Discoverie Group (LSE:DSCV) — Full Year Results

0:01 Good afternoon, ladies and gentlemen, and welcome to the Discovery Group PLC full year results investor presentation. Throughout this recorded presentation, investors will be in listen only mode. Questions are encouraged. They can be submitted at any time via the q and a tab that's just situated on the right hand corner of your screen. Please just simply type in your questions and press send. The company may not be in a position to answer every question it receives during the meeting itself. However, the company can review all questions submitted today, and we'll publish those responses where it's appropriate to do so. Before we begin, we would just like to submit the following poll. If you could give that your kind attention, I'm sure the company would be most grateful. And I would now like to hand you over to the team from DSCVRY Group PLC. Nick, good afternoon, sir. Good afternoon, Jude. Thank you very much. Good afternoon, everybody. Thank you for joining this call.

0:47 I'm Nick Jeffries, CEO of Discovery Group joined by Simon Gibbons, Group CFO. So we're just gonna take you through a couple of slides here, which are the highlights of the group's annual results for the year ended March this year, and then we'll pause and throw it open to the floor for questions. So the the the key news of this set of results was that operating profits were up by 8% at constant exchange rates, delivering a record operating margin at an EBIT margin of 14.3%, which is an increase of a 120 basis points over the prior year. As a result of that, we've come very close in the second half to reaching our, early reaching our target of 15.

1:32 Our second half operating margin was 14.8%, so only 20 basis points shy of that target in two years' time. As a result of that, we've increased our target for the next five years to 17%, and that represents more than ten years now of annual growth in operating profits and margins. Particularly important was that these results were achieved amidst an environment of some widespread inventory destocking. Sales for the group were 2% lower at constant exchange rate, 3% reported, and that was organically 7% lower, 10% in the first half, two 4% in the second half. So we're particularly pleased that the the flexible production environment flexible production model that we have enables costs to partly come down rather naturally as volumes are lower, and that's alongside certain other cluster synergies that we've created alongside robust gross margin meant that we were able to mitigate much of the lower sales through to the bottom line.

2:36 And then at the end of the year, our q four organic orders increased by 15% in both divisions. That was a very strong finish to the year and reflected, in the most part, the destocking coming to an end across sort of most of our segments. And as soon as destocking comes to an end, customers needs to start reordering at the at a rate that matches their sell through typically. And that typically leads as it did here to a a pretty pretty significant increase in orders. So all of that led to a year result of adjusted earnings per share up 5%. That's despite the higher interest charges, although they're now coming down. Europe's down to about 2%, and other other rates are both in The UK and potentially US are set to be reducing over the medium term.

3:26 So we're very pleased with that, and that was a 15% increase in the second half. And then, finally, on this slide, the cash flow, our free cash flow was up 9% to just over 40,000,000, representing a conversion rate of a 106%. So, very, very strong cash generative model. Additionally, we reduced our carbon emissions, against our baseline target by 59%. That's since calendar year 2021. We're on track for 65% reduction this year or to have reduced by 65% by the end of this year, and that puts us on track for achieving net zero by 2030. We made two acquisitions during the year for a £29,000,000 consideration.

4:14 A company called High Volt that makes high voltage components for particularly typically medical applications. And then in January of this year, we acquired Burstow, which is a sensor business based in Germany. We also completed the sale of the solar business. We actually started that in the prior year, but the proceeds from that came through this year. So that was the solar business based in The Netherlands. We have many acquisitions in the pipeline. We'll probably talk about this in the q and a a little bit more. Safe to say at this stage that we have up to £80,000,000 worth of funding capacity to fund acquisitions through the end of this fiscal year. Our gearing enters the new year at 1.3, so we're in a good place to to make more acquisitions as the conditions allow.

5:07 So that is a just a headline really the headlines really of the performance for the year. The business is in very good shape, notwithstanding the uncertain economic environment that we're in, and I'll come on to talk about the outlook later. But, we are in, you know, good shape in a in a challenging world. So I think with that, I'll pause and, let's open the floor to questions. Perfect, guys. If I may just jump back in there, and thank you very much indeed for that update. Ladies and gentlemen, please do continue to submit your questions just by using the q and a panel that's situated on the right hand corner of your screen. But just while the team take a few moments to review those questions that have been submitted already, I'd just like to remind you that a recording of this presentation along with a copy of the slides and the published q and a can all be accessed via your investor dashboard.

5:57 Guys, as you can see there, we have received a number of questions throughout today's session, and thank you to all of those on the call for taking the time to submit their questions. But, Nick, Simon, at this point, if I may just hand to you just to read out those questions and give your responses where it's appropriate to do so. And if I pick up from you at the end, that'd be great. Thank you. Great. Thanks. Okay. Thanks. All of your questions coming in. I'll I'll just read them out. Think it's the easiest thing. Yep. So first one is around Asia. How strategic is Asia in your future manufacturing footprint and sales outlook? Asia is a very important part of our manufacturing footprint and will remain so. We have, two plants in China, two in India, a very large one in Sri Lanka, another one in Thailand. So we have a big manufacturing footprint.

6:48 And over the last sort of few years, we've moved from being a sort of China for the world or Asia for the world model to a much more decentralized model. China is still very important to us, and we most of our customers in China, it should be said, are western based multinationals. So we tend to supply the Chinese base of a global customer of ours there. So it will remain very important. Yeah. Thanks. Moving on to interest rate sensitivity. So you've mentioned high interest rate sensitivity. How would a further one percentage point reduction in base rates change your investment plans? Well, actually, you know, in terms of the 1% reduction, in terms of the group as a whole, we we end up getting a nice EPS boost, about 3% EPS boost for an annualized 1%.

7:44 I think in terms of acquisitions, you know, I think yeah. You know, the deals that we do in any case are accretive. You know, they've they've always been accretive even at the higher rates. They've come down since then. So that they would just be, you know, more, you know, more accretive, you know, which is which is obviously, you know, good in terms of, you know, generating the, you know, profit and, you know, cash flow from our perspective. So, you know, I think, you know, that's yep. Yep. Yep. Okay. Manufacturing flexibility. With manufacturing flexibility being a recurring theme, are there plans to further automate or digitalize production?

8:31 So manufacturing flexibility is, right as is rightly said, a key feature of our footprint. We have sites all over the world in all of the main regions in which we operate, and we're able to move production between those sites according to, you know, various conditions. We customer requests, environmental transport considerations, and political considerations. For example, during Trump, Trump won when China when tariffs were introduced on China over the following twelve months, We transitioned all of our production in China for The US away from China to, in those in that case, India India and Mexico. So yeah. So that flexibility is very important. Automation is not a big part of our production environment, and that's principally because the volumes that we make have a very high batch mix high mix batch element to them. And automation doesn't lend itself to that. So we will remain with a largely nonautomated production capability, which has the benefit of being much lower in CapEx as well as being more flexible.

9:41 Very clear. Next up, target markets. Which of your five target markets, that's medical renewables, transportation, security, and industrial connectivity, which of those do you expect to be the primary growth engine in FY '26, fiscal year twenty six? It'll be two sectors. Industrial and connectivity and security will be the best growing. I mean, the reason for having the five target markets is because the the growth rates ebb and flow between the five segments, the timing of the and the timing of them varies as well. So you end up smoothing the overall growth profile of the business. But but yeah. Currently, it'll be industrial connectivity and security. Industrial connectivity is far bigger than security at the moment, though.

10:30 Yeah. Just worth, yeah, worth highlighting, you know, in the pack, we've shown an h one, h two split, which shows that industrial connectivity and security grew 9% in the second half, and it was down sort of 10% in in the first half. So you can sort of see that that that same Yeah. Let's pull that up there. You can see that on the the slide you should be able to see in front of you. That just reflects what Simon says. So the bar chart's on the right, h one at the bottom, and you can see the the difference between the first and second half is quite pronounced, which is unusual for it to be that pronounced. Minus 10 in the industrial connectivity and security sector up to plus nine, and then minus five to plus 13 amongst the major customers.

11:23 So, yeah, quite a swing. Okay. Next on to customer destocking. How did customer destocking affect your own inventory levels and working capital? So we've been bringing the working capital back into line over the last eighteen months. And, obviously, the the the the slower this our sales app number, then the longer it takes to adjust the working capital. There's a chart here on slide 31. It's just 28, sorry, that we will just bring up, which do you wanna come on that? Yeah. Yeah.

12:09 Yeah. Yeah. So you can you can put it full screen. Yes. I think that's how Yes. Oh, is it? Okay. Yeah. Okay. So you can see you can see the chart and, you know, the line is working capital as a percentage of sales. At at the end, you can see that the working capital percentage actually organically dipped down to 16 and a half from 16.6 to 16.5. You know, typically, the way that working capital works is, you know, periods of of high growth, you know, we it's easier to sort of turn the inventory over. And therefore, you can see that in sort of f y '22, you know, the rates got down to around about 14% and then rising up during this period of slow growth.

13:02 You know, it's got to a particular higher point, and that's the 17.2 is actually a benefit to us because that includes acquisitions. Typically, acquisitions have more working capital than than than our group. You know, we we will work that hard and we will, you know, we could probably bring about two to three million hours of the out of one of the companies that we acquired, which will be a nice a nice benefit from our perspective. So expect to see as we start to move towards a period of growth, our working capital percentage will come down. Conversely, you know, we need to invest in working capital as we as we grow, and therefore, the cash conversion rates actually will reduce more towards the 90% conversion level compared to the 106% that Nick talked about upfront in a period of of lower growth.

13:59 Okay. Great. Next up, congratulations on a on a strong set of results. Thank you very much. A couple of questions. Actually, one of them, I think we've just covered a bit with destocking, but the first question is, can you please explain how the strong organic order growth seen in q four will translate into organic revenue growth going forward? Yeah. So there's typically a three to six month lag between the orders coming in and the sales going out. So, obviously, the 15% organic growth in q four is bringing the order level back up to the level of of sales. So we will we expect that to flow through over q one and into q two, and that along with the additional orders that come through in the same over q one and q two will is what ultimately drives the sales figure.

14:56 So we expect that the organic sales will, yes, continue to steadily improve. Great. And then so the second question was where are we in destocking, which I think sort of covered. But which businesses have further to go? So the control sector overall, which is so it's worth saying that the destocking was most accentuated in The US over the last year. The US was down 16% organically, which, by the way, is a very wide you know, that's a very widespread part of a very widespread trend. The electronic components industry, globally has seen a similar trend, very widespread destocking, particularly in The US. For us, it was minus 16%, which was off the back of 20% growth organic the prior year. So a certain sort of rebalancing going on. And it's the the outstanding part of the destocking is in medical health care applications in The US, which are sort of in the final stages of working off their inventory.

15:54 Excellent. Next one, congrats on a on a great result. Your confidence is palpable. Can you continue growing EPS at similar rates to the past five years? I hope so. We all hope so. So yeah. Thank you. Our plan is to broadly, roughly double APS every five years. Actually, if you look at the macro data, the you know, we're big followers of non financial money supply, and that data has been rising and growing quite strongly over the past several months and underpins sort of growth in industrial output sort of from the autumn period this year onwards. So we are confident that we're in the sort of the right stage of the cycle. We've got this short term wind, is the headwind, which is the tariff uncertainty, but, you know, we we think that that will clear clear eventually, and then the macro data will come back to the floor and should, we hope, offset more than offset the, you know, the the the bump in the road of the tariffs.

16:59 So, yeah, we're very confident, and then we'll make decent acquisitions as well. We have a huge pipeline of acquisitions. So, you know, we're very confident in the effectiveness of our model, and we'll keep pumping away at it. Yeah. Certainly. And just a couple of follow ons from that. So to what extent is your growing scale contributing to your attractiveness to customers, or is it your breadth of technology offer rather than scale? So the attractiveness to our customers primarily is our technical solutions. That that is what gets us in the door. And then what really locks us in is our ability to manufacture that product consistently to the high quality that is required consistently, repeatedly, you know, week in, week out for months and years, and to supply that and and duplicate manufacturing and move manufacturing internationally as conditions require.

17:56 That's what really locks us in with major customers and the sort of the the the more we do with them, the more they seem to appreciate that and and and and do more business with us. So we have very, very long term customer relationships as a result of that. Yeah. Next up, AI. Are you exploring AI enhanced product development or embedded smart sensing, IoT features in your portfolio? We already use AI in some of our product development in areas like some of the basic software coding. There's an awful lot of grunt work on software that needs to be done, which AI can do rather than, having to get a person to do it.

18:43 We use AI in some of our, other sort of hardware development areas such as bill of material development and things like that. So, yeah, so that's increasingly being used. Not in all of our development centers yet, but certainly in some of them. We use so we're well we have quite a significant presence in, but, well, smart sensing, IoT, robotic towards yeah. And AI controlled environments. That's one of the reasons we bought an antenna company a couple of years ago, because it's a big play into that, sort of remote monitoring and control sector. So, yes, it's a it's an important area for us. Great. Thanks. Next up, margins. So what is what's the bridge to your new margin target?

19:31 So so roughly speaking, so from from the where we're at now to 17%, roughly 50 roughly two thirds will come from acquisitions and a third will come from organic development. Maybe just worth putting up slide nine. So there's a slide in the page which just showed you the progression of margin over the last seven years. I think it's Oh, hang on. Sorry. Yeah. I suppose. Got it. You know, that shows, you know, the increase of of 6.7 percentage points in the last seven years. And roughly, in this case, fifty fifty has come from from organic and and another 50% from acquisitions. So as Nick said, I think we see it going with the two thirds going forward, but you can just see the the breadth of initiatives certainly in the organic that we've that we've undertaken to achieve achieve that type of growth.

20:31 Great. Thanks. Next up, tariffs, the obligatory tariff question. How might tariffs affect the the business going forward? So the direct of the direct effect of tariffs, we think, will be negligible. We make 52% of our sales into The US are made in The US. We have seven production sites there with plenty of capacity to do more. We do import some materials for our production in North America, principally printed circuit boards, but we're in the process of resourcing those. So we expect to be able to offset most of the the tariff effect on our raw materials purchasing.

21:22 But any residual cost effects that come from that will be passed through in our pricing. It's a very minimal proportion of our cost of goods sold, so the effect on pricing will be very small, actually. The in it's so the the direct effects of the tariffs are pretty small, very small. The it's the indirect effects that are the bigger considerations. So all the while, there is uncertainty around the tariff levels, then that leads customers, particularly American customers, to potentially delay their activities until certainty has been reached. And so so that's the that's sort of the bigger question, but, of course, every company every company has that same same concern. Great.

22:07 Thanks, Nick. Next up, acquisitions. So can you discuss the pipeline of acquisitions in terms of target markets, size, firepower, willingness willingness to increase leverage, etcetera? Yeah. So we have a very active acquisition pipeline. We have an m and a team here at the center that works with our operating companies and independently to identify opportunities in all of our target market areas and and all the principal geographies in which we operate. At the moment, amidst the tariff uncertainty, we've paused developing any acquisition opportunities that are in or have high exposure to The US and are therefore centering more of our activities on Europe at the moment. We yeah. And we're working across all of the target market areas. I mean, and security is one of those sectors in particular that is quite active at the moment.

23:01 It just yeah. Just in terms of the the from a leverage point of view, you know, we're very, you know, cash generative company anyway. We're capitalized on cash generative. So our gearing, you'll see, comes down, you know, quickly. In terms of gearing at the moment, Nick led with that. We're at 1.3 gear. That gives us 80 around 80,000,000 that we could spend firepower to take it up to two times. You know, we wouldn't be looking to go, you know, beyond that. The one and a half to two time range is is what we've, you know, we've stuck with, you know, for the last, you know, number of years has always been our sort of target range. So it gives us plenty of of risk gap between that and the the the covenant is is a three time covenant. So, yeah, we we wouldn't go close to getting beyond two.

23:54 Very clear. Thanks. Okay. Here's gotta be careful here. Is there is may may want for Simon to answer, not not Nick because we get carried away. Is the 17% margin target ceiling? If not, what do you think it could be? Well, we did yeah. We you know, we we've we've basically raised our margin target. This is a tenth raise that we've we've done since we started. The two of us have been at this for, you know, around fifteen years. So we've we've we've raised every time we've achieved our margin target, we've raised it. I'd say this is our tenth raise. So we would anticipate hitting that target within within the the period we set, this five year period. And, you know, beyond that, we would we would look to raise it again. So, absolutely, we'd we'd want to take it beyond that.

24:47 Okay. Next up is target markets again. You announced security as a new target market this year. How is that doing so so far? Do you see it to be a major contributor of growth going forward? Yes. Yes. I do. And, yes, it's going very well. It's now the in the in the year that's gone, it's the second largest area for design wins for us, both in commercial and sort of governmental and defense areas. So, yeah, it's a it's a growing area. It has very similar characteristics actually to our other target markets in that it has, you know, good range of high quality large multinational customers that are sort of receptive to our value proposition, and it's obviously got a particular market hit a tailwind to go with it as well. So, yeah, it's doing very well, and it will be a major contributor to growth. Yes.

25:38 Great. Well, thanks all for your questions. They did we're sort of drying up a bit now on the question front. So if anyone has any more to ask, then fire away now. Otherwise, I think it's time to hand back to Nick and Simon for closing remarks. Okay. Oh, hang on. Here's one. Okay. Yeah. They'll be they'll probably be a little blurry now. So consensus expectations for for fiscal year twenty six seems to be very modest. Low single digit profit in EPS growth. Any comments you'd like to share? Well, all I would say is, yes, towards ever thus. We keep our numbers as conservative as we can with the intention fully of delivering at the moment. And if we're doing better than that, then we'll upgrade them along the way.

26:23 The markets are so jittery these days that we find that that's the better way to to to manage it and avoid negative surprises. Brilliant. Thanks. That seems to have exhausted the questions. Okay. Yeah. Any final remarks? No. I think that's it. I just I would just finish by saying that the, you know, the growth drivers for the business both organically and inorganically are in very good shape. We have clear pipelines that are very well set. Our design wins, we haven't actually discussed on this call much, but design wins are in very strong shape as well. So we're you know, notwithstanding this is somewhat volatile markets that we've got particularly in the short term related to tariffs, the business is in very good shape and well set for further organic and inorganic development. So we feel well set for the future. So, yeah, so thank you for your attention, and, yeah, appreciate the interest.

27:21 Perfect. Nick, Simon, if I may just jump back in there, thank you very much indeed for updating investors this afternoon. Could I please ask investors not to close this session? Shall now be automatically redirected for the opportunity to provide your feedback in order that the management team can really better understand your views and expectations. This will only take a few moments to complete, but I'm sure it'd be greatly valued by the company. On behalf of the management team of DSCVRY GROUP PLC, we would like to thank you for attending today's presentation. That now concludes today's session. So good afternoon to you all.