Ferguson Enterprises Inc. (FERG) Earnings Call Transcript & Summary

Good day. And welcome to the Ferguson plc FY '20 Q3 Webcast Call. Today's conference is being recorded. And at this time, I'd like to turn the conference over to Kevin Murphy. Please go ahead.

Thank you, Emma. Good morning. And welcome to this third quarter results conference call. You've got Mike and I presenting this morning. And naturally, we'd originally planned to be together doing the call today. But clearly, at the moment, this is impossible and we're certainly living in some interesting times. We did bring forward the Q3 update a little earlier than planned in May to ensure that we provide you with a rapid assessment of how we're steering the business through the volume declines in our markets as a result of the COVID-19 pandemic. So on today's call, we'll give you the sense of how we traded through the third quarter. This, of course, includes the first full month of trading since the business was truly impacted by the outbreak. But first, Mike will cover the Q3 numbers. We'll also give you some more color on the actions we're taking to protect the P&L and to ensure that we maximize liquidity. I'll then give you an overview of April trading across the group and what we've been seeing on the ground in our various businesses since the start of the outbreak in mid-March. I'll also cover how we're addressing the challenges that COVID-19 has brought and how we're supporting our associates to keep them safe. We'll also share with you how we're keeping our customers running as they support the critical industries that they serve. And of course, we'll allow plenty of time for your questions at the end. So first, let me hand over to Mike, who's going to take you through the Q3 results. Mike?

Kevin, thank you. And good morning to everybody from myself. I'll take you through the numbers briefly. All of the numbers that I'm going to talk about in the income statement are for the ongoing operations and on a pre-IFRS 16 basis. That aids for better comparability to both our peer group but also to prior year numbers. And you can see that IFRS 16 at about $17 million to the Q3 trading profit. Overall, group revenue grew by nearly 1%. We highlighted in the recent trading statement about a month ago now, revenues were strong in February and into March, but clearly weakened in April due to the wider outbreak of COVID-19. In the U.S., Q3 revenue was up nearly 2%, with growth of 8.2% in February and March, followed by 9.3% decline in April. We had acquisitions that contributed 1.3% for the quarter and another trading day. That was about the same, about 1.6%, to add on there. There's clearly a wide range across the states and across -- within our businesses in terms of those growth rates. We've clearly seen positive strong growth in Waterworks stand-alone business, and yet our traditional network sites have remained physically closed for the showrooms, though clearly operating virtual consultations. Kevin will get into that detail and give you much more color once I've got through the numbers. Gross margins were slightly lower, principally due to the mix of business. There's really been no discernible change to pricing at all, and inflation is pretty close to 0. We continue to implement cost actions across the U.S. and the wider group. We're utilizing hiring freeze, reduction in associate hours worked and temporary layoffs in the worst-affected regions. But as we set out in the trading update of a month ago, our mindset now is to stay very close to the cost base and ensuring that we preserve as many of the highly skilled and committed workforce that we have so that we can continue to position the company well for the future. I talked about acquisitions. They contributed $2 million to trading profit in the quarter, and we were clearly pleased to complete the acquisition of Columbia Pipe & Supply. Overall, pull all that together, that means group trading profit came in at $334 million. That's $5 million behind last year. Though, of course, we did have an extra trading day. Trading profit in the U.S. was $343 million. That's $3 million behind last year. And frankly, in the circumstances, a good number. Canada had trading losses of $1 million. That's $5 million behind last year, down to the lower revenues of some 30%, and with U.K. revenues down 60% in April. That had a trading loss for the quarter of $12 million. Our intention to demerge the U.K. business is unchanged, and we continue to progress that, although, clearly, the timing will ultimately be driven by the need for the market to stabilize. With regard to cash and liquidity, group remains in a strong financial position with about $3.1 billion of liquidity available to the business. This is made up of 2 main elements. The cash on hand at 30th of April, $1.3 billion, and a further $1.8 billion of undrawn facilities. Net debt, excluding leases, at the 30th of April was $1.8 billion. And the ratio of net debt to the last 12 months' EBITDA was 1x. I think given the uncertain current markets, we're going to continue to protect the cash position, having previously announced the suspension of the $500 million share buyback, pausing the current M&A activity and withdrawing the interim dividend. And we have reduced growth capital expenditure in the current financial year, and that means we'll probably spend somewhere in the region of $280 million to $300 million. That's the same number I gave you about a month ago. So whilst we're certainly not complacent here, the group has got a strong balance sheet. We've built in additional liquidity so that we can both protect the business in the short term as well as ensuring we continue to build our capabilities out for the long term of the business. And finally, it's worth noting that last week, we sold our investment in Meier Tobler in Switzerland for $31 million. This really completes our exit from all trading operations in Continental Europe, in line with our strategy to focus on North American markets. So with that, Kevin, back to you. Hopefully, you've got another cup of coffee in front of you. And over to you.

A bit early. Thank you, Mike. I'd really like to start by recognizing our 35,000 extraordinary associates who continue to support our customers, often in very difficult circumstances. And during these challenging times, we're incredibly thankful and proud of what they continue to accomplish every day. It's also gratifying to note that, in recent weeks, we've seen some of the highest ever Net Promoter scores across all of our businesses, which is a true testament to how much our customers appreciate the efforts of those associates. As the COVID-19 outbreak continues, we've remained firmly focused as a company on 3 key areas: protecting the health and well-being of our associates; continuing to serve our customers during the crisis phase of the virus, a time of critical need; and protecting and preserving the strength of our business for the long run. To safeguard the well-being of our associates and to support our customers, we implemented a series of actions following the guidance from governmental health agencies. We put in place clear guidelines to ensure that colleagues and customers follow specific health protection protocols. And we implemented social distancing at all of our facilities. We provided touchless signatures at point of delivery and at pickup. We put in place curbside pickup to serve our nondelivered customer transactions. We put an emphasis on our online channels to minimize any unnecessary physical contact and to support our customers to be more efficient. We temporarily closed our bricks-and-mortar showrooms and moved them to virtual consultations. And thanks to our IT teams, we were able to quickly put in place remote working practices. And today, in the U.S., for example, over half our workforce, some 14,000 associates, are based at home and supporting our customers. We're also playing a part to directly support the health impact of the crisis and so far have participated in more than 50 temporary hospital projects across the U.S., and we're working on similar projects in the U.K. and Canada. To date, these projects have created more than 12,000 additional patient beds in the U.S. in often challenging environments in parking lots, in parks and in convention centers. In New York, where most of the cases are in the U.S., we created a 24/7 emergency will call 1-hour pickup counter that was focused on servicing local hospitals across the New York metro area. In addition, as hospitals and health departments responded to the surge in COVID-19 patients, Ferguson donated approximately 70,000 N95 face masks to health care organizations. To date, the deliveries of masks have gone to hospitals across the U.S. from California through Virginia. It's been really phenomenal effort so far, and we're really proud of how our people have risen to the challenges. Let me turn to current trading and give you a little bit more color about what we're seeing on the ground. I'm pleased to say that, with pretty few exceptions, the group's traditional locations in the U.S., Canada and the U.K. have remained open and quite active. As we told you in our recent trading update, we closed the showroom network in mid-March, and we've been operating virtual consultations with customers. Now we're starting to roll out face-to-face consultations with customers in some markets as restrictions start to be lifted. These are by appointment only, with the appropriate safeguards being put in place. In Canada and the U.K., the impact of the virus has been more widespread with more nationwide lockdowns in place. And as a result, we've seen some pretty steep revenue declines in April. In the case of Canada, we have seen some improvement in the volume declines in recent days as markets like Québec start to reopen to construction activity. As you've seen in the statement, our revenues declined in the U.S. in April by 9.3%. It's fair to say that, in terms of trading performance, it is a very mixed picture across the U.S. And this is absolutely a function of the degree of governmental and societal restrictions that we're experiencing in each of these local markets. For example, in our blended branches, which is our largest business unit, the revenue decline in April was about 15%, driven by significant declines in areas like New England, New York, New Jersey, Michigan, the Pacific Northwest and Northern California. And outside these regions, revenues held up significantly better. Despite the revenue challenges, there have been some real bright spots. In Waterworks, for example, our Q3 revenue was ahead by 11.4%, with April being another strong month with revenue ahead by 8.5%. We've certainly benefited from our contractors having a bit fewer operating restrictions given the nature of those Waterworks projects. We also generated strong growth in our stand-alone e-business, which grew revenue by 14.6% in April as a result of some strong consumer demand for home improvement products. On the trade side of the business, we've also been really encouraged by the overall adoption rate of our e-commerce tools during the crisis. Since it started, we had an additional 22,000 customers sign on to use our digital tools. It's 5x the normal run rate. And we have now over 90,000 customers registered and active on ferguson.com. Our user activity is up nearly 50%, signaling that our customers are really embracing our site, and they appreciate the digital experience. We've continued to see accelerated growth in that mobile experience for these trade professionals. The mobile experience is going to be critical in creating a frictionless experience that allows our customers to be more efficient and allows our associates to be significantly more productive. We're in the early innings of rolling out new releases with additional functionality and customers can now seamlessly buy online, pick up in store, buy online, pick up outside store. They can use the Ferguson SKU app, which allows their mobile phone to scan barcodes from our counter and seamlessly create a shopping cart and begin to check out. We've embedded our truck delivery tracking software into the platform. It allows our customers to track their delivery truck in real time, which is a real game changer for us. We launched our shop by job feature. It allows customers to search for products by a job versus by individual product. This cuts down on their time navigating the app and allows them to select the right products for that project. We added a text-to-branch service for those customers that need to add instructions for their orders, their pickups and their deliveries. And we continue to add content, digital content, for thousands of different products across all of our businesses that we serve, giving us the widest and deepest breadth of product inventory and product visibility in our industry. As we think about the longer-term strategy, technology remains a key differentiator, and we will continue to develop and invest in e-business digital solutions that will set us apart and set us up well for the future. And finally, just a word about the cost side of the business. As we think about the challenges of COVID-19, naturally, we are focusing our resources in a very targeted way at the local level to provide the best support for our customers. Our skilled workforce, as Mike mentioned, is critical to the group's long-term success, so we are using a combination of temporary layoffs, reduction in hours in order to rightsize the cost base in the short term. This is, however, balanced with taking the necessary cost actions to make sure that we rightsize the business for our markets as the economy reopens. So in summary, at all levels of the organization, we quickly adapted our operations to continue to service our customers while keeping our core value of safety at the forefront of everything that we do. Looking forward, we're certain that the actions we've taken in these unprecedented times will serve us well as we go into the future. It's worth mentioning that the company has withdrawn formal guidance because the near-term revenue outlook remains quite uncertain, but we're confident that we're well positioned to support our customers, our vendors and our communities while continuing to build out the capabilities for the long run. So thank you, ladies and gentlemen. Mike and I will be happy to take any of your questions. So Emma, let me hand it back to you.

[Operator Instructions] We will now take our first question from James Rose, Barclays.

Two for me. Firstly, do you think that April is the trough organic growth rate for the business in the U.S.? And if not, could you talk about why? Maybe perhaps give us some color in how blended branches versus the stand-alone operations might evolve in the coming months. And then secondly, I mean, could you talk a bit more broadly about how you think the longer-term impacts of COVID-19 could be on the way you operate yourselves, the way your distribution network is set up and how customers use your services?

Certainly, James. Thank you for the question. Mike, why don't I start off and then you can jump in. In terms of April being the trough, I would not look at April, call it, down 9.3% in the U.S. as being the trough. We're really pleased with the way that Q3 played out for the organization. We're really pleased with the way April worked through in some pretty challenging circumstances. Our people put forth some incredible effort to get at this, again, going back to our conversation earlier around the changes in our operating procedures and going through some challenging ways to service customers to get at that result. As we look at going into May, June, July, and we start to reopen across the different markets that we serve, it's worth mentioning that, today, thinking from a U.S. perspective and again focusing on that blended branch network that you talked about, really, only about 40% of our counter locations are open for internal traffic today. Only about 60% of our showroom locations are open for that appointment-only in-person consultation. And we're still going through social distancing measures to make sure that we keep our associates and our customers safe. So it's far from normal. And as we start to look forward, there's really a great degree of uncertainty in terms of what's going to happen from a project cancellation standpoint, how our commercial residential new construction product -- project is going to continue to move on. We certainly are keeping a strong eye on what consumer sentiment looks like and how it affects our overall remodel business. When you start to think about the RMI side and the break-fix side of the business, are consumers ready to have trade professionals in large scale back into their homes? And quite frankly, worried about what the next phase of the virus could be and how opening is going to affect further spread. And so for me, 9.3% in the April performance was a very proud performance and a good performance by our associates. But I think it would be irresponsible for me or inappropriate for me to think that that's the bottom today. In terms of the stand-alone business, as we talked about the Waterworks business, for example, very strong growth across a very diversified portfolio, new residential construction, new commercial construction, municipal sales, public works infrastructure, water and wastewater treatment plants and metering systems. And so they did a great job of making sure that, that diverse business mix continue to drive forward in terms of revenue gains. Project work looks to be fairly solid as we go forward, but we're still in some pretty uncertain times. Similarly, Fire and Fab business tracks along with that commercial pressure that you have out there. And as we start to see markets like Michigan, like Northern California, New York, New Jersey, start to open up more construction activity, we'll start to get a better gauge as to what's going to happen with overall commercial construction activity. In terms of longer-term impacts and how we operate, I think the world has changed and so I was pretty amazed. I think we all were pretty amazed as to our ability to transition a branch-based dispersed workforce and bring it to a remote working environment. Our -- the tools that our IT teams put into place well over a year ago really made that a much more seamless process than what we had ever dreamed possible. And to think about 50% of our blended branch, inside sales teams working remotely and still being able to take care of customers is a real testament to what they do. I think it will change a tremendous amount about how our customers want to interact. I referenced earlier that our e-commerce tools, we're seeing great adoption. I think it will change the way our customers transact going forward. That buy online, pick up outside store, the text-to-branch features, the digital tracking of their delivery trucks have made it so that it accelerates a need for omnichannel, a demand for omnichannel more so than ever before. Whether or not a trade professional has been in the business for decades or whether they're new to the business, I think it will change and accelerate the way in which they adopt these digital tools. And so from an investment perspective, we will continue to make that a priority to make sure that we're set up extremely well for the future. And then as I think about the end markets, clearly, this is going to have some changes in terms of what commercial construction activity looks like, the types of projects that we're engaged in, how we think about residential, single-family detached new construction continues to play out. So there are some changes that we're going to see coming out of this, but we feel pretty good about the capabilities that we're building to make sure that we remain relevant.

We will now take our next question from Elodie Rall, JPMorgan.

It's Elodie Rall from JPMorgan. I have 2, if I may. So first of all, if we could get a sense of current trading, if we've seen any inflection following the 10.8% decline in organic sales in April. And if you could quantify out of that decline in April how much was driven by the closed showrooms. You mentioned 60% now have reopened. So it would be helpful to understand how much of the decline in April was driven by that. And second, could you speak a bit about the competitive landscape, how this is evolving, if you're seeing any additional pricing pressure following the flat inflation print in Q3?

Certainly, Elodie, and thank you for the question. In terms of a sense of current trading, as I indicated before, there's still a great deal of uncertainty out there. But in terms of May, what we're experiencing across our different geographies, it's fair to say that in all 3 countries, we're seeing better sales growth results than we saw in April. And so that provides us with a bit of spring in our step, a bit optimism, but we really balance that. Again, that it's early in the month that we're just now beginning to reopen. And we're certainly not back to normal by any stretch of the imagination in terms of those counter locations, those showroom locations. As I think about Canada, there's still a tremendous amount of restriction in terms of what construction activity looks like based on what is existing from a permit perspective as opposed to new permitting, and the U.K. in terms of how that transitions to the trade professionals' ability to go in and work on homes. And so there's still a tremendous amount of uncertainty, but we're emboldened a bit by some better trading in the early days of May. In terms of what that showroom and counter impact was, it had a big impact. They're a big part of our business. And although we saw good buy online, pick up outside store, the bulk of -- the vast majority of the decline that we saw inside of that blended branch network was driven by that counter pickup business as customers really gravitated towards delivery. And so the mix of delivery versus pickup inside of our blended branch business shifted quite dramatically. Good solid performance inside that blended branch network around project work, both new construction single-family, new construction multifamily. And so that project work helped to drive as well. We're starting to see some real good movement in terms of that counter, but it's still very early days. On the showroom side of the business, we've been really appreciative of the way that our customers have gravitated and wanted to make sure that they could get in, in a safe manner into those showrooms. And so we feel pretty good about those initial openings that we've had. The appointment count that we had, I think we had 118 appointments set up in day 1 from a Naples perspective that we needed to spread out across Naples, Florida, to spread out across the upcoming weeks and months. From a competition standpoint, in terms of pricing, we haven't seen any dramatic movements from a pricing standpoint. And if you look at the gross margin side of the business in Q3 and specifically in April, it really is more a mix issue from a business perspective as well as from a channel perspective than anything else. As we saw Waterworks grow substantially more than what we saw inside the plumbing and mechanical business, it carries the lower gross margin profile even if net margins are very similar. And so from a gross margin perspective, that mix change had an impact as well inside of the channels and not having customers being able to go in and utilize our showrooms, walk in, utilize the counter for impulse-buy items and other necessary products to fill out their job did have an impact. So we're not seeing anything more broadly today inside the competitive landscape in the markets.

We will now take our next question from Gregor Kuglitsch from UBS.

So the question is just maybe a bit of a follow-up on the outlook. I think you kind of flagged it, but your -- I think you were suggesting that, obviously, you're about project business being canceled, particularly in commercial if I heard you correctly, but correct me if I'm wrong. And I guess, the question is, from your experience in the [ business ] for a very long time, how long does that kind of take? Because obviously we're still seeing current projects being finished out, I guess, and therefore, the sort of decline, the late-cycle decline really takes some time. So if you could give us some color from your experience how long that usually takes. And then in that context, I think you kind of talked about that in your statement about the cost reduction on a more permanent basis. Could you just flesh out the thinking around how you rightsize the business? Under what scenario? And when do you actually pull the trigger? Because it's actually quite difficult to know, I guess, now where you land maybe 12, 18 months out in terms of the revenue run rates once perhaps some of that late-cycle business unwinds? So that's kind of 2 questions, I suppose, there. And then secondly, just following up on the gross margin. Is it an element of the e-commerce business as well taking sort of a bigger pie of the -- bigger share of the pie? And should we expect that kind of drag, if you want, be it mix related, to continue for the foreseeable future?

Thank you for your question. And yes, a little bit of an early morning, but we're doing pretty well. In terms of project cancellation, it is more of a watchful eye. And I think we are in some very different circumstances even than previous recessions that we've worked through. We have not seen any discernible cancellations that would cause us great concern. But we are keeping our eyes open both on the commercial side, but also on residential new construction side. What I will say is and what we're starting to notice, we believe that the construction itself is going to take a bit longer as we think about the impact of the virus going forward, how commercial construction sites have to be staffed, spreading out the different trades, working different shifts and making sure that proper PPE and entirely different protocols are taken into consideration. So we may see elongated project work as we go through the near term. One of the biggest requests that we have from our contractor base today is on the PPE side of the business, the number of masks that commercial mechanical contractors need to go through as they get on to job sites, what we're doing in terms of face masks and shields, what we're doing with gloves and overall PPE. It has become a big part of what we do and a big service offering that we have to our customer base. So we haven't seen a tremendous amount or a discernible amount of cancellations. We are keeping our eye open. We're keeping an eye open on that pause. We think there's going to be some elongation of that construction process. In terms of the cost base, Mike, do you want to jump in and take the first stab at that and then I'll follow back?

Yes, absolutely. I think it's a little bit back to James' question as well earlier, which is, Greg, we don't know what sort of the next 2 or 3 months or the 18 months will be, and I'll come back to that. I think the good thing is we are agile and flexible as a business. I think we've proven that both last year and clearly through April because you've seen the numbers being delivered. And also, we've got a balance sheet. I mean, Kevin talked about, even if the long term does change, we can change and accelerate. We have the capability, the management team and the balance sheet to do that. So I think remaining flexible in this environment is important. I think it sort of gets a little more sort of short term. We've described the various measures we've taken in the short term. We'll continue to flex those as the top line moves around over the next 1, 2, 3 months. And I think, longer term, I think we should expect the current sort of shape of the business to be a little bit smaller. There's been quite a big economic shock. And therefore, we will have to look at the balance of labor versus investment in other channels. If that means we need to get after being a smaller top line business that's driven by labor productivity, then we'll absolutely get after that. But you know that that's the last place we generally go, is our associate base, because that's where we have the skill set. The reality is if that skill set is a different skill set needed at least in part going forward and we need to continue the acceleration into digital and other channels, then we'll absolutely do that. Kevin, you might just want to build on that.

Yes. And so to Mike's point, we know, with the amount of our cost base that is labor, that we need to make sure we rightsize that for the markets that we will come into. We will -- we are in process of evaluating that and looking at what our needs are. And we do believe that there's going to be a changing skill set. As I indicated earlier, one of the big changes that we'll see out of COVID is a very strong move to omnichannel, a very strong adoption of digital tools. And so making sure that we have the appropriate skills for the customer experience changes that are going to happen in the market is going to be quite important. As we think about the value that we're providing in consultation, that will start to change as we need to be more digitally engaged with that human relationship to drive a consultative approach to engineering projects to understanding what the best product for a particular application is, engaging in things like building information modeling and making sure that our product set is appropriately placed for commercial and utility contractors and so forth. So the skills will change, and we'll need to adapt, and we are adapting to that as we speak. To get the next question that you had out there around gross margin and the e-commerce business, I would not think of pressure or degradation on the margin profile of the business as the B2B side or the trade professional side starts to migrate to those digital tools. It is a good productivity play for our associates, but it's also a good efficiency play for our customers. And they are really -- it is -- the adoption rate has been quite impressive, and it is not going to go away. On the gross margin side for shift of mix to pure-play e-commerce, I also don't think that's a pressure point that should be or needs to be focused on from a gross margin perspective. The gross margin profile of that business is in good shape and competes quite well with the rest of the core business. We're pretty pleased with what we're seeing in terms of that pure-play e-commerce business as we look at conversion rates, as we look at what that marketing spend looks like, which has been a historical pressure point, on that side of the business. And when we look at growth in the way that we're partnering with some of our really strong branded suppliers and branded vendors and how we bring a better digital experience with the deepest and broadest range of inventory to customers inside of our industry. So I don't believe you should focus on margin degradation inside of any business shift right now.

We will now take our next question from Kathryn Thompson from Thompson Research Group.

The first question is around Waterworks. With some of the work that we do on the policy side, focus more on infrastructure, we've seen state departments of transportation and certain public roads accelerating construction work given there's less traffic on the road and just fewer people out about, how much of the Waterworks growth was driven by this trend versus construction more on the residential or the private side work? And what is your expectation going forward?

Yes. Thank you, Kathryn. Great to hear from you this morning. In terms of that Waterworks business, as I started to say earlier in the call, really pleased with the diversification of that group. As we think about their end-market profile, about 50% of what they do is private work, call it, residential, commercial. About 50% of that work is public with a good mix of municipal sales, public works infrastructure project work, both line work as well as plant work. And so it's a very balanced profile. The -- as I've said on a previous call at the half year, the customers inside that business will migrate from private to public in many cases. And so it's a bit difficult to get some granularity around what projects that have seen significant amounts of growth and what has played back. There has been good new residential construction momentum inside that business. From an infrastructure perspective and road and highway, we participate. It's not a big part of the overall business. It's growing as we are developing good capabilities in the geosynthetic side of the business for soil stabilization for road construction. And so we're getting better every day. There's certainly drainage and water products that go along with that. As we look forward, what our intention would be -- and it's funny, we've joked about infrastructure builds and large-scale water and sewer infrastructure nationwide as being sasquatch because it's something you hear about but never actually see. And so we're looking very forward to seeing some momentum around water and sewer infrastructure across the nation. We're in desperate need as a country to get after that in the United States. And so if you think about public water and sewer infrastructure, should we get after a good infrastructure package that will be very impactful for our business as we go forward? We are seeing good momentum in localities around waterworks and overall infrastructure work, but we do stay cautious from that perspective as pressures on local finances and state finances manifest themselves during this COVID environment.

Okay. Helpful. Shifting to the residential end market. In early stages, a lot of our industry contacts in the field say, with homebuilders, we're pausing more on spec construction in the early days, but we're certainly continuing existing homes that were started or accounted for. What we have seen over the past, say, 2 weeks going on 3 weeks, certain markets opening up that spec construction very slowly. Are you seeing a similar trend in your business? And then as you think about just overall population movement post COVID really from cities to outside of cities, what are your thoughts for residential in a post-COVID world, given structural changes with how consumers think about where they live?