SMGKF - Smiths Group PLC (SMGKF) Q2 2023 Earnings Call Transcript
2023-03-24 11:08:10 ET
Smiths Group PLC (SMGKF)
Q2 2023 Earnings Conference Call
March 24, 2023, 04:30 ET
Company Participants
Clare Scherrer - CFO & Director
Paul Keel - CEO & Executive Director
Conference Call Participants
Andrew Wilson - JPMorgan Chase & Co.
Bruno Gjani - BNP Paribas Exane
Mark Jones - Stifel, Nicolaus & Company
Andre Kukhnin - Crédit Suisse
Christian Hinderaker - Goldman Sachs Group
Presentation
Paul Keel
Good morning, everyone, and thanks for joining us. With me in London today is our CFO, Clare Scherrer. In terms of our agenda, I'll make a few opening comments before turning it over to Clare to walk us through the numbers. I'll come back and provide an update on our strategic and operational progress, and then we'll open it up to all of you for Q&A.
By way of overview, we saw a continued improvement in the first half, resulting in meaningfully higher performance. We posted record organic revenue growth of 13.5%, which translated to nearly 26% on a reported basis. We've now delivered 7 consecutive quarters of accelerating growth as we capitalize on strong underlying demand in most of our end markets. Our earnings conversion was stronger still as we also delivered record EPS growth of 52%. And given this strong momentum, we have once again raised our full year guidance now to at least 8% organic revenue growth.
Operating margins grew 20 basis points, reflecting strong volume as well as continued investment in future growth. ROCE expanded by 1 point. Our Smiths Excellence System is the centerpiece of our stronger execution and the impact of SES is now visible in our financial statements, as we're on track to deliver over GBP 25 million of annualized operating profit from SES. Our people make this progress possible, and we have a number of initiatives underway across our company to advance our inclusive and high-performing culture. Our ESG plan is also progressing at pace as detailed in our inaugural sustainability report, which is available on our website.
In summary, we delivered another period of higher performance, enabled by our strategy of accelerating growth, improving execution and investing in our people, the focal point of our Smiths value engine, which I'll recap on the next slide.
Our value engine connects to three components of our success: Our purpose, our strengths and our priorities. We are grounded in our purpose of improving the world through smarter engineering. This has been the North Star for Smiths for over 172 years and continues to guide and inspire us today. Our strengths are unique and compelling, world-class engineering, leading positions in critical markets, global capabilities and a robust financial framework. You'll see evidence in the coming slides of how each of these is contributing to an ever stronger Smiths.
Our purpose and our strengths are then directed towards advancing the three priorities I mentioned on the previous slide: Accelerating growth, improving execution and doing even more to inspire and empower our wonderful people. We first shared this slide with you in November of 2021, my first Capital Markets event with Smiths, when we laid out the five medium-term financial commitments by which to measure our progress.
This chart provides a summary of how we're tracking. We're making good progress on organic growth. And for the first half, we're well ahead of our 4% to 6% committed range. About half our growth is coming from volume and the remainder from price, which we expect will subside at some point as the world eventually returns to more normalized inflation levels. As mentioned, we're also having good success converting revenue to EPS. We commit to 7% to 10% earnings per share growth over time and are tracking above the range here as well.
Higher profitability naturally supports higher ROCE. And you can see this in our 120 basis point gain, which brings us into our 15% to 17% range. Operating margins were up 20 basis points in the half on top of the 150 bps expansion in the same period last year. We see further upside available to us in this category as we'll continue to progress into the 18% to 20% range moving forward. The only area where we did not post year-over-year improvement was operating cash conversion. We continue to see record demand across several of our end markets, and we're naturally supporting this growth with investment. Cash generation has long been a calling card of Smiths with 100% cash conversion over the past 5 years. We expect to return to these levels as growth and supply chains normalize.
With that as an overview, I'll turn it over to Clare to walk us through our first half results in greater detail.
Clare Scherrer
Thank you, Paul. Good morning, everyone, and thank you for dialing in. I'm pleased to share the half-year results, a half which provides more evidence of the progress we're making. On revenue, as Paul said, we delivered record organic growth of 13.5%, with FX increasing reported growth to 25.6%. We generated GBP 241 million of operating profit, which equates to organic growth of 12.7% and a margin of 16.1%, up 20 bps over the same period last year. EPS growth of 52.1% was a record for Smiths. Cash conversion was impacted by investment in working capital, and I'll talk later about the actions we're taking to drive improvement.
ROCE expanded by 120 bps, reflecting our increased profitability. And as planned, we're rebuilding our dividend cover post the sale of Smiths Medical and are recommending an interim dividend of 12.9p, an increase of 5%. In the first half, we returned GBP 241 million to shareholders, including both our share buyback and the FY '22 final dividend.
Now looking at the results in more detail, and starting with our record organic revenue growth. We've posted 7 consecutive quarters of organic revenue growth, and both Q1 and Q2 delivered growth in excess of 13%. First half growth was driven equally by price and volume and we delivered growth across all divisions, geographic areas and major customer end markets. Revenue for the half also surpassed our pre-COVID revenue, up 12% compared to the first half of FY '20. As per our guidance, this revenue growth translated into moderate operating margin improvement of 20 bps to 16.1%. We delivered 60 bps of margin expansion from increased volume and 50 bps of margin improvement from the targeted savings projects, which we announced at the full year, primarily in John Crane and Smiths Detection. These programs remain on track with expected benefits for the full year of approximately GBP 15 million and annualized benefits in line with our previous guidance of between GBP 25 million and GBP 30 million.
On pricing, we more than offset cost inflation, thanks to the positive pricing actions that we took throughout last year and going into this year. FX translation had a positive impact on margin of 30 bps. SES projects in this period primarily focused on pricing, customer service and productivity and generated GBP 5 million of incremental profit. Offsetting these gains were three headwinds: Supply chain disruption in some key parts of the business, resulting in 10 bps of impact, although overall, we did see supply chains trending positively. We continued to invest in growth to support increasing demand, which had a 90 bps impact. The largest impact on margin was mix, reflecting rapid growth in original equipment in Smiths Detection. This will support future growth from the associated aftermarket services, and the final impact in Flex-Tek was from product mix.
This strong profit performance drove record EPS growth, up more than 52%. The largest contributor to this was organic profit growth, which drove roughly 1/3 of the increase or 5.1p. Our share buyback, which was 88% complete at the half, had a 4.6p benefit on EPS, about 1/4 of the total. Weaker sterling through the first half had a positive FX translation impact of 4.3p. Our effective tax rate reduced 200 bps to 26%, resulting in a 1.4p benefit on EPS. We also had reduced interest expense as a result of repaying our $300 million bond in February of '22. All of these drivers resulted in basic EPS of 46.6p for the first half.
Smiths has a strong track record of delivering over 100% operating cash conversion over time. Our operating cash conversion during this half reflects the impact of both strong customer demand and our continuing investment to secure supply. Two of our fastest-growing businesses in the half were Smiths Detection and John Crane, which accounted for over 85% of our GBP 106 million working capital outflow and 60% of our GBP 36 million of CapEx investment. These investments not only ensure that we meet customer demand, but also underpin the large order books that both businesses have going into the second half. Working capital also reflects where we have secured supply to overcome specific supply chain challenges for critical electronic components in Smiths Detection, and for elastomers and ceramics used in some John Crane products.
That being said, while we continue to prioritize customer delivery, at the same time, we're taking targeted reduction actions where we can. These targeted plans and SES projects include: Improving demand planning, optimizing our global network and continuing to reduce sole-source supplier positions. We know that we have a hard road ahead on inventory reduction, but we remain committed to our medium-term target of 100% operating cash conversion, and we're confident that the actions we are taking now will put us back on this path.
Let's now look at our divisional performance in more detail. Starting with our largest business, John Crane, which delivered accelerating growth and strong operating leverage. Organic revenue grew 14.6%, driven by strong demand across all parts of the business. OE and aftermarket grew in both the energy and industrial segments. We've improved order to revenue conversion as the actions we've taken to manage the supply chain have had a positive effect. Operating profit grew even faster than revenue, up 24.6% to deliver margin expansion of 200 bps. This was achieved as higher volumes drove good operational gearing and our pricing actions more than offset inflation.
Looking ahead to the second half, John Crane's order book remains very strong, with order intake in the first half of 14.2%. And we're excited by the critical role that our products play in supporting energy transition, particularly in methane emission reduction, carbon capture and hydrogen applications. We're well positioned in these areas with over 40 years' experience in providing sealing solutions for hydrogen and with an installed base today of over 5,000 units. Key wins in the half include multiple orders supplying the largest hydrogen project in Canada and dry gas seal upgrades in Oman. As we go through the second half, we'll continue to deliver against a strong order book, and our margins will benefit from SES and productivity programs.
Next is Smiths Detection, which has solidly returned to growth, up 14% and with revenue growth in all segments. Aviation was up 10.3% and other security systems, up 22.9%. It's especially good to see the return to growth in OE. Although this has a near impact on margin, it puts Detection in a strong position in the medium term, given that aftermarket revenue directly results from growing our installed base. Operating profit increased 4.5% with margins of 10.5%, reflecting the fact that lower-margin OE was up 20.7%, while higher margin aftermarket was up 8.4%. Again, this OE investment will be margin accretive in the aftermarket going forward. Order book conversion is also improving in Smiths Detection, although supply chain constraints continue, especially with some electronic components. And we also took action in the first half to simplify our organization, which will improve efficiency and reduce cycle times going forward.
And looking to the second half, our order book includes a number of airport CT checkpoint upgrades. At airports, which install CT at their checkpoints, passengers will no longer need to remove laptops and liquids from their carry-on luggage. An example of this is in New Zealand where we won the contract for its five major international airports. We also won a contract with DHL in Australia for centralized air cargo screening. Increased security needs is a megatrend driving not only strong demand in aviation, but also in other security systems with 39.2% OE revenue growth in the first half and good wins across all segments, including port screening in Japan and the provision of X-ray screening for the G20 Summit in Indonesia.
Flex-Tek built on its consistent track record with another period of strong growth. Revenue was up 17%, with double-digit growth in both industrials and aerospace. Operating profit was up 9% to GBP 77 million, a record, driven by increased volume and price offsetting inflation. Operating margin remained high at 19.5% and included new product launch costs and the ramp of the new ducting facility in Houston. Mix impacted margins here as well as we saw especially strong volumes in our industrial tubing product. And a few weeks into the second half, we are beginning to see slowing in our U.S. construction business as we expected. However, Flex-Tek's diversified end market exposure and new product launches are supporting resilience and continued growth in this segment.
Aerospace was up 14.8% in the first half, driven by increasing aircraft builds and our expanded product offering, and we'll continue to benefit from aerospace growth in the second half. New product launches are also ramping well. We received our first Midrex H2 Green Steel purchase order and our Python flexible refrigerant line platform is growing quickly.
On to Smiths Interconnect, which as expected, saw more modest growth of 3.3% in the first half following a record year in FY '22. Operating profit of GBP 32 million reflects pricing actions to offset inflation and an increase in R&D to support new product development. At Interconnect, we have a good pipeline of next-generation products, which will support future growth, as well the strategic acquisition of Plastronics, which closed in January. Plastronics is a leading supplier of test sockets, which complement our existing product range, and it's a great example of an accretive and strategic bolt-on acquisition. We are beginning to see the expected slowdown in the semiconductor end market, although this accounts for less than 3% of Smiths Group revenues.
Underpinning our accelerated growth is a strong and flexible balance sheet. Net debt to EBITDA was 0.8x at the end of January. This is after the return of GBP 241 million to shareholders in the first half, which consisted of our share buyback and our final FY '22 dividend payment. We also expect a reduction in gross debt in the second half with the repayment of our EUR 600 million euro bond. Our capital allocation policy is unchanged. First, we look to maximize organic opportunities through investment in R&D, sales and marketing and capacity expansion. And in the first half, we invested GBP 77 million in R&D and CapEx projects. Second, we want to implement this organic strategy with complementary and disciplined M&A such as the acquisition of Plastronics. And third, we look to return capital that is surplus to our reinvestment needs.
We have a progressive dividend policy and have recommended a 5% dividend increase. Through the first half, we continued to repurchase shares under the GBP 742 million share buyback program, which is now 90% complete. By staying true to these three pillars of our capital allocation policy, we're confident we can deliver our medium-term financial targets.
And in conclusion, as a result of the strong first half and recent trading, we're once again raising our guidance for the full year. We now expect organic revenue growth of, at least, 8% with moderate margin improvement. This is supported by a number of tailwinds, such as the strong order books, particularly in John Crane and Smiths Detection, coupled with a good pipeline of new products. SES projects will continue to deliver growth and strength in execution, and targeted cost actions will improve our speed and operating leverage. Moderating this, we have stronger top line comparators in the second half, and OE growth will continue to have a mix impact as our installed base grows.
Geopolitical and macro uncertainty remains high, and we're actively managing supply chain challenges that persist. And while a couple of our smaller end markets are showing signs of softness, momentum in the rest of the business remains strong. So balancing these various headwinds and tailwinds, we remain confident of delivering a second half of further progress.
And with that, I'll hand back over to Paul.
Paul Keel
Thank you, Clare. I'll now provide a strategic and operational update, organized within the framework of growth, execution and people, and we'll begin with growth. New products are clearly playing a role and are accelerating growth. Our new product vitality index, which measures the proportion of revenues from products launched in the last 5 years was just under 30% for the half, up 90 basis points year-over-year. The vast majority of our new products are developed to support specific customer needs. And as such, they are well aligned with key global megatrends, like energy transition, ever-rising security needs, or the world's insatiable demand for data.
On this slide, you can see examples of new platforms launched already this year in support of these trends. . Collectively, new launches delivered GBP 32 million of revenue in the half or just over 2 points of growth on a gross basis. To continue fueling our strong new product pipeline, we increased R&D investment by almost 14% in the period. In addition to strong new product performance, we're making good headway building out priority adjacencies like those you see here. Energy transition described the $100 trillion multi-decade transformation of the world's energy supply from fossil-based to zero carbon sources.
John Crane is ideally positioned to help our customers along this journey with our leading installed base and our global service network. We're currently engaged in over 40 active hydrogen and carbon capture projects around the world and have seen our opportunity funnel more than double over the past 12 months. For example, in the first half, we won 100% of the gas seals, couplings and filters tendered to date for a $1.6 billion blue hydrogen facility being built in Edmonton, making it the largest ever in Canada, producing enough liquid hydrogen to power every public transit agency across the province of Alberta.
The surging demand is propelled by a number of market and regulatory forces such as the Inflation Reduction Act in the U.S. and similar programs in other parts of the world. For Smiths Detection, in addition to double-digit growth in aviation, we expanded our presence in other high security markets like ports and borders, defense and urban security. Our business in these adjacencies grew 23% in the first half behind major customer wins in markets like the U.S., Japan and Indonesia. Flex-Tek is helping customers meet their sustainability goals in a number of ways. In October, we announced a strategic partnership with Midrex Technologies in H2 green steel to build the world's first zero-emission steel plant in Northern Sweden.
Midrex provides the hydrogen reduction process that powers the facility, and Flex-Tek provides the high-temperature electric elements that super heat the hydrogen. As Clare mentioned, we completed the bolt-on acquisition of Plastronics in January, leveraging cross-sell and new product synergies with Smiths Interconnect and extending our leadership into attractive adjacencies in connectors and testing.
Now having shared some updates on growth, let me say a few words about our progress on the execution front. The Smiths Excellence System is the framework through which we're building a more aligned, consistent, and higher-performing culture here at Smiths. SES improves results delivery and accelerates talent development. We relaunched SES around this time last year, initially putting in place five full-time master Black Belts to lead the program and 20 Black Belts to lead the projects. The first wave of projects have now been completed, contributing roughly GBP 5 million to the bottom line. The impact of SES is scaling quickly. Our initial target was to generate GBP 20 million in annualized benefit. And based on the good start in first half, we're now tracking to just over GBP 25 million. And encouraged by our progress, we've added an additional master Black Belt and five more Black Belts in key commercial and operational areas around our company.
SES is fast becoming the way we work here at Smiths. To give you a feel for how this plays out on a day-to-day basis, we thought we'd share a typical project. I'll quickly frame the effort and then turn it over to the project team to walk you through the details. I mentioned on a previous slide that demand for electric heating solutions is growing quickly, driven by the same megatrends we just touched on. Flex-Tek supports customers in this area in a number of ways. The green steel program I mentioned is one example. Another is our electric heat kits used in residential HVAC units. Around this time last year, high demand, coupled with supplier constraints, resulted in surging back orders in this part of our business. We pointed SES at the problem and over the span of roughly 6 months, increased our capacity by a quarter, cut lead times in half and fully eliminated the customer backlog.
Now let's hear from Dane, Justin and Kevin, who led the project.
[Presentation]
Paul Keel
Thank you, Dane and team, a terrific project. As growth accelerates across Smiths, we see variance of this opportunity in a number of areas and are quickly replicating the project, learning and building with each successive result. Our people priorities are focused in four areas: Safety, leadership development, diversity and inclusion and engagement. Recognizing that a picture is worth a thousand words, we thought we'd share a few photos from some of the many powerful initiatives we have underway across our company. And if we get 1,000 to 1 leverage with photos, hopefully, the following video will further bring to life the wonderful culture that we're advancing here at Smiths.
[Presentation]
Paul Keel
Sustainability, it plays an important role in our growth, execution and people priorities. On the growth front, in addition to energy transition programs that I mentioned earlier, we have multiple green new product platforms in development.
With respect to execution, we're accelerating emission reductions at the same time that we're growing our business. We're tracking ahead of plan on our 3-year targets for water, waste, renewable electricity and greenhouse gases.
In terms of people, this is the first year where delivery of concrete ESG commitments are part of both our short and longer-term incentive comp at Smiths.
You can find a good summary of our sustainability strategy from , our CSO, if you visit the capital market site on our web page, and you can find even more detail in the sustainability report, which is also available for download in the same location. Sustainability is an area of both strength and competitive advantage for Smiths. So please, do have a look.
Just a few comments by way of summary, and then we'll open it up to all of you for your questions. After a record start in the first half, we're well on track to a strong fiscal '23. Our growth is good. 13.5% in organic terms and over 25% reported. Order books and current trading remains strong. And as such, we have once again raised our full year organic revenue guidance now to at least 8%.
Our execution is continually improving, allowing us to deliver year-over-year gains in 4 of our 5 medium term financial commitments, including EPS, which was up 52%. SES is playing an important role on this dimension and encouraged by our progress, we're scaling the program accordingly. And our people enable all this progress. And I want to thank and recognize my 15,000 colleagues around the world for doing what we do best, improving our world through smarter engineering.
By aligning behind our people priorities of safety, development, D&I and engagement, we're advancing the wonderfully inclusive and high-performing culture of Smiths.
As a 172-year-old company we think as much in quarter centuries as we do in fiscal quarters. We're encouraged by the progress we've made over the past 6 months and carry strong momentum into the second half and beyond.
Thank you for your attention and support. And with that, we'll turn it back to the operator to open the Q&A.
Question-and-Answer Session
Operator
[Operator Instructions]. Now we're going to take your first question. And the first question comes from the line of Christian Hinderaker from Goldman Sachs.
Christian Hinderaker
First, on better results. [indiscernible] starting on one of the brand [Technical Difficulty] Can you talk a little bit about inventories up from of sales, year-end 24%. Not unusual in terms of [indiscernible] market [indiscernible]. And obviously, you've got a good reason for that [indiscernible] percentage growth. But you talked about targeted plan including SES project to reduce that inventory. Just be great a little bit of clarity around that as well as how we should think about inventory [Technical Difficulty] or percent of sales, but I think through this year and then to following [indiscernible]?
Paul Keel
Yes, thanks for the question, Christian. As Clare mentioned, in her comments, about 85% of that inventory increase went into John Crane and Detection. And what you'd like to see, if you broke that down was the components of inventory lining up with the growth. So we look at inventory at the three big categories, raw material, work-in process and then finished goods. In John Crane, the largest percentage increase came in work in process. These are orders that came in, materials that moved into the factory and build them and pass on to customer sites.
Further on, at Detection side, where the largest percentage increase was in finished goods. These are large detection systems that now are fully assembled, and we just wait for the customer to receive them. So that will work through naturally as the businesses progress forward.
For us, we think of it as an investment in the same way that we're willing to create near-term margin OE for the higher large recurring after market. We're building and in fact, excited to use our strong balance sheet for a competitive advantage to support that kind of growth.
I don't know, Clare, if you have anything you wanted to add to that?
Clare Scherrer
I think that's a terrific explanation where our cash conversion reflects our investments in inventory and it reflects our belief that, that will in turn, support the interim growth. So nothing has structurally changed about our ability to generate cash conversion consistent with what we've done in the past.
Christian Hinderaker
Second one, I wanted to ask Flex-Tek. We're seeing a bit of a softening in your data both in terms of soft and now year-on-year in terms of pricing. Can you talk about the positioning of Flex-Tek business within the U.S. housing market? And what you've seen in terms of demand conditions today in grounds? I know that division sales are now HVAC-related, and that might be provide a buffer and that in turn [indiscernible] towards energy efficiency, general DIY investment [indiscernible].
Paul Keel
So Flex-Tek is a fabulous business. Over time, it grows regardless of what's happening with its underlying market that's double-digit 5-, 10-, 15-year top line CAGR and even better earnings CAGR over that same period. We have been anticipating this -- the well understood the slowdown in the U.S. housing market would have impacted Flex-Tek sooner. Flex-Tek team is stronger than many people expected. Now we do see, as you pointed to those macro indicators on the U.S. housing starts -- while it did impact us in the first half, in the first 6 weeks here, now, of the second half, we are starting to see evidence of that.
So Flex-Tek will continue to grow, as it always has just not at the same record levels. We saw in fiscal '22 and then here in the half. They have two businesses, balancing that -- the construction impact that we just described. You know one of them, aerospace. Order growth in aerospace was in the double digits in the first half, and that business will continue to grow here moving forward. And then the second is the electric heating business that we touched on in the call. The demand for like heating appliances all businesses like ours, have made net zero minimum [indiscernible] you look early is on your [Technical Difficulty] So we're getting a strong inflow of questions how we can help our customers to convert from fossil-based heating to electric heat. So we feel pretty good about Flex-Tek.
Christian Hinderaker
And coming to my second question and then back to your comments on the net zero ambition. I want to ask if you're seeing any signs of incremental demand in some of the policy announcements we're seeing, for example, chip set which might help Interconnect and [indiscernible] IRA earlier on the call. Just wanted to think about how we should calibrate the impact of those policy on your demand of your business?
Paul Keel
Yes. Well, energy transition is one of these giant global megatrends, $100 trillion the world investment over the next 20, 30, 40 years, as we get to the net zero whether that's in 2040, 2050, we'll have to see. And this is not playing out in our business in a number of ways. We gave an example of the blue hydrogen facility in Canada. It's very clear [indiscernible]. The H2 green steel partnership in Sweden another clear example of that. And so legislation, like the Inflation Reduction Act and parallels of it in most major economies, all help accelerate that tidal wave of transition that is coming so we find that support, absolutely.
Operator
And the next question comes the line of Andrew Wilson from JPMorgan.
Andrew Wilson
First, [indiscernible], I'm interested in terms of what indications you're getting from customers with regard to the demand. I mean, the orders in the first half I think they were about 14% year-on-year, clearly [indiscernible] I am interested in terms of how much of that is catch-up maybe kind of demand supply chain [indiscernible] retaining an underlying [indiscernible] affecting energy market probably to be pretty strong, but maybe next year or 2 at least. But I guess I'm interested in terms of what customers are actually telling you, and interested in both sort of traditional market but also the newer market as well in terms of the second half maybe into in FY '24?
Paul Keel
Yes. Thanks, Andrew. It's a good question. So we are seeing strong demand, both on the order front and on the revenue conversion side across all of its end markets. We've been seeing it both on OE and the aftermarket side. And there's three pockets of customer demand. Yes, the traditional energy business right now, seeing very strong demand. Part of that is post-COVID. Part of that is the increased demand for supply of non-Russian sources.
The second piece, remember, John Crane also participates in a number of nonenergy segments, water treatments, pharmaceutical, chemical, all of those business are doing really strong. The third piece of it is this energy transition, we began which we had been thinking about as the future. But that future is very much here right now. I mean 40 active hydrogen carbon capture projects [indiscernible] right now. Our opportunity funnel, more than doubling. And then some very big projects like Canada project and last year we got the very large [indiscernible] project.
So it is a good time in John Crane. And incrementally exciting for us is there's good reason to believer for John Crane that a near-term demand will extend into medium term for all of the reasons that I just described. And then the long-term tailwind from energy transition, provided that we can respond to the demand, both in terms of operations, but also in terms of new product and service offerings, we should be well positioned in some time to come.
Andrew Wilson
And I guess my second question is you touched similar on the Detection side. It's a couple of aspects to it. Obviously the first half is very encouraging in terms of the order conversion [indiscernible] and I think in fairly clear in terms of the effect of the second half on a slow overall rate. But in terms of the business you're getting with customers, and then the visibility that [indiscernible] providing you with in terms of the profitability. I mean just as you've been able to, I guess, make any progress [indiscernible] is this a matter of timing for the profile or because [indiscernible] quite volatile [indiscernible] should expect in the detection [indiscernible]?
Paul Keel
No, look, we think of Detection in kind of 2x2 grid. You have aviation security, you got other security systems, you have the only part of the business and then you have aftermarket. On the OE side of the business, you tend to have good visibility on the order book and detection, hence [indiscernible]. So you can see forward across many quarters of what the OE side should look like.
Attached to every OE order is typically a committed service period. And then service piece has both scheduled maintenance as well as great fix. So you can see the schedule maintenance and -- model. What you can see as well is how fast these adjacencies grow. So we have a pretty good deal on the aviation side, but the adjacencies we're moving into, other security systems had a very rapid growth, in particular on the OE side in the first half. That was a little bit more difficult to predict.
And then again, the other security systems side that business also has the defense piece. Those tends to be very large orders. And so those coming in and those roll off in a comparable period that tends to introduce a little bit of volatility.
Clare Scherrer
Paul, I'm going to add, we entered the second half with our largest order ever in Smiths Detection, which is up double digit versus a year ago, and a high single-digit percent growth in order book versus the start of the year. And so I think that position us well. As you mentioned, it is a programmatic business. So quarter to quarter things do not always advance in a similar fashion, [indiscernible] plenty of customers to be ready to receive delivery. But overall, the order book that we entered the second half would position us well for sustained growth in that division.
Operator
And the next question comes from the line of Mark Jones from Stifel.
Mark Jones
If I can start with a broad one and then a couple more specifics. The broad one is obviously now you've roughly doubled your expectation of organic growth for the full year. If you were to isolate in particular part of the businesses driven that is more about stronger demand, which case what part of the business? Or it's more about better availability given some of the supply chain [indiscernible]?
Paul Keel
So for -- well, call it, 18 months now, demand has exceeded supply. And right now, both on John Crane and Detection, they have a such strong order books that demand is still above our ability to supply it. We have been scaling the supply in both Crane and Detection, both in terms of CapEx, adding capacity, but also SES is you saw a good example there with the Flex-Tek project. We're getting more supply out of existing capacity. So on both fronts there, that's supportive.
Mark Jones
Okay. And then this wave of early we are seeing in Detection, typically lag between one of those waves [indiscernible] aftermarket coming through but this is a period of time when [indiscernible]?
Paul Keel
Yes, for Detection, it can be anywhere from 6 to 18 months for [indiscernible] revenue on the OE side. It's shorter, more typically, 3 to 6 months for an aftermarket order in Detection [indiscernible] revenue.
Mark Jones
Okay. Perhaps one quick, obviously going on the balance sheet in terms of the benefit of [indiscernible] finance cost coming through, some indication, timing and scale of that?
Clare Scherrer
Yes. So we're planning -- and thank you for the question. So we're planning to repay our EUR 600 million bond when it comes due in April. So we'll have interest reduction of that repayment. When you think about the other bond which we will have which will remain outstanding which does mature until '27. Half of that is swapped for closing and so you should think about right now effective interest rate that we have on that remaining bond of around 4.2%.
Operator
[Operator Instructions]. Now we will take our next question. And the next question comes from line of Andre Kukhnin from Credit Suisse.
Andre Kukhnin
Can I start with the Smiths Excellence System that is delivering results [indiscernible] clearly what expected for second half and then increased annualized revenue of . But beyond that, should we think about SES as something that continue process and think about that in terms of both annual saving that generated [indiscernible] 2024 [indiscernible] beyond that? Or is this something that you are still ramping up and actually and it is something that got potential to delivery substantially more than current run rate?
Paul Keel
So SES, we've seen other businesses that have deployed continuous improvement as all across the enterprise. It brings you two primary things. It improves your execution, your project management, the predictability with which you can solve problems. And then the second thing it does for you is it accelerates development and talent. Certainly, the lack of master Black Belts are in full-time rolled into the program, but all of the project participants learn that same problem-solving methodology. And then over time, you improve your culture, you get used to, better execution and becomes the norm.
Now you can point that capability have a lot of the different things. Across the first half, we principally pointed it at customer service because of Mark's question regarding demand and supply. With demand seeing supply, our SES is focused on customer service. Also helps sort on the productivity front. So while we more than covered input inflation with our own price, there's still more margin to be captured. So we look forward for using a few more resources on the productivity side.
As we get through that piece, I think you're going to see more emphasis as Clare on the working capital side, started to bring our cash conversion number back up into the 100% range that you guys used to from us. So SES has a lot of things for the company and you can point a lot of the different problems.
Andre Kukhnin
Great. And I guess [indiscernible] to kind of I know [indiscernible] some companies have talked about kind of minimum level of productivity to deliver every year [indiscernible] talk about 3% or 5% at the highest. Is that right way for us to think about Smiths going forward with SES being [indiscernible] through the course?
Paul Keel
Yes, you like to see productivity both on your cost line in your factories. And then you like to see SG&A productivity. We look at both. We had good SG&A productivity in the first half. I think if you look at SG&A as a percent of sales is down 70 basis points or something like that. And then if you look at our margin walk, you can see example of factory productivity coming in. So yes, our productivity on both sides is absolutely something [indiscernible].
Andre Kukhnin
And if I may just a couple of quick ones on trade. One, very excited to hear about or see some numbers on the new energy. Is there any challenge you can give in other [indiscernible] potential value of those say 40 projects? I don't think you would give it for individual contract award, but just to have an idea what this 40 kind of projects mean in terms of substantial revenue [indiscernible]?
Paul Keel
Yes, at this stage, no, we couldn't give you an accurate answer because it is growing so quickly. It is tough to know what that growth rate moving forward. If the current rate continues over several years, it will be a big part of our business.
Andre Kukhnin
And the final one just on the margin for John Crane. Clearly, strong [indiscernible] H1 normally have a quite healthy seasonality in the second half. Can that happen into this year? Or
[Technical Difficulty] sequential potential for improving the margin above 40 level of each one?
Paul Keel
I mean all of our businesses have scale economies. So you book more volume through factories. You [indiscernible] shorter -- fewer change orders and all of that goes up into the gross margin line. You saw that in John Crane. And secondly, of course, the SG&A efficiencies, we put more revenue over the same cost efficiency to get margin expansion from that. John Crane's high watermark is still north of where we currently are. So if we continue to execute as we have been, yes, we believe additional upside to Crane?
Operator
And the next question comes from the line of Bruno Gjani from Exane BNP Paribas.
Bruno Gjani
My question relates to orders [indiscernible]. I recall back at the Capital Market Day. A couple of months ago, you gave that 5% to 7% kind of growth is possible in FY '23. I was certain you could share what [indiscernible] growth both in H1? And I was just wondering whether you still expect to deliver 5% to 7% growth this year? Or whether your expectations have evolved since then?
Paul Keel
Yes. Thanks for the question, Bruno. So we shared the number for John Crane, the 14% order growth. That business remains strong, and we expect similar time as well moving forward. In Flex-Tek, the order growth is most relevant in the aerospace part of that business. We're seeing low double-digit order growth for Flex-Tek. Detection, as Clare mentioned, is a programmatic business. So looking at order intake growth probably isn't as helpful as looking at total order growth year-over-year and as Clare mentioned, that was double digits you're heading into the second half.
The one business where we have negative order growth was Interconnect, and that relates to the slowing in semiconductor [indiscernible] timing as well as a little bit in our bolt-on business. Some of our customers [indiscernible] projects. We think they will come in the first half definitely.
Bruno Gjani
Okay. That's helpful. And I guess I have another question on investments and growth and [indiscernible] a bridge. Can you help us think about how we should be thinking about the development year-over-year in H2 in terms of the dilution margin? Am I right in thinking that the year-on-year headwind in H2 '22 was more pronounced so therefore this year when looking at that year-on-year impact [indiscernible] ramp up investments [indiscernible] of back end of last year -- over the last fiscal year. Just to say it would be useful. And I guess just on the mixed kind of [indiscernible] was there anything exceptional that you delivered in H1 that's weighing down on that margin specifically that might in H2? Or do you expect it to mix within revenue for H2 2023 to be large similar to that of H1 to have a similar kind of mixed headwind?
Paul Keel
For the full year, we expect to continue seeing moderate margin improvement. It will be the same trade-off that we talked about for the first half. We could boost margins more. We could back off on our R&D investment. We could be more discerning in terms of our OE tenders. But our current posture is that we'll continue to prioritize growth. So tenders that played our strength, that value technical differentiation, that value strong service using our global service networks. We're going to continue to invest in the only piece, knowing that it's a near-term margin impact because we have a decades of evidence that at least a higher margin recurring revenue. So I think it's going to be,, Bruno, the same sort of dynamic here in as we talked about first.
Bruno Gjani
Sure, sure. On Detection, I guess, we seeing more [indiscernible] technology on the capital [indiscernible] side [indiscernible]. Could you perhaps talk about the upgrade opportunity that exists [indiscernible] in terms of New Zealand. So what kind of opportunities you might look like at the over the next 2 to 3 years?
Paul Keel
Yes. I think there's two sides of that business of course, the checkpoint and hold baggage. The hold baggage conversion to CT in Europe is largely complete. It's the check bag that's not going country by country. And it's different in each part of the world. The U.K. has mandated CT out of the checkpoint here, I believe by the end of 2024. The U.S. is just starting -- one purchaser in the U.S. the TSA. And for all intents and purposes, their major tenders right now or all for CT. So it's going country by country has a different pace. Further just as another reference that they're nearly complete on both hold baggage and check baggage.
Bruno Gjani
Sure. And just finally on Flex-Tek. So you noticed that you have been to the slow down. Does that relate to just volume? Or is it pricing starting to roll [indiscernible] any more construction [indiscernible]?
Paul Keel
I would say we should expect the slowing on both sides. We did not see prices come off in the first half. We had good volume and price for Flex-Tek. But in particular, on the construction side, our customers are asking more questions around price than they did previously and that goes with demand. When demand is wrong, they ask you when you deliver. They don't ask you at what price. Now that demand on the construction size is normalizing price come into play.
Operator
[Operator Instructions]. There are no further questions at this time. I would like to hand over the call to management team for any closing remarks.
Paul Keel
Okay. Well, thanks, everybody, for tuning in. As I think you've heard on the call and you saw in the release, very strong momentum in the business right now that has 7 consecutive quarters of accelerating growth with record organic revenue growth, record reported revenue growth and record EPS growth. Also unique in that all four businesses, all parts of the world and all customer end markets were in growth in the first half.
So we feel good about the momentum we currently have. We would balance that with an observation of macro uncertainty, which remains at very high level. So the things that we can control, we expect to continue progressing in the second half. But uncertainties are pretty high. So you put those two together and you get the increased guidance for the full year of at least 8% organic revenue growth, which is our second raise now in 2 months.
So thanks again for your interest and we'll be talking to all of you guys in the coming days and weeks. Bye for now.
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Smiths Group PLC (SMGKF) Q2 2023 Earnings Call Transcript