GKN's (GKNCF) CEO Nigel Stein on Q2 2014 Results - Earnings Call Transcript

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GKN Plc (OTC:GKNCF) Q2 2014 Earnings Conference Call July 29, 2014 4:30 AM ET


Nigel Stein – Chief Executive

Adam Walker – Finance Director

Marcus Bryson – Chief Executive, Aerospace and Land Systems

Andrew Reynolds Smith – Chief Executive, Automotive and Powder Metallurgy


Nick Wilson – Espirito Santo

Rami Myerson – Investec

Celine Fornaro – BofA Merrill Lynch

Jonathan Hurn – Credit Suisse

Sandy Morris – Jefferies

Andrew Carter – RBC

Sanjay Jha – Panmure Gordon

David Larkam – Numis

Andy Chambers – Cantor Fitzgerald

Nigel Stein

Good. Thank you. Good morning everybody. And welcome to today’s presentation. This morning as well as the usual audio link, we also have video coverage for the online participants.

In addition to those of us on the stage, in the front row are Mike Turner, our Chairman, plus Kevin Cummings and Phil Swash run Aerospace and Land Systems respectively under Marcus. We're following the usual format, a brief introduction from me, Adam will give the details behind the numbers and I will then spend a few minutes looking at the future and covering the outlook statement. We shall then take questions.

GKN had a good first half. The headline numbers don't show the full extent of that due to the effects of currency translation on our overseas earnings. So although the reported sales were down 1%, management PBT up 6% and earnings per share up 4%, the underlying growth is stronger, which is reflected in the increased interim dividend.

That strength is clear when reviewing progress against our medium-term financial goals. Organic growth of 6%, margin up 60 basis points to nearly 9%, ROIC in our seasonally lower first half up to nearly 17% and reasonable free cash flow which helped us to make early repayment of some government advances. A strong financial performance.

As you’ll see throughout this presentation, we made good progress against our strategy too. Strengthening our leadership position in our chosen markets. Further expanding our global footprint, particularly in the US, Mexico and China, investing in our technology, working hard on operational excellence, and through those steps sustaining above market growth.

Let me now say a few words on each division focusing on the organic figures. Currency translation will be what it will be. We are building our business in the strongest long-term markets and the strength of sterling is not something drives our strategy.

Aerospace had a good half. Organic growth was relatively modest 3%. But that overall figure comprises military down 2% which is rather less than we expected. Commercial, up 5% or 8% if one allows for the final effects of the supply chain work taken in-house by Airbus last year. That’s a good rate of underlying growth in commercial.

As the chart shows, 74% of our aerospace sales are now coming from commercial and heading higher by the year end, the right place to be in this market. Order backlogs the large commercial aircrafts remains strong, with Airbus and Boeing between them having commitments for more than seven years of planned build rates.

Growth came largely from the Boeing 787 ramp up, which stepped up to rate 10 a month in quarter four last year and it’s running smoothly at that level. The A359 build rate also increased and we will see that picking up pace as the year progresses.

We shipped more A350 units in the first six months of this year than we shipped in the whole of last year and our start-up losses halved to £3 million. The engine systems business continued to do well.

Our key task has been further integration of all our engine activities, including the original GKN engine components plants in North America. Together, they make a very strong business with sales now representing more than 40% of our aerospace sales.

Expanding our capabilities in Mexico is a key strategic goal for both aero structures and engine systems. We made good progress with our three plants in the country, receiving investment and new work packages.

This improves our competitiveness in machining and composites work, vital in today’s highly cost conscious markets. We remain keen to also have a presence in other emerging markets and are continuing our efforts to find suitable opportunities in China and the broader Asia region.

Keeping close to our customers is a key strength of all GKN businesses. It’s not easy in times of program launches and pricing pressures. We were therefore delighted to receive Airbus's Supplier of the Year Award for our Filton site, a major supplier to all the Airbus programs.

The Farnborough Air Show brought some good news not only orders for certain hundred new aircrafts for Airbus and Boeing, but we also announced our win of the Bombardier Global 7000 and 8000 rudder elevator.

But also important, was Airbus's confirmation of the A330 neo powered by Rolls Trent 7000 engines and the 120 or so orders it received. That’s good news for GKN as A330 is a significant program for us. And even better is that the announcement of the neo model seems to have bolstered demand for the current version.

Farnborough was also very encouraging and that it confirmed that GKN Aerospace has the capability and technology that customers are looking for and plays strongly to their need for fewer more capable global suppliers.

Aerospace did well the driveline had an even better performance. Organic growth of 11% significantly outperforming the global auto market. In fact, as the chart shows, other than in Brazil, drive-line outgrew production every other single major market, fantastic.

In North America, our growth was driven by continued CBJ drive shop volume supplemented by strong all wheel-drive output, including on the BMW X Series rear-drive units which commenced production in quarter three last year.

In Europe, growth came from the continued strength of the premium brands and some new drive shop program launches. China once again stormed alone with a like-for-like growth of 27% due to continued strong sales to the western brands.

The integration of our previously wholly-owned all-wheel drive business into our joint venture SPS has gone smoothly and gives us a stronger base to benefit for more localized production.

Buoyed by growth and some good work in operations, drive line’s margin improved to 8% in the half. That’s a good start by getting there for the year is the goal we are then focused on.

The margins have further just traveled, but at a measured rate. As we navigate our way, through a competitive market, following our strategy of increased content on all-wheel-drive and a more selective approach on drive shop business. Order intake continues to be good, with £300 million of new and replacement business won.

Our decision to increase capital investment this year in Mexico and North Carolina was timely. The free capacity we had in Europe is progressively being utilized locally and we still foresee a healthy rate of growth across most regions. That investment allows us to keep ahead of the curve, positioning us to take advantage of new platforms and increased content per vehicle to drive our growth.

You will note the picture of the electrically powered Toyota at last month Goodwood Festival of Speed. That's just to remind you of our capability in eDrive that we continue to develop and which will be important in the future.

The powder metallurgy story also continues to get better. Sales up 6% ahead of the 4% growth in the car market less than drive-line because they don’t have the same exposure to Asia.

But they are working fast to catch-up. Our second plant in China is already in production helping our parts sales in Asia increased by 10%, North American sales increased by 8% driven largely by new engine and transmission programs with GM and Ford.

Our focus on hard to make, clever, design-for-PM parts continues to pay off. To be effective, design for PM requires advanced process capability including high tech presses and furnaces.

This is an area where GKN Powder Metallurgy has unparalleled expertise both designing and building exclusive products with equipment providers which protect our IP. We are in danger of outgrowing subs capacity in North America which is why this year we announced the extra capital investment of £20 million and plan to continue expenditure in this project at a lower level in coming years.

When it’s complete, we expect to have 30% fewer presses than today reducing significantly higher sales. Increasing sales of advanced powders a key part of our PM strategy.

Here we have success in high margin technically enhanced powders with sales volume in the past two years has doubled and now accounts for 15% of powder sales by value.

The PM story is not just about design for PM and advanced powders for automotive applications, good as those are, We also have several projects running in powders for additive manufacturing, which I will cover later.

Land Systems had a tough time. Agricultural markets softened particularly in Europe, although we did see some recovery in industrial markets, construction improved slightly from a low base. Land Systems sales were down 9% on an organic basis; this includes the discontinued chassis programs. So the like-for-like decline was 6%. That seems a somewhat lower decline than that reported by our major customers and peers.

This is a cyclical business and the important thing is to flex the cost base with demand. The team did a good job in reducing costs, although the margin declined to a little over 7%. And we pushed ahead with Land Systems strategic plan of realigning the business away from Western European Ag towards a broader North American and Asian focus.

That includes extending our equity position in the Huading wheels operation in China and reorganizing our commercial and engineering teams on a more cohesive basis to help win more content per platform, from our extensive customer base.

We also completed the acquisition of GKN Hybrid Power, the former Williams business which supplies energy recuperative electric flywheel systems to buses and, on a smaller scale, to Audi e Mans car.

It's a small step, but we think, this is excellent technology which would GKN’s systems can be taken into other markets. So that’s a brief overview of the half. Now over to Adam for a run through the financials. Adam?

Adam Walker

Thank you Nigel. Good morning everyone. As Nigel has said, we are pleased with this set of numbers which on an underlying basis showed good progress towards achieving our financial goals. Sales was £3.8, 6% organic top-line growth translating into 14% organic profit growth, £340 million means we’ve increased our margin to 8.9%.

Before we go any further, let’s do with currency and then move on, as I know, you all have heard plenty about it in terms of the impact of the strong pound that’s having on our sector and on others.

As we highlighted at the full year results, a significant movement in the average rates between the pound and the dollar or euro would have a material impact on our results. Versus our results this time last year translational effects has reduced our sales by £247 million and reduced our profits by £24 million.

What is unusual this year is the sterling has also appreciated against a whole basket of currencies with the Real moving up 22% over the past 12 months, the Rupee 19% and the Yen 16%. If rates remain where they are, then we could have a £50 million translational impact on our year-on-year trading profit.

Of course, any weakening in sterling in the coming years will have the opposite effect. So currency alongside a slightly increased tax charge as a result of a lower EPS growth of 4% to 14.4 P. We usually aim to grow the dividend in line with earnings but are mindful over our cash flow commitments too.

We have looked at the underlying trading position of the Group when deciding the interim dividend and growing it to 2.8 P. The interim divided usually represents a third of the full year payout. If we hold that, then it would be a 6.3% increase in the total dividend for the year.

Cash remains a strong focus within the Group and we are pleased with our cash conversion today. We end the half year with net debt of £813 million, at a ratio of 0.9 times to EBITDA on a rolling 12 month basis and we remain on track to reduce our net debt year-on-year by over £100 million.

This slide shows the top-line bridge from the first half of 2013 to the first half this year. As we said, we delivered top-line organic growth across the Group of 6%. We've talked about the currency creating a 6% headwind. So let's focus on the strong organic growth we've achieved across three of our four divisions.

Aerospace with growth in commercial offsetting the decline in military, has beaten industry market statistics. A lot of this growth has come from the increased production rate on the 787 and the 350 offsetting the rundown on the F18 and Black Hawk.

Driveline at 11% as expected, slightly down on Q1, where we had a pull forward of sales in Japan and powder metal 6% of our growing global production rates. For driveline, the Americas got off to a slow start after adverse weather, and have been latterly impacted by Brazil. But nonetheless, this is a really good half.

In Europe, we have seen double-digit growth across most of the main OEMs but remember as growth rats are forecast to reduce in the second half comparators get tougher.

Asia continues to grow strongly, particularly in China from the demand for western brands where our market share is high. Our strong representation amongst the main automotive OEMs in the Americas and Europe has underpinned PM top-line growth too. Land Systems, as you have heard, had a tougher time.

And contained within other businesses is Emitec, a 50% joint venture which we agreed to sell our JV partner Continental, in April this year. We expect the transaction which was subject to competition approvals to close shortly. We anticipate profit on disposals we recorded in the second half and we'll use the proceeds to reduce our net debt.

Moving to the bottom-line, we continue to work hard on converting those additional sales into profits. The aerospace results includes £4 million following achievements of the first milestone under the CTAL disposal which we announced earlier this year. We are also incurring start-up losses on the A350 albeit at a lower rate.

But some of our high margin military programs are coming to an end. Up to £46 million incremental profits shown on this slide for driveline and PM, £21 million is a result of the restructuring charges that took place 12 months ago.

We are making good progress in both divisions and pleased with the margin achieved in each. In total, we delivered £340 million of trading profits, a 14% organic increase when you include the benefit of last year’s restructuring charges.

It is interesting as a newcomer to the Group, how much external focus is brought to bear on one number out of all the many we produce, the drive-line margin. Well, we have reached the 8% mark.

Across 45 global manufacturing plants which generated around £1.8 billion worth of sales over the past six months, there are a lots of moving parts which is going to have a positive or negative impact on the margin.

For instance, in this set of results, we have incurred higher unusual costs relating to warranty and quality claims, as well as making commercial progress on an onerous contracts enabling a release.

Consequently, there are always some ups and downs. Our aim is the measured progress in the annual drive-line margins. Aerospace margins remains strong and we would expect them to improve over the second half of the year. Powder Met has also had a very strong six months and has now gone beyond the top of its range and we should look at this some point in the future.

Conversely, land systems, as our most cyclical business, has come below the range. The Group overall has achieved an 8.9% margin, the same as last year if you look back the restructuring costs but nevertheless a good performance given the drag the Land Systems top-line weakness has had on these results.

Turning to ROIC, remember that the ROIC calculation at the half year is lower than at the full year. Year-on-year, it shows a small improvement increasing to 16.9%. Powder met is again above our target of 20% and more investments is going into this division in the second half to help continue the top-line growth.

Onto tax, our weighted average tax rate, based on where our profits are generated around the world is approximately 33%. As you can see on the chart, the book rate which is the red line has been a lot lower than that over the past few years as we have utilized historic operating losses, which gave rise to deferred tax assets.

The book rate though has been rising as the level of deferred tax asset recognition has fallen. In the first half, we have recorded a book rate of 22%. Further unrecognized deferred tax assets will be utilized shortly and therefore we expect to see a gradual increase in our book tax rate, maybe a couple of points a year in the coming years, subject to worldwide rates staying at the same level.

Cash tax is much harder to predict. We expect the cash rate to be much lower than the 22% book rate this year, but this gap will substantially narrow in 2015.

We have generated cash flow, operating cash flow to similar level to 2013 despite the impact of currency which has marginally less of an impact on cash in the first half than it does on profits.

The investments in working capital is at a similar level when flexing the volume growth, but nevertheless we remained vigilant around inventory as well as monitoring receivable balances closely especially in some of the emerging economies in which we operate.

We’ve spent around £160 million on CapEx which a 1.2 times appreciation is slightly lower than we anticipated at last year end. This is mainly facing and we expect it to increase over the next six months.

In May, we repaid an advance we had received from the UK government when we established the western approach facility for production of the A350 wing spars. A program which has been materially de-risked over the past few years. The coupon on this funding was more onerous than our core lending facility so it made good commercial sense to repay.

Repayments of the advance is included in operating cash flow, the accrued interest repayment in the interest payable line, shown on the next slide. And a few final things to pullout in the rest of the cash flow. The increase in dividends we received from our joint ventures is purely timing.

The increase in pension funding comes from the additional contributions we agreed as part of the triennial review of our UK schemes earlier this year, the M&A spend of £8 million relates to the Hybrid Power acquisition. These results are reported within the Other business segment.

We therefore had an overall cash outflow of £81 million in the first six months, an increase of £24 million on the equivalent period in 2013 which is attributable in the main to the repayment of the government advance.

Cash generation remains a key focus for the Group and an area where we can still make improvements on a commercial basis. We end the period with net debt at £813 million. No GKN finance presentation will be compete without the slide on the pensions.

There has been a £92 million increase in the deficit driven principally by a reduction in the bond yield and the geographic markets which apply to us. We continue to work on ways to protect shareholder value by limiting the exposure to future liabilities, particularly in the UK scales.

And so to conclude for me, before handing back to Nigel, we are pleased with the strong set of underlying numbers. The businesses continue to grow above the market and are well positioned from a platform or program perspective for future growth.

Our operating margins have improved with good growth in driveline, PM and aerospace and good cost control at land systems. We are working hard on turning additional sales into profits. But we are not forgetting what we need to do from an investment standpoint too. Or the commitments that are required by our customers for us to win business and partner with them.

Cash remains a key driver for the business and we will continue to increase our free cash flow year-on-year notwithstanding the cash we service our debt, pay our tax and service our pension, a large part of which relates to schemes and businesses and their longer part of the Group.

We are cognizant of our shareholders and are pleased to have increased our interim dividend to 2.8 P. Initial areas of focus have been positioning the Group in readiness for the capital markets, weighing up the benefits of non-sterling denominated debt, managing our tax rate to take into account through utilization of historic operating losses, managing our pension liabilities across a number of jurisdictions and securing competitive funding from our principal lenders.

You may have seen in the press release that we have extended our revolving credit facilities to 2019 advantage of current market rates, and therefore will expect to see a small reduction in our interest charge in 2015. The principal element of the interest charges is fixed though due to the two bonds.

One other thing to mention in passing, our business is longer term. We invest for the future. We win business on programs that last up to seven years in automotive or up to 25 years in aerospace and yet have historically reported divisional analysis quarter-by-quarter but it’s not the way we run the business.

So to bring us more in line with the market and to reflect the way we look at our business, how should we looking at our quarterly reporting in 2015. Thank you.

Nigel Stein

Okay, thanks Adam. Now let’s look ahead. You heard our strategy is delivering value in the short-term being the leaders in what we do. That means not doing everything which is why we sold our interest in Emitec, a good company in automotive emissions, but in a market that’s not core to us.

We will continue to invest to take advantage of organic growth in all four divisions and, if the right opportunity presents themselves consider acquisitions too. Aerospace is still a primary focus for acquisitions as the supplier base looks certain to consolidate. Having a strong global footprint is important and we will continue to increase our presence in Asia in all four businesses.

Technology is what drives our margin. We will slowly but steadily increase our investment in technology. Spending more for today's projects, winglets, disconnect all-wheel-drives, design-for-PM parts and shafts and clutches.

But we are also spending more in long-term opportunity, of which more in a moment. Operational excellence is vital and still gives the opportunity for competitive advantage. It's easily said, but hard to do. We are particularly focused on ensuring our customers’ view of us and how can do better is understood from top to the bottom of the company.

And we remain focused on achieving growth above our markets demonstrating that GKN is a long-term winner in what it does. Looking longer-term we have a number of projects running to establish GKN as a technology leader in areas which will be important ten years from now.

Additive manufacturing, where we believe our knowledge of specialty metal powders gives us a good opportunity in the aerospace market and in time other markets too. You may have seen the recent announcement that GKN is leading a key UK aerospace project which has just received £13 million of government backing.

On the additive powder side, on a small scale, we have started sales of water-atomized powder and have a pilot gas-atomized plant coming on stream later this year. We are also pushing ahead with our electrification agenda as we believe hybrid electric vehicles are a big part of the future.

Here, we are focusing on activities on energy recuperation with electric flywheels and axial flux electric motors, looking for niches away from the mass market, where we can establish a leadership position. In fact, today we announced the deal to sell 500 systems incorporating both those technologies to go ahead starting with London buses.

And finally in powder met, we have just formed a technology development partnership with McPhy Energy Systems to jointly develop solid-state hydrogen storage systems.

This is a challenging science, but if it succeeds the potential opportunity is very large. So, lot going on to position GKN for an exciting future. Turning now to the shorter term and looking at the outlook for the rest of 2014, our main markets are looking broadly as before.

Aerospace, strong commercial demand driven the healthy order backlog and increasing build rates. Military is softening. Military in 2014 has been better than we thought but the declines are lower level in 2015 will still be there.

Automotive, global production for the second half is expected to grow by 3%, as comparisons get tougher with continuing growth in North America, China, India, Europe flat and Japan and Brazil down.

For land systems, the agriculture market remains soft in Europe and North America, with constriction broadly flat, industrial slightly better. Against that background, for the second half of 2014, GKN Aerospace sales are expected to show modest growth.

GKN drive-line and GKN Powder Metallurgy are expected to continue to grow above the market. GKN land systems sales are expected to be below 2013. The strength of sterling will adversely affect reported results.

However the Group’s underlying progress is expected to continue due to the benefits of its diverse exposure to global markets, strong customer positions, and healthy order books. Thank you,

And we’ll now take questions.

Question-and-Answer Session

Nigel Stein

So when you raise your questions if you’d like to say the name and the company you represent and microphones will be coming around. Sorry the microphone has reached Nick first, sorry about that. But we've one over here, you may start.

Nick Wilson – Espirito Santo

Good morning. It's Nick Wilson from Espirito. Just a couple of questions if I may, please, probing the divisional H2. In terms of automotive, I know you said obviously you're expecting the market to grow 3%. Can you continue to grow more than double that given the platforms that you know you are on?

And then in terms of just trying to understand the aerospace military, why the decline isn't quite as large? Is this equipment retirement deferrals going on, i.e. the stuff is running longer and therefore your spares, channel is slightly better or is it just a phasing issue, hence obviously your helpful guidance there for 2015 will still see that decline?

Nigel Stein

Okay, perhaps I’ll start with and then my colleagues with anything to add. Automotive is a very, very slight change first half to second half but we are highlighting and whereas one is rounded up so four of the others round it down to three.

So we are seeing it’s broadly at the same. You will notice that our quarter four for a number of factors which Adam referred to in his speech, very, very strong is back to 9% growth in the second quarter.

And I think we will see the second half somewhat lower than that but have outgrown our market by between 2% and 3%, we’ve been telling you Nick for five years we can do it and I am not telling any different, yes we can do it. So I think I am fairly confident and I hope Andy is nodding his head over there and going to be confident of that one too.

On the military, yes, I think, some of the programs we thought that would end perhaps it was hanging on a little bit longer, but clearly saying it is going to happen and this is very consistent for what we have been saying for the last couple of years.

Military, and the programs we are on which is largely US military programs are going to decline for the pickup comes when they have 35 starts that are coming through in 2016 and then on strong in 2017. Marcus, do you want to add some color to that?

Marcus Bryson

Yes, and I’d just agree with what you say and some of the older programs that are hanging, so it’s a bit phasing. And I think, excuse me, I think the spares I think it was slightly better in H1 and we will see that going forward, but as Andy mentioned, we are seeing better this year than we probably see the decline.

Adam Walker

Okay, thank you.

Rami Myerson – Investec

Hi. Good morning. Rami Myerson from Investec. Two questions, one on pricing , I think in recent years, you’ve seen less pricing pressure particularly in auto than you have in the past, can you talk about what you are seeing at the moment and whether it is deteriorating? And the second one is on capital allocation and M&A, can you talk a little bit about what you are seeing in top-line, you mentioned consolidation before in the presentation?

Nigel Stein

Okay, Andy, do you want to start with pricing? It's always a very flat price in drive-line, so it is flat is there on pricing or how is it changed?

Andy Reynolds Smith

Yes, I am feeling very relaxed now. Yes, I think the last two or three years of really been satisfied so the price was expected by the flat growth, the market was growing and recovering well.

So we were in a position to take advantage of our global positioning. As we are going forward it’s getting tougher. For sure, some of the markets are slowing down and some of the competitive pressures is increasing and the customers are pushing quite hard to keep their margins moving up as well, which is why I think most of our focus is being around how do we really leverage the advantages that drive-line has got in terms of content and technology increase in the vehicles.

And also taking some advantage of our global market position on many of the major platforms. We got a chance to supply everything to with the plants, with the customers and the world. So, a tough environment yes, but a lot of work going into and now we can take advantage of the position we’ve got.

Nigel Stein

And we have seen the margins go up, well then Andy and you heard noises about keeping that progress going. So, well done, Andy, again in anticipation.

Andy Reynolds Smith

This is getting difficult now.

Nigel Stein

So it’s part of the life, it’s the life but we are seeing price compression there as too. So, I think there is a subject for the last year as it’s an environment GKN is very, very used to operating in.

On the M&A front, yes as we said, aerospace, we think provides the best opportunity for us, it’s not the only area we are looking, but we said very much that when we did involve an aero deal we have got our heads down and work hard to reduce debt, get that business integrated, we’ve done that.

I think you will see the good results of that. And so, we are not looking at other opportunities. I think the reason for aerospace is, I think consolidation will come in the supply chain, it’s a much more fragmented supply chain for instance in automotives and I think you will see and you can hear kind of a hope from the aircraft manufacturers that they see it.

So I think it’s a supportive environment for that and we will see what opportunities come our way but we are always looking to do the right thing and doing it in the sensible GKN way.

Celine has got a question here.

Celine Fornaro – BofA Merrill Lynch

Thank you. Two questions if I may, the first one will be actually on Volvo. If you could just comment a bit on the performance of that business. I know you said a lot of the aerospace growth has come from the 787 and the A350.

So no real mention about the engine and the spare parts. And the other one would be on Volvo on the cash that is required to run that business, it seems that some of the tier-1 suppliers in engines do need a lot of cash ahead of all these new programs coming. So how do you think about that?

And in Automotive, I was wondering about the Russian investments, I know last time you mentioned you would think about investing in Russia and where we are on that and if you slow down the investment there and maybe we see it in 2015 or something? Thank you.

Nigel Stein

Okay, first of all on the aerospace and Volvo, we kind of – I did mentioned it, because when we bought it, it was Volvo of course we don’t think of it like that anymore. It’s not GKN aerospace running systems. As you’ve heard, it’s increasingly difficult to split out the performance of that particular unit as it’s been backwards integrating our own engine components businesses particularly in North America.

So, the performance has been good market expansion just in that previous question, but the spare sales have been stronger. So the business is doing well. Marcus, I’ll turn it to you in a second for a color. On the RSP things, I can guess as what you are referring to is on that investment for the engine manufacturers.

Yes, we have said, we have not done that before, as GKN. We’d always had life of programs, long-term agreements, we said we would do that and we will do that. Obviously we enter into those very carefully but we are still ready to play in that market. Do want to add anything Marcus to that point on GKN Aerospace Engine Systems.

Marcus Bryson

No, no, I think, it’s just, I mean, the performance of the business is actually expected it’s not slightly better, I mean it’s fully integrated now into the company and under synergies that we predicted has been achieved. So we are very pleased with that and all the effort of the management is putting to do that.

On the cash, I mean, it is actually a cash generative business at the moment. And we are looking to, we are always looking for opportunities. There will be opportunities arising for further investments in new engine programs.

But remember, they recently bought the business is because they had a portfolio of engine programs some that will mature and cash generative. So I think what we are seeing here is that despite the business, we are in a cash generative, we are looking at one of the opportunities that I hope it will come to operation quite shortly.

Nigel Stein

Okay, thanks, Marcus. Andy do you want to pick up the point on Russia, it’s an easily dealt with point.

Andy Reynolds Smith

So, notwithstanding the political situation at the moment, most of the major car companies that may plans on either there already or moving there because of the highest growth potential market, left in West England and Eastern Europe, thought that it may double over the year over the next year. So it’s not surprising that the people are focused there.

And we are taking a very measured approach now. Our approach has been very much driven by the customers, and we’ve asked us to go there and support them. We are mindful of the risk return environment. The customers are very much driven by the government incentives around localization, so our investment is reflecting that set of conditions.

And we are setting up a small operation taking a phased approach to it now we are not going to a piece of land there but we will have a relative facility in place by the end of this year for some activities and we will judge the next steps of investment as the situation plays out and if you can get the returns that we think we may get in the environment.

Nigel Stein


Jonathan Hurn – Credit Suisse

Good morning, hi, it’s Jonathan Hurn with Credit Suisse. Just three questions please, Firstly, just on driveline and all-wheel drive, I wonder if could just give us a little bit more color on how that business performed in the first half, maybe in terms of organic gross margin?

And is there short-term headwinds in terms of adding overhead which impacted your question of gearing the business in the first half?

Nigel Stein

Again, I’ll pass that over to Andy, but our all-wheel drive has been extremely well, it grew slightly faster than the average increasing its share of their driveline business exactly as expected it was.

We are expanding it, investing in it got a lot of our investment in North America has gone into very successful all-wheel drive business there. So I wouldn’t say anything particular. It’s very good business. Andy, you want to try this?

Andy Reynolds Smith

No, no, no, I think it’s – I mean, it will grow but as quickly than our shaft business partly due to increasing content on our side, but partly due to just increased penetration on vehicle platforms which we are seeing people think like all-wheel drive as a concept particularly in China and some of the other emerging markets.

And we are currently going through quite a heavily launch phase as we are launching with a number of major customers around the world, but expect it on the long-term to continue to grow a little bit faster than our dry shaft business.

Jonathan Hurn – Credit Suisse

Second is just on Powder Met, I know you are going to revisit the margin in the future but can you just give us an idea for the aspiration of margins for that business please?

Nigel Stein

When I dream that we can work the margin high, but what we are doing is building a sustainable business and we are always looking our business and trading up growth and margin. I think you will see we have a really nice balance on Powder Met and let’s say on drive-line too, together that business we’ve grown strongly and moved the margin up,

We’ve done in Powder Met and you can see also we are investing more for the long-term in Powder-Met you have been talking about some of those projects in adhesive manufacturing, I even mentioned something in hydrogen storage and in enhanced powders. There is a lot going on there. So we are actually investing more in Powder Met but nevertheless, still increasing the margin.

So, we can go higher, how high we can go, you have to wait and see and we are pushing hard and Adam said, we will look we are out at the top of the range at the half, and get that for the year and then we will have a look and see where we think the right range is in the future.

Well, go on Sandy is near us, sorry, this is not near the microphone.

Sandy Morris – Jefferies

Thanks very much. Not sure I’ve jumped on. Just to make really Andy’s day, you remember back in the days – we used to say that we with 180%, 185% of all available CVJ business and let me stop. If we not move a selective way what do you think it would be today? I mean, just kind of asking for a one-off snapshot, so we got a feel for what that means?

Nigel Stein

It’s lower than it used to be and the reason we stopped doing that because we said this is not the right strategy to be pursuing we own the economic take we are seeing more and more market share in the CVJ dry shaft business isn’t the right thing eventually in a sophisticated market like auto, they want dual source eventually you will bump up against the opposition you bump against dual sourcing and it’s harder and harder.

It’s exactly why we are being more selective in dry shafts and getting our growth, fantastic growth in all all-wheel drive. So the numbers drop, Andy, I don’t know what we are at now, it’s not the number we particularly focus on, but it’s probably 10% lower than it used to be, but still in order to keep our market share.

Andy Reynolds Smith

When the strategy was to increase the market share that was a point of a focus for us. We usually – where they got more and more difficult to use that as a measure because of the mix of in-house customer production in the drive shafts and outsource.

So there is a bit of a moving piece particularly with one of the big German as they flick that as part of managing the labor. So for me, I think, the key focus for me is I am expecting to continue to drive the drive shaft business.

There will be some ups and downs in share in different parts of the world but I am not expecting long-term increases in market share. It’s all about to lean out technology and taking advantage of the global position to support the global platforms.

Difficult one to answer, because we are not tracking and difficult to pick up on in time like the first half win rate versus the second half, because it’s sensibly quite peaking out, because we’ve got such large programs being sourced from one chunk rather than relatively small chunks all on incremental basis that was in the past.

Adam Walker

I mean, it’s not a barbed question, it's just, if the returns in drive-line are being increasing, I don’t know where all-wheel drive is modeling the mix, but if the returns are increasing up the way they have and we surrendered with them mainly it's safe. It's not exactly disaster, is it?

Nigel Stein

No, it's not. And that's exactly the strategy we set out to do. We don’t want to give up market share particularly, but we're not seeking to grow it. So given that we are about 40% something market share which is some of that’s in-house.

So the number we are winning before 80% was growing that. And we know where it was, largely in North America where our share was low. Well we have addressed that so it’s probably dropped 10, 15 points but we are still holding very nicely where we are now closely to that.

Sandy Morris – Jefferies

And then, a sort of quick one, just broadly on land systems. And I don't mean to sound nasty; it's just the way I come over. When we get to land systems, I mean, last year, there was an organic decline of what – eight or nine and then another nine.

What is that about the business that actually means we can still make a 7.3% margin near 15% ROIC, because that sort of movement in the past would have crippled us?

Nigel Stein

Well, we work hard and I just pay some tribute to the team under Bill we are working very hard to flex the cost because you are right it’s been very hard. Now, remember some of that 9% of the chassis program, it was ended we knew it would, the people and government so that’s taken care of.

So that was in a way we have the view without fairly easy a bit. Been harder at the 6% decline we had running through many of our businesses. We run our funds, we have to flex our costs because we know this is a flexible market and it always has been as expected or it will be.

Although as we expand more into industrial, construction and the cost that we are making it less cyclical, risk cyclical we man up and plan accordingly and we managed to flex our cost. But you are right, it is hard, on top of it 8% decline last year and then the 6% is real decline this year, that down quite of it.

The guys have done a good job and they are ready to start climbing back up. We’ll have to wait and see how the market treats us in the second half and also in the future years. I mean, hard work is the answer for that.

Adam Walker

Yes, well I knew all that, and I wasn’t really intending to be nice there, but it does seem quite good.

Sandy Morris – Jefferies

And just back tracking to Celine’s question, just in terms of where we are in these civil aerospace programs. So we can see western approach there the A350 start up what is coming down not quite sure what volumes we’ve got through yet, but presumably up quire a slug.

I mean just a clue on where we are on the ramp toward the ultimate will be helpful. But the investment or the amount of non-recurring still capitalized has been a bit lumpy. So it’s slightly up in the first half on first half. But actually down on the second half of last year. So just being nice where all the layer or in terms of the some of that kicking off.

Nigel Stein

A350 production, I mean, this year we’ve already delivered more than we delivered the whole of last year. If we – if Airbus's schedules stick and we are here to that and we are looking delivery 20 sets this year.

And again, if their schedule stick it would 14 I would say. And actually that doubles again so it’s quite a steep run that we are looking on from where we have been in the last sort of three years.

Sandy Morris – Jefferies

And Volvo Aero, is there any great start-up one-off costs that we're capitalizing there so we got?

Nigel Stein

And I think what you are seeing in terms of the lumpiness is, because we are obviously still expending money on the 1000 variant, and that did gets slow down in the second half year, so to speed it up in the first half of this year and we will see a carry-on and then it will come off as we get that configuration done and this is completed. So it’s primarily driven by the 1000 there and the A350.

Sandy Morris – Jefferies

And then last but not least favorite tax, so the theoretical rate is 33% and then it sounds about the book rate is going to go. I guess, Adam, I am wishing to lead you or get us into top of the business or really sort of planned for the tax efficiency.

Well, we’ve been trying to access the losses. I mean, when I’ve always assumed that the book rate might get to 27% or 28% when we saw this sort of planning like a normal company that would be fair?

Adam Walker

We have – the driver-all business has got lots of opportunities around to transfer products and making sure that we got the right structures in place and lot of global worldwide legislations changing around transfer pricing and that’s why we got provisions sitting in balance sheet.

So around some of the things that we have done in the past but overall, the 22% rate will probably increase by a couple of points for each of the next couple of years but up to 26% 27% something like that and then we would hope to keep it at that sorts of level assuming worldwide rates stay where they are and the mix of profits stay where they it will depend how much money have made in this stage for instance at a high rate.

Nigel Stein

I think that’s been very consistent Stanley, what we have said for quite a number of years steadily the book rate marching up. So one that’s very hard to predict is the tax – cash tax rate which jumps up and down a little bit more and that will be very low this year again, for the first half here, but that will jump up in 2015 and thereafter close that gap on the book rate.

You can’t keep the gap there forever. We think about these things all the time Stanley, I have to say and you heard Adam, we got him trained already. Really, specifically taught about we take conditions off the cash flow of the company when we set the dividends not just a simple earnings ratio and we did that.

You’d probably be thinking a bit way more of it. There are cash costs, pensions tax et cetera that we need to take into account when we plan that. But, we’ve got in our minds.

Andrew Carter – RBC

Morning, it’s Andrew Carter from RBC. I wanted to ask three more financial questions if I could. First of all, just in terms of the businesses that were that are being disposed off, could you give us an idea as to what the financial impact that was on management trading profits and sales in the first half. So that CTAL and the Emitec or et cetera just a comparison going forward?

The next one was just on pensions and I think you mentioned that you have just completed an actuarial review, could you just give us a bit of an overview as to what you found there.

The accounting steps what we see interesting to actuarial probably more important and is there anything that can be done in terms of any changes to help that situation and then the final one was, can you just update us on what your CapEx is going to be for the next couple of years?

Nigel Stein

Okay, well I am going to hand the two or the second two on to you Adam. But let me just steer with the disposal of CTAL. We specifically mentioned it’s in the it in the report, I think that there is a £2 million less sale it was absorbing costs in this year than there was in the first half of – sorry this first half compared to the first half of last year.

Emitec we don’t specifically call out, but we owned through the half, so far it has made no difference and tax performance is improving this year, significantly improved over the last year that number is relatively small business. But it is in for the full half.

And, as Adam said, we hope to complete that deal pretty soon. Just waiting for all the regulatory clearances to go through.

So that was the answer now, I don’t think that I don't think that or neither of them this is a very big number and sort of not that important in the overall numbers. Okay, so that one covered. On pensions, Adam, do you want to talk a bit about pensions and reviews?

Adam Walker

Yes, I mean just to be helpful and I would recognize about £50 million worth of top-line in the first half and it’s a relatively slower margin business, there is a not the huge contribution in the first half and as Nigel said that gets solved in the second half. So, you’ll see the other business’s revenue line not be what double the sales contribution in the second half of the year.

The triennial review, our top players concluded and we reported and now talked about that a bit in the full year results last year and that’s obviously in relation to the UK’s scales and you as could see from the slide path, that’s got a lots of the unfunded liability and we disclosed in our pensions in relation to overseas schemes as well.

But this is in relation to the UK scheme. The UK deficit is round about £200 million under that triennial valuation and as we talked about in the full year and I mentioned today that we agreed an additional £10 million contribution, cash contribution which would be recovered over the scheme, the UK schemes is split into two.

One of them got recovered over 10 years, one over 12 years and obviously that gets reassessed in three years time. So, we would hope that the markets have played that part a little bit in helping with the underlying strategy within both of those schemes in terms of where we have invested our asset.

And hopefully the bond yields might tick up a bit and this will reduce our liability and when you look out for valuation again in three years time. So it’s a relatively small amount of additional cash that’s come into the business this year, £40 million as opposed to £30 million last year in relation to the UK scheme.

And in terms of CapEx, I mentioned that we spent at about 1.3 times of depreciation in the first half of the year. But we are aiming to spend closer to about 1.4 times during the course of 2014 because we announced as part of the full year results last year an additional £40 million that was going into drive-line and £20 million going into Powder Met.

So we’d anticipate that will get spent in the second half of the year. But overall in the next couple of years, 2015, 2016, we would look to be more back towards the 1.2 to 1.3 times range were then capital expenditure to depreciation.

Nigel Stein

And as you heard me say, thanks Adam, but do you have me say, I think very timely that we spend that or plan to spend that extra CapEx in drive-line because we see the rate of growth going extremely strongly and that’s needed.

And also in Powder Metallurgy where we are really enhancing our fleet of equipment in North America to help our design for PM initiatives. So, I think, very pleased we decided to do that. Yes, questions back there?

Sanjay Jha – Panmure Gordon

Sanjay Jha, of Panmure Gordon. Couple of questions if I may. First of all, could you talk about 3D printing. Lot of people talk about it, but do you have any proprietary technology there? And can you quantify the benefits? I mean, I am trying to understand how it is like sales or margins?

Secondly, on aerospace, can you quantify your exposure to A-380 program, given the uncertainty, I believe there is another cancellation this morning?

Nigel Stein

Okay, Marcus, you can pick up the A-380 one That's $1 million I think, but you can check that. On 3D printing, we don’t have any proprietary technology, I mean this is really kind of early start. We are not looking to make machines.

The area we think we can bring particular expertise is in the powder, because we are a powder company. We are actually a very large powder company, in terms of iron powder, but other powders are now coming along, other metal powders. This is a technology that people have been using in plastics for a long time including us in our tool rooms.

So we think, we’ve got a good knowledge and a good understanding of the science of it. The other place we are looking to use it is in aerospace where we have a lot of knowledge of the components in a way the aircraft manufacturers work and the way their testing regime works and therefore how one might integrate it and design it into an aircraft.

So we are also working on those two areas specifically. And it’s going to be a long time before it gives us any benefit. Right now, it’s just costing us money, not a lot of money, but costing us money and it’s going to be some time before we see that negative contribution turning to a positive.

But we think it’s the right thing to do, because in ten years time, this will begin to make a positive contribution and beyond that we will start to grow. So, it’s very early days in the industry.

Lots of people are doing the stuff. We do already quite a lot and working hard to increase that exposure. And okay, so that’s the first. Marcus, A-380, long-term some views on that.

Marcus Bryson

I think it’s well trailed that the aircraft is going to get difficult in the marketplace commercially, sensitive position with the airlines and you’ve got the situation where there has been some cancellation. At the moment, our build rate with Airbus is between 2.5 and 3.7 a month.

So, it’s about 30 and we will continue to build with that and until we hear from Airbus that’s what we are continuing to do. In terms of our dollar content of the platform, it’s between $4 million and $5 million depending on what engine variant, whether it's a Trent 900 or a GT7000.

So, it’s a big program, but it’s not I mean, two years ago when they had all the wing problems and they’ve actually shut down production. I mean, they went back to – I think to up to 15 in one year. We didn’t see a huge impact on our numbers, So we just have to see what happens with the aircraft in the market.

Nigel Stein

Okay. Thank you. Andy?

Andy Reynolds Smith

I think we probably have to make this or the next the last question, let’s see the time is ticking by, I know you are very busy people and we've used up the time, but.

Andy Chambers – Cantor Fitzgerald

And I wish it was a better question. Andy Chambers from Cantor Fitzgerald, Just wanted to ask on the A-330 neo, I think as the wing size changed. Is there any, incremental cost slightly being incurred either in development or indeed in tooling for the Filton facility?

Marcus Bryson

At the moment we build the asset we bought from the current 330 they are going to seek an expansion on the end of the wing with a different wing look formation on that as well. We're in discussions with Airbus about that. And obviously that becomes a commercial discussion and negotiation with Airbus. But I mean, generally speaking, from our perspective in inside GKN Aerospace 330 neo is good, it’s a good thing.

Nigel Stein – GKN

Last one I said, but there is one at the back, so, well.

David Larkam – Numis

David Larkam from Numis. Can you just talk about China and premium brands out there. So obviously there is some concerns about what the government is doing and sort of trying to get the prices coming down from premium brands. Do you see that? Does that mean more pricing pressure to you? You obviously make a lot of money out there at the moment in the premium brands in Europe as well be exported?

Nigel Stein

Just, perhaps an introduction and Andy I turn that over to you, I mean, we have always said very clearly in our strategy that like in China which is good in the open market and we will get more competitive.

So I can’t say we are surprised that some steps are being taken mainly to becoming more competitive. And as the market growth slows down we expect that to happen. So, no huge surprise there, but, Andy, do you want to comment a bit more on that?

Andy Reynolds Smith

Yes, it’s an important point, there isn’t a lot of hard evidence around but in general, I think based on some of the evidence pricing is at the higher level in some cases in China or uncertainty of course. There are various activities like we addressed whether that’s the case and we’ll get done about it.

Over the longer-term the likelihood is if as vehicle prices move down and that will inevitably go down through the supply chain. It's front of mind for us. And, all the focus for us is, how we will continue to improve our competitiveness on the ground to maintain our position. But that’s a tougher situation overall I think over the next few years coupled to the growth.

Nigel Stein

Okay, with that, I think, I’d better say, thank you all very much for coming. Thanks for your questions and we are going to be around here if anyone has got any further questions. Thanks very much.

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