DFS Furniture plc (DFS) Earnings Call Transcript & Summary

Ladies and gentlemen, hello, and welcome to the DFS Analyst Call. [Operator Instructions] Just to remind you, this conference call is being recorded. I will shortly be handing you over to the CEO, Tim Stacey; and Mike Schmidt, CFO, who will give a short introduction, before we open the line to question and answers. Now over to Tim on mic. Please go ahead.

Good morning, everyone. I'm not sure who's on the call, but nice to speak to you. Hopefully, you've had a chance to see the announcement. I'll just pull out a few key points from myself and then hand over to Mike and then leave more time for questions, really. I guess 3 key points from me. I guess point #1, obviously, you can see really strong trading, particularly since reopening of the showrooms in April. So staggered reopening, 5th of April, Scotland; 12th of April, England and Wales, et cetera. So over the last 10 weeks of our quarter 4, since that reopening order intake, 92.2% upon FY '19, which is the one, which is the most recent kind of clean comparative we have, driven by, yes, footfall, but, to a larger extent, conversion and average order value. We saw customers trading up, a lot of cash business as well. So very strong on reopening and ahead of our expectations, to be honest. I think during quarter 3, so lockdown 3, primarily where pretty much all of our stores were closed, the web performed really well, even compared to post lockdown, where lockdown 1, I think, we saw a big step up, over 200% up, during that period, which gave us some heavy level of resilience, I guess, in terms of order intake through that period of time. So overall, for half 2 so far, we're the 14% up in terms of order intake, despite the stores being closed for nearly 13 weeks of that period. So very strong. And I guess that, that leads to the second point. So the implications of that from a financial point of view, it has clearly underpinned our expectations for FY '21 in terms of profit of at least GBP 105 million. We have seen probably an accelerated deleveraging, that Mike will come on to that. And it's given us confidence now that we're in the sort of desired zone to declare us a final dividend or intent to declare a final dividend of 7.5p. So confirmed, obviously, if you've got the AGM. So that's good from an FY '21 point of view, but it also gives us a boost into FY '22, which is probably the most important thing. So we go into FY '22 with a relatively high order bank still. So to give you a sense of that, our average lead times are probably in the region of 12 to 14 weeks, depending on the country that the product is coming from. Even the U.K., you're looking at 9, 10 weeks. And China 13, 14. So the blended average would be double than normal. And so it gives us a boost into FY '22, which we've tried to give you a sense of what that could look like through the robots that Mike can talk you through. So that's the implications financially. I think the third point, from a strategy point of view, it gives us confidence to keep accelerating. So we are investing in Sofology store rollouts, so accelerating that. And we've got about 8 definitely confirmed for the next financial year, FY '22. We've opened 2 more recently as well, so really putting a foot down on Sofology openings. We're investing more in our digital offers. We're investing more in DFS store formats. By the end of FY '22, we'll have nearly 40 -- mid-40s of the DFS new store format, which is evidenced in places like Milton Keynes or mezzanine done at Glasgow. So we're investing there, and we continue to invest in our self-help programs around sofa delivery company, which is -- we've completed the consultation with all of our colleagues. We've moved to 7-day delivery as of the early May, as we are delivering on par from Sofology and DFS through our depots. So from a strategic point of view, it gives us that acceleration that boost into the next couple of years. Finally, I guess the key challenge now that I'm facing into or we're facing into is all about capacity. It's all about manufacturing capacity and supply chain capacity. So our factories across the world, our own factories and our partner factories are all pretty full. So gaining additional capacity to eat into the order bank is the key challenge. And at this moment in time, it's actively in play. I'm talking to lots of our existing partners and also new partners to try and increase our capacity so that we can eat into the order bank. But at this moment in time, we're pretty maxed out. You add to that the kind of container challenges in China where it's very difficult to get containers out of China, unless you've got a decent contract, which we do have, but we need more. So that's the challenge that we're working on. But overall, we're very pleased with where we're at. And then I'll hand over to Mike, who can take you through some of the financial implications a bit further.

Thanks, Tim. Good morning all. I'm going to make a few brief comments around this year's outturn, our scenarios for next year, our leverage position and also look forward for the above meaningful dividend. So I think just starting in terms of this year's performance. As Tim has touched on, we've seen very strong order intake indeed. We, of course, report revenues and profits upon deliveries to customers. And we call out that our revenue growth over the first 49 weeks relative to the 2019 financial year is around 10.4%, which reflects, if you do the math, is around a 6% growth rate in the second half to date. So that's a good performance, we feel, overall given that we knew some of our manufacturers would run out of orders to make in late March due to the lockdown. And since then, we've also faced into COVID disruption into factory production. The container shipping challenges, not least the Suez and, of course, raw material shortage has been widely reported across many industries. But we do expect that this level of revenues will be enough to support getting to at least GBP 105 million underlying PBT outcome for the financial year, which means that we're going to be slightly above the medium case that we presented in our guidance scenarios at our interims. Obviously, this guidance does remain subject to deliveries over the final 3 weeks. It does also mean, as Tim has touched on, that we will have a lot of resilience going into the 2022 financial year. We've sought to illustrate this resilience through 3 scenarios that we included in the release. In these scenarios... [Technical Difficulty] The high case scenario assumes, as Tim has touched on again, that we are able to scale up our manufacturing output further and start to convert more of the higher level of order intake and supports revenue growth of 19% relative to 2019 and generate profit before tax of GBP 96 million. We do feel very positive about the current trading environment in calendar year 2021 and our performance, but we also do recognize, given these scenarios, that there are 55 weeks to go in a hard-to-predict environment that we're going to be trading through over those 55 weeks. We also called out in the statement the revenue to profit bridge factors. But in simple terms, we do see the risk of inflation affecting our product margins given the pressure on manufacturing capacity and raw materials prices and also our operating cost base factors and property rates resuming, showroom operating costs for new Sofology locations and also some ongoing investment in our announced strategic areas. So finally, just moving on to the balance sheet and dividends, a couple of key points. Firstly, the strength of profits has generated robust operating cash flow. And so we expect our underlying leverage will be in the 0.5 to 1x range of cash EBITDA that we previously talked about. Secondly, though, we continue to benefit from a significantly elevated level of customer deposits, which will be over GBP 50 million higher year-on-year and which we expect will normalize in the year -- in the next financial year. So together, this means, on an as-reported basis, there will be a small level of net debt reported at the end of the financial year, excluding the leases in the business. Finally, just looking at dividends. We previously talked about how we recognize their importance to investors, and we wanted certainty on outlook and leverage before we started to resume payments. We stated here in the announcement that we think we have that certainty. And so we expect to recommend the final dividend of 7.5p per share in September with our normal policy as disclosed previously continuing on from them. So all in all, a very positive outturn compared to our interim update in March with a strong result in 2021 expected and some great momentum going into next year. That's all I was going to say at this stage. I believe the plan is now to have some analyst Q&A.

[Operator Instructions] The first question is from Andy Wade from Jefferies.

Well done. Just 2 questions from me. The first one on the supply side. Just really a bit of color on how likely is that you're going to be able to ramp up that capacity in line with that higher scenario, particularly given the sort of issues with containers? And if you are able to, where is that likely to come from? And then a sort of linked question to that, this is sort of 1b, if you like, rather than question 2. Is there a possibility that orders fall away a little bit if lead time is extended too far? So that's sort of question 1.

Yes. Andy, I think on the -- to give you some color on the supply side. So I think largely, we've got U.K. is about 45%, 50% of our orders, and they are -- and that's completely full. So there's very little spare capacity and very hard to increase in the short term. We are investing in our own factories, but that's not really going to come on stream in terms of additional capacity until probably even the end of this financial year, so not in terms of FY '22. So that's not going to happen. And I think some of our other partners are also investing in additional space, but the actual challenge there is recruiting the skilled upholsterers and see interests to actually manufacture the product. So I think the U.K. is going to be a challenge to get material amounts more out. Europe, where primarily is Poland and Italy, Italy is full as well. Poland has a bit more flexibility, but not huge amounts. So the -- what that leaves you with is Far East, which is actually, from a production capacity point of view, we're working with some of the bigger suppliers in the world. They have the production capacity, but what we don't have is the containers without paying punitive spot rates of, I think, the latest rates this week in the region of $10,000 a container, which would pretty much wipe out any profit we make. So we have a forward contract with all of the big lines. People like Maersk and Evergreen, et cetera, which guarantees us several hundreds of containers a week, all of which are full. So our barrier there, our bottleneck there is about securing containers. And at this moment in time, everything I'm hearing, obviously, we're talking to all the shipping lines all the time, it's going to be hard to secure additional containers until at least the autumn. So at least, and it is maybe into next calendar year. So I think production capacity availability is more China and -- but the challenge is containers. So that's why we -- the medium scenario kind of tops out at the sort of GBP 22 million, GBP 23 million delivered revenue a week. which is a step-up from what we've delivered in FY '21. And that's going, so that's flat out. And assuming no significant disruption from COVID again in different countries. So that's the kind of the reason why we're sort of being slightly cautious. Just practically, that's a huge challenge at this moment in time worldwide. I think, from the lead times, it's all relative, isn't it? Because everybody's got the same problem. Most of our competitors are in the same boat. So -- but what we're finding is, just by looking at the conversion stats, if the customers want that product, they are prepared to wait. The key for customers is to underpromise and overdeliver on lead times. So we're quite prudent with our lead times given some of the disruptions still that you see, the backlog from series, et cetera. So -- but I don't think we're missing much business on the back of it. But they just aren't alternatives out there to go and buy huge amounts from stock. There's a small amount of stock, which is out there, which is very immaterial in the grand scheme of the market. So I don't think we're missing out, Andy. We're working hard to try and figure out if we can remix some of the offers to, for example, the French Connection Zinc from our own factories, put that on 6 weeks lead time and have that fast track through. So we are trying to cater for those who want it a little bit quicker. But I don't think there'll be a material miss from having the lead times that we have.

Great. And then my second question, it's really sort of around the integrated retail model versus pure play. I mean if you look at that sort of Q4 to date, 92% growth in order intake, that really implies that there's pent-up demand there. That customers aren't just wanting to buy online, that the store is important in this category. And that seems to be an obvious learn, but I'm just interested as to what else you've learned over the last year about your integrated retail model versus your pure-play advantage or disadvantage, that sort of thing.

Yes. I mean we talked about this a lot in terms of -- we genuinely believe in this particular category, so upholstery specifically, that the -- it's a tactile product and the sit test is super important. And we've seen that every time that we've come out of a lockdown, the flood of customers coming in to have that sit test. They're much more well researched. They know what they want. So having a strong website with great content, enabling people to feel confident about what they're interested in, we clearly need to do. We've been doing that for a long time. But in the end, nearly 90% of transactions in this category are influenced by a visit to a showroom and sit on the product and having a conversation with a sales colleague to help you really understand what's right for you. And I think -- it's interesting, our overall online penetration pre-COVID was probably running at low 20s, 21%, 22%. It will take some time to settle back down. But in this last quarter, it's been running at 19%. So there is this desire from customers to come in and spend time with human beings. And they're spending a good long time in stores having those conversations and sitting on the product. And we fundamentally believe that, that is the right business model for this category. When you talk about broader furniture, we are seeing some good early success on beds online, which is something that we're interested in, but that's more of the medium-, long-term play. So I think broader furniture categories can absolutely be served by the online channel as well, but we think Sofology has just got some unique characteristics that make the integrated model the one for this market.

The next question is from Jonathan Pritchard from Peel Hunt.

Two for me. Firstly, just could you perhaps develop your early comments on conversion on trading at what range is it doing particularly well. And cash versus IFC, I think that's probably sorted around a little bit. And then secondly, on inflation. What's your view there? Do you think you could pass some of that on to consumers? If they're trading up, perhaps they would tolerate a little bit of price increase potentially?

Yes. That's a good question. So I think from a trading point of view, as I just mentioned earlier, when the customers are coming in, in quarter 4, once we've reopened, they were very well researched. So they were coming in with a high level of intent to buy and knew which models they wanted to sit on. So I think the conversion -- because people have been sat at home for, was it 13, 14 weeks of lockdown 3, it was super high for April, May. It's coming back down, but it's still up significantly year on -- 2 years in terms of FY '19. So of course, I'd love to say that all our sales colleagues are amazing and they can convert all the time, but I think there's a real consumer intent there to buy. And they were trading up. So particularly, DFS, where we've introduced some new ranges actually during lockdown 3, grand designs has started incredibly well. The Halo Luxe range, which is the top 10 leather range, is doing well. All of our exclusive brands, Joules in particular, really flying triple-digit growth at Joules. So customers really sort of just spending that a bit more on their home, which is that trend that we've talked about. I think what we've also seen, which we didn't expect, maybe we should have in hindsight, is a lot more cash business. So people transacting, just buying in cash and not using the IFC. So certainly, when we reopened, it was probably 2/3, 1/3 or 60-40 cash to IFC, which is the opposite way around from normal trading. It's probably settled down to more like 50-50, which is still high, and that leads to the inflated cash customer deposits and cash that we're holding while we're waiting to make those orders at the year-end, as Mike has alluded to, but it also reduces our interest-free credit cost, which goes into margin, which is a positive. So I suspect it might settle back down. But given the amount of savings that consumers seem to have accumulated or certain consumer types have accumulated, it may not do for the rest of this calendar year, Jonathan. [Technical Difficulty] We're putting price points slightly higher to cover what we anticipate might happen in the next sort of 12, 18 months. But there's definitely a trend of upwards on cost of goods inflation. The rest of inflation, Mike, I don't think we see much more than a couple of percent on goods not for resale.

Yes, I think that's right, Tim. I mean, I think there's a few for standout categories. Things like insurance are spiking upwards. But likewise, offsetting that, things like media rates inflation are relatively low compared to historical levels, clearly.

The next question is from George Pilakoutas from Numis.

Three for me, if that's okay. The first one is just kind of understanding the kind of the high scenario for FY '22 and I guess what is -- how we should think of the drop-through, where demand to kind of continue to be very strong and kind of, I guess, particularly to the second half. Is there any reason -- it is literally about the ceiling? And unless you get additional capacity, you are not able to deliver additional sales this year? Or that's kind of more assuming this current peak demand period and then we see a normalization if the high demand continued throughout, let's say, towards the end of this year, you would be able to kind of see higher revenue and profit number come through? The second one is just kind of progress on some of kind of behaving upholstery if there's anything kind of you wanted to particularly flag there in terms of progress? And then on upholstery, just any thoughts around kind of the Tempur Sealy, Dreams acquisition, if that kind of changes your thoughts, makes you more excited, less excited about entering that category? And then the third one is just, I mean, the net cash position. It kind of looks to be now well within your range. If you could just kind of remind us on kind of your capital allocation policy given kind of the excess cash that is coming through? Which areas could you potentially look to invest in? I guess you've spoken about manufacturing capacity and potentially accelerating some of those Sofology stores, but there's only so much you can throw in that direction? So what's kind of next pop down the line be a kind of special dividend or buyback?

Yes. That's good. Mike, do you want to answer question 1 around the scenarios and the high scenarios and what the limiting factors might be in there?

Yes, yes. So I mean, thank you, George. I mean, I think the medium scenario that we talk about is broadly based on the full utilization of our existing manufacturing capacity. And I think, again, just to emphasize, that's about 17% higher manufacturing output than we saw in 2019. So it's a step-up there. And so clearly, high case or anything beyond the high case would require additional capacity to be secured. And I think Tim's touched on some of the constraints and the challenges around that. I think, clearly, we'll update on that in due course. But at this stage, I don't think there's anything further that we would say in terms of where that could get to. I think the consequence of that is that really -- that's become the primary constraint in terms of top-end performance for next year, with order intake being sort of the secondary factor alongside it.

Yes. And I think, Mike, to add to that, George, is that, if we can increase and step-change our manufacturing capacity and order intake continues at high levels, then all that will happen is we will struggle to get our order bank down at the end of FY '22, so it will flow into '23. So if, however, order intake, which is backwards, due to a resumption of spending on travel, et cetera, then we can eat into the order bank and deliver the medium case because we'll have the orders there. And therefore, the order bank might start to normalize towards the end of FY '22. But everything we're seeing at the moment, certainly, calendar year '21 should be a strong order intake year. Calendar year '22, it's obviously more difficult to predict. But I think that's the kind of -- hopefully, that gives you an answer to that one. On question 2 and progress on home -- and I think you mentioned about Dreams acquisition. So we're making good progress on home. It will take some time. It's probably more of a medium-term thing. But we're increasing -- our primary focus is upholstered beds and mattresses. We're developing our range there. We're just launching a French Connection Zinc Bed, for example. We've launched the French Connection Camden bed and some dual beds and they're doing very well, online growing triple digits. And that's our primary focus. A lot of work going into the website over the next few months to improve the navigation and make them -- make it more applicable to the bed market. So we're investing more in digital marketing and imagery and content. So that's our primary focus. And in the background, we're also investing in our stock fulfillment system working with the Dwell team so that we can deliver on home accessories, so coffee tables, lamp tables, mirrors, et cetera. That's more -- that starts to really land next calendar year. So beds is the primary focus. I think that when you look at things like Dreams or other categories there, I think our -- we've always got an eye on those things, but it's not our intent at the moment. We think that we can do things organically quite well with the partnerships we have with Silent Night, for example, on mattresses. They are really good partner for us and develop our own unique ranges through our -- through use of the designs that we already have. So I don't think acquisitions in the bed market is something that's on the agenda at the moment, but we're always keen and observing, seeing what's happening.

Can I just follow up on that, Tim?

Yes.

I guess just Tempur Sealy, Dreams, I don't kind of know how much proportion of Dreams is part -- it was Tempur Sealy previously, but I might expect that to kind of pick up. Do you see that kind of opening opportunities with some of the other brand partners there for? Or do you think they will kind of continue working with the kind of range of manufacturers? And so base case then, does it really change the industry landscape?

Yes. Difficult for me to comment, George, on that. I think what we found is a good few partners who are really keen to work with us because they can see that we can grow and we can grow and work in a sort of strong partnership way with them. So Silent Night being one example, but there are another few sort of mattress -- branded mattress players who we're talking to in commercially sense at the moment who are really keen to join in with the growth plans that we have. So I don't think it might change a little bit more in our favor, but yet to see that come to fruition. Mike, do you want to talk about the net cash position and capital allocation policy?

Yes, absolutely. So I mean, I think as we've talked about previously, we are focused as a business on having a resilience with efficient capital structure. We've defined that to be operating with estimated bank net debt in the 0.5 to 1x cash EBITDA range. And I think what we are saying today is that we think at the end of this financial year will be sort of on an underlying basis, excluding the one-off working capital benefits, we think we'll be sort of within that range. Looking forward, clearly, if we generate the level of profits subject to generating the level of profits that we're looking at here, we do believe we'll be strongly cash-generative. And I think the first priority is as always will be investment in the business. And secondly, though, we will look if there is -- if there are other opportunities to invest in that -- generate the required rates of capital return, we will look at those. But I think the areas -- the 2 areas that we've pointed to as being in addition to our strategic plan, being around the manufacturing investments that we're making and also around the bed area. I think we sort of define the capital requirements. And I think manufacturing does require some capital investment, but it's relatively limited over a number of years. Likewise, the beds, at the moment, it's sort of an online proposition that is on a stockless basis. So I think there's some constrained capital requirements there. And I think that will mean that there will be a choice at some point in the future, subject to delivery of performance as to what we do. But certainly, I think it will be a good choice to have, and it won't be a choice that -- it's coming as is too imminently, you're looking at least 12.5%. Aren't you?

Thank you. There are no further questions. So I'll hand back to Tim for closing comments.

Yes. Well, anyway, have a good day. Hopefully, if there are any further questions, Phil is around today. And yes, we're obviously pleased with where we're at and in a good position going forward. So we'll keep you posted next time. But update will be in September, Mike, at the full year. So have a good summer, and let's hope England win the Euros. Anything else to add, Mike?

That's right. Thanks very much all.

Thank you.

This now concludes today's call. Thank you all for joining. You may now disconnect your lines.