Business review
Group activities
Smiths is a global technology business serving the detection, medical devices mechanical seals, electronic product and engineered component markets.
Strategy
Smiths is committed to creating long-term value for shareholders by building and sustaining strong businesses in growth sectors.
The Group's objective is to create value from organic growth and from reinvestment of self-generated cash-flow. Adjustments are made to the business mix through both acquisitions and disposals to enhance value for shareholders.
Performance of continuing operations
The continuing operations comprise the Detection and Medical divisions together with John Crane, Smiths Interconnect and Flex-Tek which until 31 July 2008 made up the Specialty Engineering division.
Following the restructuring of the roles of the divisions and the corporate centre set out in the Chief Executive's statement and the adoption of IFRS8 from 1 August 2008, the divisional information in this review will largely reflect the new operating arrangements in order to assist shareholder understanding.
The key Smiths performance indicators, which are closely monitored throughout the year and measured against pre-set targets, are:
- sales and headline profits;
- cash generation; and
- return on investment.
The table below shows the overall performance of continuing operations.
|
2008 |
2007 |
|
|
|
Sales |
2,321 |
2,161 |
7% |
|
Headline: |
|||
|
- operating profit |
381 |
348 |
10% |
|
- pre-tax profit |
380 |
344 |
10% |
|
- earnings per share |
74.5p |
47.0p |
|
|
Statutory: |
|||
|
- operating profit |
326 |
257 |
|
|
- pre-tax profit |
319 |
256 |
|
|
- earnings per share |
63.0p |
36.9p |
|
|
Cash conversion |
72% |
75% |
|
|
Return on shareholders' funds (see Financial review) |
16.7% |
14.9% |
Sales
Sales increased by £160m to £2,321m. Currency translation on overseas sales contributed £46m of this increase while the net impact of acquisitions and disposals lowered sales by £6m.
On an underlying basis, excluding the effects of currency translation and acquisitions and disposals, sales increased by £120m or 6%. This £120m increase was driven by:
- Smiths Detection (£55m) reflecting the new contracts for airport checkpoint detection systems; high energy cargo screening and the Joint Chemical Agent Detector (JCAD);
- John Crane (£43m) as a result of strong demand from the petrochemical industry;
- Specialty - Other (£23m) - driven by Smiths Interconnect and its new contracts for USA 4G wireless broadband and new military programmes; and
- A decline of £1m in Smiths Medical reflects the operational challenges of supply chain disruption and product recalls.
Profit
Headline operating profit increased by £33m to £381m. Headline operating margin increased to 16.4% (2007: 16.1%). The £33m increase in headline operating profit comprises £7m from favourable currency translation, £3m from the net impact of acquisitions and disposals made during the year and a £23m, or 6%, increase in underlying headline operating profit.
The main drivers of the £23m underlying growth in operating profit are:
- John Crane (£10m) reflecting strong volume growth and price increases;
- Specialty - Other - comprising Interconnect and Flex-Tek (£9m) driven by volume and price;
- Smiths Medical (£2m) benefited from positive mix partly offset by higher costs as a result of supply chain problems and product recalls; and
- Detection (£2m) as a result of strong volume growth offset by adverse currency transaction and mix.
Operating profit on a statutory basis, after taking account of the items excluded from the headline figures was £326m (2007: £256m).
The net interest charge increased from £36m to £41m reflecting the prior year benefit of £18m of interest income from the proceeds of the Aerospace sale. There was a pensions financing gain of £42m (2007: £34m) which reflected the funding position of the company's retirement benefit schemes at July 2007.
Headline profit before tax increased by £36m to £380m. The Group's tax rate on headline profit for the period was 24.0% (2007: 25.1%). Headline earnings per share were 74.5p (2007: 47.0p). The comparison in earnings per share is distorted by the share consolidation carried out in June last year as part of the Aerospace disposal; on a pro-forma basis, earnings per share grew by 15%.
Cash generation
Headline operating cash flow totalled £273m, representing 72% of headline operating profit, and reflects investment in capital projects and increased working capital to support business growth. The working capital investment was particularly driven by the timing and nature of contracts in Detection and John Crane. Net debt has increased since July 2007 by £181m to £771m as a result of acquisitions and investment in fixed and working capital to support growth.
Outlook
Although the world economy is facing sustained upheaval and continued uncertainties, Smiths Group is well placed among global businesses to meet the challenges. Smiths Detection is expected to deliver growth although there is likely to be some variability in the timing and pattern of order flow - particularly in the US and India where there are forthcoming elections. John Crane and Smiths Interconnect will continue to benefit from their strong market positions. The creation of a unified John Crane also offers cost benefits and enhanced customer service in the future. The performance improvement programme in Smiths Medical is a key part of delivering better results. Flex-Tek will be held back by the recession in the US construction market.