Spirax-Sarco Engineering PLC

LSE:SPX

Good morning, and thank you for standing by. Welcome to Spirax-Sarco Engineering plc 2023 Half Year Results Webcast and Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today’s conference is being recorded.

I would now like to hand the conference over to your first speaker today, Mr. Nicholas Anderson, Group Chief Executive. Please go ahead.

Good morning, everyone, and welcome to our 2023 half year results announcement call. I’m Nicholas Anderson, Group Chief Executive, and I’m joined here today by our CFO, Nimesh Patel. Regarding today’s presentation, I will again start by sharing the highlights of the first half and then Nimesh, who will take you through our financial performance. Later, I will return to cover the operations and outlook for the full year 2023. And to finalize, we will be happy to take questions from the analysts on the call.

As you all know, two days ago, we announced my desire to retire after 10 years in this role and 41 years of full-time employment. I’m really pleased and proud of what we have achieved together over these years and wish to publicly thank all my colleagues, past and present, for their support and contributions along this journey. I’m really looking forward with excitement to the years ahead when I plan to realize many personal projects that have been delayed due to my busy schedule of my executive career. I’d also like to say that I’m delighted that the Board chose Nimesh to lead our Group on the next leg of this journey, which I’m sure will be even more successful.

Now, back to the order of the day. I would like to start by acknowledging and thanking all my colleagues across the Group for their outstanding efforts in what has been a good, but challenging first half. We have delivered results broadly in line with our expectations, despite weaker than expected Biopharm demand and the softening IP environment. As overall demand across the Group was higher than expected, sales were in line but operating profit was slightly below our first half expectations. We have achieved strong organic sales growth in Steam Specialties and most of ETS is offset by sales decline in Durex Industries and Watson-Marlow, where Biopharm customers continue to satisfy part of their current needs with excess stocks built up during the COVID-19 pandemic.

To note, including the weaker – including the impact of weaker Biopharm demand, Group sales grew close to 11% organically. As a result of lower sales in our highest-margin businesses of Watson-Marlow Industries, our Group operating profit margin was down 360 basis points to 20.2% in the first half of the year.

Steam Specialty sales grew 15% organically with its operating profit margin expanding 190 basis points. ETS sales grew on a pro forma basis, while operating profit declined due to lower sales in the Semicon Fabrication Equipment sector or as we call it, Semicon for short, as well as integration costs incurred to align recently acquired Vulcanic and Durex Industries with our Group’s operating standards. Vulcanic acquired in late September of last year, is performing well and ahead of our initial expectations. Sales of Durex Industries acquired in late November 2022, declined on a pro forma basis due to lower Semicon demand.

Watson-Marlow sale was declined 21% organically, which adversely impacted the operating profit. Although Watson-Marlow sales were below the exceptionally high levels experienced during the COVID-19 pandemic, demand from Biopharma end markets remains very strong, and the business’s underlying strength and competitive position in the market remain unchanged. I will come back to these points later on.

We continue making good progress with our strategic and operational priorities during the first half of this year. In ETS, the integration of Vulcanic and Durex Industries is progressing very well, and we have initiated a USD 58 million investment to expand the Chromalox manufacturing facility in Ogden, USA, which will significantly increase our capacity for Medium Voltage heating solutions.

Decarbonization of industrial processes is driving substantial opportunities and increased demand for both Steam Specialties and ETS, with many solutions based on our patented Medium Voltage technology. In Steam Specialties, we completed the installation and commissioning at the Diageo facility in Turkey, of the first-to-world ElectroFit, which is one of the TargetZero solutions we launched last year.

Cotopaxi’s proprietary digital platform, STRATA, continues being deployed across Steam Specialties sales companies. Together with the build-out of regional hubs to leverage the data this connectivity is delivering to our – sales engineers. In June, we announced the acquisition of a 15% stake in Kyoto Group as part of a strategic investment agreement, alongside major Spanish Energy Group of Iberdrola to accelerate the decarbonization of industrial process heat with Kyoto’s proprietary Heatcube, a molten salt thermal energy storage solution.

Lastly, we continue making further progress on our ESG agenda, and I’ll provide more details of this on the next slide. As I just mentioned, we have continued progressing our Group’s ESG agenda, and, in particular, our journey towards net zero. Scope 1 and 2 greenhouse gas emissions have fallen by 16% so far in 2023 compared to the 2022 midyear performance. And we have achieved a 47% reduction against our 2019 baseline, which means, that we are well on track to achieve our milestone target of 50% reduction by 2025.

We have improved our energy efficiency, reducing global energy use on an intensity basis, as well as achieving year-on-year reduction in water consumption compared to the 2022 midyear performance. We are also deploying Cotopaxi’s STRATA platform across the Group’s 40 manufacturing facilities to enable real-time monitoring and improvement of our own consumption of water, energy and steam.

We are building on the momentum of 78 biodiversity projects is completed in 2022 with a further 41 projects undertaken so far this year. In the first six months of 2023, we have also made good progress developing roadmaps to implement sustainable packaging across all Group manufacturing sites, as well as eliminating the use of solvent-based paints. These are just some of the many internal initiatives in the first half, in addition to continued support of customers to help improve their own sustainability performance.

And with that, I’ll now hand over to Nimesh to take you through the first half financials in more detail.

Thank you, Nick. Before I begin, I’d like to acknowledge your significant contributions to the Group and the strong positions you have built in our three businesses. It’s a huge privilege to be trusted with the leadership of this very special Group, and I’m looking forward to building on your legacy.

Now, let’s begin with a summary of the financials. Remember, that as always, the numbers I am presenting are the adjusted results. Details of the adjusting items are given in the appendix. Sales were 13% higher, reflecting an organic increase of 2%. Excluding sales to Watson-Marlow’s Biopharm customers, organic growth was 11%, which reflects the strong performance across our businesses where demand is more closely linked to IP growth.

Operating profit was 4% lower or down 13% on an organic basis. Our operating profit margin contracted by 360 basis points to 20.2%. And on an organic basis, the margin contracted by 370 basis points. This margin performance reflects the impact of operational gearing and an adverse sales mix with the lower demand from customers in the Biopharm and Semicon sectors impacting our highest-margin businesses.

Net finance expense increased due to higher average net debt, following last year’s acquisition activity with only a modest impact from the rise in interest rates on the floating rate component of our debt. For the full year, we expect net interest costs of GBP 35 million. Our effective tax rate was lower year-on-year at 25.4%. We expect the tax rate for the full year 2023 to be similar to the first half. Adjusted EPS of GBP 155.2 was 11% lower, higher than the rate of decline in operating profit due to the impact of higher financing expense offsetting the lower tax rate.

And finally, net debt, which is higher following last year’s acquisitions, stands at GBP 748 million. Reflecting our confidence in the Group underlying drivers of growth, we have declared an 8% increase in the interim dividend to GBP 0.46 per share compared to 2022, which follows growth of 12% in the total dividend in 2022.

Moving to the sales bridge, Translational exchange movements had a positive impact of GBP 12 million or 1.5%. Given the continued appreciation of sterling and based on rates at the end of July, we now anticipate an adverse impact on the Group’s full year sales of between 2% and 2.5% compared with the full year 2022. Of course, movements in exchange rates are often volatile and unpredictable, and therefore, the actual impact could be significantly different.

Across all three businesses, sales were supported by price increases to protect our margins and pass through the effects of inflationary pressure. Organic growth of 2% reflects the strong performance from both Steam Specialties and ETS, offsetting the decline in Biopharm sales at Watson-Marlow. The organic increase in Steam Specialties was 15%, with strong growth across all regions. ETS sales grew by 7% organically. Both Steam Specialties and ETS grew significantly ahead of the low 1% IP in the first half.

Watson-Marlow sales were down 21% organically compared to a very strong first half of 2022 as a result of the ongoing destocking by Biopharm customers. Our acquisitions, net of the disposal of our Russian operations had a positive net impact on sales of around 10%. On a pro forma basis, Vulcanic and Durex Industries sales were higher than in the first half of last year, with strong growth of Vulcanic partially offset by lower sales at Durex Industries. Both Durex Industries and to a lesser extent, Thermocoax have been impacted by lower demand from customers in the Semicon sector. Sales to this sector accounted for 18% of total ETS sales in 2022 on a pro forma basis.

Moving on to the outlook for sales, we are confident in our Group’s resilience and ability to navigate the current uncertainty in the macroeconomic climate and [technical difficulty] sectors. Demand from Watson-Marlow’s Biopharm customers is now likely to normalize in 2024, as they continue to work through COVID-19 driven excess inventories. Reflecting the continued challenges of forecasting the precise timing and pace of a recovery in Biopharm and Semicon demand, we have updated our guidance within a range. For the Group, and excluding the impact of the currency headwind I mentioned earlier, compared to 2022 pro forma sales of over GBP 1.7 billion, we anticipate sales growth of between 0% and 4% for the full year.

The next bridge highlights the movement in adjusted operating profit for the half year. Exchange movements had a small positive impact on operating profit of approximately 1.7% as a result of translational and transactional impacts. Steam Specialties profit grew 25% organically in the first half, well ahead of the growth in sales, reflecting strong operating leverage. ETS adjusted operating profit was broadly flat organically compared to the first half of 2022, despite the strong organic sales growth as a result of the weaker Semicon demand in Thermocoax.

Watson-Marlow’s adjusted operating profit was down 47% organically due to lower sales to customers in the Biopharm sector. As you will recall, actions were taken in the first half of the year to appropriately right-size capacity and overhead support costs in Watson-Marlow with the full beneficial effect to be realized in the second half of the year.

Destocking by our Biopharm customers is expected to be a short-term headwind with a return to growth expected during 2024. And as such, no further restructuring actions are currently planned to avoid compromising the longer-term growth potential of the Watson-Marlow business.

The increase in central expenses includes the impact of investments in implementing our digital and sustainability strategies through our Group functions. For the full year, we would expect central expenses in the order of GBP 30 million. The combined adjusted operating profit of our acquisitions, net of disposals, represents a first-time contribution of GBP 14 million to this half’s results. On a pro forma basis, combined operating profit in Vulcanic and Durex Industries was lower than in the first half of 2022, reflecting weaker Semicon demand in Durex industries and our planned investments in integration costs.

As in Watson-Marlow, we also undertook rightsizing actions in Durex Industries with the full beneficial impact expected in the second half. Overall, total Group operating profit was down 4% or 13% organically. While I have spoken about our adjusted operating profit, I do also want to highlight two items impacting our statutory results in the first half, restructuring cash costs of GBP 5 million incurred in the rightsizing of Watson-Marlow’s capacity and a software-related non-cash impairment charge of GBP 14 million.

This charge relates to our project to upgrade the ERP system in Steam Specialties, which began in 2018. Since then, we have made the decision to implement a consistent ERP solution across all three of our businesses, making use of newer technologies, enhancing future capability and leveraging the scale of the broader Group.

Moving to the next slide and the Group adjusted operating profit margin, which contracted by 370 basis points to 20.2%. While strong sales growth in Steam Specialties and ETS offset the decline in Watson-Marlow, lower demand from customers in the Biopharm and Semicon sectors impacted our highest margin businesses. The resulting impact of operational gearing and difference in the Group’s mix of sales compared to the first half of 2022 had an adverse impact on the adjusted operating profit margin.

Steam Specialties margin of 24.4% saw strong organic progression, up 190 basis points, reflecting volume growth, cost containment initiatives and strong pricing discipline to offset inflation and protect margins. This progression was offset by organic declines in the adjusted operating profit margin at ETS and Watson-Marlow, reflecting the temporary weakness in demand that I have already spoken about. The ETS margin, including the contribution from acquisitions was 14%. The pro forma combined adjusted margin of Vulcanic and Durex Industries was lower than in the prior year. And Watson-Marlow’s margin was significantly lower at 24.6%.

In terms of the outlook for the Group margin, we anticipate a year-on-year decline of between 100 basis points and 200 basis points compared to our 2022 adjusted operating profit margin of 23.6%. Nick will comment further on the drivers of our margin when he speaks about each of our businesses.

Turning now to cash flow. Cash conversion in the first half was 48%, slightly above the first half of 2022. CapEx of GBP 51 million represented 6% of sales, and we expect to spend around 7% of sales in the full year, which includes our initial investment in the expansion of our Ogden facility to meet the growing demand for decarbonization solutions.

We ended the half with net debt of GBP 748 million as a result of the debt taken on to finance the acquisitions of Vulcanic and Durex Industries with leverage of 1.8 times EBITDA. For the full year, we continue to expect cash conversion of above 70% in line with the guidance from earlier in the year.

And so, with that, I’ll hand back to Nick to talk you through the operating performance of our three businesses.

Thank you, Nimesh. On Slide 14, we once again share a graph with the annual growth rates by quarter of global industrial production, which, as you know, we refer to as IP. The table in the middle of the slide shows the annual IP growth rates for the last four years. And as you all know, IP is the best predictor of our markets.

Now on this graph, the blue line represents Oxford Economics’ latest forecast on the 27th of July this year. The red line represents their forecast in November of last year at the time of developing our budgets for 2023. While the green line is their forecast in February of this year, which we shared with you at our preliminary results announcements in March.

There are two observations I’d like to highlight here today. First, there is really no material difference between the full year IP forecast at each of those three dates, which hover around the 1% growth assumed in our original planning assumptions for this year and is also the actual IP growth for the first half of this year.

Second, global IP in the first quarter of this year turned out to be a little bit better than forecasted in February with the latest forecast still indicating global IP recovery starting in the second quarter and accelerating as of the fourth quarter of 2023, which suggests IP rising to 1.8% in the second half of this year and improved demand levels in 2024.

But it’s really still very challenging to make firm IP predictions for 2023. As these forecasts could still change considerably given the uncertainty surrounding China’s economic recovery and the monetary policies deployed by central banks globally to contain persistent inflationary pressures. Nevertheless, our resilient business model, ability to self-generate sales and a significant proportion of our sales from maintenance and repair of budgets of our customers underpin our confidence in continued self-generated sales growth ahead of IP.

Now, we start the half year review of our operations with the Steam Specialties business. Demand for Steam Specialty Products & Solutions grew significantly above IP in the first half of 2023, ahead of our expectations and ahead of sales, with the business further expanding its order book.

Sales were up 15% organically, while operating profit grew 25% on an organic basis. Demand was strong across all regions and most market sectors, with Asia Pacific also benefiting from some large CapEx-driven project orders that were expected in the second half of the year. The 24.4% operating profit margin expanded by 190 basis points on an organic basis as we benefited from operational – operating leverage, price discipline and strict cost management.

As I mentioned earlier, we successfully completed our first-to-world ElectroFit solution in Turkey, retrofitting the existing boilers, gas burner for electric heaters and helping that site become the Diageo’s first fully decarbonized facility worldwide. New orders have already been placed and we are building a pipeline of interest from other customers around the world.

Cotopaxi’s STRATA platform is being deployed across Steam Specialties’ operating companies to digitally enable efficiency improvements for our customers as well as for our own manufacturing facilities. We anticipate Steam Specialties’ full year organic sales growth significantly above IP with half yearly split of sales closer to our typical 48% to 52%. We also anticipate the improved first half operating profit margin to be sustained for the full year.

Given the fundamental changes we’ve made to the shape of ETS over the past 12 months, I will focus my narrative along the slide on the total performance of the broader ETS business. Demand for ETS Products & Solutions has continued growing significantly above IP in the first half of 2023, with the businesses order book further expanding over its already record levels of 2022.

We experienced strong demand for Chromalox and Vulcanic products, supported by growing interest for decarbonization solutions. While Durex Industries and Thermocoax experienced weaker demand from the Semicon sector. ETS sales grew 84% with operating profit up 110%, reflecting the first-time contributions from the Vulcanic and Durex Industry acquisitions. Excluding these contributions, sales were up 7% organically. The resulting operating profit margin was 14% and was up by 180 basis points.

As already mentioned, we initiated a USD 58 million investment to extend Chromalox’s facility in Ogden, USA and establish a state-of-the-art manufacturing unit exclusively dedicated to Medium Voltage heating solutions, which we expect will be fully operational in early 2025. We have made good progress with the integration of Vulcanic and Durex Industries to align both acquisitions through our Group culture, our values, including safety, our business model and core operational and financial processes. In addition, we have begun to leverage – cross-selling opportunities between Durex Industries and Thermocoax as well as consolidating their US manufacturing sites.

Now, compared to the 2022 pro forma results, we now anticipate full year 2023 sales growth well above IP with half yearly sales split also closer to the typical 48% to 52%. As well as larger decline of the operating profit margin than we guided to at the beginning of the year, because of the weaker Semicon demand.

In Watson-Marlow, sales for the first half of 2023 were 21% lower on organic basis due to continued destocking by Biopharm customers, which we now anticipate will continue into 2024. Although sales are lower than an exceptional level experienced during – the COVID-19 pandemic, compared to the first half of 2019 sales have grown by 9% on an annual compound basis, which is consistent with the pre-pandemic growth rate of Watson-Marlow.

In the first quarter of 2023, Watson-Marlow took steps to appropriately right-size manufacturing capacity and reduce overhead support costs. In order to offset the adverse impact of lower sales volumes on the operating profit margins, without compromising on our ability to respond to increased sales. The full benefit of these actions are expected to materialize in the second half of this year. The higher than expected first half sales decline adversely impacted Watson-Marlow’s profitability with first half operating profit declining 47% organically after a record first half of 2022.

Now, we anticipate sequential growth in sales and operating profit in the second half of this year, with the half yearly split also closer to the typical 48% to 52%. Biopharm end markets remain robust and we anticipate the underlying demand growth has continued at its pre-pandemic growth rate of over 10% per annum. Therefore, the business’s underlying strengths and competitive position in the marketplace remain unchanged, positioning the company well to meet the expected return of sales growth in 2024.

We’ve prepared this new slide to help improve your understanding of the ongoing dynamics within Watson-Marlow’s Biopharm business. Please note that this graph is for illustrative purposes only, and is therefore, not drawn to scale. The blue line represents the annual demand on Watson-Marlow from the Biopharm sector from 2016 to our latest estimate for 2023. The green line represents the underlying demand through the COVID-19 cycle, assuming continued demand growing at its pre-pandemic rate of greater than 10% per annum.

We estimate the incremental demand generated by COVID-19 to have been close to GBP 100 million. Two-thirds of the demand forecasted at the beginning of the pandemic, when expectations for global inoculation rates were higher than ultimately required to defeat the pandemic. This COVID-related demand is represented by the red line on the graph.

The vertical arrow in 2021 between the blue and the red lines, therefore, represents demand placed on Watson-Marlow in excess of what was actually required to defeat COVID. While the vertical arrow in 2023 between the green and the blue lines represent demand currently being satisfied by excess stocks built up during that pandemic.

So based on all of these assumptions, our takeaways are: first, most of the Biopharm customers destocking should occur in 2023, and second, once these excess stocks are fully consumed in 2024, we should expect Watson-Marlow’s Biopharm demand to return to those underlying levels, before resuming its pre-pandemic growth rates of greater than 10% per annum going forward.

Now, let’s be clear. Visibility in the market regarding actual levels of excess stock is very poor, with most customers unable to provide a reliable information. Nevertheless, once we get through this fog, which we believe will dissipate during 2024, we are confident that Watson-Marlow’s total organic growth will return to its 30-year high single-digit track record.

We have again added three new customer case studies that help illustrate how our three businesses improve the performance of our customers and help them achieve their sustainability targets by reducing energy expenditure and waste, while contributing to a more efficient, safer and sustainable world. These case studies are in the Appendix 1 of this presentation, and I would encourage you to read more about them at a later moment. So with that, we now move into the final slide of today’s presentation, which summarizes our first half performance and our full year outlook.

First half performance was broadly in line with our expectations as overall demand across the Group was higher than expected, sales were in line, but operating profit was slightly lower. Strong sales by Steam Specialties was offset by weaker Watson-Marlow and Durex Industries’ sales, which resulted in an adverse mix effect on the operating profit as a result of lower sales by the higher-margin businesses. It is worth noting that excluding Biopharm, the Group achieved 11% organic sales growth in the first half of 2023.

Now, our revised full year outlook for 2023 now assumes recovery of Biopharma and Semicon sectors moving out into 2024, with most of the destocking occurring in 2023. This would result in the half yearly sales split being closer to that typical 48%, 52% of prior years. If the exchange rates at the end of July prevail for the balance of this year, we anticipate a small half year currency tailwind becoming a full year currency headwind on sales and operating profits of between 2% and 2.5%. Now, compared to the full year 2022 pro forma results, we anticipate sales growth within a range of 0% to 4%, while the operating margin will decline between 100 basis points and 200 basis points.

We remain confident that the underlying Biopharm demand of the end markets remains as strong as in pre-pandemic periods. And therefore, the current demand softness is temporary rather than structural. More importantly, the Group’s underlying strengths and competitive position in the marketplace remain unchanged, and we are, therefore, very well positioned for stronger growth in 2024.

And that concludes today’s presentation. So, we will now be pleased to take questions from the analysts on the call. A request, that before asking your questions, you please state your name and that of the organization for the benefit of the other listeners on this call.

We are now beginning the question-and-answer session. [Operator Instructions] We are now taking the first question. And the first question from Rory Smith from UBS. Please go ahead. Your line is open.

Good morning. It’s Rory from UBS. Thanks for taking my questions. Firstly, Nick, congratulations on your tenure, some remarkable results in that period. And Nimesh, congratulations also for the move. My question is, I think there’s a lot to digest in here, but maybe if I go one by one and one for each division. Looking at Steam, first of all, you’ve flagged a lower rate of IP outperformance in H2, I suppose that’s relative to the high level of outperformance in H1, but if you could add any color to how you think about pricing versus sort of self-generated sales in the Steam demand for H2, please?

Well. Hi, Rory, good to hear your voice, and thank you for your congrats, and moving to your first question on Steam. Look, pricing, as you well know, is – the price management is very well embedded in our Group, all across the three businesses, not just in Steam. And therefore, we consistently have the internal processes that allow us to track what we believe are the real weighted average cost inflation. And then, look ways to pass that through to our customers in order to protect our underlying margins. And that is no difference.

So as inflation ramped up in the last couple of years, we equally ramped up our pricing, and you’ve seen that. And this year has been no different. Yes, inflation is coming off. It’s not as strong as it was last year. Nevertheless, we put through since the beginning of the year and continue to manage on the basis that we are offsetting. And that I can confirm halfway through the year, we are successfully offsetting the inflationary pressures on our costs through active – proactive price management practices across all three businesses by the way not only for Steam.

Can I add two things to that, please, Nick. So, Rory, hi. Thanks for your comments. Nick mentioned in the presentation some larger project orders that we’d originally anticipated in H2 being pulled into H1. So that’s part of the driver. And the other thing I’d point out is macroeconomic softness potentially in the second half.

Look, I think it’s incredibly uncertain at the moment. Just looking at the two credible providers of forecasts, Oxford Economics has full year IP growth at 1.4%. CHR Economics has it at 0.6%. And bearing in mind that the first half grew at 1%, essentially that tells you, they’re both pointing in different directions for the second half. A lot of that’s got to do with China. And you will have seen recent commentary in the FT, for example, around potential greater weakness in China than people had originally anticipated. So all of these things feed into our view for Steam in the second half. Thank you.

I think the extra detail you’ve given around sort of excess demand from COVID is very, very helpful, thank you for that. I suppose just looking into next year and the recovery, do you think that the level of inventories that you’re currently holding there could help with share gains versus the current sort of 20% market share that you’ve got in Biopharma as we get into that recovery next year? And then also on Process Industries. Is there anything to add in terms of the market share that you’re sort of seeing in Process Industries as well?

Look, Rory, I tried to highlight in this presentation, we put that new graph in there to try to give you a bit more visibility in that set of the dynamic. But it’s a real fog out there. The crystal ball is as hazy as you can take it to be. Because actually, when we visit the customer, you just don’t get a clear understanding. And you’ve seen that also, and you’ve commented that on some of the publications.

The reality is, look, the ultimate demand out there for the drugs from the Pharma and Biopharm industry that remains in change. That remains robust. People are still needing all the drugs that the industry has to produce. And when we visit customers you know end customers, end users, the drug manufacturers, they continue to be as busy as ever. We don’t see any slowing at the end of the market.

Where we’ve had this typical forward, the fact, is in the supply chain, and therefore, we are seeing, for example, bigger stock pills in some of the larger OEMs you know like Sartorius, for example. And so those customers, yes, we see a bit more. But, of course, those customers, because their OEMs are more related to the capital cycles of the industries and customers than we are, okay.

And therefore, we see – there are some different dynamics within the industry, which I would want to remind you in that case. We are, as you all know, a lot more exposed to the OpEx cycles of our customers and consumables within Watson-Marlow and those kind of single-use applications, those kinds of things.

So specifically, the issue about market share gain opportunities, I don’t think it really applies, because I mean, we have – these are not industries that are easy to penetrate. You’re going to have certifications in place and qualifications. So once you’re in there, you don’t get really for the vast majority of the products, you don’t get switched in or out very easily. And those excess stocks, let’s remember, for the end users, the drug manufacturers themselves.

Our products are low ticket items, but of high criticality to their process. So they typically will hold a bit more of their stocks in their part to ensure that their processes do not suffer and they can continue. They’re not worried about holding a little bit more excess stock, because they’re not very high-ticket items, but they are critical to their processes, which actually ironically also contributes to the fact that customers can’t give us really very good visibility of their excess stocks of our products because they are smaller value items. And so they’re not too worried about that.

So, what I do think that contributes to continuous market share gain across both the Biopharm and also the Process Industries sector that you questioned about, is really the strong presence that we have across all of our customers, all of our sectors through the direct sales model with this broad range of products, the broadest range of products in the industry.

The direct sales support providing customers with advice insights how we can improve their process efficiencies, their sustainability, all of these things. And that’s what really gets us the market share growth, and we’ll continue to, because that’s really underpins our strength in these market sectors. So, again, these excess stocks, they are a transitional temporary blip. They have no – as we see it, no bearing on the longer-term strength and success of the Watson-Marlow business going forward.

Yes. Can you remind me, apologies if I should know this, but was there an earn-out for Durex and if there was – has that now been actually not triggered?

I couldn’t hear, Rory, was it earn-out?

Was there an earn-out on the acquisition, yeah?

No, no, they weren’t. Neither of the two ETS acquisitions.

Understood. Very clear. Thanks very much.

Just to add to that, the one thing that is worth everybody just being aware of, is, when we bought Durex Industries, in particular, we had anticipated a slowdown in Semicon demand. So that was built into our acquisition case.

Yeah. Obviously, as usual, these things come in a little bit stronger than you had anticipated because it’s always difficult to call the magnitude, but we had already anticipated a decline in this year sales. It’s just coming out a bit worse than we expected.

Sooner than we expected as well.

Yeah, moved stronger that in May. Okay. Thank you, Rory.

Thanks.

Thank you for your question. We are now taking the next question. Please stand by. And the next question is from Dominic Convey from Numis Securities. Please go ahead. Your line is open.

Hi. Good morning, gents and thanks for taking the questions. Just two for me really. Just trying to better visualize this destocking impact within Watson-Marlow. I wonder – can you tell us roughly what the split between sort of hardware and consumables would be? And following on from that, maybe just a typical pump sold into the Biopharm sector, what the expected lifespan would be?

And then a separate question, I don’t know if it was covered there’s a bit of disconnection there. But in terms of the rightsizing benefits both Watson-Marlow and within Durex, I wonder whether you could just quantify those in terms of sequential benefit in the second half versus first and also the full year benefit, please?

Thanks, Dominic. Good to hear your voice. Look, in specifically, the Biopharm part of Watson-Marlow, okay, which I think is what your question directed at. The consumables have averaged somewhere close to about 40% of total sales. But I would remind you that what you’ve called hardware, it might be actually a bit higher, because it’s not so easy to measure these things.

Surprisingly, it’s not that easy, because when the customer orders something, it’s not clear whether it’s because he’s using it as a consumable or because the products couldn’t be used a lot more. So for example, if you’re in a single-use processing plant, then yes, it will be used once and replaced, and therefore, it becomes consumable. But those same products can be used in other clients that are not single-use production lines. And therefore, it’s not always that simple to distinguish it.

However, what you called, hardware, let me remind everybody, these are small value items. I mean an average Watson-Mallow pump is GBP 1,500, GBP 2,000. It’s not big, massive capital equipment. That’s why all of this tends to go to the customers’ OpEx plus their maintenance, their operating budgets. And it’s not that bad.

And typically, they will have backup pumps because these are critical in the production line, so they can’t – they can’t run the risk of stopping the line for the small value item that’s so critical in their process. So, even those smaller pumps is something with a break or wear out, typically, they get replaced as opposed to repair because of the small value. So these definitions aren’t as hard set as you would think. But having said that, on the rightsizing, I’ll let Nimesh address that one.

Yeah. So, you’ll have seen Dominic that we have in our adjusting items, the restructuring cost for Watson-Marlow, which is about GBP 5 million. I think you can apply usual rule of thumb, give or take of circa 2 times benefit of the cost and bear in mind, that we’ll get one half of that benefit through the second half of the year. And we’ve had a little bit, but not a huge amount of the benefit in the first half. So that gives you a bit of a sense.

In Durex Industries, the rightsizing actions are much smaller. It’s a smaller business. So we’re talking about 50, 60 people being taken out of the direct labor force in Durex Industries. Bearing in mind, that it is located in the US where there is more flexibility around labor. So you can estimate yourself what the benefit might be there.

So, fundamentally, the point is that in the second half of the year, margin improvement will be driven by higher volumes, partly because of the typical split, 52%, 48% partly because we will have, hopefully, some recovery in Semicon and Biopharm. And then the drop-through of those higher volumes, that operational gearing benefit will be higher because of some of the cost actions we’ve taken. And that’s what’s reflected in the range of guidance that we’ve given.

That’s very clear. Thank you.

Thank you for your question. We are now taking the next question. Please stand by. And the next question from Aurelio Calderon from Morgan Stanley. Please go ahead. Your line is open.

Hi, good morning. Thanks for taking my questions. And congratulations, Nick and Nimesh on the move. I’ve got three questions, and I’ll go probably one at a time, if I may, please. So, I guess first one is kind of more of a bigger picture question.

It’s like, obviously, we are going through a destocking phase in Biopharma and in Semis, but I think you’ve – probably you’ve already covered this, but has your expectations – have your expectations changed at all on the kind of long-term dynamics for this industry, both in terms of growth and margins? Is there any reason to believe that this one be to high single to low teens industries with, say, higher than average Group margins?

Thank you, Aurelio for your comments and your question. No, we have no change in expectations about the very robust, strong opportunities that we see for growth in the Watson-Marlow business and the Group. Again, we do see this as a very temporary blip, if I could call it that, as opposed to a structural issue that changes the dynamics of the industry, all of our businesses, our company.

We have every evidence as I mentioned earlier in response to Rory’s question, that the underlying demand for the drugs that are Biopharma customers and the Pharmaceutical customers, that demand continues as robust as always, all the other drugs that they had in place before COVID came around. They’re just not making as much COVID vaccines that they thought we were going to make.

But the demand, and they may have actually suppressed a bit of that demand during the COVID pandemic because of the need to make more vaccines. So there’s some indication that some customers might have diverted some of their production capacity to make vaccines and therefore, not service the market with all the other drugs that they have and the way that they were doing it before the pandemic.

So what that tells you is, they’ve just gone back to the good old world that they were having before COVID came along and disrupted everybody’s life. They continue to be busy as ever. They continue to be developing new drugs and launching new drugs. And I personally believe that there’s no reason to – no evidence that the underlying demand of the Biopharm sector, and therefore, the demand on Watson-Marlow from that sector will be any lower than it was in the pre-pandemic times.

If anything, it might even be a bit stronger. But definitely, no diminishment. And therefore, given the strong positioning that we continue to build upon, we’ve come out stronger from this COVID pandemic across all of our businesses, in particular, Watson-Marlow. So no, I just see the long-term perspectives as robust as ever.

Can I add two things? Firstly, as most of you know, Watson-Marlow over roundabout three decades has grown at a compound annual growth rate of about 9% organically. If you look back to the first half of 2019, pre-pandemic through to today, Watson-Marlow has grown at a compound annual growth rate of 9%. And I think what you’re hearing clearly from both Nick and I, is that, on a longer-term basis, we expect Watson-Marlow to continue to grow at high single-digit.

That yeah in total. Yeah, absolutely.

That’s very helpful. Thank you. Second question, again, a big picture question, and it’s picking up on a couple of your comments on kind of the ERP rollout across the three businesses and some of the cross-selling synergies you are now kind of starting to realize in ETS. It does feel like you’re moving more into the direction of one Group running the three businesses together more so than you did before. Is this fair? Or am I reading too much into the lines?

Good. No, you’re not. I mean, I think I’m glad that you’ve noticed this. Look, we’ve always said when we acquired Chromalox and started building the ETS business of today, and that was six years ago that we’ve been on this journey with ETS. We’ve always said that we would only invest in businesses that we could see were related to the existing businesses that we already have.

Our business model is really solid, and we would only – and we only acquire companies where we can deploy that business model. And therefore, if you’ve got businesses that might make different products, but are aligned in their business or how we go-to-market are reliant on the purpose of what they do. For example, Steam and ETS too, as we’ve said many times, the two most prevalent mediums for transferring heat into industrial processes.

So that bring these natural opportunities. And we continue to build upon them. And yes, of course, the target zero solutions that we launched last year, the first, but not the only obvious examples of revenue synergies across businesses. And we will continue doing that.

However, and we also have some – but these are small cost synergies, for example, when ETS companies want to expand into new territory and where Steam is already present, we obviously can facilitate that by hosting ETS people in Steam facilities, giving back office support, all those kind of things. So there’s some benefits there. But it’s mostly around speed of access to new markets, okay. Why? Because what we will not change is keeping each one of the three businesses focused on their specific products and technologies, because our people are specialists in those products, technologies and how to deploy those products and services to create more value for our customers.

And therefore, we want to – you can’t be a specialist in everything. So we want the Steam specialist to continue to be specialists of Steam and the electric people, specialists in their electric solutions and the fleet technology people in Watson-Marlow focused on their specialization. But we want them communicating across the Group and helping each other, create more opportunities. And we’re seeing more and more of those example.

We encourage it in multiple different ways. We’re beginning to see opportunities arise between, for example, across ETS into Watson-Marlow. We’re – yes, and I’m not going to make a big story about this yet, because it’s just a small example for you, but it’s an indication of what I’ve been saying.

The Durex Industries was already when we acquired them, supplying some flexible heaters into a Biopharm customer to wrap around, for example, filtration applications in the Biopharm fluid path. And so we said, “Well, this could be an opportunity to maybe find some synergies between Watson-Marlow and ETS”. And we’re finding those.

So this is very – [inaudible] very early days. Don’t get too carried away by this. But as you said, in the big picture and looking more long-term, this is exactly what we are building on the strength of each business is to leverage the power of being one Group that the sum of the parts is greater. The Group is greater than the single part.

Very helpful. Thank you. And just lastly from my side, bit of a shorter-term question. And I know that looking at the ETS numbers could be a little bit kind of difficult to compare pro forma with organic and so on. But sort of your guidance or your outlook for ‘23 implies that on the organic part, i.e., on Thermocoax and Chromalox. It seems like you are baking in a margin recovery into the second half, just purely on that organic part, if you wish. So just trying to make sure you – that’s the right way to think about it? And what are the drivers of that improvement? Is it just Semis? Or is there anything else that’s also helping you in the second half?

Look, Aurelio, yes obviously, you’re reading the guidance correctly. We will see a sequential step up, as I said, into the second half over the first half in terms of sales volume of revenues, right. There’s a couple of drivers. Number one, it’s the natural seasonality. We always have across all three businesses, a higher sales in the second half of each year. There’s – we’ve been a couple of years, which for very specific reasons that 48% sales in the first half and 52% in the sales [sic - second] half has been slightly different, but they’re very punctual exceptions to prove the rule for very specific reasons.

So yeah, what we’re seeing and expecting for this year is to return to that normality of a stronger second half seasonality and part of the reason is because some of the larger value or the other projects or some of the self-generated solutions, they take a bit longer to deliver. They don’t transition through the order book so quickly, so you end up getting them in the first half of the year and shifting in the second half of the year. So you’ve got those kind of dynamics. So that’s the first point. You have that natural seasonality with the stronger sales in the second half, and that will give you some operational gearing, of course.

In the case of ETS, there’s another factor, which as we’ve mentioned before, we had so much demand at some of our plants, and particularly, Ogden that we’ve talked about a lot. We still have capacity constraints. We’re still working very hard and the team are doing a fantastic job out in Ogden. Nimesh and I was there earlier this year, and we monitor progress there on a monthly basis. We get updates and team are making fantastic progress in terms of debottlenecking the plant, expanding capacity because we’ve got a massive order book, and we want to try to get more out of it to the pipeline.

So there’s a bit of that coming through as those benefits start coming through. Like all things, it’s always very difficult to find a precise moment when these debottlenecking effects start dropping through at a faster rate. But that’s coming through to some degree and also will have an effect going into next year. So these are some of the main points that you would see that coming through. Nimesh, do you want to add a bit more to that point?

I think the only thing I’d add, Nick, is, the reason we’ve given a range in our guidance on both sales and profit is, because, as Nick said earlier, it is difficult, very difficult to estimate the inflection point in demand for Biopharm and Semicon. And so where we are looking to that margin performance in the second half beyond the usual seasonal nature of sales, it will depend on when and how strongly that recovery comes through. And that will impact Thermocoax.

So on the organic side in ETS, it will impact Durex Industries on the acquisition side of ETS and in Biopharma it will impact Watson-Marlow same issue. So, that’s what sits behind our range. And you’ve kind of heard everything that we’ve shared with you, and we’ve tried to be as transparent as possible. So I think then beyond that, you got to take your own judgment about where you think the year will end up in that range.

That’s very helpful. Thank you very much, Nick and Nimesh.

Thank you for your question. We are now taking the next question. Please stand by. And the next question from Andrew Douglas from Jefferies. Please go ahead. Your line is open.

Good morning, gentlemen and if I can just echo all the people’s comments about to both Nick and Nimesh, good luck to you both. I’ve got four questions, but hopefully, I’ll be quick. With regards to the costs that you’ve taken out of both ETS and Watson-Marlow, if we get a reasonably sensible quick and sharp back rebound in both of those divisions, does that cost go back in? Or have you right-sized that now for what you think is the right size for ‘24, ‘25? I’m just trying to figure out exactly what you’ve done, if you’re taking a few people at the head office and one or two people out manufacturing than possibly not. Does that cost need to go back in?

Second question is with regard to your views on the Semicon market. I hear what you’re saying about the kind of cyclicality of Semicon. Do you guys have or have your customers given you any indication of the kind of the shape of that bounce back? It feels it was like Semicon to the bottom, but it’s going to take a little bit of time to rebound. And I’m just wondering if that’s a view you share?

On Watson-Marlow, can you just give us a feel for where you are with your inventories? I hear that your customers are destocking, but do you guys have to under-produce to get your inventories in the right place or maybe you do in the second half? Just trying to figure out that? And then last is for Nimesh, particularly and a slightly for Nick a few questions. Your depreciation is down year-over-year. I would have thought you would be going up quite sharply given your CapEx is running pretty heavily above depreciation. Can you just explain to me what that is? Because I’m a bit –

Okay, Andy. So we’ll take these questions in the order you’ve asked them and Nimesh will jump in to supplement my questions, and then specifically respond to your depreciation question.

Thank you.

Cost out, first thing I’d say, we have taken costs out across all of Watson-Marlow in a very targeted special way, because, as I’ve said, we don’t want to compromise our ability to bounce back when the recovery must start materializing. Now – and look, we’re doing nothing different than what we did back in 2020 when the pandemic hit and everything started closing down.

We cut back on – at that time, the actual restructuring or rightsizing of operations, we didn’t have that because we didn’t want to compromise this bounce back and you saw that, that was a good decision because when the bounce back came a few months later, we were well positioned and we’re able to leverage that very well, as you saw in our results in 2021 and 2022.

So, it’s the same process. Now we’ve taken people out in the manufacturing facilities, yes, because if the volumes are down. But again, what you need to understand is, down from excessively high levels that we – of demand that we were receiving in Watson-Marlow in ‘21 and ‘20 – and early ‘22. So there was this thing – we’re putting a lot of temporary people in the plant, expanding capacity in the lines, do all sorts of things to be able to satisfy an excessively strong demand.

And therefore, where we’ve right-sized the plants, we’ve right-sized them from those high levels of demand that we were getting to the expected levels that we’re looking at coming through in the near future in the next few months. Not to the level of orders that we’re getting now, which is why we could have taken more people out of the plants, for example, but we haven’t, because we didn’t right-size for today’s demand with right-sized for the demand that we’re expecting to recover shortly.

Therefore, in the plant, for example, we probably won’t need to be putting too many people back in, because they’ve been right-sized for that purpose. Equally, in all the other support functions, overheads and et cetera, we’ve tried to contain the organization for the levels of sales that we’re expecting in the future. But then obviously, as those – if those start coming – can we start growing at a faster rate, then we’ll do what we’ve always done, which is to start putting them back in a very targeted way.

Around the shape of the bounce back in Semicon, Andy, my crystal ball is the same as yours. It’s – yes, we’ve looked at the cycle of the industry as a whole. Remember, we are servicing the OEMs that make the equipment that makes the chips, you have the fabrication equipment sector. And within that sector, the customers that we service are operating more in the premium end of the chips, not the chip in the FOMO commodity type of chips, the high volumes as these are very high requirement chips are more specific. And therefore, not necessarily subject to the same intensity of swings and roundabouts to the more commodity chips.

But yes, it had a big boost to the industry. It’s come off. We were expecting it to come off. As Nimesh said, it’s always very difficult to call the exact timing and intensity of any of these changes. But we followed in our ETS part to service that Semicon sector, the same principles that we’ve applied in Watson-Marlow for the Biopharm sector in terms of adjusting the organization for the volumes that we anticipate will be coming. We just can’t tell exactly when it comes. And actually, neither can the customers tell us. Yeah.

And we are getting feedback from – I mean we are engaging our customers all the time, so our views here are based on what our customers are telling us. But equally, they don’t quite know what their demand requirements are going to be too far out. So they give us estimates, but they are subject to change. So that’s right material.

And, of course, as I said earlier, adding Watson-Marlow it also applies to ETS. Our products are highly critical but not high-value ticket items. So therefore, the customers aren’t too worried about stock management or having a little bit of excess. And so they don’t get much visibility to those, because they’re very busy with their higher value items, managing the stock of those. So there is that in the background also.

Now, regarding our own inventories that you questioned about, in the case of Watson-Marlow, Look, we don’t typically have a lot of finished product stocks in the Watson-Marlow sales companies around the world. The more distant operating companies in Latin America, even in the US and in Asia, there’s a bit, but it’s not to the same degree we have in the Steam Specialty sales companies, for example, okay.

Therefore, most of the stocks on Watson-Marlow are really in the plants, because a lot of components, both in components, then we assemble rapidly against orders and flow through more rapidly to the customers. So no, we don’t have the risk of a bull with effect within our own stocks in the case of finished goods for Watson-Marlow no that isn’t – you don’t need to have that concern and the stock of components in the plant. That’s not a concern for us. And then the final question on the depreciation, I’ll let Nimesh address that.

Yeah, Andy. So on Page 12 of our press release, we’ve got our adjusted cash flow table. And in that, you’ll see the depreciation this year versus last year, both including and excluding leased assets, and it’s higher through the first half of this year than last year.

Okay. Thanks very much for that.

And you know the reasons for that. That’s the investments we’ve made in our facilities around the world.

Understood, thank you.

Thank you for your question. We are now taking the next question. Please stand by. And the next question from George Featherstone from Bank of America. Please go ahead. Your line is open.

Good morning, everyone. Thanks for taking the questions. The first one would be on your more Process Industries exposure. I mean, the growth there is, I mean, significantly ahead of IP growth. And I guess, previously, you talked to those businesses delivering something like just over 2.5 times IP, but obviously well ahead of that now. What do you think is ultimately driving this? And how sustainable do you think that level of growth is going forward should we see a gradual normalization of those typical outperformance levels?

Hi, George, thanks for your question. And thank you for asking us a question about Watson-Marlow that isn’t related to Biopharm. It feels good to be able to talk about the other good part of Watson-Marlow. Look, good question, well picked up.

Yes, historically, and it’s good we get the opportunity to your question to remind everybody on the call, that whilst the Biopharm part of Watson-Marlow has its drivers of its own, which is really directly related to that strong double-digit Biopharm’s industry growth. The Process Industries with all other sectors that outside of life sciences that Watson-Marlow supports and services are correlated to IP, like the Steam Specialties business, like the ETS business. So yes, we do have that correlation.

Yes, we’ve talked about somewhere above 2 times, 2.5 times that is a good barometer, good guideline for planning around two or more than 2 times IP through the cycles. But within cycles, you could have – those numbers can vary a bit, particularly in the last few years, where you have a bit higher pricing element into that, okay, because, of course, those rough guidance is around 2 times or more than 2 times IP when price level – includes price and therefore, when prices were in more normal circumstances.

So a bit of the outperformance that you’re seeing is to price – but more importantly, the other part is because through the direct sales model, in all three of our businesses, we’re now – we’re specifically talking about Process Industries in Watson-Marlow. We are gaining share all the time.

And in Watson-Marlow, particularly, we like to talk about, for example, in the Process Industries, the Qdos pumps that were designed to take share from other types of pumps, not from other peristaltic pump manufacturers, from other types of pump manufacturers. So for example, the Qdos pump is designed to take market share away from the solar diaphram pumps, okay and it’s very successful in doing that.

So as we develop products through our R&D pipeline or sometimes through acquisitions. But as we do that, we expand our addressable market for those Process Industries. We go into sector – into addressable markets that we before didn’t have products to service those applications, and we start taking away share from other competitors or other types of applications before we didn’t service. So that’s one of the drivers of that higher than 2 times growth, and that continues.

And it comes down to the power of our business model with a lot of investments in innovation, new product development, direct sales, leveraging those innovations globally. And, of course, all of that will continue. It is happening in the background. It doesn’t get a lot of visibility, because of the distractions surrounding Biopharm, but it continues to happen as we speak.

We had actually two fantastic years ‘21, ‘22 in the Process Industries. That just didn’t get visibility because of the extraordinary exceptional demand that we got from COVID into the Biopharm sector. But yes, the Process Industries are doing very well, and that will continue going forward. So thank you for your question.

Thank you. And maybe just a final one on China. It sounds like in Steam anyway, you got some quite good large orders in the first half. I can’t remember whether you said they were from China or not, but the outlook clearly in China, certainly in terms of the recovery of that market doesn’t look like it’s an immediate snap back anytime soon. But I just wondered what you might be seeing in terms of listening to the businesses out there, what they expect in terms of recovery and the profile of that? That would be helpful.

Thank you, George. Another good question. Look yes, like everybody else, we suffered – and, of course, our Chinese operations in Steams are important operations. It’s big – it’s a big part of our Asia-Pacific division in Steam. And it’s very – it’s a great business that we have out there, very successful, fast-growing, et cetera.

So, we did suffer last year, like everybody else in China suffered with the COVID lockdowns and was expecting a recovery this year that really has not materialized to the degree that ourselves, our people out there, the Chinese government, every other company that you speak to in China is facing a subdued or underwhelming recovery in China, I think it’s true to say, we’re no different, okay and as we’ve said in so many other circumstances, it’s very difficult to call when the timing and the magnitude of these turnarounds.

So, again, in the case of China, my crystal ball is very hazy. There are lot of fog around. Our team there is fantastic. We do have a very strong competitive position in the market, very successful, they’re developing new applications. A lot of exciting stuff around, for example, the electric vehicle battery manufacturers, processing of the minerals to go into that manufacturing of the batteries themselves. There’s a lot of good stuff happening that’s helping mitigate some of the economic weakness or the weakness of the Chinese economy at large.

And, of course, the complexities of the Chinese economy slowdown with the high levels of debt, the construction sector that was an important part of economic growth, which has slowed down massively. The ability of the Chinese government to enact stimulus packages to reignite all of these things, we have no control over, and we monitor closely, but ultimately, we’ll have an effect on us also. But in the meantime, we’re tracking ahead as we always do with our niche businesses, and we’re getting some good progress out there, leveraging the strong competitive position that we have in the Chinese market.

We’ve got a few more questions left, I think on the lines, and we’ll try and go a bit quicker just to get through those in the next 10 minutes.

We will now take the next question. Please stand by. And the next question from Lushanthan Mahendrarajah from JPMorgan. Please go ahead. Your line is open.

Hey, thanks. Thanks both for taking my questions. And also want to extend my congratulations to you both on refinement and CEO role. Two questions for me, please. The first is on ETS. That 18% or so pro forma, that’s exposed to Semis. Can you sort of give us an idea of how much that was down? Or I guess how much the rest was up? Because I guess 7% organic implies that the rest of the business was pretty strong. And also just in terms of margins, that Semi exposed there, can we take sort of Durex margins as a good proxy for what the entire Semi exposure is just in terms of thinking about that mix impact?

So just a very quick answer. As you know, we don’t give growth rates sort of sector by sector within the businesses. But the way to think about it is that Semicon impacts organic through Thermocoax and it impacts total ETS through Thermocoax and through Durex Industries, okay. So that’s why you’re going to find it a little bit harder when you’re trying to break down between organic and inorganic.

Overall, for the – ETS, as you said, 18% of sales. So that gives you a sense of the quantum of the impact. And you are right in that Thermocoax and Durex Industries are the highest margin parts of the ETS Group, both of which are above 20% margins, okay. So that’s why we feel more of the impact because it’s the impact in Semicon in the highest-margin businesses, which impacts the mix of the divisions contributing to the ETS overall margin, which in turn then pulls it down.

Okay, thank you. And the second question is just on project deferrals. You sort of mentioned a couple of times in the release. Can you just give us a bit more color on exactly what type of projects you’re seeing? Or is it sort of specific end markets, et cetera.

So I think this links into what we’ve been talking about with the macroeconomic weakness. So where we have our MRO business, that tends to be far more resilient. And, of course, because we are supplying critical products into critical processes, the customers prioritize their MRO spend with us.

When we start to talk about the larger CapEx projects, we also tend to be more late cycle in terms of the CapEx. And therefore, we’re a little bit slower to feel the impact of CapEx spend dropping off, but customers do have some flexibility to just marginally adjust the timing on those orders. And I think we’re seeing some of those be deferred a little bit.

And then we have what I would call more discretionary projects, where customers are looking to increase the throughput through the facilities, maybe improve sustainability, maybe improve efficiency. And then, those projects can sometimes be GBP 50,000 up to GBP 200,000. And there, again, those are more discretionary in nature. So they are important. Our customers will do them.

But in an uncertain macroeconomic environment, there are some who will just take a little bit longer to make the decision until they see what the outlook is likely to be for the balance of the year and into next year. And so, I don’t think I would want to overplay the impact of project deferrals, but it does have an impact around the margins on growth second half versus first half.

Okay, very helpful. Thank you.

Thank you for your question. We’re now taking the next question. Please stand by. And the next question is from Mark Davies Jones from Stifel. Please go ahead. Your line is open.

Thanks. Good morning, both. Keeping it snappy on time. But can we look at the exceptional growth in Steam in the first half? You mentioned the timing of the projects coming out of Asia. But can you give us some help on other moving parts, anything that might fade in the second half? So how much of that 15% either come from price rather than volume? And is there any sort of catch up within that number given supply chain constraints, either for you or your customers slowing down delivery through the back end of last year?

Hi, Mark. Look, there’s no price differential between first half, second half, and we don’t disclose those prices anyway separately. But the driver really is the underlying strength of the business of the Steam business, which is good really to call out. Of course, price has a bigger element – a bigger contributor to the organic growth than in previous years, because inflation has been higher and therefore, price is still a significant part or a more important part this year than previous years.

But the growth is really about the strength of how the team in Steam are implementing our strategies, leveraging our self-generated growth. We have seen, and we’ve talked about this before, a growing – a rising trend of direct sales of self-generated growth opportunities.

Smaller projects, GBP 50,000 to GBP 100,000, for example, where we’re self-generating, and there’s more and more of that happening, and these things build up. So that’s really – it’s the competitive strength of the business in the market, the higher proportion – a growing proportion, I should say, of self-generated solutions that our teams as a result of all the training and the strategy that we’ve been putting in place.

Okay, thank you. If I can sneak one more on Watson-Marlow. I take a point that most of this is all about the overstocking working its way through. But on the assumption that things go back to normal, isn’t there an issue there around financing some of your customers? And what is the nature of your customer base? Is that dominated by large players? Or do you have lots of smaller and more startup entities because clearly, getting capital is more challenging now than it has been previously in that sector?

Yeah. Raising capital funding for customers doesn’t play a role in our relationships, we have from small start-ups, yes, there are a few of those, but they don’t come to us for capital. One small startup that became very noticeable to the pandemic was Moderna. We were working with them from when they started up.

But a lot of our customers are big – we’ve got all the large Pharmaceutical and Biotech end users, drug manufacturers. You have OEMs that support the main supply equipment into those end users like people like Sartorius has been in the news of late. You’ve got a variety, but usually larger big customers and financing or raising capital that hasn’t played an effect in our relationship with them.

Okay, thank you.

Thank you for your question. We are now taking the next question. And the next question from Bruno Gjani from BNB Paribas. Please go ahead. Your line is open.

Thanks for taking the question. I just was wondering if you could talk just a little bit more about that strength of the order book of the Steam. I thought it was very encouraging to see that the order book continues to grow, despite you delivering 15% organic sales growth in H1, and you mentioned on the call, there were some pull forward of some orders that were meant to slip into H2 we delivered that in H1.

So it looks like a very strong performance on the order front. What’s driving that, particularly if some customers are deferring some of the project-based orders or not placing them? And I guess, how would you expect that to convert into H2 in the context of supply chain constraints are using as Mark just mentioned earlier on?

Sorry, I didn’t hear the second part, Bruno. What was the second part again?

The second part was just on your expectations of how this even longer order book converts now in the context of supply chain constraints easing?

Okay. So for us, really, the supply chain constraints, I’ll start with that one, is no longer playing any material part, okay. So across all three of our businesses. It has played at times that fortunately not a degree that you’ve seen from other sectors or other companies. But today, that really is small noise in the background. So no longer playing any constraints on – from the supply chain point of view.

The strength of the Steam order book, again, speaks to what I was saying on the previous question from Mark. It’s the strength of the growth of the business. A little bit – we did call out that they’ve been in Asia a larger project, which was expected in the second half of the year was pulled forward in the orders placed a bit earlier in the first half of this year. So kind of distorts a bit of the Half 1, Half 2 saying and makes that first half growth look a bit strong in terms of demand income.

And – but the seasonality of our order book is always one in every year, where the order book does grow a bit in the first half, as I mentioned earlier, some of those larger value projects that take a bit longer to transition through the order book. You tend to get delivered in the beginning of the year and shipped in the latter half of the year, which, therefore, means that the order book does normally build up a bit in the first half and then come off.

What we’ve seen is a little bit distortion for that bigger project that came forward. And we’re beginning to hear the sentiment of some customers worried about the clouds in the horizon, the economic clouds in the horizon and beginning to see, okay, can I delay the order or delay the delivery of a product?

But remember, in the case of the larger projects, we are right at – we’re late cycle. We’re right at the end of the project. So by the time the customers they can delay getting started on some projects, but the projects that are ongoing by the time they get to us, they can sometimes defer a little bit of the delivery, but they can’t really cancel it because the project is too far advanced to cancel the whole thing.

Yeah and one other observation, Bruno, don’t forget we have a very high proportion of book and ship in Steam. So unlike other companies in the industrial space, the order book is a helpful indicator of demand for the second half, but not as material as it will be for some of the other businesses in your coverage universe.

And it does speak – the strength of the order book does speak to the strength, the underlying strength is because those book and ships were using very rapidly through the order book. But it just means that the orders are coming in strong. I’m actually a bit stronger than expected. And just on the energy –

One more – I’m sorry, go ahead Bruno.

Energy transition order book. No, no just on the energy transition order book, I think you mentioned it was significantly enhanced. Could you perhaps give us an idea of how large the order book is in absolute terms? Or just, I guess, the rate of growth from or would have been low levels. But nevertheless, I think that will be quite –

No, we’re not giving any guidance on that. It’s early days, and we don’t disclose that kind of information. But the sentiment is very positive. The level of inquiries is very strong. These are complex projects, and they take longer to land and then to deliver. So we’re not giving any quantified guidance on that.

Thank you for your question. And we are now taking the last question. Please stand by. And the next question from Jonathan Hurn from Barclays. Please go ahead. Your line is open.

Good morning, guys. I keep it pretty short, just three questions, which hopefully you can rattle through. But just firstly, just in terms of Watson-Marlow Process Industries, if you look at the sales in H1 that was flat. I know there was a tough comp there. I think from prior guidance, maybe you expected them to be a little bit stronger. But I think the key question is just as we look to H2, do you think that Process Industries in Watson-Marlow can grow year-on-year? That was the first one.

Yes is the short answer. Yes, you’re absolutely right. The first half was flat, but it’s a very strong comp in the previous two years, not just in last year, as I had referred to earlier. So yes, we are expecting some sequential growth, if you want in Process Industries of Watson-Marlow.

Okay. Very clear. The second one, just stay on Watson-Marlow. I know this is going to be difficult, but how do we think of that of the margin of that business more in sort of ‘24, does it go back to 30%? Or do you think it sort of progresses in sort of a step between where it is now towards that 30% in ‘24? I’m just thinking, obviously, you put a lot of excess capacity in there. I know you’ve taken some costs out, but in terms of IP, you doubled the capacity there, there’s probably going to be a little bit of overhead under absorption, I suspect coming through in ‘24 as well. So I’m just trying to get how we kind of think about that margin ‘24 and ‘23 for Watson-Marlow?

Jonathan, it’s a very fair question. Look, as we start to see the recovery in demand and then in our sales, that additional volume will drop through at a high percentage for exactly the reasons you’ve just described, the restructuring we’ve done, the general cost containment and that will drive the margin higher.

However, as that margin starts to go back up, we will also restart some of the revenue investments that we have put on hold in that business. Now, we don’t know, as we’ve talked about at length on this call, we don’t know exactly what the timing and the scale will be of that recovery, hence, our range. We would look for some of that recovery through the second half of the year. That’s certainly what our customers have been telling us, but it remains to be proven.

And therefore, we do expect a higher margin in the second half of this year than in the first half, but not back to the levels that we have experienced in previous years. And so I think it will be into 2024 and potentially beyond to really get the margin back to where we would expect it to be. But yeah, it’s a pre-pandemic levels. But, bear in mind, that we will be looking to restart those revenue investments again as well. And so I don’t think you’ll see margins of the scale that we saw in the middle of the pandemic, okay. Does that help?

No, that’s clear. That’s clear. That’s something to work on. Thank you. And maybe just a –

As the business in sales, you expect to see the margin normalizing also. That’s how you should think of it.

Okay. Very clear. And then just a last one. Just in terms of Chromalox. I think historically, there were some lower margin orders within that order book, I think, those were booked before you push through the price increases. Is there any more of that to come through? Or all those sort of exited the order book by now?

There is a bit. There is a bit, because of the capacity constraints that I mentioned earlier, we haven’t managed to get them all out yet. And some of those projects are quite substantial projects, some of them tied to decarbonization, but some of the older ones with lower margins, not so much. So, a lot of that has come through, a little bit is still pending. But the good news really is that, the team, they have taken some fantastic action in terms of pricing, such that the quality from a margin perspective, the quality of the order book is much stronger than we’ve had before.

So as soon as we can start getting more of that debottlenecking to start opening up and allowing the flow of materials to come out at a faster pace, we’ll clear out those older lower-margin projects and still remain not many, go with them, you’re going to start seeing the newer orders that are in the pipeline waiting to behind those that have already been priced at much better levels. And therefore, our expectation going forward is that you will start seeing the margins progressing to the levels that they should be across the ETS business, as the volumes start ramping up through the destocking. And this is particularly mostly around Chromalox I’m talking about.

Perfect. Very clear. Thanks. And I just like to say, Nick, thanks for your time and your input in answering the questions over the last 10 years. It’s been great and good luck for the future.

Thank you very much, Jonathan.

Thank you for your question. There are no further questions at the moment. I will hand over to Nick for closing remarks.

Okay. Well, thank you very much, everybody, who’s on the call for joining us and for the analysts that have placed their questions. I appreciate all the questions and the time and the good quality work that you do as you follow us. And I think this is the 20th results announcement that I have done in my 10 years that are now coming to a close. So I would like to actually use this opportunity to – and hopefully, I’ll see many of the people on this call before I retire early next year.

But in the event that I don’t see everybody, I do want to also say thank you to all of you because the quality of your coverage, your questions, your support has been appreciated. I’ve enjoyed working with all of you over these 10 years. And I look forward to staying in touch with you in the years to come. But hopefully, as a non-executive, not doing too much work and enjoying some other things that I haven’t been able to do. So thank you all very, very much and look forward to catching up going forward.

And that’s conclude the conference for today. Thank you for participating. You may all disconnect.