Coats Group plc (COA) Earnings Call Transcript & Summary

Hello. And welcome to the Coats trading update call. [Operator Instructions] And just to remind you, this conference call is being recorded. Today, I'm pleased to present Rajiv Sharma, CEO; and Simon Boddie, CFO; and Rob Mann, Head of Investor Relations. Rob, please go ahead with your meeting.

Great. Many thanks, Nat. I'm Rob Mann, Head of Investor Relations for Coats Group, and welcome to our scheduled May trading update. This provides an update of the first 4 months of the trading year as well as clearly an update on the COVID-19 situation. Rajiv Sharma, our CEO; and Simon Boddie, our CFO, will shortly take you through the key points of the update, and then we will open up the call for Q&A. And with that, let me pass on to Rajiv.

Thank you very much, Rob. Good morning, and welcome, everyone, to the call. Let me take you through the key points for the first 4 months of the year, and in particular, what has happened in relation to COVID-19 since we last updated the market at the end of March. By February, we were clear that COVID-19 was a very serious health risk and this was based on our experience in China. In early March, we accelerated our COVID-19 preventive measures across the entire Coats network. The speed and scale at which COVID-19 turned into a global pandemic affecting 184 countries was absolutely stunning. In an unprecedented response, over 100 countries went into some form of lockdown during the last 2 months. Under difficult circumstances, Coats and its employees have faced these challenges with determination, grit, confidence and humility. By mid-March, we started to see brands, retailers and manufacturers defer or cancel orders due to large-scale lockdowns in the West. As a result of that, the exit rate of March was significantly down and the impact on April was a sales decline of 50%, which was largely anticipated based on our customer interactions and their actions over the past 2 months. For the first 4 months of this year, group sales were down 17% year-on-year. Organic sales declined 21%, and there was a 4% contribution from the Pharr HP acquisition, which we completed in February. Apparel and Footwear declined 23% in the period due to large scale lockdowns in the West. Brands and retailers experienced lower demand in all categories during the month of April. Online sales in garments designed for home lifestyle did see a rise during this period. In April, our India and Bangladesh factories were shut down due to lockdowns, and this also had an impact on our April sales. Performance Materials has fared relatively better in the first 4 months with an organic sales decline of 12%, but an overall reported sales growth of 6% due to the Pharr HP acquisition. While still impacted by the virus situation, Telecoms and Personal Protection were strong performers whereas Transportation sales were impacted by the closure of many automotive factories. In our late March update, we had reported that 15 of our 50 factories were closed due to government-enforced lockdowns. During May, we have progressively seen factories open, and today, only 2 factories are subject to government-enforced lockdowns. In light of the anticipated temporary impact on demand and continued macro uncertainty, we continue to flex our supply chain to support customers while optimizing cost and cash. Let me flag a number of positives coming out of the current crisis. As you all know, Coats is a global market leader and a vital part of the supply chains we operate in. Our products literally hold things together. It also means we must continue to be responsible leaders, which we pride ourselves in at all times. On this front, we are providing threads to facilitate the accelerated production of millions of face masks and face coverings. We have launched Coats Fast Start, which supports manufacturers via digital means in their efforts to switch their facility to produce vital items of health care PPE. We're also seeing accelerated share gains coming out of this crisis. In times of uncertainty, customers migrate to quality, reliability, speed and trusted brands. Coats delivers all of these and more to current and future customers. I am confident that Coats will be a net winner coming out of this crisis. My confidence is based on our deep customer relationships, global footprint, strong leadership team and investments in digital innovation and ESG over the past 3 years. With that, let me pass over to Simon who will talk to you about the impact of management actions, balance sheet and liquidity. Simon, over to you.

Rajiv, thank you very much. And welcome, everyone, to the call. Good morning. As we mentioned back in March, we moved quickly to prudently underpin the group's strong funding and liquidity position that we entered 2020 with during this period of unusual uncertainty. We're pleased to say that our quick actions are having a significant effect already, and we project our Q2 like-for-like operating cost base to be around 40% lower than 2019 due to these management actions, and of course, because of lower operating levels, too. These management actions include flexing our manufacturing footprint to most efficiently run at lower levels of demand through our factory network, as Rajiv has already mentioned, and 20% reductions in pay for our Board, executive and nonoperational workforce. On the cash side, the other significant 70% reduction in 2020 CapEx we've already reported. We have now agreed with our U.K. pension trustees the deferral of our remaining 9 monthly deficit recovery contributions in 2020, which will provide us with a further $17 million of headroom this year. The catch-up with these is currently scheduled to commence in mid-2021 and will be evenly spread over the following 18 months. Our balance sheet remained strong. And as at the end of April, our net debt, excluding IFRS 16 leases, is $253 million. This is above the December '19 position due to the outflow from the purchase of Pharr HP and normal working capital outflows in Q1. At present, we have a healthy $235 million of headroom against our bank and U.S. private placement facilities, which is broadly in line with the $230 million that we noted in our last trading update. This shows that despite the demand and supply disruption caused by the virus in March and April, we're doing a good job of managing our facility headroom and associated liquidity at comfortable levels. We'll continue to manage our liquidity closely going forward to ensure we maintain the desirable financial flexibility to navigate ourselves through this uncertain position and have the optionality to enable us to thrive on the way out. Now with that, let me hand you back to Rajiv.

Thank you very much, Simon. Now let me quickly summarize for you. The impact in April was largely anticipated based on our knowledge of COVID-19, the lockdowns and discussions with customers. We entered this crisis with a strong balance sheet and a smaller SG&A cost base that was a result of the 2-year transformation program, which ended last year. Savings from the program have been and continue to be reinvested in digital innovation and sustainability. As a market leader with unrivaled global footprint and the ability to serve global customers quickly and with high-quality products, we are confident that when the demand levels return, we will emerge as a net winner from the crisis. As we also saw 10 years back in the global financial crisis, the strong got stronger, and that was the case with Coats. This story is going to repeat itself with Coats emerging a net winner after the crisis ends. And with this, let's open up the lines for Q&A.

[Operator Instructions] Our first question comes from the line of Charles Hall from Peel Hunt.

A couple of questions. Firstly, Rajiv, you talked about seeing accelerated share gains. Can you give some details on any additional business you've won? And secondly, on the donations to PPE, which you're obviously making at the moment and doing entirely the right thing, do you see this turning into a business opportunity in the medium term?

Okay. So let me start with the first part of your question here. I'll give you 2 examples around accelerated share gains. This is with a large automotive customer in Europe. We have been trying to gain entry with that customer for the last 40 years. And that was an account, which is 100% pretty much owned by one of our major competitors. During the last 3 months, we have managed to make inroads. We have proven the technical quality of the threads and we have guaranteed reliability of supply. With that -- sort of with these 2 factors, we were able to win a pretty big program with this European automotive company, and this is the first time that we're making inroads into this geography and this territory. Another example is in the last 3 months, there have been 8 -- sorry, 10 tenders in the automotive space in China. And of the 10, we have won 8. So again, it shows that even though there might be a structural decline in the transportation sector because car production is down and over the last 6, 7 weeks some of the car factories have been shut down, I think customers are going to be placing a premium on reliability of supply apart from just quality. So the fact that we have a global footprint, we're able to react quickly, clearly we have a very high-quality product and so customers are just accepting our offers as we kind of move along. And the reason why I give you these 2 examples is that we have found it very hard in the past to get our foot in the door in automotive in China and in Europe. So it's sort of strategic wins for us. With respect to the other question that you had around donations and PPE, I see this as something which could become bigger. If you look at it, we have a large Personal Protection business within our Performance Materials sector and that's largely focused on military, on industrial workwear and fast services. I can see that health care PPE has the potential of becoming something bigger. We are right now exploring that and seeing are the things we need to be doing either with respect to raw material procurement, with respect to machine changes, with respect to our commercial customer engagement so we can get deeper into the health care sector, not just in PPE, but also things in terms of textiles that are used within hospitals. So this is something that we're exploring, and we should be able to say something in the next 6 months.

Perfect. And just one other question. M&S were talking this morning about moving to more nearshoring. How do you see that the shift in supply chains occurring as a result of COVID-19? And do you see yourselves as having opportunities in that scenario?

So the answer to the last part of the question is YES. And this is really an acceleration of a trend, which has been going on for some time. So I can see global supply chains moving into regional supply chains. So you would have a European supply chain, which is consisting of an integrated set of vendors within the European theater. So Eastern Europe, North Africa serving Europe. And if you go to the U.S., you can have Mexico, Central America, Colombia, et cetera, feeding much more into the U.S. market. So absolutely, I do see regional supply chains coming up. I think what we are seeing right now in the last 3 months is customers are looking for resilience and reliability of supply chains. I think if you look at the Apparel and Footwear supply chain, which has been built over the last 40 years, and that's kind of the industry that I'm talking about, it has largely been built for volume and low cost. And I think going forward, we'll have to find a way to make it more reliable and resilient.

And the next question comes from the line of Charlie Mortimer from Citigroup.

So just a couple of questions. And I guess on the accelerated share gains, do you -- how do you see competitors positioning themselves during this? Is there -- has there been any impact on pricing? Do you see competitors visibly struggling yet? Or is it a bit too early to see some of those signs?

Okay. So let me talk about pricing first, and then I'll maybe give you a little bit of flavor of what we are seeing from a competitive landscape here. So in an environment where demand is down and oil prices are low, clearly, there is a pressure on pricing. Our history in the past has been that when raw material prices go up, we are pretty good at sort of passing on those increased costs to customers. And when the raw materials come down, we are pretty good at holding our prices. In this environment where oil prices are low and demand is low, what we have done is we have given some flexibility to both the commercial teams to actually balance out between getting more volume and creating that for maybe slightly more tactical price and price expressions. So the default position is still to hold on to price, but where we see opportunities to gain share or we see opportunities to go into a new customer account that we have not served in the past 4 or 5 years, we are giving the local teams a little bit of flexibility. But be under no illusion, there is significant pressure on price. And I think so far, we've done a good job holding the line overall. With respect to competition, again, it's very intense. As you would expect in a situation where overall demand comes down, everyone's fighting for a smaller slice of the pie. But the good news is that I think a lot of the desperation from our competition doesn't seem to be giving them wins because what's happening is customers are not just looking at lower price at this point there, they're looking for speed, they're looking for reliability of supply and they are looking at near-shoring, which clearly is an advantage for Coats. So yes, there are certain markets where it's very price competitive and we are doing all the usual sort of defensive measures to counter that. And we've been pretty successful. At the end of the day, Charlie, Coats is only 1% or 2% of the cost of the garment. So when you think of a brand or a garment factory, they are focusing on all the big cost levers and thread is not a big cost lever for them.

Yes. Understood. Just one other one, perhaps for Simon. The net debt, I think, went from $150 million to $250 million. And I think there was a Pharr acquisition of $37 million as well. So is the rest of that increase in net debt predominantly makes it very much a working capital moves? Or are there some other things in there?

Yes. Yes, Charlie, it is. So you're comparing December to the latest headroom we updated at the end of April. Yes. So there was nearly about $37 million, which was the cost of the Pharr acquisition, which went out in Q1. And then the balance is the normal working capital flows that we have in -- particularly in Q1, in the first part of the year. So that's what it is. What I'd also sort of draw your attention to is if you look at the headroom last trading update in March, and now that's basically flat in terms of it. So I think a huge amount of that was in terms of it, yes, so the increase, which is normal seasonality. But since then, actually, that headroom has been relatively stable.

And the next question comes from the line of Joe Spooner from HSBC.

Two questions, if I may. Firstly, can you just talk a little bit about what you're seeing around credit risks and how you're managing those at this point? And also, with all the action of being taken on the cost base, are there any exceptionals to come on the back of those?

Simon, do you want to take the credit risk one?

Yes, sure. Yes. So yes, look, we're very aware of the issue. Clearly, the scale and pace of the COVID crisis' hit has been very, very rapid and credit is certainly an issue out there. So we're very aligned to that issue. We've sort of doubled down in terms of our focus on that area. I think we've always been pretty strong, but we've done that. If you look at each of our markets, we've got basically teams within that. So that's the general manager, that's finance, the sales side, customer service working together to make sure that we are getting ourselves at the front of the queue in terms of getting paid. And that -- so first is to get the cash in. So big focus on that. We obviously have a fairly diversified customer base, which is good, about 40,000 customers, so that helps. And we're not a big component in terms of, Rajiv just pointed out, in terms of the component of the garment. So in terms of being the amount that is due, relatively small to Coats. But we are looking at the credit side in terms of that risk, particularly around new orders, but also existing ones there. If you went back to sort of bad debt, I mean that's typically -- it's only been around sort of $1 million in terms of that. If we went back to the global financial crisis, it spiked up to high single digits in terms of bad debt back then. So a relatively small proportion of sales, but we are acutely managing that and there certainly is overall pressure in the system.

And on exceptionals?

Yes. Do you want me to talk to that one, Rajiv? So on the exceptionals? Yes, no plans at the moment in terms of that. I mean, what we've done very much focused on is on cost and cash actions that you can see. And one of the things is that we've maintained our workforce during this Q2 period in terms of the eye of the storm in terms of COVID. So as I say, absolutely nothing at the moment. Obviously, as plans develop going forward, we'll update you. But nothing at present.

And just one more, if I may. I think you described April's performance as expected. When you think about how the rest of this year kind of trades out, is April the low point in terms of your expectations now that you've got, I think, pretty much all of the plants back up and running?

Yes. In terms of our scenario -- Rajiv, if you want to build on this, but in terms of our sort of -- we've got a number of scenarios. I think we talked about before the kind of the base scenario that we're referring to there. It's basically saying that Q2 was going to be a tough quarter, probably Q3 as well, but we were expecting some improvements in Q3 into Q4. So it's that trend basically that is only 1 month, it's April, but April was in line with that trend that I just referred to.

And the next question comes from the line of Anthony Plom from Berenberg.

Can you hear me okay?

Yes. Absolutely, Anthony.

Perfect. Actually, a lot of my questions have been answered. So maybe a couple of follow-up ones. So maybe firstly, could you mind maybe fleshing out a little bit more detail on how trading has been on the regional level? I don't know whether you want to go in that much detail at this stage. But also I suppose, linked to that, when some of those kind of 13 facilities started to reopen, trying to work out maybe what May looks like on a run rate? And then, again, follow-up on one of the other points in terms of liquidity. I think it was the March trading update you mentioned sort of stress testing at a 30% annual year-on-year sales decline, we still see enough liquidity. Based on how things have traded, and obviously, the cost actions you've taken, has your thought process there changed at all? Or presumably that is still the same?

Okay. Let me take the first one and then, Simon, you can take the second part of the question here. So with respect to a regional flavor of how we're seeing sales, clearly, China is almost back to normal from a supply standpoint. Factories are all up and running, shopping malls are open. Consumers are going out and buying. So I think China is probably the first market that's going to get back to pre-2019 -- sorry, pre-2020 levels. And it'll probably happen some time in Q3, Q4. Apart from that, we have generally seen the U.S. doing relatively all right because most of our factories are in North Carolina. North Carolina did not have a very long, protracted and very strict lockdown. So our factories in the U.S. were deemed as essential services. So we continued operating on that, and hence, sales, on a relative basis, seem to be okay. I think the same thing in Turkey. For example, Turkey, the factories continued supply for quite some time, sales were okay. Where we saw factory shutdowns due to government-enforced lockdowns, that's where we have seen the sales dip because all of a sudden everything comes to a grinding halt in that country for that period of time. So I think Asia, excluding China and Vietnam, was quite slow because of a lot of factory shutdowns, et cetera. Europe, with the exception of Turkey, was reasonably soft as we saw closures in Italy, in Spain. So -- and then in the North American theater, I think the U.S. was fine, but Mexico had shutdowns, Mexico, Honduras. So we saw some hits there. So it's sort of directly linked to where the factories opened or not.

Just -- I think the second question, Anthony, was around the stress test. So we -- I think we said back in March we've done a number of stress tests. Since then, we've kind of updated those with the new information. I think the thing that we referred to then was that we've done a stress test, which was with group sales declining by 30% for the full year, which is around 40% for the balance of the year after Q1 performance. So we've refreshed those. We do that regularly, take that through with the Board. I'd say in terms of -- in terms of -- I mean I think the main things that have happened since then is, obviously, we've firmed up a lot of those cost and cash actions that we talked about. So we have those in March, but we very much firmed those up, which is good. And then of course, obviously, we've -- since then, we've done the -- come to an agreement with the pension trustees around that net benefit of $17 million. So those are all -- so it's reassurance on the cost and cash and it's actually a bit more headroom in terms of the pension contributions, I would say, is the main update since those March stress tests.

And the next question comes from the line of Mark Fielding from RBC.

Couple of questions from me. One, just a follow-up in terms of the debt side. I mean, I think you're pretty clear in your earlier answer, but obviously when you talk about headrooms, there is some nuances around cash versus gross debt, et cetera. So when we think about the sort of debt thing, is it fair to think with the unchanged headroom that, therefore, we can broadly consider, for example, April to be running around the cash break-even level? And then my second question is in terms of the pension. Obviously, showing good relationship with the pension trustees today in terms of deferring those payments. But how do we think about things as you head into your next actuarial review, which will be set off 2021 because obviously, we have seen a meaningful shift in bond rates and things? And is there a risk that in the future we're going to see a very large jump? And I suppose where are the assumptions that were used to set the actuarial deficit versus -- which are generally more prudent versus the world we're in today?

Sure, Mark. Let me cover those off. So yes, headroom, you're absolutely right. Obviously, gross debt is what matters, not net debt, in terms of that. So it's the headroom between our gross debt and the committed facilities we have from the banks and the U.S. private placements over $575 million with maturities from '22 to '27. So that's the delta there. And you're right, it was pretty much flat. It was really a combination of 2 things. One is, yes, broadly a pretty neutral position in terms of cash in the month, but also a bit of repatriation of some of the cash from some of the overseas subsidiaries as well, which obviously helps in terms of that gross -- the gross debt. But that's what we said on managing in terms of -- there are a number of levers to manage the headroom, principally, obviously, operating cash flow. As far as the pension is concerned, just turning to that, what I would highlight there is that it is relatively highly hedged. So in terms of inflation, interest rate, over 80% hedged in terms of that. So I think that is a helpful situation. And also in terms of the asset base, we have less than 10% of the assets, which are in equity. So it's quite a defensive portfolio. So I think those things are helpful in terms of the movement on the pension deficit. It doesn't mean that it's immune to what's going on in the world in these circumstances, but I think we are in a relatively strong position. So just in terms of what happens next, I think the good news is that nothing happens to change the contributions other than the deal that we've done for quite some time. So the next triennial evaluation is at that March '21. But typically, that will take up to a year to kind of -- to negotiate and to see the change in, so if there is, in terms of those contributions. So it's going to be back end of '21 before I would say that any changes, if they were to come in, would come through in terms of that, which hopefully is helpful given the COVID uncertainty. We may be clear, hopefully clearer, in terms of where we're going at that point. So I think my key message is it's not today's issue, it's down the line, but also we are in a relatively strong position because of the hedging and the asset allocation.

And the next question comes from the line of Maggie Schooled from Stifle.

Over the past couple of years, you've done a lot of investment in technology, and I was curious how that investment has helped you through this period. And has this been one of the driving forces in you picking up incremental clients? And has it accelerated your clients' use of technology when they deal with you?

So the answer to all your sub-questions is yes, yes, yes. Let me start with a few points here. We have about 40,000 customers globally that we serve and half of them are really small that kind of engage with us largely on the online portal. And we use sort of credit cards to get early, early payments from them. So clearly technology there is helping us. The fact that 85% of our total orders are coming through our online proprietary e-commerce platform that we have allows us to stay connected and engaged with customers, and we can actually keep on sort of sending them messages services through that dedicated portal that we have. During the COVID crisis, we've had many, many people, roughly about 2,500, 3,000 people working from home. And the fact that we are 95% on the cloud gives us a lot of flexibility, low cost and a lot of control in how we manage our data. So our effectiveness in the last 8 weeks as an organization has not been impacted by 1% just because a lot of people were working from home or some of the factories were shut down. One interesting example I have here is SAP. And SAP go-live is usually a very big event in any company's sort of evolution. And it takes many, many people, sometimes hundreds of people, spending several weeks at site for an SAP go-live. We actually did a complete SAP go-live at Patrick Yarn, which is our facility in the U.S., and that was done completely remotely, online using our IT infrastructure, using CC cameras on site. And you were able to do a complete flawless execution of an SAP go-live with no one from the technology team on the ground. So it's clearly a big lever and it is ensuring that we are moving with speed, we have agility and we're able to collaborate not only internally, but also with our customers effectively.

Helping both credit risk and the sales.

Absolutely.

[Operator Instructions] Our next question comes from the line of James Zaremba from Barclays.

I have 2 questions, please. One, just on costs. Clearly, you've been able to decrease that quite a significant amount very quickly. It's very impressive. But I was just wondering in terms of whether you have a different outlook on the more longer-term cost base, having I suppose reduced things so quickly, whether there are any aspects which you previously thought were, I suppose, normal course of business but maybe you have a central -- having been able to remove them. And then the second one would just be comments on, I suppose, CapEx. You announced back in March the reduction there. Just a bit of talk about whether is there any catch-up in 2021. And if not, just I suppose why you've been able to reduce that.

Okay. So let me start with the second part of your question, CapEx. So essentially, what we're doing right now, James, is that we continue to invest in health and safety as part of our CapEx program and especially anything related to COVID-19 prevention that is getting funded. We continue to invest in innovation and digital. Apart from that, what we have done is we have clamped down on CapEx related to growth, related to productivity or any sort of incremental improvements across the estate. It's too early to be talking about 2021 CapEx at this stage. It will really depend on how sort of demand unfolds in the second half and what is our view of demand in 2021. So I think I would sort of refrain from giving any view of 2021 CapEx and if there's any catch -- sort of in a catch-up kind of going to require. The first part of your question, can you just remind me again, James, what was it?

It was about, I suppose, the costs, which you've obviously been able to reduce quite significantly in Q2 or at least forecasted, and whether I suppose there are any costs you take out which maybe a few months ago you thought you had to have but have been able to remove them, maybe you think you don't have to put so much back in when you go back to high levels of production?

Yes. So I think the cost base has come down over the past 2 years and that was part of our Connecting for Growth program where we resized our SG&A across the board. Again, whether our SG&A or our overall cost base is fit for purpose going forward is really going to depend on our forward view of demand. But I think one example that I can see is that given the fact that we have had about 2,500, 3,000 people working from home effectively over the past 6 to 8 weeks, we certainly start ask yourself the question, do we need so many offices across the world. So I think, over time, there may be some kind of rationalization that might happen of just the office space because we don't need so many offices. Depending on how demand unfolds, we may have to selectively invest in certain regions. We may have to take out capacity in some other regions. So it's a bit, again, premature. But the one assurance I want to give you is that we never stop looking at our cost and cash actions. Irrespective of the situation, we are constantly looking at: can we do things better, can we do things faster, can we do things with lower cost.

And we have one follow-up question from the line of Anthony Plom.

Yes. Sorry, just one other question. Do you mind maybe just talking a little bit about the inventory destocking risks. I guess presumably and probably through the worst of it in China at this point, but I'm just wondering how much that could be a drag on maybe the recovery in some of the other regions through the remainder of Q2 and Q3? And obviously, hopefully, you expect demand to pick back up, but I don't know that we aren't going to get a shock of some destocking coming through. Any color on that would be very useful.

Are you talking about the industry or about Coats?

Sorry, the industry more generally. I guess, from your customers' perspective. But equally if you want to talk about Coats, that would be useful as well.

Right. So I think, overall, yes, there is some inventory in the system. Again, it depends on, one, sort of brands. Some brands have got a lot of inventory stuck in the system. Some have got very little. Some of the strategies that we are seeing from brands is that they might actually go in for pretty heavy discounting over the next few months just to get over the spring/summer collection. So they create enough retail space for the fall/winter collection to come in. We've also seen some brands that are hiring warehousing space and they're going to be storing the inventory and bringing it back again next year. So that's happening with some brands. Broadly, I would say that different brands have got different strategies. I think for the -- for the next few months, clearly, there's going to be some inventory, which will have to be flushed out from the system. How it gets flushed out, I think, is sort of time will tell. And the implications of that inventory on 2021, again, it's a bit too premature, and we will have a view next towards in August, September this year.

And as there are no further questions, I will hand it back to you, Rob.

Great. Many thanks, Nat. Well, thank you, everyone, for joining the call today. If there are no further questions, we will close the call at this point. I wish everyone a very good day. Thanks again. Bye.

Thank you, everyone. Good day.

Thank you.

This now concludes the conference call. Thank you all for attending. You may now disconnect your lines.