Breville Group Limited (BRG) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to Breville Group's 2020 half year results investor and analyst briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Martin Nicholas, Group's CFO. Please go ahead.

Thank you, and good morning. I'm Martin Nicholas, Breville Group's CFO, and I'm delighted to welcome you to our first half results call. I'll start by reviewing the group's trading performance and then hand over to Jim Clayton, our CEO, who will focus on the operational highlights for the first half and our outlook for the second half of the year. Before we get into the presentation, you'll see on Slide 2, a disclaimer regarding forward-looking statements, including in the following slides. So let's now turn to Slide 3 and Group results. In summary, Breville's had another very strong half, delivering 25% growth, accelerating double-digit EBIT growth and our normal seasonal pattern of cash flows with continued strong ROE. This is all the more noteworthy given that it was achieved against the backdrop of tariff complexity and uncertainty in the U.S.A., Brexit deliberations in the U.K., geographic expansion in Europe and a weakening Aussie dollar. Before delving into the numbers in more detail, I'd just like to start by pointing out that the adoption of AASB 16 for lease accounting has inflated some of our reported FY '20 profit numbers, especially EBIT and EBITDA. So in the presentation, we have shown first half '20 before and after adoption of the new standards. This should enable you to see our like-for-like profit performance as well as the reported profit performance. So in terms of key numbers, revenue increased by 25% to $552 million, with double-digit growth in all regions and all categories. And translation benefits from a strong U.S. dollar, which added about 5% of this growth number. Our EBIT margin of 13%, primarily reflects the dilutive effect of the strong U.S. dollar. But also partially a change in segment mix with our lower gross margin distribution segment outgrowing the higher-margin global segment and also partially the net impact of U.S. tariffs, especially the 25% tariff imposed on countertop ovens. In line with our strategy of delivering a sustainable business model, we also continue to step up our investment in R&D and marketing period-on-period. But in terms of dollars rather than percentages, we have successfully accelerated our profit growth with EBIT growing by 15.6% on a like-for-like basis, up from 12.9% growth, 12 months ago. Profit after tax increased by 14% to $49.7 million and an interim dividend of $0.205, 11% up on first half '19 has been declared, and this will be 60% franked. Our cash flow followed a normal seasonal pattern with peak receivables and net debt at $53 million on December 31, 2019. Last overview point, our return on equity at 22.6% shows a continuing strong return on our organic growth investments. So all in all, a very first pleasing half, a very pleasing first half. Turning to Slide 4. We can see key segment performances. Here, you will see that our global segment revenue continued its double digit performance, delivering 24.3% growth or more importantly, 20.3% on a constant currency basis. All regions and all categories posted double-digit growth, supported by a healthy flow of NPD launches, including, amongst others, the global rollout of the Barista Pro, the launch of the Bluicer and the launch of our new microwave range in North America. Geographic expansion continued to boost our growth in Europe. And in New Zealand, in Canada and in the rest of the world, we benefited from a weak prior year comparator. Turning to our distribution segment, we grew even more strongly at nearly 30%, with good growth in ANZ, including the successful launch of the Breville Air range and ongoing Nespresso sales growth, including the virtual line in North America and ANZ. The changing segmental EBIT margins, reflects the ongoing and increasing investment in NPD marketing behind the global segment, which is partially funded by the growing profits of the distribution segment. EBIT margins were also impacted by the strength of the U.S. dollar, which boosts our sales via translation but is mitigated or hedged at a gross profit and EBIT level. This impacts the global product segments more than the distribution segment as does the net impact of increased tariffs in the U.S.A., which also impacted global product margins, especially, as I mentioned before, our countertop ovens. Turning to Slide 5 and the global segment by geographical split. Here in constant currency sales growth. In North America, in line with recent trends, the group achieved mid-teens growth. The U.S. benefited from a series of NPD launches across the half, with the team successfully delivering against the backdrop of tariff complexity and uncertainty. And in Canada, we returned to normal sales growth after a weaker 2019. In Europe, we delivered revenue growth of 60% through a combination of good performances across the whole region, in the U.K., in mainland Europe and with our Sage distributors. In ANZ, we delivered double-digit growth, with Australia, again, performing robustly, backed by solid NPD and New Zealand rebounding from a reset in 2019. Lastly, our small Rest of the World segment reverted to more normal growth levels in this half. As we compare and talk about regional growth rates and incremental sales dollars, it's important to note that our gross margin percentages are very similar across the key geographies. Meaning that sales growth in any region contributes equally to our gross profit growth. Thus as our growth engines continue to diversify, our portfolio's resilience increases. Turning to Slide 6 and the balance sheet. The group's peak investment in working capital seasonally occurs in December each year. In the 6 months, since the 30th of June, 2019, we saw an overall investment of $74 million into working capital. This was 15% lower than in the same 6-month period last year. Year-on-year, the gross total net working capital increased by $52 million or 25.2%, primarily driven by a sales increase at 25.4% as well as the tactical investments in inventory made in second half '19 and flagged in our full year '19 results. Inventory balances as at the 31st of December '19 were $175.2 million or $22.9 million or 15% higher than in June 2019. This increase was primarily driven in the U.S.A., will be bought in inventory in advance of the announced list 4B tariffs and bore the increased tariff costs on list 3 and List 4A. We also executed our normal stock build in advance of Chinese New Year, which this year, of course, fell in January. The group's December 31, 2019, inventory balances still include, as I mentioned above, the specific tactical holdings we built in second half '19 in the U.K. as a buffer against potential Brexit disruption, in Europe as we run an unconstrained stock position against a predictable demand curve -- unpredictable demand curve. Receivables seasonally peaked with sales and payables tracked year-end stock purchases. Year-on-year on a net basis, they're growing in line with the business growth. Turning to intangibles. Reported intangibles show an increase relating largely to the acquisition of ChefSteps in July 2019. Before this acquisition, our intangibles were growing well below revenue growth. The net increases before acquisition reflects our ongoing ramp-up of investment in new product development with capitalization of products occurring once we are confident of their commercialization. Our intangibles balance, also reflects our investment in our Global 2.0 IT platform, another key growth enabler. Turning to net debt. Our position of $52.9 million, represents our normal seasonal cash flow with peak seasonal sales yet to be collected. Net cash flow in the 6 months, since June 30, was broadly in line with the prior year. In terms of key ratios, the group continues to show solid returns on organic investments with ROE at 22.6% and with a short-term impact of our acquisition and tactical inventory builds showing through the reported ROE. Putting that all together and to conclude, before I pass to Jim, Breville has had a strong half, delivering 25% revenue growth, further geographic expansion, double-digit EBIT growth and solid returns on our investments. I will now hand over to Jim to provide some operational highlights of the first half and the outlook for H2.

Thank you, Martin, and good morning to everyone. Turning to Slide 7. Looking at our results in the first half of FY '20, the performance of North America, ANZ and Rest of world in the Global Product segment all fell within the historical performance patterns. Europe's Global Product segment growth of 60% and the Distribution segment's growth of 30%, however, may have been a bit higher than some expected. So I'll spend some time on both of these to give you a better understanding of the underlying drivers. Turning to Slide 8. In the first half of FY '20, we achieved an important milestone in the globalization of the company. Europe just passed ANZ to become the second largest geographic region in the global segment. Given the difference in relative size, it's no surprise that Europe would ascend to the second position, but it happened relatively quickly. The speed would -- the speed with which we achieved this as a testament to the level of effort and the quality of execution the team has put forth in our European entry. At a higher level, however, the importance of the milestone is geographic diversification. As we turn the knobs from year-to-year to drive a stable growth trajectory for Breville, we now have a growing ballast. If we ever experience a hiccup in ANZ, Rest of World or North America at the margin, the European region can behave as an offset to maintain the steady pattern for Breville as a whole. Turning to Slide 9. Europe versus ANZ, however, is not the only jostling around across the regions. In the coffee segment, the European team has set their sights on North America. Both North America and ANZ have a fairly diversified portfolio across beverage, cooking and food prep. Europe, however, given its use has had to pick it shot to build our initial brand position, and that has been coffee. Europe will diversify over time. But for now, it is weighted to the coffee category. At the end of the first half, North America held a comfortable lead in aggregate but Europe outsold North America on several coffee SKUs. It will be interesting to watch this internal competition play out over time. As a footnote, in prior reporting periods, I've shown a slide comparing German performance versus the U.K.'s historical performance. In the first half, our direct business on the mainland passed the U.K., which is another notch in the belt for the team members on the mainland. Turning to Slide 10. One highlight in the half was the deepening of our partnership with John Lewis, a strategic retailer for us in the U.K. Every year, John Lewis produces a Christmas story, which kicks off their ad campaign for the season. This year, John Lewis invited us to participate in the campaign along with Google, Microsoft, Dyson and LEGO. Admittedly, it's just an ad campaign but it is also evidence of the strength of the Sage brand in the U.K. Christmas advert, itself, has received over 10 million views on YouTube. To the right, you see the follow-on Sage specific ad in which the Dragon character makes a coffee with the Oracle Touch. The Oracle Touch was on display in the main window on Oxford Street and we were making coffees for John Lewis customers during the month of December and our Sage installation on the roof of the Oxford Street location. Turning to Slide 11. As previously mentioned, we entered Spain in September. We launched Sage with El Corte Ingles and Amazon, and we were able to execute a store-and-store installation in El Corte's flagship store in Madrid. In the second half, we will continue rolling out through additional retailers. Turning to Slide 12. Next up is France, and everything is on track for our market entry in the second half of this year. Closing on Europe, our to-do list for Europe is almost endless. But so far, we are happy with our execution, rate of penetration and run rate velocity. I'll now move onto the Distribution segment. Turn to Slide 14. To date, I haven't spent much time talking about the Distribution segment. That does not, however, mean we have not been busy. Over the last 4 years, we've been executing our all hands on deck turnaround strategy for the Distribution segment. The first component of this strategy was the reshaping of the brand portfolio. In FY '17, we dropped Philips and expanded the Nespresso machine partnership into North America. In FY '18, we added Dolce Gusto and acquired Aquaport. Slide 15. The second strategy component was the rejuvenation of our local Breville and Kambrook branded products. Looking at the Breville branded products, specifically in the last 3 years, we have added 21 new products to the portfolio. These products have accounted for over 30% of the revenue from the local Breville branded products over this 3-year period. Slide 16. We have continued this NPD cadence in FY '20 with the most significant project being the launch of Breville Air, which is a complete replacement for the Cli-Mate products we acquired with the Aquaport transaction. Breville Air is performing well, no doubt, in part driven by the breadth of the bushfires across Australia. We have executed a similar new product strategy with Kambrook, which is also performing well and growing the brand. In summary, the performance we have seen in the Distribution segment is a combination of reshuffling the brand portfolio and a concerted effort to bring new products into the Breville and Kambrook product lines. Slide 18. Looking forward to the second half, we expect our Global segment growth to remain healthy. In Europe, incremental growth will come from continued success in existing countries as well as our entry into France and channel expansion in Spain. We expect the Distribution segment to ease back to single-digit growth as it begins to comp its run rate in the second half of FY '19. Full disclosure, I've been calling single-digit growth in the Distribution segment for 2 halves now being wrong twice. But I figured if I just keep saying it, eventually, I'll be right. Our inventory should show a directional path toward equilibrium as we begin to flow Europe that we will be using very conservative inventory thresholds and sale through -- sell-through the tail effects of the tariffs in the U.S. While I don't expect us to fully achieve equilibrium at the end of the year, we should be within striking distance. And lastly, we expect the sell-in, sell-out pattern in the second half to resemble that of last year with the primary pattern driver being Amazon Prime Day in July. The upside here is, you should have a relatively clean comparison between FY '20 and FY '19 for analytic purposes. Slide 19. In addition, we have a backdrop in the second half of the coronavirus. I will assume a shared knowledge all that is written in the press regarding the current state of containment. With that context, I can give you a lens into the intersection of what is happening in China with Breville's business specifically. First, we do not have any manufacturing partners or part suppliers located in Wuhan. Our manufacturers are coming back online in stages, with some at the beginning of this week, most of them Monday next week and a few after that. All manufacturers are implementing the safety processes, as defined by the government to maintain a safe work environment. At a minimum, this means the post Chinese New Year ramp-up will happen more slowly than in prior years. For unrelated reasons, which we've covered since June, we actually sit in an inventory position above our normal equilibrium state. The Brexit insurance policy, Europe running unconstrained and the U.S. tail driven by our price increases post the tariffs. This additional inventory is a buffer in the system for a slower ramp-up. In addition, each year, we systemically buy forward a few weeks beyond Chinese New Year, most of which exist in our first half reported inventory number as a hedge against the slower ramp up for any reason. And lastly, the second half is the low part of the year. When coupled with our current inventory position, it means, as a general rule, our manufacturers have more flexibility in the rate at which they get back to a throughput level sufficient to cover incremental production needs for the rest of the second half. For those on the call who are not familiar with Breville, I thought I'd make the point that we do not have any demand risk in China because our sales into that country recorded in the Rest of World segment are immaterial. Slide 20. Concluding with our outlook for the year, it is clearly a dynamic environment, offering one surprise event after another. Assuming the economic conditions in our markets are relatively stable. We expect our EBIT for the full year, excluding the impact of AASB 16 to be consistent with current market consensus, which is approximately $110 million with an increased spend in marketing and R&D as a percent of net sales. I will now hand the discussion back to the moderator and open the call up for any questions you may have regarding our first half FY '20 results.

[Operator Instructions] Your first question comes from Philip Pepe of Blue Ocean Equities.

Firstly, very well done on a strong result, particularly in Australia and Europe. Just on the Europe growth, can you give us a bit more detail on how much of that was new regions versus NPD?

I can't because we don't track it that way. I think the thing to be careful about in Europe as we're going in, we've got, I don't know, about 120 products in total in the Global segment. I think we landed 60 of them in Europe. So for the Europeans, every SKU is new in a way. So it may be a product that's 3 years old but it's the first time it's been on the shelf in Europe. So because of that, the fact that we came out with the Bluicer or something like that, and that hit the shelves, they don't know the difference between a cattle they haven't seen before versus the Bluicer. So within that construct, all of the growth in kind of a way is NPD, with the exception of who we replaced. So we just don't track it that way.

But I think to add to what, Jim said, it's pleasing that the growth we saw was also strong in the U.K., was strong in the countries we've been in for a couple of years, like Germany and in the new territories. So it was good performance across the board.

Your next question comes from Apoorv Sehgal of UBS.

I guess my first question, just on your full year guidance. It implies a moderation in year-on-year EBIT growth in the second half. So I'm just wondering if there's any color you can provide around why you think growth should slow? And whether it's just to do with the timing of the new product launches?

It's actually -- I mean, Martin, you're better at it. It's actually how the expenses are rolled through the P&L.

Yes. It's more to do with the flow rate of our spend on NPD and the go to market, which we tend to ramp up in the second half of the year. So it's a smaller half versus the first half. And this year, we're calling higher marketing and NPD in the second half.

Right. Okay. And just on that point then, on the R&D and marketing as a percentage of sales. Should we be expecting you to hit the 12% target in FY '20 itself? And then once you've hit that, would you sort of stay there? Or would you be pushing that upwards of 12%?

So my guess right now is, I don't think we will hit 12%. And I say that because the weakening Aussie dollar really messes with this metric. And so our expenses are mostly in Australia. And because of that, I'll -- Martin and I will be evaluating the back half of the year, how to do it, which is I don't want to do something that doesn't make sense just because of the -- this metric and the weakening Aussie dollar. So we're looking more kind of constant currency as we look at this. And honestly, on the -- once I get to 12%, what happens for me, I'm just trying to get to 12%. And when we get there, I'll look at the year in front of us in our plan and whether we think it makes sense to continue to ramp that investment or ride the business model at 12%.

Okay. That makes sense. Final question, if I can, please. Just on your margins, can we get a feel for the extent the tariffs' impact of those margins? I mean, obviously, there's an FX impact there as well. But maybe just some color on how you've been managing the impact of those tariffs?

Sure. So as I tried to say in the presentation, the biggest impact, by far, was the exchange rate impact. So you'd probably say about 60%, 70% of the margin dilution came through that. And on the tariffs, I called out specifically that the 25% on the List 3 is the one that we had some challenges in absorbing. And so it probably took about 0.2% or 0.3% of the Group margin, specifically from that where we reacted with price. We cushion mainly with price but not able to absorb all of the cost input.

And then the other missing piece is just the remixing between the segments, between the Distribution segment and the Global segment.

Your next question comes from Ash Chandra of Goldman Sachs.

Just a couple of quick ones, if I could. Just on the European growth. So if I could ask that another way, is there any way to sort of give us an indication as to how much of the revenue growth you generated would have been sort of representing of repeat sell-through versus kind of first-time entry into, say, for example, Spain in the half?

Yes. Again, I just -- look, I just run it as one number. So I don't drive at that level. I think if I would -- if I characterize Europe as a whole, so you've got the U.K., it's really 3, I think of it as 3 pieces. So we've got the U.K., we've got our direct business on the mainland, and we've got our Sage distribution partners. So those are the 3 buckets of Europe in a way. U.K., obviously, nothing new about that. It's in its eighth or ninth year, I guess. The distribution partners, if you remember, back in FY '19, I said we were eating a headwind in '19 as we cut that -- those 4 distributors from Hong Kong to the Czech warehouse. So that there would be almost S&OP happening to us in a way where it was releasing working capital for them. So that means that they come into '20, they're writing a weak prior year comp, which was the headwind we ate in '19. And then on the mainland, I think, part of what you're seeing is that Germany and Austria, were sitting on top of a weak prior year because we had just entered the year before. So they had a weak year behind them. And then you had Benelux, Switzerland, and Spain having their first Christmas. So we'll -- I think in that way, we'll see if we then fast forward next year, we say, all right, well, Germany and Austria are going to have a solid prior year. We're kind of behind them but then Benelux, Switzerland and Spain and we'll have a weak prior year behind them. France will have its first Christmas. And then you go around again, right? They'll finally then get a real prior year behind them. So hopefully, that helps answer your question, how all of this phases through.

Okay. And then if I could just ask one more. Just on the finance costs coming through the P&L. That seems to have increased a reasonable amount in the period. And obviously, you've talked to the seasonality of your cash flows. But can I ask like, sort of, if kind of December is a seasonal spike in terms of the net debt position. Just to give us a sense as that through the period, how that balance is otherwise trended? What -- like is there any way, Martin, perhaps, you could answer. What your net debt/net cash position would be, let's say, March or September points in time?

Well, March is our best position in the year, Ash. In terms of the finance costs, just to trigger back to that first part of your question. What you're seeing in this half through there is some increase in bank interest costs because we have increased our net debt-to-finance working capital. But you're also seeing the impact of AASB 16 playing through there in terms of interest costs. And you'll see in the accounting for deferred consideration on our acquisitions flowing through there as well, yes? So I think when you break that down, the increase in the interest cost, if you're interested about 1/3 of what you're seeing in the total finance cost increase. Yes?

Yes. I guess, just even backing that out that was $2.7 million versus $1.5 million.

There is an increase in our net debt. We're, obviously, collecting our receivables now post Christmas. And we'll have a peak in about March of our net cash position in March. And then where we sit in June next summer report will really depend on how Prime Day in July plays out this year versus prior years. And I think we've flagged that before.

Your next question comes from John Hynd of Wilson Stockbroking and Advisory.

Jim and Martin, congratulations for such a strong result. I'm wondering if we could -- I know you don't like to talk to the EBITDA margins by region. But I guess, to help us understand and unpack the decline in the margins. Is it fair to say that much of the decline would have probably come out of North America, with the performances of Australia and Europe have achieved?

In terms of EBIT margins, did you say, John, I just didn't hear you?

EBITDA or EBIT, yes.