Dunelm Group plc (DNLM) Earnings Call Transcript & Summary

Hi there. Hello, and good morning, and welcome to the Dunelm interim presentation covering the first half of our financial year. My name is Nick Wilkinson, and Karen Witts and I are here. I'm delighted to welcome you to the offices of Peel Hunt in London. Whether you're here in person or joining virtually, I hope you're well and feel connected to us and to the continuing story of Dunelm. Into that story, please welcome Alison Brittain, our chair since January. A customer for much longer, Alison spent the last 6 months getting to know the business and its colleagues, and it's a great pleasure to have you in the Dunelm team, Alison. Those of you who were here 17 years ago for the IPO roadshows may recall that we had some product samples that we shared at that time. And today in the room, we have some more samples, this time of our most circular product range yet. These summer weight throws are made using second-life textiles, including those that our customers have placed into our very own in-store take-back scheme earlier in the year. Please do take one home. When they are launched later this month, you can post a review online. And I hope you enjoy using them in your gardens this summer. At heart, we are a product company. So before we get into the financial highlights, I thought that for once, we'd do something different. And we would start with a short video of our latest product introductions. This was filmed in Somerset House, an event we held for press and influencers in November, and you'll be shown around by our design director, Debbie Drake. [Presentation]

Great. Thanks, Debbie. Thanks for watching. I know some of you managed to attend that event, and we'll do some more in the future if you missed it. I hope you enjoyed the video. Of course, there's more to our plans than product, but it all does begin with product. So here's the running order for this morning. I'll get us started. Karen will then take you through the first half financials and show you how we're navigating the current economic climate. And then I'll be back to talk about our plans for growth and for seizing the opportunities, which we see ahead of us. So onwards, financial highlights. A strong first half. In a period of low consumer confidence and up against tough comparables from the prior year, we're pleased -- really pleased with performance. A particularly strong Q2 for sales, good gross margin and excellent operating cost ratios throughout the half, resulting in profit before tax of GBP 117 million and high free cash flow conversion. Another standout is the strong market share performance, which is a calendar year number. We've announced an interim dividend and a special today of 55p in total per share. We'll share more details with you to help you understand the moving parts. But in essence, what we think happened is pretty simple. Firstly, we grew. What we're seeing is consumers working hard to find ways to balance their budgets. They want to be smart and savvy. They don't want to waste money. They want to feel in control. How they do that is very personal to them, their preferences and their circumstances. Into this market, we've been able to offer a wide choice of relevant products, outstanding value at all quality tiers, and we've strove to be communicating as an ally, helping customers find what's right for them and not putting them under undue pressure. In the picture, some examples. Warmer weight bedding and door curtains to save on home heating, batch cooking and food storage to save on waste, gifts and treats that are practical from onesies to hot water bottles, products that make homes feel cozier like rugs and lighting. We're still selling winter warm products now as we come into spring to help people save on outdoor heating or get into the garden this weekend. But that's in addition to our normal spring and summer collections and campaigns. As a result of all of this, we continue to see growth in terms of our customer runway, so more active customers and increased shopping frequency. And on the right, you can see almost 6% growth year-on-year in the last 12 months for active customers with shopping frequency also growing by about 5%. So if that's how we grew, we were also resilient. We often talk about operational grip as being one of the drivers of our performance, and that's never been more true. Obviously, the big challenge we faced into has been how best to manage inflation while offering outstanding value to our customers at a time when they need it most. It's detailed work, but we keep it simple with clear frameworks like our good, better, best tiers. Being simple allows us to put our energy into innovation and adapting quickly. Innovation and adapting is fun, and it turns a challenge into an opportunity. Of course, it's easier to have fun when you feel your operating model is a strong one. Our brand has broad appeal and our audience of home lovers is engaged in our content even when they need to budget carefully. Added to this, our product offer is largely own brand and exclusive, and we cherish our long-standing supplier relationships. And in a half when both our stores and our digital channels performed well, we benefit now from not just a low-cost store portfolio but a cost-effective total retail system. But of all the factors behind our resilience, the greatest is the quality of my colleagues and our shared values. And whilst as a company, we do many good things to support our colleagues' financial well-being, our colleagues do even more to help the communities in which they work. Our Delivering Joy campaign supported over 500 local causes this Christmas, and this work builds our brand, and it makes us stronger and therefore, more resilient as an organization. For this and for all the other great work they do, thank you to my Dunelm colleagues. Our good performance is testament to their hard work, commitment and resilience. And now to give you more insight into our performance, I'm delighted to hand over to Karen.

Thank you, Nick. And good morning to everybody. It's great to see you here again and also, good morning to our virtual audience. As Nick said, we're really pleased to be reporting a strong set of half year results. I'll go through the various elements of performance in more detail. But at a headline level, we delivered GBP 835 million of sales in the first half of FY '23. That was 5% more than in the prior year against a strong set of comparatives. Nick has described what supported the sales growth: choice, relevance and outstanding value at every price point. Our gross margin was a healthy 51.1% and was consistent with our expectation of delivering a full year gross margin of around about 50% because the second half of the year, with its 2 periods of sale, typically has a lower gross margin rate than the first half. The gross margin rate was 170 basis points lower than last year, and we expected that as we reverted to a more typical sales calendar with bigger sale events and higher customer participation in sale offers than we saw during the pandemic. We talk about tight operational grip, and that's what kept operating costs under control even in an inflationary environment. Our operating cost-to-sales ratio last year was very low as strong sales from newly reopened stores delivered particularly strong operating leverage. Nevertheless, our H1 cost-to-sales ratio of less than 37% helps to show our focus on making every pound count. All of that resulted in profit before tax of GBP 117 million, GBP 23 million lower than the same period last year. And reflecting the PBT outcome, diluted earnings per share of 45.8p was 17.3% lower year-on-year. Our free cash flow conversion was strong at 84% versus 74% in the prior year. We delivered GBP 102 million of free cash flow, ending the half with net cash of GBP 18 million. This year, the Board has declared an interim dividend of 15p per share, an increase of 7.1% year-on-year, reflecting our strong financial performance and our confidence in future growth. And with our strong cash generation, healthy balance sheet and an ongoing commitment to our published capital policy, the Board has also decided to pay a special dividend of 40p per share. So now let's get into more detail on these numbers. Starting with sales and market share gains. Total sales for the 26-week period to the 31st of December 2022 increased by 5% to GBP 835 million. Compared to FY '20, which was the last fully comparable period, total sales have grown by 43%. Just to note, in the half, the year-on-year growth rate did include a benefit of about 2 percentage points from the timing of our winter sale, 6 days of which fell into quarter 2, so this impact will reverse in H2. We saw growth both in stores and online with digital sales now making up 34% of total sales, up 14 percentage points since the first half of FY '20. Digital sales growth was particularly strong in the late autumn and run-up to Christmas, reflecting a very relevant product range and continued focus on outstanding value for money at a time when customers were facing high inflationary pressures. We saw broad-based growth across categories. As well as the products that Nick has commented on, we saw good sell-through of our Christmas lines and a wide range of impulse buys like candles. Our make and mend and haberdashery categories have also performed well as customers think about repairing and up-cycling. As Nick said, the homewares market share benchmarks from GlobalData reference the calendar year. And in calendar year 2022, while the homewares market declined by about 2%, we reported good growth with our market share increasing by 160 basis points to 10.8%. We also gained share in the furniture market, albeit from a smaller base. And now on to gross margin. We delivered a gross margin of 51.1%, which was in line with our expectation that it would reduce from a temporarily higher level during the pandemic period, and it was therefore 170 basis points lower than H1 FY '22. This included a modest gross margin headwind of about 30 basis points from the timing of our winter sale. We plan our purchasing around 2 seasons a year, giving ourselves good forward visibility of input costs including for freight and foreign exchange, which alongside product innovation and category-level pricing decisions, gives us confidence in achieving our planned gross margin rates. Looking ahead, we expect H2 gross margin to be lower than H1 due to the impact of the 2 sale events in the second half. And therefore, our full year gross margin expectation is still in line with our previous guidance of around 50%. When it comes to operating costs, we have a culture of operational grip and of making every pound count. Total operating costs in H1 were GBP 305 million, representing an operating cost ratio of 36.6%. The operating cost ratio benefited from the timing of the winter sale in quarter 2, which increased sales in the half with relatively little additional operating cost. The prior year operating cost-to-sales ratio was also low, reflecting exceptionally strong sales, particularly in stores. Inflationary pressures, mainly on wages, increased operating costs by around GBP 8 million net. We worked hard to mitigate the impact of these increases through operational efficiencies in stores and in our supply chain. In H1, we saw GBP 6 million of investment associated with 3 new store openings and the annualization of the new supply chain sites, which became operational in the second half of HY '22. Meanwhile, supporting the ongoing digitalization of the business, we invested a further GBP 11 million building capability. We're realizing the benefits of these investments through our sales growth and through better data management, leading to better insights. Nick will provide more color on this. As a reminder, our investment in technology is predominantly expensed through the P&L and has been managed within our tightly controlled cost-to-sales ratio. The last year of impact of the withdrawal of business rates relief introduced in response to the pandemic increased operating costs by GBP 3 million in H1. We do expect to see some further inflationary cost pressures in the second half, mainly driven by wages, and we will continue to invest in our digitalization plans. These increases will be partly offset by continuing to remove the costs that we described last year as temporary, which is related to our new supply chain operations and higher stock holding. Some of these reductions started to come through in H1. This next slide covers interest, tax and EPS. Net finance costs of GBP 4 million included interest on IFRS 16 lease liabilities of GBP 3 million. That was very similar to last year. The year-on-year increase primarily related to foreign exchange gains on the revaluation of U.S. dollar balances last year, which didn't recur this year. Profit before tax in the period was GBP 117 million compared with GBP 141 million in the same period last year. And profit after tax of GBP 93 million reflected an effective tax rate of 20.8%. The increase in the effective tax rate is broadly in line with the increase in the U.K. headline rate of corporation tax effective from April 2023 but spread across the financial year. As a reminder, our effective tax rate is typically slightly higher than the U.K. headline rate due to the usual disallowable expenses. Basic earnings per share for the period were 46.1p compared with 55.9p in H1 FY '22. Diluted earnings per share were 45.8p compared with 55.4p in the same period last year. And now moving on to cash generation. The group generated GBP 102 million of free cash flow in the half year with a strong cash conversion of operating profit to free cash flow of 84%, higher than the 74% in the prior period. The improvement primarily related to the working capital position. There was a very small working capital outflow of just under GBP 2 million in the period, whereas the prior year outflow of GBP 21 million reflected the decision to increase our inventories to mitigate against the risk of supply chain disruption. Inventories at the end of the period were GBP 233 million compared with GBP 223 million at the end of FY '22. We still expect inventory levels to reduce during H2. In the meantime, we're comfortable with the quality of our stock. And just to remind you, our stock is largely continuity product with good sell-through. We carry over very little seasonal stock, and we have a relatively small amount of range change in any 1 year. Total capital investments in these first 6 months of the year was GBP 12.5 million. This included around GBP 10 million spent on the 3 new stores opened in the period as well as refits of 7 existing stores and store decarbonization initiatives. Cash tax paid of GBP 18 million was GBP 3 million higher than the same period last year as that period included R&D credits received in relation to FY '21 claims. And in the period, the group spent GBP 7 million purchasing shares to be held in treasury to satisfy future obligations under its employee share schemes. After total dividend periods in the period -- after total dividend payments in the period of GBP 52 million relating to the final dividend declared for FY '22, the group ended up with a first half with net cash of GBP 18 million. We believe that our straightforward capital allocation framework helps to deliver attractive shareholder returns. Over the last 10 years, we've returned around GBP 1 billion to shareholders in the form of ordinary and special dividends with an ordinary dividend compound annual growth rate of 11%. This half year, reflecting the strong performance to date and confidence in our prospects, the Board has declared an interim ordinary dividend of 15p per share, 7.1% higher than last year's interim dividend. Our strong cash generation in the period has also enabled the Board to declare a special dividend of 40p per share, which will return the group to within its target leverage range of 0.2 to 0.6x net debt to EBITDA. And finally, I'd like to reiterate our FY '23 guidance. We're all still adapting to a new economic reality, and it's not clear how consumers will respond to continued inflationary pressures in the coming months. However, from the input cost visibility that we do have, we continue to expect a gross margin of around 50% for the full year. We are anticipating some further inflation within operating costs, particularly given the increase in the national living wage in April. We'll also continue with our digitalization plans, which Nick will describe in more detail. We expect these increases to be partly offset by lower stock holding costs as we reduce our inventory levels. And we still expect a modest working capital benefit as inventory levels normalize. We now expect CapEx for the year of between GBP 20 million and GBP 25 million, depending on the timing of new store openings. And our effective tax rate will be slightly above the headline rate for FY '23, incorporating the new rate of corporation tax. Overall, our profit before tax expectations for the full year are unchanged. So thank you so much for your attention. And with that, I'll hand back to Nick to continue with the updates.

Great. Thanks very much, Karen. So how are our plans evolving post pandemic? How much opportunity do we see? And how are we going to seize it? Let's start by saying that we see a very significant market share runway ahead. Dunelm operates in the large and fragmented markets of homewares and furniture. And these markets break down into a significant number of further product categories, often with very different and fragmented competitors in each. The combined market size is about GBP 23 billion, with our share of this total market being about 7%. In this graphic, we've indicated our current GlobalData market share in the approximately 15 categories that they report on, which covers about 80% of our total sales. It excludes some of our seasonal ranges, and it excludes rugs, which is classified in the floorings market rather than the homewares or furniture markets. On the right of the graphic in darker shades, with higher market shares tend to be our longer-established categories such as ready-made curtains and blinds and bedding. And these categories account for 1/3 of the market. In the remaining categories, our shares are below 5%. And for simplicity, we've put together all the furniture categories in which we operate. Typically, in these categories, we find ourselves at a relatively early stage of maturity in terms of product capability. So as we develop more of what we call product mastery alongside our suppliers, we start to grow. There is significant growth opportunity across the runway. We have never been more confident about our ability to grow our total share beyond 7% in aggregate as well as our share of each and every one of these categories. Indeed, our highest rates of growth in categories are evenly spread across all 4 tiers shown here. Our approach to growth along this runway is entrepreneurial. As we learn, we invest and build, which in turn opens up new opportunities to learn and invest again. We call this our plan to become our customers' first choice for home. Our purpose, our ambitions and our shared values are constants, and I hope they're familiar to you over the years. But our priorities are evolving as we start to understand some of the key dynamics, which we are seeing. We're strengthening our customer offer, particularly in the area of choice and value. We are still digitalizing our business, but we're entering a new phase of this, which I'll explain. And we're developing further our marketing ecosystem. This is an update on our thinking on our progress and our plans, and I'll pull out the so-whats as we go through it. In terms of product, the so-what is that never before have so many consumers been reevaluating their spending and shopping habits. It's volatile, but it's also filled with opportunity. Our insight is that customers are working hard to be savvy, and many feel like they're doing it pretty well. In our categories, they are not trading down to lower-quality tiers so much as being more demanding on what they get for their money at all quality tiers. That means there's never been a better opportunity to win on value. The sideboard in this picture is a lower-priced alternative launching this spring to a best-selling line but at a significant saving because it requires self-assembly. Doing this, making products that are self-assembly, that are beautiful and high quality at the lowest-priced good tier, requires product mastery, deep knowledge of customers, sources, materials and production. We're building more of that into our furniture capabilities, although still with a way to go, and products like this are the result of it. Mastering the science of sustainability also gives us scope to win over new customers. Our Conscious Choice collection now runs to 7,000 items with strict criteria for inclusion, typically over 50% by weight sourced from more sustainable materials. It's also priced to be affordable. The throws I talked about earlier are part of a range of over 20 brightly colored cushions and throws priced from GBP 5 to GBP 35 made from post-consumer products, including those generated from our very own take-back schemes in store. And finally, we're also offering more choice, adding more curated choice from trusted vendors typically in the categories where we have less in-house product mastery. This allows us to more quickly test new products and increase the choice available to customers introducing almost 10,000 more lines in the half. As you know, we've been focused on investing in technology for a number of years now. We've talked about this through examples in the past, but I would like to share with you now a clearer overview and pull it all together and also share that we're entering, we think, a new phase. Digitalizing the total business means not just digital experiences on dunelm.com but the wider introduction of technology across the whole business and the use of the data that this generates to improve our proposition and operational efficiency. Initially, the business was seeking to catch up. In 2018, Dunelm digital sales were less than 15% of our total sales, and we still talked about the website as being our biggest shop. We then worked hard to launch our own digital front ends in the autumn of 2019, gaining confidence in investing in technology as we went. In 2020, at the same time as the pandemic, we scaled up significantly and created 5 focus areas, which we've run with consistently since then and continue to do so, setting up product management skills, roadmaps and engineering crews across each one of them. I'll now run through the key things we've been working on in each of those 5 areas. Data and insight is an overarching focus on building the data platform, which is now live, the tools, definitions, reports and data skills to manage data across the business. We're focused on a single customer view, an enriched view of network stock and a conformed view of product attributes across the business. Commercial operations is a focus area building new key capabilities in product data management and forecasting and replenishment. In essence, these are capabilities that are supplanting things which we currently do either in our SAP systems or manually in our commercial teams. SAP will carry on being the central system of record for us, but we're putting more functionality into more advanced tools alongside it where we see benefit. Customer marketing is a focus area that's developed our single customer view and the marketing tech stack to manage audiences and content distribution. Shopping experience covers the site and our stores, developing new payment services, for example, and developing the devices in store used by colleagues. We're also building out a more complete shopping experience online, particularly for higher service categories like made-to-measure curtains and blinds. And finally, in terms of our focus areas, post-sale experience is focused on the quality and efficiency of our delivery and support services as well as our warehouse operations. And the stage we've now reached, and we're excited about this, is that we're starting to now leverage what we've built to improve our customer proposition and productivity. At the same time, we'll continue to further build out new capabilities in those 5 focus areas. So we've called this new stage we're entering, building and optimizing. Now what I've described isn't a map of our technology. It's not its architecture. I haven't covered the ongoing work we do, for example, to develop our serverless cloud platforms or the development of our core SAP systems, but it does give you a sense of how we think about technology. We learn and we invest as we understand more, but we're also disciplined. It's as important to us that our total digital system is cost effective, as it is that it's fully formed and fit for the future. As I said, we're starting to unlock the improvements to our proposition and productivity from these sorts of investments. And I've listed 12 of them here, half done and half in progress, half driving growth and half driving efficiency. A couple of examples to bring this to life. We're focused on improving perfect order rates in home delivery, measured in terms of lead times, service levels and the quality of customer communication and having fewer split deliveries. Over the next 12 months, we'll start to get to our goal for where we want to be for customers. But already, we're seeing the benefit of improved order tracking, reducing post-sale contacts and reducing costs from fewer split deliveries. We're making better data-informed decisions to flex store space and range to the market opportunity of each catchment. This, in turn, is opening up a wider playbook of store sizes that we'll consider in target catchments. The store I pictured earlier, which is in Feltham, is 15,000-square foot sales space, half the size of a typical Dunelm out-of-town store and opened in December. We'll be opening a greater variety of store sizes going forward. And bottom right, we're about to leverage the customer platform we've been building to offer more personalized marketing activations, experiences and content. We've come a long way on marketing over the years, but we see a lot more scope to develop further. On the right, you can see and it's rather detailed, a picture of our customer data platform. We've now matched 5 years of customer profiles across our channels and combined this with the digital journey data from Google Analytics and delivery and product review data. In the coming months, we'll add customer demographics and marketing engagement. By the summer, we'll further improve the quality of matching across channels for our customer profiles when we move our payment services platform in stores to the same one that we use online. When we do this, we'll get another key identifier to allow us to better match cross-channel customer transactions in the form of tokenized card details, which we'll be able to back date for 2 years when we launch this new platform. We've recently built a predictive churn model from the customer data platform, which is running an automated life cycle campaign to reduce lapsing. But more personalized content will be coming into play in the coming 12 months, giving us better customer experiences and more cost-effective digital marketing. Indeed, having a cost-effective marketing ecosystem is a goal we've been nurturing for a while. Without an enormous product catalog, it used to feel hard to achieve, but we're excited by what we're doing and by what we've seen in our paid marketing returns in the first half of this financial year. This combination of a national brand, effective digital advertising and the growing followership we have in our store-based community work, we see now as a key advantage, especially when combined for our audience with unique product content across multiple home categories. So having begun this section with a picture of our market share runway, we're now talking about our customer runway, meaning more active customers and a higher shopping frequency, as we become the first choice for home for more of them. Our own data platform and personalization is a significant step-up in our ability to attract and develop our most valuable multi-category customers that we've talked about to you in the past. You may recall that our most valuable customers shop with us 5x more frequently and spend 7x as much in a year as a typical customer. So I've run through some examples of the work we're doing on our offer, our technology and our marketing. And I hope from them, you see why we are so confident about the future. But let's end by returning to what we've actually achieved so far this year, namely further growth in customer numbers, frequency and market share and therefore, sales with very resilient margins. And if you'd like to be a bit more up to date, as Karen mentioned earlier, we've had a very strong winter sale. Looking forward, our expectations for full year profit remain unchanged. We've seen our customers be resilient to date, but the consumer outlook, as Karen has said, remains unpredictable. We'll be taking nothing for granted, but we see so much opportunity to build sustainable and profitable growth, and we're very excited about the runway that we're on.