Weir Group PLC

LSE:WEIR

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to The Weir Group PLC Q3 2019 Interim Management Statement. [Operator Instructions] I must advise that the call is being recorded today, Tuesday, the 5th of November 2019.And without any further delay, I would now like to hand over the call to your first speaker today, Jon Stanton. Thank you. Please go ahead.

[Jonathan Stanton, CEO & Director]

Thank you, operator, and good morning, ladies and gentlemen, and thank you for joining us for our third quarter interim management statement. As usual, I'm here in Glasgow with our CFO, John Heasley, and we'll be delighted to take any questions you have shortly.First, let me start with a summary of the group's performance in the third quarter, where orders increased 4% year-on-year and were flat excluding ESCO. Group revenues on a constant currency basis were in line with expectations for Minerals and ESCO, while Oil & Gas reflected weaker market conditions. The group generated a positive book-to-bill ratio of 1.08.Looking at the year-to-date, the strong performance of our mining businesses has been underpinned by the continued strength of our technology and customer focus alongside our aftermarket business model. Oil & Gas has been impacted by a progressive slowdown in market activity in North America, which we're proactively addressing through a GBP 30 million cost reduction program.The main highlight of Q3 was the record GBP 100 million contract win for the FMG Iron Bridge Magnetite development in Western Australia. This will see our High Pressure Grinding Rolls technology reduce energy and water consumption by more than 30% compared to traditional mills. It's a result of great innovation and customer commitment from our team. Initial discussions with FMG started 5 years ago. And in that time, we've worked hard to solve their challenges, including building and operating a prototype plant at the site to prove that the technology will deliver.As you all know, we've been talking about the benefits of HPGR technology for some time and believe that Iron Bridge will be an important reference site for the mining industry as it looks to innovate processes such as comminution. That process of crushing, screening and grinding rock is one of the most energy-intensive minerals processes. And with this technology and other innovations we're bringing to the market, we intend to play a leading role in making mining smarter, more efficient and more sustainable. The future of this industry will be defined by those who can combine innovative solutions with deep customer intimacy, and that is where Weir is at its best.Let me now turn to the detail of each division, starting with Minerals. Overall, market conditions remained positive, and the division saw a 72% increase in original equipment orders driven by the Iron Bridge Project win. But we continue to work with customers on what remains a very strong project pipeline, underpinned by solid fundamentals particularly for metals such as copper, which is our largest exposure. In the third quarter, we did see customers delay final approval of some projects with sentiment driven by trade tensions and their potential impact on global growth. Excluding the Iron Bridge order, this translated into a 22% fall in OE, which, to give some context, represents around GBP 20 million or just a couple of project orders.Aftermarket orders, which represents around 2/3 of the total, were down 5%. And this was against a very strong prior year period that, you will recall, included a number of one-off multi-period and commissioning spares orders. If you strip these out, underlying aftermarket orders were solid, up 3% in the quarter and up 4% year-to-date. And that performance was after we absorbed the significant reduction in spares orders in Central Africa, as a result of some customer operational issues and proposed tax reforms, which will lead to a circa GBP 20 million reduction in full year revenues for our Africa business.Overall, if you look at the division's performance so far in 2019, we remain comfortable that we'll see strong double-digit OE growth and aftermarket up around mid-single-digit, both in line with our earlier guidance. And this supports our continued expectation for the division to deliver good growth in full year constant currency revenues and profits with broadly stable operating margins. Given the macro uncertainty, we are watching how customer sentiment is developing very carefully so that we can adjust operating plans proactively into 2020 if necessary.Let me now turn to ESCO, where again we saw good growth with orders up 9% on a pro forma basis and 3% year-to-date, exactly where we expected them to be. As you know, ESCO is a 95% aftermarket business, which means that revenues are driven almost entirely by production and the amount of rock moved. Like the underlying Minerals aftermarket, ESCO's demand environment remained consistently strong in hard rock markets. The increase in demand also reflects continued adoption of its leading Nemisys technology, which is gaining market share through its superior wear life and safety value proposition. The division's infrastructure markets, which represent around 1/3 of revenues, were more challenging with weaker construction activity in North America and Europe partially offset by increased demand for dredge consumables, where ESCO is the market leader.Our investment program in the division continues to be focused on improving safety and foundry operations. This is important to meet growing demand but has inevitably led to some short-term capacity constraints as we conduct the upgrades. We also made good progress on cost synergies, which continue to track ahead of our original schedule. Revenue synergies in the period included order wins in Central America, leveraging mineral service network and shifting from indirect to direct sales in West Africa. Overall, I remain delighted with the way the ESCO division is performing and the success of its integration into the wider group.Let me now turn to the Oil & Gas division, which represents around 1/4 of revenues. Here, we saw a progressive slowdown in North American activity through the third quarter. Year-to-date, U.S. land rig count is down almost 25% with a 13% fall since the end of July, as E&P operators exhausted their budgets earlier than expected. This intensified the pressure on oilfield service companies, who responded by stacking equipment, with the number of active frac fleets estimated to have fallen by 20% in the quarter. Conditions in international markets were more positive with strong activity in Saudi Arabia and an increasing number of Eastern Hemisphere projects moving forward. Overall, OE demand was 26% lower, with North American customers reluctant to invest in additional horsepower or new technologies, instead preferring to preserve cash. Aftermarket demand was down 34%, with maintenance schedules pushed out and customers aggressively cannibalizing idle fleets for consumables.Given these market conditions, we undertook a GBP 30 million cost reduction program to rightsize our business in North America. That involved reducing the Oil & Gas workforce by 20% or around 450 posts, cutting nondirect overheads and the introduction of mandatory furloughs. These actions which are necessary to protect competitiveness will incur an exceptional restructuring charge of around GBP 20 million, which also includes the impairment of certain underutilized assets.Looking to the full year, visibility in North America remained low. The division was only moderately profitable in the third quarter, and we expect a sequential decline in Q4 reflecting lower volumes partially offset by further benefits from the cost reduction program.Looking further forward, we see a pattern emerging whereby E&P companies exhaust their annual drilling and completion budgets early and then curtail activity to maximize cash flow. In response, oilfield service companies are starting to take action to consolidate and reduce capacity. We believe around 2 million horsepower has been permanently retired in recent months. Cannibalization and destocking can only go on for so long. But for the time being, customers are limiting their spend to essential repairs only. And as a result, we are continuing to keep our cost base under active review.Moving on to net debt, which at 30th of September was broadly in line with that reported at the end of June. And we continue to expect strong second half cash generation, supported by a working capital inflow relative to the position at the end of June. Finally, let me conclude with the key theme from the third quarter. We're taking action to counter increasingly challenging conditions in North American oil and gas markets. We delivered a record GBP 100 million HPGR mining order that will be an important reference point in making the industry smarter, more efficient and sustainable. ESCO continues to show its quality and the strength of its technology leadership. And while we've seen an increase in OE project deferrals, underlying mining aftermarket remains rock solid, underpinned by strong structural fundamentals. We'll discuss these fundamentals in more detail at our Capital Markets Day on the 5th and 6th of December in Venlo in the Netherlands. If you'd like to attend, more details are available on our website. Thank you. And with that, operator, can we please move to questions?

[Operator]

[Operator Instructions] Our first question is from the line of Lars Brorson.

[Lars Wauvert Brorson, Director]

Jon, maybe just starting with Oil & Gas. I think it's clear that it's going to be a challenging end to the year given continued cannibalization and destocking consumables. But then again, historically, periods of destock have been followed by snapbacks as customers restock. I appreciate at this point, visibility is very low. But we've seen some of your completions-driven customers talk about reaccelerating activity in early 2020. Perhaps too early to tell at this point, but when you talk to your customers, when you talk to their procurement department, is there a sense here that they are concerned about your ability, if you like, to respond quickly enough to potential restocking demand in consumables in the first half of next year?

[Jonathan Stanton, CEO & Director]

No, I'm not concerned and I don't think our customers are concerned at all about our ability to respond if we see a snapback. And as I said, cannibalization and destocking, it can only go on for so long. But as you can see from all of the commentary, I mean the sentiment is not great at the moment. As we go into next year, clearly, there will be a budget reset. But snapback is quite a strong word. I think as we go into next year, early thoughts are that we will see a little bit more cash deployed then with those new budgets, but I think customers are going to remain very, very cautious. And it is clear to me that this sort of seasonal profile whereby the E&P companies drill and complete as much as they deploy their CapEx budgets as quickly as they can in the year and almost then sort of sit back and let the cash flow in, we've seen that now for a couple of years. And I think that it's difficult to see without some further catalysts that we see anything other than that pattern certainly for 2020.

[Lars Wauvert Brorson, Director]

Just on the Oil & Gas guidance for the year, year-to-date, I make it low 30s million sterling operating profits or maybe mid-30s million. Hard to see much profitability in Q4. You're doing away altogether with the guidance. But can you give a little bit of a sense for how much of the cost savings you expect to come through in Q4 itself and give us a little more color around what you think you might end up at in terms of year-end for the Oil & Gas division, please?

[Jonathan Stanton, CEO & Director]

Yes. Well, I'll ask John to just comment on the phasing of the cost benefits from the restructuring program. And I would say that, as I said, again, in the speech, that we are continuing to keep the cost base under active review. And if we see any further deterioration, then we will be looking at other actions that we might want to take over the balance of the year into next year. So just to be clear, we're not necessarily finished yet, depending on how it plays out.Yes. So I think you're in the right place, sort of mid-single -- after sort of GBP 29 million of profits in H1, mid-single-digit profitability in the third quarter. And given that we're expecting quite a substantial decline in volumes in Q4 as of today, and therefore, quite where we'll end up is difficult given the lack of visibility that we are in at the moment. But whether we're breakeven or slightly profitable or slightly loss-making it's sort of difficult to say, but we'll be in that territory.John, on the phasing of the restructuring?

[John Heasley, CFO & Director]

So in terms of the GBP 30 million cost savings, we obviously started on that program through Q3. So the quarterly run rate for that is about GBP 7.5 million, of which we've got just approaching half of that through the third quarter, and we'll get full GBP 7.5 million run rate in the fourth quarter.

[Lars Wauvert Brorson, Director]

That's clear. Finally, just a quick one on ESCO. I was quite impressed with the order growth there. I was a bit concerned about potential customer inventory destocking, particularly in North American construction and aggregates market. Can you talk a little bit about the dynamic in ESCO relative to some of those headwinds that we've seen from some of your competitors? And also maybe talk a little bit specifically on iron ore, which obviously is the biggest metal exposure for ESCO. Seems to me we've seen some good production ramp among some of your big customers. Has that impacted the quarter?

[Jonathan Stanton, CEO & Director]

Yes. Thanks. ESCO, yes -- thanks, Lars. ESCO, as I said, I'm really pleased with where we are in relation to the specific market dynamics. Yes, I mean construction is slightly softer in North America and Europe. You could see that coming a couple of months ago with the new housing starts particularly in the U.S. coming off, which is always the bellwether for activity in sand and aggregates and construction. So it's a bit softer.With that said, we've seen positives elsewhere. And you talked about iron ore, then Australia has picked up pretty strongly as the year has gone on. Actually, coal remains quite resilient for that business, and we're starting to get some revenue synergies coming through as well. And our focus is clearly very much on gaining market share in hard rock mining. And again, as I said in the speech, very pleased with the progress that we're making there particularly with new Nemisys technology. So in the hard rock mining parts of the ESCO business, demand has been absolutely rock solid. And so I think we're in good shape there.

[Operator]

Our next question is from the line of Max Yates.

[Max Yates, Research Analyst]

Just my first question is just around the Minerals margin. And given the size of the Iron Bridge order, you obviously have a kind of reasonably good idea of your profitability profile into next year, which I would assume mix will be worsening. So I just wanted to get a sense of sort of how you're thinking about 2020 margins based on what you see in your backlog. And should we assume that -- sort of when you've previously talked about profitability of greenfield, this Iron Bridge order is really no different to what you talked previously? That was my first question.

[Jonathan Stanton, CEO & Director]

Yes. Okay. So obviously, we're not yet in a position to probably guide for next year. But as it relates to Iron Bridge then, clearly, the revenue for that project is going to come through in the back end of 2020 and into 2021. It is not going to be dilutive to the overall Minerals margins, so I think from a -- in terms of that mix effect, I'm very comfortable that we will stay within our well-established guidance range for Minerals margins. And stepping back, we obviously had a quarter in Q3 where we've seen some projects -- some caution just creeping into our customers. Now it's only a quarter, so I'm not reading too much into that. Fundamentally, as I sit here today, I think it's likely we're going to continue to see OE come through. I think just that bit of caution has crept in, in the quarter.And whilst we are in an expansion phase for original equipment, then clearly, the Minerals margins will be towards the lower end of the ranges where we are today. But if we see sentiment continuing to deteriorate and the original equipment environment moving more back -- the dial swinging back more towards a brownfield-type environment, then clearly, we will adjust the business. And we will look to deliver some margin expansion from where we are today. So it sort of depends where it goes from here over the next couple of quarters. But as I say, Q3 is just 1 quarter. So as I sit here today, my sense is that we are probably going to see some of these expansions come through. And actually, we've just seen the sort of print of our OE orders for October overnight, and they're pretty robust actually, so that is encouraging for how we'll perform in the fourth quarter.

[Max Yates, Research Analyst]

Okay. And just the second question is on Oil & Gas. I just want to understand a bit better from a capacity utilization standpoint whether you could give us a sense of kind of where we are in terms of utilization in Fort Worth and where the rightsizing that will take place will get us to in terms of the utilization for that facility.

[Jonathan Stanton, CEO & Director]

Yes. So if we think about our capacity at the moment, then we are down to one shift across all of the product lines and actually slightly lower than that on some of the product lines. So we've cut right back in terms of the variable overhead and partly, in terms of some of the restructuring, impaired some underutilized assets as well. So in a sense, that takes out some of the fixed depreciation that we are seeing.But with that one shift, I mean we're probably running at less than 50% of our full ESCO capacity. So back to Lars' initial question and how we're feeling, we've got plenty of flex if -- as the market recovers, but that's where we are today.

[Max Yates, Research Analyst]

Okay. And just a very quick final one. On net debt for year-end, I think in the presentation at H1, you gave the ambition of 2x net debt to EBITDA by year-end. Could I sort of check whether that's sort of still the view and you still see that as achievable?

[John Heasley, CFO & Director]

Max, it's John here. I'll take that. So in terms of the sort of cash profile through to the end of the year, then we talked at the half year about seeing an unwind of the working capital absorption that we had in the first half. We still expect that to be the case, so we expect a good healthy inflow from working capital through the second half. Clearly, with Oil & Gas profitability being a bit lower than that will have a small impact, so we'd still expect us to be going towards 2x, might just be notching above 2.1x, 2.2x, but certainly delevering from the position of 2.6x that we had at the end of June.

[Max Yates, Research Analyst]

And just within that, how much of that GBP 180 million working capital sort of outflow from H1? Just I mean any sense of how much of that would reverse within that assumption?

[John Heasley, CFO & Director]

I mean I can't be tremendously precise. I mean, that's a lot of moving parts. But if you take the GBP 180 million, then you remember that GBP 30 million of that related to Flow Control, the division that we sold. So GBP 150 million was the continuing operations number. And I'd like to see us getting -- approaching half of that on weighting through the second half.

[Operator]

Our next question is from the line of Andrew Douglas.

[Andrew Douglas, Equity Analyst]

Can we just have a quick chat through the commentary you've given in the -- in your prepared speech with regard to permanent retirements -- retirals of equipment. You say this is for the first time. And I appreciate it's a difficult question, but how much do you think will then be done in 2020? And what's kind of driving this as opposed to just cannibalization? And is this more of a structural theme we're going to be seeing into next year? Most of my other questions have been answered. But can I then just ask how important is the fourth quarter now for both ESCO and Minerals in terms of how much you guys have to do? And that would be very helpful.

[Jonathan Stanton, CEO & Director]

Yes, good questions. So look, in terms of the retirals, I think what you're seeing is the service companies responding to what they deem to be a new normal and that sort of seasonal profile that I was talking about and the E&P companies sort of living within their own means and financial constraints. So we've -- as I said in the speech, we've seen more than 2 million of retirals recently, and there was another 300,000 announced overnight actually. So we're up to 2.5 million. And I don't think that's the end of it. We could see quite a bit more come out, to my mind. So that's all of the cold stacked equipment, the equipment that's been cannibalized. It's got to the point where it's probably been refurbed 2 or 3 times. It is at the end of life, and it's being taken out of the market, which for the medium term, to my mind, is positive because we've got to get rid of the excess capacity that we have in the market today.Clearly, the other side of the equation is the attrition that we're seeing for the equipment that's working, and a lot of that attrition is being handled through cannibalization and destocking at the moment. But that will come to an end. And hopefully, as we go through 2020, I think there's more to come, and we'll get to a position where the market is tighter, which will be good for the service companies. They have got to get away from where they are at the moment in terms of their pricing and margins. They've got to get improvement. And I think they will come to the conclusion that they can't sit tight and wait for that to happen. They've got to take action to tighten the market up, so I think that is what is going on, and it could go on for a good couple of more quarters, to my mind.

[Andrew Douglas, Equity Analyst]

Does that imply that they won't need more original equipment for the best part of next year?

[Jonathan Stanton, CEO & Director]

Yes, probably. I mean if you think about it, we think there's demand for about 15 million horsepower at the moment, and we started at 24 million, 25 million in the U.S. So you've still got a bit of a way to go. But if the service companies continue to retire equipment, then the gap will close, and we'll get to more of a balanced market in terms of the supply of pressure pumping equipment. Once you get there and you've done all of the cannibalization and destocking you can see, then you'll get to a point where actually the aftermarket activity will bounce back. And just as we get a double whammy on the downside with lower activity plus cannibalization, you get the reverse effect, the double benefit on the upside. So that will -- that has to come at some point.In relation to Minerals and ESCO, look, we reiterated the guidance in the fourth quarter particularly for Minerals. We've got quite a lot of OE projects to ship and get out of the door, but that's usually the way that the seasonality in the business works. So we just need to execute well against that backlog that we've got in the order book.

[Andrew Douglas, Equity Analyst]

Okay. And then just 2 very quick questions, just follow-up. Can you tell me what percentage of Oil & Gas is now international? And can you just give me the cash costs associated with the restructuring, please?

[Jonathan Stanton, CEO & Director]

Yes. So international is between 20% and 25%. And cash cost of restructuring, John?

[John Heasley, CFO & Director]

Yes. Of the GBP 20 million that we referred to for Oil & Gas, then about 25% of that is cash, Andy.

[Operator]

Next question is from the line of Mark Davies Jones.

[Mark Davies Jones, Associate]

Jon, can I just go to the aftermarket side of Minerals? Could you just run through what's going on in Africa and the duration of that? You gave some indication of the scale in terms of revenue, but is that something we've now moved through, or is that still an issue through the balance of the year? And are you seeing any softening anywhere else in the world in terms of aftermarket demand? Does that stay very robust?

[Jonathan Stanton, CEO & Director]

Yes. So very robust around the world, as I said, in aftermarket both for Minerals and for ESCO. I mean customers are very, very focused on production and debottlenecking and getting the most out of their production facilities as they can. So that's a continuing theme. And we're seeing growth in production. We're seeing continuing grade declines. All of the things that support the aftermarket on a global basis are absolutely as we would expect them to be.Yes, Central Africa, I mean that's been quite a challenge for our African business with 2 things. The proposed tax reform in Zambia moving from a VAT to a sales tax, which would be a massive increase in the tax burden for all industry but particularly for mining and the supplies to the mining industry. So they announced that earlier in the year, and then it's been deferred, deferred, deferred. But it's created a lot of uncertainty, so people have really, really pulled back on their spend and there's been a huge amount of destocking. The government has now finally seen the light and has concluded that they're going to stick with the VAT regime, so we're hoping that we will see activity pick up. The operational challenges that some of our customers have seen in the DRC are probably a bit more fundamental, so I'd expect that to be an ongoing issue. So in a nutshell, I think, hopefully, we'll see a bit of a bounce back in Zambia. But the DRC I think is going to remain challenged for some time to come.

[Mark Davies Jones, Associate]

Great. And have you seen any impact from what's been going on in Chile? I know that's an important market for some of your business.

[Jonathan Stanton, CEO & Director]

Yes. No, it's a very big market, and we actually had the pleasure of our Board of Directors offsite strategy meeting being in Santiago as all the demonstrations were going on week before last. So it was exciting, as you can imagine, but a very, very difficult situation for the country. And it's shocked quite a few people in terms of how quickly it all sparked off and the extent of the damage that was seen. But from a Weir perspective, from a production perspective and ability to supply our customers both in Minerals and ESCO, no impact. And things do seem to have calmed down, so we hope that we -- it carries on in that vein.

[Operator]

Our next question is from the line of Ed Maravanyika.

[Edward Maravanyika, Vice President]

My question primarily is on Oil & Gas international markets. Are you able to just break out what the international OE and international aftermarket order trends look like?

[Jonathan Stanton, CEO & Director]

Yes. So I think if you look at the third quarter overall, we have seen growth across the order input in the international businesses, both in the Middle East and in the Eastern Hemisphere. And I think it's -- I'm not -- can't sort of break out the numbers specifically, but I think for both OE and aftermarket, we've seen sequential improvements in those international businesses.

[Edward Maravanyika, Vice President]

Okay. And I mean earlier, I think you point out Saudi Arabia and a number of Eastern Hemisphere projects. Do these look like having sort of long duration? Or are these sort of short-term one-off-ish?

[Jonathan Stanton, CEO & Director]

No. I mean Saudi Arabia, there's 2 things in Saudi Arabia. First of all, the rig count has picked up quite meaningfully, and the activity levels have picked up quite meaningfully relative to where we were last year and earlier this year. So I think we're seeing a market improvement, which is the first thing. And then the other thing from a self-help perspective, you may know that one of our sort of strategic initiatives for the Pressure Control business was to build a wellhead capability in Saudi Arabia. And over the course of this year, we have been getting through customer approvals for our product from Aramco and, indeed, for some of the other NOCs across the Middle East. And we are now just starting to get traction with our wellhead offering in that market. So it's a bit of market, and it's a bit of a strategic initiative on the Weir side to develop the business, so I think that that's positive.And again, in the Eastern Hemisphere, you're seeing a pickup in drilling activity on programs around Thailand in particular that were curtailed somewhat through the downturn that they're now picking up again. So again, we expect that to be a positive for the medium term for that business. So it's clearly -- if you step back, the international business is clearly a much sort of longer wavelength cycle compared to what we see in North America. And over the last few quarters, we've seen sequential improvement, and it looks like that will continue from where we are today.

[Operator]

There are no further questions at this moment, sir. Please continue.

[Jonathan Stanton, CEO & Director]

Okay. Well, look, thanks very much, everybody, for listening. I appreciate that, and look forward to seeing you all soon. Thank you very much.

[Operator]

So that does conclude our conference for today. Thank you all for participating. You may all disconnect.