Edited Transcript of BOY.L earnings conference call or presentation 23-Jul-20 7:30am GMT – Yahoo Finance

Headline operating profit, GBP 38 million. And a very good operational gearing at 42%. Our business doesn’t have naturally variable costs. So all the costs to be very — have to be done with management actions. So having an operational gearing of 42% for this kind of business is a good performance.

Turning to the dividend. So we decided to pay the 2019 deferred dividend. That was the dividend that we announced and was going to be our final dividend, and then we deferred the decision on that. We’re going to pay that at 13.3p in September. The 2020 interim dividend itself is something that we’ll take care of later. So we’ll make a decision on the details of that in due course.

So coming into the situation, Bodycote was actually very well placed to respond to the demand shock — down in demand shock from the pandemic. And some of the reasons for that is, so matching resources to demand has become a core skill in Bodycote. It’s something we have to do actively, as I mentioned before, and we know how to do it and do it well. It so happens that we did a comprehensive site capacity review at the end of 2019 that we were looking to do restructuring on the backlog, mostly because of long-term trends that we’ve been observing. And so we already had a very full understanding of where our business was and where it needed to go.

It’s also interesting to note that every year, as part of our budget and planning exercise, we do, do site-by-site contingency plans in case of demand shocks, both up and down. So we’re all used to actually planning ahead of time for these things and not leaving it to the last moment when something actually happens.

As we came into this downturn, we had very strong margins and a low level of debt. And I think it’s important to note that actually, the Bodycote business bond is very flexible. Today, a business that actually is supplying into aerospace, tomorrow, it could equally well be supplying into general industrial and automotive. It’s not a technical limitation of our equipment. What focuses our processes on a particular end market is marketing as opposed to the actual technicalities of the process itself with marketing and quality systems and the like, which are different to different sectors. So we’re quite flexible in terms of being able to redirect our physical capacity to any particular market.

So immediately, as we came into Q2, we started taking cost actions. We’re running at about GBP 7 million a month of cost savings. We laid off 797 full-time employees, 14% of the workforce. That includes, actually, our temporaries. So the majority of the temporaries have been laid off. And of course, they exist anyway in our business to provide us with a cushion during downturns.

Then we’ve got about another 619 on short-term layoff, that’s another further 11% of the workforce. We’ve received GBP 2.3 million in government subsidies for our labor around the world, but we’ve decided we’re going to be repaying the U.K. government further support that we’ve received. We’ve obviously, as I think most people have done, really lent heavily on our discretionary spending to reduce it. We’ve also temporarily closed some sites and consolidated work into fewer sites. That gives us better equipment utilization and efficiencies.

And it’s worth pointing out that we haven’t taken any so-called pandemic-related costs to exceptions. They’re all flowing through the P&L. The only thing in exceptionals is our restructuring program. So just to see how that’s manifesting itself in terms of margin management. If we take out the depreciation element, which clearly we can’t affect in the near term, then you can see that the EBITDA level, 2020 margin in half 1 is a very respectable 26.4% compared with what we were last year at 28.8%. And I would suggest that 26.4% is actually an EBITDA margin that many companies would aspire to in normal times, nevermind in times of a downturn like this.

And then if we come to the more permanent cost savings, and I think this needs a bit of explanation. But we are going to get to up to GBP 58 million of annualized cost savings or 10% of our operating expenses. These savings will be fully in place by the beginning of 2021, and they’re progressively going in place now. It’s important not to double count here. So we’ve got GBP 7 million a month of temporary savings. We will see some of our people on temporary layoff coming back in. And in other locations, we’ll be seeing people going out as we close facilities. And we’ve actually announced 18 plant closures. But it’s important to note that we’re not getting rid of the physical production capacity. We’re moving equipment to other sites. It’s the actual sites that have been closed. That reduces our overhead burden. And also, we’re taking out the people associated with that. And overall, we are targeting roughly, in most segments, to be running capacity at 20% below 2019 levels. That doesn’t mean we expect to be there. That’s where we’re putting our capacity in terms of people. If it’s higher than that, which we would hope it would be, then we would, in fact, bring back people on temporary contracts. We build our buffer in terms of the workforce.

You can see on the slide there that 13 of the closures were in Western Europe, majority in the automotive area. And we have said, as part of our restructuring plan, that we expected to take our capacity in automotive down in Western Europe, as we’ve seen a longer-term trend towards electric vehicles, primarily in the Eastern Europe scenario. So that’s part of our restructuring program that we’ve been doing from a strategic standpoint previously.

I think it’s important to note that this whole restructuring program is not a reaction to the pandemic. It’s about repositioning the business to the situation that we see after this pandemic is over. We’ve got 4 in North America being closed, 3 automotive, 1 aerospace and 1 in Hungary. But then on top of that, we’re opening 3. So we’re replacing the Hungarian plant and 2 of its facilities in North America are being replaced with brand-new facilities. In total, 17% of the workforce reduced. And as I said, this will all be in place by the beginning of ’21.

So just moving on now to Slide 10. And here, you can see a slide that we’ve shown several times before. It gives you a snapshot of 3 different views into the company. And you can see each of the markets by geography and end markets. So the way the growths have gone. And unfortunately, the word growth in this situation means a decline, and we’ve seen a variety of declines across the world in the different market segments. So aerospace and defense in the half, only down 8% so far. We’ll come into more detail on this. And general industrial, down 12%. Clearly, a much bigger hit in automotive.

And emerging market is not doing too badly at the moment. Indeed, in the second quarter, China itself grew 8%, and we’re seeing quite strong growth as we come out of the half now in those areas. Just looking at the moment at Specialist Technologies versus Classical Heat Treatment. This has been bulking up on — Specialist Technologies has been part of our ongoing strategy. And you can see on the pie chart in this Slide 11, we’re showing that on a pro forma basis, post the acquisition of Ellison, the Specialist Technologies now, in total, about 30% of group revenues.

During this pandemic issue, we’ve got Classical Heat Treatment decline 21% on a like-for-like basis, whereas Specialist Technologies down 8%. But if we exclude the acquisition of Ellison, Specialist Technologies was down 16%. So about 5% differential to the Classical Heat Treatment decline. And Ellison technology itself, this — the acquisition, I think, we are pleased with it. It’s not going to be the absolutely fantastic acquisition that we thought it was originally given the downturn in aerospace, but still a good acquisition.

We saw in Q2, Ellison’s revenues decline somewhat faster than the rest of aerospace. The reason for that is it’s tied quite closely to GE, and GE of all the aerospace players, actually immediately shut down production around the world, particularly in North America. And we expect to see Ellison rebound faster than the rest of the aerospace because as GE has opened up its facilities, their production is coming online much faster. First impressions of the business are good, in line with what we expected, and the integration is proceeding well.

So let’s just take a trip now through each of the major segments and talk through what’s going on, try and give you a bit of color there. So automotive, 23% of the group these days. Year-on-year decline of 31%, quite significant. And in Q2, you can see it’s 53% down. The reason for the very large downturn is that we saw, almost universally around the world, all the OEMs shutting their doors as we came into Q2 to try and eliminate production or actually eliminate production.

What’s happened then as we come to the back end of Q2 and to the end of the half, is that they’ve reopened and as a result, we’re seeing the output turn up and sales turn up in automotive. It’s most strongly noted in North America. There’s been an ongoing trend over time in North America for growing performance of SUVs and light trucks. And indeed, that’s accelerating. We believe that’s being helped by the low fuel prices that are there. But clearly, that’s the direction that North America is going with a strong rebound occurring.

Europe is lagging. It’s much slower than North America. And what we’ve seen in Europe is the first things turning up in Europe are, in fact, the supply chains for Asia. So you see safety equipment, things like see seat belts, friction and brake components being manufactured in Europe for Asia and then turned up the fastest supply, particularly into China. And this ongoing trend that we’ve been seeing continues where we see electrical production — electrical vehicle production escalating in Eastern Europe at a slow rate, but it’s moving that way. So that’s the automotive picture.

If we move on to aerospace and defense, and this is a little bit more complicated as I talk this through. Year-on-year, 8% down. Q2, down 28%. Now, the supply chains in aerospace reacted somewhat slower. It’s important to note that in automotive, there wasn’t a lot of inventory coming into the situation. That’s similar to some other segments. But in aerospace, there has been. And so because the downturn in aerospace has been a little bit slow, we expect the downturn in aerospace to actually deepen somewhat in the near-term here. But the picture for the longer term, medium-term is quite good in aerospace for Bodycote, and we’re a little bit different from many, I think.

So if we look, generally speaking, wide-body production is down about 50%, and narrow-body production is down 20% to 30% depending on which geography and planes you’re actually looking at. And as we go forward, we see a shift to — in mix towards narrow bodies, which is quite important for us. So the other thing that we see is that we expect revenue passenger kilometers to get back to that 2023 — by 2023, ’24 to 2019 levels. And total engines produced, so that’s wide-body plus narrow-body engines, beating 2019 in about the same timeframe.

Now if you realize that in the last 5 years or so, our mix has shifted quite strongly towards engines used on narrow bodies. We have a growing amount of our business on narrow bodies. And indeed, as the number of narrow bodies is going up at the fastest rate, that means, in total, Bodycote’s actually positioned in exactly the right place to take advantage of the recovery here. That’s both because we were on the LEAP platform, which is a narrow-body engine. And indeed, also it’s helped by the acquisition of Ellison, which has got a lot of narrow-body exposure.

Important to understand that now the situation that we have, this value-add per engine is irrespective of the size. It doesn’t matter whether it’s a wide-body engine or a smaller narrow-body engine, we make the same kind of money on both. And so when you add all that up, by the time we get to ’23, ’24, we’re in quite a strong position, and we see growth rates going out from there on in.

Turning to general industrial. This is a very diverse market for us. Obviously, it’s everything other than aerospace, defense, automotive and energy. So it’s a very wide front here. Overall, in the half, down 12%. The diversification provides some downside protection in this business. So Q2 was only down 19%. And some parts of general industrial are up, some parts are down. So for example, medical revenue is up 2%. We’ve seen electrical electronics up. But tooling, which is primarily linked to large tools for automotive, down 20%. The capital goods segments, within general industrial, it is a mix of Capex and OpEx that drives further this business. They’re weak as people have deferred their CapEx investments. But — and we’ve also seen supply chain destocking. But once again, like automotive, the supply chains in general industrial, in general, have had fairly low inventories coming into this downturn. And so what we will see is that as destocking stops, which will be happening over the near-term now, we believe, then our production — because we’re supplying into inventory for our customers will take a tick up to meet our customers’ production levels.

I mean, clearly, general industrial, which is a — follows directly from industrial production is down further than IP is. And that is due to the destocking element. So as destocking ends, we’ll kick back up to industrial production levels that are seen in the wider economy.

Turning to energy, not a lot to say for energy. It’s only 9% of our revenues these days. Year-on-year decline of 16% with 26% in the quarter. Onshore oil and gas, so that is primarily North American onshore, and indeed, it’s primarily Permian Basin. We’ve come to the conclusion that, that area of our business is not something that has got a rosy future, and we don’t intend to expand our investment in that area. In fact, we’re doing quite the opposite and redirecting business capacity there to other areas.

Subsea oil and gas is somewhat different. It’s on a longer wavelength. There’s some momentum there that is encouraging, but we’re watching it carefully. And of course, we have 2 of our — Specialist Technologies that service the subsea arena.

So in summary, we’ve taken very decisive action during this extraordinary period. We’ve got excellent cash flow, nearly GBP 70 million of cash flow, good operational gearing and resilient margins. And our balance sheet is strong. I mean we finished the half with net debt of only GBP 23.6 million, which is lower than we had last half year. And we’ve paid GBP 94 million to Ellison in the meantime. So yes, a very good cash performance.

What to expect? We’ll come back and look at the outlook in some more detail. But basically, we see a weak short-term demand for aerospace. However, picking back up to put us back in a higher position by ’23, ’24. Automotive markets are already improving from quite a low level they went down to. And the GI now market’s recovering and ending destocking will help that.

So with that, I’m going to hand over now to Dominique, and he’ll take you through the financials.

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Dominique Robert de Lisle Yates, Bodycote plc – CFO & Executive Director [3]

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Thank you, Stephen, and good morning, ladies and gentlemen. Chart 18 summarizes the group’s financial results, and you can see here the significant impact from the revenue downturn.

Margins were a resilient 12.3% in the half. And as you’ve already seen, this decline in margin results mainly from the impact of fixed depreciation costs being divided into the lower revenues. Cash flow was strong, and I’ll come back and talk about that later.

We took a charge of GBP 32.1 million in the first half for restructuring, which we’ve treated as an exceptional item. And of this, GBP 20.1 million relates to cash items with the remainder noncash impairments. Only GBP 2.8 million of the GBP 21 million — GBP 20.1 million cash items have actually been spent in the first half. So from a cash flow perspective, you should expect that the significant majority of the remainder will be incurred during the second half.

Also given the group’s performance in cutting costs in reaction to the revenue downturn as well as the excellent cash flow performance, the Board has determined that it’s now appropriate to pay the deferred 2019 dividend in the amount of 13.3p per share, and this dividend will be paid in September.

Chart 19 shows the operating profit bridge. And again, here, you can clearly see the negative impact on the group result from lower volumes. It also shows the contribution to the lowered costs from the group’s variable pay schemes. While these schemes are designed to incentivize performance in the downturn, it clearly also contributes to softening the negative impact on the business of the lower volumes.

Chart 20 shows the division’s performances. ADE’s margins retained a very respectable level of 20% in spite of the revenue reduction. While AGI experienced a more significant immediate impact with automotive revenues being down 53% in the second quarter, as we’ve already covered. And this also demonstrates why most of the restructuring effort has been focused in AGI, which accounted for 14 of the 18 announced plant closures.

Chart 21 presents the group’s results by major currency. This shows that our euro and U.S. dollar businesses are almost now exactly the same size, and also represent an equivalent amount of the group’s profit. It also demonstrate a little of the countries in Euroland where labor costs are more difficult and time-consuming to take out compared with other areas of the business elsewhere where adjustments are more straightforward. And I think it’s also worth noting the — that it shows the good margins that we make in our emerging markets business. Our emerging markets business is mostly in our other category, and you can see that, that represents a higher portion of the profitability than it does from the revenue. So good margins in our other markets business.

Chart 22, the highlight of the first half performance has undoubtedly been our free cash flow generation. Of course, you can see that there has been a significant contribution to this from the improved working capital position as a result of lower receivables from the lower revenues. And this will begin to reverse as we see revenues improve. Nonetheless, we successfully cut our costs immediately, and we’ve also spent less on maintenance CapEx in line with the lower equipment usage. I also mentioned already that we — the GBP 2.8 million that we’ve got in restructuring costs spent in the first half. And it’s worth just noting that we have deducted that from the free cash flow.

On Chart 23, taking a look at the balance sheet. Net debt is at GBP 23.6 million. It’s actually lower than the equivalent position at the end of first half of 2019. And after paying the GBP 94 million of consideration for Ellison. In terms of liquidity, we’re in a very strong financial position. We have GBP 204 million of committed headroom, and our revolving credit facility has still 5 years to run. Finally, headline tax, 22.5%, mainly in line with the guidance that we gave at the full year results.

And with that, I’ll hand back to Stephen.

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [4]

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Thank you, Dominique. Okay. So let’s look forward now. I think it’s worth at this point, just reminding ourselves as to what the key attributes are of this business. And so we’re leaving behind the half. What have we got here as a business looking forward? I think it’s pretty evident that this is a highly cash-generative business. It has been through thick and thin, even through a downturn as severe as this. Our margins are resilient, we’ve shown that time and time again. And if you can have resilient margins in this kind of environment, you have to know that this business is very robust. We do have a low level of debt, and we’ve got a very flexible business model that we can turn around to address markets as they come on stream and as they grow.

We’ve taken the opportunity here to rightsize the business so that we know that we’ll be generating good returns once the recovery occurs and beyond. And it’s important to note, I think, that operating margins post this restructuring will end up being higher than the previous historic levels that we saw. So when revenues recover, we will get to higher margins than we’ve seen in the past. And the final bullet on this slide is that we are well positioned now to capitalize on growth opportunities across all the geographies and market sectors that we serve.

That brings us to the outlook statement itself. I don’t intend to read this word to word. It is what we’ve published out there. But overall, I think we’re in a very good position.

With that, we’ll take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have our first question from Michael Byndall (sic) [Michael Tyndall] of HSBC.

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Michael J. Tyndall, HSBC, Research Division – UK MidCap Equity Analyst [2]

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It’s Michael Tyndall. Just a couple from me. Can we talk around general industrial and destocking? I know it’s probably an impossible question. But what’s your sense in terms of where we are on inventories? We started low, we’ve gone lower. Are we kind of at the trough now?

And then the second question. I think the last time we spoke, you even mentioned that with what’s going on with your customers, there is a sense that they may actually start to think about outsourcing, which could be quite beneficial. Could you talk a bit about what those — how those conversations may be progressing? And if it does happen, what’s the realistic time line to see an uptick in outsourcing?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [3]

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Okay. Thanks. Yes, I thought we changed — you changed your name. And we thought that you might…

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Michael J. Tyndall, HSBC, Research Division – UK MidCap Equity Analyst [4]

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Certainly confused for a more famous one.

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [5]

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Yes, exactly. So yes, the destocking question is always impossible to answer. I mean we’ve got thousands of customers out there. The way that we tell is we start seeing them, just the spike up one by one. At the moment, we’re really not seeing that happening much. So we still are in the destocking phase.

The only thing I can refer to here is history. So in prior downturns, it’s normally taken about 6 or 7 months before the destocking comes to an end when they actually clamp down hard. So we’ve got a few months more to go that before I think we see the destocking finishing.

Having said that, we are actually seeing some improvements in GI in various territories. North America is actually moving better. But I can’t give you any more color than that, actually. When it comes to outsourcing, it’s a very interesting topic. So I think it will vary by different area. I mean France is an interesting case because if you were going to do outsourcing in France, generally speaking, you’d have to be into a social plan, which obviously, French companies try to avoid. It’s all very difficult to eliminate labor. In this situation, those that are going into social plans will definitely be looking at outsourcing because it’s the opportunity to get out from under from their perspective. And the issue in France and why I highlighted, though, is that the French government of Macron has actually put in front of people a big temptation because if they want to continue to receive support for labor on short-term work time, they have to sign up to 2 years and not enter a social plan. So the people are facing a binary decision here. They either have a social plan and then take it on the chin in terms of the labor costs, in the meantime as the social plan winds its way through, which will be a long time, or they immediately take the government hands out, but then they can’t do a social plan. And in that scenario, if they go down the social plan, we will get outsourcing. If they don’t, then it will sustain house.

So France is an extreme example. I think in places like the United States, they’re much more economically rational about this. Having said that, it’s true to say, I think in the U.S., they’ve got many, many things on their minds right now. And the discussions on outsourcing have been at a very superficial level. But I do expect them to start kicking in next year sometime.

Germany is an area where we’ve actually — we’ve downsized significantly in Germany. So I’m not looking to a lot of outsourcing happening in Germany. So the primary targets will be companies doing social plans in France plus the United States. I hope that answers your question.

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Operator [6]

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Our second question is from Jonathan Hurn of Barclays.

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Jonathan Hurn, Barclays Bank PLC, Research Division – Research Analyst [7]

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Just a few questions for me. I think first 2 are just on aerospace. So if we look at that Q2 performance, I think you said aerospace and defense was down 28%. But in your statement, I think civil in Q2 was down 36%. So can we infer from that, that obviously, defense is performing quite well? Or is there just something in there about the inclusion of Ellison that’s kind of making these figures come through differently? That was the first one.

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [8]

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Yes. So certainly, defense is performing reasonably well. And that’s why you see the difference in the civil aerospace compared with the total aerospace and defense.

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Jonathan Hurn, Barclays Bank PLC, Research Division – Research Analyst [9]

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Okay. Just maybe a bit more color. Can you just sort of give us the sort of the H1 performance in defense, if you could?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [10]

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It’s up 20% in H1. As you probably know, our defense business is mainly U.S. focused. It was up 20% in the first half. The order of magnitude, that’s GBP 4 million worth of incremental revenue from defense. It’s still a relatively small part of the overall group result.

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Jonathan Hurn, Barclays Bank PLC, Research Division – Research Analyst [11]

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Sure. That makes sense. And just going back to civil. Obviously, Q2 — first half, you’re guiding to a tougher outlook in sort of H2 and potentially into 2021. Can you just give us some color on sort of your outlook in terms of how much more that market can decline for you, please?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [12]

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Well, that’s a tough one. The answer is we don’t really know in the near term. We’re trying to stay away from near-term dynamics, actually because there’s so many moving parts. What we’re doing is trying to look through it. So our best visibility starts in about end of ’21 and ’22. And we do expect sort of this year, towards the end of the year, it to be turning up.

But again, there’s lots of moving parts. The 737 MAX is going to be coming back into service, but exact timing of that will affect things. Can’t really give you color for 2020, I’m afraid.

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Jonathan Hurn, Barclays Bank PLC, Research Division – Research Analyst [13]

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Okay. That’s fair enough. And the last one for me. Just looking to the second half. Obviously, you’ve got some costs coming back into the business. And obviously, with the restructuring of this cost coming out. So if we look at that drop-through rate for the second half, what kind of level can we expect from you?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [14]

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I think you should expect a similar level to what we’ve seen in the first half, broadly. I mean there are moving parts in there, but I think a fair expectation will be a similar level to what we’ve seen in the first half.

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Operator [15]

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Our next question is from Andre of Crédit Suisse.

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Andre Kukhnin, Crédit Suisse AG, Research Division – Mechanical Engineering Capital Goods Analyst [16]

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It’s Andre from Crédit Suisse. I wanted to pick up first on one of the key attributes, Stephen, that you mentioned about operating margins exceeding historical levels. Maybe looking at it highly differently, can you give any indication on how far do the revenues need to recover for you to come back to the previous level?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [17]

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That’s a mathematical question. I’ll give that to the CFO.

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Dominique Robert de Lisle Yates, Bodycote plc – CFO & Executive Director [18]

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I’ll need to calculate it. Obviously, with the consolidation, it wouldn’t need to come back quite to the same level they were before. But yes, it would be a few percentage points below where the historic revenue levels were when we should begin to exceed the level of operating profit and thereby, have an improved margin.

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Andre Kukhnin, Crédit Suisse AG, Research Division – Mechanical Engineering Capital Goods Analyst [19]

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Right. Yes, the other way I was thinking about this is, when you said you’ve got a kind of business at end of the program that you’re implementing, you’ll have a business kind of rightsized for 20% lower volumes. Is that kind of an indication of where — that you can generate sort of similar to prior margins on volumes that are 20% lower? I know there’s kind of mix effect in there between the 2 divisions or…

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [20]

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The mix will have an impact. I think we need to get back to you, Andre, actually with the — I don’t want to make a guess. But it’s of that order of magnitude, that I just don’t want to make a guess.

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Andre Kukhnin, Crédit Suisse AG, Research Division – Mechanical Engineering Capital Goods Analyst [21]

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Are you rightsizing kind of aerospace to lower than 20% within the mix of kind of overall program?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [22]

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No, no. Because, in fact, aerospace, we expect to be back to 2019 levels by the end of 2023. So no, we’re not. We’re actually — we’re rightsizing far more in AGI than we are in aerospace. I mean we are going to have a 2020, 2021 sort of high interest in aerospace. But we don’t see it being 20% down once we get to the end of ’23. In fact, quite the opposite.

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Andre Kukhnin, Crédit Suisse AG, Research Division – Mechanical Engineering Capital Goods Analyst [23]

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Great. And the final thing on aerospace, since Jonathan’s question. Therefore, it’s quite a lot going on in there, as you said. What I wonder is that we’ve got, on one hand, destocking there and on the other hand, maybe we have not quite sort of mark-to-market to where the production rates are. If you do kind of mark-to-market to where the production rates are for the relevant platforms for Bodycote, what would your kind of current run rate be versus the minus, I think, 36% that you reported?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [24]

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Well, mark-to-market, not quite sure what you’re talking about.

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Andre Kukhnin, Crédit Suisse AG, Research Division – Mechanical Engineering Capital Goods Analyst [25]

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If you just look at what your kind of underlying platforms are being produced at, what would that mean for you as a year-on-year decline? Because what is between this kind of inventory adjustments sort of noise that will balance out.

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [26]

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No. But I mean, the rate that we’re seeing is, at the moment, is a combination of wide body down 50% and the narrow body down 20% to 30%, depending whether you’re in U.S., 20%, or France, 30%. So that’s where you end up with our Q2 decline.

And we — that’s actually going to be picking up. We don’t get eye exposure to retail engines. It’s not really to the planes themselves. And the engine production rates are climbing at a higher rate than demand for platforms, which is an interesting phenomenon.

So we get very detailed forecasts from our customers 5 years out. It’s just very detailed and then longer. And the — I suppose if there is an issue in there in any way, shape or form, their actual planned production rates, they’re smoothing the plane build rates somewhat because they’re trying to keep their supply chains intact. So in ’21, you’re seeing a higher production of engines forecast from these guys than actually planes to go on.

So they’re seeing — they’re actually forecasting an inventory build in the near-term because they actually take it down to the plane build rates, that 50% and 30%. If they stayed at those levels, there would be a whole slew of guys and supply chain to guard the business. And so the engine manufacturers are actually producing at somewhat higher level, and then the plane body is catching up a little bit later. So that inventory effect that you’re referring to is not straightforward.

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Andre Kukhnin, Crédit Suisse AG, Research Division – Mechanical Engineering Capital Goods Analyst [27]

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That’s really interesting, and that’s exactly what I was — because it looks like your customers are building their own inventory, but they’re reducing inventory of ours then you wouldn’t have been down 36% because your run rate is in line with the frames?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [28]

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Exactly. But it’s just a phasing issue. And the customers are starting building it.

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Andre Kukhnin, Crédit Suisse AG, Research Division – Mechanical Engineering Capital Goods Analyst [29]

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Got it. And if I may, just very final one. Has anything changed on M&A in the last couple of months since the last time you updated us? Has there been any movement?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [30]

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Yes. That’s an interesting one. So first, the 2 categories. One is private equity owned. So there are a couple of assets that have come on the market somewhat earlier than you would have expected, the PE. And I think the PE guys are looking at the fact that there debt situation somewhat die because their cash flows are quite a lot down. And I think it’s quite important to note that our cash flow performance and our cost savings are not replicated typically across this industry. We are quite different from other people that are out there. So the PE guys are in trouble, and they put some assets on the market, which we’re looking at.

Interesting though, the private owners, they really aren’t budgeting at the moment. And the reason for that is government support. And I would — if I was a betting man, I put money on the fact that once government support in terms of small business loans disappears, which it will in due course, we will then see the smaller private-owned companies coming on the market. So that’s kind of the state to play at the moment. It’s somewhat of a hiatus on the very small companies, the private owner-managed companies because they’re getting government support whereas the PE firms are actually going to market. Hope that answers your question.

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Operator [31]

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(Operator Instructions) We have now got a question from Alexander Virgo of Bank of America.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division – Director [32]

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I just wanted to pick up on your point there about resizing the business to 20% below 2019 levels in capacity terms. What sort of temporary flexibility do you have? Is there — I think you mentioned 10% as the proportion of the employees that — temporary employees that you have already let go as a function of COVID. I’m just wondering if that’s a good indication of the plus/minus flexibility that you have in that kind of structural adjustment. And then I wondered if you could maybe give us an indication of the structural adjustment by end market. I appreciate you might not want to go into that much detail. But it would be helpful just to understand which areas of your business are driving that more than others. Because I’m guessing, obviously, what you said so far on aerospace is maybe not quite so bad in aerospace.

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [33]

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Yes. Alexander, sorry about this, but I missed the first part of your question. It was a little bit interrupted there. Could you say it again, please?

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division – Director [34]

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Sure. Sorry. So you called structural adjustment in your cost base to 20% below 2019 levels. And I was just wondering what the flexibility you have in the — when you hire people on temporary contracts to adjust for flexibility on short-term demand prospects, I suppose, what’s the plus/minus flexibility in that structural adjustment, if that makes sense? So I’m just trying to get a feel for it because, obviously, 20% versus 2019 sounds quite a big number. But obviously, if we get some recovery, hopefully at least, won’t be quite as bad as that. So I’m just trying to understand the flexibility you have with temporary workforce. And then I wondered if you could provide a bit of color on the end markets.

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [35]

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Yes. So the 20% number is sort of broad brush. I mean it’s less in some areas. I mean for example, in emerging markets, we are not expecting — well, we haven’t planned at being down 20%. In fact, in China, quite the opposite. But the 20% has been sort of more in the Western markets in our older established markets. The blend — if you look at the permanent headcount reduction, which is part of this issue, it’s 17% in total across the whole group, and most of that is in automotive. So clearly, there’s a lot less reduction in aerospace because — and that’s the confusion. I think the aerospace is going to have a near-term downturn, but it’s actually going to turn up so as they restock, which is what we addressed on the last question there.

In terms of by end market by geography, we bring the temporaries on in the areas where it’s very difficult to let people go. So we don’t have temporaries in North America to speak of. What we do is we have temporaries in Germany and France, primarily. And we find that as a percentage of group headcount, typically, it’s around 15%. It’s the kind of level that we can run at maximum. You don’t want to go above that. But we run at about 15% maximum. So if you say we’re down to 17% in terms of workforce at the moment, we could add 15% of temporaries back on to that to take us up to close to where we were before.

In terms of further downturn, I think that’s also worth bearing in mind. It’s very straightforward for us to reduce headcount, which is our primary cost, of course, in North America and most of Europe, outside of France and Germany. It’s a relatively straightforward exercise. And having DM beside Germany now in our business is quite a bit. And for the social plans to — in France, our downside flexibility in terms of permanent labor, if we had to, is greater than it was before.

So overall, I think a 15% upside on temporaries, and then we’re into high in people full time.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division – Director [36]

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Okay. That’s really helpful. So I’m guessing, therefore, that auto structurally is — capacity-wise, is going to be down mid- to high-20s or 30% relative to ’19 levels?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [37]

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No. 20%. We’ve (inaudible). Yes, we’re planning to — But wait, just make sure we’ve not let the equipment go. So we still have the physical capacity. It’s just the people involved and the number of sites that — we’ve consolidated sites, but we still have the same amount of equipment.

I’d just like to answer questions come through on the web, if I might, at this point. The question is coming from Celine at UBS. The — so the question is, what is the — are the suppliers at risk in aerospace?

I think I might have confused you there. We don’t really have suppliers in the normal sense because we don’t process materials at all. So our suppliers are basically our employees. And also energy and industrial gases. There’s no risk on our supply chain. The risks in the supply chain I was talking about were our customer’s supply chain in terms of, often the people we deal with because we will deal with — from the OEM all the way down to supply chain. So there are people at risk in the customer’s supply chain. And one of the things that’s happened during this sort of engine super cycle, as they call it, the expansion in aerospace, there’s been a lot of PE going into the aerospace supply chain, and they are definitely at risk. They are strapped. So there’s a lot of maneuvering going on in that area, plus the fact there’s just too much capacity in the supply chain for the medium term. So definitely, customers out there. It’s nice to note that we don’t generally have much money at risk with the customers because we’ve basically been paid, sort of, on a monthly basis, and we do day-by-day work. It’s not like we got order books to also worry about. But we keep quite a strong eye on our receivables, and our track record on receivables is excellent.

So it’s really the customer’s supplies that are risk, not ours. And I think the rest of your questions, I’ve answered. So if we go back to you, operator, any more phone calls?

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Operator [38]

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Our next question is from Andrew Douglas of Jefferies.

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Andrew Douglas, Jefferies LLC, Research Division – Equity Analyst [39]

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Most of my questions have been answered. But I’ve just got a few short ones, if I may. Can you just give us an update on CapEx plans, CapEx plans going forward, particularly with regard to expansion of CapEx and maybe emerging markets? Has COVID resulted in any change of thought there? Or is that still kind of plan going ahead?

Secondly, just — I’m interested in when we should have a decision on the first half ’20 dividend. I appreciate that you’ve made a big move on the final dividend now, but when will we get the decision on the first half ’21? And secondly — sorry, thirdly, summer shutdowns. I’m with an assumption that actually summer shutdowns this year might not be quite as bad as prior years. I appreciate that doesn’t have a huge amount of impact on profitability over the summer. But is that a fair comment as we’re looking to the summer?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [40]

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So I’ll take the shutdowns and the Capex, and Dominique can do the dividend. The shutdowns issue is, at the moment, a big, big unknown. Normally what people do with the shutdown is their maintenance shut. But as a lot of these guys shut down, particularly in the automotive industry, I mean they’re slamming doors shut, in aerospace, GE, shut that. They did do a lot of maintenance work during that time. And indeed, when they opened up, they really only opened up to do maintenance work to start with. So the maintenance aspect of the summer shutdowns is probably not there as a strong push. It will depend on what the demand levels are, and that’s something that we just can’t call.

If demand levels were up or rising, then we would expect shorter summer shuts. But it’s hard to call it at this point in time. Because we just don’t have that kind of degree of granularity out there.

In terms of the Capex, so I think it’s fair to say that the big chunks of CapEx that we do are in HIP services. So the big chunky vessels for $20 million a piece, so that kind of numbers. And I think there is a deferral on that side because with the — HIP services business is primarily focused but the major part of it, at least, is on aerospace. And I think the general demand is lower. So we will not need as much expansion capacity as we were previously planning.

And so those chunk of pieces are probably being delayed 2 to 3 years as a result of that. In terms of the rest of it, I think that it will depend on the trade patterns and how they work. I mean if we actually are heading for a world where there’s less free trade globally and more sort of intra-continental trade, than you will see us investing at a greater rate in the emerging markets than we have up to now. I mean we’ve been pushing head hard. But I think our greenfield program might actually tick up, because if we’re seeing more local trade, both in, for example, North America and China, you can imagine that we’ll be putting more capacity on the ground in those areas. But generally, that’s the only kind of influence as we can see on our CapEx program. As far as the dividend is concerned…

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Dominique Robert de Lisle Yates, Bodycote plc – CFO & Executive Director [41]

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So Andy, we’re paying the deferred dividend in September. So the thinking is that any interim dividend would probably be paid at the beginning of next year. So we’ll make the determination on that later this year.

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Andrew Douglas, Jefferies LLC, Research Division – Equity Analyst [42]

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And just a quick question here. Have you guys done an impairment review of half year? And if so, any thoughts?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [43]

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Yes, we have. I mean the rules are that if your sales trigger the requirement for an impairment review, you have to do an impairment review midyear. So we’ve done that because our rules say that if you’re more than 10% below budget. And bear in mind, our budget was a pre-pandemic budget, then you — that triggers an impairment view. So all of our — 2 of our cash-generating units triggered that review requirement. We’ve, therefore, impairment tested all of our CGUs. And none of them required any intent.

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Operator [44]

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We have another question from Harry Philips of Peel Hunt.

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Harry Philips, Peel Hunt LLP, Research Division – Analyst [45]

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In a sense just refer to it, Stephen, in terms of heating. How flexible is heating away from aerospace? Is it easy to find alternative sort of markets, if you like?

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [46]

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Yes. That’s an interesting one. So there are alternative markets. And one of the things that this has caused us to do, we’ve been just swimming along and thinking aerospace is going on forever. It has caused us to look harder elsewhere. And indeed, there are some markets where we have a very low market share, believe it or not in HIP services, one which is — well, I won’t go into details. But the — we have some areas where we have low market share that is being served by a different means that we can target. But the primary areas, I think we’ll go for is a HIP piedmont business because the HIP piedmont business uses HIP services capacity, the big HIP.

And if you think in terms of — in sales value, the yield for piedmont is 4x that of the HIP services. And there’s a big, big market to go for in piedmont. So that’s where we will be concentrating. Plus, we’ll we look at some of these other markets that we’ve ignored where we can do some substitute work there.

So there is some — but clearly, aerospace is phenomenally important. But I think, in overall terms, it just means that we won’t need the new capacity that we were planning on in the future. It will just defer it by 2, 3 years, that’s all.

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Operator [47]

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(Operator Instructions)

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [48]

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I was hoping we’re going to get another technical question that is a terrible one. But apparently not.

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Operator [49]

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At this moment, we have no further questions. I hand it back to you, Stephen.

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Stephen C. Harris, Bodycote plc – Group CEO & Executive Director [50]

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Okay. Well, thanks very much, everybody. Appreciate it. And obviously, if you have any further questions, as you think about things or get time to digest it, please do give us a call. So all of that, thanks very much.

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Dominique Robert de Lisle Yates, Bodycote plc – CFO & Executive Director [51]

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Thank you.

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Operator [52]

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Ladies and gentlemen, this concludes today’s conference. You may now disconnect your lines.