DIPLOMA PLC

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Transcript : Diploma PLC, H1 2022 Earnings Call, May 16, 2022

16/05/2022 | 10:00

Presentation Operator Message
Operator (Operator)

Good day, and welcome to the Diploma Half Year Results Webcast and Conference Call. I will now hand you over to Johnny Thomson, CEO. Please go ahead.

Presenter Speech
Jonathan Thomson (Executives)

Thank you very much. Good morning, everyone. I hope you're all healthy and happy. Thanks for joining our half year update. It's great to have you with us today. I'm here as usual with our Finance Director, Barbara Gibbes. So I'm going to start with an overview. Barbara will then take you through the numbers, and then I'll come back for a review of the businesses, and there'll be questions as normal at the end.

So let's get straight into it. I'm delighted with our performance and our strategic progress in the last 6 months. We're executing our strategy of building high-quality, scalable businesses for organic growth. Our organic growth and operating margins have again been strong in the half, and we're confident in our materially upgraded guidance for the full year communicated in April. We've invested GBP 172 million in 3 strategically important acquisitions, one in each sector, which will build scale in key business lines and support future organic growth. Maintaining our portfolio discipline, we also disposed of 2 small noncore businesses. We continue to quietly evolve the structures, capability and culture of the group. This will sustain our strategic execution and performance delivery for the long term. And finally, we're making good progress with delivering value responsibly, our ESG program, with all our businesses embedding activity into their core commercial strategy. For a summary, it's been a very positive first half.

Our results for the first half were strong across all key metrics of our financial model. Organic growth of 16% reflects the success of our revenue diversification initiatives, the positive demand environment and pricing. Reported revenue growth of 23% includes the contribution from high-quality acquisitions completed over the last 12 months. We're pleased with our margin. Despite a challenging operating environment and inflationary pressures, margin was up 20 basis points on last year to 18.4%. This has been driven by the hard work on pricing, along with the benefits of our value-add model. Adjusted EPS was up 22%, and we're increasing the interim dividend by 20%.

Our success is due to our brilliant colleagues. We're acutely aware that they face a great many challenges right now, and so we're focused on supporting their personal well-being as well as their professional engagement and development. We've all been disturbed by events in Ukraine. While Diploma has no direct business exposure to the region, we do have colleagues who are personally affected, and we've been fundraising for the Disaster Emergency Committee. I'd like to say a huge thank you to all of my brilliant Diploma colleagues. You continue to make a difference.

Now over to Barbara to take you through the numbers.

Presenter Speech
Barbara Gibbes (Executives)

Thank you, Johnny, and good morning, everyone. We have delivered a strong set of financial results for the first half of 2022. All of our metrics have outperformed our financial model, and we're driving really good return for shareholders with an improvement in ROATCE, which is 100 bps higher than last year at 17.5%. I will tell you more about what has driven the financial results in the following slides.

Starting with revenues. Overall, our reported revenues have increased by 23% in the half to GBP 449 million. Underlying growth was 16%. Acquisitions and disposals contributed a net 7%. Johnny will cover the sectors in more detail, but to pull out a few highlights, Controls delivered very strong underlying growth of 28%, consisting of 17% at International Controls and an excellent 42% at Windy City Wire. Seals is also growing well. Underlying growth was 15%, reflecting broad-based strength across the sector and in particular in North America. Underlying revenues declined 7% at Life Sciences. Excluding last year's COVID-related ventilator sales, underlying growth was 2%, also moderated by lockdowns in Canada and Australia.

Excluding the short-term impact, the sector is trading well. We're confident in the outlook and expect the sector to return to growth during the second half. For the group as a whole, there are 3 key drivers [ impacting ] underlying growth. First, our organic revenue diversification initiatives. Second, positive demand environment. And third, half of our underlying growth related to volume, the best of pricing, of which around 5 percentage points is from copper.

Let's have a look at the operating margin next. In such a challenging environment, with both supply chain pressures and inflation, I am delighted that we have been able to increase our operating margin by 20 bps year-on-year to 18.4%. The bridge provides some insight into what has driven this margin expansion.

Our businesses continue to work exceptionally hard to contain inflationary price pressures, but where that has not been possible, our value-add gives us some pricing power. This means we can pass on cost inflation to customers and protect our margins. As I flagged on the last slide, around half our revenue growth related to pricing. What you see on the chart is the gross impact of pricing on our revenue line, including copper and the gross inflationary increase in cost. The net effect of the 2 on profit is relatively modest. The main driver of profit growth and the higher margin is volume growth. The chart reflects the drop-through of positive operating leverage and higher volumes, and this is driving margin expansion. Acquisitions over the last 12 months have contributed positively. And finally, we have then carefully reinvested in operating expenditure, and we'll continue to do so in order to sustain our business model as we scale.

Now let's take a look at the rest of the P&L, looking at the items further down the income statement that we haven't covered yet. Interest costs have increased due to increased leverage to fund acquisitions and higher interest rates. Effective tax rate is 25%. This is in line with what we saw for the full year and reflects the changing geographic profit mix with more U.S. weighting. EPS grew very strongly, over 20% higher. And the proposed interim dividend of 15p represents a 20% increase year-on-year.

Let's have a look at net debt and cash flow. Cash conversion in the first half was 64%, a very good result, with free cash flow up 10% year-on-year at GBP 37.7 million. The GBP 20 million cash outflow for inventory includes incremental investment to ensure product availability and support market share gains. In line with seasonal patterns, we expect a stronger cash generation in the second half, and we continue to expect full year cash conversion to be in line with our financial model of around 90%. Our net M&A spend of GBP 29 million principally related to the acquisition of LJR Electronics, together with deferred consideration on previous acquisition, partly offset by the proceeds from the noncore disposal of our Russian business, Kentek, back in November. Net debt at the end of March was GBP 209.5 million or 1.2x EBITDA.

Following the end of the half, we completed the acquisitions of R&G Fluid Power Group and Accuscience for a total of GBP 152 million. The noncore disposal of a1-envirosciences for GBP 11 million also occurred after the end of March. Including these transactions, we expect net debt of around 1.5x EBITDA by year-end. Strong cash generation in the second half will give us good headroom and a strong balance sheet.

Moving on to acquisitions. Our approach to acquisitions remains highly disciplined. Investments need to offer a strong strategic fit and meet our financial hurdles. We've had a great start to 2022, deploying capital across all 3 sectors, with 3 strategically important acquisitions. And we have done this while remaining financially disciplined, paying an average multiple of around 9x. Our disciplined portfolio approach also applies to our existing businesses and to disposals of Kentek in Q1 and a1-envirosciences after the end of the half. And we're delighted with the improving returns of our shareholders with ROATCE up 100 bps over the last year to 17.5%.

Finally, I wanted to comment on current trading and our outlook. The wider macroeconomic environment is uncertain. We expect that the strong demand we are currently seeing may moderate and that inflation will continue. Having said that, the second half has started well. And so we are confident in our full year guidance, which we materially upgraded in April.

For 2022, we expect low double-digit underlying revenue growth. We have delivered 16% in the first half, and we expect growth to moderate in Q3 as the comparators get tougher. The net impact of acquisitions and disposals made over the last 12 months mean that reported revenue growth will be a little over 20%. And just to remind you, since our April update, we have acquired Accuscience, which is expected to generate annualized revenues of around GBP 35 million and which you will need to include in your model. We expect our adjusted operating margin to be at the top end of the 18% to 19% range. We continue to expect free cash flow conversion to return to our financial model of around 90%. And we currently expect cash generation in the second half to take net debt to around 1.5x EBITDA by year-end. We expect 2022 to be another strong year.

Back to Johnny.

Presenter Speech
Jonathan Thomson (Executives)

Okay. Thank you, Barbara. And for a review of our businesses, I'll start with the reminder of our strategy, which is to build high-quality, scalable businesses for organic growth.

Our businesses have fantastic organic growth opportunities. We diversify and scale them into 3 ways: positioning behind structurally growing end markets, penetrating further in core developed geographies and extending our product range to expand addressable markets. By diversifying our revenues, we will grow organically, build scale and increase resilience.

As a group, we focus the portfolio around key scalable business lines. This means acquiring businesses which complement and accelerate this organic strategy. Occasionally, there may be the odd disposal as we tidy up the portfolio.

Our value-add distribution model underpins everything we do. It drives customer loyalty and therefore resilient growth, pricing power and therefore attractive margins. We continuously improve the core competencies of the model so that our businesses can deliver the value-add proposition as they scale. And we're evolving the structures, capability and culture through which we manage the group too.

Delivering value responsibly has become central to our commercial and operational strategy. It is a source of value creation for all of our stakeholders. In the next couple of slides, I'll take you through how we've been delivering against this strategy in the first half.

Now let's start with organic growth. I've mentioned the 3 ways we diversify and grow our businesses. So a few words now in each. First, we seek to position our businesses behind structurally growing end markets. Some examples: Increasing infrastructure investment in the U.S. and elsewhere will benefit Seals. Technology developments such as data centers and digital antenna systems benefit our Controls businesses, particularly Windy City Wire. Renewables and sustainability investment can be a great growth driver for Seals and Controls. And finally, in Life Sciences, we're well positioned to take advantage of significant acceleration in the clinical diagnostics space, especially after the pandemic experience.

Secondly, we'll penetrate further into core developed economies where we are currently still relatively small. For example, we've made significant progress in the U.S. Our Louisville facility is driving market share gains in Seals, and the acquisition of LJR accesses the U.S. interconnect market in Controls.

Finally, we extend our product ranges to expand our addressable market. We do this incrementally within the businesses and at a portfolio level. The acquisition of R&G provides a step change for Seals in the U.K., broadening the fluid power product capability into industrial, hydraulic and pneumatic systems.

All of our businesses have opportunities across all 3 of these dynamics, and that's really exciting for our future organic growth. We focus the activity in each business to ensure disciplined execution. That execution has contributed to the group's 16% organic growth in the first half.

Focused development at the portfolio level is key to the sustainability of the organic growth strategy. This means being disciplined about acquisitions and disposals. We target businesses with strong value-add distribution characteristics and high gross margins with organic growth potential and with great management teams. Once acquired, we add value by driving accelerated growth, whether it be through unlocking investments, providing management expertise or even cross-selling products. In some cases, we also add value through scale benefits. Finally, we allocate our capital to those opportunities that best develop the portfolio, executing the organic growth priorities for our key businesses. So far this year, we've invested GBP 172 million on 3 strategically important acquisitions. A few words on each.

In April, we announced the acquisition of R&G Fluid Power Group in Seals in the U.K. for GBP 100 million. R&G had a great management team, a broad product offering, a strong customer proposition and a platform with excellent reach across the U.K. The business has exciting prospects for continued organic growth and the opportunity to further consolidate small regional competitors. Strategically, it brings scale to our U.K. Seals business and expands our addressable markets through extending our product capability.

We also acquired LJR Electronics in January for GBP 21 million, giving our interconnect business improved access to the U.S. market. There's also scope for us to introduce wider value-add processes to LJR.

Last week, we acquired Accuscience for GBP 51 million. Accuscience is a leading life sciences and med tech distributor in Ireland. The business has exciting prospects due to its positioning in the high-growth clinical diagnostics segment, very much consistent with our organic growth strategy. It also gives us scale in Ireland and continues to build out the European pillar for the life sciences sector.

Finally, we are also tidying up the portfolio, as I said, 2 small noncore disposals, Kentek, our Russian business in November last year, a1-envirosciences in life sciences sector a few weeks ago. So looking ahead, we remain highly disciplined on acquisitions, especially in uncertain economic times. However, the pipeline is encouraging.

You've seen this slide before. For many years, we've talked about the importance of our value-add distribution model. It's the foundation of the group's success. The service component builds loyalty and therefore resilience, pricing power and therefore margins. There are 5 core competencies that underpin our value-add model: supply chain, operational excellence, value-add services, routes to market, and commercial discipline. Delivering these in big businesses is very different from small businesses, so we must continuously improve the core competencies to execute at scale.

The pandemic has been attached to the model but also a catalyst for this continuous improvement. For example, in supply chain, we've been developing a structured and proactive approach, category management techniques to evaluate partners on a fuller set of criteria such as location, flexibility, environmental and employment practices as well, of course, as quality and cost. This, together with the outstanding efforts of our colleagues, is making a difference. We're getting products to our customers. And in many cases, better product availability means we can differentiate and win market share.

Another example is our management of a challenging inflation environment. Our value-add products and services, together with commercial discipline or pricing has helped us with inflation. Our products and services deliver real value to our customers. For example, Windy City Wire's RackPack save contractors 30% of their labor costs. In aftermarket Seals, we're providing mobile machinery repair shops with access to a huge product range, technical support and next-day delivery. Our Life Sciences commercial team brings years of technical knowledge and exclusive access to market-leading medical and diagnostics products.

So we deliver real value for our customers. And this value, together with our improving commercial discipline or our pricing processes, have helped us to manage higher inflation and therefore protect our margin. We will continuously improve our value-add model to execute as we scale.

Now let's review our sector's performances. Starting with Controls. Controls posted a very strong organic growth rate of 28%. International Controls delivered 17%, reflecting revenue-diversification initiatives to position our businesses for growth, for example, in the energy, medical, infrastructure end markets. Also, the return of the civil aerospace sector in this half has also helped. As we expand our geographical reach too, we've seen good growth in our U.S. and Continental European businesses. And finally, the acquisition of Techsil last year expanded our product capability into specialty adhesives, and it's growing very well.

Windy City Wire continues to deliver. Organic revenue growth was 42% with nearly 20% volume growth. Their excellent customer proposition and better product availability is driving market share gains in high-growth technology end markets. The controlled operating increased margin 60 basis points to 21%. Positive operating leverage has more than offset the dilutive impact of passing on higher copper prices and some investments in growth. So Controls has had a fantastic first half and is well positioned for the future.

Turning now to Seals. Seals is our most resilient sector through the pandemic, and so further organic growth of 15% is really encouraging. North America led the way with growth of 19%. As I've already mentioned, our aftermarket facility in Louisville is delivering accelerated growth with market share gains particularly in the Western U.S. states. International Seals also had a good first half with organic growth of 8% against a strong 2021. Revenue diversification into new end markets such as food and beverage, medical and renewable energies has benefited the sector's growth and resilience in the last 18 months or so.

The Seals margin increased to 18.8%, up 210 basis points on last year. This was largely due to last year's Louisville dual running costs dropping out, the benefits of selling our lower-margin Russian business, and leveraging our growth. So it's been a great first half for Seals, and I feel very encouraged by the sector's prospects for the future.

Finally, Life Sciences. Organic revenue was down 7%. This decline was driven by short-term circumstances. As you'll remember, Life Sciences experienced a V-shaped recovery last year after COVID and this included ventilator sales, which were not expected to recur. Excluding these, organic revenue grew by actually 2%. Growth was also moderated by lockdown and health care staff shortages in Canada and Australia in the first half. We're confident in the market outlook and the potential of our businesses, and the sector will be back to growth during the second half. The Life Sciences operating margin was very strong at 22.5%, albeit down a little on an untypically high margin last year due to the expected return to post-pandemic variable costs.

The mid- to long-term prospects for Life Sciences are really exciting. We will benefit from the eventual catch-up in surgical backlogs and increased investments in clinical diagnostics. We continue to expand geographically, building out our European footprint as well as developing our product portfolio.

We're making really positive progress with delivering value responsibly, our ESG program. It's been great to see how the businesses have embraced DVR, defining activities within our core focus areas. We embed these activities into commercial strategy to make a more meaningful impact. Initiatives focus on positive impact revenue, by which I mean the sale of the products, services and solutions that benefit society or the environment are now part of all of our businesses' growth plans. And our businesses are engaging with their supply chain on our supplier code, increasingly measuring successful partnership on employment practices and sustainability. Across the whole program, we're measuring performance against our metrics, building ownership and working toward target setting for 2023. So we're making good progress.

So summarizing, it's been a great first half, very good results and plenty of strategic progress. However, we're not complacent. We recognize the prospect for a more challenging trading environment ahead. Our business model is resilient. And our ongoing actions support that resilience, more diversified revenues, improving our value-add model, which drives pricing power and margins, and retaining a strong balance sheet. The second half has started really well, and we feel confident that we will deliver our upgraded guidance and that 2022 will be another strong year for the group. We will deliver attractive long-term organic growth at sustainably high margins.

That's it. Thank you for listening, and we'll hand over to the moderator for questions.

Question and Answer Operator Message
Operator (Operator)

[Operator Instructions] Our first question today comes from James Rose of Barclays.

Question
James Rosenthal (Analysts)

I've got 3, please. Firstly, if we think about a scenario of a moderate recession sort of looming on the horizon, what does deployment could look like? And do you still see opportunities to grow the group through a slowdown?

The second question is on R&G. I think you've talked about it has its own M&A pipeline. What kind of businesses are in the pipeline? And what sort of multiples are you paying for them?

And then thirdly, on R&G as well, what new products does it bring to the group? I mean how scalable are they across other sectors and indeed your other Seals businesses?

Answer
Jonathan Thomson (Executives)

Great. James, thank you very much for joining and for your questions. Your first question was basically about recession and prospects. Look, I guess like many, we expect that growth will moderate somewhat over the coming months. Our comps will get harder. It may be that demand softens a fraction. Inflation will continue, et cetera.

So we're not complacent, and we manage for a harder environment ahead. Having said that, the second half has started really well as I said a minute ago. Run rates within our businesses still look good. The order book still looks strong. And one of the benefits of our decentralized model is that our management teams are very agile and proactive. So I feel good about how we're trading right now and our ability to manage into a harder environment in the months ahead.

I think the really important thing to know also is, from a long-term perspective, the resilience of our value-add business model. First of all, our products tend to be critical -- our products and services tend to be critical to our customers' needs. We tend to serve into OpEx rather than CapEx budgets, which makes any trough shallower.

Importantly, as I was talking about from a strategic perspective, we're increasingly diversifying our revenues. And that revenue diversification could mean, for example, being exposed to structurally growing end markets. It means penetrating in core economies so we don't run off to crazy countries. We're in core markets, more predictable markets, let's say. So the revenue stream being diversified helps our resilience.

I think also, as I also said, the value-add model itself. We have pricing power and margins. We have loyalty from our customers and resilience. And that helps us, of course, to sustain our growth and it helps us to manage inflation. And as Barbara talked about, we have pretty good cash conversion and balance sheet strength as well.

So look, overall, we feel we're in a good position. We're still trading pretty well. We're pretty active about managing ahead. The business model is in good shape. The strategy is only enhancing our resilience. And therefore, if there are some punches to come, I feel we're probably better placed than most to weather them.

That's the first question. Your second one was on R&G, M&A and products, I think the second and third questions. So yes, I mean the R&G story is really, really exciting. I mean they've done a great job organically. But to answer your question specifically, they've also swept up a lot of really small regional -- U.K. regional distributors. And that's given them really good reach across the country. They've got a very, very active pipeline. And we expect them therefore to continue to do that. And these are small businesses that's generally somewhere between a couple of million and, I think, GBP 10 million or GBP 15 million at the biggest. And multiples are pretty favorable, as you can imagine, somewhere in the 4, 5, 6, 7 bracket. So there's a huge amount of value, both from an organic perspective to come but also from an inorganic perspective, too.

And I think your last question was on their product capability. I mean as well as giving scale in the U.K., this is the thing for me that is most meaningful from a strategic perspective because we have been expanding product ranges, as you know, across all of our sectors. Seals has probably been the one that just requires a bit of catching up from a product expansion perspective, and R&G provides that platform for us to do that. They have industrial hydraulic and pneumatic products much broader than our traditional seals and gaskets offering and -- as well as giving us greater access into the U.K. Therefore, in time, I hope that we can take that capability into our international Seals businesses, too.

Question and Answer Operator Message
Operator (Operator)

Our next question today comes from David Brockton of Numis.

Question
David Brockton (Analysts)

I was just hoping to ask a few questions around Accuscience, if I can. Can you just sort of set out how the business will be managed? Are the current management teams staying, where the acquisition has sort of come from in terms of how long you've been tracking it, to start with.

And then just wondering if you can just sort of touch on to what extent the demand backdrop is changing for diagnostics. Or do you expect it to change following the COVID pandemic? And how that sort of positions the broader Life Sciences business as well.

Answer
Jonathan Thomson (Executives)

Yes. Okay. So Accuscience, we've been tracking for a few years. As you know, we've been trying to -- one of the key strategies in Life Sciences has been to build out our European platform. And last year, we acquired a few businesses in the Nordics. And this business obviously gives us scale in Ireland but also gives us further scale and therefore a healthier overall Life Sciences geographical portfolio. That's the first thing.

The second thing is we've been -- back to what I was saying before on organic strategy, we've been very keen to get our Life Sciences businesses behind some high-growth end markets like diagnostics. And that's one of the reasons why we were tracking this business too because a decent size of their product portfolio is in molecular diagnostics, a high-growth area. So that's very exciting. How will it be managed? Therefore, we manage within Life Sciences within our European portfolio of businesses. The management team, a very strong management team, will stay with the business indefinitely, which is fantastic. They're young. They're dynamic. They're commercial. They've built a great reputation across Ireland, presence in -- with presence in most hospitals and labs across the island. So we're very, very excited about working with them on the next phase of that journey.

And then you asked about diagnostics more generally. Yes, I mean it's really, really exciting. I mean before the pandemic came along, if health care budgets globally we're growing at, I don't know, 3%, 4%, a much greater proportion of health care budgets was -- has been allocated to diagnostics. Of course, keeping people out of bed is economically and clinically the best thing for the future of health care. And therefore, health care systems have been allocating more money into preventative medicine, research, testing and development. And therefore, budgets in that area have been growing, I don't know, 5%, 6%, 7%. So that's been a great source of growth for us even before the pandemic. The pandemic itself only accelerated that. And we've seen further investments starting to flow into that.

I would also expect that the consumer sentiment will drive a different kind of behavior in diagnostics, too. We're all just a little bit more sensitized to laboratories, to testing after what we've been through in the last couple of years, so the consumer aspect of it as well. So I feel very, very excited about that end market. We got great positioning in diagnostics in our existing Australian and Canadian markets. And so this business provides us with that access in Europe too, which is fantastic. And by the way, to get at the multiple we've got, I think, is a fantastic outcome, too.

Question and Answer Operator Message
Operator (Operator)

We will now take a question from Henry Carver, Peel Hunt.

Question
Henry Carver (Analysts)

Just a couple from me. First of all, Life Sciences, just wondering what the kind of level of pent-up demand is. There's clearly still a backlog to work through. Just wondering sort of how much -- how long that would take to work through.

A quick one just on a1-envirosciences. What was the rationale there for the disposal? I mean just wondered if there's any more detail around that and perhaps what multiple you got for it.

And then lastly, just one around CapEx and how we should be sort of thinking of that moving forward. Talking about supporting the business model as a larger group is slightly different. I just wondered if we should be thinking about CapEx perhaps getting a bit closer to depreciation or not or how to think about that going forward.

Answer
Jonathan Thomson (Executives)

I'll let Barbara answer the question on CapEx and the second. And first -- your first 2 questions, firstly on the backlog, yes, I mean look, I've seen various people or heard various people guesstimate the size of the backlog and how long it will take before the medical profession can catch up. I've heard everything between 18 months and 5 years depending on the market and the circumstances. So I guess I look at it as being a 2-, 3-, 4-year growth tailwind for our surgical businesses, which is great.

The short-term challenge is what has been the lockdown. But the challenge now has been, I guess, health care staff across core health care markets, ours and others. And there is a distinct shortage of health care professionals right now, which, of course, has meant that it's difficult for them to keep up with current demand, never mind to unwind the backlog. There's obviously lots of activity within the health care systems to work on that, as you would expect, because they can't sustain such a big backlog forever. Otherwise, health statistics will start to suffer pretty dramatically.

So I'm confident and I can already see them starting to make some improvements. We haven't -- as I said in the presentation, we haven't seen any benefits of the catch-up in the backlog, but I expect quietly as time goes on, we will start to see. And along with the diagnostics point I was making a little bit earlier, this is the second reason to be encouraged about end market tailwinds for Life Sciences, which means the long-term prospects very good.

a1, yes, I mean it's a small disposal. If you remember last year, we disposed of our other environmental business, CBISS. Why do we dispose of businesses? We dispose of them because they either don't have the value-add distribution business model that we believe is consistent with our group or we are not the right person, the group to scale it. And in this sense, this business is not so much of a distributor and therefore, it wasn't quite at the center of our business model. But secondly, there are others who do have that kind of business at their core and therefore are more natural at scaling it. And therefore, in that circumstance, we got to be disciplined.

The other aspect is as we're growing the group organically and inorganically, we've got to be disciplined to make sure that we tidy the portfolio behind the key business lines to make sure that our growth is scalable and sustainable. And that means a bit of discipline here and there. Because if we have management spending too much time messing around and stuff, which is noncore, it's distracting as we get bigger and -- organically and inorganically. So very important that we do this kind of things. Barbara, do you want to talk about CapEx?

Answer
Barbara Gibbes (Executives)

Yes. On CapEx, our model hasn't changed. I mean all our businesses are fundamentally distributors, and we continue to be asset light. The group being larger doesn't change that particular aspect. I guess the CapEx is a little bit higher in the current year than it was last year. I mean last year was a little curtailed by COVID and so on. And a lot of current year CapEx is actually going into Life Sciences, where we place capital equipment in hospitals and then that has long-term revenue streams in terms of consumables attached, so very happy with those investments. Going forward, I mean if we identify opportunities to invest organically like we did in Louisville in order to drive the scaling of the business, we'd be likely to do so. But overall, the model hasn't changed.

Question and Answer Operator Message
Operator (Operator)

We will now take a question from Daniel Cowan of HSBC.

Question
Daniel Thomas Cowan (Analysts)

I've got 3, please. Earlier, you're talking about supply chains. And I guess within that sort of context, your better availability being a competitive advantage, I was just wondering if you could talk a little bit about supply chain and any structural changes you're seeing now and how that's affecting you.

I've got a question also on operating leverage, how you're driving that.

And the last one is more of a housekeeping one, revenues and operating profit associated with Kentek and a1 last year, please.

Answer
Jonathan Thomson (Executives)

Okay. I'll ask Barbara to answer questions 2 and 3, and I'll talk a little bit about the supply chain. I mean in general, you won't be surprised to hear me say that supply chains are still pretty tough. Every now and again, I feel like things are getting easier, but then a fire will go off somewhere else. So we're still kind of managing the day-to-day of that.

I guess in the short term, we've been managing it pretty well. I feel good about how we've managed it, firstly, because our management teams are pretty agile, pretty pragmatic, pretty proactive and, therefore, have been able to deal with day-to-day issues. More recently, we don't have any exposure or much exposure in our supply chain in China, which, of course, has helped, too.

The important thing though is the long term. We have long-standing, service-led relationships with our customers. And that tends to mean that we have good visibility of what they need. It tends to mean that we can plan with them and that they give us a bit more flexibility. We mirror those relationships with our suppliers as well. And those suppliers with long-term partnerships means that we tend to get prioritized in the eyes of our manufacturing supply chain, and that's just helpful in terms of first dibs on products, isn't it? So that value-add model really sets us up well to manage the challenges of supply chain as well as we can do and therefore to be able to generally deliver for our customers and therefore, as you pointed out, in some instances, to win some market share against those who are struggling a little more.

One thing I would just point out and I guess -- I think this is a broader point in terms of something that I see over the last year to 18 months. Everybody has been managing day-to-day the supply chain. There have been sleeves rolled up in the detail, trying to make things work, trying to get product from A to B, blah, blah, blah, very, very reactive, very, very pragmatic and tactical.

What I think we are seeing now is a switch from the tactical into the more strategic. What does that mean? It means people are taking a step back from the tactical and say, well, hang on, we've seen this for the last 12 or 18 months. What does this mean for the way I want to manage my supply chain in the long term and starting to think about making more structural changes to the way they do things? And that might be customers. That might be suppliers, manufacturers. And therefore, I think the whole market will transition from tactical to strategic. And for us, that represents great opportunity. And when you're reliable, when you have strong supply chains, when you have the servicing component, I think that plays into our strength in the long term. Barbara?

Answer
Barbara Gibbes (Executives)

Thank you. Dealing with the disposal first. So the profit, the underlying profit for Kentek and a1 are probably around GBP 3.5 million per annum. On the operating leverage, it's volume growth that really drives that, and around half of our 16% volume growth -- underlying revenue growth in the first half was driven by volume. So we're seeing a good margin environment. As said, the margin went from 18.2% to 18.4%. And we'll continue to see that through the second half, which is rather confident around delivering towards the top end of the 18% to 19% range. But what's important to bear in mind is that we need to continue to reinvest in the operating margin to make sure that we've got the structure in place to support the scaling of the business so we can continue to drive long-term underlying revenue growth at sustainably high margins.

Question
Daniel Thomas Cowan (Analysts)

Just a quick follow-up on operating. You've talked about sort of scaling in some markets. Is there anything that you're doing, I guess, behind the scenes on the cost side? Were you able to sort of find the efficiencies as you're getting bigger and larger in any segment?

Answer
Jonathan Thomson (Executives)

Yes. I mean I think naturally, over time, as we scale in key locations, key geographies, then we have the opportunity to do a little more of that. And a good example of that is the one we talked about in the presentation, our Louisville facility, which is a massive upgrade in our distribution capability and our servicing component, which is a result of having the scale to be able to invest and execute at that level. We're obviously looking at different opportunities to do similar things in different geographies. And that might be about bigger facilities, sharing facilities, more technology, management across more businesses, et cetera, et cetera.

There's a number of different things that we can do as we grow and scale, but it's very, very important to remember that we are a customer-centric organization. And therefore, we won't do anything that in any way affects our businesses' ownership and accountability for their people and their customer set because that agility serves us well in tough times and in good times. And we have to preserve that service level, customer-orientated, entrepreneurial spirit within our businesses, and we'll do nothing to damage that.

Question and Answer Operator Message
Operator (Operator)

[Operator Instructions] Our next question comes from Oscar Val Mas of JPMorgan.

Question
Oscar Val Mas (Analysts)

I have 3 questions. The first one is around supply chain shortages and your Chinese exposure. Could you quantify that Chinese exposure and if you're seeing any changes in strategic suppliers?

The second question is on M&A spend. So you spent GBP 150 million in H1. You talked about the pipeline being healthy. How high in terms of leverage would you be willing to go?

And then the third question is a bit more detail on the Life Sciences division. You talked about returning to growth in the second half. Could we think about the full year also being positive growth in Life Sciences just to help to quantify the improvement in Life Sciences over the next 6 months as you see it today?

Answer
Jonathan Thomson (Executives)

Okay. I'll answer the first question on China and Life Sciences, and Barbara will then pick up on the GBP 170 million of M&A spend. I kind of touched on China a little earlier, Oscar. We don't have much, we have some, but it's not a material component of our supply chain. So are we in some way affected by the kind of lockdowns and scenarios in China? Yes, but it's modest.

And secondly, what I would also say is, as I said in the presentation, we've been working hard at the supply chain core competency and therefore to build optionality and flexibility into our supply chains. And that helps protect any exposures we've had to China and these other areas that have been challenging over the last 12 months.

You asked about Life Sciences. I've kind of talked about it a little bit. But we do expect to come back into growth during the course of this year. It can be a bit tricky to forecast because it very much depends on health care staff availability more than anything else in our surgical businesses. Our diagnostics businesses are doing greatly. In our surgical businesses, it will depend just how quickly health care systems can get back up to speed. If we're at underlying growth for the full year or flat, that might be a fraction optimistic. But we'll certainly be back into growth during the year. Barbara, M&A?

Answer
Barbara Gibbes (Executives)

M&A, I can say we spent GBP 170 million. So GBP 20 million of that was in the first half. GBP 150 million has come in April. We previously said we're comfortable going to up to 2x leverage. But it's important to bear in mind, with a strong cash generation, we expect leverage to be at 1.5x EBITDA at the end of the financial year. So we have a very strong balance sheet [ and/or ] flexibility and good headroom.

Question and Answer Operator Message
Operator (Operator)

[Operator Instructions] We will now take our next question from Thomas Truckle of Jefferies.

Question
Thomas Truckle (Analysts)

Thomas Truckle here with Jefferies. I just have a couple, if I may, regarding inventory, the first of which is the inventory balance of GBP 165 million. Just approximately how much of that is copper at any one time based on Windy City Wire?

And then secondly, I appreciate there was a GBP 20 million investment in inventory in H1, but any remarks around how we should think about H2? Would it be fair to assume that the inventory levels may reduce if the strong growth has abated somewhat? Or are we expecting continued investment there?

Answer
Jonathan Thomson (Executives)

I'll ask Barbara to talk about copper. I mean yes, look, the inventory levels, we're clearly keeping an eye on. It's been the right thing for us to do, to build inventory because customer, servicing customer -- our customer proposition is to ensure product availability. So it's been very important to do so. We're clearly at a point now where we have to think about what the next 6 months look like and when is the tipping point to start to actively manage that. That will be different in different businesses and different environments. But we're obviously in a place now where we're starting to get a bit more -- just starting to manage that down a fraction. With good growth rates, I would expect that to come down. Will it be down to a more normalized level by the end of the year? Probably not quite by that stage, but we'll certainly be on that journey.

Answer
Barbara Gibbes (Executives)

And just to the comment on copper. I mean we hold about 2 months' worth of copper stocks on hand at the moment. So that gets traded out pretty quickly. I estimate that, that would hopefully be around $15 million at the moment.

Question and Answer Operator Message
Operator (Operator)

This will conclude today's question-and-answer session. I would now like to turn the call back over to Johnny Thomson, CEO, for any additional or closing remarks.

Answer
Jonathan Thomson (Executives)

Thank you. Thank you, everyone, for joining. As I said, we think we've made some great strategic progress. We're diversifying our businesses' revenues for exciting organic growth, for scale and for resilience. We're developing our value-add business model for loyalty, resilience, pricing for our margins. And we're managing our portfolio extensively to build our business lines and for future organic growth with 3 exciting acquisitions in the last months. So we feel great about our strategic progress. The results themselves are very strong. And we're confident in another very good year ahead. We feel well positioned for long-term organic growth and sustainably high margins.

Thank you all for joining and look forward to speaking to you soon.

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