Devro PLC

LSE:DVO

Earnings Call Transcript 2021-Q4

[Rutger A. Helbing]

Good morning, and welcome to this audio-cast covering our full-year results for the year ended December 31, 2021. I will start the presentation with the highlights of the year and then hand over to Rohan for the financial review. After this section, I will take you through a review of the 2021 performance in our emerging and mature markets, an update on the 2022 outlook including what we are doing to proactively manage inflation, and how we are progressing with our next step in the Devro growth journey including an update on capital allocation. I will finish this morning's presentation with some concluding remarks.

But let me start with the full year highlights. I'm very pleased with the 2021 performance which shows that our growth strategy is working and where we delivered significant improved financial performance in what was still a year with challenging market conditions. In 2021, we grew our constant currency revenue by 5%, the best performance in the last decade and ahead of volume growth in edible casings with a positive contribution from pricing based on our value-based selling approach.

Edible casings full year growth was just below 5% and accelerated in the second half and for the year, both strong growth in emerging, plus 7%, and mature markets, plus 4%. Revenue growth combined with our continued ability to deliver cost savings and despite inflationary pressures resulted in constant currency operating profit growth of 13%.

We had another year of strong free cash generation delivering a reduction in net debt by over £20 million to below £90 million. Given the strong financial performance and with the growth strategy delivering, the board proposes an increase in the final dividend to £0.065, bringing the full year dividend to £0.093, a 3% increase on the prior year.

But let me now first handover to Rohan for the financial review.

[Rohan Cummings]

Thank you, Rutger, and good morning, everybody. As Rutger mentioned, 2021 delivered strong top line revenue growth and free cash flow generation, leading to a significant reduction in net debt. I will start today's presentation by focusing on the key financial highlights for 2021.

Constant currency revenue was up 5.4% to £261.1 million driven by strong volume growth through market share gains, together with positive pricing and improved mix, reflecting the continued success in the execution of our growth strategy. Reported revenue was up 2% to £252.4 million, reflecting £8.7 million of foreign exchange headwinds. Constant currency underlying operating profit was up 13% to £46 million with reported underlying operating profit up 3% to £42 million after reflecting £4 million of foreign exchange headwinds. Underlying profit before tax was up 9%, including the change in accounting treatment for pension finance costs. The underlying basic earnings per share was £0.181, a 15% increase.

We continue to see strong cash generation with free cash flows up to £35.6 million versus prior year of £22.5 million. There was further improvement in balance sheet leverage with covenant net debt to EBITDA ending at 1.4 times, which is significantly lower than June 2021 of 1.6 times and December 2020 of 1.8 times.

Given the group's financial position, strong trading performance and outlook, the board has proposed an increased final dividend of £0.065, representing a full year dividend of £0.093, up 3% on the prior year.

Let me now give you more detail on group revenue. Volumes of edible collagen casings were up 4.9%. Emerging market volume was up 7%, driven by Southeast Asia and Latin America. Mature market volume was up 4%, driven by strong growth in North America and pleasing growth in Europe, offset by weaker market conditions in UK and Ireland and Australia. We saw positive price during the year with further price increases being [ph] passed (04:34) in the latter part of the year to offset inflationary pressures. The positive mix was driven by better product mix and improved geographical mix as we continue to gain market share in North America.

Other products were largely flat year-on-year. We saw a gross £11.8 million negative foreign exchange headwind mainly due to the strengthening of the sterling against the US dollar and Japanese yen. This was offset by £3.1 million hedging gain which will not repeat in 2022. The net impact after the hedging was £8.7 million negative foreign exchange movements. It is worth noting the accelerated growth momentum, which was 7% in the second half of the year versus [ph] 50% (05:22) in the first half.

Looking at underlying operating profit and, in this slide, we bridged the main movements for the year. The first three bars of this waterfall show the operating profit impact of the revenue items we discussed in the previous slide. We continue to deliver on the cost savings, which contributed £5.8 million, including savings related to the closure of the Bellshill site and ongoing manufacturing initiatives focused on sourcing alternatives, cost reduction, and efficiency programs. This was more than enough to offset inflationary cost pressures driven by labor costs and raw material input costs, which were £4.7 million. OpEx increased by £3.1 million and includes an increase in our investment in new product development to drive further growth as well as higher bonus accrual and accounting charge for the three-year performance share awards as the group performance improved.

Taking account of these factors, constant currency underlying profit increased 13% to £46 million with constant currency margin increasing 110 basis points to 17.6%. We saw a gross £7.1 million of negative foreign exchange movement, which was offset by £3.1 million hedging gains, which will not repeat in 2022. The net impact of the hedging was £4 million negative foreign exchange movement.

So, let's now move on to the detailed financial review and start by looking at the key P&L lines. We have covered some of the detail on previous slides. A few highlights to call out, our statutory operating profit, which was at 18% as a result of positive exceptional items driven by the sale of the Bellshill site. Finance costs now include pension interest going forward, which were previously adjusted in APMs. Interest costs were down 25% to £5.1 million. The decrease is primarily due to the repayment of the $25 million PSP in April 2021 and increased level of cash on hand during the year.

The group's tax charge for the year was £6.7 million, which represents an effective tax rate of 18.2%, which includes a one-off impact of the revaluation of the UK deferred tax asset given the corporate tax rate change of 19% to 25%. Excluding this one-off impact, the underlying ETR would have been 22.4%. Underlying basic earnings per share was £0.181, up 15% due to higher underlying operating profit and lower tax and financing charges.

Looking at the cash flow for the year, the group delivered particularly strong cash generation. The group made substantial working capital improvements of £6.7 million due to lower finished goods inventories and higher trade payables. Capital expenditure in 2021 was £15.9 million, up £1.7 million on 2020. But spend was lower than guidance due to COVID-19 limiting access to sites. We continue to make good progress on the capacity projects in Czech and China as we invest to facilitate future growth. The net cash exceptional inflow of £2.8 million relates to the sale of our Bellshill site. Tax payments of £10.6 million were higher than the prior year due to increased profits and timing of payments.

The group generated a very strong £36 million of free cash flow, which was the highest in at least the last decade. The group has made significant progress over the last five years in improving its leverage, reducing the net debt and improving the covenant ratio. Covenant net debt at the 31st of December 2021 reduced to £88.6 million from £109.5 million as at December 2020. The covenant net debt EBITDA ratio improved to 1.4 times as compared to 1.8 times at December 2020. This is a very pleasing result and given the group's good leverage and strong cash generation gives options going forward of investing in further growth, returning increased dividends to shareholders and further reducing net debt.

If we now turn to Devro's pension deficit where, again, the group has made significant progress over the past five years. The group net pension obligations decreased to £36.2 million at the 31st of December 2021 from £55.2 million at the 31st of December 2020. This is primarily due to contributions made during the year, as well as an increase in discount rates positively impacting the valuation of the UK and US scheme liabilities. The triennial review of the UK scheme was completed in April 2021.

Looking forward, given circa £7 million contributions per annum, the group expects to close the deficits within the next five years, subject to market conditions. As with previous years, we've, once again, included some detailed modeling guidance on slide 11. Rutger will cover a slide on 2022 inflation and pricing guidance late in the presentation.

For CapEx, the group is likely to spend above depreciation in 2022 as the group invests in additional capacity in China and Czech sites. Please do contact us if you have any questions with regards to any of the guidance.

Back to you, Rutger.

[Rutger A. Helbing]

Thank you, Rohan, and let me start my section with a review of our performance in 2021 in our emerging and mature markets.

In 2021, we had another year of robust growth in our emerging markets, with volume growth of 7%, positive price/mix, contributing 1%, and the share of our emerging markets of our group's revenue increasing from 28% to 29%. The growth continued to be driven by Latin America and Southeast Asia, with both very strong double-digit growth rates. In LatAm, we continued to benefit from recent customer wins in Brazil, but also new products in Mexico and distribution gains in Honduras and Chile. In Asia, we saw strong performance in Thailand, as well as Indonesia building further momentum in the region. This was partly offset by lower volumes in Russia and more volatile markets where we were impacted by FX headwinds after a strong 2020.

We are watching the events in Russia and Ukraine, which regrettably now has turned into a war between those countries. We're continually monitoring these developments to evaluate the impact on the business, our partners, and most importantly, our employees and the communities we operate in and are committed to supporting those through those unsettling times.

Volumes in China in 2021 were marginally lower as we prioritized demand in higher-priced regions, and this is part of our strategy.

Let me now move to our performance in mature markets. In 2021, we returned to growth in our mature markets with volumes up 4% and positive price/mix of 1%. North America continues to be the key driver of growth with volumes up 20%, more than double the growth we saw in 2020. The snacking category continues to grow and we continue to capitalize on this trend with our strong market position and further customer wins. In the year, we also saw Continental Europe return to growth after a softer year in 2020 impacted by COVID and distributor destocking. And whilst market circumstances remain challenging in UK and Ireland and Australia and New Zealand, we saw an improved momentum in the second half.

Before I move on to how we are progressing in the next step of our growth journey, let me talk about inflation expectations for 2022 and how we are mitigating those. It is clear we currently operate in a high inflationary environment and it also impacts Devro. Our overall aim is to implement targeted price increases to offset the impact of inflation and protect our profitability. Like most companies, we are facing significant price increases mainly in energy, chemicals, packaging and transport. The impact of energy increases will be greater in the second half of 2022 when our hedging rolls off. And whilst the high inflation categories do impact our cost base, it is important to understand that more than half of our cost of goods sold are made up from labor and high costs and inflation in those categories are expected to be more modest and we are seeing that currently.

To mitigate the impact of rising cost, we started with targeted price increases in the second half of 2021 and continue this into 2022. These price increases are sticking, and as we said, expect – those increases are expected to offset current inflation headwinds. With higher price increases, we expect higher revenues. But as we aim to protect short-term absolute profit, percentage operating margins are expected to be held back despite continued benefit on margin from operational improvements. Having provided an overview of how we are impacted by inflation and what our mitigating actions are, we feel we are well-placed.

Let me now move to the next step in Devro's growth journey. As said, I'm very pleased with the financial and strategic performance and see room for further progress given the momentum we have created. The group has been relentlessly focused on plans and processes to help our people to deliver sustainable growth. Guided by our 3C strategy, we now have delivered firm foundations for sustainable growth. And with that, we are ready for our next step, embedding and accelerating our growth, but also broadening the business by integrating our purpose, vision, mission and values in a newly evolved 3C strategy.

Our purpose is to create the added layer of value together, responsibly, better with our vision to be our customers' partner delivering the added layer of value with high quality edible films and coatings, and our mission to sustainably utilize differentiated technology and biomaterial science-based solutions to delight our customers. Finally, our values represent how we want to drive performance and deliver on our purpose, vision, mission and strategy.

What it means to be Devro? Our values are curious, courageous, committed, connected and caring. We are focused today through our 3C strategy on winning with the winning customers, maximizing the core profitability drivers and strengthening competencies. These 3Cs serves us well, delivering firm foundations for sustainable growth.

But now, with our new purpose and as part of the next step in our growth journey, we've further evolved our 3C strategy. In our evolved 3C strategy, the customer remains central to our strategy with our winning value proposition of delivering an excellent customer experience. New to the framework is culture. Recognizing that delivering on our safety and sustainability commitments is at the heart of what we do and that living our values will enable us to execute our strategy successfully.

And lastly, we have expanded competencies to capability to incorporate our focus on leveraging and developing differentiated technologies to drive growth. Now it's not directly reflected in our 3Cs strategy going forward, core profitability will continue to be at the heart of what we do that is now an integral part of how we manage the business through our Integrated Business Planning process. So, our new 3Cs strategy framework is aligned to our purpose, delivering excellent customer experience together with a culture committed to sustainable performance, responsibly, underpinned by leading capabilities better. All of our initiatives are now clearly mapped to these 3Cs and the strategic priorities.

Within the customer, our strategic priorities are to provide excellent customer experience in the leading portfolio of edible films and coatings. Some of the key initiatives related to these are our go-to market plans and our research and development activities focused on expanding our category plans and country initiatives. It also include initiatives aimed at broadening our business through the development of alternative technologies and exploration of other applications for our edible collagen films and coatings outside of our current core markets. These exciting initiatives will have a limited revenue impact on our 2022 results that are important for the long-term direction and scope of the business.

In terms of culture, our strategic priorities are to continue to have sustainability at the core of what we do and live our values to enable a culture that drives performance. As we shared with you at our ESG investor seminar in September last year, sustainability is part of our heritage and in our DNA. From the start, we have practiced circular thinking. The business is built upon using by-products from slaughterhouses that otherwise would have been disposed of. And, through our unique process, convert those into edible products that provides affordable, nutritious protein to the world. Our commitment to sustainability has only been further strengthened with our purpose. And as it is part of our DNA, we see it very much as an opportunity and an accelerator for innovation and business choices.

And, lastly, with our capabilities part of the framework, we aim to leverage and develop differentiated technologies and achieve performance excellence. Key initiatives here are driving standardized global processes like IBP and when well-established systemized those as much as possible to improve efficiencies. Performance excellence also involves learning and development and our leading leadership training program. And we leverage and develop our technologies and our supply chain, for example, through our process, best practice teams. So, with this new framework fully aligned with our purpose, it will help to guide us in the next step of our growth journey.

Now, I would like in the following slides to provide a quick update on how our sustainability journey is progressing and how our manufacturing footprint and capital allocation support the growth ambitions. This slide is summarizing our sustainability goals, targets, and commitments to be a net zero company by 2050. Since our investor seminar in September, we've made good progress. In further detailing our climate, water, and waste road map, we've focused on first delivering our 2025 and 2030 targets. As part of that, we've already approved investments in solar panels for our Nantong site. We have appointed a group sustainability manager and established the sustainability committee that I chair and engaged with all site management teams through a road show.

And in terms of the people and communities agenda, we agreed a new three-year health and safety road map and we also agreed diversity and inclusion initiatives for 2022, as well as those focused on engaging further with our communities. So, a lot of activities, and we will continue to keep you informed about progress.

But let me now move to how our global manufacturing footprint continue to support our growth journey. As you know, we have well invested an efficient global manufacturing footprint that supports our growth ambition. With our Integrated Business Planning process, we have a 36-month rolling forecast and that enhances our ability to make better informed decisions regarding investments to support growth. As such, in 2021, we decided to further expand our existing capacity through line upgrades in both our Czech and Chinese plants. These investments are modest there and generate returns on investments in excess of 20%.

These current investments will increase global capacity by about 5%, and we can add another 25% through line upgrades within the current framework. We need this investment to meet our growth momentum. Furthermore, our plants have good global reach and continue to deliver performance improvements and, in 2021, delivered another £5.8 million of cost savings.

Let me now move to how capital deployment supports our growth, but also progressive dividends. We have a clear strategy to deliver sustainable growth, both in our historic core markets, but also through broadening our business with the development of alternative technologies and exploration of other applications for our edible collagen films and coatings.

To enable this organic growth, we will allocate capital into the growth investments yielding high returns within the current footprint, continue to invest in product development to help gain market share, as well as to develop alternative technologies and invest in related processes and systems to support the sustainable growth.

With our growth and strong free cash generation, we will also be able to provide a progressive dividend and have the ability to consider acquiring accretive strategically aligned businesses. To be clear, we are in the early stages of exploring M&A, but we will consider and pursue when appropriate.

Let me now finish with some closing remarks and the outlook for 2022. 2021 has been the best year in a decade with significant strategic and financial progress. There continue to be challenging market conditions, including inflationary headwinds, but we have mitigating actions, including pricing, and are well-positioned to deal with those. With our strong free cash flow generation and capital allocation framework, we can invest in new products and technologies, as well as in capacity within our current footprint to support our growth strategy, whilst also continuing to grow the dividend. We started the year well, and despite the macroeconomic headwinds and based on current exchange rate, we expect to make good progress in 2022 and beyond.

And with that, I'd like to finish this audio-cast covering our full year results for the year ended 31st of December, 2021.