Victrex plc – Annual report – 30 September 2023
Industry: manufacturing
Going concern and viability statement
Going concern
The Directors have performed a robust going concern assessment including a detailed review of the business’ 24-month rolling forecast and consideration of the principal risks faced by the Group and the Company, as detailed on pages 32 to 38. This assessment has paid particular attention to current trading results and the impact of the current global economic challenges on the aforementioned forecasts.
The Company maintains a strong balance sheet providing assurance to key stakeholders, including customers, suppliers and employees. The combined cash and other financial assets balance at 30 September 2023 was £33.5m, having reduced from £68.8m at 30 September 2022 following payment of the regular dividends of £40.1m in February 2023 and £11.7m in June 2023 and a strategic increase in the level of inventory held. Of the £33.5m, £3.4m is held in the Group’s subsidiaries in China for the sole purpose of funding the construction of our new manufacturing facilities. Of the remaining £30.1m, approximately 70% is held in the UK, on instant access, where the Company incurs the majority of its expenditure. The Group has drawn debt of £31.6m in its Chinese subsidiaries (with a total facility of c.£34.2m available until December 2026) and has unutilised UK banking facilities, renewed and extended in October 2023, of £60m through to October 2026, of which £40m is committed and immediately available and £20m is available subject to lender approval.
The 24-month forecast is derived from the Company’s Integrated Business Planning (‘IBP’) process which runs monthly. Each area of the business provides forecasts which consider a number of external data sources, triangulating with customer conversations, trends in market and country indices as well as forward-looking industry forecasts, for example forecast aircraft build rates from the two major manufacturers for Aerospace, rig count and purchasing manager indices for E&I, World Semiconductor Trade Statistics semiconductor market forecasts for Electronics, and Needham and IQVIA forecasts for Medical procedures.
The assessment of going concern included conducting scenario analysis on the aforementioned forecast which, given current economic forecasts and sales trends through the financial year ended 30 September 2023, where volumes dropped 24% year on year and 33% in the second half, exacerbated by rapid customer destocking, focused on the Group’s ability to sustain a further period of suppressed demand. In assessing the severity of the scenario analysis the scale and longevity of the impact experienced during previous economic downturns have been considered, including the differing impacts on the Sustainable Solutions versus Medical segments.
Using the IBP data and reference points from previous downturns management has created two scenarios to model the continuing effect of lower demand at regional/market level and aggregated levels on the Company’s profits and cash generation through to December 2024 with consideration also given to the six months beyond this. The impact of climate change and the Group’s Net Zero 2050 goal (Scope 1, 2 & 3) are considered as part of the aforementioned IBP process, from both a revenue and cost perspective, with the anticipated impact (assessed as insignificant over the shorter-term going concern period) incorporated in the forecasts. As a result the scenario testing noted below does not incorporate any additional sensitivity specific to climate change.
During the second half of FY 2023 the drop in sales to a quarterly run rate of c.830 tonnes reflected the continuation of the contraction in demand in the global economy, which started in the first quarter of FY 2023, and also the rapid destocking by customers as they managed their inventory and had extended shutdowns. This level of demand is not inconsistent with that seen during COVID-19 with Q2 and Q4 for 2020 at similar levels and Q3 lower due to global lockdowns. Other than in the current economic cycle and during COVID-19 demand has not been at this level during the past decade. With customers now largely destocked the Board believes the low point of the economic cycle has been reached and, whilst there are limited signs of a return to growth, demand has stabilised. As a result the key downside risk is that of an extended period of subdued demand. The current downturn has been running for 12 months, already longer than the previous downturns during COVID-19 and the financial crisis, but with no clear signs of recovery, the Board has considered the impact of reduced demand, in line with the lowest quarter of the previous year, Q3, for a further 6 months (scenario 1) and a further 12 months (scenario 2). As noted above, the lower cash balance at 30 September 2023 is, apart from lower sales volumes, attributable to an increase in the level of inventory held. Current forecasts assume a gradual reduction in inventory across FY 2024 and FY 2025 with inventory providing the opportunity to benefit from market recovery. The scenarios modelled assume that a more aggressive inventory unwind approach is taken to mitigate the ongoing lower cash generation from subdued volumes.
Scenario 1 – the global economy remains subdued through the first half of FY 2024 with demand in line with the low point in FY 2023, quarter 3, before a slow recovery in the second half of FY 2024. The demand then increases modestly through the second half to c.1,900 tonnes before further modest growth for the remainder of the going concern period. Medical revenue remains in line with that seen during the past 12 months’ run rate, with the economic situation historically having minimal impact on this segment, in line with the experience of the past 12 months. Inventory is reduced in line with sales.
Scenario 2 – in line with scenario 1 through the first half of FY 2024, with this lower demand
continuing for a further 12 months, i.e. throughout the going concern period, taking the total period of lower demand to in excess of 24 months, well above the duration of any previous downturn experienced by the Company. This would give an annual volume below c.3,300 tonnes, a level not seen since 2013. In this scenario Medical revenue is reduced by 10% during the second six months to reflect a limited impact from a longer lasting slowdown. With the period of prolonged lower demand, a more aggressive unwind of the inventory balance has been assumed. Inventory is reduced in line with sales. The Group considers scenario 2 to be a severe but plausible scenario.
Commercial sales from the new PEEK manufacturing facility in China are expected in early 2024, a consequence of which is that the entity will require additional funding to see it through to net cash generation. In concluding on the going concern position, it has been assumed that Victrex will provide the additional funds in full, which the Board considers to be the worst case scenario.
Before any mitigating actions the sensitised cash flows show the Company has significantly reduced cash headroom, which would require use of the committed facility during the going concern period. The level of facility drawn down is higher in Scenario 2 but in neither scenario is the committed facility fully drawn, nor drawn for the whole year. With cash levels lower than has historically been the case for Victrex, the Company has identified a number of mitigating actions which are readily available to increase the headroom.
These include:
- use of committed facility – £40m could be drawn at short notice. Conversations with our banking partners indicate that the £20m uncommitted accordion could also be readily accessed. The covenants of the facility have been successfully tested under each of the scenarios;
- deferral of capital expenditure – the base case capital investment over the next 12 months is lower than recent years at approximately £30–£35m, with major projects completed in China and the UK. This could be reduced significantly by limiting expenditure to essential projects, deferring all other projects later into 2025 or beyond;
- reduction in discretionary overheads – costs would be limited to prioritise and support customer related activity;
- reduction in inventory levels – inventory has been increased to provide additional security during plant shutdowns and to provide sufficient inventory to respond to a rapid economic recovery. The scenarios noted above include an acceleration of the inventory unwind but a more aggressive approach could be taken to provide additional cash resources; and
- deferral/cancellation of dividends – the Board considers the cash position and interests of all stakeholders before recommending payment of a dividend. A dividend has been proposed for payment in February 2024 of c.£40m and in the past an interim dividend of c.£12m has been paid in June, giving a combined annual outflow of c.£52m.
Reverse stress testing was performed to identify the level that sales would need to drop by in order for the Group to run out of cash by the end of the going concern assessment period. Sales volumes would need to consistently drop materially below the low point in scenario 2 which is not considered plausible.
As a result of this detailed assessment and with reference to the Company’s strong balance sheet, existing committed facilities and the cash preserving levers at the Company’s disposal, but also acknowledging the current economic uncertainty with a number of global economies close to/in recession, the war in Ukraine continuing and tensions in the Middle East, the Board has concluded that the Company has sufficient liquidity to meet its obligations when they fall due for a period of at least 12 months after the date of this report. For this reason, they continue to adopt the going concern basis for preparing the financial statements.
Viability statement
1. Assessment of prospects
The Directors have assessed the Group’s longer-term prospects, primarily with reference to the results of the Board-approved five-year strategic plan. This is driven by the Group’s business model (detailed on pages 12 and 13) and strategy (detailed on pages 14 and 15), which are fundamental to understanding the future direction of the business, while factoring in the Group’s principal risks (detailed on pages 34 to 38) and the potential opportunities and risks of climate change (detailed on pages 49 to 53). The Directors continue to consider the ongoing challenges to the global economy, including the impact on each market and geography which the Group serves, and the uncertainty this creates, particularly in the early years of the strategic plan. The Directors have also considered the Group’s ability to generate cash and maintain a strong financial position throughout the economic cycle, including the level of available cash at 30 September 2023.
The strategic planning process is undertaken annually, and includes analyses of profit performance (including our core business and new product pipeline and ‘mega-programmes’), cash flow, investment programmes (including manufacturing capacity increases and our acquisition pipeline) and returns to shareholders. Completion of the strategic plan is a Group-wide process engaging employees throughout the business, including all senior management in their respective areas. The strategy was reviewed and approved by the Board in May 2023 (covering the five years to September 2028). The strategy is built market by market and geography by geography recognising the differing dynamics in each whilst also considering the longer-term impact of the Company achieving our goal of Net Zero across all scopes by 2050 combined with the wider global ambition to reduce carbon usage. The Company also operates a shorter-term rolling 24-month forecast, predicated on the IBP process, which forms the basis for the 2024 budget and key operational decisions over this shorter time frame. The first two years of the strategy have been realigned to the rolling forecast, taking account of changes to the economic outlook since the strategy was finalised in May 2023. The subsequent three years of the strategy have been reviewed and updated where the revisions to the first two years are expected to have a consequential impact, either positive or negative.
The Board considers five years to be an appropriate time horizon for our strategic plan, being the period over which the Group actively focuses on its development pipeline and resulting capital investment programme. As part of our longer-term considerations, to support capacity planning and assessment of projects which will take longer to reach meaningful revenue, the Group does prepare forecasts for a period of more than five years; however, a period greater than five years is considered too long for the strategic plan given the inherent uncertainties involved.
2. Viability period
The Directors have assessed the viability of the Group over the five-year period to September 2028, being the period covered by the Group’s Board-approved strategic plan.
3. Assessment of viability
To make their assessment of viability, the Directors have tested a number of additional scenarios on the base case position of the five-year strategic plan. These scenarios encompass key trading assumptions combined with the potential impact of crystallisation of one or more of the principal risks over the five-year period. Whilst each of the principal risks has a potential impact, the scenario analysis has been focused on those considered to have the most significant financial impact, primarily on the revenue growth of the Group. The risks have been assessed for their potential impact on the Group’s business model, future trading and funding structure.
The continuing progress in the mega-programmes is forecast to have a material impact on the Company’s revenue over the strategic period with a target of £25–£35m revenue in 2025. The business case behind each of these programmes remains robust, and in most cases is enhanced by the global ambition to reduce carbon emissions, and increase adoption of and need for solutions from the Medical industry. Progress continues to be made across the mega-programmes with milestones being achieved as outlined in the Strategic report on pages 9 and 25. Timing of milestone achievement and the resulting impact on revenue growth remains the key variable across the mega-programme portfolio which the Directors have incorporated into scenario 3 described opposite.
The impact on the strategy of both the Company achieving its goal of Net Zero across all scopes by 2050 and the wider economy achieving Net Zero carbon over a long period continues to be understood and assessed. The physical risks and transitional opportunities and risks have been considered in detail as described in the Sustainability report starting on page 42. The physical risks presented by climate change are not expected to have a material impact on the Company’s ability to manufacture product over the strategy period and therefore no sensitivity has been performed. At the revenue level the transitional opportunities are considered to outweigh the risks over both the short and longer time horizons, supporting continued growth in Company revenues, albeit the impact of this is only likely to be material outside of the five-year strategy window. The primary transitional risk relates to carbon pricing and the likely levers used by regulators and governments to drive down use of carbon – taxation and levies.
The Company’s manufacturing and supply chain does use significant gas, electricity and water whilst also generating hazardous waste. Work is ongoing to reduce the use of carbon in the manufacturing process, both through using green sources but also redesigning the chemical process to reduce the overall energy requirement and waste generation. Acknowledging the risk regarding the decarbonisation of the manufacturing process, primarily in respect of timing, an increased cost of operation from taxation and levies has been assumed in scenario 5, with annual manufacturing costs increasing by £20mp.a, increasing annually by inflation, from 2025. The Company would seek to recover this cost from customers but for the purpose of the scenario analysis a worst case position of no recovery has been assumed.
The downside scenarios applied to the strategic plan are as follows:
The scenarios tested were carefully considered by the Directors, factoring in the potential impact, the probability of occurrence and the effectiveness of the mitigating actions. In addition, whilst considered implausible, a combined scenario (scenario 6) was also tested, which contained an aggregation of all scenarios considered.
Further to the risk mitigation plans, the Group’s two distinct segments, both with diverse geographic markets, assist in reducing the risk of regional economic challenges and sector specific issues. This diversity has been evidenced through the recent economic cycles, during the COVID-19 period (2020), the recovery from COVID-19 (2021–2022) and the recent contraction through 2023, with Medical and Sustainable Solutions following very different profiles, as well as Europe, US and China moving at different rates and in different directions across the respective periods. The strategy of partnering closely with customers to develop the right applications and our existing and growing list of specified products are also important mitigants.
The mitigation assessment also considered the Group’s ability to manage its cost base, reduce working capital and raise new finance and the possibility of delaying capital programmes and/or restricting shareholder returns over the viability period if required. Having moved through a period of higher capital expenditure, focused on growth in China and also the UK manufacturing base, the programme over the next few years is at a lower rate and offers increased flexibility. The Group’s current debt facilities, in the UK and China, are due for renewal during the viability period in 2026. The Group currently expects to be able to renew both of these facilities.
The results of this stress testing showed that the Group would be able to remain solvent and maintain liquidity over the assessment period. The Group is profitable under all scenarios, including scenario 6. The lowest cash balance was in scenario 6, in which the month-end cash balance remains positive albeit at a level where the RCF facility (available until October 2026 with covenant compliance tested under scenario 6) will be required to manage monthly working capital flows. Due to the severity and implausibility of scenario 6 and an outcome that may require limited use of the RCF facility this is considered akin to a reverse stress test.
4. Viability statement
Based on the results of this detailed analysis the Directors have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the five-year period to September 2028. This is predicated on the assumption that an unforeseen event outside of the Group’s control (for example, an event of nature or terror) does not inhibit the Company’s ability to manufacture for a sustained period and that the current debt facilities are renewed in the normal course of business at the end of their respective terms in 2026.
Accounts examples 