BHG Group AB (publ) (BHG) Earnings Call Transcript & Summary

Good morning, and welcome to the BHG Q2 2022 Earnings Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Adam Schatz. Please go ahead.

Thank you, operator, and good morning, everyone. Moving to Slide 2, please. We strengthened our position in the quarter, yet again, delivering profitability, despite challenging trading conditions, high comparative figures and the main focus on defending profitability rather than market share, we held up well against the contracting market. At the same time, investments in the technology and customer platform continued positioning us to take advantage of unchanged long-term growth trends. Slide 3, please. I'll start this morning's presentation by reviewing the Q2 highlights and providing a business update. Jesper will then cover the financial section before I conclude and we launch into the Q&A session. And Slide 4 -- on to Slide 5, please, for the Q2 highlights. While the long-term conditions for profitable cash-generating growth are unchanged, conditions have shifted in the shorter term. We are living through the aftermath of the pandemic and spend on services has fully normalized. Now in addition, consumer sentiment has suffered a blow. At the same time, it's important to point out that our markets remain larger than they were before the outbreak of the pandemic. Furthermore, our focus on price leadership throughout our portfolio from the value to the premium range puts us in good stead as consumers' disposable incomes are likely to be under pressure for some time to come. Against this backdrop, net sales came in at SEK 3.9 billion, corresponding to total growth of 10% on the back of recent acquisitions. Pro forma organic growth amounted to minus 7% and pure organic growth to minus 8%, more on which shortly. Adjusted EBIT amounted to SEK 162 million, corresponding to an adjusted EBIT margin of 4.2%. Cash flow from operating activities at minus SEK 162 million was adversely affected by working capital developments, which we will come back to, but also by timing effects between the first and second quarters of the year and the nature of recent acquisitions. Measures to adjust purchasing were instituted some while back and the effects of these will kick in fully from the second half of the current quarter. Slide 6, please. Zooming in on organic and pro forma organic growth at minus 7% and minus 8%, respectively, we did quite well in the quarter, given the significant contraction in the total market against the highest reached during the pandemic. We, at least, maintained our position in the Nordic region, while our geographic expansion contributed positively. Slide 7, please. For a longer perspective on growth. To the left, the group's net sales has increased by 129% over the past 3 years, a period in which pro forma organic growth amounted to 17% per annum and pure organic growth to 10% per annum. Turning to the middle of the slide. The group's share of net sales from outside of the Nordics has increased by 17 percentage points since 2019, and Germany confirmed its position as our third largest geography in the quarter. And over to the right, our growth in the quarter again confirms that we continue to strengthen our market position. The total home improvement market, although in a rough patch currently is larger than in pre-pandemic times, and we maintain that the longer-term growth trajectory of our underlying markets remains intact. Slide 8, please. Moving to the business update. Slide 9, please. Our recipe combines organic initiatives and M&A with the synergy possibilities created between the 2. The organic strategy remains focused on our 4 cornerstones of assortment, scale and own brands and unrivaled digital experience and supporting infrastructure. In the quarter, we continued to invest in our technology platform and further improved our ability to leverage the breadth of our assortment through all our sales channels. Further, customer satisfaction continued on its path to higher levels. Turning to the middle section of the slide, M&A. Acquisitions will remain an important tool going forward. However, given current elevated market uncertainties, we are particularly selective and discriminate. Nonetheless, in the quarter, our M&A team evaluated numerous potential acquisition candidates. We saw evidence of valuation expectations on the sales side, adjusting to new realities, and we completed an in-depth mapping of the German M&A landscape. And over to the right, we are unlocking synergies from assortments, tech, data and infrastructure across the group. In the quarter, we saw continued progress along the path towards larger units with harmonized tech. Moving to Slide 10, please. Traffic generation conditions resembled those seen in the past quarters. In a contracting market, our active customer base at 3.9 million held up quite well year-on-year and is up by 41% over a 2-year period. As you can see on the top right-hand side, our key customer-related metrics remain healthy with both orders per active customer and repeat orders somewhat higher than last year and a continued healthy marketing ROI. Investments into gaining further insights from customer-related data across the group continue. We launched our customer data platform in Finland in the first quarter with early promising results and 3 of our Swedish units are progressing towards launches during the latter part of this year. More generally, driving BHG towards a higher level of customer centricity remains a critical focus area for us. Technology investments into optimizing and personalizing sales and marketing as well as driving customer satisfaction are key in this regard. Slide 11, please. Handing it over to Jesper, who will walk us through the financial update, Slide 12, please.

Thank you, Adam. As per Adam's introduction, in the second quarter of the year, we further advanced our position despite a difficult market situation. Net sales increased 10% to reach SEK 3.9 billion. Pro forma organic growth amounted to minus 7% and organic growth to minus 8%. Total growth was driven by the operations added to the group through acquisitions since the corresponding period last year with HYMA and AH-Trading being the largest additions. Adjusted EBIT amounted to SEK 162 million, corresponding to an EBIT margin of 4.2%. The EBIT margin was negatively impacted by higher shipping, product, fulfillment and traffic generation costs. A weak Swedish krona also adversely impacted earnings. I will get back to the EBIT margin compared to last year in a while. Slide 13 and the segment view. Net sales in the Do-It-Yourself segment grew by 5% to reach SEK 2.3 billion, while the Home Furnishing segment grew by 17% and net sales amounted to SEK 1.6 billion. Adjusted EBIT amounted to SEK 118 million in Do-It-Yourself segment, corresponding to an EBIT margin of 5.1% and to SEK 60 million in the Home Furniture segment corresponding to an EBIT margin of 3.7%. As in the first quarter, price increases compensated to a great extent for high shipping and inventory costs in the Home Furnishing segment while that was not the case within the Do-It-Yourself segment. However, the adjusted EBIT margin in the Home Furniture segment was negatively affected by traffic generation costs and the weak Swedish krona. Let's turn to Slide 14 and a closer look at our EBIT margin compared to last year. The gross margin development in the quarter was attributable to increases in the prices of raw materials, shipping prices that remained high, higher cost for fulfillment and traffic generation as well as the weak Swedish krona. Cost increases were partially offset by implementation of price increases. However, due to tough campaign pressure in the market, not least when it comes to our portfolio of owned brands, the ability to adjust prices was more limited. Cost for online marketing remained high as a result of weak demand and tough competitive pressure. The increase in organizational costs from same period last year is partly explained by the continued high share of sales from our own brands, which requires a somewhat larger organization and partly by continued long-term investments to drive customer centricity. Finally, increase in depreciation and amortization was primarily driven by continued tech investments and new lease agreements. All in all, our EBIT margin amounted to 4.2% in the second quarter. Let's turn to cash flow, Slide 15, please. Cash flow from operating activities amounted to minus SEK 162 million, negatively impacted by changes in working capital as a result of inventory buildup during the period. The inventory buildup in turn was driven by a delayed beginning of the outdoor season, a weaker-than-expected demand in the German market and a competitive situation for the Do-It-Yourself segment's portfolio of owned brands. Actions have been taken to reduce and delay purchases, which are estimated to become fully effective beginning in the second half of the third quarter. The right-hand graph showing the development in liquidity walks us through the starting period position of SEK 274 million, deducting the cash flow from operations and the impact of investing activities, a majority of which is M&A related, and finally, adding the financing activities, which are primarily related to the new share issue completed in the period and the amortization of our revolving credit facility, but also include amortization of leasing liabilities, bringing us to the period end SEK 520 million of liquidity at hand. Slide 16, please. The group's net debt amounted to [ SEK 1.803 million ] at the end of the quarter, and net debt in relation to LTM adjusted EBITDA ended at 2.5x just inside the medium-term financial target range. On top of our liquidity at hand, we had unutilized credit facilities at the end of the quarter of SEK 1 billion. Handing it back over to you, Adam, to summarize and conclude.

Thank you, Jesper, Slide 17, please. And turning to Slide 18. As we write in the report, much has changed, while at the same time, nothing has changed when it comes to our prospects. Much has changed in the sense that we're living through especially turbulent market conditions, with the aftermath of the pandemic affecting consumption patterns, markets temporarily shrinking and now more generally, consumer confidence having been tumbled. In addition, Russia's war of aggression can be expected to continue for some time to come, creating further business uncertainty and complexity. And yet, nothing has changed in that the secular trends of rising online penetration and consumers focus on their homes remain intact. We continue to be in the driver's seat in terms of leading the consolidation of our markets over the coming years. This is a period we believe, in which the winners of the future will crystallize, and we are in an excellent position to be counted among these. Moving on to Slide 19, please. Nevertheless, we operate in the market, online high-ticket items that has taken a hit by recent developments. The fact that we continue delivering profitability also under current conditions demonstrates the strength of our model and the strength of our market position. We will continue to prioritize as follows through the coming quarters. Profitability, first and foremost, coupled with cash flow generation and also important, but third on our list for now, growth and only growth, which is profitable and cash generating. This entails preparing for a prolonged challenging market situation by fully leveraging our size, adjusting pricing campaign and marketing strategies carefully, being particularly disciplined in terms of strategies to reduce working capital and discerning in terms of M&A. While at the same time continuing our range and geographic expansion as well as investments in customer centricity. And the final slide for this morning, Slide 20, please. Summarizing the quarter. Our journey continues. We held up better than the market organically. And with recent acquisitions, we grew by 10% in the quarter. Pro forma LTM sales now stands at SEK 13.9 billion. Our Nordic online position was strengthened while we took share on the European continent with Germany, our third largest geography. We believe that the supply situation will continue to normalize, albeit in fits and starts, and we have positioned ourselves to see improvements in our working capital situation rest of the year. Weak consumer sentiment is likely to be in play for some time to come. In this changed landscape, we have adjusted our tactics and our prioritizing profitability and cash flow generation ahead of growth for now. At the same time, the underlying secular trends of rising online penetration and consumers focus on their home environments are intact. By continuing to invest into customer centricity, data and automation, we are well positioned to further leverage our Nordic pole position and to continue expanding our presence on the European continent. Moving to Slide 21, please. This concludes the presentation. Over to you, operator, to moderate the Q&A.

[Operator Instructions] Your first question comes from Gustav Hagéus from SEB.

I have a few, if I may. Firstly, you referenced that you think that the pricing pressure should gradually come down as inventories are being worked down in the market. Could you confirm whether or not you're seeing data points on this already? Or is this more of a medium-term expectation of yours? That's my first question.

We are seeing evidence of this happening, but it is a really tale of 2 stories. So we did report already in the fourth quarter of last year and the first quarter of this year, that within the Home Furnishing segment, we did see evidence of that happening. And of course, much of the increase in product cost was also first noticed on that side of our aisle. But we have seen gradual pricing adjustments, actually quite significant pricing adjustments. But also, again, cost increases have been quite high. So those pricing adjustments haven't fully compensated for the cost increases. But the situation on the home furnishing side is a market that is less fragmented than in parts of the DIY side. And so I think that's one part of the explanation for why pricing is adjusting quicker on that side. There is a caveat still on the home furnishing side, which is important for the understanding of the Q3 results, which is outdoor furniture. So specifically within outdoor furniture, of course, a very, very important category in this season. Price campaigning has been very intense also on the furnishing side. So that stands out a bit. Within the DIY segment, as you know, we have quite significantly increased the share of sales that comes from our own brands. And this part of the market, in particular, is quite fragmented. And this is also the part of the market where we just had basically all of our competitors source products from Asia in the outdoor season, but also to a large extent throughout the year. And this is the part of the market that has not adjusted to any meaningful extent yet, which, in our view, is entirely linked to assume to the high inventory levels amongst our competitors on this part of the assortment. So we are convinced that the majority of our competitors are now within this part of the business are and not profitable at these levels. And clearly, they're not running sustainable tactics and strategies. So we have great confidence that pricing will adjust, but it hasn't as of yet.

That's helpful. Then looking at growth comps, you faced, if I put together the 2 year stacked organic growth you were facing in H1, it was in the high 50s, which now looks to come down to sort of high 30s in H2. With that in mind, do you see potential for your headline organic growth year-over-year to have bottomed out in Q2?

So I think, again, this is -- there are 2 factors that move in opposite directions here. One is that our own comparative figures are much easier and now in the second half of the year than they were in the first half of the year. And on the other side, we have the deteriorating macro picture with rising interest rates, consumers under stress, very likely consumer disposable incomes under pressure during the second half of the year. So that is the tug of war between those 2 factors, I'd say, with the added uncertainty of how our competitors will act under those circumstances. So we're not making any real forward-looking statements ever. But I think that paints the picture of the reasons to hope and the reasons to be a bit cautious about demand developments in the next couple of quarters.

Sure. And you also referenced online migration in the report that you expect this to reverse back in favor of the online market already in H2 this year, which is a very bold statement. And I assume you must have seen some data points on this already? Or could you please elaborate a bit numbers this topic?

Well, whether it's a bold statement or not, I think we can disagree on that. I think it's not bold at all to say that the trajectory of rising online penetration will resume. And then I guess, the exact timing of when that will happen, there we can have an argument whether we're too optimistic by a quarter or not, but I am fully confident that online penetration will resume its secular trend upwards over the next period of time. And what we have in the past 2 quarters is really the anomaly over a 15-year period. So over the past 15 years, online penetration has been steadily rising. Now we have 2 quarters in this post-pandemic realignment period where that hasn't been the case. So this is the exception, I would say. But yes, granted, the exact timing of this, one can always argue. But directionally, I'm extremely confident that this secular trend will continue to be in play for many years to come.

Yes. No, I think the long-term trend everyone agrees. It was more the timing since you're already almost 1 month into the half year. I was thinking maybe you've seen something already in terms of a flow from offline to online. But that is not the case.

So I can't point to any very tangible data points specifically on that. But one thing I can mention, which perhaps is tangential, which we point out in the report as well, that when it comes to traffic generation costs, at least in terms of cost per click, there we did see a trend shift in June. So as you know, over the past 6, 7, 8 quarters, they have been rising [ in accordingly ]. And now in June was actually the first month in a good while where we could see a decline.

And sorry, a few more questions, if I may. Firstly, on inventory. You've seemed optimistic if I read between the lines that the inventory has peaked now in Q2 and will come down in absolute terms to end of the year. My question is to what extent is the inventory management in your own hands? And to what extent is it in the hands of entrepreneurs given the earnout structure? I guess it's a complicated discussion to have with your entrepreneurs to lower inventory given that they're incentivized on growth rather than cash flow. So could you focus really on that and shed some light on what share of the total inventory procurement is actually in your control today.

100%. So we have very, very clear governance in place now. And we all want the business to grow profitably, both we, at the group level, Jesper and I and our colleagues at group and our excellent entrepreneurs. So sometimes there can be additions of opinion about what is the wisest tactic over the next quarter or 2. And then we have those discussions. But we have full visibility, and we have full control over purchasing decisions.

All right. And two final one to -- one related to this. You had an earnout reversal in the quarter, which was quite substantial. Could you confirm if this loss relates to the 1 large acquisition did last year? And if you would expect the full earn-out, I believe it was SEK 500 million to reverse, if the growth of that company and earnings of that company does not reverse during H2?

So I'll pass that on to Jesper.

Yes, I will answer the question in a bit in a different way. But we have reversed earn-outs and that adjustment is related to more than 1 unit or more than 1 acquired company. I think that when we adjust, we typically want to feel that we are certain about the direction we are adjusting in and then gradually adjust during the year until we know more at year-end. So what I'm saying between the lines is that if liabilities would move in any direction, I would assume that they will be lower at year-end than they are now. Yes. And maybe regarding the acquisitions made last year, we did communicate the big 1 relating to the HYMA acquisition of SEK 500 million. And that one is totally depending on performance in 2022.

Okay. Lastly, just I may be greedy, [indiscernible] your items affecting comparability you put in [ 9,400,000 ] on strategy work. As an outsider who don't know the specifics, it seems like strategy would be a part of the day-to-day business. So if you could shed some light on this, that would be helpful.

Gladly. We -- as you're correctly inferring, we have an annual strategy cycle. And this year's annual strategy cycle is part of that annual cadence, but we've basically never previously leveraged the help of external partners in our own strategy work. This time around, we've done so. So we've used 2 external partners. And it's part of the ongoing work, which we've also been communicating a bit about in terms of driving customer centricity, data automation, but also as we're mentioning in the report the work in terms of continuing to simplify our operating model and structure. And so we decided this year that we wanted to have external sounding boards in the process. And we will be updating the community on the outcomes of the strategy cycle during the fourth quarter of this year.

Your next question comes from Benjamin Wahlstedt at ABG.

Firstly, regarding the inventory levels, is it possible to say roughly what portion of the inventory is summer dependent?

I don't have that number in front of me. So not really.

Right. I guess we touched upon this a bit. But regarding organic growth, is it possible to give a sense of the entry rate and exit rate for the quarter in terms of organic growth?

Sure. So the only real anomaly during the quarter was a couple of extraordinarily cold weeks in all of the Nordic region. We -- and this was, as I recall, like week 15 and 16 or 16 and 17 or something where, for instance, in Helsinki, there was still snow on the ground. So it was a very, very chilly start to the season. And we also, of course, have our network of people in the industry. And we know that basically, everyone had a couple of extraordinarily poor weeks thereabout that time line. So that was the anomaly. And other than that, no real swings but pretty similar costs.

Perfect. I know you've commented on this in the past, and we have talked about this briefly during the call as well. But given the recent development, I'm curious, could you just give us a rough update on the earn-out payments say from now up until and including 2024, please?

Sure. So the total amount on our balance sheet is SEK 1.8 billion. We have roughly another SEK 60 million to pay in 2022 and then another SEK 700 million in 2023. And the remaining amount is to be paid between 2025 and 2027.

Perfect. We've obviously seen some large movements in certain raw materials during the last months. What sort of lead times are we looking for before this is visible in the P&L, please?

I think it's difficult for us to be precise in answering that actually. But I guess you're referring to the first massive increases and now in the past 2 or 3 weeks, the fact that many of those have been falling back somewhat right.

Yes, exactly.

Yes. I think that's really difficult to provide any real timing insights on. But what I can say is that, that external environment is the same for everyone in the market. And I should see -- the question is, to what extent and how quickly will market participants adjust pricing up or down. But I'm still quite convinced despite the relief in raw material prices in the past couple of weeks that the direction on pricing in the market will be up still because of the overall cost pressures that we've seen.

[Operator Instructions] Our next question comes from Niklas Ekman from Carnegie.

Yes, a couple of questions for me as well. Firstly, a question on the market growth. You say that you grew more than the market. Do you have any good statistics there? And I'm also curious about kind of the split between online versus offline. It seems -- you seem fairly clear about online having lost market share. Could you elaborate a little bit on what kind of market data you have and how this compares to the minus 8% organic growth that you reported?

Yes, indeed. And as we've discussed previously, there's unfortunately not this definitive data source out there that we can just tap into and get a number for the overall market that everyone agrees with. So we look at very many different data points. And one of those sources is the data that Google provides us with -- through our very deep cooperation with them. And so we look at in addition to cost per click developments across thousands of search terms. We also look at the query volumes for those thousands of search terms. And query volumes are down on average something like 15%. And -- so that's one data point. Another couple of data points that I'll throw in there, it comes from our peers or competitors or near peers in the market. You probably saw Big Mac's own estimate where they said that the market dropped by 15% to 20%, and that's presumably the total market online, offline combined. If we back out Big Mac's online business, they didn't specifically provide any details on that. But if we back out -- our belief is that they dropped something like 25% online in the quarter. So that's another data point. And then we have some of the international players, many of which report much later than we do but some have come out with trading updates or profit warnings to be more precise, like, for instance, MADE.COM, the U.K.-based European furniture player, which was talking about declines of 30% or so in the market. And they also issued as part of their trading update a very serious profit warning. So it's difficult to find data points out there that talk about anything else than a difficult market situation.

Yes, but that's very clear. So that's very helpful. And a second question on your inventory levels. You're at about SEK 3 billion now, which is more than twice the level where you were last year. You're talking about how you're going to address this in the latter half of Q3. How quickly do you think you can adjust to more normal levels? Or are we talking about basically reducing the inventory by close to 50%? Or what kind of inventory development do you see in the next few quarters?

I'll just start with answering, and then I'll hand it over to you, Jesper, but there are -- sitting in the office, I guess, there are 2 elements in that equation. The one element that we are in full control of is the purchasing side of things. The other element, which we're not in full control of is the demand side of things. So that's just to frame it. And then, Jesper, if you want to provide further details.

And maybe also to remember that some of the increase in inventory comes from the acquired companies of last year, consolidated from Q3. But nevertheless, I do not see that we will reduce inventory by 50%. If we will be able to come down to SEK 2.5 billion. I think that's a great achievement. And the speed in which we can do so, again, it's depending on demand.

Okay. And this work starts in Q3, meaning that this is more ideally a target for kind of the end of the year?

No. So this work started quite a while ago. But of course, lead times are quite long, especially on the part of the assortment that is sourced from Asia. And if we hop into the time machine and transport ourselves back to the worst quarters of the pandemic, lead-times were extraordinarily long back then. And we, just as many others in the market, we had to make bets, not just 6 or 9 months in advance, but something like for some categories, 18 months in advance. So what we've been seeing here in terms of our inventory buildup in addition to the effect of acquisitions, is the legacy of those very extended lead times and the difficulty of matching that to the demand that we are currently seeing. Now lead times are really fully back, which means that additional purchasing for the next seasonal peak in terms of outdoors at least. Those purchasing decisions we won't have to make until we have the full data on how this year's season ended. So this is why I say that from a purchasing perspective, we have things fully under control now. And the question on, in terms of the speed of the working capital improvement and inventory reduction, that will depend on really on demand and competitive pressures.

Great, great. And can I ask about the earn-outs as well? The SEK 1.8 billion that is remaining and the write-down you made here. The write-down, is that only related to profits or expected profit in 2022? Or have you done any write-down for earn-outs related to the coming years as well?

We have also made some adjustments to net present values of put option liabilities in the future. So it's not only based on 2022 earnings.

Okay. And given the developments and you made a lot of acquisitions in 2020, '21. Given how the market has deteriorated since then, do you see any tangible goodwill risk related to any of those acquisitions?

No.

Your next question comes from Daniel Schmidt at Danske Bank.

Just wanted to start with some clarifications and we've been around this for some time now. But coming back to what you said, Jesper, regarding sort of the inventory and how fast you can take that down. When you said [ 2.5% ], was that more a full year projection? Or was that really sort of what you could hope for in the best case by the end of Q3 already?

No, no, no, for sure. [ 2.5% ] in the long run. I will not put out a number and a time line on in which speed we will be able to reduce inventory levels. I just wanted to say that going forward, I don't think that inventory levels will be at 50% of the current levels.

No, all right. Okay. Good. And then back to further clarifications on the earn-outs and deferred payments. Could you split that up for the coming years? You said the total amount, I think, but that's for both those entities, right, on those issues. If you split that out in earn-outs and deferred payments referring to minorities, could you give us a brief update on that?

So the total amount is SEK 1.8 billion. And that consists of roughly 1/3 earn-outs and 2/3 put option liabilities or liabilities relating to minority stakes.

Good. And the split for next year, is that the same as you mentioned, when it comes to 1/3 and 2/3?

No, because we have the big earn-out relating to the HYMA acquisition coming up already in 2023. So the earnout amount -- yes, roughly SEK 600 million. Most of it will be paid out next year.

Yes. And on speaking about that, is that a hit or miss earn-out? Or is that sort of a scale that's being applied when it comes to performance?

It's a scale.

All right. So even if they don't perform as one expected, maybe 9 months ago, there could still be some earn-out being paid, if I got you right?

There's a cap and there's a floor. And if they perform below the floor, then the earn-out is 0. And then above the cap, it's still kept at SEK 500 million.

Yes. Right. And between the -- and sort of the floor and the cap there is a gradual scale there?

Exactly.

All right. More sort of from a helicopter perspective question regarding the market and the competitive landscape, which I, of course, understand is, is there any sort of indication that your competitors or you yourself are looking into changing sort of delivery and return policies being applied in the market towards the consumer. Is there any indication that the market would turn to become sort of less generous, if you catch my drift?

I think there is some indication, Daniel, along those lines. So as you know, much of what we serve our customers with is big and bulky items. And there has been some adjustments in the market as to the parts of the categories that come with delivery costs. There have been some adjustments also in the fee supplied to those delivery costs. So yes, there is some adjustment. But nothing -- I wouldn't say it's anything dramatic. It's sensible business strategies being applied basically. Yes.

All right. Good. I think most of my other questions have been answered already.

[Operator Instructions] We are showing no further questions at this time. So that concludes our question-and-answer session and our conference for today. Thank you all for attending. You may now disconnect your lines.