DFS Furniture plc (DFS) Earnings Call Transcript & Summary

Wow. Morning, everyone. Good morning.

Good morning.

The last time I did this last week in a practice with our team. Everyone went morning, back in a big cheer. Makes you feel really welcome. Anyway. So we're just going to start. Before -- we're going to start the Capital Markets event at 11, but what we thought we'd do now is just do Q&A from the interims this morning, if that's okay. So hopefully you've had a chance to see the results presentation this morning. You've come fully armed with questions. I'm very happy to try and answer anything. We have a roving mic available, I think a couple of them, Camilla , and over there. So we've got about 20-odd minutes if you want to go through -- and we really want to focus on the interims rather than the future stuff that we're going to talk about from 11:00 if that's okay. So Jonathan? Camilla .

Just a little bit of color perhaps on current trading, please. It seems as though you've come out of Christmas quite nicely. You talked about inflation, passing that on and some decent volume upticks as well, which isn't always a combination you see. So perhaps a little bit of color on that. Is that footfall better than you thought? Is it conversion? What's going on there? And then secondly, just on the Netherlands. With the benefit of perfect hindsight, what would you have done differently? And not go there is actually an acceptable answer.

Yes. So current trading has been encouraging since -- so we knew that there's some cost prices coming through towards double digits that would hit us around December, January. So we knew that was coming. And the second thing we knew was coming was the freight rates from China. So we negotiate for the calendar year so we knew that would hit us in calendar year '22. So we factored that into our pricing for both DFS and Sofology. So as we opened up on Boxing Day, we've put the prices up probably double digits on average. We try to be smart about it in terms of where we apply those pricing increases and not just across the board, try and keep the key prices very keen from a sale point of view, but then blended overall about probably about 10% up across both brands. We went into winter sale ready to go. Obviously, there's a little bit of COVID disruption around absence, et cetera. But I think what's been pleasing, it hasn't been footfall particularly that's held up. It's been more about conversion and average order value. So you'd expect the average order value to increase by double digits, 10%, 15%, because of the price increases. But the thing that's been very encouraging is the volume increase, and the volume has been double digit across both brands, Sofology and DFS, which for us has been a real positive. Because obviously, you expect with a price increase potential volume drop. And that sustained probably for the last, what are we now, 11 weeks post-Christmas. So we've seen double digit on average order value, double digit on volume driven by conversion. You'll see today a huge amount of work has gone into getting our profiling of our colleagues in store, right? So we've got 40-odd percent part-time mix in both DFS and Sofology. So when the customers do come in, there's -- the colleagues are there to see them. So that's really driven conversion. So that's been a key point. And the websites continue to be very, very strong, so 20-odd percent up across both brands. So current trading is strong. We haven't really seen a dip off yet. Difficult to predict going forward what happens with the macro economy, but very strong in terms of current trading. I think on the Netherlands, what am I not allowed to say? Perfect hindsight, we wouldn't have gone there. No. So I think the Netherlands, to be fair, we've had a number of things that's positive in the Netherlands, whether that be Brexit, whether that be COVID. Each store, we have 6 stores there, has positively contributed a bit, but not enough to sort of sustain the kind of marketing overheads and the overheads that we have in there. We can see a route to profitability, but it probably means opening another 10, 15 stores. And when we stood back and looked at the strategic work in the autumn and we look at our opportunities from a return on capital point of view, investing in home, investing in DFS formats, which again, you'll see the returns on that, investing in new Sofology stores just clearly from a cash point of view, returns point of view, wins. And secondly, the intellectual capital, the time spent to try and drive the Netherlands versus other things, you have to make choices. And I think we're trying to be very disciplined with our approach from a return on capital point of view. We've tried lots of things in the Netherlands. We've changed the range. We've changed the colleagues. We've changed advertising, et cetera. But it's a really hard market. If you've ever been to the Netherlands, it's a very tough market in terms of competition. So I think it's the right thing to do to try and focus now from a U.K. point of view. Mike ?

I got 2, please. So firstly, the FY '23 targets based on a flat overall market. I wondered if you could give a bit of color on your latest view of the puzzle. And the second one -- and apologies if this is sort of drifting into sort of later sort of CMD talk. But the home categories, I think you flagged GBP 95 million of incremental revenues with GBP 16 million of PBT. I wondered if you could talk a bit through that profit breakdown. The drop-through is a little lower than the 40% that we've previously spoken about.

Yes. So Mike, do you want to give a color on '23?

Yes. I mean I think, look, we recognize the macro environment looking out to '23 is going to be hard for us to call at this stage. And I think our -- what we're not trying to do is second guess and produce a crystal ball to look that far ahead. I think what we're really trying to do and trying to demonstrate here is the resilience in the order bank model that we operate with. And so the strength of the trading that we've seen across the second half to date and the size of the order bank that we operate with today gives us that confidence that there'll be sort of a meaningful offset going into 2023 -- or upside going into 2023. So our starting point for 2023 really goes back to the scale of the business underlying that we see today. So it's GBP 1.15 billion of revenues. We see a 7% PBT base margin within the underlying business, and we're pointing to that 2023 roll-forward upside being relative to the underlying level.

I think it's -- can we come back to you on the home piece this afternoon? There's a huge amount on home, which hopefully you can -- Ben and Nick are doing this session this afternoon. We're having a breakout session on it, and we'll go through that a bit more in detail in there, Mike . Okay. Andy?

Andy Wade from Jefferies. Just a quick question about the GBP 21 million of one-off costs, which you flagged during the first half. How should we be thinking about that as we go into next year? Are they going to reverse out, provide a GBP 21 million boost to profitability? Have they been absorbed in terms of sort of an inflation pricing piece, where they'll sort of fall out through that? How should we be thinking about that GBP 21 million?

Yes. Okay. So I mean the GBP 21 million breaks down in terms of gross margin and operating costs. GBP 9 million in gross margin, $12 million in operating costs. Looking at the gross margin piece, in particular, that relates to inbound shipping costs that weren't sort of anticipated, weren't built into our pricing structure. And in particular, it relates to having to store goods dockside in the U.K. and then flow them through an unreliable sort of HGV network into sort of the warehouses that were very, very busy in the half. So given the work we've done on our logistics network, in particular adding in sort of 3 super large warehouses into the operation, I think we're expecting to see that inbound -- additional inbound costs that we've been absorbing effectively largely sort of going away there, Andy. I think on the operating cost side, GBP 12 million, that largely relates to COVID absences in our supply chain operation, which have been running at about the 10% level versus maybe more typically, we'd sort of see around a 3%, 3.5% number in terms of absences in supply chain. And that is the cost of having to fulfill order deliveries through delivery partners. So clearly, our future expectations in that is somewhat dependent on what future COVID absence levels will be. But clearly, as we move past that being compulsory isolation periods for COVID, which is where we are in England, and we're seeing sort of shorter isolation periods, that has materially reduced absence levels. So at the moment, on the operating cost side, we're not completely through seeing disruption coming through in our numbers. But certainly, as we think about 2023, we're not expecting those costs to continue recurring.

George from Numis. First one, can you just clarify the current trading comment? The double-digit volume, is that on a 1-year basis or on a 2-year basis?

2-year basis.

2-year basis.

Yes, so pre-pandemic comparator.

Yes, perfect. And then you've put a double-digit price increase through already. I guess what's your outlook on the rest of the year with kind of utility builds going up, et cetera? How much more do your current estimates appreciate? It's a bit of a moving target I think you might need to put through.

Yes. So I think I'll answer it at a strategic level, and then I think maybe we can talk about how we see some of the component parts of inflation because that's a key challenge. I think what we found -- and as the market leader, I think what we've got now is confidence about increasing our retail prices, passing them through to customers in order to protect the cash profit per transaction. So looking ahead, some of the broader inflationary pressures that Mike can break down, I think we'll be confident to try and get ahead of the game and probably look to be increasing prices again in the spring, so probably May, June time as we go into the summer, anticipating some of the underlying inflation. There's still cost of goods inflation coming through. So we're seeing certainly raw material cost -- timber costs are increasing probably 5%, 6%. Freight costs, we've got locked in now for the calendar year. We're hedged on the dollar as well so that's okay. But I think there's raw material costs coming through. I think, Mike, the other elements of costs, we're seeing wage inflation. And clearly, fuel is another issue.

Yes. I mean I think, look, there's probably very few line items in the P&L that aren't inflationary at the moment [indiscernible] rates is a sizable one that is broadly sort of static. But I think other than that, looking down the P&L, the wage inflation, I think we're expecting a bit less than 4% being locked in over the next 12 months. Marketing costs are, at the moment, across the sort of the first half of the year, we're up between sort of 5% and 7% on -- depending on the category of sort of media you're looking at. And so there is inflation in the market. I think the positive for us is that we are seeing that ability and that evidence of our business model being able to pass through those prices to customers. And actually, the value proposition is staying very strong because of the scale that we're operating at relative to other competitors in the market. So we'll keep actively monitoring the pricing environment that we see, and we'll keep adjusting the sort of consumer proposition as a result of that.

Yes.

Great. And just on freight in particular, given that was such a massive headwind over the past 12 months, is there any visibility on that leveling off? Or is that something that given you've locked this year in, you'll kind of focus back in on it in 6 months' time?

Yes. We've locked this calendar year in at a certain rate. We shouldn't -- commercially sensitive, but it's across about 5 or 6 of the big shipping companies. We've got enough containers coming from China. It was one of the issues in half 1, is that there was a real container shortage. Although we had a rate agreed, getting hold of containers to get the product in and flowing freely was a real challenge. So we've now got -- a, got enough containers; b, locked the rating for this calendar year. I think looking forward to '23, calendar year '23, as to what that rate might be, it'd be pretty difficult. You can see it coming down a little bit on the spot rate. So might there be some upside in '23 from that? There might. But it's far too early to call. We're probably back into renegotiations again for calendar year '23 in September, October. So who knows what the world looks like at that point in time. But certainly, we're getting all the containers we need at the moment at the rate we agreed.

Super. And then 2 more, if that's okay. One is in terms of lead times for consumers on the sofa. Where are we at this? Is the kind of norm the extreme...

Yes. So I think if you -- we would ideally in the ideal world pre-pandemic be running at somewhere between an average of 6 to 8 weeks lead time. So in the -- for U.K., you'd be at the 4 to 6. For Europe, you'd be at 4 to 6. China, 12. And when you see this afternoon how we split our sourcing, it's 1/3, 1/3, 1/3. 1/3 from the U.K.; 1/3, Europe; 1/3 China. So the blended rate comes out at 6 to 8 weeks. It's typically what we've run at. As you stand today -- as we stand today, you're probably looking at 12 weeks. So 12, 13 weeks. U.K. is actually quite high. So the U.K. is full, completely full, long lead times. Our own factory is probably at 10, 11 weeks, which is unusual. Usually, we're at 4 weeks for our own factories. So we have got long lead times in the U.K. Coming down in Europe, and China is actually coming down. But the blended is still probably around 12. So we're probably, on average, 5, 6 weeks longer than you'd want to be, which is effective. If you think about the order bank that we're carrying, which will be delivered over time, that's where we stand at this moment in time. So not ideal. We want to bring the lead times down to be much more commercial, and we are doing that on very selected products, being smarter about it. So we have got products on short lead time if you want it. We've got plenty of stock to go at in terms of clearance stock. So we are satisfying those customers who want something quickly, but we can really do -- we're bringing the order bank down over a period of the next few months.

Super. Last one is just the GBP 1.15 billion. Can you just remind us what are the assumptions and what is the size of the market and your market share? What are the building blocks for that because...

So hold that thought for about 15 minutes, and we'll take you through it. I got 2 good slides on that hopefully. Okay. Thank you, George. Any other questions?

Are we doing supply chain lakes [indiscernible]?

Are we doing supply chain lakes? Well, not in lots of detail, John . So yes, please ask a question.

Okay. Great. I mean just in terms of where you are in terms of driving production capacity at the moment that you're -- what you're putting through and how you see the supply chain changing now in light of where we are through the next 2, 3 years .

Okay. Well, I'll answer. We've got a little bit on that, but let me answer that. So I think if we step back, we've got -- of our sourcing and manufacturing capacity around the world, as I said, we've got about 1/3 in the U.K., 1/3 in Europe, 1/3 in the Far East. From a direction of travel point of view and thinking about ESG going forward, we would anticipate bringing more away potentially from the Far East into Europe, into the U.K. So more nearshoring. That's the kind of direction of travel. We've signed a long-term partnership with the largest manufacturer in the world, Manoir , who've got operations in China, but also partners in Eastern Europe. And so the plan over time was to work with Manoir to build more capacity in Europe. Point number one. Now that's challenging because, unfortunately, one of the facilities that they've got is within the Ukraine. So that's now closed off to us. They've got a big plant in Lithuania, which has also got potentially some challenges there, but we're working very closely with them because they're a long-term partner. So that was one of the directions of travel to increase our capacity. The second thing we've done is we've taken on more capacity in the U.K. We've got a couple of new suppliers. And then you also see in the statements that's gone out, and we'll talk more about it, we'll be investing in our own manufacturing in the U.K. in the next few years to increase capacity there. So I think broadly, I'd say the U.K. is pretty full in terms of capacity. It's hard to get more there. Europe, there's a bit of an opportunity, but it was more in the Eastern Europe side. Far East, there is capacity. But if you're thinking long, long term and 12-, 14-week lead times, ESG, freight costs, we've got to work very closely with that over the next few years. So I hope that gives you a sort of picture as to what's happening. Anybody else? Jonathan ?

Advertising. No sort of voice to it. [indiscernible] -- sorry. On the advertising side, obviously, it's a slight departure on where you've been in the past, certainly a departure where you were 5 years ago. But could you just talk us through the response to that and what was behind the change of voice as you go?

Yes. This -- well, hopefully, so Nick Smith, who's our CEO of DFS, will perhaps talk you through that. When you're in the store in DFS, we'll talk you through a bit more of the thinking. But the high-level answer to that is in the end of the last few years, what you'll see, hopefully, if you've not been to our stores recently, you'll see the DFS stores in particular, the range has changed dramatically in the last sort of 3 or 4 years. So far more breadth of range, appealing to all sorts of different types of customers. And the way the range is presented in the stores is really strong. So far we've always had a very strong and eclectic range. So what we're trying to do with the advertising is to think about style and choice. So that's the thing that we've been after. Worked very -- many, many months, finding the right marketing agency to support us. Nick went through very many enjoyable meetings with marketing people. And really the brief was, how do we convey style and choice to everybody? And so the concept of what's your thing and really showing the kind of -- the breadth of the offer that we have is designed to be cut through and different. And I think the reaction has been, hopefully, it's quite different from the value piece that we used to do. It's really kind of cut through with consumers, and the research is really strong. And if you think about it, it launched before Christmas, and we've seen very, very strong performance in DFS and products that are on the advertising, the Tartan sofa, which we never sold any of, have now started. So it's really starting to kind of open people's eyes to the breadth of range that we have. So it's been really strong. I think on Sofology, we've moved away from the Owen Wilson ad. But I think Helena Bonham Carter, Emma's over here, who's our MD of Sofology, has been very strong in terms of talking about style. I think she's quite eclectic. So I think both brands are pushing in their own way, but we're talking more about products. We're talking more about style and choice than we are about value. We've always got great value. That will always be there, and we do that in our below-the-line comms. But in terms of just talking about the fact that we are the sofa experts and we've got something for everyone is what we've been trying to do. Is that the right answer, Nick, Emma? Is that broadly -- Andy?

It sounds like you've seen a bit of a change in behavior on IFC. So could you just give us a bit more detail on that and how that affects you?

Yes. Well, certainly, we saw it post-lockdown one. There's a lot more cash coming into the business. So historically, if you went back, it would be very steady. Around 2/3 of our business at a value level would be through IFC and 1/3 cash. That was always the way it was pre-pandemic. Post-pandemic, we got into seeing actually 55% cash, 45% IFC. It flipped about 50-50. And today, it's more like 55-45. So 55% IFC, 45% cash. There's still quite a lot of cash, which is probably obviously a result of people not being able to spend on whether it's holidays or whatever we -- there's all the well-documented people who got decent levels of savings. So the cash business is still a good proportion. Different from before. How that impacts our business, we pay a subsidy rate on all the IFC that we write, and that subsidiary rate's coming down just because of the balance of cash. So it probably gives us a decent benefit at the gross margin level.

Okay. And another one, your store staff incentivization, that's based on -- is that based on volume or value of what's sold?

Well, I don't want to steal the thunder of the guys in terms of doing the store tours this afternoon, but I think Louise and Nick, if you can pick that up.

Just asking because, obviously, if your average price is going up and you're selling the same volumes and they're incentivized on the value of what they're sold, then you'll see some deleverage as a result. Just interested around that.

Yes. So the combination -- so they get an incentive for every deal that they do. So it's a volume-based deal. But obviously, if they're selling more expensive products, then there's a slightly higher cash amount. So I think our -- overall, if you're a sales colleague in both DFS and Sofology, you're doing quite well at the moment. We've got -- again, in terms of it, part-time mix is really helping boost conversion. So even if you're doing 20 hours, which is what some people are doing, even 18 hours, people are still earning some decent money. We've put in a -- you'll hear this afternoon we've put in -- or this morning, I should say, we've put in a base salary for DFS colleagues, which didn't exist before, which is a decent base salary, which you get proportionate for the hours you do. And then the commission comes on top. So we've really modernized our approach to rewarding colleagues in the last -- well, actually through the pandemic, haven't we Louise? So you'll hear more about that this morning. Mike ? Let's probably get one last question.

Yes. I just wondered if you could give a bit of commentary on how your smaller competitors are behaving in the current sort of disrupted or inflationary environment. Are they pulling back, increasing prices, et cetera? And is there any advance of about 2 percentage points of market share gain in light of that? Because I know that is a figure that we've seen for 12 months or so.

Yes. I mean I think when you say smaller competitors, I mean, I think the independent sector is a challenge, isn't it? Because the cost of goods inflation coming through is there for everybody. The freight costs, they can't mitigate. They haven't got the long-term contracts. So what we have seen in some of the independent sector is they're pulling away from some of the Chinese products, the more expensive products. I think that's helping both DFS and Sofology because we're still stocking that product. In fact, we've seen an overindex on some of the motion furniture. We've been pushing quite high on some of the high-end leather you'll see in the stores today. There'd be a product in DFS that we would never have stocked before, over GBP 3,000 leather sofa, which is flying. So I think the independent sector is struggling to cope with the economics of certainly Far East, point number one. I think the U.K. factories being full doesn't help them either so in terms of long lead times. So with our own sort of factories plus Eastern Europe, we can have shorter lead times. So I think the independent sector is getting more of a squeeze. I couldn't comment about furniture [indiscernible]. I don't see their numbers. I think I'll see that report soon. But I think we're seeing gains definitely from the smaller independent sector, which would make sense. And I think that macro trend is going to keep accelerating, Mike . We filled the time. That's good. Okay. So what we're going to do is walk off the stage, come back on at 11:00, in about a minute, and start the Capital Markets event. Is that okay? Right. Okay. Thank you. You don't have to applaud. That doesn't...