Jardine Lloyd Thompson Group plc (OTC:LLTHF) Q2 2016 Earnings Conference Call July 26, 2016 4:00 AM ET
Dominic Burke - Group Chief Executive
Mark Drummond Brady - Deputy Group CEO
Charlie Rozes - Group Finance Director
Well, good morning and welcome to our 2016 Interim Results Presentation. We are pleased to be able to present a good set of results that reflect the continuing underlying momentum of the business. Let me introduce my colleagues, Mark Drummond Brady and Charlie Rozes.
As usual, this presentation has been structured into three sections: Firstly, I will run through our trading performance, focusing on the results of our larger businesses. You will find a more detailed breakdown of all of our operating businesses in the supporting slides included at the back of your packs. Secondly, Charlie will provide additional commentary on some of the more detailed financial aspects of our results. I will then return to give an update on some of our key initiatives and areas of focus. Finally, I’ll provide a summary of the outlook, after which, we’ll take questions.
Against the background of a challenging environment, JLT achieved solid progress in the first-half of 2016. Amounts of the key highlights, the combined specialty operations with an organic revenue growth of 5%,, once again demonstrating the sustained resilience of these businesses. JLT Re achieved 2% organic growth, significant progress is being made with our build out of our U.S. specialty business. As anticipated, we delivered revenues double growth in the first-half of 2015, and in line with our expectations.
The UK Employee Benefits business restructure is on track. FX movements since the EU Referendum have had a positive impact on these results, which is continuing. However, our focus remains on the key metrics of organic revenue growth. And so let me remind you excluding the effect of currency, acquisitions disposals and investment income. And we’ve increased our interim dividend by 4.5% to 11.6 pence.
Looking at the key elements of the Group’s overall financial performance in more detail, total revenues increased by 5% or 2% at constant rate of exchange to £619.4 million with overall organic revenue growth of 1% compared to 2% during the first-half of 2015, underlying trading profit decreased by 4% to £98.4 million and underlying PBT reducing by 7% to £89.2 million. As a result, the trading profit margin reduced with 17.3% to 15.9%. This reduction in the Group’s trading profit is the result of the ongoing investments in building out our U.S. specialty operations and the specific challenges faced by our UK Employee Benefit business, which had a disproportionately large impact on the first-half. I’ll provide an update later in this presentation on the substantial progress we have made in the U.S., and in reshaping our UK Employee Benefits business.
We recorded good progress and growth in our specialty and reinsurance businesses. With continuing momentum in new business win the benefit of which will not all have been seen in the first half. It is important to note that excluding the U.S. net investment of £17.2 million referred, the Group’s underlying trading profit margin would have been 330 basis points higher at 19.2%.
Our reported PBT is £55.2 million, which includes the impact of exceptional costs of £34 million, which Charlie will talk about further later. As a consequence, reported EPS was 15.1 pence.
Turning now to performance of our two trading divisions, our risk and insurance businesses, which represented 5% of the turnover of the Group, grew revenues to £481.8 million, an increase of 8% from organic revenue growth of 4%. The specialty businesses increased revenues by 8% with strong organic revenue growth of 5%. The reason for the reduction in the specialty businesses’ trading profit margin to 13% largely reflects the planned U.S. investment in the period. Excluding the net U.S. investment costs, the trading margin would have been 19% for the period compared to 20% for 2015.
JLT Re increased revenues by 8% to £127.7 million, a 3% increase at post inflation exchange, all of which was organic, with the trading profit margin increasing to 38%, up from 34% in the corresponding period in 2015. Revenues within our combined employee benefit businesses decreased by 5%, reflecting the performance of our UK Employee Benefit business, which saw revenues reduced by 12%.
Looking at the performances of our larger business individually, JLT Specialty generated revenues of £145.3 million in the period, showing revenue growth of 5% or 3% on an organic basis. Trading margins were unchanged but at constant rate to exchange, reduced to 15%, reflecting the anticipated greater weighting in profits in the second half as previously guided at the time of our preliminary results in March. This is good performance, given the continued foreign insurance pricing and the challenging economic conditions. Whilst insurance premium reductions are a positive for our clients, they do mask our underlying performance.
For the first half of the year, significant new businesses went across all the divisions, which will continue to results in the second half. Particularly good performances were achieved in the Construction, Aerospace, Credit, Political and Security divisions. There was also notable new wins in energy, although the energy division showed a reduced performance compared to the same period last year. Understandably, this is due to combinations of foreign exchange rates and a much reduced activity in the oil and gas sector. To give you some context around the energy industry, it has been reported that some $1 trillion of capital projects have now been in the deferred, delayed or abandoned are in large, finance and specialty divisions has had an encouraging start with notable new client wins.
Looking into detail at the large of these businesses, in Australia and New Zealand, there were notable new business wins across the specialty division. These included one of Australia’s largest agro businesses, and one of the world’s leading legal firms. This increasingly specialty focus has resulted in JLT Australia today at the 13 of the top 50 AFX companies. This strong performance was however offset by a significant decline in insurance rates in the region. The net effect of which was that this limited the revenue growth to 1%. At constant rate of exchange, the trading profit however increased by 4% with the margins increasing by 100 basis points to 35%. This is achieved in part to the careful management approach.
Asia delivered a strong performance with 6% increase in revenues at constant rates of exchange, all of which was organic. On a reported basis, revenues grew by 11% to £44.6 million. There were new business wins, including the Airport Authority in Hong Kong in connection with construction of the third runway and Singapore Airlines, both accounts won through strong collaborations with JLT Specialty in London. The benefits of both of these were largely received in the second half.
Our Latin American operations delivered strong revenue of 3% at constant rate of exchange, all of which was organic. The impact of adverse exchange rate difference however saw reported revenues decreased by 3%. We continued to make significant investments by the hiring of leading practitioners across all of our Latin American operations to accelerate growth. The level of investment in the first-half this year was particularly noteworthy, and this is the reason for the reduction in the trading profit. The benefit of these new hires will be increasing seen as we go through the second half of this year.
Our U.S. Specialty business generated revenues of $23 million or £16.3 million double that achieved in the first-half of 2015. This demonstrates the increasing revenue momentum of this business with Financial Lines, Cyber, Errors & Omissions, Real Estate and Natural Resources all winning significant new business. We secured nearly 200 new clients during the period with a healthy pipeline of activity supporting our previous guidance that for the full year we anticipate we approach nearly double those revenues of 2015. I’ll talk now about the progress and our plans for this business in a few moments.
Turning now to JLT Re. JLT Re delivered a strong performance with reported revenues increasing by 8% to £127.7 million and organic revenue growth of 3%. This performance is although more pleasing when set against the continued decline in pricing across most lines of our reinsurance business, and in most geographies, as abundant capital continue to dominate the market. However, the rate of decline has flowed, particularly in United States. This is evident during the June 1st property renewals where risk adjusted pricing typically fell within the range of flat to down 5%. This compares with the double-digit decreases we have seen in recent years. In addition to this, the casualty business during 2016 has also been renewing at flat to 5% down.
Outside of the U.S., double-digit declines in property catastrophe, marine & energy and aviation business were evident in both the EMEA and Asia regions. JLT Re’s trading profit increased by 20% to £48 million for the period, this reflecting in an improved trading margin of 38%, generated in part by the expected savings flowing from the integration of the businesses.
The margin improvement was achieved despite a proportion of the savings being used to recruit leading talent to further strengthen our general Property & Casualty, Specialty lines and analytics capabilities. Particularly good performance repeated by Asia-Pacific, which achieved strong levels of organic growth, as it benefited from the increasing importance of Singapore as a reinsurance hub, coupled with increasing volumes of treaty business in China. This region continues to be a focus for investments.
In North America, two new divisions were created, JLT Re Structured Solutions and JLT Re Mortgage Solutions to meet the changing demand of clients. During the period, the Capital Markets division successfully continued to bring alternative capacity to clients through the issuance of a number of privately placed Catastrophe Bonds. While traditionally trading margin of this business falls back in the second half of the year, it does remain our expectation that the 20% trading profit margin will be achieved for the year, in line with the previous guidance given, and representing an improvement on the previous year.
Turning now to our UK Employee Benefit business. At the time of the [QS IMS], we indicated that we’re expecting that the business would substantially deliver this year’s profits in the second half of the year, and this expectation remains unchanged. Reported revenues for our UK and Ireland business for the period were £74.9 million compared to £85 million in the first half of 2015. This is in part due to the ending of the commission-related revenues following the RDR, resulting in a total of £5 million earned in the previous year not repeating in 2016 as previously guided. The muted demand from pension scheme trustees and corporate sponsors for any more than obligatory services continued, driven in large part by government actions, and this further impacted the first half revenues and profits.
Decisive action has now been completed to better align costs with revenues, mainly through a restructuring program. The completed actions included the introduction of a flatter, more client-centric structure, which resulted in headcount reducing by over 300 employees. In line with previous guidance, we are confident that the restructuring program will deliver annual savings of £14 million in 2017. For 2016, the restructuring program will deliver targeted benefits in the year of £9 million. Approximately £2 million has been recognized already in the first half and therefore we expect remaining £7 million in the second half of the year.
The focus of 2016 is very much about transitioning this business so that satisfactory margins are restored. Excellent progress has been made and it remains our expectation that the reshaped business will move to an approximate 15% trading profit margin by the end of 2017. For the medium term, our emphasis continues to be on strengthening our platform and technology and our client propositions since we better position to respond to the continuing change of the long-term retirement and savings market.
Additionally, for the actions we have taken, we believe that revenues in this business have now stabilized, and it is expected that we will deliver positive revenue growth in future years. This is a solid business and a leader in pension scheme administration, consulting and technology which has strong prospects for the future.
Our International Employee Benefit business delivered combined revenues of £62.7 million, an increase of 6% or 3% at constant rate of exchange. Our Asia business faced challenging conditions in the region, impacting the rate of growth during the period, where revenues reduced by 4% at constant rates of exchange. We remained strongly positive about the prospects for this business with this current high level of new business opportunities evidence of this.
Our Australia and New Zealand businesses are making good progress, with revenue growth of 40%, of which organic growth was 4%. This growth was supported by the successful execution of our strategy of focus on the return-to-work sector, with the first full contributions from our 2015 acquisitions of Recovre and Alpha, both of which have more than met our expectations. More recently, we have added to our capabilities in the sector in Western Australia with the acquisition of Workwise. Notable new business wins included two of Australia’s largest workers’ Compensation accounts.
Today we have a market-leading capability across Australia to help workers return to work and to mitigate the cost of workers’ compensation claims. This adds to the value we create for corporates and insurers alike, and also generates opportunities to extend these capabilities into new geographies, such as Hong Kong and New Zealand. In Latin America, we delivered organic revenue growth of 3%, with revenues on a reported basis reducing by 9% due to foreign exchange movements. The reduction in trading profit in the region was additionally driven by the significant investments being made in the business as we continue to build-out our employee benefits capabilities across the whole region.
I’ll now hand it over to Charlie.
Good morning, everyone. This morning, I’d like to focus on the underlying performance at JLT, and talk about three important aspects of what I think as Dominic said, are good set of results; first, the movements in our underlying profit compared to 2015; second, the composition and utilization of our debt facilities, cash flow, and funding; and finally, the impacts of foreign exchange.
Within the appendix of your packs, I’ve given you some additional supporting slides. So let me turn first to our underlying profit before tax, where we reported £89.2 million this year compared to £96.3 million in the first half of 2015. As I did at our prevalence in March, I think it's helpful to isolate the effects of the UK Employee Benefits restructure as well as the U.S. Specialty build-out. That way, you will more clearly see the underlying trends.
As you’ll remember, the first half of 2015 included the £12.6 million cost of our U.S. build-out, as well as £7.1 million of UK EB profits prior to the negative impacts from the government’s pensions reforms and the impact of RDR. Without those two moving parts in our numbers, we produced an underlying profit before tax of £101.8 million.
Turning to the year on year movements across the group several drivers of profit are now more apparent in the first half. These include the previously guided shift in the phasing of our profits from the first to the second half and the impact of foreign exchange movements particularly in the period following the EU referendum. Excluding US specialty risk and insurance saw organic revenue growth of 3% in the first half of 2016 while trading profits reduced by £1.7 million at constant rates of exchange. This was driven both by the phasing of profits from the 1st to the second half as well as the investment of people in the period. Our international employee benefits businesses grew trading profits by £600,000 also at constant rates of exchange.
Head office costs increased by £1.5 million and that was due mainly to small changes in provisions. On associates you'll remember that in 2015 we had the benefits of the profits from our former French associate business for the first four months of the year. In the first half of this year the profits from all of our associates were in line with expectations of £1.9 million. I'd also remind you that the profits in these businesses are almost entirely delivered in the first half of the year.
Our net interest expense decreased by £1 million, this was a combination of improved interest income primarily in Latin America and the reduction in interest expense mainly associated with the group's pension schemes. Foreign exchange benefited group underlying profit before tax by £8.7 million excluding the investment in US specialty the impact was £9.9 million.
Foreign exchange had an impact on the results due to the nature of our revenue flows and the businesses global footprint. Of the £8.7 million for the group we estimate that 5 million was driven in by exchange rates following the EU referendum with four million of that amount related to transactional exchange which if rates were to remain at current levels we would not expect to recur. Just to remind you that translation of our international businesses results into the consolidated P&L is done at average rates over the period. So if rates were to remain at current levels we would only see a part year impact in 2016.
Taken together all these elements drove an underlying profit before tax of £106.2 million excluding the US investment and the UK EB restructure. I'll turn now to operating expense where cost management and efficiency continued to be areas of focus for us. Total underlying costs at a group level rose year on year by £31.8 million or 6%. Of this, foreign exchange movements contributed 1% and as a result cost rose 5% at constant rates of exchange. The balance of the year on year growth comprised of three things. First the planned investment in US specialty contributed just over 2%, second acquisitions in 2015 and 2016 and further investments in other businesses contributed a further 2%. Examples of these include our acquisition of Eikos in South Africa, the expanded fine arts, jewellery and specie team and JLT specialty and hiring in Latin America and EMEA where we see significant opportunities for future growth.
Lastly inflation accounted for just over 1% of the year on year growth. The effect of this increase combined with the anticipated phasing of revenues meant that we saw some slight erosion in the cost ratios for the group. But as I mentioned at the prelims our expectation was that a higher proportion of profits would be seen in the second half of the year compared to previous years. I also anticipate that a number of actions that we recently completed around discretionary and other operating expenses will deliver subsequent run rate benefits.
The combination of these effects has made analysis of some of the cost efficiency ratios more difficult at the half year although several businesses such as JLT Re, Australia risk and insurance and EMEA maintained or improved their operating cost ratios at the half year. At our prelims next March I'll provide a further update on these costs as well as operating leverage.
We continue to deliver strong operational free cash flows. These are in line with previous averages and I'll now spend some time talking about these. We achieved an EBITDA in the first half of £115 million, this was driven by continued good underlying performance across the group but also reflected some of the items that I mentioned earlier. As a result the net cash outflow of £68 million remained consistent with prior period averages, and reflected our ability to fund our growth plans organically.
You should also note that we're looking at year on year trends, the group benefited in 2015 from the sale of our French associate business which delivered £80 million of cash proceeds, without factoring in this one off realization we'd have seen a more normalized and net cash outflow of £62 million in 2015. Our continued discipline around working capital management remained effective and CapEx remained in line with our investment plans.
So taken together, the positive operational free cash flow of £22 million in the half underlines our strong cash generation and prudent cash management. Net debt increased to £544 million including other non-cash movements which are principally foreign exchange related. I'd like to turn now to our funding position which is also particularly strong.
We have long term credit facilities that are both diversified and attractively priced. They're appropriate to support our seasonal working capital requirements and to finance the further growth of our business. There are two components to our credit structure which provide JLT with stable and secure sources of funding. First we have a very successful private placement program with two sets of notes, one totaling $500 million and the other £75 million with a maturity profile out to 2029. Second we've got committed revolving credit facilities or RCF now totaling £500 million which are provided by our relationship banks and mature in 2021. This includes the April renewal for a five year term of an earlier £50 million facility which is now incorporated within the core RCF.
Utilization of the RCF stood at £248 million compared to £164 million at December 2015. This leaves us unutilized headroom of £252 million. That level is consistent with prior years where we've typically seen the peak of our annual utilization at the half year. This reflects seasonal working capital requirements, the dividend, annual bonus payments as well as organic and inorganic investments. Our net debt to EBITDA ratio was 2 to 1. That includes non-cash accounting, translation impact of foreign exchange on the $500 million of private placement notes, that's fully hedged in terms of overall impact on our balance sheet and P&L. The ratio remains comfortably within our debt covenants. Going forward we'll continue to invest in the businesses we grow and we'll maintain our focus on the prudent management of cash flow, funding and leverage.
Now let me cover foreign exchange. There are two key aspects of this, transactional and translational. Both of these types drove the £8.7 million increase in profits in the first half that I mentioned on the PBT bridge. Transactional foreign exchange mainly affects our London markets businesses where we earn US dollar revenues on a sterling cost base. It also occurs in a few other businesses where revenues and costs are denominated in different currencies. To give you a sense of the revenue component of this our London markets businesses will generate approximately $380 million during 2016. We actively manage this transactional FX through our hedging program and I've included some details of this in the appendix.
The second type of FX impact is translational foreign exchange. This arises on the consolidation of results and subsequent conversion into sterling from our overseas businesses for reporting purposes. Overseas P&Ls are converted at the average exchange rate for the reporting period. This type of FX is not hedged with the exception of overseas dividends paid up to the group from subsidiaries. We also have foreign currency denominated assets and liabilities on our balance sheet. These are converted at month end rates and they're exposed to movements in spot exchange rates between reporting periods. External borrowings in foreign currency are fully hedged with currency swaps and that allows us to manage volatility in net assets on the balance sheet and to protect the P&L.
If the current weakness in sterling were to continue through the end of the year, we’d anticipate a further positive impact to our reported results in 2016 although we'd also have the effect of increasing the net investment loss in US specialty this year. To give you a general sense of magnitude if the sterling-dollar rate were to remain at current levels and assuming our levels of hedging remained unchanged, the combined impact would be in the order of £12 million total for the full year. I would emphasize however this is not a prediction and it’s premature to conclude on FX rates that this will actually be the case. I'll provide a further update on foreign exchange at the time of our third quarter IMS.
Lastly I'd like to cover exceptional items. Net exceptional items in the first half were broadly in line with our first quarter guidance. Restructuring costs at £10.2 million relates to UK EB, the main parts of this program are now complete with headcount reducing as planned. For this year I now expect a full year charge of just over £12 million for UK EB. Our first quarter IMS identified a litigation charge of £22 million. We also had a £1.4 million loss on disposal related to a small business in Indonesia which we sold in the second quarter of the year. So let me just summarize all of this. JLT had a good first half though it was masked by two moving parts, the UK EB restructuring program and the US build out. The underlying businesses continue to perform very well as Dominic showed, even setting aside the favorable effects coming from foreign exchange.
I still anticipate a shift in the phasing of profits to the second half albeit at a more moderate rate than previously guided at the time of the prelims in March. The financial fundamentals remain positive with revenue growing in costs well controlled and on that note I'll now hand back to Dominic.
Thank you, Charlie. Before moving on to talk about the outlook let me spend a couple of moments on the outcome of the EU referendum. While we're far from being complacent about the challenges ahead, we also have deep experience in managing and adapting to new situations whether simple or complex. And we have extensive experience from operating in part of the world where cross border trading is complicated by regulation, has restrictions of all kinds. JLT is not simply or even primarily a UK company serving the UK clients and markets. We are a global company with deep specialty capabilities on every continent and a strong and growing presence in the world's emerging economies.
While the specifics of the new terms of trade to the UK the EU remain unclear for some time, we expect them to have a limited impact on the whole range of business activities we provide. JLT has a significant network of operations and relationships across continental Europe and we'll continue to invest and expand on the ground in Europe to fully equip us to continue to serve our clients.
Turning now to the outlook, we expect global trading conditions to remain difficult, coupled with the prospects of short term economic disruption in the UK and Europe following the EU referendum. There are signs that the downward pressure on insurance rates is easing, across the market as a whole, the [indiscernible] increase in their diverse of different experiences in different lines of business and regions. As usual the market cycle is led by reinsurance whereas I highlighted earlier the decline in prices is beginning to slow particularly in the US. With underwriters taking for example a more discriminating approach for Florida cash exposures this year. Across the retail space we see continued rate reductions but at a slowing rate, in the most developed economies, whilst in Asia, Latin America and Middle East the price of reductions remain significant.
It remains our intention to continue to drive organic growth across all of our businesses, we still believe we can continue to achieve by remaining true to our specialty led strategy and being only in those sectors where we are or can become market leaders. This enables us to clearly differentiate our planned offering and to win market share and increase our market penetration. As I already outlined we have now taken the required actions to return our UK employee benefit business to improve profitability in the second half of the year and it remains our expectation this business will move to an approximate 15% trading profit margin by the end of 2017.
The US build out is progressing well and is delivering what we anticipated when we set out our initial goal almost two years ago. This is a business with real substance and momentum. Today we have 13 offices located in the US economic hubs aligned to our specialties. Specialties such as aerospace, construction, energy and financial lines where we already have leading global capability.
We have nearly 215 employees, an increase of 30% since the beginning of this year and very importantly we are winning significant new business. To date this year we've [indiscernible] three hundred broker of record of patents the full earnings of which are still to be seen. The progress to date has been significant, and based on our experience so far we now anticipate a massive investor spend through 2018 paying $100 million up from $80 million previously advised with the business then moving into profit in 2019. This will enable us to capture the significant sector and regional opportunities we now seek.
We have increasing confidence in the revenue generating capability of this business, and of course go in hand with our continued investment for growth across all of our business is the need for careful management of our cost base. At JLT we've always thought to drive greater efficiencies to the business especially around technology and back office processes, and this focus remains undiminished.
So to conclude, in the first half of the year JLT has produced a good underlying set of results with particularly strong performances across our risk and insurance businesses where organic revenue growth in the 2016 was running at rates comparable to historical levels. Good progress with both of our major programs, the repositioning of our UK employees benefit business is on track and the continued build out of the US specialty business is making excellent progress. During the first half of this year we've been encouraged by the level of client wins which has been as strong as at any time since I became CEO ten years ago.
We are seeing significant amounts of benefit from collaboration between our specialty operations around the world which is helping sustained momentum and drive organic growth across the business. Economic and industry conditions remain challenging, nevertheless we remain confident about the good stability to deliver year on year financial progress.
End of Q&A
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