Eurocell plc (ECEL) Earnings Call Transcript & Summary

Good morning, and welcome to the Eurocell plc Investor Presentation. [Operator Instructions] The company may not be in a position to answer every question received during the meeting itself. However, the company, [ for all your questions submitted today ] in public responses where it's appropriate to do so. Before we begin, I'd like to submit the following poll. Now I'd like to hand you over to Darren Waters, CEO. Good morning.

Thank you, Paul, and good morning, everyone. Welcome to Eurocell's H1 results presentation. I'm Darren Waters, CEO, and this is my first results presentation via the Investor Meet's platform, having joined the business in April. Sitting alongside me is Michael Scott, CFO, who I'm sure needs no introduction. Now most of our peers have already reported on their H1 numbers, so I'm not going to repeat stuff that you've already heard. But the first half was a lot tougher than we expected with profit before tax at GBP 6 million, down 60% versus the same period last year. Q1 was particularly tough for the business due to a combination of lower seasonal volumes and a softening market, especially in new build. In response, we've acted quickly to reduce our cost base and improve working capital, which has resulted in a better cash performance versus the same period in 2022. And as a result, I'm confident that we are now strongly positioned to benefit from a recovery in our end markets whenever that happens. I'll talk more about that at the end of the presentation. So let's start by talking about the market, which has been challenging for us, given our exposure to new build and RMI markets. As you'll know, new-build housing has been hit hard by aggressive increases in mortgage rates. And whilst the CPA and our forecasting a decline of 19% this year, the reality of what we're seeing is a lot worse than that. And in fact, we estimate that there's been a 30% contraction in new build in the first half. New build accounts for 35% of our profile sales or 15% of our total revenues so a 30% drop in activity in that sector equates to a 5% reduction in our top line. So that, therefore, accounts for the bulk of the 6% drop in our first half volumes with the remainder coming from a lower decline in RMI activity, which has been a lot more reversed. In terms of RMI. FENSA, which is the Fenestration Self-Assessment Scheme, they maintain a register of the number of door and window installations and their data shows a decline of 8% in the first half with quarter 2 down 12% versus 2022 And while FENSA doesn't cover all installations, it's a really good barometer. So against that backdrop, we delivered a resilient sales performance with revenues down just 2%, with the upside coming from pricing actions and share gains. In June, the UK Window and Doors Group announced plans to shut their Duraflex extrusion facility at Tewkesbury to concentrate on window fabrication. And in fact, they ceased production at the end of last week. We estimate that Duraflex account for around 6% of the PVC profile market. UK Window and Door Group are also the largest fabricator in the U.K. And although we held discussions with them, we were not willing to take the business at any price, and they subsequently elected to contract with VEKA instead. In June, though, we announced that we have secured Polyframe, Duraflex's largest external fabricator, and they have successfully transitioned across to us during July and August. So in terms of our response to this, let me start by reminding you that in late 2022, we divested the loss-making security hardware business and reduced our cost base by GBP 5 million including the removal of 65 roles. Despite these actions very early on in my tenure, it became clear that the business was geared up to higher volumes. And so we took decisive action to further reduce our cost base by eliminating around 100 roles, of which about 1/3 has been achieved through natural attrition. We managed to complete this restructuring exercise by the end of June, and that will deliver GBP 2 million of savings in H2, and therefore, GBP 4 million annualized thereafter. We've also taken a more disciplined approach to trade working capital by reducing inventory levels significantly beyond the drop in sales volumes, without impacting service levels as measured by our [indiscernible] performance, which remains at 97%. We've been able to do this because our operational performance is now much more predictable and consistent, which we've highlighted in the graph opposite. Inventory as a percentage of the last 12 months cost of sales has fallen from a peak of 37% to 26%, representing an GBP 11 million improvement in stock levels. Also worthy of note is a reduction in capital spend to a predicted GBP 9 million this year compared to an average of GBP 14 million over the prior 3 years. And lastly in manufacturing. Our adherence to production plans has improved from an average of 90% to 95% with less variability from month to month. Aside from a material reduction in demand, we've also had to manage rising input costs, particularly on recycling feedstock and energy. Those costs have been passed on to customers through a combination of surcharges and price increases but a lag in the implementation of these during Q1 meant that our margins were squeezed. In-feed costs have risen much faster than we anticipated as recyclers have competed for reduced availability of post-consumer waste due to a contraction in the replacement window market. And you can see the impact of this in the graph opposite with in-feed prices more than counteracting the reduction in virgin resin costs. We've now recovered those cost increases through pricing actions, but some of that benefit has been offset by margin leakage in our branch network due to the increased competitive activity. To combat the impact of rising in-feed prices, we started to target waste generators direct, bypassing waste aggregators with 80 contracts already signed, representing 20% of our annual requirements. It's also important to say that despite an increase in feed prices, recycling still delivers a cost saving compared to virgin resin, which Michael will pick up later. The actions that we've taken to reduce our cost base will not inhibit our ability to increase output. This, coupled with a 10% year-on-year improvement on operational efficiency, means that we stand to benefit from a positive operational gearing effect when markets recover. Eurocell has long been seen as an innovator in the door and window market. And following the successful introduction of our Garden room range, we just announced the launch of our new extension system, which will revolutionize the way that people extend their homes. Our EurXtension system combines our market-leading high-performing products, along with our passion to design innovation and model methods of construction. The results, as you can see here, is a stylish and affordable alternative to traditional extensions that can be erected in a fraction of the time. We see significant potential for this product as it can be fitted onto an existing concrete base, replacing tired, old conservatories that are not habitable in extreme temperatures by being too cold during the winter and too hot in the summer. Early lead generation results from our initial social media campaign have been very encouraging. In fact, we've now sold our first 2 extensions, and whilst it's very early days, we expect this new product category to make a positive contribution in 2024 as homeowners look to extend and create more living space rather than new. I'm now going to hand over to Michael, who will walk you through some of the financials.

Thanks, Darren. So I'll start by going through the financial highlights. Against a very challenging market backdrop, we delivered some resilience in our sales performance. Revenues were down 2% overall, with volumes 6% lower against an extremely strong comparative period. Price remains a significant component to sales, and we continue to recover persistent input cost inflation with selling price increases and surcharges. As expected, adjusted profit before tax decreased by 62% compared to H1 2022. This reflects lower sales volumes and competitive pressure on margins in the branch network as well as the impact of significantly higher recycling feedstock prices, which were up 66% compared to the first half of last year. More positively, overheads were 3% lower than H1 2022, which includes the benefit of actions taken to lower our cost base in response to declining volumes. In the light of difficult and deteriorating market conditions, we have prioritized cash flow, and I'm pleased to report net cash from operating activities of GBP 20.9 million, up 15% on H1 '22, with efficient stock management driving a good working capital improvement so far this year. As a result, net debt at 30 June was GBP 15.2 million on a pre-IFRS 16 basis compared to GBP 14.4 million at the end of 2022 and GBP 15 million at June last year. We have good headroom on our debt facility, which was extended by a further year in May and now matures in 2027. Moving back to the P&L. Adjusted earnings per share were 4.3p, down 63% in line with adjusted PBT and interim dividend is 2.0p per share. The full P&L is set out on Page 8, and I'll come on to the drivers of our sales performance and profits in the following slides. But first, to the right on this page is the financial impact of actions we've taken on cost in response to weakening markets and lower volumes, which drive GBP 9 million of annualized cost savings, the detail of which Darren covered earlier. The non-underlying charge of GBP 2.5 million in H1 '23 includes termination costs of GBP 1.8 million for the headcount reduction in Q2 this year. It also includes implementation costs of $0.7 million for strategic IT projects. These costs have been charged through the P&L rather than capitalized in accordance with the new accounting rules for solutions, which are cloud-based known as Software-as-a-Service. They've been treated as non underlying on the basis that they are material, multiyear projects, which underpin our digital strategy, and I'll pick up the specific projects later in the presentation. Moving on to the components of sales growth. Total sales were down 2% against an extremely strong comparative period in H1 last year, with overall volumes down 6%. We think this demonstrates resilience in the face of very tough markets. As you know, RMI is being impacted by weak consumer confidence reflected in homeowners pulling back on discretionary spend in response to higher cost of living, reduced housing transactions and a fall in planning applications for larger residential improvements. We're also seeing a severe decline in new build housing activity, reflecting successive interest rate increases. Profile sales down 1%, with volumes 5% lower, reflects this reduced RMI and weaker newbuild activity, partially offset by the benefit of market share gains with 29 new accounts won in 2022 and 18 smaller new accounts added in the first half of '23. As a reminder, new accounts tend to come on stream over a 6- to 9-month onboarding period. Building Plastics sales were down 3%, including volume 6% lower, with RMI activity in the branches subdued but steady, although it is encouraging to report that we are still seeing reasonable volumes for high-value project work. On to adjusted operating profit. Profit of GBP 7.6 million represents a decrease of 56%, down as expected against a very strong '22 comparative. Looking at the detail and moving left to right across the chart. The volume bar of GBP 4.3 million includes the impact of sales volumes down 6% and the adverse effect of operational gearing. Moving on to margin of GBP 4.2 million. We continue to offset input cost inflation with selling prices and surcharges, but increased competition for limited demand led to an increasingly difficult pricing environment and margin pressure in the branches. Continuing along the chart. As you know, we also mitigate raw material cost increases by using recycled material. However, first half profits were significantly impacted by feedstock prices 66% higher than last year, leading to increased costs of GBP 3.5 million. This was driven by reduced material availability following a contraction in the window replacement market. We've been working hard to secure additional sources of supply, which alongside reduced demand and lower virgin resin costs may see feedstock prices fall in H2, and we have seen signs that they're now beginning to ease. Looking beyond the chart. Whilst the delta between the production cost of recycled material and the buying price of virgin compound narrowed significantly this year due to increased feedstock prices and lower virgin costs, it is important to confirm that the economics of recycling remain attractive. The 9,100 tonnes of recycled material we consumed in H1 delivered an absolute gross margin benefit of approximately GBP 1.4 million compared to the cost of using virgin material. Moving along the chart. Labor inflation of GBP 1.6 million represents our April '23 pay award of 5%, which is offset by lower variable costs being reduced bonuses and share-based payment charges in the first half of the year. Finally, restructuring savings of GBP 2.5 million represent the benefit of the cost reduction program completed in Q4 '22. In summary, profits are down as a result of lower volumes, margin pressure in the branches and increased recycling feedstock prices. However, the actions we've taken to reduce cost position the business well to benefit from positive operational gearing when markets recur. Moving on to CapEx. Investments of GBP 3.8 million in H1 was mostly maintenance CapEx. We spent GBP 1.6 million in extrusion, including new tooling, and GBP 0.7 million in Building Plastics to improve welfare facilities. Our guidance for '23 is for total CapEx of approximately GBP 9 million. This is again primarily maintenance CapEx and also includes GBP 1 million to develop our IT infrastructure, including hardware replacement and a new customer-facing website. In accordance with the new accounting rules, implementation costs for IT solutions, which are cloud-based Software-as-a-Service are charged to the P&L rather than capitalized. Our new HR Information System and ERP replacement fall into this category, for which GBP 0.7 million has been charged to the P&L in H1 as a nonunderlying item on the basis that they are material, multiyear projects, which underpin our digital strategy. As a reminder, our existing ERP system will be unsupported by SAP after 2027. We also believe that its age profile has become a limiting factor in the development of our business. The current system was implemented in 2006 when the group had only a small branch operation and no recycling. We have, therefore, started a project to upgrade or replace SAP with the principal tasks for this year being scoping and system selection. Thereafter, we anticipate implementation to be a 2- to 3-year process. And whilst it's very early days for the ERP work, we estimate the total implementation costs for the 2 projects will be in the region of GBP 7 million to 9 million for that period, most of which relates to ERP. Coming back to CapEx and to sum up. The chart and tables illustrate the significant investments we've made over the last few years to build out the infrastructure required to resolve operational constraints. As a result, we now have manufacturing, recycling and warehousing capacity in place well ahead of demand, which is another important component of being ready and well placed to benefit from a market recovery. Moving on to working capital, where a net inflow of GBP 4.2 million includes the benefit of our stock reduction program. Stock days were 86 compared to 93 at December and 101 at June '22, with stocks themselves down GBP 6.4 million in the first half. It is worth reminding you that following significant supply chain disruption in 2021, we took advantage of raw material availability to build manufactured stocks at the end of that year and early in '22, to protect against the possible impact of raw material shortages. However, once we established supply chain and operational stability, we began to reduce our stock position. As a result, stock levels fell by GBP 5 million in the second half of '22, and by a further GBP 6 million in H1 '23, which includes the benefit of lower input costs, and there remains a further opportunity for the remainder of this year. On the sales ledger. Debtor days were 34 compared to 30th December and 36 at June '22, with the absolute balance of receivables up GBP 4.5 million in the first half, reflecting the impact of selling price increases and seasonality. Finally, the payables increase of GBP 2.3 million since December '22 also reflects the impact of seasonality and inflation. Looking ahead to the full year. We are now guiding to an inflow of at least GBP 5 million, which represents a substantial improvement on guidance issued at the beginning of the year, reflecting in the light of deteriorating market conditions, our major focus on working capital and efficient cash flow management. So to sum up on Page 13. Our financial results in the short term have been impacted significantly by a continued deterioration in market conditions. Against the strong comparative sales volume in the first half was down 6%, adjusted PBT was down 62%, reflecting lower sales volumes, margin pressure in the branches and recycling feedstock prices higher than last year. In response, we've acted on costs, securing annualized savings of approximately GBP 9 million, of which GBP 7 million will be realized this year and focused on efficient stock management and cash flow, without compromising customer service or our ability to grow. Our operating facilities are well invested with good levels of available capacity. Our debt is low, and we have good liquidity on our recently financed bank facility. We, therefore, believe the business is well placed to benefit when markets recover. And with that, back to Darren, to sum up and cover the outlook.

Thank you, Michael. I think kind of more positive note, we've seen some easing of input costs in Q2, and that's continued into Q3. And that, along with disciplined price management, has helped us to rebuild margins to a more sustainable level. I think this, coupled with the cost savings that we've talked about that we enacted back in June. All of that will help us deliver an improved profit performance in H2 relative to H1. However, since our July trading update, the market has deteriorated further and there is a real risk that we won't see the normal seasonal bounce in autumn sales. Therefore, when we announced our half year results earlier this month, we reduced our full year forecast to reflect the conditions that we were seeing at that time. That said, we still believe that the fundamentals that drive our business remain strong. Firstly, demand for new housing has not gone away. It's just a matter of affordability, particularly for first-time buyers. Second, higher energy costs provide an incentive to homeowners to invest in improving their homes to make them more thermally efficient, which should lead to an increase in demand for triple glazing such as our Modus profile system. And finally, the appetite for outdoor living and connecting that seamlessly to the home continues to grow. We are well placed to satisfy that demand with our range of Garden rooms, decking and fencing products and now extensions, all of which incorporate our range of patio doors. The closure of Duraflex removes capacity from a market that was oversupplied and that will create growth opportunities as end markets begin to recover. Looking further ahead, we are midway through a review of our business strategy, which has already identified several organic growth initiatives as well as opportunities to capture further cost savings through better procurement, footprint rationalization and other efficiencies. Now these initiatives will take time to deliver, but this gives me real confidence that we can not only weather the market downturn, but emerge far stronger when markets recover. That concludes our presentation, and we look forward to answering any questions that you may have and in fact, I think there's a couple already on the board.

Fantastic. Thank you very much, indeed, Darren and Michael, for the presentation. [Operator Instructions] I'd like to remind you, the recording of the presentation, along with a copy of the slides and the published Q&A can be accessed via your investor dashboard. Michael and Darren is going to probably come us back up. And Michael, if I may, just hand over to you just to start at the top. Read out the question where appropriate to do so and take it or direct it to Darren for your response. I'll pick up from you at the end.

Thanks, Paul. Okay. First one here from Stephen. "Hard markets generally offer opportunities. Can you look to reduce/consolidated competition to improve margins and sales?"

The answer to that is yes. So as I've said, Stephen, we've already secured Polyframe, which we announced back in July, which was Duraflex's largest external fabricator. That business successfully transitioned across to us during July and August and is now going at kind of full pelt. And hopefully, there will be more like it and it's something that we're continuing to progress. So yes, absolutely, it's part of our strategy.

Second question here from Alex, "What level of sales do we need to see for the benefits of the cost reduction program to make a difference?" Look, the cost reduction program is going to make a huge difference, whatever the level of sales. We have secured GBP 9 million of annualized savings, of which we'll see GBP 7 million this year. And we're absolutely confident that, that full GBP 7 million will be realized. You saw GBP 2.5 million in the first half of the year. So whatever happens to markets going forward, we'll see a significant benefit from those savings with a tailwind of a further GBP 2 million falling into next year. When we're also expecting some easing around input costs as well around electricity and recycling feedstock as well. So look, whatever the sales, we're going to see a significant benefit there. Next question is about recycling. "So your current recycling footprint produced 29% of consumption in full year '22 and 32% in half 1 '23, with a target of 33% consumption overall. Does this 33% reflect current capacity limits in the current recycling facilities?" So I'll answer that part first. The 33%, the [ seeding ] on 33% is not our own ability to recycle. It is the feedstock available in the market. We're already taking a substantial proportion of the feedstock available. And we're conservative on our ability to grow this proportion significantly from here because of the limited feedstock that would be available for us to do that as well as grow sales when markets recover. So I would continue to think about 33% as the right number here. And remember when we're saying that, that recycled is only used in our rigid profiles. So that is the profiles that are used for window and door frame. It isn't used in our phone product. That is the roof line product so fascias and soffits, which is a function of the replacement market for fascias and soffits and the nature of that production. "Is there a product-based ceiling on recycled extrusion? Could you go to 100% in certain products, for example?" We do produce a number of products that are made from 100% recycled material. Those are products such as cavity closers, which are not exposed to daylight effectively. The products that are exposed to sunlight, we would always wrap in a virgin skin in order to -- look, when we're recycling windows, we don't know how long ago those windows were made. They could contain lead stabilizers. So the regulations require us to put a virgin skin around the product, which constrains the amount of recycled material that you could use. We also, given the age of the recycled material, the product could be subject to UV degradation. And therefore, the virgin skin assumes that, that does not happen. If I think about some of the products that we've got that have -- it's not untypical for a rigid profile to have 60% or slightly more content of recycled materials. So that will give you a sense of how far we can take this from a production perspective. And given -- final point here, given the long term, "Given the positive economics in recycling, what would the long-term aspiration for recycled extrusions as a percentage of consumption be"? I think I covered that one. I think of it at this point in time, it's 33%. One for Darren here. "Could you please discuss competitive landscape? Who are the main competitors? Are you facing pressure from imports?"

Yes. So the main competitors were up against in terms of profile or extrusion, first of all, with the Epwin, who are listed on the end market. Obviously, U.K. business, Linear, who were acquired by [indiscernible] about 4, 5 years ago. VEKA and REHAU, who are both the German businesses who both extrude here. And Deceuninck, who are a Belgian business that also extrudes in the U.K. but import compound from the Belgian operations. Those are our main competitors in the profile business within our branch network. In respect of these 2, it's a privately owned business called [ Gap ] and also Epwin who operates around 60 branches. So -- and the question around imports, are we facing any pressure from imports? Not really because virtually all of the product that is supplied into both channels, whether it's the branch network or indeed our fabricator base, it's pretty much all manufactured in the U.K.

Next one from Alex, "With input costs lower, how much storage capacity do you have?" In terms of storing raw materials, it's not that significant. It's a handful of days because the principal raw material, so PVC compound is stalled in silos. We probably have 6 or 7 days worth of silo storage for raw materials, which is why we hold -- why we need to hold a reasonable level of finished stocks. That said, as you heard in the presentation, finished stocks are coming down, stock days overall now at 86. But that's not taking any risk with the business. As I said, the reduction in stock that we've seen so far is really eliminating the incremental stock that we built to protect against supply chain disruption late '21, early 2022. So there's more work to do to optimize stocks. But we -- because of the limited raw materials that we can hold, we will always hold a reasonable level of finished goods inventory. Question on capital allocation [indiscernible] here. Any thoughts on buybacks? Any preference on buybacks over dividend? Is dividend at risk? Look, the current capital allocation policy of the business is for organic CapEx, followed by an ordinary dividend at 2x cover, followed by selective M&A. Nothing on the table around M&A at the moment. And then we would look to hold an efficient balance sheet. Now that said as Darren spoke to during the presentation, we are reviewing our strategy at the moment. That's identifying a number of initiatives. So we'll need to understand the capital requirements of those initiatives, alongside maintenance CapEx and the IT projects that we've got going. But alongside that strategic review, we will also be looking at capital allocation policy. And so I don't want to sort of front-run where that might end up other than to say that capital allocation policy will look at the capital needs of the business. It will respect the ordinary dividend that I know is important to our shareholders. But we'll also determine a level of debt that is appropriate for the company on a through-the-cycle basis. And there may -- there have to be a consideration of special distributions reflective of what that debt should be over the course of time. But at this point in time, that remains work in progress. And as we conclude the work on strategy, we will comment on capital allocation at that time, too. And then another question here. "Are you facing any pressure from leases? What do expect for rent cost going forward?"

Yes. Well, I mean, typically, our trade counters are -- the sites are between 3,000 and 8,000 square feet. They are generally in locations, which are in reasonable demand in terms of other tenants, particularly wanting to take those sites. So our lease is typically for a 5-year period. So when they come up for renewal, generally, the renewal costs are slightly higher, as you would expect in what is still a fairly buoyant commercial market. But there is -- it's a small part of the running costs of a branch. Most of the costs are around, obviously, the people. And so no, in terms of pressure, no, as part of our branch strategy, we are reviewing what is the optimum format for a branch moving forward. And I suspect what you will begin to see us do is potentially in some instances, look to relocate because I think where we're going with the brand strategy is that we're probably gearing towards a larger format store so that we can showcase some of our made-to-order products, which generate high-value sales. So it's something that we keep under review all the time but we're not seeing what I would call particular pressure in terms of lease costs.

That's fantastic. Thank you very much. And as you have covered for those questions from investors. Of course, if any further questions come through, the team will have the ability to review those. And will publish responses where appropriate to do so on the Investor Meet Company. And Darren, perhaps just before redirecting investors to provide you with their feedback, which knows particularly important to you and the team. I could just ask you for a few closing comments, please?

Yes. Well, as I said at the outset, I've now been in the business for 6 months, and I feel like I've got a good handle on the business and where it is. Lots of opportunity to improve this business, some of which we've already started on. And although the markets remain challenging, I'm very confident that with the team that we have here, the strategy that we're about to put in place, a bright future is ahead of us. And very confident that we will show progress in the years ahead as we look to execute on those plans.

Fantastic. Darren, Michael, thanks indeed for updating investors today. Can I please ask investors not to close the session. We automatically redirect it to provide your feedback. In order for the team can better understand your views and expectations, it's only going to take a few moments to complete and is greatly valued by the company. On behalf of the management team of Eurocell plc, we would like to thank you for attending today's presentation, and good afternoon to you all.