Rotork plc: Investor presentation August 2022

Good afternoon and welcome to this Yellowstone Advisory webinar with Rotork plc. We're delighted to have with us the new CEO Kiet Huynh and Director of Investor Relations Andrew Carter with us today. I'm now going to hand over to Kiet to take us through the presentation.

Hi, thanks Kiet. I'm Andrew Carter. I'm the group's IR director. I have been a sell-side analyst for most of my career before joining Rotork three and a half years ago. I focused on UK industrials, or I should say pan-European industrials, but I've known Rotork for quite some time. I wrote my first note on the company I think in 1997. Seems like a very long time ago now. But should we jump forward a slide, Alex?

Yeah, jumping on one then, Alex. That's brilliant, thank you. Yeah, I won't read through everything on here, but I guess the key messages really to take from this slide is first of all the 1957 on there I think is quite important because Rotork as a business was formed right at the dawn of automation in the 1950s. That's when industrial automation started to accelerate in a very big way. Pre the formation and the foundation of Rotork and the design of its products, valves in industry were operated by hand, hence the picture on the left. So whether they would be in a remote location or whether they could be in a very hazardous location, they were operated by hand. And with that obviously comes not just cost and inconvenience, but also the ever-present risk of human error. So Rotork is very much an automation company. Rotork invented the electric actuator, and that's still very much core of the product portfolio that we have today. I think the other key message I would take from this slide is really the international nature of the business. The founders and the original senior management of Rotork were very aware of the importance of moving out of the UK and the expansion into some of the countries mentioned on there such as France and Italy actually happened at a very early stage in the company's history. And the company remains very, very international today. We are truly a global business with operations everywhere that you can imagine. I'll leave it there on history. Alex, if you wanted to just jump on to the next slide. This is just to give a little bit of an idea as to the products and services that Rotork designs, manufactures and obviously provides to the customers. There's a whole bunch of products pictured there. I think the key things to be mentioning here is to talk a little bit about end markets. So our products are really used anywhere where there is a fluid. The history of Rotork, perhaps the origins of the business, tend to be more on the oil and gas side, but over the years the applications have expanded considerably and we are a very big player in things like water and wastewater, power, chemical, general industrial, etc. And the key to the different products that you see on the slide is really it's automation as I mentioned on the previous slide and it's control, and those are the things, those are the trends that our customers are looking for when they select Rotork products. It's about operational efficiency and it's about improving the environmental or reducing the environmental impact of facilities. The products that you see on there — one of the things that you won't immediately be aware of just from looking at the little pictures there is some of the environments that we play in. We'll talk about this again on another slide, but we're very much talking about products that are able to be used in extreme environments. We're looking for products that in many cases are required to be triply redundant, therefore if something can go wrong there's a second safety network behind it or backup behind it and maybe a third. We're also talking about products that increasingly have battery backup for similar reasons, and we're talking about products that have actually got internal intelligence so that data can be taken from them and can be used by the customers. I'll leave it there on that slide. Do you want to jump forward one, Alex? This just tried to sort of split the product suite that we saw the pictures of on the previous slide into sort of four buckets. And again there's quite a lot of information on here which I won't go through in an enormous amount of detail, but the key product ranges within Rotork — there are four as you can see. So electric actuators, fluid power or pneumatic and hydraulic actuators, gearboxes and instrumentation. The core and the origin of Rotork is very much about electric actuators. And I think the key thing to take from the little box there is to point out that we're seen very much as being the leader in the market. Very difficult for us to really estimate our market share very precisely because many of the competitors are in bigger businesses, but we think it's somewhere in the region of around a 20% share. It's a relatively concentrated industry. There are not that many people that can make electric actuators of the type that Rotork does. The pneumatic and the hydraulic piece is a bit more where it's a less concentrated industry. There is more competition in this area. Pneumatic and hydraulic actuators are similar to electric but as the name suggests the power to open or close the valve is either pneumatic or hydraulic, hence fluid power. Whereas with the electric actuator the motive power to open or close the valve is electric. Perhaps just to say one that we sometimes get some questions on — people ask us a little bit about instrumentation. What exactly is that? And it's important to understand it's very closely related to the actuator businesses that we've just mentioned, as similarly is the gearbox business. So the kind of product suite that we have within instrumentation includes things like precision valves that are actually used in actuation itself, things like positioners and controllers which again could be used in actuators, and things like position indicators. So our instrumentation business is in some cases selling to our own businesses and in some cases selling to external third-party actuator manufacturers as well. If we just jump on to the next slide, Alex, I think this talks a little bit about the world in which our products operate. And again, I won't go through every bullet on here, but the message I'm trying to really give here is that the applications that our products and our services are working in, they're very demanding. Our customers are relying on our products to keep their operations working. They're critical products, cost of failure is very, very high. In some of these plants you could be talking about tens if not hundreds of thousands of dollars for every hour of downtime. So it's absolutely imperative that our product is very reliable. We're talking about really tough environments as well. So I mentioned that it could be remote, it could be in a hazardous area where there could possibly be hydrocarbons in the atmosphere. We could be talking extreme temperatures, etc. So whilst those products that we showed the pictures of, they might look relatively straightforward, our customers could be saying to us, we need this product to be certified to be able to operate at minus 50 degrees or equally at plus 50 degrees. And our products have to be able to do that and satisfy certification that they're able to do so. Specification levels are high as well. The bullet point there saying certification — we are often finding that our product needs to satisfy industry-specific certification requirements, also national certification requirements, and in many cases our larger customers have their own certification requirements on top of that as well. So there are barriers to entry to designing and selling products into the markets that we serve. And finally to say that first-class service level is absolutely imperative. Our customers, in part due to the certification but also due to the criticality, they don't want just anybody working on these products. They want to have an OE manufacturer's level of service that is available at very short notice, to a very high level of quality, and that's what we provide via a large number of service networks around the world. I'll leave that one there. I'd like to jump on to the next one, which really is just echoing a little bit of what I just said and reminding just how important the aftermarket is for us. Around 400 people out of our employee numbers of around three and a half thousand are working in Rotork site services. We've got 50 service centers globally, and we've added a couple in the last few years. Accounts for around 20% of group revenues. We think there's lots and lots of opportunities available to this business in terms of taking advantage of the installed base, providing very specific client programs for their installed base they've got out there. Things like our lifetime management programs as well. From an investment perspective, what's attractive about our aftermarket business is that not only is it 20% of group revenue, so a material part of the whole, we're also growing faster. Site services is growing faster than the group overall has done for a number of years and it's accretive to the group margin as well. So it's a very attractive part of Rotork and one where we're very, very keen to continue to grow and to invest. If you want to jump on to the next slide, Alex, and I might take it back to Kiet.

Yeah, no, absolutely. Clearly sustainability is something that's increasingly important for our investors. I think it's important to say upfront that sustainability and the environment has always been very, very important for Rotork. It's not something that's particularly new to us. However, I guess the reporting on it and the external interest has clearly gone up more than a notch over the last couple of years. What we wanted to highlight on this slide was a lot of the work that we were doing in 2021 and that was basically coming out with our net zero targets, which I say we announced in March 2022. So this was a really big project with a lot of work from a lot of people in the organization pretty much throughout the whole of 2021. And I won't necessarily run through everything on this slide. But I think the key things here are we've announced our targets. We've submitted our commitments to the Science Based Targets initiative. We're looking to reduce our greenhouse gas emissions to net zero for scopes one and two by 2035. So pretty ambitious. We're looking to on a scope three basis to be able to achieve that by 2045. We've done a lot of work on the main categories of those scope threes. They really come from the energy used by our products during operation. So we're obviously going to be working very hard over the next 10, 15 years to reduce the energy used by our products from already quite low levels actually. And we're also going to be working hard with our suppliers reducing upstream emissions. We've got science-based targets which are most interim targets which are listed there on the right as well. I think what's important to note and I guess I haven't put on this slide, it's to say that we've done a lot of work on this. We have identified how we are going to achieve these targets and we've identified that the cost to achieve them isn't going to be any greater than kind of business as usual. There are some companies out there who are working very, very hard on a similar method. But there are parts of their operations where they don't know how they're going to get there and there can be in some cases quite significant either capital or operating costs to be able to achieve net zero. In Rotork's case, we know how we're going to achieve these things and we've got a pretty good idea as to how much it's going to cost and it shouldn't be any more than business as usual, which I think is important. Alex, if you just jump on to the next one. I think we've got a second slide just talking about sustainability. Yeah, so this slide is trying to answer a question that we regularly get asked which is what proportion of our sales are of products and services which have particular environmental or sustainability benefits or which enable the energy transition, decarbonization, etc. And we spent a lot of time again last year in 2021 identifying those products and services that satisfied that question. And we introduced our Eco Transition Portfolio which we summarized here on this slide again in March of this year. I think the first thing to say is it's difficult for us to quantify this precisely and the reason is that in some cases our products are being used by a customer in a way that we're not fully aware as exactly what they're being used for. So actually quantifying it accurately is difficult. But what we can say is the three portfolios on this slide that are only part of our Eco Transition Portfolio contributed around 30% of sales in 2021. So for us, our Eco Transition Portfolio is bigger than 30% of sales, potentially significantly more so. And again, I won't necessarily run through every bullet point here, but you can see the themes in the portfolio. So we consider all of our products that are being used in water and wastewater and desalination to be part of the Eco Transition Portfolio. We've got a portfolio of products that are increasingly being used to reduce methane emissions. So we include our electric actuators that are being used in non-traditional applications in the oil and gas upstream and also in pipelines. And then it also captures these quite — slightly smaller at the moment in terms of proportion of the portfolio — but the new energies and the new technologies that are very definitely coming through now quite strongly. So you'll be hearing about projects that are going on in things like carbon capture, use and storage, also hydrogen. We put in there LNG as well. We see LNG as being an important bridge fuel to a decarbonized future. And LNG is an important segment for Rotork, tends to be a little bit more cyclical than some of the other segments, but we were very, very active in LNG through the periods of 2014 to 2016 and that cycle now seems to be upon us again. So we're anticipating LNG being bigger as we go through the next several years. I think that's all I'd like to say on that slide. So if you wanted to jump on one, Alex.

Yeah. Great. Back to you.

So, Kiet and Andrew, thank you very much for that presentation. We are now going to go on to questions. There's a Q&A box at the bottom of your screen, so please type any questions into that. I see a couple have come in, and we also had some ahead of time. The first question is: it's good to see that order intake is up 14% in half one. The company does state, however, that price increases were implemented in January and May. Could you please elaborate further from a unit perspective — are unit sales up, flat, or down in the same period?

Okay, thank you. Got a couple of questions that came in on the dollar. One was: how does the weak sterling benefit you? And the other: how does a strong dollar impact your business?

Okay, thank you. Coming back to the supply chain — you said sales were impacted by supply chain problems. Can you give an indication of the magnitude of that impact, and are you still seeing supply chain problems?

Yeah. So around one and a bit for the full year, but it's probably 1.06 or 1.07 in the first half.

Yeah. And maybe just on the book-to-bill point we were making — what we're trying to say is if we'd had a first half like previous first halves, that book-to-bill would probably suggest revenue would have been in the region of around 320 million. If we use the orders as being in a normal time where the supply chain means we can get stuff out the door, that's where we'd have thought our revenue would be. The actual number was 280 million, so there is a big difference. That difference of around 40 million sits in the order backlog as we go into the second half. If we see stabilization of component availability, logistics, and our self-help measures doing better, we would anticipate seeing some reduction in that order book as we go through the second half. That's why analysts and ourselves are thinking it'll be an unusually big second half for Rotork this year.

Brilliant. That's very helpful. Thanks for clarifying. You elicited a slight follow-up question on the chips, Kiet, which is: can you ensure that the chipboards developed from the subcomponents are qualified?

Okay, thank you. Question here: margins fell in the first half of the year. Is that just due to lower sales, or are you finding it more difficult to pass through cost increases?

And there's a slight follow-up or linked question. If order books are at record levels but you're experiencing cost inflation, when you come to deliver those orders, are you going to be squeezed on margin?

Okay, thank you. A question here on ROCE. What ROCE do you want to see from your acquisitions, and how will that affect your regular ROCE? And how do you treat goodwill as part of your capital?

I think it's worth noting the financial characteristics of what we're looking for — it is definitely ROCE returns greater than weighted average cost of capital in year three. And we want to be very disciplined — we don't want to overpay for assets.

Okay, thank you. Next question: what is the spend on R&D?

Yeah, very clear, thank you. Next question: what percentage of sales do you expect from adjacencies over the next five to seven years?

I don't think we're trying to be evasive in any way with that. We're holding a Capital Markets Day in early November, which I hope people will get the opportunity to listen into or get feedback from afterwards. We're working with external management consultancies on questions a little bit like that. In many cases, it's impossible to be very specific. How big will the hydrogen market be? How big will the carbon capture market be? No one knows. We think all the signs are these are going to be good-sized markets that will be very material for us, but genuinely, who knows.

Okay, thank you. The oil and gas market seems pretty buoyant at the moment, and the question is wondering why your sales to this market actually fell during the period.

Okay. Next question: can you say more about the scale of the opportunity in predictive analytics, and do you need to get more involved in software?

I think where we are at the moment is we're further ahead than some of our customers are. So we're ready whenever they are. But that one's a hard one to put a number on simply because the market data isn't there at the minute.

Okay, thank you. I think we've got time for another couple of questions. Are the current concerns around global recession likely to impact potential future capex plans at your chemical and oil and gas industry customers over the next couple of years?

And maybe to add — just as we were working very hard in 2021 thinking about net zero and what it means for scope one and scope two emissions, many of the customers you've just referred to have been doing very similar exercises. They'll have made commitments to reduce their scope one and scope two emissions. We have a play there — we talked about methane emissions, product quality, efficiency, and automation. Capacity expansion plans may be slowed a little bit, but expenditure on items that help reduce scope one and scope two will likely continue, and that can be good for a company like Rotork.

I think one of the ones you mentioned was also the chemical industry. One of the things Rotork has seen for many years is the refining industry moving from the west to the east. We're seeing that a bit now with the chemical industry as well. You're actually seeing some of the major oil and gas companies in the east becoming more vertically integrated into chemicals. So there's a movement of where manufacturing is happening, and that could be quite good for us given we've got a very strong market position in Asia. We're very aware and watching what's going on in terms of the economy, and we know the market is very concerned about a coming recession. But there are other things we can play and areas we can target as well.

Brilliant, thank you. And I've got one last question. You commented during the presentation about the strength of your balance sheet. What's the plan for the cash on the balance sheet?

Brilliant. Well, Kiet and Andrew, thank you very much for that presentation. Really good to hear your encouraging comments about the future despite some tough market conditions, and to hear that you're still performing well. We are now going to draw this presentation to a conclusion. As people exit, you will come to a short survey — it would be really appreciated if you could spend a couple of moments completing those questions. I know management find that feedback quite helpful. And just for me to flag up our next webinar, which will be on the 20th of September with Capita. So again, thank you very much for coming, and we hope to see you all again soon. A final thank you to Kiet and Andrew.

Thank you and goodbye.