Thales S.A. (HO) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's Thales Q1 2023 Results Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today. I would now like to hand the conference over to Mr. Bertrand Delcaire, VP, Head of Investor Relations. Please go ahead, sir.

Yes. Hello. Good morning. Welcome, and thank you for joining us for the presentation of Thales' Q1 2023 Order Intake and Sales. I'm Bertrand Delcaire, the Head of Investor Relations at Thales. With me today is Pascal Bouchiat, our CFO. As usual, this presentation is audio webcast live and on our website at thalesgroup.com, where the slides and the press release are also available for download. Replay will be available soon after the end of the event. With that, I would like to turn over the call to Pascal Bouchiat.

Thank you. Thank you, Bertrand, and good morning, everyone. Before moving on to the numbers, as usual, I wanted to highlight a few items. I'm now on Slide 2. First, I wanted to point out that while we are not yet back pre-COVID '19 levels, our IRO aftermarket and biometrics business continued to be boosted by the ongoing air traffic recovery, which clearly showed in our Q1 numbers. The second important matter I wanted to stress is the better visibility that we now are in regard to the new LPM, the military programming law in France. The LPM gives direction in terms of defense spending in France between 2024 and 2030, which offers 7 years of visibility for a country that represents 40% of our defense sales and is our lead customers and source of innovation funding. It was a growth acceleration moving from 5% growth per year in recent years to 6% expected from 2023 to 2027, before reaching 7% per year, from 2027 to 2030. In addition, it is striking to see that the plan significant investments in new domains of consultation such as cyberspace, space or drones in which we have strong positions. Obviously, this is very positive for Thales and confirm the trajectory Patrice Caine highlighted in March, when he said that we expected the growth for our different segments will move up from mid-single digits in 2023 to mid-single-digit plus in 2024. Looking internally, we continue to implement our ESG roadmap with 2 significant milestones to share with you. First, where we received the SBTi certification in March and a great validation of our strong commitments in regards to CO2 emission reduction. We're one of the very first launched aerospace and defense company to [ receive it ]. Second important [indiscernible] to update, [indiscernible] remains paramount at Thales across our different markets and geographies. Hence, the importance to continue to expand the certifications to ISO 37001 [indiscernible]. The certification now covers 5 countries, which represent almost 3/4 of our sales, France, U.K., Netherlands, U.S.A. and Canada. So let's now have a look at our Q1 headline numbers. I'm now on Slide 3. New orders amounted to EUR 3.4 billion up 13% on a reported basis and 14% on an organic basis. So a strong start of the year in terms of commercial activity, which I will comment in further details in the next slides. Sales came to EUR 4 billion, up a solid 9.4% on an organic basis, above full year guidance. Despite a negative scope effect, this Q1 sales represent the new record high for first quarter. Looking to details at our order intake, I'm now on Slide 4. As you can see, the strong organic growth by 14% is fueled by each category of orders. Three large orders above EUR 100 million for a total of EUR 401 million, versus 2 large orders in Q1 2022. Two of these 3 large contracts were related to space in observation and explorations. And one contract was for an undisclosed large military customer. Orders between EUR 10 million to EUR 100 million were up by 8%. And finally, orders below EUR 10 million, progressing by 17% mainly driven by the ongoing rebound of our civil aero and biometrics businesses, especially in aftermarket and passport production. Turning now to Slide 5, looking at sales growth. First, a word on currency and scope. The currency impact was not material this quarter minus EUR 6 million. The scope impact was most significant, resulting from the acquisition and transfer activity of activities carried out in [ 2023 ]. The biggest factor was a transfer of our IoT connectivity module business [ to sell i ]t, which drives a negative EUR 97 million impact Q1. This impact is expected to be at around EUR 360 million over the full year. On the acquisition side, we add the bolt-on transactions we closed last year, [indiscernible] , AAC, SEC 21 and Excellium in the Defense & Security segments and also [indiscernible] welcome [indiscernible]. All of that for a total of approximately EUR 16 million over Q1 and an estimated EUR 150 million over the full year. So as you can [indiscernible], a negative impact of EUR 39 million in Q1. And you should expect a similar type of impact going forward in Q2. And then clearly, more negative in Q3 and Q4 as acquisitions were closed in Q2 and Q3 last year. For the full year, the overall negative impact should be around EUR 250 million, and this doesn't include the expected disposal of our Aero Electrical Systems business. The organic growth reached 9.4% ahead of the full year guidance. It was driven by the ongoing performance of [indiscernible] and by the [indiscernible] business and was supported by a steady strong quarter in defense. And I will comment in greater details the dynamics by business in the coming slides. Turning to the geographical perspective, a strong quarter across the board with most geographies strongly up. The only region clearly negative was Australia and it didn't come as a surprise as the country's facing the production of the [indiscernible] vehicle. So overall, a strong first quarter in terms of sales. Now looking briefly at each segment one by one. I'm now on Slide 6 for Aerospace. Orders were slightly down by 3% organically and despite 2 positive news. First, the 2 contracts above EUR 100 million in space that I mentioned earlier and also the ongoing rebound of small orders in civil aero. The reason behind the slightly negative organic variations with that in Q1 [ 2022 ]. The total value of the 2 large contracts was greater than the total value of the 2 large contracts booked in Q1 this year. Sales were strongly up 10.2% organically driven by the strong growth in Aeronautics, including a 45% in civil and aero aftermarket. The state business remained flat as forecasted versus a strong Q1 in 2022. Now turning to Slide 7. looking at the Defense & Security segment. As you can see, another strong quarter in terms of order intake, up by 31% organically with one contract above EUR 100 million versus none in Q1 2022. And also small orders nicely up high single digits. Organic sales growth was up by 5.4% organically, continuing on a positive trend across most business lines from air defense to secure communications or marine emission system. One point that I wanted to highlight is that despite these good results, important to keep in mind that component shortages and supply chain tensions are still [ reality ]. Hence, nice to see and to confirm that the teams have been able to manage to grow mid-single digits despite this ongoing headwind. It's obviously a positive sign in regard to our ability to deliver the mid-single digits organic growth. We're committed to for the defense business for the full year 2023. Now turning to Slide 8. Looking at our last segment, Digital Identity & Security. At EUR 779 million, sales were up by 20.1% on an organic basis. This strong performance was mostly due to an ongoing growth in passports within our biometric business above expectations. However, forecasting a lower time for growth for the last of the year, this is what we need to have in mind. And also a new strong quarter for smart card businesses, still benefiting on pricing effects on top of a small volume growth. Again, let me remind you that this smart card businesses are a bit difficult to forecast over multiple quarters as they are short [indiscernible]. We expect growth to soften in the coming quarters and pricing in this market will even turn negative over the second half of 2023. So let me finish with Slide 9 and a reminder of our financial objectives. Q1 represents a solid start of the year, which allows us to confirm the financial objectives for 2023. So this concludes my presentation. Many thanks for your attention, and I will now be pleased to take your questions.

[Operator Instructions] It comes from the line of Olivier Brochet from Redburn.

I will have 3 small ones, please. First of all, in DIS, could you maybe tell us when you mentioned price negative in H2? Is it based on the orders that you've received? Or is it the planning assumptions that you've made? Second question on the aircraft carrier, the [indiscernible], there are press comments about the industry having to put forward some funding to help the development and the recent dip later. Will that impact you? And then to what scale and when? And lastly, are you involved in any artificial intelligence development outside of defense or government projects?

Okay. Olivier. Thank you for your 3 questions. First on DIS. No, it's not based on orders that we already received. It's more a global comment. I mean to -- to be probably a bit more on the safe side, considering that today, we might be at a peak in terms of pricing, considering I mean, the increase in selling prices that we managed to pass to our clients throughout 2022. And it's true that today, I mean, we compare Q1 2023, which takes advantage of the continuous increase in selling prices along 2022 versus the Q1 2022, which by definition, was not impacted by the 2022 increase in pricing. Now as we see [indiscernible] in particular, on electronic components in our DIS business to be progress [indiscernible] and also and probably reminding you that at our last call, we mentioned that we are starting to see a bit of softness in terms of demand in the telco sector following the drop in the phase of electronic goods like smartphones. It's more my comment is more, I mean to convey message of -- of care which offer cautiousness. Yes, of caution, yes, relating to what might happen in the second half of 2023, where, of course, we will compare ourselves again, of course, not demanding what translates. Aircraft carrier in France, you probably refer to, I mean, probably some request from the French MoD. I mean, in particular, in the new LPM where the Minister of Defense seems to be willing to ask some companies and in particular [indiscernible] group to [ fund ] part of these developments. It's not what we've got from the French MoD at Thales. But of course, I mean, we are quite vigilant on this matter. Your last comment was about questions was about Artificial Intelligence development. At Thales, I tend to believe that it's really across the board. I mean in all of our business teams, whether it is defense, whether it's digital identity security or is in our [indiscernible] space. I mean we are working on bias projects and artificial intelligence. Maybe I could comment -- I mean one obvious example, which is basically how to make -- what are [indiscernible] intelligence [indiscernible] [ whether ] as to sort out, I mean very complex situations. One's the track [indiscernible] air space, and it is extremely useful. I mean to develop Artificial Intelligence for [ weather ] to be [ for instance ] self-learning systems. So this is one example that I could mention in a number of examples where, I mean, we are looking marketing [indiscernible] yes, I mean after the [indiscernible], despite of the differentiation that Thales will provide in most of our systems in the next few years.

We will now take the next question. It comes from the line of Victor Allard from Goldman Sachs.

I have 3 quick ones as well, if possible. The first one is simply on the unchanged guidance. There is a solid start to the year. And if I'm not wrong, the unchanged sales guidance implies a deterioration for the growth rate for the rest of the year. So I was wondering if you could help us think about the coming quarters and possibly share with us what would make you more confident as to raise guidance? Is that mainly DIS? And then if I can continue with the 2 next questions. The other one would be on Aerospace. I was wondering if you could split out the growth that you have seen in civil by comparing OE versus aftermarket? The quarter seems to have been very strong in these areas. And it would be helpful to hear how the trajectory has been so far this year compared to your initial assumption? And how you think about the coming quarters in Civil? And finally, a quick one on the transport deal. Just wondering if you could share an update on the deal and whether the H2 timeline for closing still looks achievable?

Victor. So quite detailed questions, at least on your first one. So on the first one. So yes, unchanged guidance for the full year. Of course, I mean, the Q1 figures in some of growth gives us a good comfort on our ability to deliver on the 4% to 7% guidance in terms of growth -- organic growth but of course, by definition, you are right, starting with 9.4% and confirming the 4% to 7%, it's of course, I mean, [indiscernible]. Now I'm coming back on my explanation about in particular, DIS. You have seen that our DIS business in Q1 has seen especially strong and as I explained, of course, the more we move forward, the more we'll compare our performance against a more demanding reference base. So we need to be a bit vigilant on this matter. Although [indiscernible] is that, as I mentioned and in the supply chain challenge is not fixed and we keep working very hard on this matter and still affecting some of our businesses, Defense & Security, but also space in particular. We are also quite vigilant on the -- even [indiscernible] even though, I mean the situation is improving, but there are still -- I mean, quite significant challenges in terms of supply chain. So this is basically, I mean, the opinions are our global message of a strong start, but also still being a bit cautious relating to the full year. Now of course, we'll get back to you as we will release our Q2 figures and we see whether or not we'll adjust our sales growth for the full year. But at this point, we're probably a bit -- a bit too early. Now, I mean, overall, your questions about aero, I mean, the [indiscernible] in particular, I mean, what I can share with you is that overall, our aero business, but involving both -- including both Civil and Defense that ends quite strong in Q1. Organic growth around 20% which is overall, I mean, stronger than expected. Let's be clear about that. And in particular, quite strong in our aftermarket that grew around 45% in Q1 '23 against Q1 2022. So quite a strong growth in this sector. Transport disposal, I mean, things are progressing as expected. Hitachi is working quite closely with the antitrust bodies. And with -- I mean the appropriate level of [ remedies ]. And I mean, all of that really confirming -- I mean transactions that would take place in the second half of 2023.

We will now take the next question. It comes from the line of Aymeric Poulain from Kepler Cheuvreux.

My first question concern inflationary effect in the first half. I mean you mentioned the impact of pricing on DIS in particular. And I suppose some of the slowdown has to come from the annualization of this price hike made last year. So could you give us some granularity on the kind of pricing effect we see at DIS, but also in the other division? And also how this impacts the operational leverage given the fact that it must also reflect some cost inflation as well. So that would be extremely useful. The second question is on M&A. You -- you want to do some more M&A in 2023. What is the progress on that pipeline? And do you see multiples coming down given the recent market jitters or are we still seeing some very punchy multiple for some of the targets you're looking at? That would be the main question I have.

Thank you for your 2 questions. So first on inflation, maybe [indiscernible], I mean, coming back on the situation of each of our 3 key reporting segments. So you mentioned DIS. So today, overall, I think it was clear in my comments, the fact that we take advantage of quite a strong level of pricing on our DIS business across all our segments, and this being the outcome of progressive increase in pricing that we put in place throughout 2022. Of course, I mean, all of that also to -- to compensate. I mean, increase in input costs overall. So that's here, and I'm quite positive on the overall DIS EBIT margin for the full year and very much in line with the guidance that we shared with you a few months ago. So the 13.5% to 14.5% is really, I mean what we've seen, and that's really something that I can really confirm. On the Defense. Yes. I mean, as I already shared in the past, I mean, we've got something that's [indiscernible] that has a variation of price escalation mechanism in our contract. And this is working as expected. I mean -- I mean the return of those mechanisms is right in line with what we're expecting and allowing us to preserve overall our margin. All of that very much consistent with the guidance also for 2023 in terms of overall EBIT margin for this business, that would be around 13%. So here again, I mean, [indiscernible] be able to show that when it comes to defense, whether we've got inflation or no, we can preserve our margin. Last point is probably more on -- on the aerospace pillars on which I mentioned in the past, this is where we were less protected on the civil aero [indiscernible] segments. Yes, even though, I mean, we keep negotiating with our clients to pass some increase in prices, reflecting high input cost. A bit more difficult in the space business, where in the past, this business was more a fixed and some price type of business, and this is where I mentioned in the past that we will be slightly affected into [indiscernible] margin because of that. Now you mentioned also I mean the overall cost inflation. As you know, I mean, at Thales, overall, I mean, our first -- cost, I mean, cost driver is really, I mean, wages overall. Now that was concluded, I mean, with Thales negotiations for 2023, ending up right in line with what we are expecting. So if I take France, for instance, overall, I mean we are talking about overall increase in wages that is around mid-single digits. And this overall consistent with the overall level of inflation that we have in this country. This, of course, not taking into account a positive factor, which is the fact that as we've got people getting retired and being replaced by the new engineer to take advantage of this positive mix effect that, of course, overall reduce the overall wages, of course, not to mention also all the productivity measures that we keep putting in place. So I mean all of that very much consistent with the full year guidance in terms of EBITDA, EBIT margin. Now question on M&A is quite interesting. So to your question, I would say that we don't see multiples coming down. It's not the case. And again, it's not a surprise because this is also a constant message that we convey to investors. I mean, good quality assets are -- I would say, quite expensive when it comes to valuation. Of course, I mean, we keep looking at various potential targets. Of course, I mean, our primary -- I mean, criteria for decisions is the first, making sure and that -- making sure that targets are a part of any of our 3 key businesses. We mentioned that we don't consider -- we don't consider any transformational acquisitions. We are working more for target that we could just plug in within Thales in any of our global business unit very easily with quite a simple integration process. Also, I mean, criteria for us is the potential for us. Of course, opening us -- I mean potentially new geographies in the existing segments, but in countries where, I mean, today, we would like to expand our positions. And lastly, of course, I mean, financial discipline is also, of course, I mean, a key criteria for us. And yes, I mean, we are considering multiple very closely. Once again, and we have seen in the past, I mean some transactions that took place in our sectors where, of course, when it comes to good quality assets, we -- I mean, we see a multiple still not quite high.

We will now take the next question. It comes from the line of Ian Douglas-Pennant from UBS.

It's Ian Douglas-Pennant at UBS. Could we talk about Asia a bit? So strong growth in Asian orders in Q1, which I assume is defense-related, but perhaps you can correct me. Perhaps you could comment on that and then go on to comments if there's any implications from the Australian defense review and what you're hearing from Japan on where the focus will be there and whether there's opportunity for you and other European players? And then the second question is on supply chain. You mentioned it's still tough. Would you say that things are getting easier? And are there any particular elements of the supply chain that you are especially concerned about at the moment?

Okay. Ian. So your first question, I have to concede that I don't have the answer about our Asian orders in Q1. Did we get anything very specific on this matter? That's not -- I mean, obviously. Now Asia is quite important for us, and I could mention, in particular, in 2 countries that might not be in your radar screen, which are becoming more and more important for Thales. One is Korea in particular for our space business. I mean we had quite good successes in Korea in our space business, and we keep pursuing opportunities in this country. Second country in Asia, which is also, let's call it, a new country of development of our talent, which is Indonesia, and this on various topics. Of course, I mean, we all have in mind the [indiscernible] prospect, not just prospect, but projects in Indonesia. But we also managed in the past, I mean, to book a nice contract on the -- in our space business, and we're also looking for opportunities, in particular, in air surveillance, air defense. As you know, in Indonesia, it's quite a fragmented country in terms of geography and it's true that our overall what our offer can really match the needs of our clients in Indonesia, I mean, to ensure, I mean, the overall production of the country. So Korea, Indonesia, of course, on top of India, Singapore, but Indonesia is going up. Probably the 2 most [indiscernible] countries that I can think of when I comment about opportunities in India. Australian defense, nothing very specific in this matter. As you know, I mean Australia is second or third in largest country for defense, almost at par with U.K. No recent updates in terms of strategic review in this country. But I mean, we keep seeing in the Australian government, the Australian commonwealth willing, I mean, to keep developing a number of different projects. Japan for Thales is unfortunately a very small country when it comes to defense. We sell them some specific equipment in particular in the field of radar. However, I have to say that at this point, Japan is not a large country for Thales in terms of prospects. Will it become tomorrow opportunity? At this point, probably a bit too early. Supply chain. So supply chain, thank you very much for the question because it gives me the opportunity to come back on this matter. And to comment where we see improvement, but where also we see -- I mean, still some tensions. So where we see [indiscernible] improving, its overall availability of chips in particular in our DIS business. This is probably a reminder that this is where an intention started, that was probably 2 years ago. And we see, I mean, really and some relaxations and situation overall in terms of availability of chips really improving in this segment. It's not totally fixed, but I think we are now on the win and the positive side in terms of difficulties of supplies for DIS business. Availability of chips because we use different type of chips. The situation is a bit different in our other businesses. In particular, in our Defense but also in our Aero business, where we keep seeing -- where we keep seeing intentions in chips availability. This goes also, I mean, not just to chips availability, but also to printed electronic board. So which is the level below in terms of value chain, we take chips then to produce PC boards and this is also where we see today's tensions. Where we see are not deterioration but are situations, which remains a concern is more on the hardware part of our supply chain, in particular, in our Defense and Space business. I think my comment is not different from the comments of other companies in this matter. But it's true that we see our supply chain, I mean having some difficulties in terms of ramping up their overall production output when it comes to more of the hardware components of what we buy. And this a bit across the board, it's in particular the case in Europe because we supply more from Europe, but I mean a similar situation in many countries where we see, I mean, this network of SMEs, I think in some cases, trouble in ramping up their overall production output. This is really a matter on which we spend time today. As you have seen in our Q1 figures, it has not prevented us to report quite a significant growth, in particular, in different business. But still, I mean, the point of vigilance for the next few quarters. This is probably one of today, the most -- limiting factor for us in terms of [indiscernible] .

[Operator Instructions] We will now take the next question. It comes from the line of George Zhao from Bernstein.

I guess, first, can you just provide some more color on the strong performance for DIS? For Biometrics, where is the business -- where has it recovered versus like, say, pre-COVID levels? And how much of the 20% organic growth for the segment would you consider that to be pricing for Q1? And second one, following up on your comments just now on the supply challenges. Has that impacted your ability to deliver avionics equipment on time for new Airbus deliveries?

Okay. Good morning, George. First on DIS. I mean, third, yes, I mean, I was quite clear saying that in Q1, we only took advantage of quite a strong growth in our biometrics and in particular in our secure documents business. And really, I mean, it's across the board. It's not just in the [ second ] country, but I guess, I mean, we can all testify that getting a new passport is to be quite a challenge in many countries. And I mean this is basically, I mean what we see today. So we will take advantage of a recovery from kind of catch-up effect following the drop in terms of demands for passport in particular, following the COVID-19 [indiscernible] . Second point, I mean, we keep adding quite a solid overall growth in our smart card businesses. As I mentioned, in particular, the banking area where, I mean, the level of demand at this point, still pretty good. Now in terms of volume, price, let's consider that it's probably half volume and half price. It can vary a bit across segments, but overall, I mean, this is what I can share with you in terms of split between volume and price. So 50-50 overall. So avionics, now let's be clear. Today, I mean, Thales is not the limiting factors for the large aircraft producers to deliver their own production process. Even though, I mean, I mentioned -- I mean, still -- I mean, a bit of challenges in terms of chips in this sector. We don't see Thales and Thales is not today -- I mean, preventing our largest customers -- our customers to deliver on their production output. My comment about mechanical parts, in particular, was more on Defense & Security and Space, much more than avionics.

We will now take the next question. It comes from Chloe Lemarie from Jefferies.

A few of my questions have been answered already, but I have a few follow-ups. Maybe in Aerospace, if we could have like the breakdown of space versus aero's growth in the quarter and what you expect for the full year? And just in particular, in IFE because we've seen relatively low widebody deliveries in Q1. So I wanted to check how that business went in Q1? And the second question is on Telesat, if we could have an update on there. I was wondering if there's any risk that the new offer you submitted could require another repricing due to inflation or it was still a matter of finalizing the financing from them?