Dunelm Group plc (DNLM) Earnings Call Transcript & Summary

Good morning, and yes, a really warm welcome to the Dunelm prelims presentation for 2021. My name is Nick Wilkinson. And I'm delighted to say that Laura Carr and I are in person and live from London. It's lovely to see so many familiar faces in the room. We've got many of our Board here and members of the analyst and investment community. So thank you so much for coming in today. We've also got people joining us virtually as well, so warm welcome to you. I guess as a business, just one thing to say is that we sort of measure the quality of our business by the quality of our relationships with customers, colleagues, suppliers and investors and I guess COVID has made that even more important. And I'm just thrilled that you're interested in our company and are with us this morning, so thank you. And let's get started. Here's our running order for the morning. It's what you'd expect. I'll make an introduction. Laura will then take you through the FY '21 financials. I'll then update on our proposition development. And Laura will then give you a financial look-forward on these plans and an update on trading. We'll have plenty of time for your questions. Morning. Welcome. This time last year, 12 months ago, my main worry was whether there'd be further lockdowns and whether we'd be classified as an essential or nonessential retailer. Well, we all know the outcome of that worry, and our shops were closed to customers for about 1/3 of the trading days of the financial year yet we coped really well. And dealing with these sorts of challenges has become business as usual, if you like, for many organizations and we're getting more adept and agile all of the time. The latest challenges that we are facing are well publicized in the media and relate to freight capacity, the driver shortages, the cost price inflation and we'll cover some of these topics as we go through the slides. But we do feel well placed to manage them especially relative to others. We're not -- we'd rather not be facing into them, but we faced a lot worse in the last 12 months. And in those 12 months, we've delivered an extraordinary level of sales growth, 26% sales growth. And I guess what really stands out on this page of highlights is the level of digital growth of over 100%, but also a really strong trajectory of gaining more active customers. And is it market driven? Well, not really. 160 basis points of gain against the global data U.K. homewares market suggest most of our growth -- the vast majority of our growth was from share gains. Sales flowed well into profit and cash. Good gross margin and excellent profit, in fact, a record in that 45% year-on-year. And the strength of our profitability and our cash flow allows us to pay both a final and a special dividend to bring dividends to 100p per share in the year. Here's a summary of what we've delivered for all of our stakeholders. We've worked really hard to make decisions, which are balanced and reflect the interests of everyone. I'll not run through each of the groups, but I will pull out 2 of them, please. Firstly, colleagues, who have adapted brilliantly to serve our customers and support the business. In the year, I'm delighted that we decided to award an exceptional thank you bonus, the second one we've done since COVID began, to all of our colleagues. We've also created over 700 new jobs and have very ambitious programs underway on inclusion and diversity and on mental health, which includes specialist training for all of our leaders and all of our store colleagues. And secondly, suppliers who've been an integral part of our business from its origins. Our suppliers scaled, grew their home delivery capacity at the start of the pandemic and they've been alongside us every step of the way as we've navigated dramatic changes to product flows, supply and freight challenges to ship stuck in the Suez Canal. We've kept the cash flowing to them in full and on time. We've given them support in terms of freight capacity. We've also learned a lot from each other, sharing sourcing know-how and insights. And their businesses have grown with ours. We'll pick up on the other stakeholders during the presentation, but I'll now turn to answer the question about what's really driving our growth and all-around performance. And the answer is digital investments, digital capabilities built and confidence in digital that comes as a result of these investments driving growth and excellent returns. The new platform was a big step-up for us and we've continued investing in the last 12 months. As a result, we could respond rapidly to increased demand, able to handle very high levels of traffic on the site, able to increase our home delivery capacity. And we've done all this with good quality, too. Customer quality scores grew in all channels and lead times have come down, although there's still more work to do there. During the year, we continued to release improvements to both the front end and our home delivery services. We extended the range available on Click & Collect and included not just store stock but also lines held in our central warehouse. We made it easier for customers to shop our made-to-measure ranges by introducing the product range online for the first time and offering a choice of virtual or physical consultations. We also enhanced the site for organic search and made a big step-up in our paid search marketing by movement to profitability-based bidding during the year. And when stores reopened in April, we were ready with an upgrade to our in-store tablet-based selling tools for colleagues. I think emotionally, we've come a long way on our digital journey, too. In lockdown 3, that was the one between January and April when our -- when we were committed to serve Click & Collect at the front door of each of our shops. And we continued to pay 8,000 store colleagues at their full rate of pay. A colleague said to me that the way she saw it, Click & Collect was paying her wages. Our stores have embraced digital growth. Ask them how we can improve our business and most of you will give -- most of them will give you a tech enhancement to either the customer or the colleague digital experience. I'm describing a digital transition and it's one that's built on top of our existing strengths. Indeed, our stores are growing in importance within our total retail system. They're benefiting from new digital services and are a key differentiator in terms of being a fast and friendly part of our offer that's close to home. This digital transition changes how we can now think about growth. More of our new customers will be acquired through digital content and performance marketing. And the second runway for growth, frequency, opens up with digital capabilities, meaning we can offer more choice, more reach, more convenient services and more effective marketing. There is much to do to achieve our full growth potential, but we feel really well positioned with a clear runway ahead of us. Our view on sustainability is that our ambitious targets here are not only compatible with growth, but will further drive the appeal of our proposition and brand. Today, we're able to announce we've now established science-based targets for scope 3 carbon emissions, scope 1 and scope 2 we shared 6 months ago, with the intention to reduce emissions in absolute terms by 50% by 2030. Sustainability is integral into our thinking and it's at all levels of the business in all parts of the business. Our commitment to net zero is built into company purpose, into metrics and into management incentives. And we are moving forward with our plans. Stores with links to their local communities will be at the center of our take-back schemes. Our existing vertical supplier relationships and new partnerships will accelerate our learning about circular sourcing. And in terms of our own operations, one practical improvement we're making this autumn is the packaging we use in our mailing bags for all of our courier-delivered home delivery items will move to over 95% recycled content, it's currently 30%, as well as being 100% recyclable. Though there is much to do and to learn, I'm optimistic about our starting position. More of the future shortly. I'm now delighted to hand over to Laura, who will take you through our FY '21 financials.

Thanks, Nick. Good morning, everybody. It's really great to see you here in person. And hi, everybody, who's dialing in virtually. I'm now going to take you through the financial results for the 52 weeks ended the 26th of June 2021. As Nick has already said, we are really pleased with the FY '21 results with strong performance against all financial metrics. Excellent top line growth, strong gross margins and continued focus on controlling the cost base delivered record profit before tax of GBP 157.8 million, up GBP 48.7 million compared to the prior year, which was obviously impacted by the start of the pandemic at the fourth quarter of FY '20. The strong profit growth led to diluted earnings per share of 62.9p, up 47% on the prior period. We had very strong top line growth in FY '21. Total sales of GBP 1.336 billion were up 26.3% compared to the prior year. And if comparing against the pre-COVID period, FY '21 sales were 21% higher than those reported in FY '19. This excellent growth was driven purely through our digital channels with total digital sales more than doubling during the period to GBP 616 million. The digital sales penetration was 46% compared to 27% in FY '20 and only 20% in FY '19. The FY '21 number was obviously impacted by the significant period of store closures, where stores were only able to offer contactless Click & Collect. And therefore, we expect that if our stores remain fully open during this year, digital penetration will be around 35% to 40%. There are significant fluctuations in our quarterly performance given the store closure periods. We saw exceptional growth in Q1 and Q4 as the customers came back to us after the national lockdowns, whereas Q2 and Q3 were impacted by the store closures. Despite the challenges we faced, we are really pleased that we've grown market share. The annual read of the homewares market by GlobalData shows that we grew share by 160 basis points with our share being 9.1% of the homewares market. We also continued to monitor the weekly information that we received from GfK, and we've consistently disclosed this for several years to show our quarterly market share performance. The data from GfK is a panel of homewares retailers and represents just over half of the market as defined by GlobalData. The analysis based on GlobalData -- sorry, based on GfK shows that we significantly outperformed the market when our stores were fully open, and conversely, we underperformed the market when the stores were closed. Gross margin for the year was 51.6%, up 130 basis points compared to the prior year. The increase in gross margin this year was mainly due to having lower levels of promotional activity during the year. The timing of store closures at the end of the second quarter and into the third quarter significantly impacted our ability to trade a winter sale. And then the uncertainty surrounding the reopening of stores in the middle of April led us to delay our usual summer sale, which would normally take place at the end of the fourth quarter into the new financial year. We expect that in the absence of any further trading restrictions, we will return to a more normalized trading calendar in FY '22. And this should therefore result in having more sale activity in this financial year compared to FY '21. This shift will likely lead to a margin headwind of around 50 to 75 basis points. And additionally, as Nick has already mentioned at the beginning of the presentation, we note that the global supply chain is under significant pressure from ongoing disruption from COVID, raw material price inflation and freight cost increases. We've been facing into these pressures over the last 18 months, and the situation remains dynamic with new issues emerging such as shortfalls in HGV drivers. We are not immune to these issues, but we feel well -- that on a relative basis, we are well placed to manage them. We continue to work closely with our long-standing committed suppliers and are focusing our sourcing efforts to mitigate cost increases. Where appropriate, we will take retail price increases to offset the cost price pressures whilst always considering the competitiveness of our offer. Total operating costs during the year were GBP 522.5 million, up 25.5%, which is marginally lower than the rate of sales growth. The cost-to-sales ratio was 39.1%, 30 basis points lower than FY '20, whilst noting that both years have been impacted by the additional costs relating to COVID. The net impact of one-off costs and benefits relating to COVID, including government support, was an adverse GBP 16 million compared to the prior year. Beyond the COVID impacts, operating costs were well controlled and the biggest increase related to higher sales volumes. Additionally, we invested approximately GBP 12 million into growing our digital and data capabilities and adding supply chain capacity to facilitate growth. And finally, incentive costs were GBP 10 million higher than in FY '20 given that the majority of store and management incentive schemes did not pay out in the prior year due to the impact of COVID. The business is highly cash generative, and free cash flow was GBP 108.5 million. And whilst the operating profits were significantly up year-over-year, this year's free cash flow was GBP 66.2 million lower than FY '20 because of the swing in working capital. In FY '20, we highlighted that the GBP 80 million of working capital inflows were exceptional and related to the first lockdown period in the fourth quarter of FY '20. We had anticipated that most of this inflow would reverse in FY '21. However, given the very strong trading in the fourth quarter of FY '21, the full year working capital reversal was only GBP 35 million. We therefore expect the further GBP 15 million to GBP 25 million of working capital will reverse in FY '22, but it's difficult to predict the exact timing of this given the ongoing supply chain disruption that's impacting the flow of inventories into the business. Capital investment in FY '21 was GBP 15.7 million, reflecting a lower level of store refits than normal due to the COVID restrictions. CapEx included 1 new store and 2 relocations, and I'll talk more later about how we're thinking about CapEx moving forward. Given our strong financial performance in FY '21 and our confidence in the future of the business, the Board has proposed a final ordinary dividend of 23p per share, taking the full year ordinary dividend to 35p per share, representing dividend cover of 1.8x. Noting that no dividends were paid to our shareholders in respect of FY '20 and the strength of our balance sheet, the Board has also declared a special dividend of 65p, which will be paid in October. We're pleased that this special dividend allows us to return to our published capital policies. But given that there is still some uncertainty relating to COVID, we have chosen to pay a special that takes us only to the minimum leverage in our target range of 0.2x EBITDA, which, considering that we continue to generate cash, maintains a very prudent balance sheet. And on that note, I will now hand you back to Nick to talk us through becoming our customers' 1st choice for home.

Great. Thanks, Laura. So looking forward, obviously, our strategy continues to evolve as we learn more about our customers and we develop more capabilities. And I'm delighted to give you a further update now, starting with purpose. So the pandemic taught us many things including that we can play a broader role in the lives of our customers and in society at large. In the lockdowns, we got to know our local communities better than we'd ever done before, and we listened hard to understand what customers wanted from their homes. That led us on to a very collaborative journey with our customers and colleagues to renew and clarify our company purpose. Founded on the insight that truly feeling at home is one of the greatest joys in life, our purpose is to help create the joy of truly feeling at home now and for the generations to come. We wish to give people the means to make their homes comfortable, organized, beautiful, secure and sustainable, but we're also interested in how we make them feel at home by being nonjudgmental and by being friendly. In a fast-changing world, we think being focused on empowerment, inclusion, well-being and being a progressive organization are essential to great customer and colleague relationships. How do we achieve our purpose? Well, one of the ways is through our focus areas for investment. You can see 6 laid out here, and I've covered them in the past and I'll cover them again briefly now. And I'll organize that in terms of how they ladder up into our proposition in terms of products, services and experiences. So in terms of our product offer, you know that choice, value for money, quality are a really big part of our appeal today and we're working with ambition and confidence to go further still, both deeper, we now use online customer insight to identify gaps in our ranges; and broader into new ranges like paints and wallpaper, outdoor lighting, more living room furniture, sofas and chairs, seasonal items and gifts. And we're making it easier for customers as our ranges grow to discover and find our products across our ranges. So we're creating collections, we've got one launching in collaboration with Natural History Museum for this autumn and Christmas, and developing more our own brands that run across different categories. So Churchgate is an example of a brand that we're expanding across our assortment. Churchgate was the location in Leicester of our very first store where we had a sewing room next to the shop, which you can view from the shop through a glass wall. And we're also supporting all of this work with investments into our commercial systems to better leverage product data, to accelerate the product onboarding process and to add capacity for further range expansion. In terms of services, we're developing our services proposition further by investing in capacity and systems capabilities and by working more closely with our partners. The picture here shows you the addition of a new fulfillment center into our Stoke setup, which will be operated by a new partner, GXO, that you may better know as XPO. And in terms of furniture services, where we operate our own highly rated home delivery network, we're also taking a big step up in capacity and proposition quality with a new heavy and bulky goods center coming onstream this winter in Northamptonshire. We've also scoped to increase the breadth and availability of products for Click & Collect by adding our supplier stock ranges into that offer. And Click & Collect is a fantastic frequency driver. Over 1/3 of our customers shop again in store when they come to collect their goods. And finally, we're developing our take-back schemes. For example, in textiles, quilts and pillows, we're announcing the launch of one in parts of the country today and have started to promote local take-back schemes organized by store colleagues and advertised by our local community groups. In terms of our experiences proposition, you'll see us deliver digital features such as wish lists, save baskets, smart filters, linked and alternate products, visualization tools for products like sofas. We're also moving our payments onto the same platform for all channels, which will bring both options for -- more options for payment type. And we'll move our primary customer identifier on our customer data platform from e-mail address to tokenized card details. We continue to build this single view of our customers across channels, which will eventually power next best action optimization across all of our shopping and marketing channels. At the same time, we continue to invest in our stores. Having brilliant store is a key part of our retail system and core to our differentiation. We'll continue our disciplined opening program and continue to test smaller formats in smaller catchments. We're aiming to be within 20-minute drive times, we're about 2/3 of U.K. households with 200 shops. And we'll continue to refit to move older ones to our optimum layout and design. And we're doing about 10 of these in this financial year. Through these proposition enhancements, we'll grow our market share. So let's talk about the market. You know that the U.K. homewares and furniture markets are large and fragmented. And in terms of growth rates, GlobalData estimates that both markets declined versus the prior year in the 12 months to June 2020 and recovered back to FY '19 levels in FY '21. And GlobalData is forecasting growth in low single digits over the coming years. Our view is that notwithstanding the month-to-month volatility to trading patterns caused by locking down and opening up, there are now some well-established drivers of increased consumer demand: the practical focus on home caused by permanent adjustments to how we work will continue; the desire to upgrade, to relocate, to improve your home to increase its value will also continue. Consumers are also turning to what you could call wholesome homemaking activities like decorating, crafting and home cooking. And interest in sustainable living is growing gradually. We've been running an attitudinal customer segmentation of home shopping now for a number of years on a consistent basis. And as I said before, it's attitudes to home rather than socioeconomic profiles that are the distinguishing feature of who shops with us and how frequently. We classify 4 customer segments as home lovers. So these are people who are highly engaged with improving, styling and shopping for their homes. And these segments now make up over 50% of U.K. households, and we expect their needs and wishes to continue to develop at pace. So I focus all those comments on the market because I know you're interested in our read there, but most of our growth will come from market share gains as was the case in FY '21 and indeed throughout our history. With only 9% market share of homewares and with less than 1.5% of furniture, we see significant headroom to grow our share. And as I said earlier, we expect that share gain will come from acquiring both new customers and increasing purchase frequency. So our runway for acquiring customers, I think, is now pretty well established and we've had another good year. We see a lot of scope for material additions to our U.K. customer base. And our methods of acquiring customers will continue to get more sophisticated. However, it's the scope to grow frequency that represents a second runway, which is equally significant. As shared at the interims, 12% of our customers contribute 40% of our sales and we call these our high-value customers. But they're not more affluent and they don't buy into our higher-quality, higher-priced product tiers, they simply shop more frequently with us. And we have a higher proportion of their home spend. They shop multiple categories and are more likely to be multichannel customers. So another way of thinking about this, shown on the right-hand side here, is the customer who shops multiple categories and both online and in-store in a year will have shopped 5x as frequently and spent 6x as much as a single-category, single-channel customer. And with half of our customers only shopping once a year, the frequency opportunity is very significant. Let me try and pull all this together for you in a picture rather than words. This is taken from one of our autumn looks Global Coastal and I counted 20 different product categories in the picture. Now from this picture, people probably know us for curtains and maybe rugs, both of which are bought relatively infrequently. Yet you can buy sofas and chairs from us, living and dining furniture, paint, pots, plants, door handles and we even sell beds for the cat. So choice is expanding all of the time. And once customers start to shop across channel, all this becomes more accessible for them and new buying habits are formed. When a customer Click & Collects, 1/3 buy again in the shop. When a customer follows a social page for the store -- a social community page of the store, their emotional connection to our brand deepens. When we deliver an order perfectly, a customer is more likely to shop again that year. So we're busy developing product choice and our channels to be fast, friendly, seamless and offer perfect orders. But remember, all of these things are just a means to an end. The purpose of them is the joy you feel with your version of this picture. And by helping you do that, without judgment better than others, we will become the first choice for home for more of the country. And that's the journey we're on. Our confidence comes from the excellent returns that we're getting from both digital investments and continue to get from our store investments. So Laura will now share with you our financial plans and outlook.

Thanks, Nick. We have a strong track record of long-term profitable growth and shareholder returns. Since the company began back in 1979, we have consistently shown strong revenue growth. And since we floated in 2006, we have delivered on average 10% sales growth each year, leading us to return over GBP 1.1 billion to shareholders during that time. As Nick has demonstrated, our digital investments have allowed us to significantly grow the business, and we are doing this profitably. As the business continues to evolve, we are committed as ever to ensuring the business remains highly profitable and cash generative. We'll continue to invest in the proposition and the business model to drive organic growth, applying the same disciplined criteria to ensure a good return on investment. But at the same time, we'll maintain operational grip and drive productivity improvements to optimize the cost base and offset increasing cost price pressures. Nick has shared how we are developing our proposition and building new capabilities to enable growth. This means that we're investing broadly across the business in many different areas. We expect that CapEx levels moving forward will be around GBP 30 million to GBP 40 million, and we will remain very disciplined about maintaining the strong paybacks that we've seen on our investments. We've already announced our 2 new warehousing and fulfillment centers which will become operational this winter. And we will also optimize our existing facilities to enable further growth within our store operations. And we are continuing to invest in our stores. We expect to open around 3 to 5 new stores each year. In FY '22, we will expand the trial of smaller format stores. To maintain our estate and to continue to optimize the store experience and layout, we will undertake around 10 refits per year. We'll also replace the gas boilers in our stores as we pursue our net carbon targets -- net zero carbon targets, more importantly. When we launched our digital platform back in October 2019, we decided that we would no longer capitalize our internal digital development costs. These costs, which are increasing as we become more digitally enabled and grow our own in-house engineering teams, are included in the P&L. The technology CapEx costs relate to enhancements that we are making to our back-end systems, which are necessary to maintain the quality of our operations as the customer offer and our business grows. We're also investing in people, perhaps the most critical enabler of our strategy. We're expanding our teams in digital and data engineering and insights and analytics, product management and sustainability. And we continue to invest in the overall colleague experience, extending learning and development programs and ensuring that we can attract and retain the very best people. Pulling these all together, I'd like to share how our plans are reflected in our financial model in the short to medium term. Our model assumes continued strong revenue growth in line with our track record as we acquire more customers and increase their frequency. We are aiming to maintain product gross margins at around the 50% level through leveraging our committed supplier base and deep product knowledge. Our disciplined approach to promotional activity and markdowns will be maintained, as will our relentless focus on sourcing especially as we move to increase the amount of sustainable products -- materials in our products. We expect that operating costs over time will continue to be around 38% of sales even though our digital penetration will increase and reflecting the ongoing investment into the proposition. Additionally, we will continue to drive productivity improvements across all of our operations to help mitigate the impact of cost inflation. This model therefore delivers around a 12% pretax profit margin with absolute returns increasing in line with the business growth. In summary, strong profitability, which translates into cash, coupled with modest levels of capital investment, should result in continued excellent returns for our shareholders. Before we finish, I thought it would be helpful to pull together on one slide all of the areas of FY '22 guidance that we've already covered. Whilst we expect another good year of revenue growth, it is worth noting that the quarterly sales performance should be reviewed in light of the prior year fluctuations due to the national lockdowns, which impacted both negatively due to the store closures and positively due to the pent-up demand following reopening. I think that's a good segue into talking about current trading. Trading in the first 10 weeks of our new financial year has been very encouraging and has been better than we expected, showing continued growth against a tough comparative period. Our summer sale in the early weeks of the year was well received by customers across the total retail system, and we've continued to see market share outperformance every week using our GfK analysis. Given the strong start to the year and excluding any further trading restrictions from COVID, our full year -- FY '22 PBT expectations are now modestly ahead of the top of the range of analyst -- latest analyst expectations. So before taking any questions you may have, I'd like to summarize today's presentation by saying that we are really pleased with both the strong performance in FY '21 despite the challenges that we faced during the various lockdowns and also the strong start to the new financial year in FY '22. We are emerging from the pandemic as a much stronger and better business, having transitioned from being a physical retailer with digital aspirations to being a proven digital-first multichannel business. Whilst the macro environment remains uncertain and is constantly changing, we think we are relatively well placed to keep managing these challenges. We are looking to the future with a clear runway for growth to win more customers and increase their frequency, and we'll do this by developing our market-leading proposition further. We are investing for growth, and we are committed to maintain our track record of profitable growth, strong cash generation and excellent shareholder returns.

It's been great to see you. I hope you've got a flavor of why Laura and I feel privileged to be running this business while we're confident about the future. And thanks for your interest. Thank you.