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

Good morning, ladies and gentlemen. My name is Juan, and I will be your conference operator today. At this time, I would like to welcome you to the Ferguson plc First Quarter Results Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Brian Lantz, Ferguson's VP of Investor Relations and Communications. You may now begin your conference.

Good morning, everyone, and welcome to Ferguson's first quarter earnings conference call and webcast. Hopefully, you've had a chance to review the earnings announcement we issued this morning. This is available in the Investors and Media section of our corporate website and on our SEC filings web page. A recording of this call will be made available later today. I want to remind everyone that some of our statements today may be forward-looking and are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Additional information is included under the legal disclaimer in our earnings announcement this morning. In addition, we will be discussing certain non-GAAP financial measures. Please refer to the earnings announcement on our website for additional information, including a reconciliation to the most directly comparable financial measures calculated in accordance with GAAP. With me on the call today are Kevin Murphy, our CEO; and Bill Brundage, our CFO. I will now turn the call over to Kevin.

Good morning, everyone, and welcome to Ferguson's first quarter results conference call. On today's call, I'll give you some highlights from our Q1 results and an update on our end markets before I turn the call over to Bill for the financials. I'll come back at the end to set our outlook for the rest of the fiscal year before Bill and I take your questions. We begin by saying the group delivered exceptional performance in the first quarter, driven in part by strong market share gains. This success is due largely to our associates who we would like to express our sincere thanks to as they continue to make our customers' projects simpler and more successful. We've continued to leverage our global supply chain and strong balance sheet to support our local customers through a period of supply chain disruption, reliably delivering a period of industry supply chain pressures remains a gravitational pull for our customers to our business and has helped us to continue to capture these outsized market share gains. Technology remains a key strength, allowing us to make our customers as productive as possible while at the same time, enhancing our own productivity. For our end markets, residential, which comprises just over half of our U.S. revenue remained robust in the first quarter. Both new construction and RMI saw strong demand our residential revenues grew approximately 24% in the first quarter. Non-residential end markets grew faster than residential as we lapped negative comparables in the prior year, with an acceleration of activity in areas such as education, health care and hospitality. Our non-residential revenue grew by approximately 31% and near-term economic indicators appear to be in pretty good shape. Inflation trends stepped up further in the quarter, driven both by finished goods and commodities. Our pricing discipline and particularly strong gross margins contributed to profit growing significantly faster than revenue, delivering strong operating leverage in the quarter. On the acquisition front, we acquired 4 high-quality businesses bringing in approximately $125 million in annualized revenue, and we're pleased to welcome these associates to Ferguson as these local relationships help us drive further growth in the future. We initiated our new $1 billion share buyback program, completing approximately $100 million in the first month of execution. And finally, we remain on track to hold our second vote on listing in the spring of 2022 and as we look to move our primary listing to the New York Stock Exchange. So again, we are proud of our strong results in the first quarter and are confident in the ongoing strength of our business model. Now let me pass you over to Bill, who will take you through the financial numbers in more detail.

Thank you, Kevin, and good morning or afternoon, everyone. As I start today, I wanted to remind you that we adopted U.S. GAAP effective August 1, and therefore, the first quarter results we'll cover today are presented on that basis. Now turning to the results. As expected, we've seen a continuation of trends from the fourth quarter with strong market share gains contributing to revenue growth of 26.6%. Organic growth of 24.5% was at similar levels to Q4 of last fiscal year. And as Kevin mentioned, price inflation stepped up in the first quarter into the low teens. Gross margins were 170 basis points ahead of last year, reflecting the value we deliver to our customers, the strength of our business model and our ability to manage price inflation. Operating costs continue to be well controlled as we focused on productivity and efficiencies, while investing in our talented associates, supply chain capabilities and technology program. As such, adjusted operating profit grew by $283 million, up 58.5% and adjusted diluted EPS grew by 64.5%. Moving to our segment results. The U.S. business mirrors the group results with a strong performance. Total revenues grew 27.1% with organic growth of 25.2% and a further 1.9% from acquisitions. Price inflation stepped up further in the first quarter into the low teens. We expanded gross margins, tightly controlled costs and generated strong operating leverage. Headcount and variable costs grew to appropriately support volume growth and consequently, adjusted operating profit came in at $752 million, $280 million ahead of last year, with adjusted operating margins expanding 240 basis points to 11.7%. We've provided a breakout of the revenue growth across our largest customer groups in the U.S. We saw strength in both the residential and non-residential end markets, and our growth was fairly well balanced. Residential trade and building and remodel grew well, with strong demand coming from both new construction and remodeling project work. Residential digital commerce continued to benefit from elevated demand from the project mining consumer and the light decorative Pro. HVAC, where the majority of our business serves the residential end market, grew by 23% in the first quarter. Waterworks continued to outperform with revenue growth accelerating to 50% driven by an increase in inflation and a balance of strong public works demand, good residential growth and growth in non-residential end markets. The Commercial/Mechanical and other non-residential customer groups saw good growth in the quarter. These businesses have lapped negative prior year comparatives. We continue to see growth in areas such as education, health care and hospitality. The Canadian business performed well in Q1, with revenue growth of 19.6%. Organic revenue grew by 13.9% with a further 5.7% tailwind coming from the positive impact of foreign exchange rates. Residential end markets, which account for over half of our Canadian business performed well in the period with another particularly strong performance from our HVAC business. We saw continued growth in civil infrastructure markets and a return to growth in our industrial markets. Good gross margin performance and tight cost control led to an $11 million increase in adjusted operating profit with adjusted operating margins stepping up 170 basis points to 8.8%. As we focus solely in North American markets, we continue to see success as we leverage the considerable expertise, knowledge and know-how from our U.S. associates to enhance operations and customer experience across Canada. Finally, the balance sheet remains in great shape. Our capital allocation priorities and leverage targets have not changed, and we continue to prioritize moving back into our stated leverage range of between 1 to 2x. We are continuing to invest in the organic growth of the business and look to sustainably grow the ordinary dividend. Acquisitions are an important part of our growth strategy. We've completed 4 acquisitions to date in the fiscal year, and we currently see a healthy future pipeline of bolt-on acquisitions. We remain committed to returning surplus capital to shareholders and continue to execute the $1 billion share buyback program, having completed just over $200 million to date. So let me wrap up. We're pleased with the start we have made to fiscal 2022. Strong earnings while continuing to invest in the business and a strong balance sheet put us in a great position going into the balance of the year. Thank you. Now let me hand you back to Kevin for an update on the outlook and his closing remarks.

Thank you, Bill. Since the start of the second quarter, we've continued to generate revenue growth similar to that of the first quarter. That being said, we do continue to expect a tapering of growth rates as we enter the second half. The recent tailwinds we've seen from inflation on our gross margins are likely to moderate, but the timing and the extent of this remain unclear. Given the momentum in the business and the strength of our business model, our full year expectations have now increased. So to summarize the first quarter, the business is performing extremely well. We're leveraging our core strengths in the face of global supply chain challenges to deliver outsized market share gains. We believe we are well positioned for growth and remain focused on executing our strategy over the rest of the fiscal year and beyond. Thank you for your time today. Bill and I are now happy to take your questions. Operator, I'll hand the call back over to you.

[Operator Instructions] And our first question comes from Will Jones from Redburn.

A couple from me, please. The first was just whether we could -- or you could help us unpack the gross margin uplift in the quarter of 170 basis points by -- if it's possible to dissect it by factor. I'm particularly interested within that as to how much was inventory holding gains as opposed to other factors like servicing the customers well and mix? And the second one was really just more around market share, whether you had a view on your outperformance in the quarter. I appreciate it's only a small period. But -- and within that, how much of -- how much do you think is as a function of constrained supply chains and really how you go about then retaining those customers potentially want supply chains normalize through, say, calendar 2022? And I guess within the whole issue of market share, just interested in that Waterworks 50%. It's the stand out versus the other areas? And is there anything particular to note there around market share gain?

Yes. Will, this is Bill. I'll take the first part of that question, and thank you for that question. If you think about our Q1 gross margin of 31.3%, they were really a continuation of what we saw in Q4, which was right about the same level, 31.4%, really driven by the continued step-up in inflation. As we said in our release and our prepared comments, inflation moved from about 8% in Q4, up into the low teens. The majority of that further increase was driven by finished goods inflation. And that enabled us to continue to put up a very strong gross margin in the first quarter. So again, very much as that inflation continues to move up, we're able to translate that, manage that price inflation and leverage the strength of our supply chain to produce those outsized gross margins. We would expect that as inflation tapers at some point in the future, that those margins will moderate at some point. But it is difficult to say when that's going to happen and to what extent that will be, but certainly, the majority of that driven by our ability to manage price in the first quarter.

Yes. Will, if we tick down your question to market share, as we think about market share in the quarter, it's difficult for us to tease out exactly what that market share gain looks like. But I would think of it as broadly similar to what we experienced as we exited the fiscal year last year. And so that market outperformance is slightly above that 200 to 300 basis points that we normally target. And as we said, at the end of our fiscal year, really, that's driven in large part by that supply chain chaos that's happening and our ability to service customers. And like we said at the close of the fiscal year, hanging on to new customers and the durability of those new relationships, we believe is, in fact, durable. And the reason for that is these customers have been targets of ours for a period of time. And given the opportunity to service that customer, make their project better, we think is a bit of a durable proposition. You're going to win some. You're going to lose some, but we think we win more than we lose over the long haul. In terms of the Waterworks outperformance, we're really pleased with the balance of that performance, that balance across municipal, public works, residential new construction, commercial. And when you look across that performance, you've got a balance of inflation, especially in the commodity side of the business, things like PBC on the piping materials side, with also good volume growth. And we think that's about, call it, half and half in terms of the growth inside of the quarter. So really pleased with what that brings because if you look at the totality of the project, that's the opening gambit, if you will, for our company as we look to then take advantage of opportunities with the finished side of that building above underground construction, especially in residential and commercial settings.

And our next question comes from Elodie Rall from JPMorgan.

Maybe 2 questions on your end markets. So one of -- first of all, a follow-up on your Waterworks business. So it's done really well indeed in Q1, how would you quantify the upside for this business from the U.S. in pipeline that was just announced? And second, maybe could you give us a bit of an updated view on the new housing market in the U.S. in light of the rising interest rate environment through the mid-term?

Thanks, Elodie. I'll take the beginning of that and then if Bill wants to add in. In terms of that end market, residential and infrastructure and commercial, when we think about Waterworks, the infrastructure bill will certainly be a tailwind, and it will likely play out over time, as we think about what those projects are going to start to look like. And then as we discussed previously, there is a bit of a pressure on trade labor. And so putting those projects into action will take a bit of time in our view, but certainly will be a tailwind for us. I'll reflect back to that residential commercial side inside of Waterworks because of the broad-based nature of that performance. And the residential new construction market across the U.S., in particular, appears to continue to be quite strong. We've seen good bidding activity inside of that Waterworks business. We haven't seen any substantial reduction in lot count for subdivisions or postponement of new subdivision construction, which again points well towards our residential trade business, our building remodel business and the rest of the construction process inside of Ferguson. In terms of the new housing market, the external indicators look to be good. Permit activity at 1.65, starts at about 1.52 look to be good. And so that new construction growth appears to be strong as we move into the next calendar year.

Our next question comes from Keith Hughes from Truist.

Question on inflation. Can you give any sort of feel on the inflation levels you saw in your commodity products versus how much you saw more of the value-add of HVAC finished funding and things of that nature?

Yes. Keith, thanks for the question. Commodities really trended in a very similar level from an inflation standpoint to what they did in Q4. So think of that in the 50% inflation range year-over-year. So very similar. Some puts and takes in there between the different commodity categories, but overall, very similar level. As you know, commodities represent today what used to be about 10% to 12% of our business. Today, it's more like 13% to 14%, just given the fact of that price increase. But where we've really seen the step up, and we talked about this a bit on the Q4 call, is we're now seeing the commodity and the input cost playing through to finished goods. And so we saw that finished goods inflation step up into the high single digits in Q1. And so it's really the combination of that and the acceleration on the finished goods side that drove that further uptick in inflation from Q4 to Q1.

Okay. And I guess 1 other question, maybe the like share repurchase, you talked about the progress on the $1 billion plan. Can you just give us an idea of where you are on share count right now, given all the repurchase activity?

Yes. We're just under 221 million shares today, Keith. And to date, we've purchased about $225 million to date on that $1 billion share buyback program.

Okay. And just one kind of, I guess, bigger picture question to finish off here. As you had talked about, the inflation will probably subside, do you have any historical evidence of when you have periods of inflation and then it goes away, how much of that you're able to keep? Is there any rough guide to use on -- and this is not on the commodity products or on the finished goods more value-added product. Is there any -- do you have any good historical examples?

Well, we're -- I'd tell you, Keith, we're in a period that is unusually high from an inflation standpoint. So we don't have any great historical data points. But if you think about the gross margins that we delivered last year, stepping up to 30.6% and now stepping up further into the mid-31% range, we would anticipate that moderating somewhat but really focused on the overall operating margins of the business. We were quite pleased with stepping that up from about 8% to about 9.2% last fiscal year. And we talked about that being a new base from which we could grow incrementally into the future. And sitting here today, we still believe that we can grow that operating margin over time. Gross margins will come off a bit, but really difficult to say where they're going to ultimately settle.

Our next question comes from Gregor Kuglitsch from UBS.

A couple of questions. I mean maybe firstly, you say you have raised your expectations if you could maybe share with us sort of what you're thinking about now? And I guess -- or maybe putting it differently, what the sort of different building blocks are to get there? That's the first question. The second question is on previous calls, you talked about fill rates into the DC, into the branch. And so if you could just update us where we are on the whole supply chain challenges? And if they're perhaps easing a little bit? And then maybe final question is, I think in the statement, you reiterated your desire to have a vote for relisting in the spring. Can you just share with us if there's any specific kind of news or, I suppose, any incremental step towards that perhaps compared to the last time you spoke in September?

Yes. Sure. Thanks, Gregor. If I go back to your question on expectations first, we started the fiscal year in a strong fashion and really pleased with the growth, almost 24%, 25% organic growth in Q1 and really pleased with the operating leverage that we produced. And as we said, we've started from a growth perspective, even though it's early, we started Q2 at a very similar growth range. So I'd play that through, and we would expect to have a very strong first half set of results. As you turn to the second half, as we've talked about in the past, the organic comparables get much tougher. They moved from roughly 3% in the first half to 22% in the second half. And there are some uncertainty, as we've already talked about a bit today, from an inflation standpoint in terms of how that will play through to gross margins. So we would expect a tapering still of growth. But sitting here today, 2 months after we last spoke to the market, given the start to the year, given the momentum we have, we're incrementally more positive for the full year outlook at this point.

Yes. Thank you, Gregor. And building on to the fill rate and supply chain area, as we discussed previously, we were using our balance sheet to invest in inventory using our supply chain to make sure that we took what were pressured fill rates at the time, call it, in that 30% area on time and in full into our DC and turning that into high 90s fill rate and in-stocks for our customers at the branch level. That hasn't changed materially in terms of what that on-time in full looks like into our DC and it hasn't changed materially in terms of our fill rate and in-stocks at the branch level. What has changed is we have seen as we exited the quarter, some improvement and some firming up of the ground under our feet in that supply chain area, especially in certain product categories, certain SKUs, but it has been intermittent. And so the way we've been looking at this is we have certain areas of our product catalog that are coming in at normalized fill rates and normalized time horizons. And the way we measure that is we look at the entirety of a purchase order to one of our suppliers, and how quickly we can get to, say, 75% of that purchase order being filled into our DCs. And that time horizon to get that fill has improved by roughly 26% as we exited the quarter. So we're starting to see some of that improvement. Now that's going to play out with a little bit of challenge inside of our network because you've got to make sure that you can take care of the project for the customer, in its totality. And so we're going to use that scaled relationship with the supplier. We're going to use our location base and our supply chain to make sure that we can aggregate that product and make sure that we can bring it to the customer on time and in full. So it's improving, but there's still some inconsistencies that are going to lead to a bit of challenge as we go forward into the new calendar year. Last question on the vote. Nothing new to talk about as it relates to vote number 2. We had talked about bringing that vote in the spring time. And originally, when we took the first vote for the additional listing of shares in New York, we said that we would bring that vote back within 1 year of stand up of the additional listing. We think that's largely still on track.

Our next question comes from Kathryn Thompson from Thompson Research.

Just a follow-up on supply chain and narrowing it a little bit. Could you give us an update on the build-out of the DC supply chain and tech improvements? And in particular, given in light of continued challenges to supply chain, how is this contributing to gaining market share, in other words, with next-day delivery bogeys that you put out? And also, any changes in terms of purchasing from key suppliers. In other words, doing some advanced purchasing to ensure that you have inventory for finished goods?