SGS SA (SGSN) Earnings Call Transcript

Ladies and gentlemen, welcome to the SGS 2024 Half Year Results Call. My name is Ariel Bauer, and I'm in charge of Investor Relations, Communication and Sustainability, I'm here with Geraldine Picaud, our CEO; and Marta Vlatchkova, our CFO. Please note that this call is being recorded and will be available for a replay on the SGS website. [Operator Instructions] I would now like to turn the conference over to Geraldine Picaud, CEO of SGS.

Thank you, Ariel. Good morning, ladies and gentlemen, and welcome. It is a pleasure to share with you today our H1 achievements. We are very happy with the progress made with the execution of our strategy. During the second quarter, we further developed our service offering in digital trust and sustainability which will be strong growth drivers in the coming years. We also reinforced our market position with the acquisition of great companies. Our restructuring plan is well on track with initial savings already documented, and I will come back to it in a minute. Additionally, we are proud to be ranked as the sixth most sustainable company in the world by TIME Magazine. On the financial results, we reported a strong organic growth of 8%, and we have been able to fully mitigate the negative impact of the ForEx on our margin rate, mainly with the early savings realized from the restructuring plan. This is a great achievement as well as a significant improvement in free cash flow. The Strategy 2027 is well on track, and we clearly reconfirm our outlook for the full year. Let me now move to Slide #4 and give you some more color about what we have done on sustainability and digital services. We place sustainability as one of our growth -- main growth drivers for both testing and certification businesses. Over the past months, we have defined a number of priorities to have the right service offering for our customers. For instance, we are quadrupling PFAS testing capacity in North America, where we witnessed over 50% growth in H1 and see significant opportunities in the future. In Natural Resources, we are recognized as a leader in critical minerals and battery metals. We are also pioneers in the way we support environmentally responsible companies in their transition to sustainable energy. We are leading the way in sustainability report assurance in Asia, where we signed several contracts with top listed companies and expect significant revenue growth in this area, especially in other geographies. More generally, we remain a pioneer in ESG assurance and are preparing a global rollout of our portfolio of services to meet rising demand. In digital trust, where we have a leading edge we have continued to invest in cybersecurity, which is a key growth driver for us. Let's now look at M&A. As part of our strategy, we have reactivated bolt-on acquisitions. We choose companies with a good strategic fit, which will strengthen our position or complement our geographical footprint. We also ensure that we will be in a position to execute a smooth integration and realize the identified synergies. In H1, we have signed the acquisition of ArcLight and Gossamer, which reinforced our presence in North America and our leadership in connectivity. IEC strengthens our global leadership in cosmetics while AQM and Cromanal are key players in pharmaceutical testing in Colombia. As with all of our investments, we apply strong financial discipline with criteria on growth potential, profitability and payback. Let me now switch to another key item of our Strategy 2027. In order to streamline our organization and improve agility, we have launched a cost savings plan with the ambition to reduce our cost by CHF 100 million fully effective before the end of 2025. This plan is very well on track, and the savings represent already 0.3 percentage points of margin in H1. As of now, corporate functions are fully reorganized and disciplined execution continues in countries and shared service centers. We see no limitation to reach the CHF 100 million as planned in 2025. On Slide 7, you see here the growth split across all business lines. And now I will go into the detail of each one of them. Let's start with Industries & Environment. Organic sales growth of 10.9% was driven by all regions and services. Our strong growth is more specifically driven by advisory, safety and environment. Advisory was supported by sustainable construction projects in the renewable energy sector, for instance, in Latin America. In safety, we recorded strong growth in risk assessment and industrial hygiene services in Europe. And last but not least, in Environment, like I just mentioned, we signed multiyear contract for site remediation and PFAS testing. Finally, I would like to note that we are seeing increased activity related to CBAM regulation and carbon capture, where SGS has a strong expertise and more generally, those related to the transition to renewable energies such as hydrogen. Natural Resources benefited from the strong momentum of the energy transition and delivered strong organic sales growth of 8.6%. We have a large number of projects in Metallurgy, notably in battery metals in North America. SGS has a recognized expertise in this field. We are at the forefront of supporting companies and national governments in their transition to sustainable energy with over 180 projects ongoing at the end of H1. Also high single-digit organic growth in Trade & Inspection was driven by project wins across all commodities and regions with particularly strong activity in minerals reported in Asia Pacific and North America. Let's now go to our Connectivity & Products, which continued to accelerate in H1. It generated solid organic sales growth of 6.9%. New opportunities in sustainability continued to fuel organic growth within Softlines business segment. This was supported by rising consumer expectations and regulation. In Hardlines, high single-digit organic growth was mainly driven by toy safety and lower inventory levels. Connectivity achieved another strong set of results, delivering high single-digit growth and solid performance in product safety and cybersecurity in Asia Pacific. Organic sales growth in Health & Nutrition was driven by Cosmetics in Asia Pacific and in Food globally. High single-digit organic growth in Food was driven by project wins, regulations and network expansion. In Cosmetics and Hygiene, we benefited from double-digit organic growth in Asia Pacific. Market conditions in health science remained challenging. Health science market is a bit soft and suffering, but remains a strategic market for us, where we have outsourcing capabilities. Let's now and with the Business Assurance and Business Assurance delivered organic sales growth of 7.8%. Double-digit organic growth in Certification was supported by strong activity in North America Europe and Asia Pacific. Medical devices continued to be a strong driver with over 100 new contracts signed in 2024. Strategic segments of digital trust and food assurance also continued to fuel growth. Organic growth and sustainability accelerated further, thanks to strong performance in ESG assurance and sustainability audits where our expertise is well recognized. In H1, we delivered over 16,000 supplier audits, addressing social, ethical and environmental risk, and we also launched a new digital platform for CS3D compliance. In Consulting, a high basis of comparison at main point weighed on the results. And with that, I will now hand over to Marta who will present to you our financial performance.

Thank you, Geraldine, and a very good morning to everyone. I'm excited to share some more details on our strong first half performance. As a first overview, net sales reached CHF 3.3 billion supported by 8% organic growth, which accelerated in the second quarter. The adjusted operating income of CHF 471 million, translated into 14.1% margin on sales, stable compared to last year. In addition, we generated a free cash flow of CHF 155 million, which was 35% higher versus prior year. Let's now move on the next slide and see how the sales compared to last year. In the first half of the year, our sales reached CHF 3,335 million, up by 1.6% compared to prior year. We can see that the strong organic growth of 8% was partially offset by the scope effect and the ForEx. The negative scope of 0.6 points reflects the prior year disposals of the automotive assets assessment and the powertrain testing businesses, partly compensated by the acquisition of Nutrasource in May 2023 and ArcLight in May 2024. The negative ForEx translation effect of 5.8% was mainly driven by the Chinese Yuan and the euro depreciation against the Swiss franc compared to the same period of last year. Let's now drill down in our sales growth. Looking at the sales by division, both Testing & Inspection and Business Assurance divisions grew at a similar pace of around 8%. In Testing & Inspection, Europe, North America and Latin America were fueled by Industries & Environment and Natural Resources business lines. Europe sales grew organically by a steady 4.5% with strong contribution from all major countries despite the challenging environment in health science. North America sales increased by 5.8% organically, further expanding in Environment and more specifically in PFAS. LatAm expanded by close to 20% organically. We saw double-digit growth in all major countries and a strong pipeline of projects. APAC delivered 6.3% organic growth with strong performance across all business lines, high single-digit growth in China and a double-digit growth in India. Eastern Europe, Middle East and Africa grew organically by 15.7%, supported by all business lines and a double-digit growth in Trade & Inspection for minerals, agricultural, oil and gas and chemicals commodities. Our Business Assurance global segment expanded organically by 7.8%, with double-digit growth in Certification and Management Systems and a strong performance in ESG assurance and sustainability audits, partially offset by a high basis of comparison in Consulting. Moving to the adjusted operating income, where we delivered 11.5% of organic growth, equivalent to 40 basis points of margin improvement. Around 30 basis points came from the first positive impact of the disciplined execution of our cost savings program. This allowed us to fully offset the negative ForEx impact and deliver a stable 14.1% margin compared to prior year. Now we will look at the foreign exchange effects. In the first half of the year, the Swiss franc appreciated against all major currencies compared to the same period of last year. This led to a negative ForEx translation impact of 5.8% on sales, translating into minus 40 basis points in the adjusted operating income margin. Let's now have a look at the full P&L. Starting with operating income of CHF 415 million. It includes CHF 34 million of restructuring costs related to the execution of the CHF 100 million savings plan. The financial expenses as well as the effective tax rate are broadly stable. As a result, we achieved an EPS of CHF 1.44 to compared to CHF 1.47 in H1 2023. Before restructuring costs, the EPS reached CHF 1.58, a 3.3% improvement compared to prior year. Now moving to the free cash flow. In the first half of the year, we generated CHF 155 million of free cash flow, up by CHF 40 million compared to prior year. The improvement was driven by lower net working capital and a disciplined CapEx spend focused on growth. and with that, I hand it back to you, Geraldine.

Thank you, Marta. So let's now go to the outlook. And to conclude this presentation, I would like to confirm again our 2024 guidance. We were very pleased with the strong performance achieved in the first half, and we are confident that we are doing the right moves to achieve what we have promised, a mid- to high single-digit organic growth, a full M&A program relaunched, improvement on the reported AOI margin on sales and a strong free cash flow generation. So with that, I will now hand over to the operator for the Q&A session.

[Operator Instructions] The first question is from Will Kirkness from Bernstein.

Two questions then, please. The first one just if you could help us understand the price component of organic revenue growth. So if you could give us a split between volume mix and price, that would be really useful. And then secondly, I suppose you don't want to get too much away ahead of November, but just wondering now you've had a bit more time in the business. If you've seen any areas beyond the cost cutting, where you think there are productivity gains, potentially a lower cost to serve, other things that might help on the margin.

Well, the -- the second question was very, very difficult to understand. The sound was very bad. The first question, we understood that you wanted to know the composition of the organic growth between price and volume. And I will give the floor to Marta for that. Marta, do you want to answer that first question? The second question, you have to repeat will, because I didn't get it.

On the second question, it was just around margins.

Okay. All right. I'll take the second one. Marta, do you want to take the first one?

Yes, we see roughly 50-50 split between price and volume in our 8% organic growth.

Okay. We'll your question is that we're going to have more productivity gains on top of the CHF 100 million cost-saving plan, I am affirmative. We have a margin improvement that always come from productivity initiatives. And on top, you have effectively the restructuring or the CHF 100 million cost-saving plan.

The next question is from Daniel Bürki from Zurcher Kantonalbank.

I have 2 questions. First, on profitability. You had a strong increase in the margin in Industries & Environment. Could you elaborate on this? And the other 4 areas divisions are down, what is stopping, let's say, Natural Resources to improve profitability if you have such a nice top line growth? And then the second question, you did not dispose of your Crop Science business. Were these only financial considerations? Or did you change your mind how attractive this business is for you in the future?

Okay. Daniel, I will start with the second question. Look, it is fairly simple. The transaction was subject to a long stop date and to closing conditions and this condition were not just not met within the agreed timing. So Crop Science, therefore, remains part of SGS Group. We will run and develop our business, it remains inside SGS. Then you had a question about the margin. I want to be clear here. All our margins have improved. If you look at it at constant currency, apart from Health & Nutrition. Your question about I & E in is also a good question. The product mix, we have subsegments below have favored that increase in margin that you see in Industries & Environment. In Natural Resources, again, the margin has not decline when you look at it at constant currency, and we are expecting a strong momentum to continue in our Natural Resources business segment.

The next question is from Sylvia Barker from JPMorgan.

First question on the cost savings. Again, it seems we've achieved maybe CHF 10 million already in the second quarter. So how should we think about the quarterly run rate of these cost savings or presume they might be accelerating into Q3 and Q4, and then obviously, into 2025? And then second question, just on the PFAS agreement. How much of a benefit those were already in the second quarter, but also how should we think about, I guess, the impact of them on that division into H2 and beyond?

Yes. Thank you, Sylvia, and good morning. So on the cost savings, look, we have recorded already with a rapid ramp-up and a good phasing of our CHF 100 million cost saving plan already CHF 9 million in Q2. So you can effectively at least project such savings for Q3 and Q4. And then the rest, as we said, will come in 2025, remember that we guided in January that we will reach the full run rate of the CHF 100 million at the end of 2025. On your second question on the PFAS, we have invested, as you know, capacity substantially in order to capture that fantastic demand that we have and we see it continuing and accelerating in the coming months and in 2025. So we're very positive about PFAS. That's why we invested again in capacity which quadrupled our capacity in terms of PFAS testing.

The next question is from Agarwal, Himanshu from Bank of America.

The first one, yes, on the first half numbers, congrats on a good set of results. But can you just talk about like what surprised positively on both organic growth and margin which seems to have come in even better than your expectations? And also, how should we think about the second half? You mentioned CHF 9 million we can extrapolate into second half. But can we expect a bit more of cost savings in the second half? So that's the first one. And then second one is on Industries & Environment. You've highlighted PFAS as one of the drivers for strong growth in first half. I see that EPA has delayed the enforcement of the PFAS regulation to 2027. In that context, does it like impact your business related to PFAS?

Yes. Can you repeat the last -- you have seen that or what has been -- Himanshu, the last part.

Yes, sorry. Yes, I was talking -- so EPA in the U.S. has delayed the enforcement of PFAS regulation to 2027. Do you see any impact of that delay on your PFAS business?

Okay. All right. Well, if I start with this last question. No, there's no impact on our business at all. And I want also to stress because we always talk a lot about North America when it comes to PFAS, but it's also -- we see also a strong demand in Europe. So no worries about that at all. And you're right, it's a booster on our Industries & Environment result, and we see a high -- a very high pipeline of projects in terms of PFAS and in general for this business segment. So you're asking if we can do more than CHF 9 million multiplied by 3, basically. Of course, we're working on it for the moment, and we'll stick to that number. But we're doing or maximum to accelerate the savings program and to get where we want to be as soon as we can. For the moment, we will stick to the CHF 9 million that you have at least -- that we will produce at least for Q3 and Q4, Himanshu.

If I may just follow up on the organic growth, which seems a bit better than we expected. Can you talk about the second half expectations because you have still confirmed the guidance mid to high single digit, but first half was already at 8%.

Right. Look, we stick to our guidance of mid- to high single digits. We have to see how the world is developing now. There is -- there is always a macro political uncertainties in the world. So we are confident and super confident about our guidance, and we want to stick to that for the moment. Do you remember that we have Q3 call in 3 months, so be a bit patient. And maybe I should reinforce, Himanshu, on a separate note that we are reinforcing throughout the organization, a sales culture.

Next question is from Annelies Vermeulen from Morgan Stanley.