Edited Transcript of ITRK.L earnings conference call or presentation 3-Mar-20 8:00am GMT

Our full year adjusted EPS of 211.7p was up 6.8% at actual currency and 5.2% at constant currency. In line with our dividend policy that targets a payout ratio of circa 50% of earnings, we’ve announced a proposed final dividend of 71.6p, taking the full year dividend to 105.8p, an increase year-on-year of 6.8%. Our cash conversion was strong with a free cash flow of GBP 380 million, up 8% year-on-year. We are pleased with the consistent performance delivery of the group, underpinned by our strong earnings model and our disciplined performance approach. In the last 5 years, on a CAGR basis, we have grown our revenue by 7.4%, operating profit by 9.6%, our free cash flow by 15.5% and our dividend by 16.6%. During that period, our margin improved by 170 basis points.

In 2019, we have benefited from a broad-based organic revenue growth of 3.3% at constant currency with a run rate improvement of 60 basis points in the second half. We’ve delivered an organic growth performance of 2.3% in our Products division, 4.1% in our Trade division and 5.7% in our Resource division.

2019 marks the fifth consecutive year of margin progression at constant rate, and we’ve delivered last year a margin improvement of 10 basis points at constant currency. We believe there is scope for further margin improvement, and we remain very focused on margin-accretive revenue growth.

Our cash performance was strong with a cash conversion of 127%. Our financial net debt-to-EBITDA ratio was 1x.

I will now hand over to Ross, who will take you through our financial results in detail.

——————————————————————————–

Ross McCluskey, Intertek Group plc – Group CFO & Executive Director [3]

——————————————————————————–

Thank you, André, and good morning, everyone. As André has described, we have accelerated our revenue growth with robust EPS growth and a strong cash performance. I will now take you through some of the details underlying our results.

In summary, the group has delivered good revenue growth in 2019 with 3.3% organic revenue growth at constant currencies, further progress on margin and an EPS growth of 5.2%. Free cash flow generation remained strong with a cash conversion of 127%. The positive FX impact on total revenue was 180 basis points for the year, driven by the depreciation of the sterling. At constant rates, operating profit was up 5.2% to GBP 513.3 million, and margin was up by 10 basis points. Our operating profit was up 6.5% at actual rates. So overall, fully diluted EPS grew 13.4p to 211.7p, being up 6.8% at actual rates and 5.2% at constant rates.

I’ll now take you through the high-level margin performance by division. And as André said, the group recorded an operating margin in 2019 of 17.2%, stable year-on-year at actual rates and up by 10 basis points at constant currency. Organic margin was stable at constant rates with 10 basis points improvement driven by Resources margin, offset by a 10 basis points movement from our Trade business. Acquisitions contributed 10 basis points of margin improvement, while FX had a negative 10 basis points impact on the group margin.

Now turning to group cash flow and net debt. Our disciplined focus on cash management continued throughout the period. Cash flow from operations was GBP 652 million, up 8.1% year-on-year, with working capital down 8% year-on-year, reducing to 3.4% of revenue. We invested GBP 116.8 million in CapEx, in line with 2018 to expand our market coverage and develop innovative ATIC solutions. Adjusted free cash flow in the period was GBP 395.3 million. And the acquisition that we made in 2019 led to an outflow of GBP 16.9 million. Financial net debt stood at GBP 629.4 million. And including the IFRS 16 lease liability, total net debt was GBP 875.4 million.

Now turning to our financial guidance for 2020. On an IFRS 16 basis, the expected net finance cost will be in the range of GBP 35 million to GBP 38 million. The effective tax rate is expected to be in the 25.5% to 26.0% range, a minority interest between GBP 21 million and GBP 23 million. For your models, I’ve set out the number of shares for the EPS calculation, and we’re currently expecting full year CapEx to be in the range of GBP 130 million to GBP 140 million. And for financial net debt, we expect to close the year at GBP 520 million to GBP 550 million, although noting this guidance is stated before any M&A, any material movements in FX and, of course, the impact of coronavirus.

I would now like to hand you back over to André.

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [4]

——————————————————————————–

Thank you, Ross, for a comprehensive review of our ’19 results. So today, I would like to give you an update on where we are on our good-to-great journey. You will remember that 5 years ago, this is what we said we will do when we presented our 5×5 differentiated strategy for growth. In the last 5 years, we have made continuous progress on strategy and performance, and I would like to start with a short video that will show you how we have operationalized our strategy inside the group.

(presentation)

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [5]

——————————————————————————–

The operationalization of our strategy, as you know, has delivered strong results over the years. Between 2014 and 2019, our revenue has grown by 43%, operating margin has increased from 15.5% to 17.2%. Our adjusted EPS has grown by 60%. Our cash generation has more than doubled. Now it’s GBP 380 million. Our return on invested capital has progressed from 16.3% to 22.8%, and we’ve improved our employee productivity. And I would like to take this opportunity to recognize and thank all of my colleagues around the world who are delivering sustainable value through their unmatched expertise and customer-centric approach every single day.

As you’ve seen in our video, we’ve made disciplined investment in attractive growth and margin sectors. We’ve invested GBP 560 million in CapEx over the last 5 years to better serve our clients with additional market coverage, capacity extension and, importantly, innovative solutions. We’ve also invested in M&A selectively, GBP 710 million for the period, making acquisitions in attractive sectors: connected world, sustainability, people assurance, food and hospitality. We’ve invested both organically and inorganically in breakthrough innovative SaaS platforms like Alchemy and Inlight that provide a tremendous level of service to our customers.

A few words on Alchemy. 2019 was the first full year of Alchemy at Intertek, and we are really, really pleased to have welcomed Alchemy inside the group. We have inherited a passionate organization, working with leading-edge technology in the food sector, both factories and multi-sites. And I’m pleased to report that we are on target from a financial standpoint, and we are really pleased with the progress that we are making on commercial activities, frankly, reflecting the strong demand for Alchemy SaaS platforms. Our 5-year guidance that we published last year remains unchanged, and that includes an EBIT margin of over 25% in year 5.

Moving forward, we’ll continue to execute our 5×5 differentiated strategy for growth that you know so well. Our mid- to long-term strategic goals remain unchanged, focusing on our employees and superior customer service to deliver margin-accretive revenue growth. Strong cash conversion remains a core priority, and we’ll continue to pursue a disciplined capital allocation strategy.

The growth opportunities in the quality assurance market, the way we define it, are very attractive. The total quality assurance market is worth $250 billion, yet only 20% of this market is currently outsourced. The global operations of corporations are more and more complex, and that drives more demand for end-to-end quality assurance services as companies increase their focus on systemic, operational and corporate risk. This untapped market potential is really exciting, and this is all about what companies do not do today and we’ll start doing to improve the quality, safety and sustainability of their operations.

Based on the attractive structural growth drivers in the global quality assurance market, we expect the group to deliver GDP+ organic revenue growth in real terms. We expect our Products division, which represents 78% of group’s earnings, to grow ahead of global GDP. We expect our Trade division that represents 16% of the group’s earnings to grow at a rate broadly similar to GDP through the cycle. The growth prospects in our Resource divisions, which represents 6% of our earnings, are improving with increased investments in oil and gas exploration and production activities as well as in renewable energies.

We are extremely well positioned to seize these exciting growth opportunities ahead, capitalizing on our core strengths. Our strength #1 is our Total Quality Assurance superior customer service. Our second strength is our powerful portfolio. Our high-quality compounder earnings model is a real core strength of Intertek. We have a passionate customer-centric organization and a disciplined performance management.

Innovating in attractive growth and margin sectors is an integral part of our strategy, helping our clients resolve the increased complexity they face in their global operations to deliver their products and services with the highest quality, safety and sustainability standards. We continue to identify margin-accretive innovations, leveraging our industry-leading expertise.

Intertek operates with a high-quality compounder earnings model. Our capital-light business model, combined with our customer-centric organization, enables us to react quickly to new growth opportunities by following the supply chain of our customers in new geographies. Our approach to value creation is based on the compounding effect year-after-year of margin-accretive revenue growth, strong cash generation and disciplined investment in growth.

We believe in the value of disciplined capital allocation. Our first priority is to support organic growth through capital expenditures and investment in working capital by offering new services and developing our client relationships. Typically, we target circa 5% of revenue in CapEx. Our second priority is to deliver sustainable returns for our shareholders through the payment of progressive dividends. In recognition of our highly cash-generative business model, our strong financial position, the Board’s confidence in attractive long-term growth prospects for the group and its ability to fund continued growth investments, our targeted dividend payout ratio is circa 50%. And our third priority is, of course, to pursue M&A activities in attractive growth and margin sectors to offer superior customer service to our clients and deliver good returns.

One of our core strengths at Intertek is our performance management discipline. As we talked about over the years, our performance approach is based on leading and lagging indicators for every single team in the world of Intertek, from every single site upward in the organization. The insights we get from our NPS surveys, more than 7,000 interviews a month are tremendous. They enable us to drive superior customer service with a continuous improvement operational approach. Our incentive system for our colleagues is aligned with the interest of our shareholders, targeting revenue, profit, margin, cash and return on invested capital. Importantly, we believe in the growth of our people, and we give all of our people the opportunity to learn and grow using our leading global learning platform, 10X Way!

Sustainability is central to our 5×5 differential strategy for growth. We believe that doing business the right way with a systemic approach is the only way to deliver our corporate goals and create sustainable value creation for all stakeholders. To do that, we follow precise processes and standard operating procedures in 10 areas of our sustainability approach. It starts with quality and safety, risk management, enterprise security, compliance, environment, people and culture, communities, governance, financial and disclosures.

Now that we’ve reviewed where we are from a strategic standpoint, I’d just like to spend some time now on the outlook for 2020, and let’s start with an update on the coronavirus. We’ve made regular updates on our website since February 3, and let me recap where we are. We operate more than 80 sites in China with the following business lines: Electrical, Softlines, Hardlines, Food, Business Assurance, Supplier Management, Transportation Technology, Caleb Brett, Agriculture, Minerals and Industry Services. We have almost 12,000 employees in Mainland China and Hong Kong. And in Wuhan, which is obviously the area where the Hubei province is locked down, we only have one site, a branch office with 30 employees working for TT, Food, BA and Supply Management.

The actions we have taken in China include health alerts and guidance to our colleagues, including a detailed coronavirus control and prevention manual. In accordance with this manual, we’ve put in place hygiene and other protection measures in the workplace and at customer locations for field-based colleagues, including the use of face masks and the use of hand sanitizers and gloves. When conducting field-based audits and inspections for factories, vendors or customer sites, we are asking our partners to first confirm that they have no suspected case of coronavirus and that they have taken the precautionary measures before we deploy our people.

We’ve put a complex — complete restriction on international travel from and to China and Hong Kong. We’ve also issued a prevention guide to all of our people globally, in line with the World Health Organization guidance to minimize the risk of infection. As you know, this is a developing situation, and we’ll provide you with regular updates moving forward.

Let’s now discuss the outlook for 2020. As I said earlier, we’ve delivered 5 years of consecutive progress on revenue, EPS and cash, exiting 2019 with improved organic growth momentum. We are well positioned to continue to deliver sustained value creation for all stakeholders. Prior to the outbreak of the coronavirus, we were targeting the group to deliver continuous progress in 2020 with broad-based, good organic growth across the group at constant currency based on good organic growth in Products and Trade, robust growth in Resources, moderate margin progression at the group level and, of course, strong cash conversion.

We are not immune to the impact of the coronavirus, and our 2020 performance will be affected by the temporary disruption to the supply chain of our clients in China and any impact it might have on global trade activities. It is too early to quantify the impact of the coronavirus, and we’ll provide an update at a later stage during the year once we have more visibility on the full resumption of the supply chain of our clients. We will remain, of course, very disciplined on cash conversion. We’ll continue to invest in growth, and we expect our full year CapEx investments to be circa GBP 130 million to GBP 140 million.

A quick update on currencies for your model. The average sterling rate in the last 3 months applied to the full year results of 2019 would reduce our revenue and earnings by circa 250 bps.

Let’s now discuss our divisions. And given difficulty in quantifying the impact of coronavirus, we are not providing business line guidance for 2020 at this time. In 2019, our Products business delivered a robust performance with continuous margin-accretive revenue growth. Our revenue growth at constant rate was 4.6%, and our organic revenue growth was 2.3%, driven by broad-based revenue growth across business lines and geographies. We’ve delivered robust operating profit of GBP 398.6 million, up 5.7% at constant currency, enabling us to deliver a margin of 22.2%, up 20 basis points compared to last year, as we benefited from positive operating leverage and disciplined cost management.

Our Softlines business reported an organic growth performance slightly below last year. We benefit from the investment we made to support the expansion of our customers into new markets, seizing the exciting growth opportunities in the footwear sector and continuing to leverage the strong demand from our customers for chemical testing. However, as discussed in November, the lack of visibility around the outcome of negotiation on tariffs has resulted in a delay in the launch of new products in the second half.

Our Hardlines and Toy businesses continue to take advantage of our strong global account relationships, the expansion of our customers’ supply chain into new markets and our innovative approach to factory inspection. We’ve delivered solid organic revenue growth performance across our main markets of Greater China, India and Vietnam. We’ve delivered good organic revenue growth in our Electrical & Connected World business, driven by higher regulatory standards in energy efficiencies and by the increased demand for wireless devices and cybersecurity.

Our Business Assurance business delivered good organic revenue growth as we continue to benefit from the increased focus of corporations on risk management, resulting in strong growth in supply chain audit and increased consumer and government focus on ethical and sustainable supply. Driven by the growing demand for more environmental-friendly and higher-quality buildings and infrastructure in the U.S. market, our Building & Construction business reported good organic revenue growth.

Our Transportation Technology business delivered robust organic revenue, benefiting from our clients’ investments in new powertrain to lower emissions and increase fuel efficiencies. We continue to benefit from the increased focus of corporations on food safety and delivered good organic revenue growth in our Food business. We delivered an organic revenue performance slightly below last year in our Chemicals & Pharma business due to the baseline effect driven by the 2019 REACH registration deadline.

In the mid to long term, our Products division will continue to benefit from exciting structural growth drivers, including product variety; brand and supply chain expansion; product innovation and regulation; the growing demand for quality and sustainability from developed and emerging markets; the acceleration of e-commerce as a new sales channel; and the increased corporate focus on risk.

Let’s now move to Trade. Our Trade-related businesses benefit from acceleration of its revenue momentum with 4.5% growth and 4.1% organic revenue growth at constant rate, driven by broad-based revenue growth across business lines and geographies. We’ve delivered a stable operating profit of GBP 83.5 million, enabling us to deliver an operating margin of 12.3%, down 60 basis points versus last year, driven by a portfolio mix effect within GTS and challenging trading conditions within Caleb Brett in North America and Northern Europe.

Our Caleb Brett business reported good organic revenue growth, reflecting the structural growth drivers in the crude oil and refined product global trading markets. Our Government & Trade Services business delivered double-digit organic revenue growth, driven by growth from existing contracts and new contracts. Our AgriWorld business delivered good organic revenue growth, driven by a broad-based growth performance across our global inspection businesses. In the medium to long term, our Trade division will continue to benefit from regional and global trade flow as well as the increased customer focus on quality, quality control and supply chain risk management.

Let’s now discuss Resource. We benefit from an improved revenue momentum with margin accretion in our Resource-related businesses. We have reported a robust organic revenue growth, up year-on-year by 5.7% at constant rate, and we’ve delivered an operating profit of GBP 31.2 million, which was up year-on-year by 16%, enabling us to deliver a margin of 6.1%, up year-on-year by 50 basis points.

We’ve delivered robust organic revenue growth in our CapEx Inspection business, which benefited from the increased investment of our customers in exploration and production activities as well as the win of new clients in several geographies. The demand for OpEx Maintenance Services remained stable. We benefit from robust organic revenue growth in our Mineral business, driven by stronger demand for testing and inspections across most geographies. In the medium to long term, our Resource division will continue to benefit from investment in exploration and production of oil, investment in renewable energies and minerals to meet the demand of the growing population around the world.

In summary, we are pleased with the progress we have made both on strategy and performance in the last 5 years, and this is a real tribute to the quality of our organization. The opportunities for growth ahead are exciting, and we are well positioned to seize these with our superior Total Quality Assurance customer service. We’ll remain very focused on delivering sustainable value for all stakeholders, executing our 5×5 strategy with operating discipline.

Thank you for your attention this morning, and we’ll now answer any questions you might have.

================================================================================

Questions and Answers

——————————————————————————–

Operator [1]

——————————————————————————–

(Operator Instructions) Our first question comes from the line of Suhasini Varanasi from Goldman Sachs.

——————————————————————————–

Suhasini Varanasi, Goldman Sachs Group Inc., Research Division – Equity Analyst [2]

——————————————————————————–

I don’t know if you cannot quantify the impact from the coronavirus, but can you give some color on how February has been in terms of, let’s say, trading activity in China and Hong Kong or in terms of, let’s say, how many employees have actually come back to work out by the end of February? That would be helpful. And regarding the virus impact, can you talk about what kind of leverage you have on the cost base to mitigate any impact to margins? Are you thinking about taking any cost-saving measures?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [3]

——————————————————————————–

Okay. Thank you very much for your question. I guess we’re going to have quite a few questions on the coronavirus. So let me just give you a bit of color on how we are handling the situation. As you can imagine, we are very close to our Chinese colleagues, and I personally chair a daily session to track the progress of all of our activities in Greater China, given the fact that China and Hong Kong represent 19% of our group revenues based on the 2018 annual report data. As I said in the call, of course, we are not immune to the impact that these temporary supply chain disruptions is creating in the world of our clients because this is basically the main point here. And as I said, trying to be helpful as much as we can, it is not possible to quantify precisely the impact.

And I will give you a few data points. As you know, the Chinese New Year holiday was postponed — the return was postponed, I should say, to February 10, and we basically resumed operations from February 10 onward in Mainland China. Hong Kong operates with a different calendar, and we resumed operation on January 29, as expected. Unfortunately, we had one case of — one of our employees inside operations being identified having the virus, and we decided for the health and safety of everyone inside operations in Hong Kong to basically close the operations for 14 days to give everybody the time to go through the required quarantine period. We reopened in Hong Kong on the 25th of February. And Hong Kong is now, like Mainland China, fully operational. Our Taiwan operations has resumed operation on January 30, as expected.

What’s really important for all of us to consider on how to think about the next steps is twofold. One is it’s a function of how many employees do we have inside of our operations back to resume work. This is, if you want, our own capacity, if you want, and I will give you some data points on that. But this also applies to our clients. And there is another important factor for clients is what is the availability they have in their supply chain of all the components and parts from their Tier 1, Tier 2, Tier 3 suppliers. And if you visualize our operations in China, as I said, we have close to 12,000 colleagues. We operate in more than 80 sites. Just to give you a sense, we work for close to 130,000, 140,000 clients in Greater China.

So it’s not only a question of how much capacity does Intertek have, and I’ll come back to this point, but it’s how much of the capacity of clients can basically resume. Because for them, it’s a function of 2 dimensions: How many of their employees are back to work; and do they have the parts from the Tier 1, Tier 2, Tier 3 suppliers. That’s why it’s very difficult to quantify how long it’s going to take and what it means. Having said that, I can assure you that everybody in China is focused on being back at work, trying to resume as much as possible their operations, but it will take time. And I will keep you informed throughout the next few months where we got more visibility.

So what does it mean for Intertek? We’ve seen a gradual progress of capacity build up in our operations, and we will see — also see a gradual progress of the supply chain resumptions from all of our clients. But just to give you a sense, we restarted operations on February 10. And in the first week after the Chinese New Year, we basically had about 20% to 30% of our employees back to work. And you will recall that after the Chinese New Year, for lots of provinces, if anyone had traveled outside the province, they had to go on quarantine for 2 weeks. That was basically mandatory. That was what created the delay in the capacity buildup. In the week of February 17, we saw some further progress, and we had about 35% to 45% of our capacity back. And last week, for the week of February 24, we had about 55% to 65%.

So that gives you a day — an idea of how much capacity we have rebuilt step by step. What I want to really stress here, this is the Intertek capacity, i.e., how much can we produce for our clients. It’s not an indication of our revenues because, as I explained before, our clients also need to rebuild their supply chain. And it’s complex, it’s taking time and nobody can really quantify that. What we are doing for our clients is very important, making sure that we have the utmost hygiene and safety standards inside our operations. And when we go and visit our clients, we are obviously available 24/7 to help them resume their work when they need to start testing for their export activities. And we basically cannot really quantify and determine when all of our suppliers — customers are going to be back to 100% capacity.

Now one thing that I would like to stress is we are a B2B business. We are not a B2C business. So what matters for us is the resumption of the supply chains of our clients. And you know that so well. If you’re in a B2C business — if you’re in a restaurant business, if you don’t go out for dinner because you’re worried about certain things, you’re not going to have 2 dinners the next night. But in our business, we have an order book, and it is usual in our industry to make sure that we add extra shifts to serve our clients and meet the demand in the order book we have. So there will be some catch-up down the road in China. Obviously, I cannot say more than that.

So the last question you asked in terms of what type of cost savings could we pursue if we want to reduce the impact of the lost revenue. Our view is that we have had a very good year last year in China. We had targeted our China businesses to continue to grow at a very healthy rate. And all our costs, fixed and variable, are geared to deliver that growth. It’s not possible to save cost during what’s going to be a temporary reduction of the supply chain because we want to be there when our clients need us to resume the production of testing activities for them. So thanks for asking that question. I used the opportunity to give you a broader perspective on where we are, and I’ll take any additional questions from anyone.

——————————————————————————–

Suhasini Varanasi, Goldman Sachs Group Inc., Research Division – Equity Analyst [4]

——————————————————————————–

Can I just ask one follow-up, please? You mentioned that at the end of February, you’ve got 55% to 65% capacity back at your businesses in China. Would it be fair to say that within your customer base, the ramp-up has not been very strong and, therefore, you have not been able to use your existing employee capacity to service all your clients that basically, your customers are still ramping up and so your employees are basically sitting — some of them are sitting idle? Is that fair to say?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [5]

——————————————————————————–

Look, I know exactly where you’re trying to go. Today is not a trading statement about 2020. I’m trying to give you the parameters to think through how to look at your model. As I said, this is Intertek capacity, and I’m not making any statement on our revenue in January, February. We’ll do that in due time when we announce our results for the first 4 months in May. So I’m not trying to be difficult. I just want to be precise. This is our own capacity numbers, which I think gives you a sense of where we are.

I would also ask you to think through that there are different levels of business resumptions in the supply chains of our clients in China. There is a bit of data out there. We have to be all very careful with the data being published. But it’s going to take some time, and we have to be patient. And I think the best way is to wait for the numbers to be released.

——————————————————————————–

Operator [6]

——————————————————————————–

The next question comes from the line of Paul Sullivan from Barclays.

——————————————————————————–

Paul Daniel Alexander Sullivan, Barclays Bank PLC, Research Division – Director & Analyst [7]

——————————————————————————–

Just following up on that. Can you hear me?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [8]

——————————————————————————–

Yes, yes.

——————————————————————————–

Paul Daniel Alexander Sullivan, Barclays Bank PLC, Research Division – Director & Analyst [9]

——————————————————————————–

Yes? Okay, great. Outside of China, are you seeing any impact in other parts of Southeast Asia at this stage?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [10]

——————————————————————————–

I think that’s a great question, Paul, and thanks for asking it. As you can imagine, there are less import and export activities in China. And that is, of course, having an impact on some of the global trade activities. You will have heard that some of the factories in Europe or in the U.S. are not getting the supply of components they need to produce, and that’s basically a reflection of that because it’s more difficult to get in and get out of ports in China. So yes, I expect some impact on global trade. It’s very difficult to quantify, Paul, but we are monitoring it very, very carefully because it’s part of the global supply chain points I mentioned earlier. Yes.

——————————————————————————–

Paul Daniel Alexander Sullivan, Barclays Bank PLC, Research Division – Director & Analyst [11]

——————————————————————————–

And just following on from that, and if we can, wishful thinking maybe to just put COVID aside for one second, the impact from the trade war became a little bit more evident in the second half. How are you seeing that wash through?

And then finally, were you — on the change in tax slightly on the balance sheet, the cash flow is good, looking under-levered now. Were you tempted to think about a cash return this year? But has the uncertainty put — sort of kicked that into the long grass?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [12]

——————————————————————————–

Look, I think the news at the end of the year, certainly confirmed — early January, on the tariff discussions between the U.S. and China have been very welcomed by the entire business community. And what it really has done, Paul, it has reduced the level of uncertainties in terms of future issues. Unfortunately, with the Chinese New Year holidays in January and what’s happening in February, we have not been able to see any benefit from that, as you can imagine. But certainly, this is positive news in terms of reducing the uncertainties moving forward for all of our clients.

As far as our balance sheet and the strength of our balance sheet, look, we believe in disciplined capital allocations. We have tremendous opportunities, organic, inorganic. As you probably have seen, we’ve made a small acquisition at the end of December. We continue to look at acquisition opportunities around the world in a very disciplined fashion. We’ve been at 1x net debt-to-EBITDA in the past, and we are happy to be there if this is what we need to find the right acquisitions. We’ve never made any commitment to any return to shareholders in terms of cash because we never had to do that in the past. But as you can imagine, this is a decision for our Board, and we want to do the right thing for the long term. So the good news is, we are extremely strong financially. We’ve got a tremendous balance sheet. We’ve got a lot of opportunities. We are very disciplined, and we will make the right call.

——————————————————————————–

Operator [13]

——————————————————————————–

The next question comes from the line of Edward Stanley from Morgan Stanley.

——————————————————————————–

Edward Stanley, Morgan Stanley, Research Division – Equity Analyst [14]

——————————————————————————–

Following up on Paul’s question on the impact from the trade war. Can you give us a feeling for the products that are being delayed in the second half? Is that a small number of products from a small number of customers? Or is that a sort of larger number of customers spread across your total customer base? Just trying to get a feeling for how quickly it might bounce back, whether it’s isolated or broad spread.

The second point, I’m just wondering whether you’re seeing any incremental pressure on price or increased competition in either Hardlines or Softlines in the second half of the year because the operational gearing in Products was perhaps not as great as I might have had in my model.

And then on the third point, during the year, you said you lost some Food share or market share in the Food business. Do you have a long-term plan for how you get that market share back in Food and where you expect that division to grow over the medium to long term?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [15]

——————————————————————————–

Okay. Thanks, Ed. Look, I think going back to your first question in terms of the delay of the launch of new products that we saw on the back of these discussions on tariff, basically, it’s not complicated to understand is if you are a brand or if you are a factory in China, and you know that the tariffs are going to increase across lots of categories. And you know that potentially, there will be some solution to these negotiations. Why would you invest in tooling and equipment to start producing new equipment, so what — new products. So what we saw is across several customers, these decisions to be delaying investments, nothing more than that.

As far as the situations in Softline and Hardlines, look, we operate in a global market. We have, as you know, competitors. There is always price competition out there. We do not use price to deliver revenue growth. We believe that good revenue is based on volume and strong pricing power. And the operating leverage point that you’ve mentioned is just a function of a portfolio of multiple business lines. And it’s true that in our Softline business, we saw slower revenue in ’19. And when you have a business that is a high-quality business and you value your customer service, you have to accept to get some negative operating leverage from time to time because you want to protect the quality of your customer service. As far as — but I wouldn’t say that the pricing environment has changed significantly. It’s been more or less the same for many years. And we know which companies use price more than others, and good luck for them.

As far as the Food point, yes, you’re right. I mentioned that during the year, as I said at the time, it was really local issues in a few sites. As a matter of fact, I was there a few weeks ago, and some of the customers that went for the lower price have decided to come back to us because they’ve got a better customer service. So sometimes, it takes a few months to stick to your guns and say, you know what, we are the superior operator here. If our competition wants to lower their price and our clients want to try it, they can do that. And this is the best compliment we can get when our clients say, you know what, we’re back.

——————————————————————————–

Operator [16]

——————————————————————————–

The next question comes from the line of Tom Sykes from Deutsche Bank.

——————————————————————————–

Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [17]

——————————————————————————–

Just going back to, sorry, COVID again. Are you able to say which sort of supply chains are being most affected, that be sort of Softlines or electronics at all? And perhaps, is there any way you can kind of give us a typical walk-through of H1 in terms of the seasonality and kind of what months are really important, i.e., if April comes back and is quite strong, is that disproportionate for you in the first half in industries that may be disproportionately large for you, please?

Then just on the cash flow, I think payables pushed out a bit. Obviously, you brought working capital down again. But do you still see some improvement in that working capital and where might that come from, please?

And then finally, just on the tax rate. What’s the reason for the tax rate increase, please, because you’ve got several number of large geographies which are not at that level of tax, please?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [18]

——————————————————————————–

Thanks, Tom. So let’s just start with your question on the profile of resumption across industries and the seasonality in China. Look, on the first question, Tom, as you can imagine, this is something that we are looking at in details with our colleagues. And just to give you — because I want you to get the full picture. There is a difference in terms of resumptions between the testing that we do in our own labs and the inspections and audit activities that we do in our factories or the factories of our clients, as you can imagine, because going out to a factory, there is an additional complexity, is the factory ready for us to get there. So I just wanted to mention that because I didn’t do that upfront and it’s important. Obviously, inspection and audit is not a majority of our activities in China, but it’s important to understand that.

And you’re absolutely right, there is a difference in terms of the profile of supply chain resumptions between clients. I wouldn’t say necessarily between industries, Tom, because every client have got their own supply chain and where they source their components. And this is something that we are monitoring; very complex, though, because it’s also a function of how many stock companies operate with. So this is going to be the difficulties because supply chains are super intertwined, super connected, and we have to do it a step at a time. The differences we are seeing, Tom, is by clients, not necessarily by industry.

And as far as your question in terms of seasonality, not all of our businesses have got seasonality in China. But it’s fair to say that Softlines, the peak season tend to be slightly in the year. So that’s a fair point.

I will let Ross handle the tax rate and working capital questions.

——————————————————————————–

Ross McCluskey, Intertek Group plc – Group CFO & Executive Director [19]

——————————————————————————–

Sure. Thanks, André. Tom, thanks for your questions. I mean, look, on working capital, as you saw in 2019, we continue to make good progress, reducing working capital intensity down to 3.4% of sales down to — down from 3.9% in 2018. And that’s been driven both by improvements in the receivables side and the payables side. So our DSOs and DPOs have both moved in the right direction over that period of time. And as we talked about before, we continue to see the opportunity over the medium term to make this better by driving down the standard performance across our global operations.

In terms of tax, as you saw, the guidance was 25.5% to 26% versus the 24.5% we delivered in 2019. And the driver of that really is around simply the mix of operations across the globe, the changing tax regimes that are out there and also how the group is using its tax attributes over a period of time. So it’s no more than that.

——————————————————————————–

Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [20]

——————————————————————————–

Okay. And just in terms of behaviors of people around the virus, is there any — or what effects of switching, of sourcing, sending, I don’t know, sending products to different labs at all or is there any counterbalance? I know you mentioned to Paul that you would expect world trade to be affected, but is there any counterbalancing that you’re actually seeing some unexpected increases everywhere? Or is it all bad and then we’re waiting for a resumption? And — yes.

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [21]

——————————————————————————–

Look, I mean if you put yourself in the shoes of our clients in China, their main focus is to go back to business and go back to where they want to be after Chinese New Year because they had to worry about where are the employees, are they going to be able to come back, are some of them going to be in quarantine. And then obviously, the next implication is how much do they have in the order book that they need to produce. Where are their clients, really becoming impatient and how do they deal with it. And obviously, as I talked about, components, supply chain, stock management is important.

Look, if any of our client wants to think of alternative locations because they have a faster way to get to market by moving the production from China to Bangladesh or Vietnam or India, of course, we are there. That’s what we are trying to do to make sure that we help our clients 24/7 in their supply chain activities. It’s fair to say, Tom, that until today, the focus has been very much on trying to go back to normality in China. The discussions on where else to produce, we’re obviously already in the pipeline, as you remember, last year. So these continue, but it’s been quite an unprecedented time for everyone in China, and they just want to go back to business and to — back to normality, and that’s where they want to go.

——————————————————————————–

Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [22]

——————————————————————————–

Okay. And sorry, just one final short question. If you have a resumption in activity and it’s quite strong, is there anything you’re being told by the authorities which would prevent you from pricing, say, the overnight shift appropriately or in line with your historical rate cards if you needed to bring on that activity quickly at all?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [23]

——————————————————————————–

No. Look, it’s a great point. If you look at the Hong Kong, basically, situations where we had to shut down our operations for 2 weeks, as I said earlier, and as you know, in our operations in terms of turnaround time, we offer an express service. And what we have done is, basically, we basically offered this express service at preferential terms to help our clients. So the way I’m thinking about it is helping our clients. In very difficult times like this, the partnership we demonstrate in this really, really tough moment is going to go a long way. And yes, we want to drive margin and revenue growth. We all want to do that. But what really matters most at the moment is helping our clients to resume their operations, and we will do whatever is required.

——————————————————————————–

Operator [24]

——————————————————————————–

The next question comes from the line of Rory McKenzie from UBS.

——————————————————————————–

Rory Edward McKenzie, UBS Investment Bank, Research Division – European Support Services Analyst [25]

——————————————————————————–

I wanted to ask a couple of questions about the Business Assurance division within Products. Can you clarify where the growth did accelerate into year-end as you hit easier comps? And also, how much were you hoping for it to accelerate in 2020 on a pre…

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [26]

——————————————————————————–

Sorry, the connection is not too good. Can you repeat your question, please?

——————————————————————————–

Rory Edward McKenzie, UBS Investment Bank, Research Division – European Support Services Analyst [27]

——————————————————————————–

Sure. Is that better? I wanted to ask about the Business Assurance business…

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [28]

——————————————————————————–

Yes. Yes, much better. Thank you.

——————————————————————————–

Rory Edward McKenzie, UBS Investment Bank, Research Division – European Support Services Analyst [29]

——————————————————————————–

And I wanted to — if you could clarify whether growth did accelerate into year-end? I think you had easier comps. And how much are you hoping for it to accelerate in 2020 on a pre-COVID-19 basis? Just obviously, you started last year hoping for robust growth and ended up with good, and you’re also investing a lot there both organically and with Alchemy coming in.

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [30]

——————————————————————————–

No, you’re right. I mean, we had a baseline effect in ’19 for our Business Assurance given the ArgiWorld’s talent change at the end of ’18. And yes, it’s for sure, we saw some good progress, as expected, in the second half. And prior to coronavirus, we were targeting the group to continue its progress on Business Assurance. And as you rightly said, we now have Alchemy also part of our Assurance business. So we continue to be very excited about the prospects in our Assurance business. So it’s all good.

——————————————————————————–

Rory Edward McKenzie, UBS Investment Bank, Research Division – European Support Services Analyst [31]

——————————————————————————–

Can you share any numbers with us about the interest or the head count growth and the sustainability, assurance services that you launched through last year? And again, anything you can talk about particular areas of the market you’re seeing more maybe interest in some clients, sectors like Softlines or anything like that? What was picked up the most?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [32]

——————————————————————————–

No, it’s a great question. And as you can imagine, we’ve been quite active meeting with our clients over the last few months. I do regular customer meeting myself. And what’s really, really interesting is that the interest has been really broad-based, as you would expect, but with particular interest in the energy sector, which is very encouraging given some of the pressure our clients are under in terms of environmental data and sharing the sustainability strategy. So we’ve seen quite a lot of interest there. Of course, in the Softline industry, lots of interest there given all what we’ve been hearing in terms of the global supply chain management. And as I mentioned in one of our call, we’ve also been seeing some quite interest from the financial sectors, and that’s quite interesting. I would say green financing is a big thing, and our model applies there.

So what’s been really, really, really impressive is the way our clients have said, finally, we have a framework. We have a set of standards. We understand where sustainability starts and finish, and it’s really global. I had the opportunity at the beginning of January to launch TSA in Delhi, and the amount of interest we got from everyone across all sectors was very, very significant. And I’m going to the Middle East in a few weeks, and the interest is very strong there, of course, Europe and U.S. No, it’s been a really, really good reaction. We are really pleased.

And if you would recall from our presentation, it’s not only the certification, which is our new approach to sustainability, it’s also the operational solutions that companies use to go very, very deep in monitoring the emissions, looking at the social standards, et cetera, and so forth. So it’s been very positive. And frankly speaking, it’s now part of our ATIC discussion with our clients. And there is no one presentation where our clients don’t want to hear about our views on sustainability.

——————————————————————————–

Rory Edward McKenzie, UBS Investment Bank, Research Division – European Support Services Analyst [33]

——————————————————————————–

Yes, very interesting. And just how we’re tracking. If so you do win a contract, let’s say, apparel supply chain certification, does that go into Softlines or into this Business Assurance division?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [34]

——————————————————————————–

That’s a good question. If it’s a certification, which is about an audit certification of the corporate processes, that will be done by our Business Assurance teams. And in terms of the operational sustainable solutions, we have solutions that are industry agnostic done by Business Assurance and some that are business line specific and done by our Softline teams. Because we do, as you probably recall, sell assurance, testing, inspection, certifications in every of our business line — in each of our business line.

——————————————————————————–

Operator [35]

——————————————————————————–

The next question comes from the line of David Roux from Bank of America.

——————————————————————————–

David Roux, BofA Merrill Lynch, Research Division – Associate [36]

——————————————————————————–

Just a couple from me. André, in terms of Intertek’s investments into lab expansions over the year, could you perhaps elaborate on how these investments were allocated by region?

And then just sticking with capital allocation. On M&A, you mentioned the various inorganic opportunities out there. The reality is I don’t think we’ve seen a sort of sizable transaction since Alchemy. I’m just wondering what is holding into the take-back in this case. Is this just a function of high asset prices and you guys being prudent on that?

And then lastly, on China, can you perhaps give us a breakdown of your China business by main segments, i.e., Products, Resources and Trade?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [37]

——————————————————————————–

Okay. Thanks. Look, just I’ll go in reverse order. On China, as you know, we do not disclose by geography. But it is fair to say that the Products is a very strong part of our business in China, as you can imagine, given the strength we have in this market.

In terms of M&A, look, this is a very important question. For us, M&A has got to be selective to augment the financial trajectory of the group moving forward to basically provide additional services, and it’s got to make sense from all aspects. So we are very disciplined. It’s not only about, is the business attractive? But is the business going to continue to perform in a sustainable basis from a revenue and margin standpoint? It’s also about, do we believe that we can add value to this business? And do we have commercial IP innovation synergies? It’s obviously, of course, about the financials. And if we don’t tick all the boxes, we just don’t do it because we don’t need it. I mean, we have a very strong business where the growth opportunities from an organic standpoint are very, very attractive, and we want to be and remain selective.

And that’s true that we’ve not done any large transactions since Alchemy, but this is fine. I mean, we have lots of opportunities. But we are always looking at all transactions out there, and we say no more than we say yes. That’s what discipline is all about. And the opportunities remain there. I wouldn’t take anything from what I said that we are not focusing. We are very focused on it. We want to seize the right one at the right time.

As far as our lab expansion, good question. As you can imagine, we have invested to either increase our capacity or technology — technical capability in certain sectors. So we’ve invested a lot in our electrical labs around the world in terms of energy efficiencies, for instance. We’ve obviously made investments that you know in terms of connected world, cybersecurity in the U.S. and also in Asia. We tend to expand where the supply chain of our clients goes. So as you can imagine, over the years, we’ve expanded our footprint in Vietnam. We’ve expanded our footprint in Bangladesh. We have expanded our footprint in India. We’ve seen some good opportunities in Africa. But also in the U.S., we have seen some really interesting segments. So it is opportunity based. And this is where we want to take our customer service to either create capacity where our clients are going with the supply chain or improve the level of customer service. So this is how we think about it.

——————————————————————————–

Operator [38]

——————————————————————————–

(Operator Instructions) And our next question comes from the line of Ed Steele from Citi.

——————————————————————————–

Ed Steele, Citigroup Inc, Research Division – Director [39]

——————————————————————————–

It’s Ed here from Citi. A couple of questions on Trade, please. Obviously, you had very good growth in Government & Trade Services, double digit in the year. Part of that was the new contract component. Could you remind us of how that flows into next year, into 2020, please? That’s the first question.

And secondly, on Caleb Brett, obviously, you cite competitive pressures as your competitors have done or your big peers have done for a couple of years. I think your approach has been to stick to price discipline in the past and maybe sacrifice a bit of share, but you talked about good organic growth in 2019, but negative margins. So have you changed your approach? Are you now maybe considering a bit of price to keep share?

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [40]

——————————————————————————–

Thanks, Ed. Look, on GTS, you’re right, the double-digit growth has been on the back of new contracts. I mean, these new contracts have been almost from month 1 in 2019. So I wouldn’t expect too much from these in 2020. Having said that, our team is always active to get new contracts. So the year just started, so I wouldn’t be too worried about GTS.

And on Caleb Brett, I mean, you’re right, we are very disciplined in terms of price. And what’s happening is relatively simple, if I may say. Let me just explain it in simple terms for you. Obviously, in the second half, we had a baseline effect because the second half of ’18 was very strong. We saw a slowdown in the market in the second half in North America and in Europe. And for us, when there is destocking in the supply chain of our clients with Caleb Brett, this is a slowdown for us because, obviously, they sell refined products that we’ve already tested from stock and the same in terms of crude.

Now what’s happening in these situations is this is a competitive market, so our competitors will lower their price to basically gain some market share. And while we are commercial, and we want to make sure that we stay competitive in the market, our preference is to not lower our prices because if you start, where do you stop? And the negative margin impact in the second half has been a function of slower growth in an environment where you have to recognize your inflation and your cost, and that’s what it is. But it’s not a change of pricing discipline. That’s a good question, Ed. Thanks for asking.

——————————————————————————–

Operator [41]

——————————————————————————–

We have no further questions in queue. So I’ll now hand the conference back to André for any concluding remarks.

——————————————————————————–

André Pierre Joseph Lacroix, Intertek Group plc – CEO & Director [42]

——————————————————————————–

Well, thank you very much to all of you for joining on the call. Again, thanks for your patience this morning. We had a technical issue with our webcast operating platform that was resolved by our providers relatively quickly, so really appreciate your patience. And if you have any questions, obviously, we are available, and Denis is obviously on standby for you at any time. Thank you very much. Have a good day.

——————————————————————————–

Operator [43]

——————————————————————————–

Thank you for joining today’s conference. You may now disconnect your lines. Hosts, please stay connected. Thank you.