discoverIE Group H1 2025 Earnings Call Transcript

Quartr
Provided by Quartr
December 3, 2024

There are 8 speakers on the call.

Operator

Okay. Good morning, everybody. Thank you very much for attending to hear the talk through the half year results for Discovery to the end of September. So let's just take you through the highlights. So here today are Bruce Thompson, our Chairman Simon, our Finance Director and obviously, me.

Operator

So we'll start with a few highlights and then I'll hand over to Simon to take you through the details. So this has been a tricky period from a sales perspective. Sales were down 4%, organically down 10%. But we're very pleased to say that despite that, our operating profit, EBIT, up 4%, with operating margins up to a record high of 13.8%. That's up 1 percentage point on a CER basis.

Operator

So notwithstanding a softer sales environment, which is all about the destocking that we'll talk about later, The cost management, the efficiencies program, the pricing policies, etcetera, have all enabled us to build or continue a decent operating result. In addition to that, orders were up 1% organically, up 5% sequentially, quite a difference between the 2 divisions at the moment. There's a cyclical difference becoming apparent, and we'll talk a bit more about that later. But the S and C, the Sensing and Connectivity division, orders up 20% organically, very good to see that. Whereas in Magnetics and Controls, which is where most of the big destocking industrial customers are at play, their orders are still down, down 11%.

Operator

Earnings per share down 4%, that's all principally all related to the higher interest costs, which we've now passed through the peak point there. And so we'll start to see some benefit of that as we go forward with as interest rates come down. Cash flow, absolutely excellent. Simon will talk about that. I won't steal all the thunder on that.

Operator

We made one bolt on acquisition in the period, a company called High Volt, which makes high voltage capacitors for principally medical applications. We bought that for an EBIT multiple of 6. And just to note, we announced it in the previous results, but we've completed the sale of the solar business unit. We've got a very strong pipeline of acquisition opportunities. Although we haven't closed many acquisitions in the first half, there's actually been an awful lot going on.

Operator

It's all about getting the timing of the transaction right relative to the sort of fairly variable market conditions that we've been seeing. We've got about €70,000,000 of funding capacity for the second half. And there's, as I say, a lot on the go at the moment. So we expect more to come in the second half. I always talk about design wins.

Operator

Design wins continue to be up strongly. They were up 8% in the period and up 33% over 2 years ago. They are critical to our performance through the cycle. The reason our orders in essence are up by 20% organically is because we have the design wins in place, which I always say we have the design wins in place so that when conditions allow, we get the full benefit of that. And we have the design wins in place in the M and C division as well.

Operator

So as conditions improve and we work through that destocking cycle, we expect to see a similar kind of recovery. So all that being said, we're on track for the full year. I will talk about the outlook later. But notwithstanding that comment later, we're in good shape to hit our targets and our expectations for the year. So without further ado, I'll hand over to Simon to take you through the numbers.

Speaker 1

Great. Thanks, Nick. Good morning, everybody. So just, yes, firstly for me, a few of the financial highlights. This is a slide we if you were at the Capital Markets Day, you'd have seen it, a bad event.

Speaker 1

What it shows is our strong through cycle performance across the last 10 years, comfortably ahead of the targets you can see at the top there. And we've layered on underneath, you can see the performance, the summary performance for this particular period. So from a sales perspective, we've had really good decent 6% organic growth across that 10 year period. This period, we're coming through to the low point of a cycle. We're at minus 10%.

Speaker 1

Actually, that's very similar to if you look at the COVID period, it's a very similar sort of period there. And obviously, we bounced back out of that very strongly. We've had acquisitions and we've had a fair number of operating efficiencies, which I'll talk about. And that's helped us drive this operating continue to drive growth in profits and growth in operating margins. We're up 90 basis points, 100 basis points at constant exchange rates.

Speaker 1

That adds to the 800 basis points we've achieved in the last 10 years. So really good progress there. And that's helped us minimize the impact of the destocking and the interest rates Nick talked about on the EPS, so we're just 4% down. And the cash flow, yes, Nick said very strong, I'll talk about that later, but very strong generation and conversion rates, 126%, which is brilliant and way above the average for the last 10 years and obviously, our target. We've maintained our ROCE above our target.

Speaker 1

We're at 15.2%. And we continue to make improvements in terms of carbon. We're down at around about 50%. So we're halfway to our net zero target for 2,030. So well on track there.

Speaker 1

More on all these later. So next slide is the sales. So sales of £211,000,000 in the half. That's sort of down 5% reported, 4% at constant exchange rates. And that sort of comprises, obviously, the minus 10%.

Speaker 1

We've actually got 8% from acquisitions. We've done 14 6 acquisitions in the last 14 months. And then we've 2% of sales comes out because of the disposal of the solar business we announced at the end of last year. So that's 4% overall down. In terms of organically, you can see the trend is improving.

Speaker 1

So it was minus 12% Q1, minus 7% Q2. And we would expect that trend we're expecting and we're sort of seeing that trend improving as we go through the rest of the year. And then in terms of margin and profits, despite the destocking, we've as you can see on the chart, we've continued to deliver strong growth in operating margin, growth in profits. In terms of that operating margin, it is a combination. We've done those acquisitions.

Speaker 1

But yes, a big chunk has come from our own operating efficiencies. It was a combination of tight cost control, but also from a gross margin perspective, there's better pricing. We're doing clustering. We've done production transfers, we talked about last time. The cross selling is starting to improve.

Speaker 1

So lots of really good things going on under the bonnet. And that's helped us go through that. We had a 13.5% target for the year. We've gone through that 6 months early. We're at a record 13.8%.

Speaker 1

And we feel we're well on track to hit that next target, which we set ourselves, which is 15% for FY 'twenty eight. So profits up 4% at constant exchange rates. And you can see, if you look at the chart, we've delivered 18% compound growth since FY 2018. And actually, if you just look from a period just before COVID to where we are now, we've actually doubled our profitability. And there's 2 down cycles in there as well.

Speaker 1

So there's a COVID and obviously, the period we're in now. So that's not too shabby. And this chart, I put it up every time, and I think it's a really good chart. So you can sort of it gives you a walk from profits last year, 28.6 percent, 29.1 percent this period. The first three bars on the left, that's our organic performance.

Speaker 1

And you can see that we've covered the impact of the destocking through gross margin improvements, operating costs and acquisitions, roughly €3,000,000 each. It's quite neat from that perspective how we've done it. Gross margin organically, that's up 1.4 percentage points. It's up around about 2.5% overall if you include acquisitions. Costs, we've taken 5% of costs out.

Speaker 1

We've just tightened up the cost base, and that's good. And acquisitions, I said, there's 6 acquisitions in there, bringing us up to that GBP 1,000,000 profit increase. And then just Nick touched on this. This is the divisional performance. And there's a real distinction here between the 2 divisions, which is a cyclical differentiation.

Speaker 1

S and C are roughly 6 months ahead, we would say, than M&C, more early stage. M&C is later stage. So S and C, you can see sales down 5% overall, but that was very much an improving trend Q1, Q2, and we would certainly see that we see that improving even more and going into growth in the second half. That minus 5%, we've improved gross margin, costs are down 4%. We've done 3 acquisitions in that division.

Speaker 1

And so you can see profits up 12%, and that's taken us to a €70,000,000 EBIT number. And the margin is up 2.4 percent up to nearly 20%. So really good shape from that business. Conversely, contrast that with M and C, it's still coming through that destocking cycle. Sales are down minus 12%.

Speaker 1

We've done some good work in terms of reducing the impact, gross margin improvements again, 6% out of OpEx of the 3 acquisitions. So actually, the impact is reduced down to only 7% of the EBIT line and only 0.3% at the margin line. So really strong performance from S and C coming out of the cycle, out of the low point and a very resilient performance we feel from M and C as it still comes through the bottom. PBT and EPS, this chart just gives you a walk from operating profit $29,100,000 down to EPS of $18,400,000 The big standout is obviously the interest. Nick referred to that.

Speaker 1

You've got it's almost 50% higher on the finance cost line, and that's the annualization of increasing interest rates that were happening last year. And we won't see that happening in the second half. We'll see the benefit as rates are starting to come down. Tax rates are better, 1% better, and that's a profit mix. We've got more profit now in the U.

Speaker 1

S, which is a lower rate for us. And so that reduces the impact from an EPS line to 4%. And as Nick said, as interest rates for sensitivity, as interest, we've got a variable rate debt base. So as rates come down, we should see the benefit of that. And roughly a 1% annualized reduction in rates is around about 3% on EPS.

Speaker 1

So something to look forward to there. For a reported basis, acquisition costs are less this period than last period. So actually, we've got a 4% uptick in reported EPS, and we've increased our interim dividend in line with that. Henry, just move your foot. Onto cash flow and balance sheet.

Speaker 1

So the chart at the top, that just gives you this is the last 12 months. We also report on the last 12 months basis from a cash flow perspective. This gives us a walk from €66,000,000 of underlying EBITDA to free cash flow of €45,000,000 The two bars on the left of that, that's our capital investment. So actually, you've got working capital. We've actually released €5,000,000 of working capital in that period.

Speaker 1

And you'd expect that as sales come down, you expect to release some working capital. But we've also made improvements. Inventory turns are starting to improve slightly, so they're up to 2.9. And once sales growth does return, we would expect those turns to go nicely through the 3 time and above. From a CapEx point of view, we've invested €4,500,000 in that 12 month period.

Speaker 1

That's quite it's a very capital light business. That does cover we put in a new facility in China. We've done other capacity expansions and some line extensions. So it does cover quite a bit for us, but it is only 1.1%. So I keep echoing, we're a very capital like business.

Speaker 1

In the middle chart, you can see we're achieving 33% growth in operating cash flow, 46% growth in free cash flow. Both of those are up over 80% in 2 years and tracking at about 17% compound over that 10 year period you can see. So pretty good progress there. It's a strong balance sheet. Net debt is at €99,000,000 We brought the gearing down across the year from €1,600,000,000 down to €1,450,000,000 And we've made 4 acquisitions in the process.

Speaker 1

I feel that gearing will come down to about €1,200,000,000 by the year end, and that will give us access to roundabout €70,000,000 of Fireflies. So some good resources to spend in the second half. So it's a capital light, and it's very cash generative as a business. On to ROCE, it's a compounding model. I've talked about this before.

Speaker 1

So it's just a reminder, it's a compounding model. The organic ROCE will grow as the businesses grow, but that's tempered as we do acquisitions, and we'll be looking to do more acquisitions. So you see that theme happening. On the chart, you can see that across an 18 month period, our organic ROCE has gone from 15.9 up to 17.3. And then in that period, we've made a record number of acquisitions, 87,000,000 of acquisitions, and that tempers the ROCE rate down to 15.2%.

Speaker 1

And if you look at it, there's a chart in the back when we presented at the Capital Markets Day, businesses that we acquired before FY 2018, they're actually now delivering ROCE of 29%, and that sort of includes head office costs. And we would expect the businesses acquired after FY 'eighteen to also continue to compound and grow up to that 30% level and so on. That's the sort of the nature of a compounding model. And we've also got a ROTE key measure. So ROTE key sort of excludes goodwill and excludes intangibles.

Speaker 1

And so it's a measure of the underlying returns of the business. And that sort of moved up 1% to 49%, really just reflects how profitable and cash generative those businesses are. Capital allocation, again, we talked about that. So just a reminder, it's a simple policy. We invest in organic growth opportunities as they arise.

Speaker 1

Typically, CapEx will be have paybacks in the 2 to 4 time range. We pay a progressive dividend. And then the rest of free cash flow, we invest into acquisitions, whether it's bolt ons with multiples around 4 to 8 or new platforms in the sort of 9 to 12 range. And so you can see on the chart, €235,000,000 of cash flow since FY 2018, Half of 75% has gone into growth opportunities, acquisitions and CapEx, and a quarter has been returned to shareholders. And overall, €460,000,000 of capital has been spent in that period.

Speaker 1

Half of that has come from free cash flow and a quarter each from debt and from equity raising. So very balanced and disciplined approach to funding, I hope you can see. And in turn, you can also see that reflected on the lower chart, which is the shows all the gearing levels across since FY 'fifteen. And you can see that we've never exceeded our target range of 1.5 to 2 times. So it's a very disciplined approach.

Speaker 1

On the right, you could also see reflected how that sort of cash generation, so I've got what I call an organic gearing. So if we hadn't done any acquisitions beyond FY 'twenty three, our gearing would have come down from 0.7% down to 0.2%. And that's given us the capacity to do that record value of acquisitions and still be below the target range. And just finally for me, it's just a refresher of our financial journey we've been on for the last 10 years. And you can sort of see it in the KSI's that we've been reporting on.

Speaker 1

So in the good times, if you look at we're delivering strong sales and EPS growth. But in the tougher times, it's a very resilient performance you can see. That's number 23 on the chart there. Throughout that, we've delivered strong profit growth and margin growth, that's number 1. And also strong cash flow and returns, that's 4, 5 and 6.

Speaker 1

And we're continuing to do our best to help the environment, which is number 7. So it's a resilient first half. We think we're very well set going into the future. And with that, I'll hand over to Nick for a look at the

Operator

operations. Thanks. Okay. So I want to start with just a recap of some of the highlights from the Capital Markets Day, really just to sort of take us up to the high level of where we are and what we're trying to do. So the first thing to emphasize is that we're all about unique essential electronics.

Operator

We design custom super niche products for high quality through cycle structural growth markets. That's what we're all about. As Simon said, we've been on this now for path now for over 10 years. And believe it or not, we still feel as though we're only really just getting started. Most of our revenue is derived from big international customers that are sort of leaders or major players in their fields.

Operator

And I've listed a few of the customer names, typical customer names there. We have a very low individual customer concentration, but collectively a very large base of wide base of large international operators. And the model that we provide them, which is unique products designed to the applications that they need that we can design, make and support them internationally is one that has growing resonance for these international customers that in themselves of themselves are trying to differentiate and create sort of world beating products in their respective markets. So it's a great value proposition, we think. We're a niche player in a very, very large market.

Operator

But we have a very clear strategy. As I said, it hasn't really changed at all really over the last 10 plus years. We want to focus on high quality growth markets where we can focus through design activity to get high quality revenue streams into these high quality customers. We then want to be able to layer that up such that we grow ahead of GDP through the cycle. In addition to that, we then want to go and acquire more businesses that we can work with and sort of roll out the same model.

Operator

So we've acquired 28 businesses now over the last sort of 10 years or so. And one of the benefits of acquiring these businesses is that they all kind of have a very similar DNA even though the products may be different, what they do and how they do it, the business process is very similar. So as we bring these businesses in, we're increasingly fine that we can get more efficiencies by arranging the businesses and introducing sort of collaborative collaboration initiatives and the like. And that has played a big part or is playing a big part in improving our margins. So generating efficiencies to improve margins, further improve cash flow is what it's all about.

Operator

And then underpinning all this is, as Simon said, we're halfway to reaching our net zero goals, also very important. But strategies aren't static as well. Although it hasn't changed substantially over the years that we've been at it, it evolves and it's evolving now. We're increasing the level of product innovation and differentiation. At the Capital Markets Day, we introduced some of the higher end products that we're making for some of our customers now, some of which are involving multiopco collaboration within discovery across different clusters, which is really exciting and generates real very, very highly differentiated product solutions that in many cases customers can only get from us partly because we help them come up with the idea in the first place.

Operator

As we grow bigger, we're expanding and rolling out this cluster concept. We have 2 large clusters now and 4 smaller ones that are that in time will become larger themselves. We've introduced a 5th target market, which is security. It's about sort of commercial security. So things like data centers is obviously a hot topic at the moment, but also passive defense, also a fairly hot topic at the moment.

Operator

We've introduced more operational integration to get these efficiencies. We don't we're not a company that creates massive restructuring costs by closing a factory here and putting it together somewhere else. But what we do, do is we have lots of tactical initiatives that enable effective integration and importantly do it without having big associated restructuring costs. And we're scaling up the rate of acquisitions. As Simon said, we've done a record rate of acquisitions over the last 14, 18 months now, and that will certainly continue.

Operator

We operate in our part of the market is about a $30,000,000,000 market. So we have we're a very small player in a very, very large, very fragmented global components market, driven by all the markets at least that we focus on driven by structural change. So we think we're in a very good space, both now, but for the medium and longer term as well. And one of the best things about this strategy, I said it 10 years ago, I say it now and I'll probably say it in 10 years' time is that there's a very long path that we're on. This is not a strategy that's going to run out of steam anytime soon.

Operator

So just to look at the group a little bit, you can see in the pie chart in the top right that North America now accounts for 26% of our revenue. Western Europe, which is principally or half of that is Germany. Western Europe accounts for 21%, Nordic 17%, UK 12%, Asia and Rest of World 17%. You can see in the bar chart at the bottom left that the biggest slowdown in the period was North America, down 19%. That's on the back of growth of 38% last year.

Operator

So just a sort of bit of a sort of correctional adjustment there. That's principally driven by the industrial and transportation sector in mostly in the M and C sector. But you can also see there Germany down 8%, Nordics down a similar amount and U. K. Relatively resilient at 4%.

Operator

Principally, the U. K. Resilience is due to some of the transport security projects, which are all led and designed and made in the U. K. Design wins.

Operator

So I think the key point here is that all 8% year on year is pretty good, not bad. Over 2 years, it's up over 33%. And you can see in the bar chart on the right, the extent of that growth over the last sort of several years. It's just something that we can apply continuous focus on. Actually, the quality of the design pipeline that we have now and the opportunity pipeline, which is significantly over £1,000,000,000 in lifetime value estimate as well, is probably the highest it's ever been, the highest quality it's ever been.

Operator

And it continues to expand and build the engine that is what drives organic growth and market turns. And as I said right at the beginning, if we didn't have the focus on this that we do, we wouldn't have we wouldn't be seeing the 20% pick up in orders in essence at the moment. So it's the 2 are although they can't be you can't predict when the orders are going to come, You can be absolutely sure that without these design wins, you're not going to get that kind of recovery. So super, super, super important. And we're very, very pleased with the progress that we're making.

Operator

Magnetics and Control, so this is 60% of the group revenue. This so this is, as Simon said, it's about 6 months later cyclically. So when we started to see the slowdown, Magnetics and Controls was holding the numbers up as S and C started to soften. And now here we are a little time later and it's Magnetics and Controls that is still down whilst S and C is recovering. And that's principally due to the big industrial customers and some transportation customers and their destocking.

Operator

We've seen, as I've said before, very, very extensive destocking as these big international customers that got very substantial shares of semiconductors to sort of support their internal supply chains 2 years ago, ended up with very significant overstocks, which have taken a long time, a year now really to really pull back and correct. Notwithstanding that though, we've almost held operating margins only down 30 basis points, which on revenue that's down 12% is a reasonable result. Book to bill is still a little below 1 at 0.91. I think the key point to make is that from Q1 to Q2, the booking trend amongst the major industrial customers improved quite significantly, still negative year on year, But sequentially, Q1 to Q2 was up actually 13%. So we need that trend to continue in Q3 and Q4.

Operator

And it looks at the moment as if that's going to happen. Geographically, Asia is quite strongly up, you might be surprised to hear, driven by China, up 16%. That's due to Western based customers operating in China, some big renewable and medical customers that Western Medical and Renewables customers that are operating there that drove that growth. Conversely, North America down, big industrials destocking in industrials and transportation. And you can see just geographically North America accounting for 27%.

Operator

So actually the geographic split is actually fairly similar across the 2 divisions, as you can see, slightly less in North America, but to all intents and purposes quite similar in sensing and connectivity. So but the big difference is in the geographic performance in sensing and connectivity, Asia down, Europe sort of flat up slightly at 1%, and Asia down actually principally because of some domestic Chinese customer delays, which drove that. North America, a better performance here, principally because of some big commercial transport security projects that are in this sector that sort of prop that up and offset some of the corrections elsewhere. And Europe, 1%. Actually, there are some good projects in Germany, believe it or not.

Operator

I mean, our view on Germany is that it's not quite as bad as everything you read about in the media, principally because we don't operate in the automotive and consumer markets. And the some of the sort of the niche industrial German markets are actually doing pretty well. So we supply one of our businesses, we supply into EMI shielding projects that go into data center applications internationally and the areas like that are actually still doing quite well. I missed anything else on there. No, I think we talked about the recovery in the orders up 20%, book to bill over 1%, 1.08%.

Operator

That's very good, obviously. So yes, we think hopefully the corner is turning. So So the order book, I mean, it still shows a downward trend there. That will start flattening out now. It should start flattening out now from here on.

Operator

The order book is down about 20% year on year. That's principally due to the normalization of lead times. Lead times are back to normal. And therefore, order books don't need to be as long. And that's a good thing for us.

Operator

We want a reasonable order book, but we don't need it to be unduly long. And it isn't now. It's back to 4.5 months, which is slightly higher than pre COVID levels, and that's plenty for us to drive our production planning cycles. So to summarize, Q3 trading is in line. Orders are running ahead of sales and ahead sequentially, which we're obviously very encouraged by.

Operator

We think more importantly than that though that we've got the right growth drivers in place to really keep that progress, that early sign of progress going. The design wins I've talked about, they're in place. And as I mentioned earlier, even though we didn't do that many acquisitions in H1, we've got a lot going on and we've got a fairly full pipeline that should start to come through in the not too distant future. So we've got a lot going on in those two areas. The margin is looking good.

Operator

That again is a reflection of the all of the initiatives that we put in place for several years now that really started to come through to fruition. So we're looking eagerly at our next target of 15%, which we state officially is around FY 'twenty eight. But we're making very good progress ahead of schedule so far. Just got to keep it going now. So all told, we're on track to deliver the results for the year that we and the Board and the market are expecting.

Operator

So yes, so without further ado, I'll hand over to any questions. Okay, who's going to go first? Hi, Andy.

Speaker 2

Hi. Andy Douglas from Jefferies. Three questions, please. Can you talk about costs? You've done a cracking job on the margin through lots of different things, but cost has come out.

Speaker 2

Do you have to put cost back in if we get a volume recovery coming through over the next few years? Or is this more structural cost that you've taken out? I appreciate you've got clustering, you've got all kinds of things

Operator

going on.

Speaker 2

But in terms of OpEx, does that come back in or have you taken it out forever? So I'd say there's a bit of both. There is structural improvement. It out forever?

Operator

So I'd say there's a bit of both. There is structural improvement. I mean, we've definitely taken the opportunity through this period of the cycle to it's a bit like a heavy frost, kills of all the bugs. You just got to make a check on everything, make sure your costs are in the right place, make is the time to reconsider stuff and do things slightly differently if it warrants it. And so there are several of those kind of initiatives that it means that those costs won't come back.

Operator

But yes, otherwise, there will be costs that come back in as we start to grow, as we want to put more engineers in and things like that, and we will invest for those. But as always, we always invest in our OpEx in accordance with the rate at which we grow and we aim for this sort of drop through rate that allows for some operating leverage as well.

Speaker 1

Jed Laiwat, we've got quite a bit of flexibility from a sort of bonus and commissions basis. So obviously, that's designed in order that in times like this, that number comes down and we'll pay it out of increased profitability.

Speaker 2

Perfect. In M&C, clearly a tough market from a destocking perspective. What's your best guess on how long that destocking will go on for? And as and when it finishes, do we automatically go back into a big restock phase? Or do we go back to more of a just in time perspective, just from a modeling perspective?

Operator

Well, we so we think that there is a 6 month lag between S&C and M&C. We think that we're the destocking is getting less bad in Q3. And so we think that bring those two points together by the end of the second half, hopefully, we will have seen that. Now that whether that's Q3 that that's finished or whether it's Q4 remains to be seen. But we're it's in I think we're getting close to sight on it now.

Speaker 1

And also the shift to sort of just in time to just in case came about because of the supply chain constraints and obviously lower interest rates. As interest rates went up, people go, crikey, I don't need all the stock. So that's sort of come back down again. So I don't think it will necessarily get back to just in case.

Operator

Yes, although to your other point, what level of bounce back will we see? Well, who knows? Hopefully, it will be quite a nice bounce. I think hopefully, we'll see a decent bounce back in orders. That's usually what happens because in order to destock, they need to be running below their demand level.

Operator

So usually, when that comes to an end, it comes back up quite sharply. But I think beyond that, the end market pull through is not going to be strong for certainly the first half of calendar 'twenty five. The macro conditions have probably got to improve a bit yet for end market growth to be stronger.

Speaker 2

And then last one, National Insurance contribution, can you give us an impact on net

Speaker 1

income and

Speaker 2

how you offset that, please?

Speaker 1

Yes. It's a good question. There's a number in the press release. It's €900,000 for the yes, for next year. So Is that

Speaker 2

set up by price or

Speaker 1

or Yes, possibly, yes, possibly. But we'll look at that. But yes, it's a chunk. We've got quite a few employees in the U. K, so it does hit.

Speaker 3

Can we talk a bit more about the U. S? I take the point about the tough comps and some specific destocking. Is there anything else causing concern there? Obviously, it's big political change and some suggestions that some of those renewable projects are in a rather more difficult territory as a result.

Speaker 3

Is it just a question of destocking ending? Or is there something underlying behind that weakness, do you think?

Operator

So we did very well through the Trump one. As tariffs were introduced into principally China, we were able to move our production globally accordingly. And in fact, we gained business during Trump 1 because we benefited from having facilities that in Mexico actually that could pick up production from elsewhere in the world. So as customers moved and moved their demand around or as customers responded to this, we were able to respond by moving production around, which not everyone could do. So we talk and there's a lot of sort of hot tweets.

Operator

But what that really means in terms of tangible action is too early to really comment. I'm very confident that we will weather it. The two things to say. Firstly, over half, just over half of everything we sell in the U. S.

Operator

Is made in the U. S. The next biggest region is actually made is the products made in the U. K, which is about 15%. So you've got 65%, 70% of our products made in those two regions alone.

Operator

14% of our revenue is derived from products made 14% of our revenue in the U. S. Is derived is manufactured in Mexico. But it's manufactured in Mexico using raw materials, principally raw materials from the U. S.

Operator

So there'll be some presumably there'll be some letting off. So I think from a tariff perspective, I think we will weather the storm. If Mexico were to become penalized through tariffs, we can make those products elsewhere cost effectively. So I think that will be okay. In terms of end markets, well, our renewable business that we have is actually doing quite well at the moment, and it's on an international basis.

Operator

So it's not heavily dependent on the U. S. At the moment. So I don't think there's any well, yes, I don't think we're likely to be dramatically affected by that, but I don't really know.

Speaker 3

Thanks very much. Can I ask one more? I think previously, you talked about 9 big customers being behind the bulk of the destocking. Any change to that number? Are some of them through that process, some sticking?

Operator

Well, so if you look at the last year, we had our industrial and connectivity sector was down 19% and the rest of the businesses grew 9%. This year, industrial and connectivity is only down 10%. But the other sectors, all the other sectors are also down 10%. So it's got the big 9 are less bad, but the general destocking has spread across the industry more broadly. And so within that industrial and connectivity, actually what you've got is you've got the industrial customers, which still lead the charge of that reduction, although not as badly as last year, offset to quite a degree by some of the big connectivity projects that are coming through.

Operator

So that's a sort of long winded way of saying the big 9 are still down from a sales, but were still down from a sales perspective, but destocking had more broadly spread more widely throughout the industry. From an orders perspective, as I mentioned just earlier, the order run rate from Q1 to Q2 amongst the big nine customers was up by 13% sequentially. So it's still negative year on year, but it's a lot better than

Speaker 4

it was. It's Maggie Schooley from Redburn Atlantic. I have two questions very quickly, if I could. I missed the same question as Andy's, but focusing on working cap. So you've taken working cap has been quite nice.

Speaker 4

When you see a pickup, do you expect that to be structurally slightly lower? So how should we think about working cap as you move into a rebound?

Speaker 1

Yes. I think if you look at our trend over a number of years, obviously, as sales start going up, we're going to have to invest back in working capital. So we are, as I said in the presentation, we I'd expect to see inventory turns improve. We should get some benefit from that. But ultimately, you do have to invest back in working capital.

Speaker 1

What you'll see, our rate of working capital as a percentage of sales, which is currently around about the high 18%, will come back down towards the sort of 16% to 17% level is what we'd expect. But ultimately, sales grow, we would typically see conversion rates of cash come down to roundabout the 90%. And obviously, as sales are down, you've got the rates north of 100%.

Speaker 4

Okay. And the second one, just a follow-up actually from the Capital Markets Day. You're tracking ahead of your margin targets clearly. Of the 120 basis points to get to the 15, can you remind us what you think the mix is going to be between organic and acquisition? Or

Operator

Well, we said at the Capital Markets Day, it would be about fifty-fifty. And yes, I mean, yes, it sort of ebbs a bit about fifty-fifty. Sometimes it can move a little bit in favor of acquisitions, maybe sort of sixty-forty in acquisitions. But we think rule of thumb, it will be about fifty-fifty.

Speaker 5

Good morning, everyone. Lydia Kenny from Investec. Two questions from me. So firstly, on the S and C division, obviously, orders are up 20%. Could you give kind of more color on what sort of demand you're seeing there?

Operator

Yes. So we've seen a it's quite a lot. So the 20% is includes 1 OpCo in particular, which has seen a very, very strong pickup in orders in transport security and actually food processing. So this is screening equipment for those applications. If you exclude that very large pickup, then the across the rest of S and C, it's up the orders are up by 13% organically.

Operator

And that's driven by data center applications across a number of our OpCos. It's driven by comm communications applications for passive defense, literally communication amongst on from military in military fields. And then we've got some general industrial pickup as well in the midsize industrials. Actually, we think that's principally due to customers that have sort of worked through their stocks earlier because they weren't as overstocked in the 1st place. So we've got a rollout, for example, of a big industrial water metering project in the U.

Operator

S, which is underway and things like that. So quite reasonably widespread.

Speaker 5

Okay. And then my next question is on China. You're obviously investing here or put a bit of investment into facilities here when others are sort of pulling back. And then you see a mix between the divisions, the performance in China there. So I guess how are you guys positioned when local competition is also intensifying?

Operator

Well, so we're now in a position differently to several years ago. We're now in a position where China is in we produce in China for Chinese demand. And our customers so it's a China for China market, whereas it was a China for global market sort of several years ago. And in that market, it's an important market for us, and there are a number of very large international customers there that we work with. And in that context, it will continue to be an important market for us.

Operator

The divisional differences between M and T and S and C is not actually that meaningful because it sometimes comes down to just a handful of customers that make the difference. But the territory generally is still an important region for us. And the customers that we're selling to are generally very highly differentiated in the technologies that they're providing. And so they don't tend to see the same extent of sort of copycat or me too local competition that a more commoditized product range might do.

Speaker 5

Thank you.

Speaker 3

Henry Carver from Davy. Just one around pricing trends, if I'm obviously, gross margin was pretty strong. I just wondered if you could elaborate any more on trends and outlook on pricing and between the two divisions, if there's any real discrepancy there to be aware of.

Operator

So the pricing, there are some slight mix effects that contribute to the margin from pricing. So as the big nine have dropped off, and that's given a slightly favorable margin mix because inevitably some of the bigger customers are lower margin. So you get little effects like that. Yes, I think that's probably the biggest pricing effect. I mean, the if you look at the makeup of our margins, principally, it's volume related.

Operator

The margin change is volume related. And there's some mix related to the relative growth rates of higher margin versus lower margin operating businesses as well. So there's a bit of that coming through. And that has certainly partly influenced the stronger EBIT margins that we're seeing in S&C at the moment because there's some of those areas are growing better and they're slightly higher margins.

Speaker 1

Great.

Speaker 3

Thank you.

Speaker 6

It's Andrew Humphrey at Peel Hunt. I wanted to ask about M and A and the pipeline there. You've talked about that, I think, fairly extensively back at the Capital Markets Day in September. You're indicating sort of vendor expectations around pricing have sort of adjusted and become more reasonable. Would love an update on kind of where things are at with the M and A pipeline, how we should think about the next 6, 9 months there.

Speaker 6

I wanted to ask about Europe as well. Clearly, kind of there's a lot of focus on the political situation in the U. S, but Europe has some kind of challenges over the next few months as well in terms of potential government changes in Germany and France. Any feedback you're getting from customers on that would be interesting.

Operator

So on I've forgotten your first point, Andrew.

Speaker 1

M and A.

Operator

M and A, thank you. On M and A, the multiples so we paid 6 for our recent acquisition, which was a small bolt on. For midsize acquisitions, the kind of margins that they're generating, so sort of 20% plus margin businesses, we're looking at sort of 8% to 9% typically EBIT multiples, something like that. And generally a bit lower for smaller businesses. So yes, so I mean the multiples ebb and flow a bit, obviously, according to sort of the overall market conditions.

Operator

It's worth saying that 2 thirds of our deals these days are generated in house as well. So and I would say that the at the moment, the multiples are they've come down over the last year, a turn or 2, and they're pretty static at the moment. And they're kind of back where they should be. The hubris has gone and they're kind of back where they should be. In terms of yes, who knows what political, my goodness, only knows what's going to happen politically in Europe.

Operator

From our perspective, Germany isn't as bad as, as I said earlier, as sort of perhaps the media portrays the German economy because we're in these industrial niches where Germany is very, very strong. And these Mittelstand German companies create great products often. They sell them to great customers, both domestically and internationally. And often those domestic customers have a strong export contingent themselves. So they're relatively immune from some of the more sort of high profile problems.

Operator

So high quality German businesses, we really like that Mittelstand concept really fits with the Discovery DNA. So we will continue to develop businesses in those areas and acquire businesses in those areas. So as with any acquisition, we're super cautious on what we're buying. We're very diligent very, very carefully. We look at the customer concentration, the customer trading metrics and all manner of detail to make sure that there's real substance and quality in the revenue that's been generated.

Operator

And then you've got to sort of choose your timing right. And if it passes all of our sort of diligence points, then we generally crack on. So in that extent, we think now is a good time to be cracking on. I think that probably concludes all the questions in the room. Are there any questions coming in online?

Speaker 7

Yes. We've got some questions from Ethan Swamy from HSBC. He's got 4 questions. First question, with organic orders turning positive, when can we expect the inflection point for organic sales growth? 2nd question, is there any potential impact from U.

Speaker 7

S. Tariffs? 3rd question, since short term margin target is achieved ahead of schedule, can we expect a medium term guidance lift when sales growth flows in? And last question, in the absence of M and A, can we expect share buyback from excess free cash?

Operator

Right. What was the first question again?

Speaker 7

All at once. With organic orders turning positive, when can we expect the inflection point for organic sales growth?

Operator

Yes. Well, good question. I mean, the order book will start to rebuild and that typically flows through into sales in about 3 to 4 months. So you can sort of work on an assumption of 4 to 6 months following the return of order recovery as a sort of rule of thumb, I would say. And the second question?

Speaker 7

Is there any potential impact from U. S. Tariffs?

Operator

Yes, we kind of covered that. I mean, I think the we feel as though the impact is we certainly didn't feel any negative impact under Trump 1. I think we're well placed as any business can be, to not be negatively impacted. And you never know, we might even be slightly positively be able to slightly positively benefit from it because of our global footprint. Yes, I think that's probably what we need to say on that.

Operator

And the third point was, was it something about raising guidance? I don't think we're in raising guidance territory. And I'm with and not nor we are in share buyback territory either.

Speaker 7

And the 4th question was in the absence of M and A, can we expect share buyback free excess free cash?

Operator

Yes. No. Well, so there isn't an absence of M and A. There's a lot going on and it's all about getting the commercial terms of the M and A deals right. And if that means we won't have to wait a few months longer as we've done over the last sort of first half, then we'll do that to get to the right position.

Operator

And we feel as though we've done the right thing there.

Speaker 1

I think you've got to be typically, you've got to be sitting on a lot of surplus cash. And we wouldn't want to you we're not in that position. You don't want to be sort of borrowing to buy shares by books.

Speaker 7

There are no further questions. I'll hand back

Operator

to you. Okay. Well, thank you and thank you very much for your time. Have a great rest of your day.

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