Smiths Group accelerating growth with organic revenue up 3.4%

Growth

Smiths Group plc (LON:SMIN) has announced its half year results for the six months ended 31 January 2022.

HIGHLIGHTS

·    Good growth delivered in H1

o Organic revenue +3.4%2

o Strong demand across most end markets with good order growth

·    Strong profit conversion and earnings growth

o Underlying operating profit up +11.1%3 and underlying operating profit margin +110bps3

o Successfully managed cost inflation

o Underlying EPS +13.8%3,5 for continuing operations

·    Good cash generation and strong returns

o 93%4 operating cash conversion despite the challenging supply chain environment

o ROCE7 up +370bps reflecting higher profitability and working capital discipline

·    More focused portfolio following earlier completion of Smiths Medical sale

o £1bn profit on disposal with further value to come from ICU shareholding and potential earnout

o Stronger balance sheet enabling continued investment for growth, the early repayment of a $400m bond and capital returns

o Over 25% of the £742m share buyback already completed

·    Demonstrating meaningful progress against our strategic priorities and targets

o Accelerated organic growth

o Advancing the new phase of the Smiths Excellence System, improving speed and efficiency

o Heightened focus on sustainability and maximising accompanying growth opportunities

Headline1H1 2022H1 2021ReportedUnderlying3
Continuing operations5
Revenue£1,192m£1,150m+3.7%+3.4%
Operating profit£189m£166m+13.9%+11.1%
       Operating profit margin15.9%14.4%+150bps+110bps
       Basic EPSOperating cash conversion4ROCE730.6p93%14.0%26.0p158%10.3%+17.7% +370bps+13.8%
Total Group6
Profit for the half year (after tax)£171m£171m0.0%+10.4%
Basic EPS43.0p42.9p+0.2%+10.7%
StatutoryH1 2022H1 2021Reported
Continuing operations5
Revenue£1,192m£1,150m+3.7%
Operating profit£157m£143m+9.8%
Total Group6
Profit for the half year (after tax)£1,123m£129m+771%
Basic EPS283.9p32.3p+779%
Dividend per share12.3p11.7p+5.0%

OUTLOOK

·    Strong demand in most customer end markets; but expect more challenging Aviation OE market in the near-term

·    Clear strategy with improving execution

·    Continued good operating leverage

·    Further new product launches on schedule

·    Geopolitical and macroeconomic environment creating uncertainty; navigating supply chain challenges and increasing inflation

·    Maintaining full year guidance of 3% organic revenue growth

Paul Keel, Smiths Group Chief Executive, commented:

“We are shocked and appalled by the tragic events in Ukraine.  We join with the broader international community in calling for peace.  In response to the conflict, we have suspended sales into Russia.  Our highest priority is ensuring the safety, security and wellbeing of our colleagues in the region; all are safe and continue to receive full support from Smiths.  Our business in the region represented less than 1% of Smiths’ revenues in FY2021.

Our performance in the first half demonstrates the meaningful progress we are making against our strategy.  We accelerated Smiths’ organic revenue growth to +3.4% and converted that into even stronger profit and earnings growth, despite supply chain challenges and cost inflation. 

Improvement in the first half centred on the levers we are pulling to accelerate our growth and consistently deliver results, underpinned by our focus on continuous operational excellence and investment in our people and culture.

An important milestone for us was completing the sale of Smiths Medical, ahead of schedule.  This has enabled us to simplify our business, focus on our higher-performing, more strategically-aligned industrial technology core, whilst investing for growth, deleveraging and returning surplus capital to our shareholders. 

We’re encouraged by our good progress and I thank my 14,000 colleagues around the world who make it happen. Notwithstanding the significant uncertainty in the geopolitical and macroeconomic environment, we maintain the 3% organic revenue growth guidance we previously provided for the full year.  We are making good headway towards the medium-term targets set at our Capital Markets Event last year, as we move with greater pace to realise our significant potential.” 

Statutory reporting

Statutory reporting takes account of all items excluded from headline performance.

See accounting policies for an explanation of the presentation of results and note 3 to the financial statements for an analysis of non-headline items.

Definitions

The following definitions are applied throughout the financial report:
1 Headline: In addition to statutory reporting, the Group reports on a headline basis. Definitions of headline metrics, and information about the adjustments to statutory measures, are provided in note 3 to the financial statements.
2 Organic modifies headline revenue to exclude the effects of foreign exchange and acquisitions.

Underlying modifies headline performance to exclude the effects of foreign exchange, acquisitions, restructuring costs, the share buyback and include depreciation and amortisation of discontinued operations.

Operating cash conversion excludes the impact of restructuring spend.
5 Continuing operations exclude Smiths Medical which is accounted for as ‘discontinued operations – businesses held for sale’. Discontinued operations are defined in note 17 to the financial statements.
6 Total Group comprises continuing operations and discontinued operations.
7 Alternative Performance Measures (“APMs”) are defined in note 19 to the financial statements.

OUR PURPOSE

We are pioneers of progress – improving our world through smarter engineering.  Smarter engineering means helping to solve the toughest problems, for our customers, our communities and ourselves.  We help to create a safer, more efficient and better-connected world.  At the heart of all that we achieved during the first half of FY2022, and all we will continue to achieve moving forward, is our purpose.

OUR PRIORITIES AND TARGETS

Smiths is intrinsically strong with world-class engineering, leading positions in critical markets, distinctive global capabilities and underpinned by a powerful financial framework.  At our Capital Markets Event in November 2021, we set out how Smiths will deliver performance in line with our significant capabilities and potential by focusing on three priorities:

1) growing faster

2) executing better and

3) doing more to inspire and empower our people.

This is our focused plan, the Smiths Value Engine, through which we will deliver the medium-term targets that we have set:

Organic Revenue Growth  4-6% (with additional upside from M&A)
EPS Growth  7-10% (with additional upside from M&A)
ROCE  15-17%
Operating Profit Margin  18-20%
Operating Cash Conversion  100%+

These targets are underpinned by Smiths’ operational KPIs and environmental targets, including a commitment to Net Zero emissions from operations by 2040.

H1 2022 BUSINESS PERFORMANCE

The commentary below refers to Smiths Group performance excluding Smiths Medical, which was accounted for as ‘discontinued operations’ before the sale completed on 6 January 2022.  

  £mH1 2021ForeignexchangeLower restructuring chargesAcquisitionsUnderlyingmovementH1 2022
Revenue1,150(38)42381,192
Headline operating profit166(7)11118189
Headline operating profit margin14.4%(10)bps+10bps+40bps+110bps15.9%

In H1 we made good progress against our focused plan. We are growing faster, with organic revenue up +3.4%; executing better, with operating profit margins up +110bps; and doing more to inspire and empower our people; all whilst moving swiftly to build on our strong foundation in ESG.

GROWTH

Growth is our biggest upside to value creation, and we demonstrated encouraging progress in H1.

Organic revenue growth (by division)H1 2022
John Crane+5.1%
Smiths Detection(7.2)%
Flex-Tek+10.0%
Smiths Interconnect+12.9%
Smiths Group+3.4%

In H1, we delivered organic revenue growth of +3.4% (+£38m).  Growth remained strong in Flex-Tek (+10.0%) and Smiths Interconnect (+12.9%) and we delivered acceleration in John Crane (+5.1% vs (10.4)% in H1 2021).  As expected, Smiths Detection contracted in the period
((7.2)%), reflecting the challenging Aviation OE market.

Revenue grew +3.7% on a reported basis, to £1,192m (H1 2021: £1,150m). This included £(38)m of adverse foreign exchange translation, and +£42m from the acquisition of Royal Metal Products LLC (“Royal Metal”) in February 2021.

Growth acceleration is being driven by four actionable levers, the first being strong execution to maximise underlying market expansion that we see across most of our portfolio.   

Our business operates across four major global end markets: General Industrial, Safety & Security, Energy, and Aerospace.    

Smiths H1 2022 growthin our primary end markets% of SmithsrevenueSmiths organic growthH1 2022
General Industrial40%+5.7%
Safety & Security32%(3.5)%
Energy21%+7.5%
Aerospace7%+16.7%
Smiths Group100%+3.4%

Smiths’ organic revenue growth in our largest end market, General Industrial (40% of Group revenue), was +5.7% in H1.  This was driven by original equipment (“OE”) and aftermarket (“AM”) growth for John Crane in segments like chemical processing, pulp & paper, and mining.  Demand for Flex-Tek’s construction products and Smiths Interconnect’s semiconductor test solutions remains strong.  Smiths’ organic revenue growth in the Safety & Security market was down (3.5)%, reflecting the performance from Smiths Detection and growth from Smiths Interconnect’s defence related products.  We grew +7.5% in Energy markets as demand continues to ramp quickly.  Our fastest growth in the first half of +16.7% came in Aerospace, as accelerating aircraft builds drove strong demand for Flex-Tek and Smiths Interconnect’s aerospace solutions. Our strong market positions, coupled with the balanced market exposure we have across our portfolio are distinctive long-term advantages for Smiths.

Our second lever for faster growth is improved new product development and commercialisation.  We are focused on bringing our innovations to market more quickly and commercialising them more effectively.   We launched nine high-impact new products in H1.  One example is our space qualified connectors, which enable high-speed, reliable data processing for communication satellites and GPS navigation systems. Another example is a new seal for demanding pipelines that protects the environment from harmful leaks.  

In support of our growing new product pipeline, we invested £52m in R&D in the first half, an increase of 8% over H1 2021.  Roughly 90% of this recorded in the income statement, with the balance being capitalised.  In addition to growing a new product pipeline, we are seeing increased return on investment.  The Vitality Index7, which measures the percentage of total revenue derived from products launched in the last five years, was 28.6% for the period. This measure has been redefined to cover a five-year period to better reflect the launch profiles of our products.  

Investment in capex of £(32)m (H1 2021: £(29)m) remained stable and represents 1.3x depreciation and amortisation (H1 2021: 1.2x) as we continue to invest for growth.

Our third growth lever is building out priority adjacencies.  Each of our four businesses has well-scoped plans to grow beyond their strong core market positions.  In H1 we launched John Crane SENSE® Turbo, a sensor enabled dry gas seal.  This ground-breaking product is an extension of the John Crane SENSE® platform, which uses sensors and machine learning to monitor networks, helping customers prevent leaks, reduce downtime, and meet their environmental commitments. In Smiths Detection, we launched iCMORE Currency, an extension of our automated detection algorithm.  The iCMORE software can automatically find hazards or illicit goods within inspected cargo, baggage or palleted goods, and is now able to detect multiple currencies, supporting the fight against global money laundering.

Our fourth growth lever is using disciplined M&A to augment our organic growth focus.  Royal Metal, which we acquired in February 2021 for $107m is a good example.  During H1, the acquisition contributed £42m of revenue and £11m of operating profit.  Since acquisition, the business has grown at an annualised rate of +45%, a sharp acceleration versus prior ownership.  This strong growth reflects the benefits of complementary HVAC portfolios, synergies in distribution, and positive pricing.   We have converted accelerated top line growth into even stronger operating profit expansion, up +109% on an annualised basis, driven by improved operational efficiencies as well as raw material inflation pass through. We are currently exploring a number of other M&A opportunities across the Group. 

In January, we successfully completed the sale of Smiths Medical to ICU Medical, Inc. (“ICU”), several months earlier than expected.  This was our largest portfolio move in over a decade and positions the Group even more strongly to access the growth available in our industrial technology core.  The sale generated a profit on disposal of £1.0bn, with immediate net cash proceeds of £1.35bn and further value to come from a potential $0.1bn earnout and our stake in ICU, which is recognised as a £0.4bn asset on the balance sheet.  Net cash stood at £262m at the end of January 2022.

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In light of our strong balance sheet and cashflows, we initiated a £742m share buyback in advance of the transaction completion.   As at 24 March 2022, we had completed over 25% of the programme.   At the current run-rate and share price, the average shares in issue for FY2022 would fall from 396m to 387m and we would complete the programme in early calendar 2023, with ~350m shares remaining in issue (a 12% reduction).  For more information on the divestment, please see note 17 of the financial statements.

EXECUTION

Improved execution is our second key priority.

In H1, the Group delivered strong profit conversion, with headline operating profit up +£18m or +11.1% on an underlying basis. Headline operating profit increased +13.9% on a reported basis, to £189m (H1 2021: £166m). This included +£14m from improved volumes, +£1m from successful management of price and inflation, +£8m benefit from the Group’s strategic restructuring programme, +£11m from acquisitions and +£1m benefit of no further restructuring charges, all of which more than offset a £(7)m impact from adverse foreign exchange and £(5)m of reinvestment in growth.  Headline operating profit margin increased +150bps on a reported basis.

Operating profit marginH1 2022 ReportedReported change  Underlying change
John Crane20.0%+20bps+20bps
Smiths Detection11.5%(110)bps(80)bps
Flex-Tek20.9%+240bps+150bps
Smiths Interconnect16.9%+570bps+490bps
Smiths Group15.9%+150bps+110bps

The £(32)m difference between headline operating profit of £189m and statutory operating profit of £157m is non-headline items as defined in note 3 of the financial statements. The largest constituents relate to amortisation of acquired intangible assets, pension equalisation, asbestos litigation in John Crane, Inc and subrogation claims in Titeflex Corporation. Statutory operating profit of £157m was £14m higher than last year (H1 2021: £143m), reflecting higher headline profit partially offset by higher non-headline charges.

We have made good progress on advancing the next phase of the Smiths Excellence System, “SES 2.0”.  SES 2.0 represents a step change in pace, culture and approach to operational excellence.   It builds on the foundations of the Smiths Excellence System that was launched in 2018 and advances it from operational excellence theory to results focused execution.   In support of this advancement,  we have put in place resourcing across all divisions, rolled out additional training and tools, and established delivery targets aligned to our external commitments.  We are moving faster, executing better, and doing even more to inspire and empower our people.

PEOPLE

Our primary focus is always keeping our colleagues safe and well.  We have a strong and robust safety culture and strive for a zero-harm workplace, with safety considerations fully integrated into all of our activities.  Our Recordable Incident Rate has been at or below 0.41 for the previous five years, roughly 50% better than US industry averages for the top quartile of similar manufacturers.   

In recent weeks our particular focus has been on ensuring the safety, security and wellbeing of our colleagues in the Russia/Ukraine region.  We remain in regular contact with this group and continue to pay salaries and benefits.  In response to the tragic events, we have stopped all sales into Russia.  Smiths has also made a donation to the Red Cross to support the vital work they are doing for the people of Ukraine, and we have implemented a donation matching scheme for our colleagues who also wish to contribute.

Leveraging the breadth and depth of talent across the Group is a competitive differentiator for Smiths and we actively promote the cross-pollination of talent between the divisions and central functions. 18% of appointments made during the first half were internal candidates and over 20 appointments were cross-business moves, demonstrating how colleagues build careers at Smiths and how skills are transferred across the Group.  

In support of our focus on diversity and inclusion, we completed diversity and inclusion workshops with over 800 colleagues in the last 6 months, in 11 languages across 21 countries, and we established an extended leadership team comprised of the top 200 leaders; 33% of this group is female.

OUR ESG APPROACH

Sustainability is central to each of our priorities.

We are helping our customers meet their environmental targets by developing products and services targeted at climate risk, energy transition and other environmental needs.  For example, John Crane’s long experience of reducing leaks enables it to play a leading role in customer efficiency including decarbonisation through its methane reduction initiative.  Flex-Tek is developing new high temperature heaters to support a significant reduction of CO2 emissions generated in the production of steel.  We are also focused on making our products more sustainable through attention to raw materials, supply chain, durability, repairability, circularity and end-of-life outcomes. 

We continue proactively to manage reductions in the environmental impact of our operations and manufacturing processes.  We first implemented environmental targets in 2007.  Since then, we have reduced greenhouse gas (“GHG”) emissions in our operations by 60%, water usage by 53% and non-recyclable waste by 63%.   Around 60% of the electricity currently used in our operations now comes from renewable sources, and we are currently assessing a promising list of locations for onsite renewable energy installation.

Building on this strong ESG foundation, we have re-energised our focus on sustainability to both multiply our sustainability influence and maximise the accompanying growth opportunities.

During the period, we established a Science, Sustainability & Excellence Committee of the Board, chaired by Dame Ann Dowling, to provide guidance and supervision of our sustainability strategy.  In addition, we now have a dedicated Chief Sustainability Officer in place who is driving our sustainability strategy and targets through the business.   To support the delivery of our sustainability strategy, targets and time horizons, executive compensation is now linked to our sustainability targets, with an ESG metric (GHG reductions) included in our long-term incentive programme.

Alongside all of this, we have set and communicated 2024 environmental goals, an important step to support the delivery of our commitment to Net Zero GHG Emissions from operations by 2040.  We have a clear roadmap for how we will achieve this (as published on our website). It details the path we are taking to achieve Net Zero Scope 1 and 2 emissions from operations by 2040 and, furthermore, our ambition to achieve Net Zero Scope 1, 2 and 3 emissions by 2050.  In H1, we have modelled and mapped our approach, signing on to the Science Based Targets Initiative and the UN Race to Zero pledge.

OTHER FINANCIAL MATTERS

Finance income/(costs)

Headline finance costs of £(19)m (H1 2021: £(21)m) were £2m lower than last year due to lower swap interest rates. Statutory finance costs were £3m income (H1 2021: £(59)m), mainly due to a £22m foreign exchange gain on an intercompany loan with Smiths Medical (H1 2021: £(38)m); the matching credit in discontinued operations nets out to zero in total Group earnings.

Taxation

The headline tax charge for continuing operations for H1 of £48m (H1 2021: £41m) represents an effective rate of 28% (FY2021: 29%). 

Non-headline taxation items of £4m relate to amortisation of acquisition related intangible assets, legacy pension scheme arrangements, litigation provisions and non-headline finance items.  The statutory effective tax rate was 28% (FY2021: 35%).  Please refer to notes 3 and 5 of the financial statements for further details.

Profit after tax and EPS5

Headline profit after tax increased by +17.3% on a reported basis.  Headline basic EPS was up +13.8% on an underlying basis and +17.7% on a reported basis, driven by the strong operational performance.

Discontinued operations – Smiths Medical

On 6 January 2022, the Group completed the sale of Smiths Medical to ICU Medical, Inc. (“ICU Medical”) at an enterprise value of $2.7bn and an equity value of $2.4bn after adjustments for debt, liabilities and working capital.

For the 5 months that Smiths Medical remained in the Group, it delivered headline profit after tax of £49m.

The difference between statutory and headline profit after tax is £958m, which includes £1,021m gain on disposal, £(33)m of Medfusion regulatory remediation costs,  £(14)m from the impairment of investments, £(22)m of foreign exchange losses on the intercompany loan with Smiths Group (continuing operations), and +£6m of tax credit on these non-headline items. Please refer to notes 3 and 17 of the financial statements for further details.

Total Group6 profit after tax and EPS

Statutory profit after tax for the total Group increased by +770.5% to £1,123m
(H1 2021: £129m) which included the profit on sale of Smiths Medical. Statutory basic EPS was up +778.9% to 283.9p (H1 2021: 32.3p).

Cash-flow

Headline operating cash-flow5,7 was £167m (H1 2021: £254m) with operating cash conversion4 of 93% (H1 2021: 158%); a good result in the current challenging supply chain environment.

Free cash-flow5 was £91m (H1 2021: £163m) a decrease of £72m, reflecting the lower operating cash performance against a very strong performance in H1 2021. Free cash-flow as a percentage of operating profit was 48% (H1 2021: 98%). This metric has now been added as a key performance measure to our long-term incentive programmes, to ensure closer alignment with shareholder interests.

Statutory net cash inflow from operating activities for the total Group6 was £182m (H1 2021: £262m). See note 15 to the financial statements for a reconciliation of headline operating cash-flow to statutory cash-flow.  

Debt

Net cash7 at 31 January 2022 was £262m (FY2021: £(1,018)m6) as a result of the proceeds received from the sale of Smiths Medical. Headline EBITDA7 for the 12 months to 31 January 2022 excluding restructuring costs for continuing operations was £500m. 

Gross debt7 was £1,485m (FY2021: £1,546m). There are no financial covenants associated with this debt and the weighted average maturity was 2.4 years.  On 17 February 2022, we redeemed in full the $400m bond that was due to mature in October 2022.  The next maturity is due in April 2023.  Cash balances increased to £1,710m (FY2021: £405m).

An $800m (c.£597m at the period-end exchange rate) revolving credit facility (“RCF”) remains undrawn and matures in November 2024.  The only financial covenant relates to interest cover, under which EBITDA must be greater than or equal to 3 times net interest. Taking cash and the RCF together, total liquidity was over £2bn at the end of the period.

High operating cash conversion and a strong balance sheet are the foundations of our financial framework, ensuring we are well positioned to deliver sustainable, long-term shareholder value.

Pensions

The net accounting pension surplus increased to £435m (FY2021: £413m). 

Both main UK schemes (SIPS and TIGPS) are estimated to be in surplus on the Technical Provisions funding basis.  Given the strength of the funding positions, no cash contributions are currently being made to these schemes.  The Group and the UK Trustees continue to work together to achieve full buy-out funding for both schemes.

The two main UK pension schemes and the US pension plan are well positioned to withstand a volatile market environment.  They are well hedged against changes in interest and inflation rates.  Over 90% of their assets are invested in third-party annuities, government bonds, investment grade credit or cash, with no remaining equity investments.  As at 31 January 2022, over 40% of the UK liabilities had been de-risked through the purchase of annuities from third party insurers.

Pension contributions in H1 were £(6)m (H1 2021: £(19)m). For FY2022, we expect total cash contributions to be around £(12)m (including funded US schemes, unfunded schemes and post-retirement healthcare plans).

Dividend

The Group maintains a progressive dividend policy, aiming to increase dividends in line with long-term underlying growth in earnings and cash-flow, with the objective of maintaining a minimum dividend cover6 of around 2 times.  The policy enables us to retain sufficient cash-flow to finance investment in the drivers of growth and meet our financial obligations.  In setting the level of dividend payments, the Board considers prevailing economic conditions and future investment plans.

Reflecting the Group’s strong performance and financial position, the Board is recommending an interim dividend of 12.3p, a year-on-year increase of 5% (H1 2021: 11.7p).  The interim dividend will be paid on 13 May 2022 to shareholders on the register at close of business on 8 April 2022.

The Company offers a Dividend Reinvestment Plan (DRIP) enabling shareholders to use their cash dividend to buy further shares in the Company – see our website for details.  To participate in the DRIP, shareholders must submit their election notice to be received by 27 April 2022 (“the Election Date”). Elections received after the Election Date will apply to dividends paid after 13 May 2022.  Purchases under the DRIP are made on, or as soon as practicable after, the dividend payment date and at prevailing market prices. 

Return on capital employed (ROCE)5,7 

ROCE increased +370bps to 14.0% (H1 2021: 10.3%).  This reflects higher profitability during the period and continued working capital discipline. For further detail of its calculation, please refer to note 19 to the financial statements.

Foreign exchange

The results of overseas operations are translated into sterling at average exchange rates. Net assets are translated at period-end rates.   Smiths Group is exposed to foreign exchange movements, mainly the US Dollar and the Euro.  The principal exchange rates, expressed in terms of the value of Sterling, are shown in the following table.

Average rates
31 Jan 2022(6 months)
Average rates
31 Jan 2021(6 months)
Period-end rates
31 Jan 2022
Period-end rates
31 Jan 2021
USD1.361.321.341.37
EUR1.181.111.201.13

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