Victrex PLC

LSE:VCT

Earnings Call Transcript 2019-Q3

[Operator]

Hello and welcome to the Victrex Q3 IMS 2019 call. [Operator Instructions] Just to remind you, this conference call is being recorded. Today, I am pleased to present Jakob Sigurdsson, CEO; Richard Armitage, CFO; and Andrew Hanson, Investor Relations Director. Speakers, please begin your meeting.

[Jakob O. Sigurdsson, CEO & Executive Director]

Yes. Good morning, everyone, and welcome to the Victrex’ Interim Management Statement for the Third Quarter of the 2019 financial year. This covers the period from 1st of April through the 30th of June 2019. I'm Jakob Sigurdsson, CEO, and I'm also joined by Richard Armitage, our CFO, together with Andrew Hanson, our Director of IR. I'd firstly like to summarize the key trading themes, I'll then let Richard cover the trading in detail before we come back and talk about our new product pipeline, and we'll then cover the outlook and open the call up for questions towards the end. Our key messages today are that we saw good growth in several markets in the Aerospace, Energy and Medical. Energy growth, excludes the benefit you had last year from MAGMA revenue, which will be lower this year and explained by the preparation for the base for the Libra field and the optimization work that is going on within MAGMA. We held -- we were held back by deterioration in automotive and electronics, however, during Q3 compared to what we saw in Q2. Although we aren't quite back to Q1 levels in terms of run rates. We also faced very strong comparatives this quarter across the business. Examples being growth in Electronics and Value-Added-Resellers, also we've set record quarters in the corresponding quarter last year. We also had the comparative [ from around 40 tonnes ] of business with a large consumer electronics contract last year. And remember that this year, we've got negligible volumes for that contract. So overall, while pleasing to see growth in Aerospace, in Energy and in Medical, this has been offset by the weaker quarter for automotive and electronics. This is very much in line with all macro indicators that we are following and I'm sure you're following as well. And sort of broader performance elsewhere in the market in segments, and in companies that are exposed to both automotive and electronics. It's worth keeping in mind that IHS who forecast global auto demand have been pulling back their forecast for car builds every month this year. IHS now forecast 3% -- 3.7% decline in global car builds for 2019, whereas at the start of the year, they were forecasting 1% growth. Then we've seen car sales in China 17% down in May, and Europe demand has been pulled back to similar levels. Adding to this, supply chain inventories remain very low. This provides a much weaker picture sequentially. In Electronics, a main theme -- key area is semiconductor was 30% down for the year, the industry linked to smartphone sales were also reported, they were down 17% year-to-date. We also had some volumes in Q3 last year for consumer device, which hasn't repeated this year, although we do have approvals and would anticipate volumes associated with that opportunity to pick up towards the end of this year and into 2020. I'll now hand it over to Richard for a summary of the financial performance. Richard?

[Richard Armitage, Group Finance Director & Executive Director]

Thank you, Jakob. Good morning, everyone. As Jakob has indicated, quarter 3 was weaker year-on-year against a very tough comparative, and sequentially versus quarter 2. It is important to stress, we still registered an improvement versus quarter 1, and our performance in auto and electronics is reflective of the macro data and the results we have seen from other companies exposed to these markets. Overall then, quarter 3, group volume was down 21% to 912 tonnes versus 1,161 tonnes in the prior year, with group revenue down 14% to GBP 72 million versus GBP 84 million in the prior year. If we exclude the large consumer electronics order, quarter 3 group volume was down 18%, and quarter 3 group revenue was down 12%. Year-to-date group sales volume of 2,811 tonnes is 18% down on the prior year, with year-to-date group revenue of GBP 217.8 million, down 13%. We have seen an improved mix in the quarter, with an average selling price at GBP 79 a kilo. Although this does reflect weakness in Industrial, driven by automotive and electronics with medical remaining in growth. We also continue to see average selling price being slightly ahead of financial year 2018 on a full year basis. Briefly on margin, we saw a 380 basis points decline in the first half, although about half of this was due to the presentational impact of IFRS 9, with losses on currency hedging contracts now accounted for in gross margin. The remainder was inflation and operating leverage. For the second half, we're anticipating a small uptick in margin sequentially, with our guidance being around the 61% mark. If we briefly look at the market performances, automotive volumes were down 13% year-on-year. We have seen a decline of 23% in Q1, then 5% in Q2. So we have seen a weaker trend, but not as weak in quarter 1. In Electronics, which had a record quarter last year, we saw a decline in volumes of 22% year-on-year and by 5% versus quarter 2. This reflects the decline in the wider semicon market as well as strong orders for an undisclosed consumer device in the prior year, that weren't repeated this year. Aerospace saw good growth as PEEK penetration and plane build increased, and in energy we saw growth in the core applications, as oil prices and activity remains healthy. Finally, in Medical, we achieved solid growth also, much of it coming from Asia, including cranio-maxillofacial applications and other areas of non-spine. Our share of the spine market has remained stable at around 65%. We should also note that our next-generation HA Enhanced product is tracking above last year. We would expect to grow on the GBP 1 million of sales delivered in financial year '18. Before I hand back to Jakob, a brief word on our financial position, which remains healthy, and currency remains broadly neutral for the second half with a small tailwind into financial year 2020. Although we would note that we're only around 50% hedged for next year. Additionally, it's worth remembering that the automotive and electronics markets represent over 50% of group volume, if we include related volumes sold through the value-added resellers. If we see no sustainable improvements, these markets may start to weigh on our financial year '20 performance, at least in the first half. We should also remind investors that with a weaker trading environment, we're taking the opportunity to carry out substantial debottlenecking of all of our polymer production plants to support future growth. As we signaled in May, this may have an impact on overhead recovery in financial year '20, which could result in our shares growth being more modest than expected. But I would stress that this is a good opportunity to carry out cost-effective capacity expansion, whilst we continue to assess our options. Remember that, as we have indicated previously, those options are more diverse than our historic large scale investments. What the debottlenecking may allow us to do is to push any large-scale capacity expansion into financial year '21 and beyond, supporting the opportunity for additional shareholder returns over the next couple of years. Thank you. And I'll now hand back to Jakob.

[Jakob O. Sigurdsson, CEO & Executive Director]

So -- thank you, Richard. Two final areas to cover before Q&A, and firstly, our mega-programs. We've delivered further milestones here. Notably, we now have another major PEEK Gears contract secured with an American OEM. This supports the opportunity for meaningful revenue in financial year 2020. So we're extremely happy having landed this one, which is significantly larger than the one that we have reported on before. We also have other -- 10 other development programs with other auto manufacturers in gears, and lined up partners to help us execute on those programs as well in the various places in the world. In Aerospace, the first prototype parts have been supplied from our new U.S. Composites facility, which is now in operation. And we've also received our first commercial order and are starting to deliver on that. In Medical, HA Enhanced sales are tracking well above 2018, and knee patient recruitment is underway with the chance of first knee implants in quarter 4. Secondly, on our outlook, in line with all recent data points, we remain cautious in automotive and electronics, as Richard alluded to. But favorable comparatives in Q4, with the opportunity for more stable performance compared to declines we saw in quarter 3. We would note that [ PBT ] consensus of around GBP 110 million assumes no further material deterioration in Q4. And we're pleased to say that July is currently tracking well on plan. To the medium- to long-term then, we remain well positioned and have sizable opportunities -- growth opportunities to go after and develop. With that, I will now open the call up for questions.

[Operator]

[Operator Instructions] The first question is from the line of Chris Scott from UBS.

[Andrew Gregory Stott, Managing Director and Research Analyst]

I think -- I hope that's my line, Andrew Stott, UBS? I had a couple of things I wanted to address. Firstly, the shorter-term comment, Jakob, you just made on Q4 and what our consensus is. So July, are you saying July is up? I mean, I know it's not even closed yet. But are we starting to see a small inflection point? And are you endorsing that consensus number? Or are you just referring to it? That's 2 different things. Second question is much more long-term on your CapEx requirements. You reiterated the debottlenecking for next year. And you're also saying you'll continue to look at, I guess, greenfield/brownfield projects, as you've talked about before. But I suppose my question is, given volumes have come down so much, given you've got that debottlenecking opportunity, do we -- is there a bit of a shift in message today on that around, do we really need to go for greenfield after all? And are you starting to think about a different scale of CapEx on a mid-term view? Or am I reading too much into this?

[Jakob O. Sigurdsson, CEO & Executive Director]

No, I'd be happy to clarify both of those Andrew. So the on CapEx, clearly, when we were mapping out our demand pattern in our strategy planning cycle last year, we did see that we would be needing extra capacity. The period of large scale, sort of towards the end of that time frame getting to 2023 or so. Since then, we have identified debottlenecking activities at Hillhouse that allow us to get our capacity in a much more economical way. Nonetheless, we are continuing the program to evaluate options for further capacity increase above and beyond that. Clearly, a debottlenecking opportunity that could bring us somewhere close to 1,000 tonnes, will push back the need for that capacity to come online. But as we're -- our projections as it relates to momentum in the underlying business, even if that's been halted a little bit this year. The momentum in the underlying business, where we expect to -- to return, coupled with our best predictions as far as well as when the large volume consuming mega programs might start to hit. We'll still call for the need for additional capacity, probably beyond '23 now since we have identified debottlenecking opportunities and volume has to improve that a little bit. But we're still progressing that project, but not -- probably will not need that as quickly as we would have in the absence of the opportunity that we have identified for debottlenecking. We also know from past downturns in the last couple of decades or so, if you look at our demand pattern that we have seen significant drops year-on-year when we're sailing through recessionary territory. The demand has also snapped back pretty quickly once economy starts to recover. And there's a couple of very clear examples of that. So we do view this as a temporary situation as it relates to the slowdown in demand. We're obviously taking all the measures we can to navigate that as cost effectively as possible. But we're also mindful of the fact that when things turn the corner, demand hits us pretty hard and fast. I think that hopefully explains and answer your question on the CapEx out?

[Andrew Gregory Stott, Managing Director and Research Analyst]

Yes, perfect.

[Jakob O. Sigurdsson, CEO & Executive Director]

On Q4 then, consensus assumes around GBP 110 million. We're saying, we feel comfortable for that. That assumes that there will be no material deterioration in demand versus Q3. The July comment is based on our current, sort of, order book for the month and the order outlook for August, but we're also mindful of the fact that demand has been very volatile for the year as a whole. So we're taking comfort in the fact that we're seeing, sort of, demand in line with our expectations for July, particularly strong in some of the more profitable segments, but that's no guarantee that the quarter is going to play out well, so first indications for this quarter are promising.

[Andrew Gregory Stott, Managing Director and Research Analyst]

Great. And sorry, [ one other here ], but just one final quick question for Richard. You said gross margin, and I wanted to clarify, in the second half will be slightly higher than the first half? I just wanted to check that comment?

[Richard Armitage, Group Finance Director & Executive Director]

That's right, Andrew. The first half was 60%, we're probably going to get close to 61% in the second half.

[Operator]

The next question is from Kevin Fogarty from Numis.

[Kevin Christopher Fogarty, Analyst]

Just, if I could touch on, firstly, the mix effect in terms of what that's doing to average selling prices. Obviously, sort of, medical is helping to contribute there. Could you just give us a feel as to possibly what effect Medical has done in Q3? Perhaps the outlook for Q4 there. And also, I guess, if you could, sort of, just touch on, in terms of any of your front -- any -- the front-end investments during the second half of the year. Could you talk about if that sort of run rate is in line with your thinking at the half year stage? Or has any acceleration gone on there, please?

[Richard Armitage, Group Finance Director & Executive Director]

Kevin, it's Richard. So in terms of average selling price, we did note that we were at GBP 79 kilo in quarter 3. That is pretty much driven by medical in the mix. Underlying selling prices by sector remain stable, but actually, as we're moving back into growth in medical and obviously seeing weakness in industrial, then that is what has driven that. It probably won't quite do the same in quarter 4. Again, as Jakob has indicated, we are seeing a little bit of an improvement in Industrial in quarter 4. So that's going to swing back the other way a little bit, but we would still expect average selling prices there for the year to be a little bit ahead of last year. I think in terms of front-end investments, probably the way to look at this is that half 1 and half 2 will be reasonably similar in terms of the profile of overhead expenditure. Therefore, rather than there being any kind of weighting towards half 1 or half 2, that's been reasonably evenly spread over the year.

[Kevin Christopher Fogarty, Analyst]

Okay, okay. And just as I'm on, just -- sorry for harping here, but I guess, in terms of CapEx, again, given what you said about, I mean, I know the debottlenecking issues are further out. But could you just sort of help us, any change in CapEx for this year from what you outlined at H1, please?

[Richard Armitage, Group Finance Director & Executive Director]

I think we'll be very close to what we outlined. So we've indicated a normalized level of spend of around GBP 25 million a year. That's exactly where we expect to be. That has included some expenditure in relation to our Gears capacity and our aerospace loaded bracket capacity. So we have been able to accommodate within our normal level of spend capacity expansions for those projects.

[Operator]

Next question is from Dominic Convey from Peel Hunt.

[Dominic Convey, Analyst]

[ To date haven't ] given any various end-markets at the moment. But I wonder if you would kick off first, just with regard to that more stable performance that you're hoping to achieve in the fourth quarter. Just to be clear, is that intended to be with respect to year-on-year or sequential?

[Richard Armitage, Group Finance Director & Executive Director]

Both, I think. So let me just give you a flavor for that. So we are expecting in terms of year-on-year performance, volume in the fourth quarter to be slightly down still. But by no means as dramatically as in quarter 3. And in terms of sequential performance, a small improvement. So I think you can say that sort of feels more stable in both cases. And I think we've made the point that, that is primarily driven by our own sales activity, things that we have done in the market rather than any particular assumption about recovery in the underlying markets.

[Dominic Convey, Analyst]

And just following on in terms of this issue around monthly volatility. A number of people saying that actually April-May was okay, but June was notably weaker. I wonder whether you might give your perspective on that? And then finally, just for me, in terms of also, I think, notably, [ Crodius ], they suggested that they now feel that the demand/pull from them is running at or around end demand run rate, suggesting that at least, destocking has eased. I'd just be grateful for your thoughts on that as well?

[Jakob O. Sigurdsson, CEO & Executive Director]

Yes, you're absolutely right, Dom. We've seen very volatile demand, I mean, over the whole financial year, actually. And it's almost as if you see a correlation of times with whatever [ treats ] might be floating across us to date. We see demand patterns sort of fluctuating in accordance with that. It is clear that we did see, as an example, a significantly greater run-down of inventories in our channels business, as an example, when it went down towards the end of the last calendar year, with energy demand snapping back in January, and we had our second largest January ever, as an example. Our February started well, and then demand sort of tapered off after that. April and May were reasonably good, particularly in April, and then June has been very soft. July has been strong and started off strongly. But I just think there is probably some inventory run-down to happen yet in our channels and that's probably mainly at the end. In China, with the transition from emission standard 5 into emission standard 6, there were clearly a large amount of inventories, of course, that were only fulfilling the 5 standard. That seems to be running its way through the system according to our contacts. According to what I heard there a week ago. So that gives a little bit of a promise. Towards, we believe, in a slowly recovering demand. Europe is still in a little bit of a doldrum, demand in Turkey, actually has been quite sluggish and demand in Central Europe as well, but that's sort of mainly for the mainstream autos. But I think many of these issues are hopefully working their way through the system. We had the global testing protocols, kind of, and the impact of that late last calendar year and into this one. We have seen, like I said, the impact of changing climates in China as well impacting demand. Political situation globally, having a big influence as well. Not necessarily seeing land disappear, but I think many of the sort of interesting specific structural things are hopefully working their way through the system. Although I would underline as well that we're not necessarily backing our comments on Q4 based on that. I think we're approaching it with a fairly cautious outlook.

[Operator]

Next question is from Mubasher Chaudhry from Citi.

[Mubasher Ahmed Chaudhry, Vice President]

Just 2 please. For the debottleneck, I think you mentioned that the CapEx would be around the GBP 25 million. If I understand it correctly, historic guidance has been around the GBP 20 million to GBP 25 million. So this is on the higher end. Is that correct? And the second question is, if you could give some color on this U.S. Gears contract in terms of the pace of the kind of these volumes coming through, should we expect that to be from Q1 '20 or maybe further down the line? And then on why that 2020, when you look out, do you forecast an uptick because when I look at the consensus numbers at the moment, this is due to the -- quite an uptick year-on-year. Do you -- is that how you think about it internally or you're a bit more cautious on this, with the outlook?

[Richard Armitage, Group Finance Director & Executive Director]

So let me take a couple of those and then perhaps Jakob will comment on the Gears project. So just some clarity on CapEx. Our sort of normalized ongoing run rate of CapEx, we expect to be about GBP 25 million a year, and that is indeed the case this year. The debottlenecking we have indicated will be about GBP 20 million in total. Spread over 2 years, pretty much financial year '20 and '21. So that's going to be about an additional GBP 10 million next year, we think. So total CapEx for next year of the order of GBP 30 million to GBP 35 million. And then your question about sort of the outlook for financial year '20. I think, we can do no better at the moment, given the state of a couple of key markets than to assume that those markets will be flat going into next year. Certainly, in the case of automotive, the latest IHS data, the July data suggests flat global light vehicle sales and production next year. And our sense from the various electronics market indicators is also probably a flat performance. So that's sort of the underpinning of the way we're viewing it. We, of course, would expect to continue to achieve some degree of growth from our own activity and product launches and so on, but I think we should look at that as probably being low single-digit growth, given where the markets are at the moment.

[Jakob O. Sigurdsson, CEO & Executive Director]

And then on your second question, as it relates to Gears, the start-up production there is expected around the 1st of March 2020. So it should still allow us to get into meaningful revenue on the Gears program in next financial year.

[Operator]

Next question is from Chetan Udeshi from JPMorgan.

[Chetan Udeshi, Research Analyst]

A couple of questions. Firstly, just on the magnitude of the volume decline, Jakob. It seems like you guys are seeing a much bigger hit in terms of volume drag, right through the, maybe, last 3 quarters. Is there some competitive dynamics around it because your ASP has been pretty good. So it doesn't feel like the ASP is under pressure, but it does feel like the volumes have been much, much weaker than most of the other players are seeing in the moment. That's first question. The second question, Richard, you said something about low single-digit volume growth, was that for specific end markets or for the company as a whole next year?

[Richard Armitage, Group Finance Director & Executive Director]

Let's start with the last one first, Chetan. So it's for the company as a whole. It was what I was indicating. And I think probably just to repeat, our assumption around, particularly the automotive and electronics market is for them to be flat and therefore, the low single-digit growth coming from our own sales activity.

[Chetan Udeshi, Research Analyst]

Understood.

[Richard Armitage, Group Finance Director & Executive Director]

Coming back to the, sort of, competitive dynamics. I think that's a good question. But actually, that is relatively normal for us, whilst there are always some small gains and losses as we go through the year, what we're seeing at the moment is that those make out to, to represent no particular change in our competitive position. We will also highlight the point between Medical, our share has stabilized, it's been stable for quite a while now, which is another good indicator, and it's helping to underpin Medical returning to growth.

[Jakob O. Sigurdsson, CEO & Executive Director]

I think if I may add just a little bit on your question on competitive dynamics. I don't think it's explained by that, and Richard, I think, explained, that piece of the question quite well. I think it's more, sort of, explained by our exposure to geographies and segments in light vehicles markets as opposed to anything else, where we have a disproportionate exposure to the higher-end cars and European cars versus, for example, North America.

[Chetan Udeshi, Research Analyst]

Understood.

[Jakob O. Sigurdsson, CEO & Executive Director]

And European cars being exported to China as well. So that's why we see some impact of this market change.

[Operator]

[Operator Instructions] Next question is from Thomas Beevers from Stockviews.

[Thomas Edward Beevers, Co]

Two questions, please. Firstly, on the dental prosthetic market. I just wonder if you could give an update on any progress there, particularly the agreement with Straumann, how that's progressing? And then secondly, on your debottlenecking, just to understand that, does that -- I think in the past, you talked about the debottlenecking effectively unlocking some of that nameplate capacity? Is that effectively what you're doing here? Or is there potentially capacity above and beyond what remains of your nameplate capacity?

[Jakob O. Sigurdsson, CEO & Executive Director]

So on the first one, in terms of Straumann. Yes, you're -- that's progressing a bit slower than we expected, and we have commented on that before. But I think the prospects there are still good, however. We are seeing data coming in from clinical studies on an ongoing basis that make the case for our prosthetics more compelling by the day, I would say, and hopefully, we'll be in a position and our partners to publish some of those soon, which show and continue to show much lesser degree of bone loss and a much reduced rate of infection, as an example. So I think further underpinning the clinical value proposition that was strong already. We continue to expand our avenues to market. And that is the name of the game from this point onward, it has been for a while. We have a very strong clinical case, as I mentioned, and the mission now is to build roads to the market, in what, admittedly, is a very fragmented market. And probably one of the most fragmented ones that we are dealing with in our mega-programs. But Straumann relationship, I would say, is going well. We're focused on educating and helping to educate and inform their sales force as to what it takes to sell PEEK-based prosthetics. And you know that I use to word prosthetics and not implants because there is a difference there. And prosthetics is very much the nature and the subject of a collaboration with Straumann. On the debottlenecking, different ways to look at it, your nameplate is -- has a certain definition and demonstrated capacity is something entirely different. I think what we're seeing here is an avenue towards getting 1,000 tonnes of real capacity, if you wish, which ultimately will get in closer to our nameplate capacity in demonstrated terms. So what I'm saying is, with what we intend to do, our demonstrated capacity should start to reach 7,000 tonnes.

[Thomas Edward Beevers, Co]

Okay. Just one final question on the overhead, the level of overheads, which I know you said similar level H2 to H1. But thinking about our medium term, do you anticipate upward pressure on that overhead as a result of new mega-programs coming through as we go into 2020, or how -- those -- just trying to understand how we should think about that overhead cost and the, sort of, dynamics affecting it more medium-term.

[Richard Armitage, Group Finance Director & Executive Director]

I think for 2020, very little upward pressure. And that's because in terms of the mega-programs that are expected to commercialize next year, we pretty much already have the cost in there. So we're, sort of, ready to go with these loaded brackets and so on. Beyond that, I wouldn't want to quantify it right now. But of course, as we get to more mega-programs commercializing, there will, I suspect at times be step-ups in overheads, but I would reiterate that not for next year. There will -- always bear in mind our bonus mechanic. So we have a substantial employee bonus scheme which pays out part of any profit growth delivered. So in a year of profit growth, one would always see an element of the that going towards the bonus accrual.

[Operator]

Next question is a follow-up from Andrew Stott from UBS.

[Andrew Gregory Stott, Managing Director and Research Analyst]

I just wanted to come back to a small issue for 2020, which is FX. Richard, you said, you're going to be 50% hedged for next year, and you see a small benefit, therefore, from currency. If I use spot rates, it looks like it's more than just a small benefit. So I just wonder if you could either give me a rough back-of-the-envelope for next year as you see it at the moment, or qualify what small means.

[Richard Armitage, Group Finance Director & Executive Director]

Yes, at current spot rates, given the interesting things going on in the world were to maintain, then I suspect we get some more of a tailwind, but we are extremely reluctant to predict how that might fall out in the current environment. So for now, we're indicating a small, so low- single-digits of millions tailwind. We are only 50% hedged and we'll see what happens.

[Andrew Gregory Stott, Managing Director and Research Analyst]

Right. But if I'm to use spot, it's significantly more than low single-digit millions. Is that the right conclusion?

[Richard Armitage, Group Finance Director & Executive Director]

You -- you can -- I guess, make whatever assumption you feel appropriate. So yes...

[Andrew Gregory Stott, Managing Director and Research Analyst]

I don't know your hedge rates. So that's really my point in this question.

[Richard Armitage, Group Finance Director & Executive Director]

So yes. No, I get that. So yes, the tailwind would get a little bit bigger if there is -- if the exchange rate slope would be maintained.

[Operator]

And next question is from Martin Evans from HSBC.

[Martin John Evans, Analyst of Global Chemicals]

Just because 2020 has been raised now, as a -- as a sort of topic for discussion, can we just clarify, maybe, Richard, where your confidence comes from such that this -- I think you said the end markets, you're shooting will be broadly flat. But you would hope to grow, I think, single digit. Is it because of things like these mega-programs beginning to lock in and a little bit of FX that despite the tough market that you're selling into, you can still grow? Because given the year you're having this year with volumes down, what, so far, 18%, profits down sharply, if things essentially aren't going to get much better next year, maybe not worse, but no better, common sense might suggest that your profits, overall, given the overhead situation it sounds could actually be flat to down next year on this year. So is it, to clarify, things like, as I say, these mega-programs beginning to lock in, which should give you some optimism for growth?

[Richard Armitage, Group Finance Director & Executive Director]

I think, Martin, that is the starting point. But I really want to reiterate the point here that we are currently in our planning only assuming that, particularly in electronics and automotive markets remain flat, because that is what the best available market data tells us, for what it's worth. And we can't assume anything else. It's not us predicting that those markets remain flat, no it isn't, we're simply reflecting the market data. So then what does drive the growth, 2 things. And one is the emergence of mega-program volumes, Jakob has particularly referred to Gears and an expectation that following commercialization in March of next year, we start to get up to a meaningful revenue. Aerospace loaded brackets. We actually have our first commercial order. It's a relatively small order but it's really important because it's our first commercial order and tells us that we're doing the right things there. And then on top of that, secondly, just a continuation of making good progress in medical, in energy and other things in aerospace, for instance, that give us some confidence there will be a degree of growth. So therefore, what does that do to our profitability? Our current outlook is not flat to slightly down. Our outlook is flat to slightly up. But I will keep coming back to the point, our assumption for the underlying market is for flatness.

[Martin John Evans, Analyst of Global Chemicals]

Okay. And just to clarify on the Gears, you say from March, is that when you'll begin to get revenue coming, as you'll get half a year of it next year, I guess, and a little bit of a contribution from brackets for 2020?

[Jakob O. Sigurdsson, CEO & Executive Director]

Yes. Well, bracket is already contributing, Martin, and -- for Gears, and the specific program, we're expecting from March onwards.

[Operator]

Next question is from Sebastian Bray from Berenberg Bank.

[Sebastian Christian Bray, Analyst]

I would have 2, please. Could you give any comments on how group cash flows have developed in the quarter, and in particular, inventories, have there been builds associated with demand weakness? That's my first question. And the second one is on gross margins. I'm interested in the amount of operating leverage, negative or positive, in your business? And in particular, just a bit of a thought experiment, if volumes have been flat year-on -- or were to be flat year-on-year, how much higher would you -- in 2019, how much higher would you expect the gross margin to be -- or put another way, if you were to completely fill all of your capacity up to the 6,300 tonnes with a similar mix, how much higher in that circumstance would gross margins be?

[Richard Armitage, Group Finance Director & Executive Director]

So certainly in terms of cash flow, where we have built inventories -- so we started out the year deliberately building inventories ahead of the first Brexit deadline. Remember that we have moved pretty much all the [indiscernible] stock outside the U.K., that is still -- they're outside the U.K., and we have retained additional contingency stocks inside the U.K. in anticipation that the second process deadline should supply chains become disrupted. And then as the debottlenecking plan is evolved, it is actually really quite helpful to have those inventories still available to it, probably through much of next year, so that we can take it then and shutdown to enable the debottlenecking. We are currently expecting inventory to be in excess of GBP 90 million by the end of the year. As a consequence of that, cash generation for the year will be a little lower than they might have been, but we are still expecting to generate something up to more than that, GBP 70 million of cash notwithstanding what we have invested in inventory. I think the operating leverage question is a good one. I don't believe we've ever quantified what would happen, if we were producing pretty much flat-out at effective capacity. But your question is a correct one that there would be a small improvement in gross margin. In other words, we can achieve operating leverage, certainly, at the Hillhouse site, there is a high proportion of fixed costs, and therefore, there will be some benefit.

[Operator]

Our next question is from Dominic Convey from Peel Hunt.

[Dominic Convey, Analyst]

Sorry, gents. It's one quick follow-up. Jakob, you mentioned that you've got some approvals, and it sounded that as though that was in respect of the consumer electronics, specifically, the large customer and the large consumer electronics opportunity for the original contract. Can you just confirm that I interpreted that correctly? And would you intend to continue to strip out those volumes for us going forward if they resume at the back end of '19 into '20? Or do you intend to just wash them through the broader consumer electronics space?

[Jakob O. Sigurdsson, CEO & Executive Director]

Yes, good question. And sorry, Dom, I probably haven't been clear. The thing is that the reference to the consumer electronics device that we had on our books last year and we haven't had this year so far, is independent of the large consumer electronics order. So these are 2 separate things. On the former one, in other words, the consumer device application, we are starting to see volume kick in there, again, approvals having been obtained. As it relates to large consumer electronics order, I think we're probably going to be stripping that out of our comparisons going forward. We saw practically no volumes from that in the second half of last year, and it's pretty much gone from our books all of this year. So we -- so it's really not meaningful for reference going forward as it looks. I hope that's clear now. Thanks for giving me the opportunity to clarify that.

[Operator]

And there are currently no further questions registered. So I'll hand the call back to the speakers. Please go ahead.

[Jakob O. Sigurdsson, CEO & Executive Director]

So thanks again, everybody, for attending the call, and we look forward to catch up with you again towards the end of our current financial year. Thank you.

[Operator]

This now concludes the conference call. Thank you all for attending. You may now disconnect your lines.