Breville Group Limited (BRG) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Breville Group Ltd. 2021 Half-Year Results Investor and Analyst Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Martin Nicholas, Group CFO. Please go ahead.

Thank you, and good morning, everyone. As said, I'm Martin Nicholas, Breville's Group CFO, and it's my pleasure to welcome you to our first half '21 results call. I'll start by walking you through the group's first half trading performance, and then Jim Clayton, our CEO, will provide an operational and strategic update as well as guidance for the balance of the year. Before turning to the specifics of the half, and we put this on the front page of our presentation, I'm going to start by noting that in the calendar year, running to December 31, 2020, the group achieved revenue of over $1 billion. Look, it's only a number, but an important number for us and a milestone in our growth agenda, especially when accompanied by accelerating profit growth. Now I'm going to turn to Slide 3 in the investor pack and the group summary results. And in summary, we are delighted with our first half results, delivering solid sales growth in all regions and all categories, which in turn has afforded us the opportunity to tactically step up our investment in medium-term growth drivers, while still maintaining and accelerating profit growth. Our overall sales growth of 28.8% was undoubtedly supported by the working from home and premiumization trends that we felt across the globe, but was also operationally facilitated by our decision to invest in inventory in May 2020, underpinned by our capital raise. Sales growth was strongest in our Global Product segment at over 34%. And this positive mix, along with lower promotional spend and a weaker U.S. dollar, more than offset the impact of increased freight costs, resulting in a gross margin increase of 1.1%. Whilst maintaining strong EBIT growth for this half of 29.6%, up from 15.6% in the prior period, we have tactically invested in the medium-term growth drivers of our digital marketing events, product development and IT capability. Our investment levels here can be maintained or reined in, depending on the sales trajectory experienced in our second half. We have also, you will note, increased our doubtful debt provision to reflect the seasonal peak in receivables. I'll say more on that later. Our other core operational costs were largely contained. The resulting overall EBIT margin grew slightly to 13.3%, and our NPAT dollars grew by 29.2%. In terms of cash flow, we ended the half with a seasonally abnormal strong cash position of positive net cash, $90.6 million. This was driven by working capital levels temporarily below equilibrium. Again, I'll say more on that later in this presentation. Our interim dividend of $0.13 per share, 100% franked, reflects the group's desire to self-fund future growth opportunities, both organic and inorganic, on a cash-neutral basis. And Jim will cover the target payout ratio in his section of his presentation. So finishing on Slide 3. In summary, the first half was a pleasing and growth-focused half for the group, both in terms of sales achieved and investments made. Now turning to Slide 4, and here, we see key segment performances. Our global segment revenue built on its already strong growth momentum to lift to 39% on a constant currency basis, with broad-based category growth I referred to, continued geographic expansion and our products proving more than relevant to the working-from-home reality, which effectively expanded our addressable market across all geographies. This 39% constant currency global segment growth, followed strong retailer sell-out performances across our markets, which we largely manage to chase and match, although this has, as you will see, meant that we've eaten into our normal inventory levels. Now across the globe, different geographies experienced very different and often erratic retail backdrops. But where access to physical retail was periodically restricted, our consumers successfully found us through our online channels and continued to show a preference for our premium offerings. In our Distribution segment, sales grew at 7.9%, with strong double-digit growth in the more premium Breville local offering, offset by lower growth in Kambrook and Nespresso. But most importantly, for the Distribution segment, it fulfilled its strategic role by delivering $15 million of EBIT, a 15% growth for reinvestment into the global segment. Well-controlled core OpEx outside of the investment I referred to in the medium-term growth drivers fueled this profit growth. Turning to Slide 5 now. In terms of the Global Product segment sales by geography, here, we see the $150 million growth or 39% constant currency growth split out by regions. As previously announced, the Global Product segment is now reported in 3 geographic theaters: the Americas, EMEA and APAC. And prior periods have been restated to facilitate comparison. All 3 regions delivered double-digit growth, with the group benefiting from sustained geographic expansion in Europe and, as I referred to, an addressable market expansion arising from the work-from-home phenomenon. Turning to these theaters. In the Americas, the group delivered 29.1% constant currency growth, bolstered by strong growth in B2C sales and online channels, generally, as the bricks-and-mortar retail environment continued to face disruption. Of note, the Baratza acquisition was also successfully completed in mid-first half '21. In EMEA, Europe, Middle East and Africa, despite ongoing retail disruption, the region performed well, with robust growth in the U.K. and strong growth in mainland Europe and in distributor-run markets. And Jim will talk about this more. France posted a solid first holiday season despite the complexities of launching during the COVID period. APAC achieved a very strong first half '21 growth, with demand boosted by working from home, the strength of the Breville brand and ongoing price realization. As you know, retail stayed largely accessible -- physical retail stayed largely accessible to consumers throughout the period. And the region was supported by nimble supply chain management to match this strong demand. Gross margins percentages remain similar across the 3 geographies. So looking at the size of sales by each theater, Breville's increasingly diversified global footprint provides us with stability in both sales and profit delivery in the face of individual market volatility. Of note, EMEA and APAC are now of a similar size. And together, they now match the Americas. Turning to Slide 6. Here we pictorially show, and I referred to it earlier, the reinvestment of our gains in gross profit while still delivering EBIT growth, accelerating EBIT growth. Sales were strong, and gross margins were boosted, as I said, by the tailwinds of mix, lower promotional activity and a trend for more premium products, which more than offset the headwind of increased transport and container costs. Gross profit dollars grew by $62 million or 33% in the half. However, with the objective of driving medium-term growth, a portion of this increased gross profit was reinvested. We have accelerated our spend on our go-to-market capability, specifically on our digital offense, on our new product development and our IT team and capability. Looking forward to future periods, this accelerated level of investment can either be expanded further or trimmed down depending on sales momentum. But for now, we're on course to meet our strategic goals of 12% of net sales per annum invested in go-to-market and NPD. Doubtful debt provisioning costs also increased in the half as our receivables balance grew in the peak season. Yet the appetite of our insurers to provide receivables cover remained very mixed, as did the financial position of our in-country retail partners. The percentage of our total receivables that are either insured, covered by our debt provision or do not require cover was held steady at 90%, the same position as we had at June '20. Outside of these priorities, core overheads and OpEx were well controlled, with some headcount increase invested to support growth. Having absorbed these tactical investments, our resulting EBIT growth nearly doubled, as I said, to 29.6%, up from 15.6% growth in first half '20. Turning to Slide 7 and the balance sheet. Here, we see the impact of the below-equilibrium working capital levels that we're experiencing and our investments in growth. Under normal conditions, the group structurally invested in working capital to drive growth, and we expect to see working capital peak in December in the first half. However, this year, despite 28.8% sales growth, December working capital was 21% below the prior year and approximately $95 million below what we regard as a normal equilibrium level. Inventory levels have been suppressed by continued strong demand, constraining our ability to rebuild normal cover levels. Receivables, in turn, have grown more slowly than sales as we have deliberately shortened terms to some customers. And also, the Christmas selling period began earlier in the year, meaning some receivables were already collected by the end of December. Meanwhile, payables have largely grown with the business. Collectively, this resulted in an abnormally low working capital, high cash flow and high net cash at December 31. This imbalance should unwind during the calendar year of 2021, but perhaps not by June 2021. Looking at intangibles, intangible assets of $237 million grew by $77 million on the prior comparable period, largely due to the acquisition of Baratza in October 2020. Excluding the IoT platform impairment that we spoke about in June 2020, internally developed intangibles are growing in line with recent trends as we continue to invest in NPD and our group IT platform. As mentioned at December 2020 -- 31st December 2020, the group had a net cash position of $90.6 million, which reflects the below-equilibrium working capital mentioned above and the net inflow of $42 million arising from the May 2020 capital raise less our acquisition of Baratza. Finally, the group's return on equity at 19.6% continues to show strong returns on the group's growth investments. And coming to a summary slide on Slide 8. I hope that the unpacking or the limited unpacking of our reported numbers there has been helpful in what I can only describe as a pleasing half. The key messages I'd like to take away from this half's results are that we saw both revenue and gross profit grow strongly in the half with a mixed swing towards the Global Product segment. Gross profits were tactically reinvested in areas to support medium-term growth, namely go-to-market, product development and IT. Outside of these priorities and alongside a consistent bad debt provisioning, other costs were largely contained. Our working capital and cash positions that we've spoken about, we do not regard as being at equilibrium and should correct in future periods. So those are the 4 key messages. And on that note, I'm going to pass over to Jim Clayton, our CEO, to provide you an operational and strategic update. Jim, over to you.

Thank you, Martin, and good morning to everyone. Let's see, I'm on Slide 9. I'll give you an update on our progress with the acceleration platform, highlight key considerations as we move through the second half and end with our current outlook for FY '21. On to Slide 10. Since last March, we've been navigating our way through an extremely dynamic environment. But the team has managed extremely well with the separation between the tactical and the strategic. Tactically, we've run daily supply allocation and credit verification processes for almost every order as demand has generally outstripped supply in each geography, and counterparty risks have differed by customer. At the same time, we've had to pivot operationally to address a spike in consumer orders from our websites, all this managed against the backdrop of U.S.-China tariffs, Brexit and COVID with physical retail shutting, opening and shutting again in several of our key markets. It would be reasonable to think that all of this disruption could have impacted the continued strategic development of the acceleration platform, but it has not. While the sales, operations and customer support teams were dealing with the daily challenges, the rest of the company was methodically executing our strategic projects. We went live in France while preparing for Mexico, Italy and Portugal. The NPD and go-to-market teams continue to push forward, with go-to-market focusing on the acceleration of our digital offense. We deployed our new corporate platform in the U.K., the U.S., Mexico and Hong Kong using Zoom and other collaboration tools to communicate and developed and took beanz.com live. We closed the acquisition of Baratza, and we executed an equity raise and lengthened our debt tenure to create the headroom to make all of this possible. It's external shocks such as COVID that truly test the robustness and resilience of your team, processes and platforms. Breville has been tested, and we passed, which bodes well for the next 5 to 10 years. On to Slide 11. We've been executing our acceleration program for quite some time, and I thought it might be helpful to visually see how things are changing. Here, I'm comparing the first half of FY '17 to the first half of FY '21. The success we're seeing in our global expansion efforts is resulting in a more diversified company. EMEA plus Asia Pac are now almost the same size as the Americas. If in the future, we face a localized challenge in any one region, the other 2 may be able to close the gap. Over this 4-year period, we've delivered a pretty solid clip of Global Product segment revenue growth at 21% CAGR. Both the Americas and Asia Pac delivered an 18% CAGR, while EMEA delivered a 39% CAGR across the 4 years. As we grow our existing markets and enter new ones, revenue and profit will continue to diversify geographically. On to Slide 12. In EMEA, France just went through its first holiday selling cycle and performed well. Our launch into France was particularly interesting because we did it during the COVID pandemic. But despite the challenges of COVID, we executed in-store build-outs like the one shown in Le Bon Marche, a premium retailer owned by LVMH; engaged with all premium retailers, both physical and online, delivering a solid geographic footprint, which you can see in the upper left of the slide; and executed master classes with leading third wave specialty coffee retailers and roasters. Given the challenges we faced, I'd grade the rollout in France as exceptional. On to Slide 13. Moving to the new markets, we are now live with our website in Mexico and Italy, and Portugal will soon follow. All 3 will go live with physical retail in March through April, selling through premium retailers as planned. Slide 14. We are almost complete with our rollout of the new corporate platform in the northern hemisphere. Europe, U.K., the U.S., Mexico and Hong Kong are live. All we're missing in the northern hemisphere is Italy and Portugal, which are going live in weeks, and Canada, which will follow. We will then move on to New Zealand and Australia. As mentioned in previous reporting, we have also taken the Middle East live with our website as our partners' content site for the region. I don't believe I can overstate the size and complexity of this project, given that it all must be done remotely, nor the importance of this project to the future growth of the company. The fact that our team is executing this program remotely against tight time lines is a testament to the quality of our team, as well as how comfortable we are working in distributed teams across time zones and geographies. The historical platform was an inhibitor to growth. The new platform will be an accelerator. On to Slide 15. Over the last 2 years, we have built in-house capability centers that have made this possible. When confronted with new technologies, many companies look to outside consultants to solve the problem. The digitization of our vertical, however, is simply a natural evolution that many verticals have already experienced. As such, we have chosen to build this as a core capability within the company itself. This will enable us to bring and support new capabilities to market much faster. We have already seen this with the Joule Oven Air and beanz.com, both 100% internally designed, developed and deployed. Our internal team will also be doing 100% of the corporate platform deployment for Italy and Portugal. When we are finished deploying the corporate platform, not only will we have a platform designed for speed, but we will have a team that knows how to get the most out of it. On to Slide 17. Looking at the second half, we see both opportunities and challenges. We expect demand for our products to remain healthy. However, we entered the second half with inventory tight across the globe. We are pulling all the levers we can to try to get in front of the demand line and repipeline our retail partners. It's too early to tell whether we will get this done by the end of the half or whether it will slip into FY '22, but we are committed to rebuilding the inventory to support future growth. Brexit finally happened and, no surprise, it has led to logistical challenges, complexities and delays. We intentionally built our inventory buffer in the U.K. going into January and believe we have enough inventory to cover the expected delays. Lastly, as we leave the first half on a solid financial position, we are focusing on FY '22 and FY '23. As such, we will continue to drive investment and spend into NPD, marketing and IT to put the acceleration platform in a strong position for the forward years. Slide 18. Before getting to the outlook, I'd like to give an update on a change to our dividend policy. Historically, our payout ratio has been 70% of EPS on an annual basis. With an increasing range of growth opportunities, geographic expansion, increased capital investments and tuck-in acquisitions ahead of us, we have chosen to change the target annual payout ratio to approximately 40% of EPS. We believe this will enable us to fund this growth on a cash-neutral basis. At this level of payout, the dividend can and will be 100% franked. Moving to the outlook. We have had a good first half. And although we will continue to invest in our medium-term growth drivers, we believe our EBIT for FY '21 will now come in somewhere around $136 million, which is an increase to the guidance we provided at the AGM of $128 million to $132 million. I'll now hand the discussion back to the moderator and open the call up for any questions you may have regarding our first half FY '21 results.

[Operator Instructions] Your first question comes from Apoorv Sehgal from UBS.

Congrats on a strong result. Just my one question then, it is on the FY '21 guidance. So that -- if I look at it, it implies a second half EBIT skew of about 30% versus 36% when looking each of the last 3 years and suggests about 3% EBIT growth year-on-year for that second half. I'm just wondering if there's an element of conservatism in that guidance? Or if you can provide us the building blocks of why momentum would potentially sort of slow in that second half. It looks a little bit conservative.

So let's maybe separate into 2 pieces, right? So there's one question, right, which is what does the top line do? And then the second question is, what's the EBIT going to do at the same time? That -- the EBIT question is a function of the level of investment we make in the second half for the acceleration platform for '22 and '23. So the guidance that we gave for the outlook assumes investment in the second half for '22 and '23.

Yes. And Jim, I'd just add to that. Apoorv, you remember last half, by [ 18 ] units, we had a number of normalization adjustments that we added to the accounts. If you look through those, the step-up is considerably more. We're not going to do that. We're going to report against the normalized half that we put forward as our underlying performance. And there, Jim is exactly right. It's about the spend, not so much around the sales trajectory.

Your next question comes from Callum Sinclair from Macquarie.

Martin, Jim, maybe just an extension to that, just around the supply chain. Have you seen anything around retailer restocking and maybe just the visibility that you've been able to give to your manufacturers, I guess, to keep up with the demand? And is there an assumption around sort of the timing of Amazon Prime Day, either in the second half or in the first half year of FY '22?

Look, the outlook, as we define it, is us trying to get -- catch up with demand, get in front of it and ultimately repipeline. So I mean we mentioned that we think that may -- that could slip into '22, and it's mostly because we don't know what the demand line is going to be specifically between now and then. So I think it's fair to say that our manufacturers are flat out, and we're all kind of pulling as hard as we can and as fast as we can. Amazon Prime Day, I would think, I would hope, for Amazon's sake, that it's going to happen this year. So that would be naturally kind of in the forecast of the second half, which again, Amazon Prime Day, at least historically, has happened at the end of July. I think Amazon is still having a little bit of struggle, depending on the geography because we're still going through hard lockdowns in some of the spots. But assuming that starts to settle out, maybe they can pull it off. If that happens, it then becomes a question of within any given geography, whether you're loading in the second half of this year or the first half of next year.

Your next question comes from Ash Chandra from Goldman Sachs.

Gentlemen, I know Baratza has only recently closed as an acquisition, but any comments you could sort of make about how easy that's been to kind of integrate into your global distribution channel and your thoughts on how that gradually scales into your broader global business?

Sure. My expectation is that it's going to be easy. And I say that we intentionally did not integrate them. So we acquired in October. They were having a similar experience that we were being behind the demand curve. So that's a bad time kind of on both sides to think about going through the integration process. We will be integrating them in the second half of this year, and that looks to be a really straightforward process because it's just kind of folding their SKUs into this corporate platform, and the rest of it takes care of itself. So within that model, I think it will be as simple as Aquaport or ChefSteps was. I think that the next step is they come with their own go-to-market, meaning what they've done over the last 20 years. And we'll need to go kind of theater by theater and evaluate with them what's the right way to go-to-market in that theater and then how do we leverage the infrastructure that Breville has in that theater, to either help their existing partners accelerate, like we've done with our partners in Europe and the Middle East or whether we step forward and just fold them in direct. I think the bit that's a little different about Baratza is that, as a general rule, Baratza doesn't sell into our channel. And I mean what I'm going to call the mass premium channel, the kind of Best Buys and Harvey Normans of the world. They sell into the specialty channel, which is coffee equipment retailers, roasters and so forth. While we, through Breville and Sage, have product in that channel, it hasn't been a core focus of ours. So in a sense, that's a bit of the pickup in the acquisition itself is to have a team that is really focused on that channel. So it's as much about thinking about how Baratza sits on top of the infrastructure of Breville globally as it is about how Breville folds into the Baratza go-to-market.

And Jim, I'll just add to that. It's not really a comment on integration, and it's relatively small acquisition. But in terms of performance, since it joined the Breville Group in October, it's been bang on line with what we expected. So we're very pleased with the performance, integration to come, as Jim says, now.

Got it. And can I ask just along the lines of further acquisitions? Your balance sheet is obviously pretty healthy, but you're also calling out that you're running at a lower level of inventory than you think is equilibrium. In that context, how do you think about the sort of gearing that your balance sheet can carry? Should there be another acquisition opportunity that you may wish to execute on?

Yes. So as we said on the working capital, it's -- I mean this is a judgment number, but we think we're running about $95 million below an equilibrium level. If you look at -- especially if you look at the inventory levels versus the growth in the business, that's -- they're tight. So certainly, we'd expect that to flow back in over the next half or 2 halves. And that is very much an investment in growth because, as you know, we've laid down, successfully laid down inventory pools across Europe and new territories that we go into. That would actually be covered by our current cash reserves. So that would almost take it back to 0. And then in terms of what leverage the Board would find acceptable from acquisition. I think they've proven themselves to have good judgment in this space, and we have debt facilities with very sensible covenants in place, which would allow us in the short term to gear up if the right acquisition came along and then pay down those leverage levels to something we're more comfortable with. I'm not giving an exact number, but giving you the feeling that we've got the flexibility to gear up in the short term if we wished and then pay that down as the acquisition performs.

Got it. And sorry, just one last follow-up along these lines. Given the buoyancy that consumers or consumer demand is delivering for your type of product, does it in any way, shape or form make prospective acquisitions harder to come by since expectations on price might be adjusting just in this environment?

Look, I think it's not necessarily that companies wouldn't be thinking about selling. I mean, obviously, valuation gets a little more interesting in kind of how you think about what value you would pay. And within that construct, I think there is a little bit of complexity in that conversation. But we closed Baratza in, whatever it was, October plus or minus, September, October. They were certainly in the height of COVID starting in March, if you want to call it that. So we've been able to negotiate at least one example of that. But it is definitely a part of the conversation of what's -- to both parties, can we get to agreement on what we think kind of long term sustainable is.

Your next question comes from Sam Haddad from Bell Potter.

My question also relates to guidance. Can you give more color in regards to the increased level of investment in the second half? Which areas of the business are you looking to increase investment? And at what point do we start to see EBIT grow in line -- more in line with top line growth? So where is that inflection point in the time horizon, given that you've also called out that you're approaching 12% of investment in product development and marketing as a percentage of sales. So I just wanted to understand those moving parts, please.

Good question. What I would say is, historically -- I mean, I think it's been a while since I looked. But I think, historically, we tended to have top line growing faster than EBIT. And I think this half, we reported EBIT growing in line with top line.

Slightly faster.

Yes, slightly faster. That's new for us. So look, from my perspective, if we were -- if FY '20 and FY '21 and '22 and '23 were just the normal cadence, I think I could give an answer to that question. But given how dynamic the environment is, I think it's a really hard time to call what does equilibrium look like and how does that work out over time. So right now, it feels much more tactical. I would say when I look at the first half, I'm happy -- I'm really happy with what we did back in April and May, where we did the equity raise and ran both an offense that assumed things went really well and a defense that assumed they didn't. That range, that aperture range allowed us to divert the top line that came out in the first half. And we continue to manage costs carefully and tightly. So I think we're going to be in this play it high, play it low aperture reality for a little while until we all feel like we can have any sense of real predictability to the future. And I think when we get on the other side of that, then I might be able to give an answer to the question. Now the other part of the question, which is, "Well, what are you investing in?" That one is pretty simple, which is we -- NPD is easy, right, because NPD has a kind of 3- to 4-year cycle. So it's not bothered, if you want to call it, by the vibrations. As we get to go-to-market and the corporate platform and so forth, we are investing in things that are not designed to affect FY '21. I guess the best way to describe it. So everything we're investing in is for '22 and '23. And I'd say when you're tight on inventory, the last thing you want to do is accelerate -- try to accelerate the top line with more marketing. So we're actually playing forward into '22 and '23, and there's a long list of stuff that we can do and are doing. So it's basically the goal that I set or the statement that I set back in April is that we're going through what I describe as a marathon. It's going to be a multiyear cycle, whatever it is, and we want to come out of that cycle with velocity. So on the strategic side of the business, we continue to play 1 year to 2 years ahead, and we'll keep doing that until we all collectively and globally get back to some sense of normal and predictable.

Okay. That's helpful. Just one further question on that. In some of the identified projects that you're invested in, will they roll into the first half of '22?

Some of them will if we turn them on. So it's back to potential, right? So if we come into the first half of '21 and we're behind the 8 ball, and we hadn't been able to get in front of demand and all that kind of stuff, I'm not turning them on, because for the same reason. But if we start to get in front and we can start to manage the top line, so to speak, because we've got enough inventory to play, then they're there to be turned on. So some of them are pointed at the first half of '22, if needed, or if we can use them. Others are second half and '23.