Grafton Group plc (GFTU) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the live Q&A call for Grafton Group half year results for the 6 months to 30th of June 2021. [Operator Instructions] But for now, I would like to hand the meeting over to the Chief Executive Officer, Gavin Slark. Please go ahead, sir.

Good morning, everybody. This is Gavin Slark, and I'm joined here today by David Arnold. First of all, if I can just apologize for the slightly tardy start to this. This was just down to a technical issue that was beyond our control. But if anybody does remember how to put 20 pence into a pay phone, that would be quite helpful to know going forward. But I just apologize for the slightly late start. Obviously, this is all about Q&A. This isn't about going through the presentation as you will all have seen the presentation went live at 7:00 this morning. But just to reiterate the point from myself and David, in terms of operationally, the first half of the year has gone incredibly well. Financially, really good results, great cash generation, great operating margin, strong return on capital employed, putting the business in a great shape financially, and strategically been really important period for us, 1 with the divestment of the traditional GB merchant business; and secondly, with the acquisition of IKH in Finland that we completed on July 1. So hopefully quite a bit to get through. We've got about an hour before we need to move on to other things on an absolute outside. And at that point, we'll move straight into the Q&A because I can see we have got some questions really stacked up.

Operator, if you can now take it to questions, please.

[Operator Instructions] Our first question this morning comes from Mr. David O'Brien from Goodbody.

A few for me, please. If I could start on gross margins for the first half. Look, it's a very strong performance. I was just wondering, could you give us a little bit more color on the drivers there? And how should we think about that gross margin going forward? And an extension to that, longer term, not necessarily just into the second half, but how should we think about the operating leverage specifically for U.K. distribution now given the kind of the reshaping of that business? And then with regard to kind of activity levels, there seems to be an element of conservatism in the guidance. I wonder in terms of the evolution of what product is being sold or ticket sizes across the business, is there anything in recent trends that suggest change in behavior in your customer base or underlying markets? And then finally, a little bit more longer term, how do you think about the U.K. RMI cycle into 2022 and beyond?

David, let me pick up on the gross margin in the first half to start off with. So it was an exceptionally strong performance from a gross margin perspective in the first 6 months of the year. In fact, if I look at the first half of 2019 as a benchmark, which I think is probably a better place to start rather than the first half of last year, which was obviously distorted by the pandemic and actually some of the businesses being shut for a period, which weighed down on our gross margin. So if we go back to the first half of 2019, compare that to the first half of 2021, then what we actually saw was that the group's gross margin increased by around about 200 basis points. Now of that 200 basis points, I think there are probably 4 important components, and they probably each account for sort of roughly equal amounts behind that 200 basis point increase. There's about 50 basis points of that increase which is attributable just to the mix of businesses. And when we look at the first half of the year, those businesses, which had the strongest gross margin, in general, grew the strongest in the first half of the year. So it was a weighting on proportion of business. Not only that, of course, we've got the acquisition of StairBox, which was a relatively modest contribution from a profit perspective in terms of the first half. But nevertheless, it's a higher gross margin business. So we had a business mix effect and that accounted for about 50 basis points. If we then look at the sort of the other 3 elements to that gross margin uplift, I think the key one is that over the last few years, the distribution businesses on the ongoing activities, worked really hard from a systems perspective and a price book management perspective to improve gross margin. And our expectation is that, that improvement and the work that's been done -- the hard work that's been done really at an individual branch and store level, now that should prove quite sticky going forward. So I think that's an important element. The other 2 elements behind that gross margin improvement, I think the first is that we'll all be aware, we've really been through a quite unprecedented period of price inflation. And that benefited us in the first half, benefited us because we've executed really well pushing through those price increases that we've been on the receiving end of into the [indiscernible] selling prices. So there's an element around inflation. There's an element around stock gains that we've seen in there as well. But in general, we've been -- those are realized stock gains. And -- but that's an important element. And then I think the final element is when you look across those distribution businesses, that actually each of the businesses have had a favorable customer mix element. So we've seen very strong growth in the first half around private residential RMI and the spend associated with that. So we've had a much higher proportion of customers who are buying in cash and collecting products. Now as we start to move forward and we see the increase in new build activity, whether that's housebuilding or commercial, which of course, has been relatively subdued, there will be more delivered products and so there'll be some gross margin dilution, I think, associated with that. So it has been a really successful first half on gross margin. I think those are the components. I think we look to hang on to the elements system-wise and management wise that we've gained, but there will be some dilution going forward as we see that customer mix change and as we see inflation start to moderate.

I think in terms of trends, David, I think, obviously, product mix is quite an interesting one to look at, but it's also about geography. And obviously, if you look at our continuing U.K. business, which in terms of distribution is predominantly now Selco and Leyland SDM in terms of the U.K., and the RMI market is the key driver there. Probably the biggest thing that we've seen has been geographic as opposed to product mix. And that has been outside of London has performed more strongly in the first half of the year rather than inside of London. But in recent weeks, we've started to see activity levels significantly rising within that kind of Greater London area. So I think in terms of the overall trend, the RMI market, we're still seeing, is very strong. We haven't seen significant movement in different product sectors, but we are now starting to see the Southeast of the U.K. coming through and being more strong than it was in the first half of the year. And I think if you look at the underlying trends in terms of RMI going forward in the U.K., the fact that the Southeast is getting stronger is a positive for us, very strong penetration there with Selco, very strong in terms of Leyland SDM, and we would anticipate that the underlying RMI trends in the U.K. will stay strong for the foreseeable future.

Our next question comes from Will Jones from Redburn.

Three, if I could, please. First was just picking up on that commentary around gross margin. I noted that competition or the competitive backdrop wasn't really cited as 1 factor for the gross margin increase. Perhaps you could just reflect on, in the U.K. particularly, how you see that dynamic? Obviously, there's lots going on in the industry at the moment with the various business ownership changes. So an update there would be great, please. Second, maybe just around Ireland. I think, in Ireland merchanting, I think in July, you had thought that potentially the 2-year like-for-like might slow a little bit in H2 versus H1. At the moment, it's obviously running usefully ahead of that. It's still, I think, 20% plus in July and August. So perhaps you could just give us an update there in terms of the underlying market. And again, if there's any change to how you see H2 playing out? And perhaps just a sort of question within Ireland, but do -- at some point, do you need to consider branch openings there? Or is there enough capacity in existing business to satisfy growth? And then perhaps just over in the U.K., again on Selco, if you could just give us an update on the medium-term store rollout process that path, I think, to 90 to 100 branches that you talked about. Is that still the view? And any update on, I guess, geography store size en route?

Guys, apparently we're having a sound isue. So we're going to try and switch on to something else that's going to work. Can you hear us now?

Yes, carry on.

Okay. Sorry about that. I'm sorry, Will, I might need you to sort of just go back over some of those Q&As. But I think your first one was around gross margin and was around the sort of competitive dynamics of the market, and I haven't mentioned that in terms of the factor in the first half. I think we'll probably all be very familiar, if we go back a few years, that we've been through periods where the gross margin has been under pressure because of the competitive nature of the market. And I think we talked about it probably over the last couple of presentations that actually at the present time, the strength of underlying demand in the market, to some extent, product shortages, I think, has meant that the competitive dynamic has been, from a customer perspective, much more around availability rather than one where they're particularly sensitive to price. How do we think that, that's going to continue to evolve? Well, fundamentally, that will be driven by that underlying demand backdrop. We think that's good across the geographies. We think that's a very positive position at the moment. We think supply challenges are probably likely to continue at least in the short term. So we would envisage that, that competitive dynamic will have less of a bearing on gross margin than the other factors, which I've talked about. You asked about Irish merchanting, and you said that the like-for-likes there are sort of running usefully ahead. And we'd absolutely agree. I think once the Irish construction market emerged from its lockdown back in April, we saw a very strong recovery in May and June, and that has continued into July and August. So we're really very encouraged by the prospects of the market. New house build has recovered and come back very strongly, which is a real positive. And we know that, that continues to lag behind where underlying demand sits. So both on an RMI and a new construction perspective, we think the market is very positive there. We obviously bought Proline in the first half of this year. I think that adds also an additional dimension in terms of growth of the Chadwicks business. And I think it's probably about adding on and broadening our capabilities in the construction market more than it is about a new branch openings. I think when you look at white space on the map and our coverage that we've got, Chadwicks is absolutely the market leader from a geographic coverage perspective. There aren't that many white spaces. There are a few, but not that many white spaces. So I think it's -- I think the growth from Chadwicks is around outperforming in the current market. Looking at broadening its offering, yes, potentially some either bolt-on acquisitions or new organic opening of branches. But probably that is more at the edges than I think the outperformance in the market and the broadening of its product offering. You asked about Selco in the medium term.

Yes, I think Selco is a really interesting one now, Will, as well because obviously, it is the predominant U.K. distribution business that we have following the divestment of that traditional sort of build based type business. So as we sit here today, we have 70 Selco stores. Liverpool opened earlier this year. We'll open up in Canning Town in London and Rochester in Kent before the end of the year. And I think with where we sit now, with the branch numbers at around about 70, I would say, medium term, could definitely see a road map towards Selco being 100 stores in the U.K. We've learned a lot over recent years about operating outside of London with some very successful sites now in different parts of the U.K. And it's a very proactive development plan. But I think Selco sitting at 70 today, we can definitely see at least another 30 stores going into Selco in the medium term.

Great. And I note the online share in Selco continues to hover around 5%. And is that more about getting customer preferences in the way they want to do business? Or is it partly about your offer as well that, I guess, could change anything?

No, no. I think it is quite customer-driven. And I think the other interesting thing is that between 75% and 80% of that 5% is actually Click 'N' Deliver. So it is about people going online and organizing building materials to be delivered. The actual instances of Click and Collect is tiny. And I think part of that is also driven well by the fact that the customers have got a lot of confidence that they can go into Selco, as many of you have seen the Selco stores and the inventory is used, the inventory is there. So I think it will continue to grow. But I've always thought that a trade business like Selco will have a lower penetration on digital sales as opposed to pure retail because of the way our traders operate. But I think it is very much around the way the customer behavior is. And it is interesting that the vast majority of what we're doing online is for delivered products and not for collected.

Our next question comes from Christen Hjorth from Numis.

Three questions from me, if that's okay. First of all, just touching on sort of the -- obviously, last year, there was a lot of conversations around the structural changes, perhaps in the industry as a result of COVID. Just sort of any update on that now that demand has clearly rebounded strongly. Will some of those sort of structural changes that was generated at the base, stick, or will we continue to see that, do you think, going forward? The second one is just on the Netherlands. I noticed that you sort of added a few branches. I'm just wondering how much more there is to go for, obviously, having done the larger acquisitions there and continuing to acquire branches and take up that white space? And then finally, StairBox. As you've mentioned in the presentation, clearly, it's been a fantastic acquisition and is performing very well. I mean to what degree is there an opportunity to perhaps roll out that business model in other jurisdictions?

Yes. Good question, Christen. I think in terms of structural changes in relation to COVID, it kind of changes very much by geography. If you look at the restrictions that we've had in place, they've been different in Ireland to what they have in the U.K. And if you look at the Netherlands, they have very few COVID restrictions that directly impacted our business. I think if you look at generally across sort of business, working from home seems to have been the biggest change. But obviously, in the construction market, working from home is actually quite difficult when you're winning builders, merchant branches or DIY stores and how our customers are working in customers' homes. So I think probably the biggest change we've just seen is the way that we communicate. But I think the -- if you look at what we're doing in terms of digital penetration, we expected that maybe to be a little bit higher than what it has been. It grew last year, as Will said, it's kind of steadied at about 5% in Selco. So I do think that we're seeing huge structural changes on the back of COVID in our specific industries. Although obviously, I think that whole area around flexible working and just better communication for our own people has been a critical part of it. In terms of the Dutch business, you're absolutely right. We are more now into bolt-ons in the Netherlands than we are about big seismic acquisitions because we are now the market leader in the field in which we operate. We did a couple of small bolt-ons in the first half of this year. There are still more bolt-on opportunities that we see going forward in the Netherlands. Some are active conversations now. Some will probably come through more in '22 than the second half of this year. But there are still opportunities for bolt-ons within the Netherlands. But of course, a key part of our strategy has been new geographic markets that give us new platforms for growth. When we acquired the Dutch business in 2015, it was turning over about GBP 90 million a year. It's now over GBP 300 million a year, and we just needed to find the next opportunities, if you like, to sort of carry on with that growth profile. So the acquisition of IKH in Finland was a key part of that. That business is a great business in Finland to date. It already trades into Sweden, already trades into Estonia. And I think we've been quite open in recent years about our aspiration to get into more European territories and to give us more platforms for growth, and that's still very much part of the plan. And hopefully, now as travel becomes easier, we can actually get back on the sort of acquisition trail and spend more time really getting under the skin of some of those opportunities that we've been looking at in the past 18 months. But I think our aspiration hasn't changed on that front, but neither has our discipline in terms of the way that we deploy capital. We've always been very careful and disciplined about what we bought. That hasn't changed. We'll continue to stay disciplined. We'll continue to look for good businesses in good markets with good growth profiles. Your comment about StairBox is absolutely right. Alex and the team at StairBox have done a brilliant job in the first 6 months of this year. We've learned a lot about that business. They've learned a lot about being part of Grafton. There may be opportunities to look at other geographies, but we want to make sure, again, that we do things in a very disciplined way and looking at making sure we've got everything nailed in terms of the U.K. And if we take it into a different jurisdiction, Christian, probably the logical place to be to see what we could do in Ireland, where we've already got a really good distribution network. So it is part of the thought process. It is part of the plan. We have only owned that business for 6 months. The guys have done a phenomenal job there in the first 6 months as being part of Grafton. But certainly, buying StairBox was about can we make it a better business in the U.K. than what it was? And are there growth opportunities for us? And that's certainly not lost on us.