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Edited Transcript of FENR.L earnings conference call or presentation 19-Apr-17 8:30am GMT

Thomson Reuters StreetEvents

Half Year 2017 Fenner PLC Earnings Presentation

London Apr 28, 2017 (Thomson StreetEvents) -- Edited Transcript of Fenner PLC earnings conference call or presentation Wednesday, April 19, 2017 at 8:30:00am GMT

TEXT version of Transcript


Corporate Participants


* John Pratt

Fenner PLC - Group Finance Director and Executive Director

* Mark Simon Abrahams

Fenner PLC - CEO and Executive Director


Conference Call Participants


* Andrew Douglas

Jefferies LLC, Research Division - Equity Analyst

* Andrew J. Wilson

JP Morgan Chase & Co, Research Division - Analyst

* David Alexander Larkam

Numis Securities Ltd., Research Division - Analyst

* Dominic Convey

Peel Hunt LLP, Research Division - Analyst

* Edward Maravanyika

Citigroup Inc, Research Division - VP




Mark Simon Abrahams, Fenner PLC - CEO and Executive Director [1]


Good morning, ladies and gentlemen. Welcome to the interim presentation for Fenner. I'm Mark Abrahams, the CEO. Start off with an overview. And as no doubt you will have seen, healthy performance improvements and as we go down the P&L it gets dynamite. So that by the time we get to the earnings level, quite strong healthy growth. John will explain more what is behind that in a minute.

In addition to the operating performance, we have also generated strong cash flow, such that our borrowings at the half year were less than they were at the year-end. Very unusual for us to be able to do that, and again, John will show where that has come from, but it shows the underlying healthy cash flow capability of this group.

Perhaps more interesting than that is that the improvements that we've seen, the progress that we have made has largely come from self-help. And as the presentation unfolds, you'll hear things like market share gains, new product developments, operating efficiencies and improvements, and that is the theme throughout. The markets haven't hurt us. But for the most part, the markets haven't particularly helped us during this period.

As it happens, as we move through the period towards the period end and into the second half, the outlook is starting to show some signs of improvement finally. We need to be careful that we don't get too excited about the rate of growth of the market, but they are starting to look a little bit better. But what we are doing is creating a platform and a platform for growth with the themes that I talked about, new product development market share. And therefore, the platform we're creating should position the group very nicely for the next 3 to 5 years, poised for growth, helped as the market starts to improve. So in summary, the strategy I've been talking about for the last year is being delivered. And with that, I will hand over to John to talk about the current position and some of the numbers.


John Pratt, Fenner PLC - Group Finance Director and Executive Director [2]


Thanks, Mark. Morning, everybody. So strong operating performance by both divisions in the first half of this financial year as this chart of underlying operating profit demonstrates for us. True, there's been some assistance from currency, given the weakening of sterling post-Brexit and that sum shown by the lighter colored tips on the charts of the comparative period. Even without that, very substantial progress in terms of profit in both divisions. And as Mark said, this has really been about self-help, not significant movements on the top line for the market from any of our operations, and, therefore, I guess, not surprising that what you see is the operating margins improving quite handsomely through this first half.

If we move over and look at our financial summary, and we start with the revenue line, there are a few moving parts here. Headline number says that revenue increased by 11%. If we knock out that currency impact and look at the things at constant currency, group turnover actually down by 6% period on period. But that in itself is not quite the full story because we've had some closures and some disposals over the last year.

So in AEP, we sold Xeridiem, and we part sold, part closed CDI Europe, and within ECS, we closed the Allison business, and we also consolidated some of the service branches. In total, about GBP 12 million of turnover between the 2 periods. So if we corrected for that and we looked on a true like-for-like basis between the 2 periods, group turnover is down around about 3% between the periods. And that is all about ECS, which we shall see in a moment actually, underlying growth in AEP.

Underlying operating profit moving ahead reasonably strongly to GBP 24 million, as we saw on the last slide, and with some benefit from the reduced tax charge that I will talk about in a few moments. Underlying earnings per share more than doubling to 6.3p. On the back of reasonably robust earnings recovery, we have increased the dividend by 40% interim dividend, albeit from a low number, rebased to 1p up to 1.4p.

And cash flow, again, as Mark alluded to, strong, again, in the period. Operating cash flow GBP 34 million. So 140% of the operating profit in the same period. All of that leads to a closing net debt, GBP 145 million lower than the year-end, as Mark said, and GBP 10 million lower than February '16 and that's not on constant currency. Had we put it on here, and I suppose I should've done really, constant currency, the debt at the half year almost GBP 30 million below the position it was 12 months ago, so a significant reduction in underlying debt.

And all of that adds up to a net debt-to-EBITDA. I always said, when I stood in front of you before, want to get to 2x by the end of the financial year '17, and we've got there at the half year. In fact, on a constant currency basis, which is how our covenants are measured, and several of our bankers in the room, so they can all nod at this point, a constant currency basis 1.9. So comfortably there 6 months earlier than we said.

Segmenting these a little further, revenue in AEP on the face of it, down 2%, again, allowing for those discontinued in actual fact is growth over the period of 4%. In ECS, revenue down 10%, underlying 7%. But the margin enhancements that I talked about earlier, you can clearly see 2 percentage points in AEP and 2.4 percentage points in ECS.

So moving forward, thinking a little bit more detail about AEP. It's a chart you've all seen before, end market analysis. I think there's only really 2 things I want to pull out of this chart. The first is medical, which is the second bar from the top where you see a reduction. And as I've mentioned a moment ago, that is all to do with the sale of Xeridiem, which was on the 1st of September last year, so no contribution, full contribution in '16 half year and nothing in the '17.

And then the other area I'd like to talk about is oil and gas. So a reduction from 16% to 15%. The dark blue bar representing on a constant currency, a reduction of about GBP 2 million in oil and gas revenues. Again, if I took out the discontinued of CDI Europe, what you would see is a modest, it is only modest, increase in underlying oil and gas sales of around about the same number. Minus 2 becomes plus 2. So a small increase in oil and gas revenues.

And just hang on to that thought for a moment, whilst we have a look at the Baker Hughes U.S. rig count, which we've always said is a reasonable proxy for our oil and gas facing businesses. And that's demonstrated by the vertical blue bars at the bottom of the chart. The green line is the oil price, just for reference. And if we think about what the average rig count was, first half this year against first half last year, and you may have noticed that I have slipped the shaded areas, 3 columns to your left in both cases and that's to allow for the order book period the lead time in orders. And we look at what the average rig count was these 6 months here. It's just over 800, 820 I think was the number, and we look at the same number here, a tad over 500. So in terms of the base market, a 40%, like a 39% or 40% reduction in the average rig count across that period.

If you remember what I said a couple of moments ago, our oil and gas revenues marginally up. So strong performance when you understand what's been happening in the market. Now what's caused that, 2 things. Sure the rigs are producing more oil and gas. There's more being produced per rig and therefore using more products, but crucially and importantly, Mark's got some data later on, significant changes in market share, gains in market share.

And that takes me neatly onto talking about Advanced Sealing Technologies. Again, the turnover looks flat. If we take out the discontinued, it's plus 7. I've said enough really about CDI and EGC in terms of what I've said about oil and gas.

Hallite, really pleasing, very strong performance from Hallite. This is the industrial side of the seals business, makes seals for reciprocating hydraulic cylinders, something like a top line 8% growth year-on-year in Hallite, driven really by 2 things. Firstly, new product developments. So a new PTFE range of products and high temperature polyurethane products being added to the portfolio and significantly improved service levels to our customers, which has also benefited the top line. Put that together with internal efficiencies and a very nice increase; the best-ever bottom line result that we have seen from Hallite. AIP, small business within the division, concentrating on medical and aerospace.

Onto Precision Polymers, just shy of 3% growth in this business. Precision Polymers U.S., you remember that last year we put 2 businesses from this division in the U.S. together, and we've put 2 businesses from the U.K. together. So as the U.S. is concerned, a bit of a lackluster start in Q1 from Fenner Drives, and we attribute that to uncertainty regarding the outcome of the U.S. elections. Some more stability after that result was confirmed and good growth in terms of order intake in Q2. That together with the internal efficiencies from putting those businesses together delivering a good improvement in the bottom line.

In Precision Polymers U.K., strong demand for some of the new products. I didn't refer to it, but if you notice the transportation sector in the end market analysis, ticked up a little bit. That's really being driven by the Precision business in the U.K. And hose, this is the James Dawson business, remember silicon organic hoses, relatively steady, again, benefits from putting those businesses, both based in Lincoln, U.K., together benefiting the bottom line.

And lastly, in this subdivision, Mandals, a business that we made no bones about had a difficult time following the fallout in oil and gas. Recently done much better. Order intake up quite significantly, some of that coming -- little bit of that coming from oil and gas, but actually resurgence in some of its more traditional markets, largely the agriculture market. And the management team strengthened in that business with both the new MD and the new FD put into that business in the last 6 months.

And lastly, on AEP Solesis Medical, again, I've covered it already, but the reduction in turnover accounted for by the sale of Xeridiem at the beginning of this first half. Secant in the very final stages now of the relocations. I mean we've touched on during these presentations but not talked too much about, which may be a little surprising. So this is a huge project, very significant project but delivered absolutely on the nail by our local team, fantastic effort and has gone really well. And we're absolutely in final phases now.

On top of that, the all-important in medical new product pipeline strengthened both in terms of the number of products but I think also in terms of the quality. Our first projects that are coming through and a good proportion of that work will fall into -- well, some of it will fall into the second half and a good pipeline for '18 onwards. Again, and it sort of gets rather repetitive, we talk about internal efficiencies again here. We moved from 7 buildings to 2 buildings. You've got to generate some efficiencies, and we see that coming through in a very strong operating result for Solesis in the first half.

Charter acquired, I guess, 18 months ago, something like that now by the group, again, benefiting from the operation improvements that we made shortly post-acquisition to that business. And perhaps to just note for future reference that cell therapy, which we always said was the growing part of that business, is where we've seen the biggest increase in demand.

So on to ECS. Analysis of revenue by markets served. Coal in absolute terms down a little bit. I think no surprises there. As a percent of the business, 44% of divisional revenue, largely unchanged. The good news here is bulk materials. So the true industrial business, sand, gravel, cement, aggregates and that is really driven by what's happened in our U.S. business. You remember that January 16, we announced the refocusing of that business. Certainly not walking away from coal but, by the same token, putting more emphasis into the industrial markets, and that's where we've seen the growth come. Other extractive you'll notice is down. This is non -- it's mining but non-coal mining. So it's iron ore, copper, phosphate, potash, and those markets still remaining pretty difficult over the period.

By type, there really not much to say here. The percent of the split between service and replacement roughly the same. I guess, the only point I would make is that new customer capacity OEM conveyors down to an all-time low of 4%. At its peak, that number was round about 15%. So we're still not seeing any new conveying projects coming forward as of yet.

And if we segment the ECS business into Northern Hemisphere and Southern Hemisphere. North America, we've seen a reduced turnover from the Allison closure, I've talked about it, and the consolidated service footprint. Industrial sales growing well, as I mentioned a few moments ago. And coal, well, yes, some recovery. So down compared to the first half of last year, but compared to the second half of last year, a modest, not the right word, because it is modest improvement in coal revenues. But more than anything, what has really driven the improvement in the ECS result was the reorganization that I referred to few moments ago. So the reductions in the cost base that we've made in that business in North America more than anything driving the improvement in the ECS result. That business back to making a reasonable, given the market, return on sales.

And in Europe, this is largely the Drachten-based business. Its base business, which is again true industrial, sand gravel, cement, aggregates, okay, respectable return on sales. It does really well when it has the project work, largely from those other extractive industries. In their case, largely iron ore and phosphate, and as I alluded to a few moments ago, that work remains at this stage very thin on the ground.

As far as the Southern Hemisphere is concerned, remember that this subdivision is dominated by Australia. The South Africa and China businesses are very small in comparison. Australia, strong market position, maintained both in coal on the Eastern side of the country and in iron ore on the Western side of the country. And notwithstanding improved market sentiment that I guess we've all read about from the mining groups, we have not seen a wave of new orders as yet coming out of the industry and the order flow has remained steady. But again, that concentration on internal efficiencies within our plants, driving a better bottom line result.

South Africa remain -- I'd say, small business remains quite difficult, structural change, and you've read about one of the mining majors announcing quite significant disposals of some of its coal mines only last week.

And lastly, a word on China. Again, an industry in reorganization. An industry where it is very difficult to secure acceptable credit terms. The reduction in turnover actually you see within this division is largely about China, which remains a very difficult market for us at this point in time.

So back to the numbers. Group income statement. I guess I've covered the trading part in my previous comments. Couple of things I would just pick out from here. Firstly, on the interest line, which on the face of it has increased. That again is to do with the interplay of exchange -- translation exchange rates. Actually it has reduced on a constant currency basis, as you would expect, given that we have been generating reductions in net debt.

Just a note for those of you looking forward to FY '18, to note that we repay $90 million of the $290 million of private placement debt in June of this year and essentially that is done from cash which is currently on deposit not earning very much, therefore, there is quite a benefit next year '18 on the interest charge, roundabout GBP 3 million of benefit to the reduction in the interest charge moving forward.

The other number I think just worth touching on is tax. So 25% underlying tax rate for last year. We're now guiding towards 22% for financial year '17. It's driven by better utilization of some of the tax losses that we have in the U.S. so a reduced rate for this year. But the quid pro quo for that is the rate will return to the more normal group average, which we've always said is upper 20s approaching 30%. That's the natural tax rate for the group, and it will return to that more quickly. So in '18, you should expect the tax rate to increase, as I say, probably to the high 20s, all assuming, of course, there is no change in underlying tax rates, which there may well be in the U.S. by that point. But those 2 impacts coincidently, the reduced interest or the increased tax charge, roughly offsetting each other, as we move forward into '18.

Exceptional items. Well, we've had some charges in the last couple of years, as we have restructured. This is a credit. So this is a credit exceptional item, and it comprises the profit, the book profit that we made on the sale of Xeridiem, about GBP 5 million offset by a small loss on the sale of CDI Norway and also offset by payment to the estate of Nick Hobson, former CEO, I think we all know, died in January of this year.

So on to cash flow, we said we had a strong cash flow, GBP 34 million, 140% of OP that I talked about. You notice an increase in depreciation here. That's nothing, again, more than the exchange rates having the effect that they're going to have given the weakening of sterling. EBITDA are up to GBP 37 million. CapEx is a low number and guided towards GBP 15 million or GBP 16 million for '17. Very much the same number that we had in '16 and you should hang on to that thought. That is still a good number for this year. It's just that the CapEx has been low in the first half. There's nothing particularly around that. It's just the timing of projects, capital projects and how they fall. So it is low, notwithstanding that the shape of the number between the 2 divisions, what we always said exceptionally low CapEx in ECS if I finished over GBP 1 million of CapEx in the first half.

In terms of working capital, those of you with longer memories will remember that Mark alluded to this at the start. Traditionally, the group absorbs quite a bit of working capital at the half year as it prepares for the seasonally stronger second half. That didn't happen last year. First time it didn't. We took GBP 1 million out of working capital. And you'll see that as far as this year is concerned, we've done the same thing again. We take another GBP 1 million of working capital out.

Interesting to note the moving parts, perhaps in ECS, where underlying turnover has come down again. We talked about GBP 6 million taken out of working capital. But in AEP, we've allowed working capital to increase a little bit. And that's 2 things. Some of the underlying growth that I've talked about and also, again, reference that seasonally stronger second half.

Moving further down the cash flow statement. Reductions in tax payments, again, following what I said about the tax rate. The dividend, of course, significantly reduces the payment of the interim dividend from last year, 4p in the previous year, 1p in this year.

Acquisitions and disposals a net of GBP 8.6 million. Couple of things there. That is firstly the payment of GBP 14.4 million out on the final acquisition, the minorities into the service businesses in Australia, and that marks the end of all the deferred consideration -- deferred and contingent considerations. There's no more to pay across the group. And that's offset by the receipt of monies that we had from the 2 disposals, Xeridiem and CDI Norway.

So movement in net debt before currency GBP 11 million. Currency, as ever, played a part. Cut the balance sheet to GBP 131 million, I think it was at August versus GBP 124 million at February, so that added GBP 5.4 million to net debt. Even after that number, bottom, bottom, bottom line, net debt coming down by GBP 5 million to the GBP 145 million that I talked about.

I've already mentioned the net debt-to-EBITDA headline number, just calculated straight off the face of the account we get to 2. If you do it at consistent exchange rates, as I say as is how our covenants work, 1.9x.

And lastly from me, just a note on the dividend. As I say, given the earnings recovery that we've seen, we've increased that by 40% over last year's number. Big increase but -- and a small number and still representing very safe levels of cover both in terms of profit and cash. With that, I'll hand back to Mark on the outlook.


Mark Simon Abrahams, Fenner PLC - CEO and Executive Director [3]


Thank you very much, John. So on to the outlook now. And we'll start with AEP and the sales business first. I have been talking now for a year or so about the market share gains we have been making. I've also said that it takes a time to come through because of the bespoke nature of the products, the development period, et cetera. Now for the first time, we can actually start to see those orders and intentions coming through into actual sales.

And John referred to the fact that the average rig count was down by 40% and yet our sales grew. It shows the extent to which we're gaining momentum in this market, and also the fact that the market is moving in the direction that plays to our strength. As it becomes increasingly technical, products become higher specified, documentation becomes more critical and the value that we bring becomes more significant to our customers. And therefore, the gains are continuing and will continue into the future pretty much along the lines I have been saying. It's just nice to see it unfolding.

A factor that we do need to be aware of, however, is the increase in uncompleted wells, at record levels increase of something of the order of 4,000. Now that's good news and bad news all at the same time. There's potentially an increase in pent-up demand because the drilling drives product demand, but so does completion. So there is some increase in pent-up demand, but of course, when all of that capacity comes on stream then that could possibly have some kind of impact on to prices. But what is interesting is what is going on in the Permian Basin, and we'll look at that in a minute. But it is quite encouraging that the expansion is happening in those areas which are the most efficient, and therefore, the long-term survivors.

A lot of new product developments, a lot of the growth is coming partly as a result of customer service and partly as a result of product development. And indeed, we have stayed ahead of the curve in terms of putting resource in, investing in the development areas, investing in the technical areas so that we can continue to make progress. And across CDI and EGC, the new gains from these developments remains extremely encouraging.

In addition to that, we are now starting to see some market pickup. You can see the rig count starting to move in our favor and question is to how much it grows from here and how fast it grows from here. But given there's a lag in terms of the feed-through into our sales, a very encouraging trend. So for the first time, we got the alignment of new products, market share gains and the market starting to pick up. So quite encouraging outlook in this business, and that's an encouraging outlook for the second half but for the next 3 years, and I think it's important that we appreciate the platform that has been created for the next 3 years in this business.

John mentioned Hallite and the strong results from Hallite, and those are continuing. Very, very encouraging. We've got to bear in mind a significant driver of the Hallite business was the mining business that it enjoyed, and that has dropped quite significantly. So for it to be moving ahead with relatively the whole mining business is a credit to the people who have developed the new products and increased the market penetration were encouraging to see.

So to add a little bit of color to what I've been saying about past, I've got a couple of graphs. This first one shows you the EIA chart as to what's going on in the Permian Basin. And here, you can see a reasonably significant pickup in the rig count, but far more significant than that, this yellow line here shows you the production per rig. This is one of the most efficient producing areas, and it's getting more efficient all the time. What it means is, as an area, it is more capable of withstanding downward pressure in oil prices, and that productivity means that their demand for the higher specified products, the things that play to our strength are going to be accelerating in this region. So that's actually quite an encouraging chart for us.

The next shows you our market share and our market share gains. This chart, similar to the one I showed you last time but this one is smooth and against a market that has fallen a long way starting to improve, but our market share gains are very significant. Whichever way you cut it, you can see that the market gains are significantly starting to show.

So next, on to Precision Polymers. We talked about the reorganization and the focus that, that brought, a, to the markets, and, b, the cost efficiencies that it brought about and that is clearly starting to show.

Fenner Drives, encouragingly, is starting to grow again. We went through a fairly uncertain period in the run-up to the U.S. elections. This is fairly common. Every 4 years, we get the same sort of pattern, and very pleasing to note that we have started to see a return to a more normal level of growth that we would expect post the elections. That in part is due to stability in the market but also significantly down to a number of quite exciting new product launches which we have brought onstream, so that business is actually doing quite nicely for us.

In addition to that, our hose businesses, this is Mandals, is growing, particularly in the U.S., where we put more resource in, and both the agricultural business but also the oil and gas starting to show some interesting signs. I did talk about new product developments last time. Those are starting to hit the market, and that will be an interesting driver, again, for the next 3 years in that part of our business.

So putting it all together, this part of the division is starting to show growth again. Lastly, but very definitely not least, on to the medical business. John referred to it, the pipeline steadily growing. Up to 168 products in the pipeline and the quality of what is going on in that pipeline more and more encouraging. And what we are trying to do is increase our base of technology and putting more value into the product offering so that we can provide more value to the customer and differentiate ourselves further.

And the examples I give here, heart valve, neurovascular repair, orthopedic and fiber development. We are into contract manufacture to do precisely that. Perhaps not what you would necessarily think of contract manufacture, but it's a way of putting a broad spectrum of our technology into the devices so we can give value to our customers. So very much on track with its developments.

You may remember last time, I talked about this material PGS, which stands for poly(glycerol) sebacate. We had been awarded the patents on this product. We trade under the name Regenerez, and we are moving now towards individual product developments, developments of applications. This is a long term, just to remind you. This is a 5-year program of developments, possibly longer than that, but quite encouraging with a patented material that has phenomenal properties. So interesting potential. So again strengthening the platform for moving forward in the business. So that covers AEP.

Now on to ECS. And I start with the Southern Hemisphere and Australia, the substantial business in the Southern Hemisphere. And everyone will be aware that the miners have had a much better time as of late, with higher commodity prices and the input costs pretty low, partly as a result of the cycle but partly as a result of the job they've done. So product like ours are cheaper than they were, unfortunately. But it's been a quite a good time for them. But for various reasons, in some cases, because the miners are unsure as to the longevity of the higher prices. In other cases, after a long period of suppressed margins, they are actually able to make money, but for a combination of those reasons, there had not been an awful lot of investment in project work. So the industry, from our perspective, has been somewhat out of balance.

In addition to that, I've talked about the destocking in the past -- just 6 months ago, I was talking about the destocking. And there are clear signs that, that is coming to an end. We have seen an element of bounce relating to the end of that destocking. And clearly, destocking can't go on forever. And so that pattern has happened exactly in the line that we predicted.

So that leaves us with a solid market position with our contracts being retained and a very strong position in Australia. But interestingly, we're now starting to see a lengthening of the order book. It's not changing the rate of order flow, but we have more visibility. We can plan the factory better, we can get better efficiencies and the customers are starting to think slightly more long term. That is obviously an encouraging first sign.

The quick response orders still flow. Again, something where we're differentiated in terms of our service response so another positive. And the service business is actually quite full. Now in every other downturn, that has been a precursor to the market picking up. I don't see why it shouldn't be this time; however, I just think we need caution in terms of how quickly we expect it to pick up. From our point of view, we see that as happening in the next fiscal year in 2018 and, although the development work is still thin, we are starting to talk about projects coming through in '18.

So in the short term, we expect to gain from the end of the destocking. In the longer term, the market has to return. There is not sufficient development just to maintain stability let alone grow the production capability. So there has to be some bounce. And then the margin gain should come from the mix changes, from the efficiency and from new products. So as I've said in the past, the margins should come back a bit, not to the levels they were at their previous peak.

On to the Northern Hemisphere and Americas first. The industrial business has shown steady progress, steady growth as we continue to make small gains here and there pretty much across the business. So very encouraging. So the refocusing has paid dividends.

Interestingly, in this business, and unusually in this business, because it's relatively mature, we have a new product being launched or a new product range being launched, pretty much as I stand here today. It is aimed at the industrial market. It is very competitive and it's a patented product. It's patent-protected. So the potential for that over the next 18 months to 3 years is actually quite exciting what it can do for us. And it should help the strategy of growing the industrial business in North America.

We have what I describe here as steady U.S. coal volumes. Given it was absolutely on the floor, there was only one direction it could go from here. So it has bounced. I mean, percentage terms it's quite large but it's still nowhere near where it was at the peak. However, we don't think it's going to grow hugely from here. It'd be nice if it did, but that is not our expectation. Our focus is on growing the industrial business where we do see growth in the market.

The other feature of the Americas, which is quite significant, is the productivity gains that we have made. These have been significant. And not only have they taken cost out of the business, but we have generated something of the order of 20% extra capacity for free, simply by taking inefficiency out. So that's quite significant. So we can grow the business where we get a fairly substantial drop-through in terms of profitability, so hardly surprisingly that profitability is increasing.

When we did the reorganization in January of last year, we said that there was going to be a big one-off saving, which we achieved, and we said we were going to go into a period of continuous improvement, which indeed we did. The only thing that is changing from that is we're ahead of the game in terms of that continuous improvement and the profitability that is flowing from it.

In Europe, pretty much as John said, the underlying industrial business is steady, still relatively thin in terms of project work, but we expect some projects to start coming through, probably towards the end of this fiscal year, but those will really benefit 2018, so fairly slow throughout the rest of this year.

So when I put it all together, the market share gains, the new products and the efficiencies are continuing. It's creating an important platform, and it's a platform for 3 to 5 years, not just the rest of this year or next year. The extent to which we're rejuvenating the product range is quite significant, between 10% and 30% depending on which part of the group we're looking at. So over 3 years' time we are building some quite interesting potential for growth.

The outlook is improving, but I do say slowly. So we just need to be a little bit cautious in terms of how fast we think it will feed through, but we put the self-help, which is continuing, together with a slightly improved market position, and we have, therefore, increased expectations, again, reasonably significantly at the earnings level.

So in summary, the first half shows improvements across the whole of the group everywhere. Second half has started well, and the theme, as I started off saying, it's about market share, product development and also efficiency improvements. So we're into a period potentially of recovery and also growth through those self-help mechanisms. Many of the developments will benefit future years. We are creating a platform for the next 3 years. So the strategy is being delivered. Thank you very much. And that ends the formal part of the presentation. Questions?


Questions and Answers


Edward Maravanyika, Citigroup Inc, Research Division - VP [1]


It's Ed Maravanyika from Citi. Just wanted to ask how much of your exposure is completion versus drilling on the oil and gas side? And what signals do you look for to sort of get confidence that completion of those DUCs is kind of -- is beginning basically?


Mark Simon Abrahams, Fenner PLC - CEO and Executive Director [2]


I'll answer the second question first. There's not a lot of sign that the number of uncompleted wells is reducing at this stage is to do with balance of teams, but whether there's the resource available to do those completions. So far as our products are concerned, because similar products go into both, you can't be 100% sure what proportion goes into the drilling and what goes into the completions. There are also a number of other applications. There's well head. There's fracking as well. So it's not just one or the other, but there is a reasonable chunk of our product that will go into those completions. That's all I can say. Otherwise, I'd mislead you.


Dominic Convey, Peel Hunt LLP, Research Division - Analyst [3]


Dom Convey from Peel Hunt. Just following up on that theme. When you talk about market share gains and the chart you showed, actually showed that the steady gains really began back in 2013. So I wonder what you anticipate -- or what your expectations are for further share gains going forward. How we might think about the correlation from here with respect to the rig count? And obviously, you talked about the modest growth against rig count headwind year-on-year, but if we think second half on first half, I've not done the 3-month lag calculation, but just plain data would suggest it's up almost 40% second half on first half, so what your expectations are for the second half performance.


Mark Simon Abrahams, Fenner PLC - CEO and Executive Director [4]


Okay. Right. There's a lot of bits to that question. Firstly, that chart, as I said, was smooth. So you need to be slightly careful because we did quite deliberately smooth it. However, yes. I mean, the gains have been steady and, yes, we do expect them to continue. Exactly as to the rate it's quite hard to predict. Because when you're into accounts which could be worth a few million dollars then you introduce product by product. So it's phased over a 2- to 3-year period. And therefore, we expect this to continue for a 3-year period in terms of these gains. So it will go on for quite a while.

Yes, the rig count has picked up, but we do have to be careful of the statistics. Because of the uncompleted wells, there is a lot more production per rig, particularly in the Permian, as I've showed, which means, you sell more product, and therefore, some of the gain when I relate it purely to the rig count is as a result of individual rigs consuming more product. Exactly how much is hard to be precise, but it's probably about 10%. The rest is probably market share.

So yes, there should be some pickup, both in terms of market share and in terms of the market through the rig count going forward. There will be both elements, and that is -- that is a large element of what is incorporated into our guidance, which is to increase expectations for the year. That's the single largest driver of that statement.


David Alexander Larkam, Numis Securities Ltd., Research Division - Analyst [5]


Dave Larkam from Numis. Few more questions, please. ECS, can you just talk about firstly, Russia, South America, China we sort of pulled back in those markets of late. Are they sort of almost insignificant now?

And then secondly, talk about -- you're obviously at a great point at the moment. You've taken a lot of costs out of ECS. You'll be able to load the plant an awful lot better than you have been. Hopefully, the destocking is completely finished now. So at what point do you need to start putting costs back into that business as the volumes recover? Can you just talk about that? When do you start taking people back on, and when do you have to start putting some more CapEx in as well? And then finally, just on AEP, what was the organic growth on the medical business in there? You said what the absolute number is, but I just wondered what the organic growth was.


Mark Simon Abrahams, Fenner PLC - CEO and Executive Director [6]


Okay, right. Well, let's deal with the ECS stuff first. The markets that you talked about, Russia. Russia is actually doing okay, but it's not large in the scheme of things. It's large to one plant but it's not large to the division or the group.

China, as John referred to, is actually very difficult, because credit periods are quite long, and at the end of the day, there are risks that are probably not worth our while taking. So it is a lot smaller than it was, and it has ceased to become a material part of the group, which is why we talk about Australia principally when we talk about Southern Hemisphere.

In terms of costs, we're probably at a point where there's not a large amount more costs that can come out without impacting on productivity, but I would look at it more the other way that we will become more efficient as volume comes back and, therefore, we don't have to put that much cost in, so we will get further productivity out, and that is indeed what we've seen in the U.S., for example, with that increased productivity and that will apply to almost all of our plants. So yes, you'll have to put a little bit in, but not a lot as the volume comes back.

So far as the CapEx is concerned, then basically, not a huge amount. We have the capacity, machine-wise. There are always things that you do on the margin but it's not huge. And as far as medical is concerned, so far as the existing business is concerned, reasonably flat period to period, but there are specific phasings of projects. So taking the business as a whole, it is exactly where we expected it to be for the year.


John Pratt, Fenner PLC - Group Finance Director and Executive Director [7]


There's also some -- sorry, (inaudible) there's also some buy ahead given the project that we did the consolidation by customers. There's some product in there that has reversed through this period as well.


Andrew Douglas, Jefferies LLC, Research Division - Equity Analyst [8]


Andrew Douglas from Jefferies. Just one quick question on North America and ECS. You've talked about a new suite of products or a family of products. Can you just expand upon that and kind of where we are in the cycle? And how potentially important that is for North America, particularly if coal may or may not be kind of flattish? How important is that going forward?


Mark Simon Abrahams, Fenner PLC - CEO and Executive Director [9]


Yes. It's actually a very innovative product with quite interesting potential. Because of the technology that we've got, the product is thinner and lighter for a given tensile strength, and therefore, it is going to be very cost-efficient compared to other products on the market. So I'll leave you to work out from that the competitive position it will be able to put us into.

And it will address something approximating 30%, maybe 25% to 30%, of the potential markets, the industrial market in North America. So it's aimed at quite a large area of the market where we hitherto have struggled to be competitive against low-cost manufacturers with the lower labor content in their product. So this is why I say over the next 3 years, it could be potentially quite interesting for us.


Andrew Douglas, Jefferies LLC, Research Division - Equity Analyst [10]


And where are we in terms of the -- the approximate suite of products? Have we got one in the market and more...


Mark Simon Abrahams, Fenner PLC - CEO and Executive Director [11]


It's developed, it's proven and it is in the process of being launched. I would have said rather more if it wasn't so early in that launch stage.


Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [12]


It's Andy Wilson from JPMorgan. And just a few questions. Just to follow up on David's question around medical. I think you've been quite clear in terms of the expectations for growth over I guess, a 5-year period, kind of business doubling and that sort of magnitude. And I think you've talked about being -- sort of the real growth being weighted to the second half of that?


John Pratt, Fenner PLC - Group Finance Director and Executive Director [13]




Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [14]


Which seems to be consistent with what we see. Can you just give us an idea of what we should expect for the second half? And then sort of year-on-year '18 on '17, just to give us some sort of idea of that trajectory?


John Pratt, Fenner PLC - Group Finance Director and Executive Director [15]


Yes. So there will be a increase in the turnover and in the second half by a few million. And then as we move into '18, we should be seeing reasonable growth coming out of medical as we move forward into that year. As you quite rightly say, the doublings of 15% compounded annual growth rate is weighted towards the end of that 5-year period. But you will see something notable in the second half and you'll see something else notable in '18.


Mark Simon Abrahams, Fenner PLC - CEO and Executive Director [16]


I mean, one of the difficulties is predicting exactly when some of these things are falling, which is why we talk about a 5-year growth rate rather than individual years, because we're having a project that's coming onstream where we could get $3 million, $4 million, $5 million worth of sales. But does it come onstream in July, does it come onstream in September? And it could quite significantly affect any individual year-on-year across a 5-year spectrum. It doesn't make any difference and that's why we can talk quite confidently about that long term, but it might appear that we sort of hedge when it comes to talking about any individual period. But it is because new projects coming onstream it's hard to be precise about timing.


Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [17]


Yes. I'm just trying to understand almost how much is -- John is already expecting this -- but just trying to understand kind of how much is left to go for. Or how reliant we are on just the top line picking up, which I think we probably expect it to? But just trying to understand just how much has been in cost and given -- yes, how much is still to come?


John Pratt, Fenner PLC - Group Finance Director and Executive Director [18]


Okay. So we have taken, as we said in the previous presentations, a huge amount of costs out, I think I quoted GBP 70 million at one point that had come out of the cost base. And we're essentially not taking cost out of the business now, other than the sort of daily concentration on improving productivities and efficiencies, which just goes on day in, day out.

But in terms of having to lay anybody off, that's not what's happening. In fact, the opposite in some of our markets. I think we said previously that we were keen to get ahead of the curve, in terms of recruiting into oil and gas. So in the Houston area, huge numbers of people laid off. Some of those people that never want to come back to the industry, we wanted to make sure that we were going to get the better people. So we've actually been recruiting slightly ahead of the curve. And indeed, you're right. The results that you've seen, improvements that you see that we're talking about today are generated by the cost savings that we did previously. So we don't see large slugs of cost to come out of the business now. As we move forward, it is, I say, that day-to-day grinding out a better result, improving efficiencies, but any significant change, of course, has been driven by what happens in the market.


Dominic Convey, Peel Hunt LLP, Research Division - Analyst [19]


Sorry, just a couple questions in terms of following up on the margins. You've made a couple of references to drop-through just this point about being ahead of curve in Houston maybe dampening drop-through in the AEP or the gas space, particularly, the efficiency savings in ECS. One would anticipate a higher drop-through there. If you could perhaps give us some numbers around that. Just in overall terms, how you anticipate the margin trajectory from ECS, given those continued improvements specifically with respect to maybe a 10% target over time?


John Pratt, Fenner PLC - Group Finance Director and Executive Director [20]


Okay. So if we think about ECS, Dom, we traditionally said a drop-through might be something around 25% to 30% as a normal reported drop-through, and I think given where we are and the efficiencies that we've seen ticking through plants in the U.S., we could think about a number that might be a little bit higher than that. It still round as far as ECS is concerned, and typically, a bit higher number than that -- being very vague here, aren't I -- in terms of AEPs or maybe around 40% or so in the AEP business.

And longer term, we said that we don't see the ECS business getting back to the peaks that we saw in '11 and '12. What we have said is that we see the business getting back to a double-digit return on sales. That it will take a couple of years for us to do that. But that absolutely remains within sights and our target. AEP, we have talked previous some time ago, it seems forever ago now, about AEP achieving a 20% margin. That requires oil and gas to be absolutely back to where it was. And as we know because the rig count won't go back to where it was, that will take time for us to deliver that in terms of the new products and market share, but again, remains a worthy longer-term target for the division.


Mark Simon Abrahams, Fenner PLC - CEO and Executive Director [21]


Okay. Thank you very much.