Ricardo PLC
LSE:RCDO
Earnings Call Analysis
Q2-2024 Analysis
Ricardo PLC
The company has built a solid foundation through strong sales momentum across most business units, achieving a record order book of GBP 477 million at the half-year mark. This growth was propelled by standout performances in the defense sector, particularly the ABS program, a strong recovery in rail with a proactive sales approach, and ongoing structural growth.
Despite robust order bookings, the company faced initial delays in its A&I business, causing a temporary dip in operating profit margin at the group level. Nevertheless, the second quarter showed signs of improvement, and continued momentum into the third quarter has restored confidence in delivering a strong second half. As a result, the full year consensus remains achievable.
Underlying cash from operations rose by 25%, marked by efficacious working capital management and a cash conversion of 130%. Acceleration in the operating model was achieved through realignment, aiming to sustain this robust cash generation into the second half and uphold confidence in meeting the full year consensus.
The company proposed an interim dividend of 3.8p per share, up 13% from the previous year. This strategic approach reflects the strength of the order book, pipeline visibility, and actions to heighten profitability, indicating a full-year dividend policy that aligns with consensus and maintains a cover between 2.5x to 3x.
The company continues to prioritize its portfolio, investing in innovative solutions to fortify its organic growth within the environmental and mobility domain. Efforts are underway to launch a new digital platform, consolidating multiple industry solutions, beginning with energy pricing models set to reach Europe in the fourth quarter.
Targeting large markets in environment, water, and green energy, estimated at over GBP 30 billion by 2027, the company is positioning itself to leverage the projected annual growth rate of more than 7% CAGR. Investments in hydrogen testing capabilities and the development of digital twin solutions underline their commitment to this high-growth sector.
Despite delayed orders resulting in decreased revenues and a minor loss increment in A&I, various cost reduction measures and a shift towards flexible resourcing have improved profitability prospects. The company anticipates a recovery in this segment, underpinned by increased Q2 orders and ongoing operational enhancements.
Operational restructuring, including the centralization of functional teams and establishing a flexible resource model in the A&I business, has led to substantial cost savings. With an emphasis on maintaining sales discipline and a balanced approach to resource allocation, the company looks to further improve profitability and return to mid-teen margin targets.
The company showcases strong organic growth across all business units, maintaining meticulous focus on working capital and inventory levels, especially in the PP and Defense business. Confidence in tapping into the second half's revenue combined with operational changes solidify the pledge to full-year consensus delivery.
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So good morning, all. As always, I'd like you to just take note of the disclaimer page on your screen and in your. tabs. So for the agenda today, I'll start with a quick summary of the overall performance of the group and the progress in our strategic transformation. Judith will then take you through a bit more of the financial detail, and then I'll spend a bit more time updating on the strategic progress that we've made in the first 6 months.
Before we finish with a few closing remarks and obviously then we'll take your questions. So we continue to build strong sales momentum in most of the business units, which has led to a record order book of GBP 477 million at the half year. This is delivered through particularly strong sales in defense through the ABS program, a strong recovery in rail, as expected, with a more proactive sales approach and continued structural growth in the [end].
We previously signaled the complexity of energy transition will mean the order flow in A&I will be lumpy, and we've seen delays in the first half, which have impacted operating profit margin at the group level. As I'll show later in the presentations, we've seen improving sales momentum building in A&I in the second quarter, and I'm delighted to say that, that has continued in Q3, that gives good confidence to have a strong [indiscernible] second half.
Underlying cash from operations is up 25% with strong working capital management leading to 130% cash conversion. We've also made good progress in accelerating our operating model with the alignment of our functional teams. These actions contribute to a strong second half, and we therefore remain confident in delivering the full year consensus.
This slide is just a quick reminder of the sequencing of our 5-year transformation to become a leading engineering consultancy in environmental and energy transition solutions. We're only 18 months into that 5-year journey and have made huge progress so far with one divestment, three acquisitions, restructuring of A&I and consolidation and alignment of our functional teams.
As we are seeing in H1, it's not always going to be a straight line for all of our business elements or business units, but the actions we are taking position us well for acceleration into '24/'25 and deliver our 5-year plan. Our strategy is to shift to having 75% of our operating profit generating in environmental and energy transition solutions. These solutions will typically be higher growth, higher margin and have lower capital intensity compared to our established mobility portfolio.
We don't have historic PET data. But given more than 90% of the established mobility portfolio are the assembly and production businesses of Performance, Products and Defense. If we exclude these, just to show the consulting businesses, we have a pretty good proxy for the shift in environmental and energy transition.
But the total group orders graph shown in the middle of the page, the key messages here is we've made good progress in diversifying our business with now only 6% of our total business in passenger car automotive compared with 25% in 2019. And the A&I total being only 14% on total group orders mix compared with 40% in 2019. These are the areas that have typically been more volatile impacting profitability over the last few years. And therefore, given the lower mix now, we have greater confidence of profit consistency going forward.
Within the consulting orders graph, the proxy for EAT, as I said earlier, the key message here is that 74% of our orders are now in EE and rail compared with just 38% 5 years ago, and only 26% in A&I compared to 62% 5 years ago. Judith will show, EE and rail are the areas that are showing strong growth in revenue and margin, giving confidence in the longer-term growth and margin outlook for the group. We're therefore delivering on our strategy to become a diversified engineering consultancy in environmental and energy transition solutions. I'll now hand over to Judith to take you through the financial performance.
Thanks, Graham. Good morning, everybody. And I can take you through the results for the first 6 months. As you've heard from Graham, in a period where we've seen record [indiscernible] and continued strong performance in our [indiscernible] business. [indiscernible] orders in our O&I business has impacted overall group performance.
With those strong orders and actions we've taken in the second half to accelerate our operating [indiscernible] confirmation and improve profitability, we remain confident around delivering our full year market consensus. But we'll see more weight in our profit in the second half of the year than usual.
This is our usual KPI chart, so it shows the performance of our continuing underlying business on a constant currency basis. You'll see orders are up 10% at GBP 314 million, revenues up 9% at GBP 224 million. So you can see our orders are exceeding our revenue, so we're continuing to grow our order book. But those delayed orders in our A&I business and also some change in mix within our PP business means our operating profit margin is down 40 basis points to 5.4%.
As we go into the second half with the actions we've taken to accelerate our operating model transformation by centralizing [indiscernible] those margins improved. As expect interest costs increased underlying profit [indiscernible] that is [indiscernible] EPS down 13%. We've seen real cash performers on a cash conversion 130% up from last year at on 90% target. Net debt increased EUR 31 million to EUR 63 million. We delivered 1.5 points, so a little bit above our target [indiscernible] 1.25x. I expect as we see improvements in profitability, and we continue to manage our cash that will come back down to our target levels.
And then finally, because of the strong order books, good pipeline visibility and the actions we've taken to improve profitability in the second half, we remain confident around delivering our full year market consensus. So we're proposing an interim dividend of 3.8p a share, up 13% from last year. When we come to the full year and look at our total dividend, we're planning to keep that in line with consensus and in line with our policy of maintaining cover of between 2.5x and 3x.
So looking now at our overall performance. As I said, revenue is up [9%]. Our gross margin and gross profit's up 24%. So we've seen a little bit of erosion in our margin. That's really those delayed orders in our A&I business, which has reduced utilization, and also the change in mix within our PP business.
The improving order intake in A&I and actions we've taken to reduce our fixed cost base there for neutral or flexible resourcing model and with mix coming back within the PP business, I expect [indiscernible]. Our indirect costs absolutely remain under control, reducing as a percentage of revenue or [indiscernible] function. I expect to see further reductions going forward.
Selectives operating profit of GBP 12 million, in line with last year. As expected, interest costs are up GBP 1.4 million, and that's really due to increased rates. We've seen around a GBP 1 million increase where rates have increased [indiscernible] just under 4% to just under 7%. We did also see some increase in our debt in the second half of last year as we invested in acquisitions.
So profit before tax at GBP 7.9 million, down 15%. Underlying tax rate just under 27%. I do think I'll see that increase towards that 30% level, partly as we see the real impact of increased rates in the U.K. and also as we see growing profit overseas in higher tax jurisdictions such as Australia.
So that gives profit for the first period of GBP 5.8 million, down 13%. Looking now at the performance of our individual business units. First of all, our environmental and energy transition portfolio has been impacted by those delayed orders in the A&I business. So we continue to see strong growth and margin accretion in EE and rail.
In EE, all orders are up with revenues up 35%, and we've seen our acquisitions perform well and accelerate our organic growth. Organic revenue growth for the period was 18%. And we're seeing strong demand in policy, strategy and economics and quality and environment. We see margin improvement, margins are now up above 17%, [indiscernible] profits up 40%, of which around 13% organic.
In Rail, we entered the year with good order book and a good pipeline. So we've seen our orders up 23% and revenue up 10%. We've seen good revenue growth in Australia and Asia on the back of recent project wins, and growing opportunities in the U.S. and Canada. We've increased revenue. We've seen some operational leverage, so margins are now up at nearly 11%, so profits up 17%.
In the emerging A&I business, as we said before, we operate across diversified markets of marine, of aerospace, heavy-duty vehicles and automotive. And we're seeing new entrants into those markets and changing client needs as they manage the complexity of energy transition. So we've said we expect to see short-term volatility in orders there, but remain confident around the long-term growth potential.
We have seen delayed orders in the first 6 months, meaning orders and revenue are down, and we generated a small loss of GBP 1.5 million. We've taken action. We've really focused our business on the markets and the greater solutions. And we saw improved orders in the second quarter compared to the first.
We've also taken action to accelerate and move to increase our flexible resource base and reduce our fixed costs, improving profitability and also making us more able to manage that order volatility. So as we go into H2, I expect to see a return to profit.
And then our [indiscernible] liability portfolio, seeing good growth in orders, revenue, profit, margin accretion, and that's really being driven by strong performance in defense. In Defense, orders are up, revenues up nearly 50% and profits more than doubled with margins now over 19%. And that's really been underpinned by increased volumes on the ABS program.
In Rail, we -- sorry, in PP, last year, we had GBP 40 million of order intake on two new multiyear transmission program. If you strip those out, our underlying order intake is up about 13%. As we indicated at year-end, our volumes on the current have been down in last 6 months. And hence, our revenue is broadly flat.
So with those reduced volumes on the [indiscernible] and also a change in mix in the transmission business, our margins and profit are down. As we look to H2, we're starting to see some improved volumes on the panel program and are starting to see a reverse in the mix within the transmission business as those new transmission programs start to ramp up.
And then, finally, in the established A&I business. Again, we've seen delayed orders here. But we remain confident around demand in defense, in marine and in heavy duty vehicles. So our orders are down, our revenue is down, but our loss only increased by GBP 0.6 million because of actions we took in the second half of last year to reduce our costs.
Because of ongoing demand in this area, we are seeing our orders pick up. So Q2 orders were ahead of Q1. And with the actions we've taken again to reduce our fixed cost mix, we expect to deliver a profit in this area in the second half.
We've also incurred GBP 10 million of specific adjusting items in the first 6 months, predominantly around the amortization of client intangibles and the recognition of earn-outs on the acquisitions we made last year, which are due to payment [indiscernible] this year. Because of the actions we've taken to underpin our full year performance and accelerate our operating [indiscernible] by centralizing and enabling the function and reducing our fixed cost base within the A&I business, we are going to incur the restructuring costs in the second half, around GBP 7 million, but I expect those to be broadly funded by our cash generation and for our net debt to be broadly in line with December.
With the actions we're taking, we'll see improved profitability and we'll be saving circa GBP 4 million of costs in the second half. Looking at our cash performance, we saw good performance in the 6 months. Cash conversion of 130%, ahead of our target 90% and up on last year. Working capital has come down GBP 5.8 million, partly because we collected those delayed receipts from the back end of last year, but also because of an increased focus on working capital management.
I'm pleased with the progress we've made in the first 6 months, but there is still more to do. We need to continue to focus on our inventory levels within the PP and Defense business and really make sure that focus on working capital is embedded within all our business units. We generated a cash inflow of GBP 2.5 million before acquisition and reorganization costs, up GBP 6 million on last year. And that's broadly funded the reorganization and acquisition costs in the first 6 months.
So we [indiscernible] net debt of GBP 1.2 million to GBP 63.3 million. [indiscernible] leverage of 1.5x. So I said a little bit above our target of 1.25x, but still well within our bank covenant limit of 3x. We've got good headroom on our RCF facility. So we've got a GBP 150 million RCF. At the end of December, GBP 46 million of that was on [indiscernible]. We've got over GBP 40 million of cash in the business.
And finally, looking at our order book. So we've got a record order book at the end of December, GBP 477 million. Of that, roughly GBP 215 million is deliverable in the next 6 months. That's an increase of over GBP 30 million from last year. We've seen order books grow at just about all of our business units. The one exception is A&I. But within A&I, we've seen the order book deliverable in the next 6 months increase compared to the position at the end of June.
So this gives us confidence, along with a good pipeline, in our delivery of our H2 revenue. So to summarize, as I just said, the strong order, good pipeline visibility gives us confidence in H2 revenue. With the actions we've taken to accelerate our operating model transformation and improve profitability, along with the confidence in revenue, it means we're confident in delivering our full year market consensus. We've seen strong cash conversion in the first 6 months, and we expect the second half's cash to cover the restructuring costs. So definitely won't be [back] in December.
Leverage will come back down towards our target 1.25x, as we continue to focus on cash and see improved profitability. And we remain focused on delivering organic growth across all of our business units. With that, I'm going to hand back to Graham, who's going to take you on the progress we've made on our strategic journey and also give some insights on what's driving that organic growth.
Great. Thanks, Judith. So this is just a quick reminder of the key building blocks of how we're delivering our 5-year strategy with clear growth levers and enabling levers.
This year, we're focused on the A&I recovery, and I'll share an update on the progress that we've made. I'm cautiously optimistic that we've turned the core on A&I performance, and we can, therefore, look forward to more consistent profitability going forward. We also continue to invest in our digital portfolio and market expansion, taking advantage of the energy transition market opportunity. We're also accelerating our operating model transformation, as Judith suggested, to align our functional teams.
As I've discussed before, we've historically been quite a silo-ed business, and we see huge opportunity to deliver cost efficiency but actually, more importantly, to accelerate our transformation with a lined operating model. So we're focused on creating a sustainable business model for A&I. As part of this, we've done a detailed review of our portfolio of solutions and the target markets into which we can support.
As I shared at the start of the presentation, the passenger car market has seen a significant decline in the share of our total [indiscernible] from 25% to just 6% in the last 5 years. We're therefore proactively targeting new customers in commercial vehicles, marine and aerospace to expand beyond traditional automotive customers, who are strategically in-sourcing their electrification capabilities. These other industries are all looking at ways to decarbonate their propulsion systems. But pure electrification is less likely to be the solution, certainly in the short term, given the performance range and energy infrastructure requirements.
As a result, we are prioritizing hybrid sustainable fuels and hydrogen fuel cell solutions where we can leverage our combustion and integration expertise for these target markets. We've also made some changes in our operating model. I've appointed a new Managing Director for A&I, flattened the organization structure to create clear accountability for growth and delivery. As Judith showed, we've established greater resilience in H1 with nearly GBP 10 million of lower costs in A&I compared to H1 last year. Further to the changes made in H2 '22, '23, we've looked to the flexible resourcing model at a growth solution and therefore specific skills level, which further improves our ability to manage fluctuations in orders and deliver more consistent profitability.
Finally, we've materially increased our sales discipline, establishing greater visibility and action planning for sales and marketing teams. As we'll see on the next slide, this is starting to build good momentum in our order intake.
Some of the actions we've taken, we are seeing early signs of a change in direction in A&I. The graph shows the rolling 3-month order trends over the last 2 years. Left-hand side of the page, you see the downward trend in red through 2023. However, the green trend line shows the improving trend we delivered in Q2 of this year. And as I said earlier, I'm very pleased to hear that this continues into Q3.
You can also see the cost actions we've taken last year in March and this year with further focus on flexible resourcing to reduce the revenue breakeven point with a more flexible resourcing model. This has established by profit headroom between revenue and cost and therefore, good confidence in a return to profitability in H2.
We clearly need to maintain the sales momentum. But as I said earlier, I'm cautiously optimistic that we have the right team, strategy and operating model to return to long-term sustainable profit delivery in A&I. This expected improvement in the A&I performance, combined with a higher mix of higher growth and margin of [E3M] and Rail, underpins the overall group transformation.
Within portfolio prioritization, we continue to invest in innovative solutions to accelerate our organic growth at the intersection of policy, environment and mobility solutions. We're excited about the launch of our new digital platform in Q4 of this year, which will be the core for developing digital subscription revenues going forward. This digital platform will enable us to scale repeatable solutions across multiple industries and geographies, and we have a number of applications in development.
The first application will be the conversion of one of the energy pricing models from the acquisition of E3M last year, which will have a phase launch across Europe in Q4 this year. We're also expanding our hydrogen testing capabilities given increasing demand for ICE using sustainable fuels and hydrogen fuel cell solutions. With our physical testing capacity already booked out for more than 12 months, we're developing digital twin solutions that enable accelerated product development.
Within the expansion, our focus on energy transition is supported by large target markets that are also expected to see robust annualized growth rates. The global market for environment, water and green energy is estimated to be over GBP 30 billion in 2027 and growing at more than 7% CAGR. Given our relative size, we believe we can deliver double-digit revenue growth in these business units. And as shared by Judith, we are delivering well ahead of that at the moment.
Our confidence is unpinned by having leading expertise and track records of delivery in industries and geographies that are most advanced in some of these areas and could be further expanded into new geographies. Example of this is providing water management advisory services to Neon in the Middle East, leveraging our team's expertise from Australia. Another example is supporting the Asian Development Bank in Malaysia with air quality support, again, leveraging our leading capability in the U.K. and Europe.
The global mobility consulting market is expected to be GBP 9.2 billion in 2027, growing at 5.7% CAGR. We believe we can achieve consistent high single-digit revenue growth underpinned by increased regulation across mobility industries, leading to new propulsion technologies being developed. An example is supporting the California High-Speed Rail Network, our first major rail program in the U.S.
As mentioned, we've also been working on a number of hydrogen applications across multiple mobility solutions, as you can see on the slide. One of the most significant is the work we are doing in A&I with the sustainable hydrogen powered shipping consortium, or SHPSC, to design and develop hydrogen fuel cell propulsion technologies to power the next generation of zero emissions passenger ships.
Ricardo is leading the specification, design, build and test of a 375-kilowatt fuel cell module and the design of a 40-foot containerized multi-megawatt power plant that combines the output of several cell modules. The containerized solution is intended to be installed onboard passenger ships going forward. This is actually part of a wider strategy across the group to provide end-to-end environmental and mobility solutions to support the maritime industry, defining our policy, environment and mobility solutions. This short video gives a bit of color on that.
[Presentation]
As Judith mentioned, we've accelerated the consolidation of our functional teams to support One Road delivery model. As we've just seen in the video, we are increasingly cross-selling services into marine and actually all of our target industries. The actions taken deliver some cost benefit that helps underpin our full year underlying profit guidance and will also support our ambition to deliver mid-teens operating margin as part of the 5-year ambition.
In addition, though, the actions are already accelerating improvements in operational efficiency and customer experience to support our growth numbers. A great example of this is creating one global sales enablement team with a consistent bidding process to improve customer delivery and ensure technical excellence in all our proposals.
The team are also establishing steady sales and commerce reporting, including pipeline management and focus on the key opportunities to continue to build our sales momentum across the business.
So overall, we're making some significant progress in delivering our 5-year strategic plans, and I look forward to being able to share more progress in the second half. So in summary, we're accelerating our transformation to continue to deliver in the short term and achieve our ambition in the longer term.
In the first half, we've seen strong sales momentum and our strongest ever order book. This, combined with changes we have made in A&I, the cost benefits from consolidation of the functional teams, give confidence in delivering our full year consensus performance. I'm also cautiously optimistic that the changes we've made in A&I provide visibility of a return to long-term sustainable profit growth in A&I. This, combined with the targeted digital and hydrogen investments in the attractive environmental and mobility markets and the acceleration of our One Ricardo operating model continue to give me confidence in the delivery of our 5-year strategic objectives.
So that completes the presentation for today. Thank you for your attention, and happy to take questions.
Three questions, if I may. Firstly, could you talk us through your expectations from the cloud volumes in H2 and beyond? Secondly, on data days, I can see that your receivables come down despite the sales growth was great because your funding some of your exceptionals through work capital management. Could you give us an indication of where that can get to? And thirdly, on your A&I order book chart breakeven point, but I know there's no wire access. Could you give us an indication of where that breakeven point is now and where you see that going to?
So look, on Makara volumes, again, I think, relatively well publicized. They've had some quality issues in the production. They've therefore slowed off their volumes in the first half. We are clearly in regular dialogue with them in terms of the uptick, and we expect those increased volumes in the second half and then to continue at that sort of second half run rate into next year.
We don't necessarily see a big uptick in next year's volumes beyond the sort of H2 run rate. In terms of debtor day...
So debtor days, we're currently running around 45 days, which is about a 17% reduction on where we're at this time last year. So good improvement there. I think a lot of the debtor days will depend on the mix of our revenues and the geographies it comes from. So I think there may be a little bit more to do on that, but not much.
My main focus now is around how do we reduce our inventory levels and get our accrued revenue down and get invoices out the door quickly and make sure we really embed in business that achievement of the debtor days we've got to.
Do you want to do the breakeven?
Yes. So I think with the A&I business, the key piece to look at now is that we've got a good gap between the order intake or the season and our breakeven position. We're driving that business to get to mid-margin like the rest of our businesses. We won't get there, obviously, in the second half.
But now with the actions we've taken to [indiscernible] that fixed cost base and the centralization of the enabling functions, we're on track to start to drive those base and margins.
And [lots of] moving parts there. Can you give us an indication on a sort of full year basis, how much the costs are down through the A&I moves and the operating model shifts? What does that all mean on an annualized basis?
Yes. So as I said, about GBP 4 million in the second half last year. And I think the key thing to say here is we have accelerated what we planned to do. So this centralization of enabling functions and the move to flexible resources in A&I was all part of a shift in our operating model. We've just brought that forward a little sooner to underpin this year's numbers. So we will see this age of move that we're looking at to get back to our mid-teen margins over the target period.
On an annualized basis, it's probably somewhere around sort of GBP 10 million worth of savings. But I say that's part of that transition to get our indirect cost down to 20% and get to those mid-teen market margins.
And the push-out of the A&I emerging orders, are those delays or are those cancellations as people rethink their plans?
So actually, as you would expect, it's a bit of both. We did have some fairly significant orders that have landed in Q2. And look, clearly, a few months of delay have a disproportionate impact on the profitability given the fixed cost base.
So actually, the bulk of the orders have landed as we expected. They've just been -- they have been delayed. Look, like any business, we don't win everything, and therefore, look somewhere [indiscernible] that's part of our concession.
Can I do a third, if that's not greedy.
Defense had another spectacular performance.
In some ways, is that storing up a bit of a headache because that's not a [indiscernible] finite in life. It's now a pretty large proportion of your profit. So what's the progress on diversifying into how the project is there?
So yes, clearly, the ABS program has done very well, and we've signaled that in the results. But we've also got about 5 programs now that are in development beyond ABS. Of the profitability, about 25% is generated from non-ABS business. And look, we are continuing to develop those campaigns, as we call them, in terms of the future development and are increasingly confident that they will come through.
I don't want to get into the specifics because I think my predecessor perhaps slightly suggesting they were going to come sooner rather than later. But look, we're building that pipeline.
I think we've got a question from online, Graham, from Thomas [indiscernible] from Davy. And we will forecast in delivery.
So Thomas, I'm going to ask you to unmute yourself.
You said tax heading towards 30%. Is that for fiscal year or is that more medium term?
That's more medium term. So just under 27% the first 6 months. It might increase a little bit. So somewhere between 27% and 30% this year and then increase it over time. [indiscernible]
Yes, we're going to try one. Some meeting issues.
Thomas, are you there?
No, I think we're finished out. We can take that offline.
All questions done? Okay. Well, thank you for coming, and we'll see you soon.