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Edited Transcript of MGGT.L earnings conference call or presentation 25-Feb-20 9:30am GMT

Full Year 2019 Meggitt PLC Earnings Presentation

London Feb 27, 2020 (Thomson StreetEvents) -- Edited Transcript of Meggitt PLC earnings conference call or presentation Tuesday, February 25, 2020 at 9:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony Wood

Meggitt PLC - CEO & Director

* Louisa S. Burdett

Meggitt PLC - CFO & Executive Director

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Conference Call Participants

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* Andrew Paul Gollan

Joh. Berenberg, Gossler & Co. KG, Research Division - Senior Analyst

* Celine Fornaro

UBS Investment Bank, Research Division - Head of EMEA Industrials Research

* Christopher Leonard

Crédit Suisse AG, Research Division - Research Analyst

* David Howard Perry

JP Morgan Chase & Co, Research Division - Head of European Aerospace and Defense

* Harry William Freeman Breach

MainFirst Bank AG, Research Division - Research Analyst

* Michael J. Tyndall

HSBC, Research Division - UK MidCap Equity Analyst

* Nick Cunningham

Agency Partners LLP - Managing Partner

* Rory Smith

Investec Bank plc, Research Division - Research Analyst

* Sandy Morris

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Anthony Wood, Meggitt PLC - CEO & Director [1]

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Okay. Good morning, everybody. Thank you for joining us this morning. Hopefully, you can hear us clearly. So welcome to the 2019 Full Year Results for Meggitt, where over the course of this morning's presentation, we'll provide an overview of our strong financial performance during the year and the ongoing successful delivery of our strategy against the backdrop, interestingly, of below-trend growth in our Civil Aerospace market, particularly during the second half of last year.

I'm going to introduce the results, as always, before Louisa takes you through the numbers in more detail. And then I'll take you through our end markets, provide more information on the progress we're making in executing our strategy, and finish, importantly, with the outlook for this year and for 2021. And finally, we'll open it up to your questions.

But first, as always, please note and read quickly the following cautionary statement.

So we've delivered another year of strong organic growth in 2019, which was ahead of our revised guidance. Organic orders are up 10%, with book-to-bill of 1.09x, and organic revenue grew by 8%, reflecting strong performance in growing end markets and particularly defense, where we've increased by 11%. Underlying operating profit grew by 10%, thanks to the increasing focus of the business and particularly strong execution across our teams on the ongoing operational transformation of the group despite some softening in the macro environment during the second half of the year.

We continue to make very good progress in reducing purchase costs, footprint consolidation and delivering further operational improvements through the Meggitt Production System. Margin of 17.7% is in line with our guidance and reflects benefit of our strategic initiatives, offsetting a number of headwinds, as previously disclosed in our quarter 3 trading statement last year.

Cash performance has also been strong, with free cash flow up 60% to GBP 268 million, inclusive of property-related transactions, which Louisa will cover in a little bit more detail later. And consistent with previous years, the full year dividend will increase by 5% to 17.5p per share, reflecting our continued confidence in the prospects for the group.

So before I move on to talk a little bit more about the highlights for the year, I'd like to take a step back and talk about the progress we've made over the past few years through our focused strategy to make Meggitt a higher-quality and more resilient business. Firstly, through a number of disposals and investment in differentiated technology, we've refocused the portfolio with nearly 80% of the business now in attractive growth markets where we have a leading market position. Secondly, our organization is now aligned to our customers, making us more streamlined and much easier to do business with. And through SMART Support, we're growing our market share again in the aftermarket. Thirdly, through our competitiveness initiatives, we're reducing our footprint ahead of our original target, delivering reduced purchase costs, improving our management of inventory, and through the Meggitt Production System, we're making our sites leaner and more efficient around the globe. And finally, we're making excellent progress in creating and reinforcing a high-performance culture across the group, vital to ensuring the continued growth and success of the business into the future. As a result, the Meggitt you see today is more focused, better aligned, more competitive and higher performing, attributes that have underpinned our strong growth rates over the last 2 years and which position us well to support continued growth above market over the medium term as we look forward.

So it's a busy slide, but you'll see it in your packs, and I'm particularly pleased with the progress we continue to make in building for the long term through the execution of our 4 key strategic priorities, as shown on this slide from left to right. We've strengthened our strategic portfolio, prioritizing investment in sustainable and differentiated technology with over 2/3 of our innovation investment focused on the environmental performance of our products and systems. We've also enhanced our positioning through our investments in a number of new areas and also disposals within the year. And we've expanded our relationships with customers and grown our installed base again with new positions on civil and defense platforms and a series of important new SMART Support long-term agreements in the year.

On competitiveness, our footprint rationalization scheme continues at pace with the construction of Ansty Park nearing completion ahead of the transfer of 4 other U.K. site. Our centralized purchasing to that site -- our centralized purchasing also continues to deliver in excess of 2% cost out per annum. And we're improving our management of inventory, and we continue to successfully transfer production of labor-intensive products to our lower-cost manufacturing facilities.

And on culture, we've successfully embedded our new customer-aligned organization, and I'm very pleased with the changes that we've made. We've had good feedback from customers, and we're seeing our new divisions work particularly closely together across the new structure, something that will gain further momentum, I'm sure, in 2020 and beyond.

I'll talk more about the progress in each area and our outlook later, but for now, I'll hand you over to Louisa, who's going to talk through the numbers in a little more detail. Louisa?

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [2]

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Thank you, Tony, and hello, everyone. As usual, I'm going to start with a review of the income statement focusing on the underlying numbers. But basically, in summary, 2019 was a very good year in the round. At a group level, our organic orders grew by 10%, with particularly strong growth in our defence business. The defence order book grew by 23%, generating a book-to-bill of 1.17x, and that included new multiyear orders across a number of platforms, including fighter jets, military ground vehicles and within our training business. Group revenue grew 9% on a reported basis to GBP 2.28 billion, slightly ahead of our expectations. And after we adjust for the effects of currency and divestments, revenue grew 8% organically. Underlying operating profit exceeded GBP 400 million, increasing 10% on a reported basis to GBP 403 million and growing 7% organically. Underlying operating margin, as Tony has already said, is 17.7%, and that's in line with our guidance that we gave you in our Q3 trading update.

Finance costs are flat at GBP 33 million. And as anticipated, our underlying tax rate has increased to 22%, and that's reflecting provisions in respect of the U.K. CFC regime. So taking all this into account, our underlying EPS increased by 9% to 37.3p per share. And consistent with prior years, we are increasing our dividend, our full year dividend by 5% to 17.5p per share.

So on the next slide, we look at revenue in more detail. Organic revenue growth of 8% reflected strong performance across each of our end markets. And working down that left-hand chart, civil OE revenue grew 8% organically, and that was principally driven by large jet platforms. Additionally, we did see strong growth of 23% and 14%, respectively, in regional jet and business jet OE. Civil Aftermarket also grew organically by 8% driven by A220, A330, 787 and 737 platforms. And business jets also saw good growth with revenue up 6% for the year, and that was driven by Falcon 7X and various Gulfstream platforms. Growth in large and business jets was partially offset by a slight decline in regionals.

Defence revenue was up 11% organically, broad-based across all of our platforms and training systems, and we had strong growth in parts for the F-35 Joint Strike Fighter. And in energy, revenue grew organically by 10% driven by another strong performance in our Heatric business. So on a portfolio basis, on the right-hand side of the chart, OE is currently 52% of our business, with Aftermarket at 48%.

So moving on to operating margin where we show the usual bridge, which compares our full year performance against last year. As I've already said, we delivered underlying operating profit of GBP 403 million, equating to a margin of 17.7%. So I will take you through the constituent parts of the chart, but the takeaway messages are: firstly, that we continue to invest in the future of our business through FoCs and the OE -- and strong OE; second, and as expected and as guided, our Engine Composites business did improve in the second half of 2019; and thirdly, our strategic initiatives continue to contribute financially, and they help us to be much more resilient in the face of unplanned market and operational headwinds.

So moving from the left to the right of the chart, there are 3 sections that I want to refer you to. In the first orange segment is a net headwind of 60 bps. And we have consistently talked to you in recent outings about the investment that we continue to make for the future of our business, notably in Free of Charge and in the relative OE to AM mix. So within this 60 bps are, firstly, dilution from FoCs largely relating to brakes for A220 and business jets. And as you know, that investment, whilst dilutive in the short term, builds aftermarket annuity for the company for years to come.

The second constituent within that 60 bps is negative mix, which reflects strong growth from the lower margin parts of our business, including OE and defence.

And then the final constituent is a net positive impact from MPI, reflecting that we are past the peak of R&D investment relating to new programs that are already in service, offset to a degree by higher amortization.

The second orange subsection shows the impact of Engine Composites, which did perform more strongly in the second half of 2019. And as a reminder, the impact at the half year of that product group on group margin was a negative 100 basis points. Sorry, too quick.

And then the third large green section shows the net financial contribution of our strategic initiatives, which delivered 80 basis points of margin improvement. I believe the work -- the benefits within this segment are well trailed: reductions in purchase cost, factory productivity, initial savings from footprint moves and the disposal of margin-dilutive businesses. However, offsetting these gross benefits are some unplanned 2019 events, most notably, the loss of initial provisioning spares for the 737 MAX grounding, and the supply issue that we talked to you about at our Q3 of forgings and castings. We have mitigated these items to a large extent with self-help measures. They have been hard to cover completely.

So turning to performance by division. I'm going to talk to the third column of the chart, first of all, where you can see that each of our divisions grew revenue on an organic basis, with 3 of the 4 divisions growing in double digits. So I will pick out the more notable trends, and there are some narratives in the gray boxes on the right-hand side of the chart to which I would draw your attention.

So Airframe Systems revenue grew organically by 2%. Within this division, civil OE growth was 6%, and that was higher than Aftermarket of 1%. And it is this revenue mix as well as high-brake FoCs, which contributed to the reduction in operating margin of 200 bps, alongside the forgings and castings supply disruption that we talked to you about in the second half of 2019.

Organic revenue growth for Engine Systems was 16%, with particularly strong growth in Engine Composites for the F-135 Leap and GENx engines. And improvements in operation and performance within the division underpins the 170 basis points increase in margin.

Energy & Equipment grew by 11%. Revenue grew by 11% driven by strong performance in defence and energy. We saw strong demand for both defence and training equipment. And as I've already mentioned, we saw a good performance from our Heatric business. And the increases in operating margin here reflect the impact of disposals and the benefits of operational leverage.

And finally, in Services & Support, organic growth grew by 16% with good levels of growth across all end markets, with Civil Aftermarket being driven by large jets; and in defence, by fighter jets and transport aircraft.

So turning next to cash where we delivered a very good performance in the year, reporting free cash flow of GBP 268 million versus GBP 167 million last year. Cash conversion was 93%. The 2019 numbers were helped by 2 one-off property items, which totaled GBP 40 million. Firstly, a GBP 21 million receipt from the sale of land at our old Coventry site, which we noted in our December '18 results, was received in January '19 instead of December '18. And secondly, a GBP 19 million inflow in reverse premium for our new Ansty Park site, which came in December '19 slightly early. But even adjusting for these items, cash conversion was 79% in a year where we are managing short-term inventory buffers, investing at Ansty Park and expanding our carbon manufacturing capacity.

So moving very briefly from the top to the bottom of the cash flow chart. Working capital outflow was driven by a GBP 50 million increase in inventory, offset by strong management of other working capital, notably receivables.

On inventory, our increase continues to reflect 3 active choices, and we highlighted these at our half 1 results: firstly, buffer stocks to support site moves; secondly, to support the strategy in Services & Support of being more customer-responsive, which Tony will talk to a little later; and three, and to a lesser extent, as a contingency for Brexit.

On CapEx, as already mentioned, the fit-out of Ansty Park and initial investment in carbon capacity has underpinned higher CapEx of GBP 94 million, up from GBP 74 million last year. Capitalized development costs continued their recent downward trend as more programs enter service and start depreciation. And at GBP 55 million, these are 7% lower than last year.

Pension deficit payments of GBP 35 million in 2019 reflect our agreed deficit reduction payments for the U.K. defined benefit scheme. And finally, the increase in exceptional costs to GBP 27 million reflect the site consolidation activities across the globe, including those relating to Ansty Park.

So staying with cash on the next slide, the first point here is that one-off items in 2018 and 2019 have caused some lumpiness in our reported cash metrics. If you'll recall, we had a GBP 30 million one-off payment in 2018 into our U.S. pension, and I've already talked about those 2 property items totaling GBP 40 million that have helped cash flow in 2019. So on the bottom row on this chart, we've just provided the math to show what our cash conversion is adjusted for those one-off items.

And the second point, and I guess the key takeaway here on this slide is that as we guided during 2019, we do expect the level of free cash flow and the cash flow conversion rate to be lower in 2020. There are 2 -- we have 3 drivers for this, 2 of which are well known and 1 which I will obviously talk about. The first 2 well-known items are that 2020 represents the final year of our investment relating to Ansty Park and the associated site closures. And secondly, there is ongoing capital in the business, notably carbon brake capacity to support growth in large jets. Both those 2 items are included in our 2020 CapEx guidance, which is in your appendix in your pack, where we expect an increase in CapEx in this peak year of about GBP 30 million year-on-year.

The third driver of lower 2020 cash is the EU's decision in April 2019 on the U.K. CFC regime. As you all probably know, the U.K. government has appealed this decision, and we have made our own appeal. However, in the meantime, HMRC has an obligation to collect monies from U.K. businesses. We quantified this amount at GBP 18 million, and we expect this to be requested and paid in 2020. Clearly, some or all of this sum could be reversed in future periods if the appeals are successful.

So as a result of these 3 factors, and the fact that GBP 40 million of one-off property receipts in 2019 will not repeat, we expect our cash conversion to be around 60% in 2020. After this, the level of cash flow will return to more normal levels. 2020 is a peak year of investment, with cash flow conversion at 70% plus again in 2021.

And to conclude from me, a very brief look at our debt profile. We have headroom of over GBP 800 million against our existing committed bank facilities at the 31st of December. We've recently executed 3 new bilateral loans in anticipation of around $200 million of U.S. private placement that is due to roll off in 2 tranches during 2020. Our reported net debt-to-EBITDA ratio is 1.8x. And on a covenant basis, that ratio is 1.5x.

So I am going to hand you back to Tony.

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Anthony Wood, Meggitt PLC - CEO & Director [3]

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Great. Thank you. Okay. Thank you, Louisa. Before I outline the progress we're making on executing our strategy, I'll start with a brief overview of the dynamics in our end markets and as always, starting with civil OE. The grounding of the 737 MAX dominated the headlines across the industry in 2019, resulting in a reduction in large jet deliveries of some 25%. However, underlying demand was solid. And aside the ongoing uncertainty surrounding the Max, the outlook is supportive, at least in our view, until the early 2020s when we expect the growth of new deliveries to peak. Deliveries of business jets were up 12%, while regional jet deliveries were down 8%.

Turning next to the Civil Aftermarket where air traffic growth of 4% was somewhat below the 6% to 7% growth rates that we've seen over the last few years, and the growth rate reduced significantly, obviously, in the second half of 2019. Despite this, load factors have remained high, with continued low levels of aircraft retirements. Utilization of regional jets was just slightly ahead of the prior year. However, business jet usage was slightly lower. In defence where the environment remains particularly positive, in the U.S., spend on both new programs, particularly the F-35 and fleet readiness on some of the older platforms has driven strong demand for OE, spares and retrofits.

And in energy, oil prices remained relatively stable throughout 2019, underpinning oil and gas CapEx and associated infrastructure projects last year. This, together with growth in more sustainable power generation systems, saw increasing demand for small frame turbines, with emerging markets continuing to drive much of the growth.

So turning then to our strategy where, as you can see, our focus remains unchanged. We remain focused on executing our 4 priorities on the slide that will enable us to outperform the market over the medium to long term.

So starting first with our strategic portfolio. Further to the announcement at the half year of our exclusive agreement with Luna Innovations, we continue to make excellent progress in developing our fiber optic sensing technology with customer trials for both aerospace and industrial applications scheduled for this year. This combination of Luna's best-in-class optoelectronics and our market-leading capability and fire detection and sensing solutions gives us an important competitive edge in the market.

And then in January of this year, we made an investment in HiETA Technologies Limited, a U.K.-based company that specializes in using additive manufacturing technology to produce high-performance thermal systems. This is an exciting and a strategic investment, which will help to position Meggitt as a leader in using additive and advanced manufacturing techniques to produce the next generation of thermal systems, critical to making both aviation and power generation much more fuel-efficient as we look out into the future.

And as announced at the half year, we've also strengthened the portfolio with the sale of 2 noncore businesses. And as a result, we've increased our exposure to attractive markets where we have strong competitive positions to around 77%.

So I'd now like to take you through how we're focusing our innovation spend to address both the opportunities and the challenges that are clearly out there to underpin sustainable aviation. While our portfolio and a lot of our technology development is already focused on helping our airframe and engine manufacturers make their products more environmentally sustainable, we're devoting over 2/3 of our innovation investment across 9 core technologies that will further enhance our position as a key enabler to meeting the carbon reduction targets being set out across the wider aerospace industry. These 9 technologies support 4 core themes: reducing aircraft weight and making them more fuel-efficient, the development of geared turbofans, hybrid electric propulsion and supporting the introduction of more sustainable aviation fuels.

In 2019, we've made good progress in moving key technologies into the customer demonstration phase. And examples of this include successfully completing customer pilots with our next-generation of heat exchangers on development engines and also on fire suppression systems flown last year on demonstrator aircraft. We're excited about the opportunities that our strong technology capability will enable us to unlock as we look out into the future.

Turning to customers. This slide shows some examples of contract awards that were secured during the year. In defence, we've secured some significant contract wins across a breadth of platforms, including auxiliary cooling and power for ground-based applications last year. In civil, we've been selected by Gulfstream to supply the braking system for the new G700 business jet, adding to the already strong content on this and other Gulfstream platforms. We've also secured an agreement to provide NuCarb brake and wheel upgrades for the global ATR 72 fleet, the best-selling regional turboprop in production today. And we're also very pleased with the progress we've made with our SMART Support offering, securing an additional 21 contracts during the year as we continue to grow our market share. And in Energy, we've secured a number of contract wins for LNG and oil and gas projects, which are providing the building blocks for Heatric's ongoing recovery. The strong progress made across all of our end markets demonstrates the strength of our new customer-aligned organization and the increased accountability of our divisional leaders for growing market share across all of their key accounts.

I'd now like to update you on how we are growing and recapturing market share through our new organization structure and specifically through SMART Support in the aftermarket. Our historic approach was very much to build our install base and to wait for the spares orders to arrive on the basis that it was our part and we were the sole source provider of authorized spares in the marketplace, and that worked very effectively up until about 10 years ago. Since then, however, the increasing availability of surplus parts, repair schemes created by third-party repair shops, known as DERs, and supplemental-type certificates has eroded our market share over the period. So in response, we've radically strengthened our capability. Through our new organization structure, we've created a single point of contact for customers, and our 3 hubs provide a focal point for MRO and spares in the different regions of the world as well as a 24/7 customer response center network.

And increasingly, it's this approach which is giving us access to more data and allowing us to enhance our service offering and reduce our cost to serve. Through SMART Support, which is Meggitt's brand name for a range of tailored, long-term aftermarket offerings, they're usually 3 to 5 years in duration, we're able to offer a tailored package of parts and services depending on customer requirements and very much focused on their operational needs, from time and material spares and MRO repairs to exchange pools and rotable programs right the way through to power by the hour and cost per brake landing contracts in our Braking Systems business. And looking ahead, as our access to and the interpretation, importantly, of data increases will enhance our offering further through predictive techniques to improve efficiency and drive costs down further. And I'm delighted to say that over the last 2 years, this approach is enabling us to win back market share, a trend that we can -- we expect to continue, as you can see by the swish on the chart, over the next few years.

So our new organization structure and the regional hubs have also enabled us to better target our route to market, including, obviously, directly with airlines and defense departments, third-party nose-to-tail MRO providers, engine MRO providers and also the original equipment manufacturers around the world. And this, coupled with a broad range of content that we have on any given platform, enables us to create the right type of SMART Support contract depending on the specific customer. For example, with nose-to-tail MRO providers, like Lufthansa Technik who look after about 20% of the world's large jet fleet, our agreements encompass all Meggitt parts across their platforms. Whereas an agreement with an engine MRO would naturally be more focused on certain packages of parts and services for the engine specifically. But as you can see from this chart, we've made great progress in 2019, and we now have a total of 25 contracts with an aggregate value of GBP 155 million and growing.

Our progress to increase competitiveness and improve the customers' experience continues to be underpinned by the Meggitt Production System. At the end of the year, we had around 60% of our sites in the green stages or later and importantly, 14 sites, about 1/3 of our sites worldwide, that are now in the bronze and silver phases. We're looking ahead to our first gold site in Meggitt. These are very much world-class businesses.

MPS is not just about passing through a series of gates, but it's about having a structure that allows us to identify and tackle some of the systemic issues in businesses, raising the bar for our sites and making them leaner and more efficient, but on a sustainable basis. And our core MPS team allows us to deploy the right expertise to those sites that really need it most. We remain firmly committed to MPS, and our target remains for all sites to be at least in the green stages by the end of '21 -- 2021. We certainly got a big program ahead of us.

Our center-led approach to procurement continues to enable the group to reduce net purchase costs. And in the year, we exceeded our target of 2% per annum. Within Engine Composites, we've made good progress in improving our operational performance, with ultimate yield reaching over 90% across the majority of our key parts and against the backdrop of continued rapid growth in that business. We've started to see the investments made in this part of the business feed into the financial performance, with margins improving during the second half, a trend that we very much expect to continue throughout 2020 as we move more of the volume production into Mexico.

And turning to inventory, where turns in the year remained flat at 2.7x, very much reflecting the investment we've made in buffer stocks to support the site consolidation moves, also, as Louisa mentioned, to grow our inventories to support SMART Support contracts and to some extent, some limited investment on Brexit risk reduction. On an underlying basis, however, inventory turns were up to 2.9 in the underlying planning of the business, and we continue to target inventory turns of around 4 by the end of 2021.

And then finally, our strategy to expand our activities at our low-cost manufacturing facilities also continued at pace during the year, with Vietnam reaching a really important milestone for us of 1 million production hours delivered last year.

But we've also made very good progress on the group's largest footprint projects, namely the construction of our new state-of-the-art U.K. facility and manufacturing campus at Ansty Park in the U.K. This will be home to our Braking Systems and Thermal Systems capability. It will also be the location for our European Services & Support hub and our research and technology center of excellence and also to some of the group functions. Work on the main building, as you can see on the photo, is now complete, and we're on track to begin the phased transfer of activity from quarter 2 this year, with the production lines transferring progressively throughout the year. This investment underpins planned improvements in operating efficiency, which we expect to start to realize through 2021 and beyond.

We've also implemented some significant sustainability measures at the new site, including a photovoltaic roof, which will be capable of providing up to 20% of the site's energy needs and also greywater systems. It's a great opportunity when you're investing in new facilities to be able to take advantage of some of the new technologies.

We've also made further progress consolidating our footprint, which now stands at 42 sites, representing a 25% reduction from our 2016 baseline, ahead of our original target of 20%. With a number of moves in progress, we're on track to continue to reduce and tighten our footprint over the next few years.

And finally, culture. As already mentioned, we're very pleased with the new organization structure, which has been successfully embedded and well-received by our customers. We continue to make good progress during the year on the rollout of our high-performance culture program, enabling us to execute -- accelerate the execution of our strategy. The success we've seen during the year, moving to our new organization structure, has very much been underpinned by our high-performance culture program, which has been rolled out now to over 8,000 of our employees. This has proven highly effective in helping our teams work productively together to deliver common goals as a very much more integrated group, improving productivity and, importantly, reducing attrition in a tight labor market in many of the regions of the world in which we operate. And in 2019, we also launched 5 Employee Resource Groups as we look to strengthen a culture of diversity and inclusion across Meggitt.

What's important here is that against a significant backdrop of restructuring and operational transformation, employee engagement in Meggitt is up 8% over the last 2 years and actually reached something known as the global high-performance norm level based on a data set of employees working for some of the very best high-performing global companies. A big backdrop and obviously a lot of focus by our teams to achieve that.

So importantly then, turning to the outlook for 2020. The overall environment for the global aerospace industry continues to be supportive, with new aircraft deliveries and air traffic growth both expected to continue to grow and robust defense spending over the medium term. However, a number of headwinds have emerged in recent months: firstly, obviously, the pause of production of 737 MAX, which will temper OE growth in 2020; secondly, air traffic growth softened in the second half of 2019; and lastly, obviously, the outbreak of the COVID-19 virus is expected to slow the near-term level of global air traffic growth. The production backlog created by the supply chain disruption experienced in the second half of 2019, particularly for forgings and castings, is also likely to be a factor for the industry and for the group in the first part of 2020 and will -- with potential supply chain issues resulting from the COVID-19 virus, and we're very much working that today. While recognizing the above factors and on the back of our strong organic revenue growth rates in the last 2 years, we remain confident in our ability to deliver organic revenue growth ahead of the market over the medium term driven largely by our exposure to the fastest-growing and the hardest work platforms, our market share gains and our strong market positions.

So turning to our end markets, specifically in civil OE. While the increased chipset we've secured across a number of platforms will help to underpin our OE revenues in large jets, the uncertainty around the MAX is likely to temper the overall growth rate in 2020. Deliveries of regional jets are expected to increase mid-single digits in 2020 after 3 years of declining deliveries. While in business jets, deliveries are expected to grow low single digits after a strong year in 2019. So in 2020, as a result, we expect civil OE revenue growth organically of between 1% and 3%.

Looking into the Civil Aftermarket. Continued low levels of surplus, our strong content and continued momentum on SMART Support is expected to underpin growth in large jet aftermarket revenues. We expect this growth will be partly offset by flat to low level of growth and utilization for both business jets and regional jets, which account for about 44% of the group's Civil Aftermarket revenues. As a result, in 2020, we expect organic Civil Aftermarket revenue growth of 2% to 4%.

In defence markets, the medium-term outlook remains positive, particularly in our largest market, the United States, which accounts for 73% of group revenue. Our strong technology offering, robust order book and a broad portfolio exposure should enable us to outgrow the market. And in 2020, we expect to grow organic revenue in defence by 3% to 5%.

And then finally, in energy, we expect the recovery in Heatric to continue into 2020 based on solid demand from the oil and gas sector and emerging markets. Growth in Heatric is expected to be partially offset by more challenging conditions in the power generation market. So as a result, in 2020, we expect organic energy growth in the range of 0% to 5%. And on the basis of the above, the group expects organic revenue growth of 2% to 4% in 2020.

We expect operating margins to increase by between 30 and 50 basis points in 2020 driven by the continued momentum in the delivery of those strategic initiatives that I've outlined. And as Louisa has already highlighted, our cash conversion is expected to be somewhat lower in 2020 at around 60% as we continue to invest in the business and complete a number of those site consolidation projects.

So looking to the 2021 outlook. Noting the material uncertainties that currently exist in the Civil Aerospace market and the challenges particularly of forecasting when you're looking 2 years into the future, we are more cautious about our 2021 outlook, particularly given that we have a specific margin target out there for that year. We've therefore taken a view of the current softness in air traffic growth and the anticipated return to service and production of the 737 MAX, and we've extrapolated that into our assumptions for 2021. Specifically, we have assumed a progressive return to service and production of the 737 MAX that runs across both 2020 and 2021, and RPK growth rates comparable to the second half of 2019. As a result, we now expect to deliver low- to mid-single-digit percentage organic revenue growth and operating margins of between 18.5% and 19% and cash conversion of around 70% plus in 2021.

Over the last 2 years, we've demonstrated the successful delivery of our strategic initiatives. And our confidence remains high for further progress in 2020 and beyond, including margin expansion as we complete the bulk of our footprint moves, drive the continued recovery in Engine Composites that we've spoken about and move sites into the later stages of the Meggitt Production System. Over the medium term, with a more focused and resilient business, strong technology and exposure to the right platforms, we expect to be able to continue to deliver good levels of organic growth, an attractive margin profile and to sustainably deliver good levels of cash flow and cash conversion of at least 70% per annum over the same period.

So in summary, 2019 was another very successful year for Meggitt. Our order book remains strong, with organic book-to-bill of 1.09x. We delivered another strong year of organic growth underpinned by our strong content and exposure to growing end markets. We delivered double-digit growth in operating profit and generated more cash during a period of high investment for the wider business. And at the same time, we've successfully embedded our new organization structure and maintained progress on our targets for 2021. While we've achieved a lot, we still have more to do, and Meggitt remains a great business with tremendous potential ahead.

So on that note, I'd now like to invite your questions. And as always, if you could please wait for the microphone and state your name and the organization that you represent before launching into the questions.

So who'd like to start us off? Gentleman on the right here. Nick?

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Questions and Answers

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Nick Cunningham, Agency Partners LLP - Managing Partner [1]

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Nick Cunningham, Agency Partners. The emerging headwinds are obviously undeniable. We -- it's very clear that that's going to impact on Civil Aerospace demand. But you did have a book-to-bill of 1.09 and 10% organic order growth in 2019. So 2% to 4% organic growth seems like quite a low number for 2020, even in the context. Is this driven by a sudden slowdown in demand that you've already seen? Or are you anticipating it? And how does the -- how do the changes divide between like the short-cycle and the long-cycle parts of your business?

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Anthony Wood, Meggitt PLC - CEO & Director [2]

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Yes. No, I mean we're still growing and we're still growing profitably. But in relation to the sort of book-to-bill versus the revenue guidance for the year, a lot of the orders we took in the year were multiyears, so particularly in defence where we're taking 4-, 5-year contracts. So there's a bit of lumpiness in terms of how that flows through.

Equally, large parts of our business, particularly the aftermarket, we're winning a lot of that work through the course of the year, and we're trying to build a business that's more resilient and has got better forward visibility of aftermarket volumes rather than selling spare parts a piece at a time. So I think with our support, you'll see some of that benefit flowing in. So we're still confident we're going to grow. But that's really the main difference between the 2 numbers.

Clearly, the world is a little more choppy out there. There are real macro factors. But I think we still feel we're pretty well positioned when you look at our content on aircraft and the sort of market positions we have. I feel a lot better about the portfolio we have today than the one we had 3, 4 years ago.

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Nick Cunningham, Agency Partners LLP - Managing Partner [3]

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And the last few months?

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Anthony Wood, Meggitt PLC - CEO & Director [4]

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Last few months, well, last couple of months, clearly, the coronavirus is impacting everybody. We've made an assumption on what we think that means. But Louisa can probably cover that in a moment. But I mean it's been quite a dramatic, quite sudden. We're modeling effectively the fact that we've got frameworks of what SARS looked like, what MERS looked like. This is an industry that's actually had to deal with this before. And as long as the characteristics of the sort of infection rate and peak infection are similar to what we've seen before, then we think we're guiding it correctly. But I don't know, you might want to put some numbers around that.

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [5]

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I was just going to comment, the first few weeks of January have been in line with where thought, so just wanted to pick up that specific point. I mean just for corona, we have got some more caution in our 2020 guidance because of those headwinds. And at the moment, we are looking at around -- clearly, it's very fluid and it's quite difficult to model, but we're looking at about GBP 10 million UOP impact in our forecast. And we've tried to build that both bottom-up based on what we can see of our business in Asia, in particular, and some of the servicing events and engine overhauls and then matching that top-down with some of the commentary about traffic growth. But clearly, that's very fluid. We are assuming impact in the first half only. And I guess like many of our peers, we'll update you as we go.

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Anthony Wood, Meggitt PLC - CEO & Director [6]

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Thank you. Other questions? David Perry? Behind you.

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David Howard Perry, JP Morgan Chase & Co, Research Division - Head of European Aerospace and Defense [7]

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Yes. Can I just kick the tires a bit on the guidance. I mean the overall sales growth for '20 is kind of what I expected. I thought maybe you'd be a bit more bullish on Defence, a bit more cautious on Civil. So just on your specific slides, first of all, on the aftermarket, I think the phrase you use is air traffic growth softening. I mean you're now saying negative, a small negative, but that's a very, very unusual thing to have. So I just wondered exactly what are you assuming for air traffic for this year globally?

And to follow up on what you just said, Louisa, was that a caveat to the guidance? Or are you saying that you've fully baked in current IATA forecast into your guidance?

And then just on the same thing but on Civil OE. The aircraft deliveries were well down last year for obvious reasons. I think they're probably going to be flat or small down this year. You had Civil OE growth last year and you're still expecting growth this year, so I just wondered why you think you'll get Civil OE growth this year?

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Anthony Wood, Meggitt PLC - CEO & Director [8]

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So on the RPK, yes, I've obviously seen the IATA one, which is just slightly negative. We're -- our view is it's going to be slightly positive, but it's not going to be in the 4% range this year. So exactly where it lands will rather depend on exactly what the shape and it's very difficult to call. But we're not going to be growing at 4% this year on RPKs. And that will have a time phased impact, obviously, on our aftermarket business, just based on the flying in the fleet.

On Civil OE growth rates, we've got pretty good forward visibility. So absent some -- we're making a call based on our close conversations with Boeing that are happening pretty much every day at the moment on what they're going to do this year. But we still believe in the round with the programs that we're on, that we'll see some growth.

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David Howard Perry, JP Morgan Chase & Co, Research Division - Head of European Aerospace and Defense [9]

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Okay. So just to clarify, if IATA's correct and they may be correct, they may be wrong, but if they're correct, that would be down slightly you think to the GBP 10 million operating profit impact?

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Anthony Wood, Meggitt PLC - CEO & Director [10]

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Yes. We're slightly better than that in our outlook. Yes. Maybe Sandy over there, and then Celine.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [11]

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Yes. It's only me from Jefferies. I'm probably supposed to know this, but we are still making at what rate on 737? I'm thinking more of Composites.

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Anthony Wood, Meggitt PLC - CEO & Director [12]

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So on 737, we're not making. We are delivering parts into the engine manufacturers that ultimately will go onto LEAP engines and those continue, but we've had a pause on direct deliveries. So stuff that goes on to the airframe, effectively, we've got a pause for about 3 months before we recommence.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [13]

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Okay. And the engine guys are still paying you?

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Anthony Wood, Meggitt PLC - CEO & Director [14]

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Yes.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [15]

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Presumably, they're still getting paid by Boeing. And so whilst people are picking away at your guidance, this could make for a really tricky first half. And yet you somehow seem to be quite sanguine about that, which is -- I don't get the trade-off between what you were losing and what the impact is if you see what I mean? But you seem to be coming out of this without any significant headwind.

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Anthony Wood, Meggitt PLC - CEO & Director [16]

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Yes. I mean clearly, the growth rate that we're guiding is quite a bit lower than where we've come from last year, so that's reflected in the latest. But the global supply chain to build the 737 MAX is clearly quite complex. I don't want to get into exactly where we're at with the various either direct supply or indirect supply through engine or through some of the some -- the other consolidators. But it's not a pause on everything. We're still supplying in some areas. But the outlook is lower growth than last year, but still profitable growth for Meggitt.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [17]

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Well, quite. But depending on what you've actually assumed about how production comes back, I mean there are obviously scenarios out there where they release the inventory first and production comes back really slowly. Production doesn't actually come back until -- okay, they keep it ticking at, whatever, 15 a month. And then -- but really, it doesn't come back until the middle of next year until they clear the inventory. So it would be handy to kind of have some scenario that's built into what you're doing because actually your guidance could be quite punchy depending on what you've actually assumed.

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Anthony Wood, Meggitt PLC - CEO & Director [18]

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Yes, I understand. But I think our guidance is very realistic. We do have purchase orders, so we've got clarity on what the demand is today. We've equally got agreements with our customers, which do have frozen periods that give us some confidence in terms of our ability to supply. I think it's really the second half when we get to the summer, there's a critical milestone in terms of the MAX returning to service, which is what Boeing are saying. I'm certainly not going to get ahead of them. If that event turns out to be as they're indicating today, then I think the second half will pretty much turn out as we're currently planning. If it's worse than that then, clearly, that is one scenario that we'd look at, at that time. But I think the whole industry at the moment is pretty much planning on that, around the summer return to service redelivery of the aircraft that were in service and then a progressive delivery. That's actually going to take nearly 2 years, 18 months, to actually deliver the aircraft that have been stored right out to the end of 2021 and that's the assumption that's built into our guidance.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [19]

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So I do, I mean I get that you can't get ahead of Boeing. I mean nobody seems willing to do that for obvious reasons.

And then just a slightly sort of tedious question. I know we get hooked on this 1% to 3% revenue growth thing, but then the free-of-charge stuff has always made it that that's one measure of how you're growing. So if A220 is ramping up, if we were looking at it on a unit basis, you're actually going quite a lot faster. Do you have any idea?

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Anthony Wood, Meggitt PLC - CEO & Director [20]

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We are. It's one of the things, maybe Louisa can add to this. So clearly last year, we started to step up deliveries on A220, but a lot of that is free-of-charge equipment, so you don't see it in the revenue line and it's a headwind to profit in year. But we're building a phenomenal annuity on that aircraft in the public domain. Airbus is already talking about 14 aircraft a month split, 10 in Montréal, 4 in Mobile, Alabama. So that's a great program for us. We're building an annuity for the future and that is embedded within the guidance we're giving. But would you like to...

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [21]

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So it might be worth doing a couple of housekeeping points on FoCs because I'm sure I'm probably going to get asked it anyway. But in my margin slide, I had a 60 bps aggregation of FoCs mix and NPI. Within that 60 bps, there is a 30 bp headwind from FoCs. That's pretty much in line with what we told you in May '19 at the Capital Markets Day. And Sandy, to your point, the major driver of that is the ramp-up in A220, but clearly some other bits and pieces with 321 as well in the back end. And within our '20 and '21 guidance, we do give you some indication of this in our appendix. We've got -- we're predicting a similar sort of 20 to 30 bps in each of those 2 years on FoCs. So that's within our guidance.

And then sorry to change tack just a little bit. While we were on half year, I think it's probably worthwhile of me just pointing to cash. I've already signaled that we've got that 60% conversion rate in cash in 2020. It's our peak year and then we come back up, and we do have a temporal thing going on there as well with quite a lot of the Ansty Park moves. A lot of our people, our relocation, redundancy pieces are happening in the first half, so there is going to be a heavier pressure on the half 1 cash. And we don't really half 1, half 2 cash pattern, but it will be a little bit more marked this year.

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Anthony Wood, Meggitt PLC - CEO & Director [22]

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There's a question in the center on the aisle, the lady. Sorry, we'll come back. Yes, this one.

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Celine Fornaro, UBS Investment Bank, Research Division - Head of EMEA Industrials Research [23]

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Celine Fornaro from UBS. I've got 2 questions, if I may. So one for Tony regarding an update on the brake certification for the A321neo and commercial prospects, with there your main customer, but where are we on market share targets there? You have 20%, maybe it could be higher.

And the second one more for Louisa. Regarding the underlying operating cash flow where if you actually strip out the one-offs, it's basically flat year-on-year, '18 versus '19. And your guidance for 2020 implies significant deterioration, looking at elements below the line to get to the free cash flow. So maybe you want to comment on that reconciling the underlying improvement you're making to inventories, factories, et cetera?

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Anthony Wood, Meggitt PLC - CEO & Director [24]

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Fine. I'll let Louisa do the cash flow walk for you. On A321neo, we continue to work with Airbus on the certification of that equipment. We've got some critical tests that happen this month and next. We've always taken, as I've always said on that, a very cautious view in terms of market share. We're a second player in that market. We're not looking for a particularly large market share. We have our launch customer Wizz Air. We're talking to other customers. We've got none others that I can announce in this environment today beyond our launch customer Wizz, but we're generally talking to other customers on new opportunities as they come along. But the key milestone really is the certification and qualification of the equipment.

We're working with Airbus. So in terms of the plan, a number of things going on there. So but it's a big year this year for us in terms of that with Wizz at the moment due to get their first aircraft in 2021. And on cash, perhaps you can...

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [25]

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Yes. So I hope that I've articulated the reasons why we take a dip down to 60% conversion in 2020 without -- I'm going to labor the point again that it is a peak year of investment and they are all good investments for the business. I've said that we will go back up to 70%-plus in 2021. We've had a huge amount of moving parts in this business starting with Tony's tenure in '17 and we're still undergoing quite a lot of radical operational change in the business right out through to 2021. You see some of those stats around footprint changes, around the way we run our factories. And I think that a 70%-plus even through those changes in that short-term period, I think is a good commitment to us until we actually get a handle on what that steady-state piece will be as we exit through some of these very large change programs.

And I think specifically on 2021, we might have some working capital around the edges across the back end of '20 and into '21 with the timing of the site moves.

Specifically on Tony's point about the more medium-term guidance around cash at 70%, look, we thought we were trying to be -- well, we were intending to be helpful with providing you with a consistent and sort of guaranteed floor of around 70%. But absolutely, of course, there is more cash upside in this business as we continue to sort of exploit margin opportunities and that critical point when our OE and AM mix switches. So the 70% floor was designed to be helpful in the medium term.

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Anthony Wood, Meggitt PLC - CEO & Director [26]

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But maybe I'd like to answer that. I mean we are building a business that will consistently deliver strong cash flow conversion through the cycle. We have a peak year for a specific set of events in, obviously, 2020. But there's nothing clever. We're a business here that's becoming increasingly deleveraged. We're not a business that has peak years when you sell a big asset and take lots of deposits and then cash flow is very high and much lower the next year. This is a business that we're building where it's a relatively operational business that we win orders, design equipment, deliver product and collect the cash fairly quickly afterwards and that's the business we're building. Andrew. Gentleman on your right side.

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Andrew Paul Gollan, Joh. Berenberg, Gossler & Co. KG, Research Division - Senior Analyst [27]

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Andrew Gollan from Berenberg. Firstly, sort of accounting technical question. Good to see return on capital on the front page and an improvement, so good progress there. Is there anything within the definition that we should be aware of if we're trying to calculate ourselves? That's the first point. And where do you see that rising to within a 3- to 5-year period?

Second question is really on the 2021 margin revision. Sorry to be fixated on this, but just playing devil's advocate here. From previous guidance, to the low point, it's 190 basis points lower, so 18% versus 19.9%. Can you say how much of that downgrade is just, firstly, MAX related; secondly, more cautionary outlook on traffic? Those are the 2 points that you cited. So what else is in that number? What -- basically, what else has changed?

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Anthony Wood, Meggitt PLC - CEO & Director [28]

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Fine. Okay.

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [29]

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So just briefly on ROCE, there's nothing funny in our definition. We are pleased with the uptick to 11% from 10% last year. Again, given that we've got this 2020 peak investment year, I'm not expecting that to move significantly upwards in 2020 because of the amount of capital employed. But obviously, we are looking to move the needle on ROCE once we get through that period. So yes. And actually, we define that in our annual report sort of in terms of where we're incentivizing management. So there's a good few points of accretion over the next couple of years.

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Anthony Wood, Meggitt PLC - CEO & Director [30]

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Another t-shirt with a target. It's clearly going to improve, and you can think about low to mid-teens over time. But we're not going to get specific in terms of exactly where that is at the moment. I think we're giving pretty clear guidance on a lot of other areas on cash.

On the margin point and 2021, I mean you're right, there are essentially -- if you've -- are probably best framed by the one thing that I'm more confident than I've ever been on is our ability to operate and execute our strategy. So the operational transformation of the group is something that's speeding up and is now happening in many of our sites across the world.

The backdrop, however, is essentially to -- one event and one area of softening macros where we've tried to be as explicit as we can on what's the assumption that we're making that underpins that 18.5% to 19%. The first one is the MAX. We are following Boeing's guidance and that is that it's going to take that 18 months to redeliver the aircraft and restore production, obviously, on the production line. That has an impact on 2 sides of our business. One on the manufacturing of new equipment, and obviously, we've got volume assumptions and overhead absorption assumptions that are within that, but also probably more significantly, the aftermarket assumption as to how do those aircraft get into service and how does it change the dynamics of the fleet. But then secondly, the big unknown, very difficult to call at the moment, which is why we're explicitly saying we're taking the back end of 2019 as our best projection for 2021. And this year, in line with David Perry's question earlier, broadly flat in terms of RPKs, flat to slightly positive.

So that's about the best we can call it. That is what explains the delta. I don't know whether you want to add any other numbers on that?

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [31]

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Yes. So for 2020, the big 2 blocks, Andrew, are the corona piece that I articulated earlier and then 737 non-production following the customer. The biggest impact for us is the loss of the IP provisioning spares, a consistent theme, $1 million a month. It's slightly tricky on the basis points because clearly, we've got this tension with OE and it really depends on what assumptions we're making around recovering overhead on other work as that work is displaced, so we have a middle point. But those are the 2 chunks, roughly around sort of GBP 10 million each on a UOP basis.

In 2020 -- 2021, sorry, we are not assuming anything specifically for corona. But to Tony's point, we have got that softness carried forward in RPKs. And then we've also assumed, given some Civil caution in our guidance, that actually we've got a bit more of a mix headwind from Defence just because that is quite a strong part of our portfolio.

I would say though, I know that we are very focused on the 2021 revised guidance, but we are still growing 30 to 50 bps in 2020. And we are growing, again, our strategic initiatives in the background, are still contributing. We've quietly glossed over Composites, which has been a tricky subject for us for a number of years. And I think we're very proud that the team have done what we said they would do. And we still got work to do, but we're on that to get that back to a pre-Act margin of mid-teens by the time we exit 2021. And the product group had a profitable exit rate coming out of 2019.

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Anthony Wood, Meggitt PLC - CEO & Director [32]

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There's a lot of work going on. I would add to Louisa's comments there in terms of managing workload and parts around the world. I mean we have sister plants to many of our facilities. One of our sister plants is in China. That very quickly enables us to flex capacity. We've had some other issues for the last couple of months as well in that. But we've got options, and we're pretty active in terms of managing all costs over time become variable. And we're managing that pretty tightly at the moment.

Question here on the right and then one behind afterwards.

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Michael J. Tyndall, HSBC, Research Division - UK MidCap Equity Analyst [33]

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It's Mike Tyndall from HSBC. A couple, if I may. Just thinking about the MAX's return to service, is there a potential negative here? I realize you'll get the initial provisioning. But I mean the retirement rate at the moment is very low, which I presume is beneficial for you. Is there a potential headwind against that positive? And where does the balance come out there?

And then the second question is just on CapEx. If I'm not wrong, you came in very much at the bottom end of your guide for this year. Is that because something has been pushed to the right? Or is that because you found savings in terms of what you were spending, just thinking about it in the context of what you plan to spend this year?

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Anthony Wood, Meggitt PLC - CEO & Director [34]

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Yes. I'll let Louisa do CapEx. It's relatively straightforward. On the MAX, that is more complicated. So we have a number of scenarios that we model against in terms of what is the ultimate demand line for passenger traffic and how does that get satisfied? Is it going to be with a new MAX as they start getting delivered? Does that force other aircraft into retirement? It is quite a complicated model, and there's also a timing effect there as to when you actually get the aftermarket.

We are more sanguine than I think some of the other things I'm reading out there. I'm not expecting a big flip back to the large quantities of surplus aircraft on the market. I think there's still enough buoyancy in the demand line as you look out into the future to be able to absorb the new aircraft that are getting delivered. But we will see the progressive retirement of some of the -- particularly the older aircraft.

But at 2%, I mean these are historically low levels. I mean I've seen some people flagging that it's gone up significantly. I mean it's gone up a percentage on a very small number relative to the previous year. So I wouldn't get too excited about that on surplus.

And we play in that market. The one thing with SMART Support is that we do eat our own tail. We do buy Meggitt used equipment in the market when an engine gets stripped down or an aircraft is taken out of service. So we can participate in that in a way today that we couldn't 3 years ago. So I think we've got a natural hedge because we're more capable and we're very much in that marketplace, but I'm not expecting the macro to suddenly flick. As I say, 2015 when retirement rates were towards 4%, 3.7-or-so percent, just if -- all the models that we look at, we just don't see that over the next few years.

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [35]

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Just picking up the piece on CapEx. You're right, it was at the bottom end of our guidance. There were elements that have shifted into 2020, largely associated with the Ansty Park project. It was a very complicated move with the closure of old sites and moving quite a lot of pieces of equipment and replacing equipment into that site. We are getting better at our forecasting. And I think the 2020 outlook is really governed by kind of 2 events that have a deadline, and that's Ansty Park and getting our carbon capacity in place. So I think the GBP 30 million incremental guidance that we've given is pretty solid at this point, yes.

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Anthony Wood, Meggitt PLC - CEO & Director [36]

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I won't praise them too much because they're probably watching, but our indirect purchasing team are getting much better at negotiating how stage payments actually -- when they actually get paid for a lot of the new equipment that's going into the new factories. We've got scale on purchasing and such I want to say. So the cash phasing of that is better than it used to be.

So one behind if we pass the microphone. Sorry. Thank you. And then one at the back on the right.

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Rory Smith, Investec Bank plc, Research Division - Research Analyst [37]

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It's Rory Smith from Investec. Two questions, if I may. The first on SMART Support, you've obviously seen some good momentum there. How do you see that sort of developing or potentially stabilizing over the more medium term? And also, how should we think about maybe profitability there in terms of contracts versus the more transactional place that you've come from?

And secondly, maybe more technical question, so apologies. But on bleed air leak detection, what's the sort of potential size there? Or how do we see that developing? So apologies for that maybe more geeky question.

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Anthony Wood, Meggitt PLC - CEO & Director [38]

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Fine. Do you want to do the bleed air?

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [39]

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Yes, I'd love to.

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Anthony Wood, Meggitt PLC - CEO & Director [40]

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So I'll start with SMART Support. So I mean SMART Support is working. It's quite interesting that actually we've found that what we're offering seems to be novel, certainly at our sort of Tier 2, Tier 3 level in the supply chain. It is really about winning back market share. It's not per se a margin play. Where there's margin opportunity, clearly, we'll take it. But it's really about recapturing some of that market share that we've lost over the last 10 years or so. We're running today, our best estimates are that it's quite a complicated model, so it is an estimate, is that we're capturing about 50% or so, maybe slightly more than that, of the total addressable aftermarket for Meggitt's products. And you're never going to capture it all. Big piece of our business is Defence and that's typically done by the military where they'll apply the labor and they'll be making assemblies and spare parts and doing the repairs and such like. Equally, you're always going to have third-party integrators like the big Lufthansa Techniks and the Delta TechOps.

So it's about pushing up in that band. And we put 2 lines on the chart very deliberately. We think that it's the sort of -- there's an opportunity to move from sort of low 50s up towards the 70s. That's quite a large capture for us. And it's not going to be that all of our aftermarket is traded through SMART Support, but a much more significant slice of it when you think that half of our revenues come from aftermarket today. So that's how it works in principle. It's not a profitability play, it's a profit play by winning more revenue.

On bleed air leak detection, I don't want to get into the specific sizes of that. We've certainly got the technology there that has caught the attention of our customers. There is a need, I think, for a more reliable system and one that can offer some more capability than they've had in the past. It's much more accurate in terms of how it pinpoints where temperature changes are happening in the wing, for instance, of an aircraft as you go towards the engine. So I don't want to get into specifics because that's breaking a product group into a product line. But needless to say, we think that's an area where we can grow, albeit there will be some replacement of existing capabilities and new [tactic salt] technologies, which is done today.

A question at back.

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Christopher Leonard, Crédit Suisse AG, Research Division - Research Analyst [41]

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Chris Leonard from Crédit Suisse. A few if I can, please. What market share are you looking at the moment in terms of Meggitt surplus parts? Previously, I think you said you captured around 10% in 2016. I just wondered if that figure had gone up in terms of what you go back into the market and buy for surplus parts.

And then secondly, looking at SMART Support, GBP 155 million of revenue currently, how much of that extends to legacy platforms? Is it holistically across-the-board for Lufthansa Tech where you'll take every single platform they have? Or is this more for the new generation of planes?

And then equally, going back to the retirement point that you've just made, looking into the future not seeing a flip in retirement, I'm just wondering if that slightly contradicts the view on air traffic reducing, equally the 737 MAX needing to be delivered from Boeing coming into airlines. And just really wondering what your assumption is to your models in terms of replacement rate given that OEMs are looking sort of 40% to 50% for replacement for new generation. I just wondered what your assessment was there given that we've been at all-time lows for a time, as you say, and the A320 just doubled in retirements year-over-year in 2019.

And then lastly, bridging the gap for your margin targets for 2021, it'd be interesting to see the quantum for what you think MPS can deliver for you guys, looking to get to green phase all plants by 2021. I think historically, that was the ambition for 2018. Maybe the goalpost slightly shifted there as to what you deemed good. But equally, having a 25% footprint reduction, I just wondered on -- are we on plan for the restructuring program in MPS?

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Anthony Wood, Meggitt PLC - CEO & Director [42]

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Okay. A lot of questions there. Hopefully, I've captured them all as you went through. The first one, I think was on surplus, what's our market share of surplus at the moment? Virtually no activity in surplus. I mean it's sort of low single-digit million, GBP 1 million or GBP 2 million, really, on surplus at the moment in our parts. We do have a stock of surplus used material on the shelf of Meggitt technology. But I would think of the surplus market of sort of a maximum probably around GBP 10 million or something like that a year in terms of how it plays into our aftermarket. So it's still pretty modest when you look at where we generate most of our revenue and our margin.

On the GBP 155 million worth of SMART Support contracts, there's a mix. It's actually becoming more biased towards some of the newer platforms. So Lion Air, for instance, they're a taker of the 737 MAX and have not very old 737s in their existing fleet. So there's a mixture. There are a few legacy platforms in here, but it's more aimed actually at the runner/repeater the new platforms going forward. And that's because that's where the volume is. That's where the future maintenance planning is going. We tend to find on legacy platforms we're still supporting those in many cases with the parts provision and mostly ourselves, but sometimes through distributors when the fleets get very small and spread around the world. It's better for distributor relationships on those.

On replacement rate, that is the complex part of our modeling. I wouldn't really give you anything new to how I answered the earlier question on that. We still have around 3,500, what I would call legacy aircraft in the Meggitt 73,000 aircraft portfolio. A lot of those aircraft will continue to fly for other reasons, they're in parts of the world or unique capabilities. They're not going to get knocked out by a 737 MAX. It's a different requirement. So but equally within that, we still have some MD80s flying and some of the older aircraft that will over time get replaced. But no, our model says over time that we expect replacement, but no great surge in parking of aircraft.

And on MPS, I think overall that is but one piece of our wider operational transformation of Meggitt. And again, I'd allude to what I said earlier where we're 3 years more confident having really been focused on this with our teams. So the rate of improvement and the delivery of that plan and even the ambition to get all sites into green by the end of 2021 is really -- that's our focus and we're increasingly confident we can do that.

And it does drop into margin. We -- there's various ways you can move the margin improvement, but I don't want to get into specifics. But we have shown the margin benefit of that in the Capital Markets Day in May last year.

A question in the front here, Harry.

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Harry William Freeman Breach, MainFirst Bank AG, Research Division - Research Analyst [43]

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Yes, Harry Breach, MainFirst. Maybe 3 questions, if I can. Firstly, the forgings and casting supply constraints, can you give us any feeling, especially sort of in the first months of this year, about whether supply shortages, any out-of-sequence work for you guys and inefficiencies are about the same compared with when we talked in November about or improving?

Second question, maybe a sort of slightly technical one. Just looking at the back of the presentation pack at the quarterly organic revenue growth breakdown, has there been any restatement of the Civil Aftermarket quarterly organic revenue growth rate? Just, in my mind, I have slightly different ones reported as we went through last year, but maybe they're completely the same and I've got it wrong again.

And then -- and maybe the final one, just, again, thinking about aftermarket growth, sort of maybe more structurally, if you think about Meggitt over the last 10 years and the very strong Civil OE revenue growth rates you've had, and I think in my mind about meantime between parts replacement, clearly, there's a big delta there between the wheels and brakes side and other. But if I think about -- I would be thinking about the long-run organic Civil Aftermarket revenue growth is sort of being fairly consistent with what you guys did last year. And I guess to that end, are we leaving quite a bit of upside in there looking into 2021 when the factors affecting this year have sort of normalized?

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Anthony Wood, Meggitt PLC - CEO & Director [44]

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Well, forgings and castings, there is disruption. But the one thing we saw and it's washed up in our inventory numbers at the end of last year and one of the reasons sort of the headwinds to where we ended up flat is we had a lot of deliveries of forgings and castings suppliers catching up as they were pushing for their year-end. So we've got plenty of material to go through our factories, particularly our production lines in wheels and brakes are running pretty much flat out at the moment, eating into whether it's wheel forgings or brake frame or forgings and such like. So we've got pretty good productivity coming through, but we're still eating through inventory. We still need more, and I think -- still think that disruption is going to occur through the rest of the year. We've got forecast dates for catching up to purchase orders that extend right out to the back end of the year at the moment from our suppliers on some of those critical forgings.

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [45]

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Yes. Sorry, so just to be specific, we mentioned at Q3 that it was about a lot of the timing of getting the stuff into the factory and just causing that lumpiness. So building on Tony's point, we do have a degree of lumpiness particularly through the first half, but it is getting better.

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Anthony Wood, Meggitt PLC - CEO & Director [46]

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It is getting better. And obviously, these are suppliers that are making less MAX parts at the moment, so they're trying to catch up with some of the overdues that they had on other programs.

Civil Aftermarket, it was a technical question. We'll check, I don't know.

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [47]

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We may need to take this offline. I don't -- I'm not aware that we'll make any restatements, but we can check with you.

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Anthony Wood, Meggitt PLC - CEO & Director [48]

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I don't think there's a change, but we'll check it.

And then just more broadly on aftermarket growth rates. We're just coming off a year of 8% growth, is that indicative of a better outlook for the future? The one thing that, it's very hard to model, that I know it's true having seen it for so many years, is that airlines can still do extraordinary things in tough times to reduce their aftermarket revenues. And we don't have a large proportion of our revenues that are related to flying hours or fixed agreements. They are about buying spare parts and packages and such like. So they will run planes and the green time on planes later and longer. Ultimately, the spare part order comes through, but it does tend to get quite lumpy. And we're going through a period where as RPKs drop, the coronavirus bites this year, we're going to see airlines managing their own business cost line as tightly as they can. Ultimately, they'll have to come to us when the life is expired on those parts or the engine goes in or the plane goes in for maintenance. That's why we're guiding softer this year. We will see that effect, I'm sure. Thank you.

Any final questions? Yes, David again. Second question.

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David Howard Perry, JP Morgan Chase & Co, Research Division - Head of European Aerospace and Defense [49]

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Yes. Sorry, just one last question because I'm surprised it hasn't been brought up at all. One of the possible headwinds is the wide-body production cuts. Can you just remind us how exposed you are to that and whether it will have any impact?

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Anthony Wood, Meggitt PLC - CEO & Director [50]

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Yes, we have packages of equipment, as you know, on the wide-body 787, A350, quite good shipsets for us, and A330. The rates are softening a little on 787 and A330 as you look out into the future. But as a slice of our flying fleet of 73,000 aircraft and all of the various variants that we're delivering, still quite modest. We don't have the exposure that I know other companies have that are more focused on the wide-body segment. So we're taking more marketplace risk, I think, rather than that which we've seen as a specific shock. We're more focused on the MAX, frankly, and working our way through that. Small negative impact, I think is the best way to summarize it.

Okay. I think with that, certainly, thank you all for coming. And we'll conclude with that today. Thank you very much.

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Louisa S. Burdett, Meggitt PLC - CFO & Executive Director [51]

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Thank you.