performance. Our revenue benefited from the high demand for ATIC solutions and of course from the acquisition that we have made recently, enabling us to deliver revenue growth of 11.5%.

For the period like-for-like revenue growth of 4.3% globally. Outside of China, we delivered a like-for-like revenue growth of 7% driven by double-digit growth in Softline and Business Assurance, two of our star businesses high single-digit growth in Food, mid-single-digit growth in building construction as well as chemical and pharma, low single-digit growth in high-line Electrical and Transportation Technology.

Our margin in H1 was 19.3%, down 170 basis points due to the impact of the lockdown restrictions in China, of course. In 2022, we expect our Products division to deliver robust like-for-like revenue growth.

Moving to Trade. Following a good 2021 driven by the rebound of global trade, our Trade division benefited from a growth acceleration enabling us to deliver a good margin accretion. The higher demand for energy and Agri products drove like-for-like revenue growth of 5.7% globally and 7.2% outside of China. Operating margin of 7.6% was up 90 basis points. In 2022, we expect our trade divisions to deliver robust like-for-like revenue growth.

Just a few remarks regarding the conflict in Ukraine, our exposure to Russia and Ukraine is small less than 1% of the group revenue. The war, however, will continue to impact the global energy supply chain and the global food supply. Russia as we know is a major producer of oil and gas and the export activities, represent around 7% of the world consumption.

Following the sanctions implemented, we expect to see the following challenges in the global energy market. The amount of oil and gas exported from Russia into Europe will reduce of course. The amount of oil and gas exports from Russia into Asia will increase, and we're already seeing it. The overall amount of oil and gas export by Russia will reduce all the time. The production of oil and gas in the US and Europe will of course increase. The amount of LNG important to Europe will increase. And importantly, investments in renewables in Europe will accelerate. For Intertek, the change in energy trade flows, as well as increased investments in renewables will be a net positive for Caleb Brett and Industry Service operations.

The war is also impacting the global food market, as the conflict has disrupted, the trade flows in the Black Sea in several categories, grains, oilseeds, veg oils and fertilizers. In the short-term, these disruptions are increasing pressure on price. Over time, this will be offset by an increase in production from major exporters like the EU, Argentina, Canada, US and Morocco. This trade flow change will be a net positive for AgriWorld operation.

In the resource sector, we've seen a high demand for ATIC solutions. There is no question our clients are benefiting from the global recovery in oil and gas as well as minerals that enabled us to deliver 6.4% like-for-like revenue growth globally and 7.4% outside of China. Operating margin was slightly below last year, reflecting our investment in growth in Australia. In 2022, we expect our Resource business to deliver robust like-for-like revenue growth.

Let's now discuss the outlook for 2022. The lockdown restrictions have had a significant impact in our China business between March and June and Shanghai was the most impacted region and as I said earlier, is now back to normal.

We have an excellent business in China, with leading and scale position and very strong margin across all of our businesses. And in H2, we expect our business to deliver good like-for-like revenue growth like we saw pre the restriction period.

Globally, we are seeing an increase in demand for ATIC solutions in products trade and resources. Our like-for-like revenue growth outside of China was 7.1%, enabling us to deliver double-digit operating profit growth and a margin accretion of 20 basis points, as I mentioned earlier. In 2022, we expect robust like-for-like revenue growth at the group level, with robust like-for-like revenue growth in product trade and resources.

We continue to leverage our strong pricing power, especially in the markets where we're investing in capability to seize these extra growth opportunities and where we are facing higher-than-expected inflation. Our disciplined cost management will remain in place to continue to drive productivity improvements.

Given the impact of China in H1, we expect divisional mix and the investment growth we are making, our margin at constant currency will be slightly below 2021. For the margin model, I just want to remind you that the group benefited in 2021 from additional government subsidies in the orders of GBP10.5 million as we disclosed at the end of the year with one-third in H1 and two-third in H2.

A brief update on currency, the average selling rate since the beginning of the year applies to the full year results of 2021, would provide an uplift between 400 bps and 600 bps at the revenue and earnings level. Net-net we expect the group to deliver a robust earnings performance in H2 and for the full year at constant rate.

Let's now move beyond 2022 and talk about the exciting growth outlook for Intertek. We already said it before, but let me just share my main insights. COVID-19 has been much more than the tragedy for the world. It will be remembered as the greatest dislocation of the global supply chain since the '70s, creating significant imbalances between supply and demand in raw materials, components, goods, service and manpower, resulting in higher-than-expected inflation across many markets.

In the post-COVID world, stakeholders' expectations in quality, safety and sustainability are higher than ever, making the case for risk-based quality assurance stronger than ever. The ATIC demand will grow faster in a post-COVID world. And let me explain you why.

Of course we operate in a highly attractive industry, with strong structural ATIC growth drivers that we know so well that they've delivered great performance for all stakeholders in this industry and will continue to deliver GDP-plus like-for-like revenue growth in real terms.

Based on our market research, and as you know we do about 6,000 to 7,000 interviews a month with our customers with our NPS survey. These attractive structural ATIC growth drivers will be augmented by an increase in new clients, higher investments in safer supply, higher investment in innovation, a step-change in sustainability and high growth in the world of energy.

Let me talk about these five accelerators one at a time. We are seeing a significant growth in a number of companies globally, given the ease of regulations to create new businesses, the lower barriers to entry for any brand with e-commerce capabilities and the increased level of talent to develop new technology, new products and new services.

The lack of quality assurance expertise of these young companies is great news for Intertek.

Our decentralized customer-first organization has a strong track record indeed of winning new clients. And I don't know if you're aware of that but on the second of November 2021 at the Cotswold Airport here in our home market in the UK, we had the first flight powered by sustainable fuels. These synthetic fuels were developed by a company called Zero Petroleum a startup here in the UK. And they work with our experts to make sure that the fuel was proper and ready from a molecule development standpoint safety and sustainability. This is the type of companies we partner with very early on at the early stage of their R&D work. And of course, they achieved a Guinness World Record. We are very proud of being partnered with Zero Petroleum run by the fantastic CEO very famous in the Formula One world Paddy Lowe.

Second, growth accelerator increased investment in safe supplies. COVID-19 is proving a catalyst for many corporations to improve the resilience of their supply chains. We expect major corrective actions inside companies. Better data, on what's happening in all parts of the supply chain. Cater risk management, with regular shop business continuity planning. A more diversified portfolio of Tier 1, Tier 2, Tier 3 suppliers. A more diversified portfolio of factories investment in processes, technology training and independent assurance and we are really well positioned to help our clients reduce the intrinsic risk in their operations given our superior assurance offering. You know that we are the leader in terms of ATIC offering and you've seen the tremendous growth of our Business Assurance business in the first half.

Let me tell you a recent development with one of our major clients and we cannot name our client. They don't let us do for obviously confidential and commercial sensitivity reasons. A few months ago, I got a call from the Head of Supply Chain at one of the major global luxury cosmetic headquarters in North America. And they were facing some real difficulties with quality and recall in their supply chain in China. They're called Intertek to basically not go and check what's happening in China, they also wanted us to do that, but they called us to basically do an end-to-end audit of the quality assurance management systems throughout their operation. And this is a fantastic company with a tremendous track record that they realized that they had intrinsic risk in their supply chain they will not deal from a systemic standpoint. That's the type of assurance work we do for our clients.

Let's move to innovation. Our clients have realized that they need to invest more in product and service innovations to meet the changing needs of their customers. As you would expect, during a measurable crisis like COVID-19, consumers' expectations are changing given the desire to live in a much better world. A recent survey by Gartner show that 60% of the R&D leaders expect to increase their R&D spend in 2022. This investment innovation will result in a higher number of SKUs and a higher number of test SKUs, which will be of course beneficial for our product divisions. And we got tons of examples of clients coming to us to basically get our subject matter expertise early on in the R&D stage to develop their new products and solutions.

The other major area of investment in site corporation is of course sustainability. Indeed, we have seen a positive momentum for sustainability with emerging regulations, in addition to what has been put in place in the last few years. Companies will have to reinvent the way they manage the sustainability agenda with a great emphasis on independently verified ESG disclosures. This is an excellent development for industry-leading solutions in Assurance. And I'm not sure if you've seen in the recent development that has happened at the EU. As the CEO of Intertek, I'm part of the Tech Council which is our global trade association and a share global sustainability efficacy group, that basically work with regulators around the world to get higher sustainability reporting standards.

And we just achieved a major win, which is an amendment to the 2014 non-financial reporting directive in the EU with basically a corporate sustainability directive that will get into effect from 2025 and 2024 that basically will force companies to have independent audited sustainability report. And the big win is that we have secured that our industry will be part of the 35 companies that can audit these reports. That's a major win. And you can imagine we had a bit of competition for the big four that we want.

Let's talk about the fleet growth accelerators and I'm super energized about the opportunities there. These are the growth opportunities in the world of energy, which are truly exciting. A lot of commentary has been available in the press. So our insights will not be a surprise to you. But let's try to bring these key insights in a few succeed points to our discussion here. To meet the expected increase in global energy demand the world needs a significant increase in energy production. There has been underinvestment in traditional oil and gas exploration and production in the last decade. And we know that renewables are great but not scale. Therefore investment for production in traditional oil and gas and renewables will increase significantly.

There is no question that the investment and technology required to build a new infrastructure is very, very challenging from an IP standpoint and of course funding standpoint. And there will be a divergence between the energy mix in developed and developing countries.

In developing economies we'll see growth in oil and gas, trade flows and infrastructure investments. The diversified energy mix in developing economies will increase the complexity and risk in a just-in-time energy value chain. We've seen quite a lot of examples of grids not being properly operational in the US or here in the UK. Watch the space, this is just the beginning of a new big risk, which is energy supply 24/7.

To achieve net-zero, we expect a major acceleration in both technology and investments to create scale, carbon capture and storage infrastructure. The world will not get to net-zero unless there is a big, big, big, big progress in terms of technology investments to basically capture carbon wherever the carbon is being emitted.

The growth acceleration in the world of energy I just described is fantastic news for our Caleb Brett, Industry Services, Electrical and Assurance businesses. And you've seen this morning, the announcement we made in the Solar Energy segment a very, very exciting space for us.

So when you step back and you look at the ATIC structural growth drivers, the track record of the company and these growth accelerators have to say, we are extremely well positioned to seize the growth acceleration in our end market for many years to come. Our science-based customer excellence USP gives us excellent client relationship and a strong pricing power. We have a powerful portfolio with scale position in attractive growth segments, a high-quality component earnings model deliver sustainable value as you know and we are very agile with our disciplined performance management on price, cost and cash.

And importantly, we invest in organic and inorganic growth with discipline. Investments are essential to remain the best in terms of customer service and to deliver superior ATIC solutions. Our teams are very focused on scaling up the winning innovations we've launched in the market over the last few years as well as developing the next big ideas for the industry. We're also scaling up our M&A investments successfully as evidenced by our excellent ROIC. And we continue to look at new opportunities to invest in high-growth high-margin sectors. And this morning, we've announced a significant role in the solar energy sector with the leader in the space.

Moving forward, we'll continue to deliver sustainable growth and value for all of our stakeholders of science-based customer excellence USP is giving our clients the ATIC advantage that they need to strengthen their business. We operate a high-margin, capital-light, carbon-light and highly cash-generative earnings model. As you know, our approach to value creation is based on the compounding effect year-after-year of margin equity revenue growth, strong cash generation and disciplined investment in growth. That approach has delivered 13% annual TSR in the last decade a tremendous performance.

Moreover, our earnings model has strong intrinsic defensive characteristics. It's important to note that the ATIC solution we offer are mission-critical for our clients to make sure that their operations continue to operate safely. We operate a highly diversified set of revenue streams offering a broad range of ATIC solutions in 17 industries in more than 100 countries working with slightly more than 400,000 companies around the world. And given our superior customer service, we have strong and lasting relationships with our clients.

So in summary, we are a high-quality growth business with strong defensive characteristics, creating value in good and challenging times. We are purpose-led offering ATIC solutions that are mission-critical for the world. We operate a high performance earnings and cash compound model. And importantly, the growth in our end market is accelerating. We are extremely well positioned to continue to create sustainable value for all.

Before I close, I would like to thank all of my colleagues at Intertek for the incredible commitment, passion, innovation, agility and energy, giving Intertek, a science-based customer excellence advantage in the global quality assurance industry.