IMI PLC (IMIAF) CEO Mark Selway on Q3 2018 Interim Management Statement Call (Transcript)

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About: IMI plc (IMIAF)
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IMI PLC (OTCPK:IMIAF) Q3 2018 Interim Management Statement Conference Call November 8, 2018 3:15 AM ET

Executives

Mark Selway - CEO & Director

Daniel Shook - Finance Director & Director

Roy Twite - Divisional MD, IMI Critical Engineering & Executive Director

Massimo Grassi - Divisional MD, IMI Precision Engineering

Phil Clifton - Interim Managing Director, Hydronic Engineering

Analysts

Mark Davies Jones - Stifel

Alex Virgo - Bank of America

Andrew Douglas - Jefferies

Jonathan Hurn - Deutsche Bank

Edward Maravanyika - Citigroup

Robert Davis - Morgan Stanley

Glen Liddy - JPMorgan

David Larkam - Numis

Colin Campbell - SocGen

Sandeep Gandhi - Exane

Ryan Gregory - Liberium

Operator

Hello. Good morning. Thank you for standing by. Welcome to today’s IMI PLC's Interim Management Statement Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions] I'd also like to inform you this conference is being recorded today, 8 of November 2018.

I'd now hand you over to your speaker, Mr. Mark Selway.

Mark Selway

Thanks, Roby, and good morning, ladies and gentlemen. Thanks very much for taking time out of your busy schedules to be on this morning’s call. I have with me Dan Shook, Roy Twite, Massimo and also Phil Clifton. I hope you had a chance to read through the IMS statement today. I don’t propose that I’ll read it out verbatim, but I will be happy to cover some highlights and then take your questions.

Overall, our key messages are that we’re continuing to make good progress across the group. And most importantly, our results continue to be in line with current market expectations for the full year. Trading momentum has continued to be positive for the group. And we delivered 3% growth in the third quarter, giving 5% growth for the 9-month period to the end of September. And most importantly, those businesses where we have seen some cost increases. We’ve largely recovered those through selling price increases in the period.

Moving now to the divisions. In Critical, the market backdrop remains largely unchanged. The most notable achievement is order input where, as we predicted, we've substantially reversed the 12% decline, which we experienced in the first half. Significant new Petrochemical projects or bookings rise 40% in the third quarter, and that leaves us with an order book at $520 million, just 3% below the same period last year. Happy to say that Value Engineering again made an important contribution and delivered $139 million of new orders in the 9 months to September. And you recall that's the same total that critical achieved in the whole of 2017.

Margins in the order book remains slightly better than last year. And as Roy previously outlined, we expect to deliver a modest order input decline in the full year, which is always will provide a reasonable indicator for revenues in 2019.

Organic revenues were 3% higher in the quarter, 10% growth in our aftermarket and that offset modest decline in new construction. And then in the round, we’re expecting second half organic revenues, profits and margins to improve when compare to the same period last year.

Turning now to Precision, revenues continued to make good progress delivering 5% organic growth in the quarter. Now that result follows the strong Q3 compared to last year, where we delivered a 9% improvement, which is why we previously guided towards a lower growth rate in the second half of this year. Happy to say that sales across CV, in Energy and Life Science and Rail, all continued with a strong growth trend in the quarter. Industrial Automation revenues were flat when compared to the third quarter of last year, which was a particularly strong comparator. I’m also pleased to say that Bimba is making good progress, and overall as a division we still expect second half organic revenues and profits to improve when compared to last year.

In Hydronic, good progress has been made by Phil and the team in getting this business firmly back on track. With that an early progress as a backdrop, we're absolutely delighted that Phil is to remain permanently over the division's Managing Director.

The next most important news is to remain absolutely confident that we will achieve high-teen margins in the second half of 2018. And achieving that had involved exiting some lower-margin business and that contributed to Q3 organic revenues being 3% lower than last year. Now we continue to pay the margin over the revenues, particularly in this early refocused phase, which is why in the second half we're expecting profits to be improved from marginally lower revenues when you compare to 2017.

So in conclusion, I'm pleased to confirm continued progress since our last update and that gives us every confidence that we will meet market expectations for the full year. And further on, we'll have a clear review of 2019 when we complete our budgets. There remains a number of completing economic indicators, and we'll need to consider those when we build our plans.

I think with that, we'll be delighted to take your questions. Back to you, Roby.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Okay, your first question comes from the line of Mark Davies Jones. You can go ahead now. Your line is now open.

Mark Davies Jones

Hi, Mark. It's Mark Davies Jones from Stifel. If I can just dig into the Precision trends, a little particularly the Industrial Automation piece. Is there any regional color you can give to that? Obviously, things slowed. I gather they picked up a little bit again post the end of Q3. But is that principally an Asian or European issue has been that remains -- sort of the same sort of level in the U.S. through the period? Any color you can give on the moving part to that would be great?

Mark Selway

Yes, sure. Hi Mark, how are you? When we take a look at the Industrial Automation, as I said, there is a very strong comparator in Q3 of last year. You're right. In October, in fact, we saw about 5% to 6% growth coming out of Industrial Automation globally. There were some variances regionally, U.S. was down, Europe was stronger, and we continue to see some good progress in Asia, particularly out of China. But look, it is a moving phase. We think tariffs had an impact in terms of the U.S. certainly in the third quarter. I had the entire board of the group in the U.S. last month, and we were fortunate we met with a number of our distributors, and it is interesting the distributors are expecting to see a strong final quarter to the year. The conflicting information is that The National Fluid Power Association in the U.S. is expecting to see a softer final quarter. So a little difficult to be absolute in it, but certainly, the U.S. was slower in the third quarter. It was softer in October, but Europe was substantially up.

Mark Davies Jones

Great. And with that increased volatility, has there been any impact on the profitability of the Precision? Obviously, it makes it more difficult to manage in some respects.

Mark Selway

No, not really. I think the big issue is mix because we continue to see a very strong North American Class A truck production. It’s softened a wee bit in Europe, but certainly the U.S. has been strong right for the year, and we saw about 9% growth coming out of CV. And that was offsetting a flat industrial automation. And the mix of those two in terms of margins does have an impact overall. But we’re still expecting Massimo’s profits, revenues and margins to be yet particularly strong for the second half of the year.

Operator

Thank you. We will now take your next question. Please go ahead. Your line is open.

Alexander Virgo

Thanks very much. It’s Alex Virgo, Bank of America. I wondered if you could talk two things. Just a little bit to the utilization rates in factories. I think, you were targeting 70% or so this time last year when you talked about the second half of 2018. I [indiscernible] where that is. And then secondly, just on margins in the backlog in critical. I would imagine that such a strong order intake in the quarter on -- probably takes a little bit of shine off the margins in the backlog. But it clearly sets that well for volumes for next year. So perhaps a little bit about how that margin [indiscernible].

Mark Selway

Good. Thanks, Alex, and good morning. Utilization rates? Yes, Precision is the one that’s got the most impact in terms of the utilization. We were slightly above 70% in the third quarter. We in-sourced some machining work that was capacity restrained in terms of the external market. Look, we expected about 70% in the full year, we'll be where we’re at, that includes the in-sourcing. It also includes some movement of business from Europe into Asia where Massimo has got a localization program that’s progressing very, very well. I think, in terms of Critical, we still got low utilization. But the market outlook, and particularly in terms of new quotations in LNG and oil and gas are very strong. So I think that will improve as we go forward. And Phil continues to add it about 70% across his business. I think, in terms of your question on the margin backlog in Critical, you’re actually the right. We saw $39 million petrochemical orders in the third quarter. That was a big component part of the 40% growth that you saw in the period. Obviously, the original equipment is lower margin, so the way that breaks down in terms of the order book today, we’ve got about minus 1 on new construction, plus 1 on tax. And Roy and his team had done well in making sure we’ll recover whatever increases we see, and mix gives us a 1% benefit as well. So net-net, we’ve got about 1% improvement over this point last year, Alex.

Operator

We will now take your next question. Please go ahead. Your line is now open.

Andrew Douglas

Hi. It’s Andy from Jefferies. Just three questions for me, please. When we look at Critical, I appreciate that third quarter last year for original equipment was reasonably soft, so we had a reasonably weak comp. And aftermarket plus 19, I guess, maybe a slightly surprise. I was late onto the call so apologies if you already talked about that. But can you just give us a bit of color for plus 19 and aftermarket because that looks kind of really quite good. Second question, again as a very brief one on critical. You talked about Upstream Oil & Gas being strong. I wouldn’t necessarily kind of put you down as naturally Oil & Gas play maybe in Middle East, so you can just -- maybe give us a bit more color on that that would be great. And then finally, just wondering what you guys are thinking or how you're thinking working capital and how that's going to play into the -- remainder of the year, and maybe into February, March next year as we go towards Brexit. What your thoughts are there? That would be helpful.

Mark Selway

Hi there Andy. I'll tell you the last question firstly in terms of working capital. Tough old position for Massimo to be in at the moment, I mean, we saw broadly flat Industrial Automation in the third quarter. We saw 5% to 6% growth in October, so managing that and the CV part line is difficult. We do have good plans that we always would as we run down into the final quarter. Difficult to do is do you turn it all on or do you turn it off at this point. So I'm expecting inventories, particularly in Precision, to be a bit higher than we would ideally like. But look, that's in anticipation of a stronger first quarter of next year. I think in working capitalized overall, company is doing free well in terms of managing its status, albeit, I think, critical of finding it pretty tough in the market to get paid. But you wouldn't see an extensive increase in debt [indiscernible] across their business. And I think net debt broadly 380-390 for the year-end is what you could probably expect from the business.

Roy, if you can, could you take the aftermarket question in Critical, and also the Upstream Oil & Gas.

Roy Twite

Andy, so Upstream Oil & Gas, over the last couple of years, we brought out a new valve. It's a choke valve, which goes in the wellhead. This has been very successful in the Middle East. And it lasts a lot longer than over the competitors' valves. So it's a ready-made design, and that's actually grown our orders so that this year-to-date would have been £25 million in New Construction in Upstream Oil & Gas. So that's been a nice story. Yes, it's not massive, but it's improving, and we see further runways as we go forward as well.

In the aftermarket, Andy, we think a couple of big larger parts orders, which, again, even on a quarterly basis, it's a bit lumpy. Parts year-to-date are 1% up, which is good because there is no doubt that the maintenance budgets of the big power companies are under massive pressure. We're definitely seeing that. Where we're up year-to-date is on upgrades. So you probably remember when we're talking a bit about the half year -- talking a bit about the fact that we're targeting our competitors' valves in the installed base, and we've been upgrading those. And in fact, that's been very strong for us this year. That particular segment is 30% up. So it takes a long time to do that sort of sale because it's a technical sale, but the good news is we see it and it comes through in the numbers.

Operator

Thank you. We will now take your next question. Please go ahead. Your line is now open.

Jonathan Hurn

Hi, good morning. This is Jonathan from Deutsche Bank. Just a couple of questions, please. Just, firstly on coming back to Critical. Roy, I just wonder if you could talk a little bit about 2019 and what you're seeing in terms of the sort of key end-markets for you such as LNG. And also what do you expect the nuclear in 2019 and maybe into 2020, please?

Roy Twite

Yes, I mean, Mark said, I think, I've been guiding for the last two or three updates, but I expect full year orders in critical to be flat to slightly down this year. So it was slightly up at the moment after a good third quarter, but I still expect the same outlook for the full year Jonathan. LNG, you probably saw that Shell are going ahead with Canada LNG, and we’re starting to see more and more pressure on companies to put in place LNG compression capacity, and that’s obviously good news for us. As we said before, between FID, so after the investment decision is positive, we’re typically a year to 18 months after that when we see orders. So that’s why Mark is indicating sort of second half of next year, we would expect LNG to start picking up again for us, all things being equal. So that’s a good positive story. On Nuclear, China isn’t really moving. At the moment, there's still -- they've connected its 81,000 equivalent reactors of the grid, but they're still not big orders following on after that at the moment. And the other place where there is opportunity is obviously India. And we are quoting big projects in India. But it’s notoriously slow Nuclear in India.

So that will be over the next few years. Hopefully, we’ll see that start to rollout, Jonathan. Of course, one thing I should say, on Hinkley point, we did a good portion of those orders on Hinkley point as well. So that was a good one for the UK. So not much changed in terms of the outlook since the last update.

Jonathan Hurn

Second question is just on pricing. I think when we heard from you last, you started -- you’re saying that you start to see some gains and pricing, particularly in the aftermarket. I mean, is that trend continued through Q3? Do you expect that to continue into Q4?

Mark Selway

Yes, I would say we’re getting more pricing, Jonathan. But as Mark said, the aftermarket order book -- the margin in that is about 1% up. And that's despite a negative mix effect because, obviously, upgrades, on upgrade valves, we don’t make the same margins we make on parts. So that has been moving positive in the right direction. We’ve slightly overcompensated for the inflation effect. So, yes, pricing still solid in the aftermarket.

Jonathan Hurn

And then maybe just one final one. Just as we look to 2019, obviously, you’ve got restructuring benefits to help you in '18. What kind of number in terms of benefits could we expect in '19, please?

Roy Twite

Wow. I mean, Jonathan, we haven't even gone through the budget with the Board yet. So I think the early days for that, Mark, yes?

Mark Selway

Yes, clearly there is, we would be disappointed if there wasn’t further progress in 2019 in terms of margins. But we’ve got a lot of work to do until we get there Jonathan.

Operator

We will now take your next question. Please go ahead. Your line is now open.

Edward Maravanyika

Hi, Mark, it’s Ed from Citigroup. Just I had a question on the power business. I may have read incorrectly, but I didn't see any sort of mention on trends. If you could just comment please on what trends you’re seeing that business?

Roy Twite

Yes. Thanks, Ed. Give me a second, Mark.

Mark Selway

Yes.

Roy Twite

Yes, so our power and New Construction business in the third quarter was 10% down and 11% down year-to-date. So it is still being hit pretty hard and you’re probably seeing some of our peer group results have come out today even, and obviously, you’re seeing what's happening to GE. It’s just a very, very tough market. Coal, we expect it to be down, but the surprise has been gas has been even worse than we had expected on New Construction.

Mark Selway

Yes, aftermarket remained pretty stronger.

Roy Twite

I mean, as I said, the Aftermarket -- I mean, overall, Aftermarket parts are up 1%. And then even within the power sector, third quarter parts was sort of 3% down. So parts is still very resilient.

Operator

We will now have your next question. Please go ahead. Your line is now open.

Robert Davis

So it's Robert from Morgan Stanley. Just a couple of questions. I guess one was around the intentions for the hydronic business going forward. You've obviously had a sort of change in strategy. What are your expectations for the business next year and kind of focus on priorities, obviously, getting margins up in the near term? But how would you kind of fit that within the context of trying to get overall group growth going on a midterm basis? That was my first question. And then the second one, maybe you could just flush out a little bit more around some of the timing. I know you sort of mentioned briefly around LNG. But what are the customers are actually saying around timing and projects. And whether you're seeing kind of potential for LNG that you've already got installed doing more sort of service and aftermarket work on that? Thanks.

Mark Selway

So, Phil, can you take that one?

Phil Clifton

Good morning, Robert. Thanks for your question. Yes, you're absolutely correct. This year is all been about focus on margin even though we've been working away from some unprofitable work, and that will continue into next year. I want to continue that margin focus. But we do expect to get back to some profitable growth. So our revenue this year has been hit by walking away deliberately from low margin percent. So that's what you're seeing this year. Next year, I would hope to be back to some good profitable growth.

Roy Twite

Yes, and on LNG, we’ve obviously got a list of projects. Frac, I'm just looking at the list now. We probably got 20 projects on year, and we track exactly -- most of them waiting for FIDs. You would expect some have just gone through FID, and some have just awarded EPC. And as I said, that sort of looks like it should give us some pretty good situation in the second half of next year in terms of orders. And customers are generally saying that they are prepared to invest in FID. And as you see, Shale, as you know, been under pressure from investors to make sure they spend every penny super wisely in Oil & Gas, but they decided to back LNG as one of their growth areas, as a typical sort of bad weather for the sector. So I think, LNG is a good space and we continue to broaden our product range within that. In terms of the aftermarket, yes, it's great. We see over the next 5 years that growing as more and more installations come online. Typically, we have a follow-on set of parts with the initial installation. That can last for a couple of years. But then beyond that you get a nice stream of parts in LNG. And the margins are as good as if not slightly better than the power parts margin. So it’s a nice stream of business for us, Robert.

Robert Davis

That's great. And maybe just one final one. Just on what the Oil & Gas growth you're seeing in terms of CapEx? There, you obviously mentioned that make them to be more capital has being of all quarters been spending. What are they saying to you in terms of priorities of whether you mentioned LNG as a place that you're willing to spend money? But just sort of a typical middle downstream Oil & Gas customer, what are they saying in terms of their focus for going into '19 around maintenance budgets or any new projects? Just to be interested here what the messages in the company themselves?

Mark Selway

Yes, I mean. Folks on LNG, as I said, bit of a focus on downstream. We see certainly opportunities -- continuing opportunities in Petrochem. So you remember our orders were up over 50% last year. We can -- we're going to get close to holding that this year, so that will be sort of 50% growth over the two years. So it's certainly those downstream Petrochem areas that we see opportunity.

Operator

Thank you. We will now take your next question. Please go ahead. Your line is now open.

Mark Selway

So, Glen, the mic is open for you.

Glen Liddy

It’s Glen from JPMorgan. A couple of years ago, Massimo launched a clutch of new products. Are they starting now to contribute to the growth?

Mark Selway

Yes, I’ll look on it and let Massimo take the detail for the quarter. Just to reflect on that, we got couple of the most important platform products are now in the market. And we’re really pleased with the way they’re starting to progress. And there is about $370 million of existing revenues over the course of the next few years. It’ll be replaced by brand new products. So the pipeline for Precision is growing and there is a consistent range of brand-new products coming through over the course of the next 18 months, Glen, but in terms of the quarter itself and year-to-date, Massimo?

Massimo Grassi

Yes, good morning, Glen. Massimo here. We are quite pleased with the contribution of new product introduction to our growth. You know that we are measuring our vitality rate, which is the percentage of sales we are realizing we brought that has been recently introduced more precisely in the last three years. And we started this process about one year ago. There are 5%, and we reached now at the end of the quarter, 12% vitality. So we are quite pleased. To be remember that our new product introduction is a mix between platform products, so important for all the, like the ISO line we presented and over rather than the new FRL Excelon Plus, but also a lot of gasoline product that we make -- we developed for our Industrial Automation and CV customers. So we are quite pleased. And we are also quite excited looking forward, because we have in place a very solid process to date. So we believe this is going to be a competitive advantage for Precision Engineering going forward.

Glen Liddy

Okay. Sticking with Precision, I mean, commercial vehicles have been amazingly strong in the U.S. this year. But again, a couple of years back, you won some new contracts that weren't due to start immediately. Are they due to kick in next year?

Massimo Grassi

Partially, but the largest contribution of new projects recently won will really be impacting 2020.

Mark Selway

So Glen, the Kongsberg program that we won a few years ago is now launched. It’s smaller in overall dollar volumes. The big one that Massimo has just mentioned is running through the system at the moment in terms of new product development. We’ll see about GBP 10 million in total of contract completions this year. And that’ll be offset next year by stronger new contract size. So just to give you a mix on it all, that's what it will look like in the full year.

Operator

We will now take your next question is coming from the line of David Larkam. You can go ahead. Your line is open.

David Larkam

It’s David Larkam at Numis. A couple from me, please. Firstly on hydronic, can you talk just about the sort of the gross loss of business albeit you’re walking away from, obviously, we see a net number. But can you give us a sort of a gross to exactly what you’re moving away so we can see whether the business is underlying actually, keeping up with the end markets? And then on Precision and the automation side, can you talk about exposure to automotive? What do you see from them and how big is that for the automation piece?

Mark Selway

Yes, so -- and that was just the book work we've been walking away from, it's close service business. We've also closed our Turkish business where we were making losses. And we've also walked away from a number of projects, principally in Europe, and also couple of the emerging markets, where we weren't getting the margins that we would have expected. So in overall terms, we've walked away from around GBP 3 million to GBP 4 million of revenue.

David Larkam

That's for the quarter. Is that for the quarter?

Mark Selway

As you note, in the end it take. Massimo in terms of …

Massimo Grassi

Yes, good morning, David. With regards to our exposure to automotive, this is mainly related to our North American business. We have an activity that we call inaugural automotive solution, which supply arms and automation for the automotive industry. So this year, we are really performing well. But the market expectations for next year are quite negative because of the dynamics of the automotive industry. I think that that is the relative limited revenue for us. So all-in-all, we expect it that could be limited.

Operator

Thank you. We will now take your next question. It's coming from the line of Colin Campbell. You can go ahead. Your line is open.

Colin Campbell

Good morning. It's Colin Campbell at SocGen. Can you hear me okay?

Mark Selway

Yes, we can Colin.

Colin Campbell

Great. Yes, I just wanted to ask a bit more on Industrial Automation within Precision, clearly, a slowing there in the short cycle areas. Do you expect that long term momentum to continue into Q4 given you've talked a greater volatility? Is there a chance that flat growth goes negative, please?

Mark Selway

Colin, I mean, again, we got a little bit of competitor in Q3 as last year we were up about 9%. So Industrial Automation, we're expecting the final quarter of the year to be a bit stronger than last year. It is a good volatile. As I mentioned we saw good growth in October coming out of Europe and some big volume in North America. Cash have had an impact in mid-term, so I expect to have an impact also. But look, net of all of it, coming into Q4, we expect some progress whether it's a stronger than 5% to 6% that we saw in October, we'll just have to play that out. But it is a bit more volatile today than it was. And we certainly don't see going backwards at any time, same time.

Colin Campbell

Okay, that's encouraging. Thank you.

Operator

We now have your last question. It's coming from the line of Sandeep Gandhi. You can go ahead. Your line is open.

Sandeep Gandhi

Good morning, everyone. This is Sandeep Gandhi from Exane. Just one question from me. I'm just wondering if you can talk a bit about your plans for future capital allocation. Are there any parts that for the portfolio you could look to exit? Or any areas you might look to strengthening, maybe a bit of color on that. Thanks.

Mark Selway

Good question. Net of all it, we love that everything we currently do. The new product development continues at pace, as I said Massimo has got some great new projects coming through. Value engineering in Roy's world. The factories are now pretty well invested. So I think capital allocation will be pretty much as it has been. We’ve been spending about GBP 70 million a year, and are expecting it will be about that same number as we come into 2019. In Phil’s world, there will be less new products, but much more focused at bigger picture, wins in terms of markets. So I think, again, looking at all three businesses, our balance sheet is in great shape. As I said, we probably expect net debt to be in the order of GBP 380 million, GBP 390 million for the year-end. So we’ve got a situation we can invest in all of the business. We continue to invest in great new products. We’re working hard to improve the factories across the business and that’s the priority, Sandeep.

Operator

We will now take your next question. It's coming from the line of Ryan Gregory. Please go ahead. Now your line is open.

Ryan Gregory

It’s Ryan from Liberium. Just a quick one on pricing in Precision. How is that currently looking against raw material and wage inflation? And how do you think that looks going into 2019? Just wondering whether there is some volatility maybe makes it a bit harder to raise prices?

Mark Selway

Look, I think, Ryan, if you take a look at Massimo’s team have done a good job. There’s always a delay from the time, we see the increases in the time we get a recovery, tough to get them in CV, as you’re probably aware. But, I mean, we’re very proud that Massimo has been now returned pricing into a positive against these inflationary costs this year. And we think there’s probably a bit of momentum in the first half anyway, because it’s a lag from recovering those increases as we move into 2019. So I think he’s done a decent job. Market’s been receptive. Tariffs would be now - put surcharges on and recover those. So generally, Massimo, I think we’re in good shape.

Massimo Grassi

Yes, absolutely.

Mark Selway

Okay. I think with that, that’s the very last question, Roby. So thank you very, very much to everybody for being on today’s call. Again in conclusion, I’m pleased to confirm a continued progress we’re making every confidence that will meet market expectations for the full year. And we will be working diligently to give you further meat on the bones in terms of 2019 as we come into the year-end. Thank you very much. I appreciate your time and attention.

Operator

That does conclude our conference call for today. Thank you for participating. You may now disconnect.