Schneider Electric SE (OTCPK:SBGSF) Q2 2016 Earnings Conference Call July 29, 2016 3:30 AM ET
Anthony Song - IR
Amit Bhalla - IR
Jean-Pascal Tricoire - CEO
Emmanuel Babeau - Deputy CEO & CFO
Ben Uglow - Morgan Stanley
Andreas Willi - JPMorgan
Gael De Bray - Deutsche Bank
Guillermo Peigneux - UBS
James Stettler - Barclays
Jonathan Mounsey - Exane
James Moore - Redburn
Alasdair Leslie - Societe Generale
Ladies and gentlemen, welcome to the Schneider Electric 2016 First Quarter Results. I would now like to turn over to Mr. Anthony Song, Head of Investor Relations. Please go ahead, sir.
Good morning Ladies and gentlemen, welcome to attend our 2016 first half result conference call. Today we have our Chairman and CEO, Mr. Jean-Pascal Tricoire; and our Deputy CEO, CFO Mr. Emmanuel Babeau, with us. We also have a gentleman called Amit Bhalla as well. Amit is going to replace me, as the Head of Investor Relations since the August of 1. So with that, first I hand over to Mr. Jean-Pascal Tricoire.
Thank you, Anthony. And I'm happy to make the transition from you to Amit on solid results so it’s a good way to salute your contribution to investor relation. I will go straight into the presentation, presentation of, as I said solid on strong results in H1 2016. And I’m going to move straight to slide 5, a picture of the Company at the end of H1, 11.8 billion of revenue, 40% % of revenues in new economies, 43% revenues in solution. Very, very balanced distribution of turn over across geographies. On the balance 50-50 between, what I call our tertiary end segments, meaning on building and IT; on our industry and infrastructure segments representing 50% of the Group. One of the strengths of Schneider, illustrated, once again in this H1, is a residence of this balance of geographies, on balance of end markets is providing us.
Moving on to slide, next slide which is slide 6. Well again strong results in this H1, in an environment, which remains challenging and uncertain, but where we saw some signs of stabilization. The first one is China, we’re down low single digit of H1, literally minus 3 in Q2, on we’ve there are signs, which are really interest in house sales, on the construction market are slightly positive, due to stabilization on market, on the reorientation of our sales on marketing forces.
Oil and gas which I remind is today 6% of our direct exposure, so being at a lower level, remains now more stabilize and we feel that, the stakeholders and our customers are getting more rational, in front of that new environment, so decisions are now been made. The consequence that some of the countries where we operate, like Russia are doing better, is actually back to positive in H1. Actually the only element of disruption is Brexit, that we have talked about already, but where we see today an impact which is limited to the UK, which is less than 4% of our sales on equity, we delivered a stable H1, in the UK. Well the fundamentals of performance of the H1 is really execution on all cylinders of Schneider is On. We had explained 1.5 years to go the price of Schneider is On, it’s starts by the strategic repositioning of our business. Do more in products, On do more on services.
We delivered 0.3 organic growth in products in the first half and 7% organic growth in services and the pure continuation of what we did in 2015. Second half is better selection and execution of our solution business which is on its dimension of project and equipment and we're very happy to report that our systems margins -- systems being the sum of projects and equipment is up one point, thanks to better selectivity, thanks to better execution. What I'd like to say is that we're quite happy that in the first half Europe, North America, new economy outside of China are all up and China is stabilizing. So, it's really old geographies which are going positive.
The second cylinder of Schneider of optionality is on is an intense work on simplification that we described, we don't make much noise about it. But we work in depths on this subject. We have target cost reduction of 1.6 billion by 2017. We delivered in H1 300 million, one third of base cost, two thirds at the cost level by productivity. We've been realizing in the past 18 months €900 million of cost reduction for a cost of [restructuration] which is half of it. So, we're also attentive to the productivity on the return of restructuration but there is a lot of work happening in our global supply chain. I'll come back on that. On the de-layering on the simplification of the way to work at the white collar level. This has been very visibly bearing fruits in H2 last year but also in H1 this year.
Second point which is not mentioned here is the work on the supply chain really is having effects on the inventory on the cash flow generation, I'll come back on that in a minute. The next two changes are about innovation on product launches where we keep developing our connected offers, EcoStruxure,io, I'll come back on that later. Plus 20% more products connected in H1. On growth by innovation a number of new product launches happening in H1. So, at the end of the day, challenging uncertain environment, deployment systematic and disciplined deployment of Schneider is on, repositioning strategically is the company in the places, in the business where we do best. Learning and correcting the places of projects and equipment where we have to do better and we start to show now for 18 months positive trends. On intense work in the time of low investment in the world economy on our structured cost, on our cash conversion.
Moving onto the next slide which is Page 7, we're good on all financial parameters, and adjusted operating margin up 80 bps including the negative effect of ForEx of 80 bps which means an increase at constant ForEx of 160 bps. This means that the adjusted EBITDA is up 12% organically, that translates straight into a net profit up 13%. I'd like to mention here good performance in net pricing where actually we have a positive price outside of China. On China, benefits from high productivity, so we maintain the margins whilst we have a negative price.
Last 12 months cash conversion at 123%, we more than doubled the free cash flow generation in H1, so that’s another proof of the good performance. We keep running the portfolio. We achieved in H1 Emmanuel on the team achieved the sale of Telvent Transportation. One of the changes that we have in H1 is the deconsolidation of Delixi where the operations are going to same profitability, going through same Emmanuel will detail why we operate in this change, which is actually a conformity to compliance to rules of consolidation. Then, next point is we are executing the program of share buyback in the first-half we brought back 320 million of shares around an average level of €63 on the top of €600 million we realized last year. Seeing the strength of this H1 on what we see coming in H2. We agreed our targets upon the full year and I will come back on that later.
I move on to the slide, which is growth by business. I would say, well, very happy to see all of our business performing, all of them have different priorities. So building on top up in a mix market, but up by 1.3% and you know that this is big shift at Schneider, a very world leader business at Schneider. Industry at minus 1.9%, remember that we have a part of our business, which is exposed to oil and gas. But this Emmanuel and I’ll speak in detail about that, this is improving through the quarters.
Infrastructure at minus 1.3, which is the byproduct of selectivity on projects, actually it would plus 1 without the selectivity. And overall today as we show roughly flat sales on H1, the impact of project selectivity on the total portfolio is 70 million to 80 million which means the underlying is plus 1. IT is delivering $0.30 flat shares at a solid margin. When you look at the dynamics of those sales, you see improvement -- continuous improvement in products and services that’s the strategic repositioning we have explained to you at the beginning of Schneider is On, on more selectivity on projects and equipment, on services and like, in all of 2017 delivers a plus 7% of organic growth.
Moving on to page nine on having a look at geographies, while West Europe confirms its rebound on actually Q2 is a plus 3, so we benefit from everything we know, low euro, low interest rates and low prices of fossil energy which are helping the investment of the zone. U.S. and North America are back to positive in an environment where construction is doing well. Technology is doing well. But we know that industries impacted particularly by oil and gas and the high level of dollar.
On new economies, while China is down low single-digit actually, which shows a strong repositioning of our teams on the right segments, and the rest of new economies is growing actually plus 1% on the total of the first half, which I want to mention the rest of Asia, which actually is growing above 4%.
So as we go to the next slide, this is a very important thing, part of what we do at the moment at Schneider. In a time where markets are more mixed, we are really working on our internal performance, our internal whole organization, balancing costs and growth capabilities, therefore, reducing in the segments which are not growing; and, at the same time, reinvesting in the places that bring potential.
What I want to mention is that we do an excellent productivity in H1 with less volume and, don’t forget, inventory reduction translating in cash, which is adding to the volume reduction. Big work on sales and operation planning maturity, reducing the inventory; big work on the consolidation of our supplier network and the quality value engineering on our products; big and continuous work on the footprint, rebalancing, and restructuring, while being very, very, targeted on restructuring that makes sense economically.
And I’m quite proud also that during the first half our supply chain has been recognized by Gartner as belonging to the top 20 best run supply chain, all industries included, in the world; a big recognition for the bold move that we took a few years ago to globalize the supply chain on the one roof and operate our supply chin as well.
Second, a part of the work that we do in cost is on support function costs, where we generate in H1 €120 million gross SFC savings, on the top of the €300 million last year. Remind you that we have a commitment to deliver €300 million on the total of 2016 and 2017. A lot of work on the simplification of our business organization and regional organization; a lot of work on putting together some business which were separate before; a lot of work on R&D efficiency; mutualization of the back office, which is something we have started a long time ago.
So all of this, again, is carrying results in our environment. Next point, which is part of our strategic repositioning, is delivering better on projects and equipment, which goes with, and I’m on slide 11, increasing the selectivity on projects; on improving the tendering procedure; reinforce the governance on the risk assessment; enhance the project management skills. And that goes with the significant consolidation of our tendering on project centers, on the rightsizing of the teams as we mutualize those teams.
The reasons we see today that the hit rate is improving significantly as we focus on the segments where we bring a very differentiated added value, while the gross margin is improving during H1 by 1 point. And you’ll see the effect on the industry and infrastructure divisions, which are the biggest carriers of those projects on cash generation is better than what we used to be. I want to mention briefly it's probably not the main topic of the presentation of today. What we are doing in the next three slide which starts with slide 12 in terms of product on innovation. The big event of H1 was the officialization of evolution of our EcoStruxure architecture. You knew EcoStruxure and the integration of connected products on edge control, automation platforms. We have been working and we've kept you informed of each of this evolution we've been enriching, augmenting the capacities of this architecture. We act with analytics with services with setup of a cloud that we can put together on the customer's premise or on our premise if the customer wants it. We've built an end to end cyber securities department at Schneider that helps our customers to integrate those four components in to a fully cyber-secure environment.
On the next slide 13, some examples of some products that we have launched in H1 around this architecture. There are some very conditional products in this slide, I want to mention Masterpact MTZ, which is a world-leading product, which is the core of the low voltage distribution or MTZ is brining unparalleled capacity of precision-one meeting, which means that customers don’t have to equip their systems of supplementary accessories to measure the characteristics of power, so that's incredible savings for people to have to control their process in their energy. New launch of speed drives which are saving 30% to 705 on energy, on motors, on preserving the mechanical assets and complete renewal of our range of relays of protection. Plus, the launch of Galaxy VX, which is our new range of UPS for large scale data center and for industrial applications.
More launches in the field of automation platforms, our BMS building management system platform; PES, which combines together the control of process on energy, micro grid controls. We are doing more and more micro grids not only in emerging countries but also in mature countries. Our totally new system for Data Center Operation that is plugged on at the next level, which is the level of analytics to our cloud based structure on software which ask customers to manage assets. On that level of analytics there again you see a number of new applications on analytics which help our customers to manage our installations.
I want to mention also very specifically the number of new products we're launching on the home on small building space which is very significant space for us on actually which is growing worldwide mid-single digit. It has been the case now for some years where we enrich the system going deep into wiring accessories into automation and into power automation in the field on small building. This has been certain is a must successful part one of the most successful part of Schneider in the past period.
So this is about innovation and now I want to go into the detail of each business, starting by the major business of Schneider, 45% of the group H1 revenues, which is building on partners that goes from home building that is all of lower digit goes also that pervades in to our industry infrastructure. Well, very good organic growth at plus 1.3% in this business, we’ve been also selective with projects of building controls. So if focus on the on the low-voltage product part, we have been actually growing quite well, I would say around 3% for the total of the company on a worldwide scale, which is a great performance in the place which is our areas of excellence on a global scale. What are our priorities? Is really priorities every business we do with partners.
When we moved into solution, we learned about solutions and we realized, we could channel part of solution business through a partners and this is something, we’re keeping and pushing. Keeping, pushing our strong expansion into wiring devices and final distribution, which is growing mid-single digit; really a powerful and successful development, launch new connected offers, which is MTZ, our connected breakers that I spoke about, this is Smart Panels; and smartly connecting the rest of the distribution to a full set of analytics. Were we grow in the US, we grow in West Europe, we’re stabilizing in China, because of construction market particularly in Tier 1 and 2 series.
We’re having great results in India, South East Asia, Russia is back to up again, good success in final distribution. What is really good to is that the sales grows, growth together as profitability grows almost two points, this part of the business has been benefiting from what we do in productivity a most, raw material tailwind, which is important in H1, net pricing I spoke about it, plus 1% outside of China. China has been protecting its margin on the base of very strong productivity. Cost cutting, with a lot of simplification, especially putting a larger business together, on some scope effect of Juno deconsolidation that has been quite in this case, quite neutral.
IT, as I go to the next slide, which is slide 16, which is 15% of the group results, slightly negative or flat sales. Actually decreasing profitability fractionally. But actually, it's up 10 bits, if you exclude the Forex impact. Why is it, why is the Forex impacting us here, because it’s a lot of electronics, on the electronic currency which is a dollar is impacting more on margin than in other places. What’s our priorities here? Privileged product sales for the IT channel on the electrical channel, keep and pushing the advantage of supplying a full data solution, leverage on new cloud-based software offering structure on, keep the service gross momentum. We have a lot of services around those very critical applications, and very strong cost control on this business to make sure that we stay lean, mean and extremely competitive. Growth in the U.S., growth in Asia, Europe market, soft. Services, solid. We keep working as I said in protecting the margin in this business and keeping growing this business linked to digitization.
Moving on to Slide 17, going into infrastructure, what I would say is that the priority is keeping on improving the margin. So, 70 bps of improvement in H1, that grows after a 50 bps continued improvement in 2015. This is the business which has been impacted a lot by ForEx, actually without ForEx it would have gone up by two points, so that's, that would have been or that has been a spectacular improvement before the ForEx. The other priority is one more services, one more products, we want to execute better the systems that we select more precisely and we keep cutting cost on rationalizing the industrial footprint. So, if you exclude selectivity this business was growing one point organically in H1. Again services growing up. I'd tell you we did better metro markets on this H1 than in the new economies and I spoke about the root causes of the margin improvement.
Moving onto Slide, next slide 18, on industry, well there again and continuous progress. Industry has been impacted by weaker market and especially the collaterals of the oil and gas evolution. Q1 was at minus 2.3, Q2 minus 1.2 resulting minus 1.9. Work on profitability plus 40 bps in terms of adjusted EBITDA. It would have been one point, two points before ForEx there again. So, what we want to do here is and I'm pushing the slide up, here grow more business with partners and integrators. The business that we do with machine manufacturers particularly in Europe is doing very well. So, we keep pushing that. Grow software in key segments, rebalance our exposure outside of more depressed markets at the moment and we really see dynamics which are very different market-by-market and continue to control the cost. We had good dynamic in Europe boosted by OEM markets, we're impacted in the U.S. by oil and gas and strong dollar which impacts OEM. We had decline in China which remains a difficult market. Process automation actually which is the legacy of Invensys, was slightly up in weak markets because it's impacted by oil and gas particularly but we kept benefitting from revenue synergies, on the cost synergies of the integration of Invensys.
Quick look at continuous focus on sustainable development with a lot of recognition of the commitment of Schneider in this. Lots of progress, we're above the targets of our barometer which measures us against the main teams with particularly good performance in energy savings on development of secular economy within Schneider. So, a pretty busy first half but very focused. Again nothing very sophisticated, just the deployment of Schneider is On, proven, and it's great by the result of good figures.
Now I would like to hand over to Emmanuel.
Thank you, Jean-Pascal. Good morning, everyone. Good to be with you to commence this good set of results. Jean-Pascal has already highlighted many drivers for our performance, so I am going to enter into more detail on various dimensions that we’re already been commencing. Starting of course with our sales and I am on page 21 of the presentation, our sales amounted to €11.846 million. It's flat organically and we’ll commence in a minute by region, the performance. But in total, it's down minus 7.8%, two reasons for that, the ForEx impact and the scope impact.
Let's start with scope impact, which is significant, minus 4.1%. You have the disposal of Juno of Telvent Transportation and these are two significant impact. And you have also the change of consolidating treatment for Delixi. So far Delixi was integrated globally in our accounts. I am sure you will remember that this is a joint venture in which we own 50% and nothing has changed in this ownership and in Delixi during this first-half. But the rules governing the consolidation for this type of joint venture are quite complex. This is the IFRS statement.
And during this first-half looking at the way the governance is organized we came to the conclusion that looking at the various criteria that IFRS10 is detailing that it was more appropriate to change the method of consolidation and go for equity method. Let's be clear, it doesn’t change at all the net profit, so it has no impact on the net profit of the Company. And we are of course absolutely preparing to give a pull up on the Delixi numbers. You have in appendix already the full set of number for last year. And what I want to share with you regarding this H1, first of all, regarding the organic performance of Delixi.
It would have been a bit better actually than the all China performance. China has been decreasing a bit more than 3% globally, when the Delixi organic performance was a bit more than 1% decrease, so a bit better than the average. In terms of margin, there was a big difference between H1 and H2 last year with a strong H1 and weaker H2. And average for the year of high single-digit 9.7. We expect for the full year this profitability to stay about the same and stay in line. And this is exactly what has been happening in H1, the profitability in H1 is absolutely in line with the profitability for the full year 2015.
And if we had not changed the consolidation method for Delixi, the adjusted EBITDA margin would have been 13.2%. So the improvement is not coming from Delixi, it's coming from the good work that we have been doing elsewhere, and that I will further comment in a second. So that was for the scope impact. Regarding now the ForEx many currency impacting us, no surprise of course; China’s yuan, British pound, Canadian dollar, Australian dollar, Indian rupee, Russian ruble, Brazilian reais, they all have been depreciating versus the euro, creating a significant impact in H1.
Now looking at the full year, we would now expect as we mentioned at the end of Q1, a close to €1 billion negative impact for the top-line. So, we are not changing our view on that one. And we are slightly upgrading by 10 bps the impact on the margin. We are at 40 bps to 50 bps negative. We believe now that given the volatility that we’ve seen in Q2, the evolution of the British pound, we could be negative by 50 bps to 60 bps.
Looking now at the performance by region, Jean-Pascal has already highlighted a few elements. Western Europe positive, plus 2%. We’ve been growing in Germany, in Italy. We have been growing in the Nordics. We are flat in France and in the UK. And we’ve been negative also, on high comps, on Spain. North America is up 1%, U.S. is up 1%, with construction still going well and growing nicely, and more than offsetting more difficult performance in industry and infrastructure.
Canada was negative with a difficult situation in the country, driven by commodity prices. And Mexico was nicely oriented. Asia-Pacific minus 2%. So, I’ve highlighted the Chinese performance. Jean-Pascal talked about our success in India. Globally, in South East Asia, I can mention that Singapore, Vietnam, Philippines, Malaysia were all positively oriented for more than 4% growth altogether for South East Asia. Two other markets were negative in Asia-Pacific: Australia and Japan. Australia clearly being impacted, I would say, like Canada, by the low price on commodities.
Then, rest of the world, minus 2% really mixed bag. Central and Eastern Europe still positive. CIS positive. And clearly we think we have troughed in Russia. We are even growing in Russia in the building business, and in the industry business. South America, outside Brazil, also growing And in terms of negative, we have Middle East impacted, maybe more than what we thought at the beginning of the year, by the low price on energy. Africa, negative as well. And Brazil, which, as expected, has been tough.
I am now moving to what certainly is the most striking element of our financial performance in this H1, which is the significant improvement of our gross margin rate. Moving from 37% last year to 38.2%. And when we enter into the detail of the performance, we can see that we managed to play positively with all the levers that can help driving up our margin. First, starting of course, with net price, a nice plus 0.8%.
Net price was, of course, already positive last year. You remember that it’s a clear objective that we are. We keep adding the good contribution coming from raw materials, a nice €100 million positive in H1, which is, by the way, most of the positive impact for raw mat, we expect a very little, if any, contribution or positive contribution coming from raw mat in H2. And besides this good news coming from raw materials, the good news is that we are improving the situation on gross price.
We were negative last year because of China. We still negative in China, but during this first half we did manage to compensate the Chinese impact by growth outside China. And Jean-Pascal highlighted it, we are close to 1% growth on our price in China which shows our capacity which is intact of increasing price even in a very low inflationary environment.
Next driver playing, once again positively, even more than in H1 last year, productivity plus 1.4% and we have already mention all the driver between procurement, between the optimization of the manifest platform, the re-engineering of our products, all that is driving the productivity and will continue to do so.
Next element which is very significant improvement this is H1 last year and the full year, by the way of 2016 which is obviously is a mix and sure the result of all the work that we're doing the mix which is almost neutral when you have very negative last year minus 1.6 for the first half and you have really the impact of the good job I started to do it's beginning of the journey, it's certainly over. On the improvement on margin on system and that is reflected here on the fact that the mix is no longer weighing down the gross of our gross margin.
Then you have the traditional inflation on our labor cost of production minus 0.3. The effect is negative by minus 0.7 and not going to repeat the list of currency may be I like the fact that the Chinese yuan, the Pound, Canadian, Australian, Indian, Russian Ruble are having the highest impact here on the gross margin rate decrease. And then, scope and others, it's a positive 0.1 this group is positive by 0.6. And Delixi is helping here, but it found its compensation at the level of the SFC. And the Juno and the Telvent transportation disposals are also helping. And in front of that there was a traditional other close to minus 0.5 is a number of technical position or impairment on inventories. 38.2% of gross margin that is for delivering gross profit of 4.528 billion and this organically plus 3.1%.
Next driver for our profitability on which we continue to progress successfully, this is our support function costs, a bit less at 3 billion for the H1 minus 6% in reported change and organic minus 1% which of course compares well with flat organic sales. We keep managing to curb our SFC and decrease our SFC and create a leverage between the revenue information and the SFC. Jean-Pascal has already largely detailed all the action that we are implementing on our SFC to deliver this performance and of course will continue to do so in the coming quarters.
All that drive and adjusted EBITDA of €1.570 billion marginally down of course because of ForEx impact, but organically we are up 12%. The margin rate which is showing the quality of the profit, the fact that we keep now on good track to grow our profitability the margin rate is reaching 13.3% plus 80 bps. And at constant ForEx, it would have been plus 160 bps. So without the ForEx we would have been at 13.10%. So I think it highlights like liquidity of the improvement of the profitability, during this H1. I’m now going to go deeper in the P&L, other income and expenses, it’s negative minus 8, here you have. Compensation between positive and negative, the positive year is, notably, the positive end to a few claims and litigation that we had, and which has a lot for release on provision for risk, in front of that, you have the consequence of disposal and M&A and you have some impairment of assets.
On restructuring, you have a negative 132 million. It's a bit less than last year, we anticipate for the full year to restructuring around €300 million, we’re absolutely in line, our three year vision that we’ve shared with you already, which is to go for some scene like 900 million of construction cost, over three year period. Then, the following line, amortization of purchase accounting intangibles, you see a significant improvements by 60 million, it’s only negative by 83 million and it’s improvement structural improvement. Because in fact, we’re coming to the end of some amortization linked with the acquisition of APC and TAC in the past and therefore we’re fully amortized a number of intangible assets and that’s why it’s no longer year impacting negatively our profit. That is an EBIT of €1347 million, it’s up 10%. If I now look at the finance costs, minus €246 million, the cost of debt actually keep decreasing by 18 million and the average interest rate on our debt after H keeps going down. We were at 3.8 in H2, 3.6 in H1 2016, and we certainly expect the cost of our debt to continue to go down. So it’s more good news to come. And therefore, here, the increase is really coming from one that coming from the big volatility on the currency during this first half.
Income tax 275 million, as expected reflected, we’re expecting an income tax rate to go up as we’re ramping down the benefit of the Invensys acquisition. And today, we expect to be along 25% for the year. And then in share of profit from associates and minority interests, you have, of course, all the variations linked to the various element consider on the line and you have number impacting. Once again, I repeat the change is, the miss-synergy of consolidation for Delixi is not impacting the net income group share. Precisely our net income group share is €809 million and it is plus 13%. Very strong progression of our net income group share during this first half.
Another good news for this as, which is the free cash flow generation at €446 million, it’s more than twice the free cash flow of the first half for 2015, which was already seen some progress in the first half of 2014, so we keep improving the cash flow generation. Good growth of the operating, cash flow growing double digit at 1.3 billion. CapEx growing a little bit at 402 million, change in trade working capital its good news, because its lower negative impact than last year, it is a good job that we’re doing, on the receivable; and, even more important on the level of inventories, another attribute to the quality of our supply chain, that Jean-Pascal was mentioning previously. And then the change in non-trade working capital, its impact is also improving and that's a favorable evolution on the amount of tax -- cash taxes we're being paying. Below the free cash flow you have the traditional dividend, 1.1 billion, acquisitions net very little impact during this first half, very little seen to report. The net capital increase is largely the impact of the share buyback. We continue to implement our share buyback program, we've been buying 320 million so far in the year at a value little bit below €52 per share and of course when we see our share price going down after the Brexit we've taken this opportunity to buy on what we think were very interesting level of our share price for a buyback. And then you have FX and other, here it's mainly the ForEx impact once again on our various treasury and debt exposure and you've some consolidation and scope impact on that line as well. All that is driving net debt level at the end of June of €5.7 billion and we keep therefore having a very efficient generation of free cash flow.
That ends my presentation on numbers and detail on our financial performance. Jean-Pascal, I hand over back to you.
I will speak about the 2016 targets or where we've written everything on the slide, but we've very good solid performance and solid growth around products and services. Strong improvement in adjusted EBITDA margin during H1. Of course we saw headwinds in oil and gas, in resource based markets which are remaining. We see growth continued in the U.S. construction market and in Western Europe. The China construction market I'd say short improvement. New economies outside of China were up. So, additionally as we say several times the organic growth was negatively impacted by project selectivity which we anticipated at the beginning of the year. So, the impact of the selectivity is 70 million to 80 million negative in H1. But it's expected to accelerate in H2 to 2% of the turnover.
So, for the second half the priority remains, it's to accelerate growth in products, software, services, select on execute better systems and really keep focusing on cost, on cash efficiency. We also realized that we're in a phase conditions which are slightly different, a higher base of comparison in margin, we had the remarkable H2 in 2015. We're going to see an accelerated negative impact from project selectivity. We're going to have less favorable raw material tailwinds and actually almost none, and a slowdown possibly in the UK which today we estimate limited to the UK due to Brexit. So, based on this on given the strong performance in H1 what we target is a flat underlying organic growth before project selectivity impact, that will impact our sales by minus 2% in H2 and an improvement of the adjusted EBITDA margin before FX of 60 basis points to 90 basis points. The negative ForEx impact on margin been estimated at 50 basis points to 60 basis points at current rates. So, that’s what we see for the full year 2016. This being said, we are open now and ready for to take your questions.
Thank you. And we will take our first question from Ben Uglow with Morgan Stanley. Please go ahead.
First up, could you talk a little bit about the infrastructure division, in particular, and how you see the margin progression in to the second half? I think before you've been hopeful that, that could potentially be a double-digit margin business this year. You've had a 70 basis point improvement in the first half. Do we see that growth continuing, and potentially increasing? I guess I'm curious to know if you are able to confirm the previous 10% target there. And then secondly, can you just give us a sense of the industry environment in China. We've heard mixed reports from some of your competitors. You called out, in industry, some form of acceleration. Could you elaborate on that a little bit, please?
Ben, thanks for these questions. In infrastructure we confirm the objective of reaching an adjusted EBITDA of double-digit at the end of the year. Unfortunately we’ve been really impacted by ForEx in the first-half more than we thought initially, but we are working on it and what we do at infra is really encouraging, so confirmed. In industry in China we’ve seen high single-digit negative in H1 due to weak markets. I was probably not clear enough. I don’t see much of acceleration there. But what we do is that we had presence and OEM linked to construction, which is impacting us negatively. We are repositioning our presence on the market on segments, which are doing better. On that I think we’ll be upward in the months to come.
Thank you. We will take the next question from Andreas Willi with JPMorgan. Please go ahead.
First question is on your software business, if you could give an update there, how that's performing on growth and profitability; and what the strategy is there now, also regarding the two failed attempts to come to an agreement with Aveva. Is that chapter now closed? And the second question, on your earnings bridge. The support function cost savings were quite a bit lower what's implied by your run rate to get to the target in 2018, but this is offset by much lower labour inflation. Maybe, you could just explain a little bit what's going on there, and whether you still have the 2018 support function cost savings numbers that still confirms. Thank you.
On software Andreas we have contrasted the dynamics, we keep growing and so clearly in H1 it's really sales by 2%, but it’s really contrasted between the part of the portfolio, which is on the oil and gas, which is under pressure for what is upstream, but on very good dynamics, actually, double-digit on things which are linked to discrete automation. So there is really a repositioning on end markets which is happening. On Aveva, we already commented, or, actually, it’s nice to have, strategically, a making sense on both sides. And I think both sides said that. We didn’t find the right conditions to make the deal happen. On inflation?
On your question, Andreas, on the cost evolution, the labor inflation. So I can confirm that we have experience a lower labor inflation, which is just in line with lower level inflation globally, at the world level. So that’s something that is probably going to stay for a period of time. And regarding the SFC evolution, yes, it’s true that we are not exactly at the run rate of last year. Remember that we have the €600 million target for a three year SFC saving. We have done something like €300 million last year, we have done €120 million this first half, so we are more than €400 million. We still have 18 months to go. So we believe that we are, clearly, going to deliver on this €600 million. And of course, we know we make sure that we continue to work on savings and efficiency together. But I think we are in line with our plans.
Thank you very much.
And we will move to Gael De Bray with Deutsche Bank. Please go ahead.
Gael De Bray
Yes. Good morning, everyone. I have a few questions, please. The first one is about the guidance. If I take the midpoint of the new guidance before currencies, it seems to imply relatively flattish margins in the second half, after the 160 bps improvement in H1. So what’s really driving the cautious expectation here? I guess, lower raw material cost of deflation probably explains half of it, but why the other half?
That’s question number one. The second question is on the inventory level. Inventories has dropped significantly in the first half as a percentage of sales, and I was wondering if there was any negative impact on the margins due to a lower absorption of fixed cost. And then, the last question would be on the pricing side. Clearly, flattish prices in H1, which seems to be a significant improvement on a sequential basis. So I mean, that would be great, if you could elaborate on this, in particular, in terms of what you see sequentially in the infrastructure division pricing. Thank you.
Thank you, Gael. I’m going to take the one on the question on the guidance, which is always an interesting one. So you take the middle point of the guidance, which I let you do, the only thing I can comment is that, certainly, the €100 million on the raw mat was an important booster for our H1. And explain that, we are not going to see it again in H2, and we think it could be actually close to zero. So that’s one element. Remember that there was some significant improvement last year, year-on-year, notably, due to Invensys. But there was more than 2 points, which was certainly much above the average, between H1 margin and H2 margin last year so you have this dimension as well. And you have also what we've been describing in terms of selectivity impact which is going to on the long term of course, be favorable for the margin. But that will mean that the top line will be impacted more than in H1 by the selectivity and of course that can have an impact in terms of absorption of figures. So, again I am not seeing that the middle of the bracket is one you should be looking at I think we've been giving in full bracket on purpose I hope I have been able to put a few reason why we have decision on our margin on it's too.
On the inventories, that's actually a very good question, of course the reduction of inventory impacts directly the volumes and therefore it impacts the potential of productivity. I think we're benefitting really of globalizing, on simplifying our supply chain, getting a better articulation of our supply chain together with sales. Although we're developing quite processes in that sale, therefore what I am practically satisfied about is that during the first half not only we reduce inventory but we also adjusted the costs so that we could also deliver productivity which is better than what we used to do. So it's a double progress on that one. But I really confirm that effectively it's more difficult to deliver that level of productivity when you are reducing the inventories. So there is more miracle here just hard work on the foot of organization choices we have done some years ago.
On pricing, well we're told you at the beginning of 2015 that there were some places where we needed to reposition our price which we did. Want to mention also that 2015 was a more deflationary environment because there was release of raw material gains which we were above what we have this year. And we know that in our industry even if it's absolute if it's not index there is a correlation somewhere. So what we're monitoring is net pricing. One thing which it show is that we've worked a lot on it. And it was a decision and we've been more selective in a certain number of cases because we wanted to maintain the right balance between pricing on volumes and we're there again a bit like we did on the inventory on what we call the SIOP, which is the adjustment between sales and inventory operation management. We have been progressing on the way we manage our prices.
Gael De Bray
Thank you. Can I just have a follow up on the selectivity measures in H2? Do you expect the impact on margins to be relatively neutral, or slightly positive, or even slightly negative in the short term?
I will work on it to make it positive. Just it has to be very clear, we said it from the beginning we're learning to a certain extent I think when we developed into industry and infrastructure which is asking in a lot of cases direct engagement of us in delivering projects on equipments. We've been learning what we would have to keep doing directly, what we could do with our partner. We always privilege our partners. And we now are learning also by developing, keep base in them, into more customers, we’ve been improving all to do better things, and we know where we bring real values that we can value in our margin, on place where we don’t bring enough value. So what we want to do is to be more precise there on do less but do it better.
Gael De Bray
Okay thank you, very much.
Only where it makes sense. I believe that from the beginning, we said it was not a game of market share for us, in projects and equipment it was the capacity to serve applications that we didn’t get any access to in the more remote past. We have gain this access, but we realized that we can be innovative in serving those markets, very often using the strengths of our partner network. So it’s a reposition, I can’t find the better way of, that saying it continues repositioning.
And we’re moving to Guillermo Peigneux with UBS. Please go ahead.
Thank you for taking my question. I, actually, want to go to the guidance and maybe try to understand a little bit more about the implications of the divestments you announced on your margins. If I do back-of-the-envelope numbers on your region, there is a small accretion from the divestments to your margin, and I wonder how much of that is also reflected in your new guidance for margin improvement. Thank you.
Thank you Guillermo off course, there is an impact, which we’re absolutely flagging which is 10 bps on the margin on the adjusted EBITDA margins, so -- and, basically, Delixi has no impact on the analysis of change in this H1. We’re not, surprised by the disposal of Juno and transportation, so that was expect to get a beginning of the year and off-course it’s guidance that we’re giving you, is taking that into account.
It's really a maximum of 10 bps. For having followed since the inception, actually the operation of Delixi, we are facing criteria’s of consolidation which are extremely complex that we reviewed and want always to be on the appropriate, whatever I don’t know, I want to call it, but super-safe side of the equation. So, we are deconsolidating it. But we’re having good results in terms of growth, in terms of profit and we’re going to keep growing that operation and developing that operation.
Thank you. And maybe a follow up, regarding china; and I think I want to follow up on Ben Uglow's question. But we saw some of the indicators, leading indicators, that were basically very positive during the first half this year may be slowing down in the latest data points, and they're actually slowing down dramatically, and some tightening measures announced in top-tier cities around China. I wonder how much visibility you have on how sustainable this recovery you are seeing at the moment is?
Look there are two element, there is the market and there is our exposure to the market, so what we’ve been addressing, I guess, we discuss that with many of you, more in detail during road-show in past years, is reposition in ourselves, on the faster growing part of the market, which are corresponding to the priorities of , 5 years plan, discovery. No mystery, no big discovery.
Now, the time that KPIs are translating into the dynamics of the market, they need a few months, what we see day, again there has been an adjustment last year which at the end was around 10% and after many years of strong growth it was pretty positive. What we've seen in H1 is really a continuous improvement of dynamics so we're not -- we're expecting that continuous recovery coming from the market which is kind of stabilizing through the transition to the new normal of China.
People are revaluating their priorities but we see more direction now especially with the publication of the new brand but a large part of what we do here is due to ourselves. There are places where we've diminished our allocation resources, there're places where we've increased our application of resources. So, when you look at what China does today, things like the push to a more green society is all in our direction. And it's not about new construction, very often it's going back into a previous construction or previous industry or previous infrastructure on instrumenting our putting together the equipment in those infrastructures to make them more energy efficient and more sustainable.
When we speak about more innovation, it preaches for more automation which we're in a very good position to serve. And that goes in to particularly the industrial sector, where we're working a lot by putting together our software on our automation platform. When we speak about [Internet Plus], that's serving the need for datacenters which were positive in H1. On, when China does one way, one doubt we've a lot of projects that we drive with our Chinese partners outside of China. So, they are the indicators but they're the priorities, and you'll notice that the priorities of China in the '15, in the '13s five year plan are very consistent with what we can supply as a technology provider.
Moving now to James Stettler with Barclays. Please go ahead.
Just on China, I think you said pricing was down in Q2. As you look in to the second half of the year, do you start to see a stabilization with the market now flat? Secondly, if you look at your portfolio and under-performing assets, in terms of your divestment plans, could you maybe give us a bit more color here?
So, on pricing in China I think we would expect things to continue stay under pressure. So, we would certainly hope for some improvements as things started to be difficult last year during the summer in terms of price and we took a number of decisions last year during the summer in terms of price reduction but let's be clear as long as we are in an environment with some deflationary pressure, that would be reflected in the price performance in China. So, to hope for some improvement, yes, but I would certainly expect China still to be negative in H2 in terms of pricing impact.
And regarding the underperforming asset as you call them that we would probably call less core asset and not priority. I think that we traditionally never comment about then before we actually to take the decision, not only that we do take the decision to sell them but we have to be get to a solution to find a buyer. In order not to weaken them, not to destabilize them I guess you have a pretty good idea of what it could be and you have a few assets in mind. We certainly confirm our intention to keep pruning our portfolio to concentrate on the asset with the right level of performance, or profitability, generating synergy with the rest of the business. But we won’t be more specific that at that point once again until we come with an agreed disposal.
We are moving to Jonathan Mounsey with Exane. Please go ahead.
Just to follow up on that last point around pruning the portfolio, and also in the context of the excellent free cash flow generation in H1, how do you see yourselves deploying that capital? Obviously, you've accelerated the buyback program. Could you see yourselves extending that buyback program, using some of that extra cash, giving it back to shareholders? And then secondly, on mix, obviously, we're back to pretty much flat now on mix and I wonder what is the progression of mix as we go in to the second half? Can it turn positive? Or should we expect mix to become positive as you continue to focus on products over solutions in to 2017?
Thank you, Jonathan, very clear. Well, first on capital allocation, on the buyback we have this significant program of 1.5 billion buyback. We are a bit above 900 million so there is still quite journey on buying back and we’re going to do that in the second part of the year, very clearly. It's too early to say beyond 2016 what we could be doing in buyback. Again, we don’t have any kind of religion on that matter. I think it's our strategy to do buyback, so it's matter of pragmatism and shaping the balance sheet if we want to shape it. So, if you allow me we’ll be back on that topic at the beginning of 2017, depending on where we are in terms of balance sheet structure.
On the mix, it is clearly part of the objective as we improve the performance on the system to have a better performance on the mix. So I am not able to comment exactly what will be the impact at the end of the year and what’s going to be the performance on H2, because you have many elements playing in the mix. What certainly I can say is that globally improve the performance on the mix impact versus what we have been doing the recent years is an objective and I think H1 is illustrating some success on this objective.
Maybe one follow-up, please, just on the cost savings, the SFC program. So I think you're about, what, two-thirds through the savings generation now. And, obviously, the end-market outlook, or how end markets have travelled since you originally announced the program, probably, I think we'd all say a bit softer than you would have hoped at the time. As we look out to ’17 and ’18 and with the program maturing, can we maybe expect a further additional program, perhaps, at the Capital Markets Day, in October?
We’ll not put any final periods to the program. Once again we’ll be flexible with the agile and addressable situation. So if we think we have to do more, we’ll do more. And we think that will as you said mean that the market are not where we think they should be and that we have identified more pockets of savings or efficiency. So, at this stage, I stick to my €600 million that we already have been reviewing upward, compared to the initial bracket. Now, to go beyond the €600 million, it’s premature, and again we’ll see how things develop in the coming months, before making any conclusion on that.
Jonathan, it’s a very good question. And we are completely adaptive from that point of view. We’ve put the bottom-line that we described. It’s all to be adjusted by business, because when you can develop your business, a very profitable business, our job is to invest and to develop the business. When we have to turn around or to improve the profitability of the business, we have to get harder, harsher, and deeper, which I think we show we are doing. The good news at China is that we have a very solid portfolio. I would say infrastructure is seeing recovery of margin, but the rest is navigating at high level of margins.
And we can still do better on what we did this first half, for instance, in building, which is a leading franchise, is really one example that shows that we are not resting on our laurels, even when the profitability is good. I mean we increased the adjusted EBITDA by close to 2% in the first half of the business, which is a margin leader in its industry. So I, your question is just right to the point. We’re going to keep questioning, grinding, what we do. We have started a long time ago to neutralize some costs. We have taken the bold step of globalizing our supply chain, probably, the only company in our industry. [Indiscernible] majority, it’s not easiest, but it is bearing fruit: we saw that on the inventory, we saw that from productivity.
So be sure of one thing, is that we are really working on that. But we have one advantage, that really our portfolio is really sound and very integrated. There is a lot of cross-selling happening every day between the businesses we describe here to make full systems every day, and there is a lot of cost sharing, which is happening in the country organization. One of the characteristics Schneider is that when you come to a country there is one Schneider; one country organization facing the customer, and being one in front of the customer.
But it feels like as you are more selective on projects the implication is to falling sales, and we already see it, and you’re going to see another impact in the second half. That kind of necessitates, I think, a greater amount of restructuring now, otherwise you won’t have the effect on the margin that the lack of emphasis on --.
I don’t disagree, but not everything is fixed costs there in the first place. And, well, fall in sales is not exactly the word I would use. What we are doing is controlling the trajectory of the landing. What you saw in H1 is a controlled trajectory of said activity.
Understood. Thank you.
[Indiscernible] is not to be surprised, right? And this is why we pre-announced it, which is a clear logical consequence of the strategy at the beginning of the year, and we keep you informed closely of the profitings of the execution of the strategy.
All right, in the conscious of time, we will take two more questions. So, first
Thank you. We will move to James Moore with Redburn in London. Please go ahead.
Yes. Good morning, everyone. I have three questions, if I may. Firstly, thank you for giving us the systems margin increase of 1%. Could you perhaps say how the service margin changed year on year, so we can think about the overall solution change? Secondly, on project selectivity, you've been helpful about this year, the €350 million-ish; but beyond 2016, I think in the past you've mentioned a couple of billion. How should we think about 2017, 2018, 2019; €500 million a year-type thing?
Finally, can you help us a little more on the Invensys seasonality? I know you want to stop the full disclosure that you were doing, but I get the sense last year you were 10% in the first half then 19% in the second half. It was a very big swing. And you've already told us about less seasonality this year. I just wondered if you could give us a sense in how the first half Invensys margin developed year on year, and what the full -year, year-on-year looks like, just to understand that swing, please. Thanks.
Good morning, James. I am not sure I fully captured your second question, could you kindly repeat it please?
Sorry, if it was rushed. The project selectivity, where you said 1% in the first half, €70 million, €80 million, 2% in the second half, I calculate that's about €350 million, so you've been clear about that. What I'm asking about is beyond 2016, where you have in the past mentioned that there might be a couple of billion of difficult projects that we can maybe see further project selectivity in the outer years. I'm thinking should we all model €300 million, €400 million, €500 million a year down in 2017, in 2018, 2019?
Okay. First on system margin and impact on service. So on service any growth is great because of margin on services grade. It's exactly at the level of the product that that far away and of course it's pure cash, almost pure cash, so it's great. So any growth in service is actually on that rate contributing to the mix. During the H1 the gross margin is slightly down because we think the service evolution, the service have been growing and I have been in businesses where on average the margin is a bit lower, but it's still super high level compared to system, therefore that remain of course on the long term about the driver first plan growth and profitability improvement as well.
On project selectivity I am certain in that telling you James that the minus two is the end of the story. No, you are referring to €2 billion. I'm not either telling you that we've got over €2 billion impact due to selectivity. But certainly there will be some more impact in 2017 please allow me sometime to calibrate what it could be and of course you know on the order intake in H2 I will be able to base a more reasonable view about what could have been in 2017.
If I can just, James complement on that one. I think on selectivity, on [indiscernible] I can only confirm what Emmanuel is saying, that the judge of this is also the margin and it will be the evolution of the market. Again, we speak about selectivity we make sure that we position our project on equipment value proposition in the places where we can bring value on where we can monetize. On its link to the evolution of markets and make an example on some data centers we bring value because we integrate things that other people cannot integrate on the selectivity is linked also to the opportunities we have on the data center market.
So I am not doing it may be yes, may be no kind of answer is that the target here is to balanced volume on the level of margin, but the level of margin being the acid test of our added value. In terms of projects that we have in reserve deteriorate that, I think we are more and more cleaning the backlog of projects and now these are projects that we’re, that are under control, that we have in front of us.
On your third and last question James on the on the Invensys' profitability, so very difficult for me to report something on investors I can, give you kind of broad view yes, indeed, the margin on the former Invensys parameter and for as much as we can rebuilt it now, was up and up significantly in H1, doesn’t mean that we necessarily have been recovering the margin of 2014, but I certainly expect much more reduce gap between H1 and H2 in the profitability of Invensys.
That has been as been certainly our margin on this H1 and by the way if you just look at the industry margin, it’s 40 bps, it’s a pretty unperfect proxy, I would say, for the margin on Invensys, but it it’s a first indication. And I like to in last had a very, very high margin on Invensys in H2, and I don’t expect the same super-high and a normal or no normalized profile I would say this year on the Invensys margin.
On more is the ForEx, which we know industries like IT is impacted by the cost of goods sold, which is really a [prank] in this case.
That's very helpful. If I can just quickly follow up. Do you think the Invensys margin this year will be roughly flat?
I think that, we would be depending again, we highlighted the fact we were growing on positive measures, that software we’re growing so. So I don't discount the possibility that we could further improve this year, depending on it, we’ll see. All right the last one please.
The last question will come from Alasdair Leslie from Societe Generale. Please go ahead.
First question on service, 7% growth in H1. Just with greater selectivity, is that service growth compromised at all? Are there other levers you can pull to maintain that kind of pace of growth in the medium term? And then, a follow up on the selectivity. Against those four initiatives that I think you set yourself a year ago to improve project margins, do you feel you're delivering and seeing the benefits from all four, thinking about the tailored supply chain, moving to a regional set up? And does the momentum you seem to be highlighting and having on the broader Schneider is On supply chain initiatives make that easier? Thank you.
Let complete the answer which is on your first impact is of selectivity would be quite marginal, I would say, for the region that we have explained several times, the installed base that we have outside that can serviced is very large on the part of the installed base, that we cover we services is still limited, it’s truly discipline that we’ve been developing around time and because our customers asking for that, like we do inside Schneider, it makes more sense for a Company to outsource top of the servicers to accompany that was on, and I tell you, we do that for our company.
In IT we do that for part of the services that we buy, it’s more and more we globalize them, we aggregate them and we give to specialists to focus on places that make the difference. So there may be some up’s, down in the gross rate and that’s more linked as the market on the time we sell those services, some of those services can be multiyear contracts, they can happen at different parts of the cycle. But at the end of the day it's a very solid trend which is supported by the fact that we're working on the market that was not existing for us before. And that was very often not even covered at the customer place. I've to say I did not understand your second point. Maybe --.
Can you rephrase it please?
Yes. I suppose, it's just I think you highlighted a year ago, when you talked about the different initiatives you were going to drive to improve project margins. Obviously, we talked about high selectivity and project governance, but there was a focus also on perhaps areas that maybe carried more execution risks. So, you talked about the tailored supply chain and the scope to improve consistency, moving to regional structure. I was just wondering how those initiatives are developing, because you seem quite positive on a broader Group level just in terms of supply chain initiatives. Just whether you can get some leverage off that, whether that helps you improve [Multiple Speakers]
If you speak about tailored supply chain, we spoke about the productivity which is above last year's volumes which are not as good. And reducing the inventory which is even reducing the volumes. So, I believe the figures speak by themselves. We're not publicizing the figures of customers satisfaction that we've been measuring for 12 years every quarter and we've been improving once again significantly in the first part of the year. And delivery is an important part of the simplification.
What we can say that by types of customer, if there's one space where our customers are expecting to see one Schneider, it's really the supply chain, because when you want to commission a new project or new machine you need all the part of Schneider to arrive -- to land at the same moment at your door. By the way not always at the same moment according to the type of customer you are.
So, I just confirm that customer -- the tailored supply chain is not only helping the cash rotation, the inventory, the simplicity of our Company; it's helping the customer satisfaction by a lot, by improving the quality which is not only produced at Schneider but also in the expanded ecosystem of Schneider including the suppliers and by delivering a very specific level of customer service. A much better level on adapted customer service. So, I just can confirm that this has been very material in our development.
We're coming to an end to this presentation. But before totally closing the call I would like Anthony once again to thank you very much for you've been doing -- the great work you're being doing over the last three years. Thank you and all the best in your new responsibilities in the Group.
So, I would like to add to that. Thank you very much for your continued support over those years. And you're going to take an important call in the next coming years in China.
And I wish all the best to Amit Bhalla who's going to replace Anthony and it was the former tax SVP for Asia Pacific and we're very pleased to see him joining us. So, all the best Amit.
And thank you all for being with us this morning and spending the time to understand.
[Call Ended Abruptly]
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