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Edited Transcript of MGAM.L earnings conference call or presentation 25-Jul-19 10:30am GMT

Half Year 2019 Morgan Advanced Materials PLC Earnings Presentation

London Jul 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Morgan Advanced Materials PLC earnings conference call or presentation Thursday, July 25, 2019 at 10:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Pete Raby

Morgan Advanced Materials plc - CEO & Executive Director

* Peter A. Turner

Morgan Advanced Materials plc - CFO & Executive Director

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Conference Call Participants

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* Andrew Douglas

Jefferies LLC, Research Division - Equity Analyst

* Edward Maravanyika

Citigroup Inc, Research Division - VP

* Harry Philips

Peel Hunt LLP, Research Division - Analyst

* Mark Davies Jones

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

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Presentation

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Pete Raby, Morgan Advanced Materials plc - CEO & Executive Director [1]

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Well, good morning, everybody. Thank you. I'm Pete Raby, the Chief Executive of Morgan Advanced Materials. I'm joined on stage by Peter Turner, our CFO. I want to say a few words of introduction. Peter will then take you through our interim results for 2019. And I'll then talk through the business positioning and outlook and the progress that we're making with the implementation of our strategy.

We've made good progress with the implementation of our strategy in the first half of the year, and we're on track against the objectives that we set ourselves at the beginning of the year. Market conditions have been relatively challenging with declines or slow growth in the key industrial markets, and that's impacted order intake and revenue growth in the first half of the year. The group grew revenue by 1% on an organic constant currency basis in the first half of 2019.

Operating margins expanded 0.7% to 12.8% with the benefit of the efficiency actions that we've been taking across the business, the drop-through on the incremental sales and the impact of the IFRS 16 accounting changes. This delivers on our commitment to expand margins this year, following the completion of the significant investment that we've made in the business over the last 3 years. Earnings per share grew 3%, reflecting the improved operating profit.

Looking to the second half of the year, we expect our revenues to be broadly flat against the prior year. Our profit expectations for the full year are unchanged. I'll describe our progress to you in more detail after Peter has taken you through the numbers for the first half. Peter, over to you.

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Peter A. Turner, Morgan Advanced Materials plc - CFO & Executive Director [2]

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Thank you, Pete, and good morning, everyone. Let me start with the summary financials for the half year. Firstly, I'd just like to note that as with our 2018 full year results, the figures presented here are for the group's continuing operations, the divested Composites and Defense Systems business has been treated as a discontinued operation and prior year comparatives restated accordingly.

Revenue at GBP 525 million was 2.2% higher than last year on a reported basis, reflecting underlying growth and a modest foreign exchange tailwind. On an organic constant currency basis, revenue was 1% higher than last year. Group headline operating profit was GBP 67 million and grew by 8%, with margins of 12.8%, 70 basis points ahead of last year.

Operating cash flow at GBP 61 million was 10% better than last year, and I'll give some more detail on cash flow in a moment. Headline EPS was 3% higher at 13.8p per share, reflecting an improvement in operating profit, higher finance charges and the effective tax rate remaining at 28%. The interim dividend declared is 4p per share, maintained in last -- line with last year as we continue to rebuild dividend cover.

Included in the appendix of the presentation is the financial information in statutory format. There are no reconciling items in the first half of 2019.

Turning now to cash flow. On trade working capital, we've seen our typical outflow in the first half, and we expect this position to improve during the second half. Capital expenditure is higher than the prior year, with investments to support growth in the business to improve efficiency and in safety and infrastructure investments across the manufacturing base of the business. We expect this to be around GBP 50 million for the full year.

On the financial items, you can see the impact of IFRS 16, as guided, and the movement in tax paid mainly reflects the lower tax paid in 2018, following the additional U.S. pension contribution we made at the end of 2017. Free cash flow before dividends for the half stood at GBP 11 million. The ratio of net debt, excluding lease liabilities to EBITDA is the metric most closely aligned to our financial covenants, and this remains in line with last year at 1.2x.

On pensions, we've seen a GBP 6 million increase in the defined benefit pension deficit through the first half, with a reduction in the European bond deals increasing the liabilities. Within the U.S. and U.K. schemes, the impact of the movements on the bond deals and the liabilities have largely been matched by movements in the scheme's assets. We are partway through our next trial new valuation of the U.K. schemes and expect this to conclude by the spring of 2020.

And finally, I've included, as a reminder, some of the guidance we've provided for the financial items in 2019. As you can see, we expect our headline effective tax rate to be around 28% this year. Based on current exchange rates, we expect our finance charge to be around GBP 16 million, comprising a cash interest charge on our net borrowings of around GBP 8.5 million, a GBP 3 million finance charge on the IFRS 16 leases and a noncash pensions financing charge of around GBP 4.5 million. And we expect our cash contributions to the defined benefit pension schemes across the group to be around GBP 17 million this year, the majority of which are to the U.K. schemes.

So with that, I'll hand you back to Pete.

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Pete Raby, Morgan Advanced Materials plc - CEO & Executive Director [3]

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Thank you, Peter. So before I talk you through our business unit performance, I'll just discuss what we're seeing in our key market segments. The growth position was quite mixed in the first half, with growth in semiconductors and electronics, defense, petrochemical and health care segments, offset by an overall decline in industrial and a sharp slowdown in automotive. Industrial is our largest overall segment. And here, our revenues have declined to 2.3%, with Europe particularly weak, continuing the depressed position from the second half of last year. Asia also declined. North American industrial revenues grew modestly. Transportation was down 5.5%, with growth in aerospace more than offset by the sharp decline in automotive sales, in particular, in our thermal business. Chemical and petrochemical sales grew 4.5%, with thermal project activity, the primary driver in both North America and Asia.

Sales of pump seals out of Seals and Bearings also contributed. Sales into the energy segment increased by 2.5%, driven by thermal products and carbon brushes into the power generation segment. Sales of our consumable products into the semiconductor and the electronics markets were up 11.8%, with sales of carbon products offsetting a modest decline in Technical Ceramics products. Healthcare also grew strongly and was up almost 12% on the first half of last year. This reflects growth in the underlying market and share wins for our Seals and Bearings and our Technical Ceramics business units.

I'll now take you through the performance of each of our global business units, and then come on to the implementation of our strategy. Thermal Ceramics declined 3.8% organically during the first half. While project activity grew as expected given its later cycle timing, automotive sales declined, down 30% on the first half of last year. Sales into Asian and European industrial markets declined, with Europe particularly weak, continuing the trend from the second half of last year.

Margins in the business improved to 12.4% of sales despite the declining sales. And this reflects benefits of our exit from our Brazilian business at the end of last year and operational efficiency improvements across the business. The business has a range of growth opportunities, including in petrochemical, electric vehicle and passive fire protection markets. And we're investing in sales resources and capability building and new product development in support of these as well as operational efficiencies to support the growth over the medium term.

Turning to Molten Metal Systems. The business grew 0.4%, with the downward pressure from the automotive segment, reducing the growth rate. EBITDA margins reduced, with the impact of restructuring costs in part of the business and the full year impact of investments that we made during last year in technology and product development. We expect to see margins improve in the second half. We've been investing in new product development and manufacturing capability to support growth in adjacent market segments, and we expect that to progressively enhance the growth rate of this business.

The electrical carbon business grew organically 2% in the first half, with continued growth in the wind segment and strong growth in the semiconductor and electronics markets. This was offset by modest declines in industrial markets and some reductions in export sales from the United States into China and from China into the United States related to tariff impacts. EBITA margin was up 0.6% at 13%, driven by the drop-through on higher sales and operational improvements. Here, we're working on a range of new technologies and products to drive growth in the transport, semiconductor, in the electronics and wind segments.

Moving to Seals and Bearings. The business has continued to perform well, with first half revenues up 5.2%. Healthcare and petrochemical sales expanded with further share wins in both markets, accelerating the growth. And sales into the ceramic armour segment also grew. This growth was partially offset by declines in the automotive segment and a drop in sales into the water pump segment with lower end market demand in China from a slowdown in coal-to-gas heating conversion. EBITA margins improved 0.4% to 18.8%, driven by the drop-through on the incremental sales. We're continuing to invest in new products for the automotive segment, with new production technologies to improve our offering to our markets. We're targeting growth in automotive, water, petrochemical and consumer appliance segments.

Technical Ceramics grew organically 6%, with broader-based growth starting to come through as the new business development pipeline starts to mature. Growth was driven by demand for ceramic cores in the aerospace market and the supply of ceramic parts into the renewable energy and medical markets. This was partially offset by a modest decline in industrial and semiconductor and electronics sales. The team delivered a strong improvement in operating profit, with margins up 2.2% to 12.8%. 1.4% of that margin improvement was driven by the drop-through on the incremental sales and operating improvements with a further 0.8% coming from the change to IFRS 16. We've got a good portfolio of development projects, bringing new material and product solutions to customers in the semiconductor and electronics, aerospace and medical markets.

Turning to our strategy. I'll briefly recap the key elements just to frame what we're doing across our execution priorities.

Our strategy is to build distinctive capabilities in 3 areas: in material science, in application engineering and in customer focus. We'll apply these capabilities to solve difficult problems for our customers where they value our differentiated products and support. And we'll apply these capabilities ethically and safely in line with our high group standards. We'll operate businesses that are at scale and that are scalable. By at scale, I mean they're among the leaders in their markets, and they're big enough to be resilient and able to sustain investment and sustain their position. By scalable, I'm talking about our ability to run these businesses on a global basis, getting synergies in sales, in operations and in technology. We'll serve markets that are growing and where we have room to grow and where customers value our differentiated products and support. So this is our strategy for the group. It's how we add value as a group and through the execution of this strategy, we aim to deliver more resilient financial performance and faster growth. We've made further progress with the delivery of our strategy in the first half of the year, continuing the good momentum from 2018.

We've got 4 priorities that we're working on this year. Our first priority is our sales effectiveness program. This is a broad program of work, changing many aspects of our sales activity. We're targeting to complete training for 80% of our sales and customer service people by the end of the year, and we're on track to meet that goal. We're also working on CRM deployment and corresponding sales process optimization to give our salespeople and sales managers better data and a more efficient process. We're progressively deploying our pricing tools across the organization, and we have pricing work underway in each of our global business units. We now have modified sales incentives in place for most of our salespeople that link their reward more directly to their sales performance.

Our second priority is to expand our technical differentiation. We're spending GBP 10 million a year more on research and development than we were in 2015, and we're using these additional resources to drive priority developments forward at a faster pace. We have 5 to 10 priorities in each of our global business units that support key customer and market growth plans. We're also working on a small number of longer-term developments that could provide new growth areas for us in the future.

Our third priority relates to the development of our people and our teams. Our leadership teams are now complete across the global business units, and the focus has shifted to developing those teams and getting them working effectively as teams. And that means aligning them on the strategy, the priorities and the plans for their businesses. We've launched a new set of development programs for our leaders at a range of levels in the organization. And I must say I'm delighted with the quality of those programs and the impact that they're having.

Finally, we continue to improve our operational execution. We've continued to drive our operational improvement activity across the business. Efficiency savings in the first half have compensated for inflationary headwinds and have supported the expansion of margins in the first half of the year. We've continued to widen the deployment of lean tools and approaches and invest in newer equipment and automation to improve labor productivity.

Taken together, these changes are building the capabilities that we need to deliver our strategy. We're developing our customer focus through our work on sales effectiveness and wider improvements in our global business units. We've introduced key account management for our larger customers and for key growth segments, we now have dedicated sales teams. As we've worked more closely with our customers, we've understood more clearly what they want from us. We're making delivery, quality, lead time and service improvements off the back of that. Some of our newer customers are growing quickly, and they want assurance that we'll support their demand needs. And with closer relationships, clearer strategies and better market understanding, we've been able to make decisions quickly to support them.

Through the work we're doing on materials, we've developed more insight and data about the performance of our materials. And armed with that, we've been able to have better technical discussions. Our customers then share more with us, and that reinforces the relationship, and it allows us to shape our development plans. We've been investing in real-world test capability and testing that is helping us to generate more proof data that helps our scientists suggest the materials and helps us to give better advice to our customers on the material choices that they should make. The developments in each of these areas is mutually reinforcing, and it helps us do a better job for our customers and accelerate the growth of the business. Let me give you a couple of specific examples. So to serve the metro market in China, we've modified our selling approach, changing the route to market and establishing support capability across the country. We've invested in new manufacturing capabilities that shorten lead times and allow faster supply of products and more rapid innovation of our products. Our local team have worked closely with metro customers, developing unique products for the different metro operating environments across the country, and we provided faster and better service than the competition. And we've grown that business over 20% per year in each of the last 2 years.

In the electronics and semiconductor segment, we put in place key account management and clearer growth strategies based on a much deeper understanding of market in the segments where we have materials that can make a difference for our customers. We've added technical resources, and we've invested in process and materials development to enhance our product portfolio and our technical insight. And armed with that insight and that data, we've been able to have more open discussions with our customers on their needs. We're now involved in materials and process development, working alongside our customers. We're helping them to optimize their processes. And we're providing new differentiated revenue streams for our business. 3 years ago, we simply didn't have the knowledge or the relationships to do that. We've grown this segment 10% a year for the last 2 years.

In summary, we've made good progress with the implementation of our strategy in the first half of the year. Revenues have grown 1% organically. We delivered EBITA margins of 12.8%, up 0.7%, and this is delivering on our commitment to expand margins once the investment phase over the last 3 years was complete. We grew earnings per share by 3%. Our balance sheet remains strong with net debt to EBITDA in line with the year-end position at 1.2x. For the second half, we're expecting market conditions similar to the first, with weaker demand in global industrial markets, offset by continued growth in other segments. We're expecting revenues for the second half of the year to be broadly flat, and our profit expectations for the full year are unchanged. Thank you. That ends the formal presentation. I will now take questions. If you could wait for the microphone and state your name and affiliation. Thank you very much.

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Questions and Answers

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Andrew Douglas, Jefferies LLC, Research Division - Equity Analyst [1]

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It's Andrew Douglas from Jefferies. Two quick questions, please. Transportation is 21% of the group. Are you able to break that down, give us what the auto numbers? And if you can break the auto number down by ICE and non, that would be great. And can I just quadruple check what your FX assumptions are when you're giving full year guidance, which is unchanged?

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Pete Raby, Morgan Advanced Materials plc - CEO & Executive Director [2]

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Certainly. So Automotive is about GBP 35 million to GBP 40 million for the group on an annual basis. At the moment, the vast majority of that is ICE. We are developing the electric vehicle position, but it's relatively small at the moment. Pete, did you want to comment on FX?

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Peter A. Turner, Morgan Advanced Materials plc - CFO & Executive Director [3]

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Yes. We're just assuming the end of June rates, Andy. So yes.

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Edward Maravanyika, Citigroup Inc, Research Division - VP [4]

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It's Ed from Citi. Just a question on your self-help efficiency gains. How much could you say they contributed to the margin expansion? And going forward, what would be a decent sort of base case assumption for contribution from self-help?.

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Pete Raby, Morgan Advanced Materials plc - CEO & Executive Director [5]

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So this year, I think efficiency savings will be running around 2% of sales. We're typically looking at an inflationary environment that's call it 2.5% to 3.5% of sales. And then we've got pricing at sort of around 1.5%. So that's the equation we're typically trying to balance. This year, we've had a little bit of extra support there, so you've probably got 30 or 40 basis points of support that's come through as a result of us doing a little better.

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Mark Davies Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [6]

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Mark Jones from Stifel. Pete, when you took this job, one of the issues was that the company was growing more slowly than its markets and losing market share and some encouraging evidence that you're actually gaining some share in some areas. Where is the overall picture? Do you think you're at the point of growing in line with your markets across the group as a whole? Or are you ahead of that now?

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Pete Raby, Morgan Advanced Materials plc - CEO & Executive Director [7]

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I think this year, overall, I'd say we are in line. I think last year, we outperformed a bit. We won a bit of -- we won more share than we lost. This year, I'd say it's about in line overall. We have seen share wins, as you say, in Seals and Bearings. We've seen some nice share wins in Technical Ceramics and also in Electrical Carbon, Thermal. I think we're winning a bit in Asia. We're probably still losing a bit in North America sometimes on payment terms. I think in Molten Metal Systems, we've probably been winning in India, winning in Mexico, holding around elsewhere and probably losing a bit in China on some lower-cost competition. But if I average that, I'd say this year, we're in line. Our goal is to -- was to be in line this year and to look to replicate that and then to expand beyond it. And I think we're getting in a better place to do that. You can see with the growth rates in some of the sort of nonindustrial segments, the impact of some of the focus we've had on those segments on the revenue position.

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Mark Davies Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [8]

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That's great. It leads me on to my second one, which is you were suggesting, obviously, slow industrial outlook, but better growth elsewhere. Does that include semis? Because obviously, there's some more negative industry trends there, but your growth rate is very strong.

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Pete Raby, Morgan Advanced Materials plc - CEO & Executive Director [9]

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Yes. We have seen -- absolutely seeing that slowdown in semiconductors. I mean the products we're providing typically are consumables. So we are more exposed, if you like, to the amount of chips being developed and being built in fabs as opposed to demand through the OE market. We have seen some slowdowns in some of those spaces. We have been working on some new differentiated materials that make quite a big difference for customers and those bits have been outgrowing the headwind we've seen for some of the consumables.

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Unidentified Analyst, [10]

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Can you just address the issues of a couple of things which come to a halt over the next couple of years? One being throughout the ceramic armor business or down to a lower level, I should say. The other one being the U.S. electro-ceramics. Are there any changes in your expectations on those, please?

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Peter A. Turner, Morgan Advanced Materials plc - CFO & Executive Director [11]

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So on U.S. electro-ceramics, that closes at the end of the first quarter. Next year is our current timing. So an extra quarter of revenue from where we were before, but no significant change on the ceramic armor. We've got order coverage through to the end of this year. We have the potential for some follow-on orders, but we don't have them yet. So we expect that to start to decline from 2020 onwards, but we could get some follow-on orders that improve the position from that.

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Pete Raby, Morgan Advanced Materials plc - CEO & Executive Director [12]

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Any more for any more?

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Harry Philips, Peel Hunt LLP, Research Division - Analyst [13]

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It's Harry Philips at Peel Hunt. Another half year of a flat dividend covers up to probably, what, 2.5, 2.6? In this world of progressive dividends, when do you move into a progressive dividend phase? You've got leverage, nice to know. So when do you think that might be appropriate?

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Peter A. Turner, Morgan Advanced Materials plc - CFO & Executive Director [14]

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So as you say, Harry, based on consensus, we are around 2.5x dividend cover this year. I think we'd love to start getting that growing again. But once we -- we want to keep growing it once we start. And so we just want to create a bit of headroom before we do so, I think, particularly given FX volatilities. As you know, most of our earnings are in sterling, how different it is, so there's a mismatch there. And I just want to give ourselves a better space to make sure that we don't grow for 1 year and then stop to save room.

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Andrew Douglas, Jefferies LLC, Research Division - Equity Analyst [15]

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It's Andy from Jefferies again. M&A, we've had some disposals over the last kind of couple of years. Any thoughts on kind of that progress as we move into 2020 given how it's coming on balance sheets and executing?

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Pete Raby, Morgan Advanced Materials plc - CEO & Executive Director [16]

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Yes. We certainly have the capacity to do incremental M&A, which is what we are looking to do. We have our teams across the business working on it. It is inevitably slightly opportunistic and a relatively slow process, so we have a developing pipeline of opportunities. I don't think we've got anything that's particularly current. I think our view remains the same that we're likely to be doing a sort of relatively small number of transactions, somewhat infrequently rather than sort of several deals a year given the availability of attractive prospects across our market segments. But we are (inaudible) it, yes, see an absolutely incremental, things that at add on the technology or routes to market or some scale benefits where we can get some synergies.

Any further questions? I'm happy to eliminate Paris Hilton's cabinet if that's...

All right. Very good. Thank you very much indeed everyone.