Grafton Group plc (GFTU) Earnings Call Transcript & Summary

Hello, and welcome to the results presentation for the Grafton Group plc for the year ending December 2020. The my name is Gavin Slark. I'm the group CEO, and I'm joined today by David Arnold, who is our group CFO. The program for this morning is very simple. I will start off by giving you an introduction and taking you through some headline strategic progress. David will then take you through the detail of the numbers, and then I will come back at the end, give you a summary of the content and also have a look at current trading and the outlook for this year. We do believe that 2020 was a resilient performance and also enabled us to progress some of our strategic initiatives. As many of you will be aware, some of our businesses were closed for part of last year, some remained open throughout. But in general, by the half year, all of our frontline staff were back in place, delivering a great customer experience and a safe and secure environment for our colleagues and customers online. We did have an outstanding contribution from our 11,000 colleagues, and I have to take this opportunity to personally thank them for their efforts in getting us to where we got to at the year-end. We did see a very strong recovery in profitability in the second half, with operating profit for the year, exceeding our expectations and the most recent market updates that we gave. When David takes you through the detail of the numbers, you will see some of the outstanding performances that we had in the group last year. We have talked for some time about maintaining an operating margin within the group in excess of 7%. And I'm delighted to say that last year, over 90% of our operating profit came from business units that had an operating margin in excess of 7%. And it's also fair to say that last year, we did see that our higher-margin businesses did prove the most resilient. We still managed to complete 3 acquisitions in 2020, and we've also done 2 in the early weeks of this year. And later on, I will take you through the detail of that. It is also fair to say that on the acquisition front, travel restrictions due to COVID-19 did hamper our progress in furthering our geographic expansion. We did see an accelerated investment into technology last year, including the continued rollout of the new ERP system in Buildbase, significant investment into the e-commerce capability of both Selco and Woodie's and both of those gave us a significant increase in our online sales. We also progressed our sustainability agenda and really we took the opportunity to engage with the business teams to establish a real plan for sustainability going forward. We appreciate that sustainability is a journey, but we do believe that it is fundamental to our future success. In terms of the financial highlights for last year, you will see there that revenue of GBP 2.509 billion and operating profit at GBP 193.3 million was slightly down on the prior year. But given the disruption that we encountered during 2020, I think both of those numbers are an outstanding achievement. The adjusted earnings per share of 56.7p and dividend of 14.5p for 2020, which we believe reflects an appropriate balance between the trading that we saw in the U.K. and also giving us some headroom for short-term uncertainty still around. Net cash for the year, pre-IFRS lease commitments was GBP 181.9 million, significantly up from last year and that puts the group in a very strong position to withstand any future disruption or more positively to invest in high-quality growth opportunities. We have talked previously about the resilience of Grafton being underpinned not only by our investment strategy, but also geographic diversification. And you will see from the chart on the right that in 2020, over 50% of our operating profit came from businesses outside of the U.K., really underpinning the strength of that geographic diversity within the group. Our mindset and our purpose is building progress together, supported by 3 key pillars of ambition, innovation and sustainability. And I will talk in more detail about those in a moment. But underpinned by our group core values: being sustainable, trustworthy and responsible in all of our dealings with our customers, our suppliers and all of our stakeholders; valuing our people, treating people fairly and creating real career opportunities for people within Grafton; being brilliant for our customers, this is a very simple mantra and what we mean by this is when our customer has dealt with any part of the Grafton Group, they can walk away and say that experience was brilliant; being entrepreneurial and empowering, which to us means creating a positive business environment, giving people the room to flourish and to contribute to the business overall; and being ambitious, investing in organic and acquisitive growth opportunities with an ambition, not just to be bigger, but also to be better. Looking at ambition. In terms of growing the group with high-quality additions, we are very disciplined in the way that we allocate capital across the group. And many of you will have dealt with myself and David over recent years, will appreciate that we have always been what we would term careful shoppers when it comes to acquisitions. I mentioned earlier that travel restrictions have been an impediment to some investments. And there were definitely some opportunities that we were looking at prior to COVID-19 that have gone on the back burner, but when we can travel more easily will certainly come back towards being towards the front of those opportunities. We have got the 3 Gs strategy in place when it comes to looking for acquisition opportunities, either in new geographies or with new products. And that is very simply about buying good businesses in good markets with good management teams. And it's about focusing on quality with growth potential. Last year, we acquired 3 businesses, first of all, StairBox, the innovative U.K. manufacturer and distributor of staircases that really utilize web-based technology in terms of their customer interaction. And I'm delighted to say that Alex Hancock and his team at StairBox have settled into Grafton really well and are committed to staying with us for the long term. We added a 5-branch decorator's merchant business to Leyland SDM called GDC Paints, and we also added a single-branch builder's merchant business in Dundalk, both of those being high-margin bolt-ons to existing good businesses. We've also progressed 2 acquisitions in the early weeks of this year: Proline being a Dublin-based architectural ironmongery business; and Van den Anker, which is another ironmongery business on the west coast of the Netherlands, which will drop into the Isero business. And it's great when you have really good management teams led by [ Patrick Ambert ], and they're able to progress those acquisitions in their own territories even during the COVID pandemic. In terms of innovation and making the business better, too often, we always think of innovation being technology-led and technology does play a key role in our innovation, but there are also things that we can do regarding logistics and products and services that make the business better. If you look on the left-hand side there under e-commerce, you'll see that last year, we invested significantly in the capability of e-commerce in Woodie's. And if you look at November last year, you'll see we actually transacted 50,000 online transactions compared to just 6,000 the prior year. And we also really improved our website experience with digital revenue increasing over the year to 3.6% from 1.6% the prior year. In Selco, we accelerated our investment into the Magento 2 web trading platform and you'll see that last year, we got to about 5.3% of Selco's revenue in the second half, being driven by online sales. And in the early weeks of this year, it has maintained around about that 5% level. It's also interesting to note that of that online business in Selco, 80% of those transactions are for Click 'N' Deliver. And where there is 0 price negotiation on online sales, we actually extract a higher margin on Click 'N' Deliver sales taken on the web than we do on orders actually taken in store. And also in some of our traditional businesses in the U.K. like Buildbase, we saw a significant increase in our digital capability and also our online transactions. If you look at logistics in the center of the chart, last year, we opened our Edmonton distribution hub. Not only did that play a role in making Selco's deliveries in North London more efficient and certainly a more safe environment, but it also played a significant role in the fulfillment of online orders in Selco. And our anticipation is that we will open another customer delivery hub in Birmingham later this year, enabling us to replicate that service level in the Midlands. We're also shortly going to open an e-commerce hub within Woodie's, and that will enable us to give a far higher level of service on the faster-moving SKUs that we have. And sometimes last year, what we did find with e-commerce in Woodie's, we were constrained by capacity, and this will significantly increase our capability to do more online orders and give a higher level of fulfillment first time. On the right-hand side of that chart, you'll see some information around products and services. In Chadwicks, we invested significantly in product information management, enabling us to track product data and give the customers a higher level of service and a far better experience. We've also this year -- or last year, sorry, should I say, we rolled out electronic proof of delivery for all ex-yard deliveries from Buildbase. And later this year, we'll be trialing that within the Chadwicks business in Ireland. And that really is a group benefit where we can roll something out in one part of the group and take the learnings of that rollout, and therefore, make the rollout in a different part of the group more efficient. It's also worthy of note that within Grafton, there is so much more to our business than selling bags of sand or bundles of timber. And the Isero e-locks project last year was a great example of that. We worked in conjunction with a social care provider in the Netherlands, where we provided electronic locks, which the care providers can access via secure app, gaining access to their customers' homes. That enables the care provider to enter the property safely and particularly during the COVID pandemic, enabled more vulnerable people to be cared for in their own home. On sustainability, we are absolutely committed to building a more sustainable future for everyone where our businesses can play a leading role. If you look at the 5 key focus areas within our strategy, being customer and product, people, resources, the communities in which we work and our business ethics. Put very simply, it's about making sure that we do the right thing by everybody impacted by those groups. We did have some great achievements last year. We invested over GBP 3.2 million into LED lighting in Selco. Not only does that help in terms of reduced electricity consumption and therefore helping the sustainability agenda, it also reduced the cost within Selco and gave us a better quality lighting product, so a genuine 3-way win from an investment into the Selco stores. We're also piloting compressed natural gas trucks in Selco with very low emissions, and actually, next month, we'll take delivery of our first fully electric 3.5 ton delivery vehicle within Selco. And later this year, we'll also be trialing a 26-ton fully electric commercial vehicle within Selco. Our overall waste diverted away from landfill improved by over 6% last year, with over 90% of our waste avoiding going to landfill. We also have many great charity initiatives across the group. Our Woodie's colleagues run a Heroes program every year, where the colleagues choose 4 specific charities that they will fund raise for and last year, even within the COVID-19 world, they raised over EUR 400,000 for those charities through Woodie's. And Selco raised over GBP 100,000 for their chosen charity within their business. We also have many local community initiatives across the group, and most of those community initiatives are chosen by the local teams. Including last year, donating end-of-life laptops to schools to help with home schooling for families that are most in need. At that point, I'll hand you over to David.

Thank you, Gavin, and hello, ladies and gentlemen. Before we get into the detailed 2020 financials, I thought it was worth putting some historical context to a couple of important metrics given the year which we've just been through. You'll recall that one of our key financial objectives is to deliver a 7% operating margin and 15% return on capital employed, all on a pre-IFRS 16 basis. Last year, we again achieved our operating margin objective, but the first half reduction in activity caused by COVID did weigh down on our overall return on capital employed, which reduced slightly to 13.6% for the year as a whole. In the second half, however, on an annualized basis, the return on capital employed pre-IFRS 16 was just over 22%. You'll see that in 2020, our reported return on capital employed after leases was 10.4%, although the annualized second half return on capital employed on a post-IFRS 16 basis, was just under 17%. We've always said that Grafton's business model is resilient. For example, we came through the global financial crisis without recourse to shareholders. We came into the COVID-19 crisis with the balance sheet in good shape. And with the continued strong cash generation of the business, we ended the year with net cash of GBP 182 million before leases. Now this balance also reflected that no dividend was paid last year, although the suspended 2019 dividend of GBP 30 million was paid in February 2021. It's also important to note that notwithstanding the strengthening of the balance sheet in recent years, we've continued to invest for future growth, with over GBP 600 million in cash deployed on new acquisitions and organic development spend over a 10-year period, as highlighted on this chart. Turning now to look at the 2020 income statement. I thought it would be useful to look at the marked variation between the first and second half performances. In 2019, H1 and H2 profitability was fairly evenly split. By stark contrast, with much of the group temporarily suspended from trading for several weeks in the first half of 2020, adjusted operating profit before property profit was 59% lower at GBP 39.1 million. However, in the second half, the group saw a strong recovery with adjusted operating profit pre property, 47% higher than H2 2019 at GBP 151.6 million. We incurred exceptional costs in 2020 of GBP 24.7 million. GBP 16.7 million of this was attributable to the restructuring we undertook early in the second half, which saw us close a small number of underperforming branches and reduced operating costs and a further GBP 8 million related to the U.K. pension scheme, which was close to future accrual at the end of December. Now this slide sets out the revenue bridge. And as you can see, there was a GBP 248 million organic reduction in revenue as a result of the suspended trading in the first half. Partially offsetting this was an increase of GBP 70 million attributable to acquisitions, the largest component of which was the purchase of Polvo in the Netherlands, which completed in July 2019. This slide analyzes the reduction of GBP 248 million in organic revenue, and you can see how almost all the reduction, GBP 235 million, is attributable to the U.K. distribution businesses. Irish distribution was much less impacted by the suspension of branch operations, and Woodie's saw a significant pickup in activity immediately on reopening in May, which continued through to year-end. Turning to the movement in reported adjusted operating profit. This slide bridges from the GBP 204.8 million in 2019 to the GBP 193.3 million reported for 2020. GBP 16.7 million of the reduction was in the like-for-like business, which from a geographic perspective, as we shall see shortly, was wholly attributable to the U.K. businesses. Acquisitions contributed an additional GBP 6.8 million to 2020 profitability and property profits were GBP 4.3 million lower than prior year. Turning to that GBP 16.7 million reduction in like-for-like profits. As I've mentioned, this was wholly attributable to the U.K. with the profitability of the distribution business, GBP 29 million lower, which was purely a first half issue and a direct result of the GBP 250 million reduction in sales revenue caused by the pandemic, which in turn, left a GBP 53 million like-for-like reduction in operating profit. Manufacturing profitability was GBP 6 million lower as a result of the lower levels of activity in new house building, which led to a reduced level of profit in CPI EuroMix. Irish distribution performed really well despite the suspension of trading brought about by COVID and only saw a modest reduction of GBP 2.5 million in its like-for-like profitability. Our Netherlands business was allowed to continue to trade throughout last year as it was designated as an essential supplier and saw a like-for-like profitability improvement of GBP 2.2 million. From a reported profits perspective, the real star of 2020 was undoubtedly Woodie's, which generated an uplift in like-for-like profitability of GBP 18.3 million, despite being closed for 51 days in the first half. In U.K. distribution, the majority of our branches temporarily closed on the 24th of March and were not fully operational until the 22nd of June. Leyland SDM traded successfully throughout the period, having been categorized as an essential store. We saw a strong return to growth in the second half with a marked pickup in profit from just GBP 2 million in the first half to GBP 74 million in the second. The second half gross margin increased by 170 basis points, which was a function of stronger growth in those higher gross margin businesses, which have been the beneficiary of our strategic investment CapEx, Selco and Leyland SDM, for example, as well as improvements in gross margins more generally, including within Buildbase. The second half operating margin in U.K. distribution was 8.7%, 280 basis points higher than in the second half of 2019. Selco was a strong contributor to this, reporting an operating margin of 11.3% in the second half. Buildbase operating profit was substantially ahead of prior year through a combination of gross margin improvement and good cost control in the second half, supported by the restructuring, which we undertook early in July. And Leyland SDM performed well. And as Gavin has mentioned, we added in 5 complementary locations to Leyland with the acquisition of GDC. In Ireland, our Chadwicks branches temporarily closed from the 28th of March to the 18th of May, except to support essential services. Following reopening, our strong market position saw us increase second half revenue by 15% in sterling terms as we saw a recovery in the housing market as well as strength in repair and maintenance improvement. The full year operating margin was just 30 basis points lower at 9%. We continued with our program of rebranding and 6 more branches were rebadged as Chadwicks. Following the success of our fixing center in Dublin, we opened a further center in Cork as well as acquiring Daly's in Dundalk. As Gavin has touched on, we continue to invest into digital and systems. In the Netherlands, our operations continue to trade as they were classified as an essential business. Second half revenue increased by just under 2% on a like-for-like basis despite a reported 3% fall in residential new build and renovation volumes. The operating margin increased in the year to just over 10%. We saw good demand amongst our core customers operating in both RMI and new build. Polvo delivered an excellent performance in line with plan and with the anticipated buying gains secured. And we continue to invest in an ongoing branch upgrade program as well as migrating acquired businesses onto the common AX platform. Woodie's was temporarily closed for 51 days from the 28th of March through to the 18th of May, except for online sales. Following reopening, the business saw a surge in demand and second half revenue increased by 39% on the same period in 2019, leading to a record year for revenue, operating profit and operating margin, which increased by 600 basis points to 17%. Woodie's saw exceptional demand across a number of categories, but particularly decorative, outdoor and Christmas. The average transaction value increased by 20% to EUR 34, whilst transaction numbers were slightly down. Digital revenue represented 3.6% of sales up from 1.7% in 2019. Finally, our mortar manufacturing business was temporarily closed from the 24th of March with a Phase 3 opening in late April and early May. Our Scottish plant did not come back on stream until late June as a result of the impact of different COVID rules on construction north of the border. We've seen a good recovery in demand in the new housing market, although production volumes remained down on 2019 and even towards the end of last year. Despite the revenue reduction, the business delivered an excellent operating margin, which exceeded 20% in 2020, down slightly on the prior year. We acquired the StairBox business at the end of November and are really pleased with the performance to date. Turning now to the balance sheet. Just a couple of points here. Intangible assets increased to GBP 820 million, with the principal increase being the acquisition of StairBox. Net working capital reduced from GBP 196.5 million to GBP 112.6 million, and this was largely a function of the reduction in receivables from trade customers and procurement rebates due from suppliers. And we'll see that benefiting the cash flow on the next slide. The pension deficit increased from GBP 21 million to GBP 51 million. This is a function of the reduction in discount rates as well as an increase in liabilities in the U.K. scheme, which was close to future accrual at the end of the year. Strong cash generation remains an integral strength of Grafton's businesses, and we conceive the resilience of the business model on this slide, with GBP 378 million accounts in cash generated from operations. There was a reduction of GBP 81 million in net working capital. And as mentioned already, this was a function of the lower level of receivables as well as being reflective of the strong growth in the business that we saw in Woodie's and Selco, which are the cash-based businesses. I would expect that this year, we will see something of a rebalancing in net working capital. Free cash flow of GBP 304 million represented 157% of adjusted operating profit. Net replacement and development CapEx were kept to very modest levels relative to depreciation. As a precautionary measure, we suspended the payment of the 2019 second interim dividend, which, as a consequence, benefited the 2020 net cash flow by GBP 30 million, although this has now been paid to shareholders. Overall, there was a net cash inflow of GBP 243 million, with the closing net debt, including leases, being GBP 355 million. And finally, just a few elements of technical guidance. We currently expect full year property profits to be approximately GBP 2 million to GBP 3 million. Depreciation on an IFRS 16 basis is forecast to be GBP 100 million to GBP 110 million or approximately GBP 50 million on a pre-IFRS 16 basis. We're expecting net working capital to increase in 2021 as trading normalizes. Naturally, this is dependent on the balance of sales growth, but at this stage, an increase of GBP 30 million to GBP 40 million would be a reasonable assumption. Gross replacement CapEx is expected to be approximately GBP 45 million and development CapEx approximately GBP 25 million. On the basis of currently projected levels of cash, debt and leases, we expect the finance charge to be approximately GBP 27 million with GBP 18 million related to leases. And finally, we expect the full year tax rate to be approximately 19%. And now let me hand you back to Gavin.

Thank you, David. I'd just like to have a look now at current trading. Obviously, we are very early into the new year, but we have got some data here for the first 7 weeks that runs up until the 21st of February. Within U.K. distribution, you'll see our total revenue is down by 0.9%. And the U.K. COVID restrictions have dampened demand. And as yet, we don't have the offset growth in decorating and landscaping products that we get as the weather improves when we go further into the year. In Irish distribution, where we do have some quite significant restrictions on construction, our revenue is down by 12.7% so far this year. And we are expecting those restrictions on Irish construction to run now at least until the end of April. In the Netherlands, where our business was able to trade all the way through 2020, we have growth of 1.1% in the first 7 weeks of this year. And in our Irish DIY retailing business, Woodie's, which has been designated as an essential retailer, we have significant growth of 40.8% in the first 7 weeks. Our manufacturing business, which is primarily our CPI EuroMix business, is down by 29.8% in the first 7 weeks of this year. That really is attributable to new housebuilding activity, still not quite being back to the same levels as it was in the same period last year. So across the whole group, our total revenue for the first 7 weeks is down by just 1%. In terms of the outlook, we are optimistic that the vaccine rollout will mean economic and construction activity will increase in the coming months, although we do accept that our businesses will recover at different rates in different sectors and in different geographies. We are pleased to have the clarity and certainty following the Brexit deal. In short, we know what we have to work with, and we're just getting on with it. In the U.K., underlying demand in RMI and new build markets are expected to remain favorable, even though we have some short term uncertainty, but we do believe the medium to long-term fundamentals remain very strong. In Ireland, we do expect Chadwicks to return to pre-lockdown levels of activity once construction is allowed to resume in full. But as I mentioned, we are anticipating now that those restrictions will be in place at least until April. And in the Netherlands, we are expecting subdued growth early on with a gradual recovery coming later in the year. But that Netherlands business has now proved to be a very high-quality, high-returning business within the Grafton Group. And obviously, that balance sheet strength gives us the ability to invest in high-quality, organic and acquisitive growth opportunities. So in summary, we are very proud of our achievements last year, and I have to say we received remarkable support from our colleagues in some very trying circumstances, and I cannot praise them enough for what they delivered for Grafton last year. We endeavored to do the right things by our colleagues, customers and suppliers, and it is important to be able to look at yourself in the mirror at the end of the day and believe that you have done the right thing. We do believe that we emerge from the COVID crisis as a better business. We are certainly better from a technology point of view and we are certainly more savvy of our sustainability agenda, and I believe that we're also more operationally agile. Our business model demonstrated its resilience and certainly benefited from our strategic investment focus. And remember that 3 Gs strategy: we want good businesses in good markets with good management teams. We are driven by ambition, innovation and sustainability. We do want to be a bigger business. We want to be a better business, and we want to be a better corporate citizen. In short, I believe Grafton is operationally sound, financially very strong. And strategically, we have a good plan and with everybody in the group pulling in the same direction, we look forward to the future with confidence. Thank you.