Headlam Group plc (HEAD) Earnings Call Transcript & Summary

Welcome to the Headlam Group Interim Results Webinar. We'll now play a recording of the interim results presentation given by Chris Payne, CEO; and Adam Phillips, CFO. Chris and Adam are with us, and we'll answer questions straight after the presentation. [Operator Instructions] This webinar is being recorded.

Hello, and welcome to Headlam's 2023 Half Year Results Presentation. I'm Chris Payne, the Chief Executive, and I'm delighted to say I'm joined by Adam Phillips, our CFO, who joined us earlier this year. There are 4 sections that we're going to talk to today. One is a brief summary and a reminder of what Headlam is about. Secondly, a look back of the performance in the first half of the year. Then we're going to provide us an update and progress on the strategic development of the business and then look forward at the outlook, in particular, current trading and what we might expect going forward. So about us. There are 4 main sections to this slide. Firstly, talking about the experience of the business; secondly, talking about the depth and range of the product that we have and we offer our customers. Thirdly, the network and how we offer that service to different customers. And then lastly, customer service, and that's a key feature of the business. And Headlam has been around for many years and does have this market-leading position, particularly in the U.K., offering great service, great quality of products through a mixture of distribution centers, trade counters and an online business. So just turning to the overview. I'm going to cover this in summary before I hand over to Adam, who's going to cover some of these areas in more detail. So what we saw in the first half was revenue was up, so that was up 2.5% year-on-year for the first 6 months of the year. But that belied a weakness in volume and we talked a little bit more detail about volumes shortly, but we saw U.K. volumes under pressure, particularly on the residential side of the market, but we're still able to report revenue growth primarily through a strong performance through the new areas of strategic growth that we've seen in the large multiple accounts and through the rollout of trade counters. And that meant that our regional distribution business was slightly under revenue year-on-year. Our profitability was affected by some of the macro and industry headwinds that we've reported. So clearly from the macro side of things, consumer sentiment and RMI spend is down. The cost of living crisis that we've seen has resulted in both cost inflation for us and also a depressed demand level, resulting in those weaker volumes. To offset some of those headwinds, we were able to take some mitigating actions. So we looked at some of the efficiencies in the business, we're able to reduce our costs to offset the weakness in volumes. And also we've passed on some modest price increases that we've seen through our cost inflation on the supply side, and we pass those on to some customers. So that was a mitigating action, if you like to protect the profitability during the first half. So just turning to the balance sheet. We did see a strong cash performance during the first half. So we reported some solid operating cash, which we generated through trading. And that's meant that we've been able to continue to spend on our capital investments to support the long-term performance of the business, whether that's through the continued rollout of trade counters, our investment in new cutting equipment and operating equipment around the sites and indeed, the investment in solar panels that I've talked to before. That's also meant that we've been able to support an interim dividend, which we are announcing for the first half and we trailed that during the trading update at our pre-close. And I'll now hand over to Adam, who's going to cover the first half performance in a little bit more detail.

Thanks, Chris. I'll now talk through a few slides on the P&L, cash flow and balance sheet for the first half, starting with an overview of the key numbers. Revenue, as Chris mentioned, grew by 2.5% in the first half and this comprised 3.3% growth in the U.K., partially offset by a 2.9% decline in Continental Europe. And on the next slide, I'll take you through a more detailed breakdown of the revenue movements. Gross margin of 31.5% was a return back to the pre-2021 average of 31% to 32%, reflecting the unwind of the significant manufacturer-led price increases in the previous year. Underlying operating profit was lower year-on-year at GBP 8.2 million, reflecting lower volumes. The unwind of the temporary margin benefit in 2022 and high operating cost inflation, partially offset by a number of mitigating actions across price, margin and cost. Cash generation was good, GBP 19.8 million of positive underlying operating cash flow, an increase of GBP 35.2 million year-on-year. Net debt pre-lease liabilities of GBP 19.6 million increased by GBP 21.4 million from the end of last year, reflecting the combination of good operating cash flow, offset principally by investments in CapEx, M&A and shareholder returns. And the board has declared an interim dividend of 4p, with dividend cover lower to 1.5x, reflecting confidence in the medium term and strong operating cash generation. So turning to revenue. On this slide, we've broken down the revenue growth into its component parts. And taking the U.K. first, where like-for-like growth was 1.0%, and this is before the impact of an additional working day in the U.K., which added another 0.8% of growth. And also before the acquisition of Melrose Interiors in January, which added 1.5% growth, taking the total U.K. revenue growth to 3.3%. This growth is comprised of 5% volume decline, offset by price growth, principally reflecting the annualization of manufacturer-led price rises last year. Moving to Continental Europe, like-for-like growth was a negative 5.9%, driven by particularly weak markets in the Netherlands, with some suppliers reporting that their volumes into the Netherlands market are down around 20%. In France, we did see revenue growth in half 1 with price growth in the market, offsetting volume decline. There was a small negative impact from change in working days with 1 less day in France and 1 more day in the Netherlands, and foreign currency translation added 3.2% of revenue growth, taking the total Continental Europe revenue movement to a 2.9% decline. Now in previous results presentations, you'll have seen a U.K. distribution daily sales chart. However, given the disconnect, we've seen over the last 18 months between revenue, volume and price, we felt it was more useful to show year-on-year volume. And this chart shows the monthly year-on-year volume movement in our U.K. distribution business from the start of last year through to the end of the first half of this year. And this is all of our U.K. business, basically, excluding the Domus specification business. And we've also excluded Melrose on this chart, so that it gives you a like-for-like view on volumes. And as you can see, there's been an improving trend from Q2 last year, all the way through the first half of this year until June. And volumes at the start of this year were trending around high single-digit decline and this improved to around 1% decline in May. And based on this trend, we've been expecting volumes to return to growth in the second half. However, June surprised to the downside with 9% decline and a number of macroeconomic data points and external forecasts suggested that the recovery in residential related spending would be more prolonged. And we, therefore, revised our expectations for half 2 in July, as per our trading update to an assumption of broadly flat volume overall for the second half. And Chris will talk about current trading later. So moving on to the income statement. I've covered the revenue and margin movements already. So moving on to costs. The total operating costs, which is the combination of the distribution and administration lines in this table, grew by 6.1%, but this includes the impact of the Melrose acquisition. On a like-for-like basis, costs grew by 4.1%. This is a combination of cost inflation and strategic investments, offset by cost savings and efficiencies. And I'll show a bridge of the year-on-year movements in costs in a moment. Operating profit declined by GBP 9.7 million to GBP 8.2 million, reflecting lower volume, the unwind of the temporary margin benefit in 2022, strategic investments and cost inflation, partially offset by mitigating actions. I'll also show this on a year-on-year bridge in a moment. So moving down the P&L. Interest costs increased by GBP 1.6 million to GBP 2.2 million, reflecting the higher average borrowings and increases in the base rate. Non-underlying items were GBP 1.5 million expense and I have a breakdown of those, which I'll take you through shortly. And finally, at the bottom of the table, the Board has declared an interim dividend of 4p, as mentioned earlier, and this represents cover of 1.5x. And Chris will talk through our capital allocation and dividend policy later on. So moving on to operating costs in a bit more detail. And on this slide, we presented a breakdown of the movement year-on-year. And as I mentioned, these increased by 6.1% in total and 4.1% on a like-for-like basis, after excluding Melrose, which added GBP 1.9 million of costs in the period. Total cost inflation was GBP 5.8 million, mainly driven by payroll, with an average pay increase of 6.7%, and energy costs with U.K. electricity costs more than doubling year-on-year. Strategic investments increased costs by GBP 1.8 million, comprising the costs of new trade counters and associated management team, plus investments in capability and resource to deliver on the other areas of strategic focus. Efficiencies and cost savings provided GBP 3.9 million of year-on-year benefit. This included year-on-year reduction in operational head count, reflecting the lower volumes, the transport consolidation project and lower bonus accruals. Turning to a bridge of the year-on-year operating profit. Volume drove a GBP 4 million adverse impact and this is the net of volume growth from larger customers and trade counters, offset by decline elsewhere. The unwind of the temporary margin benefit last year from manufacturer price rises had a GBP 3 million impact and strategic investments introduced an incremental GBP 1.8 million of cost. And cost inflation was GBP 5.8 million as explained on the previous slide. Offsetting this then was GBP 5 million of benefit from mitigating actions, and this comprised GBP 3.9 million of cost savings year-on-year and GBP 1.1 million of price and margin benefits. So taking a look at the mitigating actions in a bit more detail. And these actions build on previous efficiency initiatives and include in the period, reducing operating head count to reflect the lower volumes, transport centralization, renegotiation of fuel contracts, targeted price increases and margin improvement actions and lower bonus accruals and other cost savings. In the second half, these will be supplemented by further cost efficiency initiatives, including dynamic route planning in the U.K., which optimizes vehicle and fuel requirements and renegotiation of energy contracts. Moving on to nonunderlying items, which this year totaled GBP 1.5 million in the first half and were all acquisition-related. The main component was the amortization of acquired intangibles, which we consistently report as non-underlying, as in previous years. And this increased from GBP 0.7 million last year to GBP 1.3 million this year, reflecting the acquisition of Melrose in January. In the previous year, we had a significant credit from insurance proceeds relating to the fire at the Kidderminster site in 2021, and we expect further proceeds in the second half of this year. So turning to the cash flow. Working capital was broadly flat year-on-year, compared to the GBP 33.8 million outflow in the previous year. And this reflects a stabilization in the working capital position, following the unprecedented inflation in inventory costs seen over the previous couple of years. Underlying operating cash flow was strong at GBP 19.8 million, a year-on-year increase of GBP 35.2 million. In January, we acquired Melrose Interiors for GBP 3.7 million. And so far in the second half, we've made 2 small acquisitions, totaling GBP 2.3 million, which Chris will touch on later. Capital investment in the first half was GBP 10.1 million, principally comprising GBP 3.3 million relating to trade counters, GBP 2.8 million on cutting tables and associated safety equipment and GBP 1.5 million on solar panels. Lease payments of GBP 7.2 million were up year-on-year, reflecting new leases for trade counters. And finally, there were GBP 14.2 million of shareholder returns in the period, comprising GBP 9 million ordinary dividends and GBP 5.2 million in respect to the share buyback program that completed in March this year. The net cash flow before movements in borrowings then was a GBP 21.3 million outflow, representing the combination of the strong underlying operating cash flow principally offset by investments in CapEx, M&A and shareholder returns. Headlam has a strong balance sheet, underpinned by a freehold property portfolio valued early this year at GBP 149 million and inventory of GBP 148 million. And there is significant liquidity headroom, with nearly GBP 80 million of cash and undrawn facilities available at the end of June. Net debt, excluding leases was GBP 19.6 million at the end of June, representing 0.5x EBITDA. Now this is a chart that's been presented before, showing the daily net debt balances, and I find this a useful illustration of the profile of cash generation. And you can see that there is relatively small peak to trough swing in the net debt balance within each month or half year period. And the red line shows this year. And the final dividend in respect to 2022 of GBP 9 million was paid in June, which creates that dip that you see before stepping back up as we exit the first half. And Chris will talk about outlook later, but we expect that red line to trend up with slightly over the second half. I'll now hand you back to Chris to cover the strategic progress in the first half and the outlook.

Thanks, Adam. So turning to an update on our strategy. Now as a reminder, there are 5 pillars to our strategy. The first one talks to service. And do I say that our latest customer survey that we do every 6 months, sees us remaining as the #1 service provider in the U.K. The second pillar talks to revenue growth. And now I've got some detailed slides that talk about an update on the growth initiatives that we've been working on in the multiple retailers, the trade counters and our brands in particular. The third pillar talks to operational efficiency and we've heard at length from Adam, the steps and actions that we've been taking to mitigate the cost base during the year and some things that are planned for the year ahead. And the last 2 pillars, the fourth and the fifth one, relates to our sustainability and environmental agenda, together with making Headlam a great place to work. And those 2 pillars are really covered by our ESG strategy, which I'll talk to you again in a moment. So just providing a bit more detail about the strategic growth initiatives that we've talked to so far. So as a reminder, this covers the multiple retailers, the trade counter rollout that we're midway through and the development of our own products and brands, all aimed at giving us around GBP 200 million worth of growth in these areas. So firstly, if we talk about the multiple retailers. Now as a reminder, this is a very much bespoke service-driven offer that we give to these customers. This is all about offering a specific product or specific logistics service that no one else can offer in the U.K., and it's a really compelling offer for these large customers, we can offer consistent service across the country. And previously, we've talked about having Tapi as a significant customer. Homebase is a new customer we introduced into 2022 and Screwfix is a new customer for this year. So we've seen significant growth in this space year-on-year, 26% up on last year. And that remains the trajectory that we're looking for in the future as we continue to roll this service out to new customers. Secondly, trade counters, we talked at length about this and the trade counter rollout continues. As a reminder, it's aimed at offering new customers in the kind of white space around the U.K., if you like. There are parts of the country where we have little or no offer. And we've done some work to look at a heat map of where people are and where flooring demand is. And we are going on a program or filling in that white space with new locations, small footprint offers, bringing our service to customers. And this trade counter rollout is doing very well. We're tracking in line with the business case we expected and we undertook to come back and provide regular updates to shareholders on the performance of this initiative. Again, pleased to say that, that's reporting strong growth, just under 9% year-on-year. And we've also been able to drive down and make efficiencies in the cost of fitting out the new sites, which has meant that we are able to save some of the capital of each of the site openings. We're expecting that to mean that we'll end up probably closer to 100 sites in the U.K., rather than the 90 we talked to previously. And that's really driven by the fact that when we look this heat map across the U.K., we do think there are other towns that we can include in the new site opening. And in fact, we've been able to reduce our capital spend, so we should come in at a similar level to that we indicated before. So thirdly, we are going to update on the product brands and a rollout on how we're investing in those initiatives. So I mentioned earlier that we've had an award-winning new product hit the market in one of the other slides and that's called Everyroom, and some of that is behind me on the screen here. So that was a new product launched at the end of last year, and that's seen some significant growth and enabled us to drive demand up in our own brand part of the market to a plus 7% year-on-year, despite the weak residential volumes that I reported earlier. So very much a product for the moment. Very well received by our customers, good quality, good price, and that's something which is seeing good traction this year. We're also investing in the digital side of our business. Now it's something that we've feel that it's important that customers, both in the multiple space, but also in our brands, we need this sort of digital awareness and engagement with our customers. And we have been investing in kind of e-commerce and digital capability, launching new B2B websites and are planning a new overarching Headlam website later this year. And finally, Adam mentioned acquisitions. We made a couple of small acquisitions in the last few weeks, and they are relatively small, but pretty much aimed at adding capability to our own brand business, by offering a kind of in-house sampling service in the business that we acquired in Yorkshire and another one where we're looking at product expansion in our own brand business in the Netherlands. So just turning to ESG. I sort of move together the 2 strategic pillars that I mentioned earlier into a single update. So we did launch a new ESG strategy in our March update. So as a reminder, I've just reproduced that on this slide. So just a handful of points really to update since that strategy update in March. I'm pleased to say that we've been awarded AAA status by the MSCI ratings agency for our ESG credentials, which is great to hear. We've also engaged with SBTi to make an assessment and commit to the net 0 and interim targets for our Scope 1, 2 and 3 emissions. And building on the great work that we did in 2022 with our people, we are doubling down on our focus on health and safety, in particular, and we've rolled out some leadership training about health and safety awareness in the workplace, and keeping people safe in the workplace and getting them home at the end of the day is our #1 value. So I didn't mention I'll be covering the outlook. So just turning to current trading first. July and August, very similar to what we've seen so far. So Adam shared with you the trend of volume. So we've seen pretty flat volumes for July and August, which has meant that revenues remained relatively flat year-on-year. The same sort of pattern, residential volumes slightly negative, but probably improving a bit. And commercial volume, remaining a bit more robust, but certainly the positive sort of declining a little bit as well. So everything normalizing back to a relatively flat position. What does that mean if I look forward to the outlook? We said in the trading update at the pre-close, we expect that the outlook will remain relatively subdued for the rest of this year as the RMI and residential spend remains subdued. But we do expect in the medium term that, that will improve. Now whether that happens sort of second half of '24 or beyond, we'll see. But I think our expansion of our offer to customers and the efficiencies that we've developed, mean that we should see in the medium term a significant improvement in profitability, as that volume comes back and we get the operational benefit of putting more volume through our network. So I think a more positive outlook, perhaps in the medium term, albeit the short term is obviously affected by the macro factors we've discussed previously. So capital allocation. Just a quick refresh on this, really. We've been considering how we talk about capital, how we use the strong balance sheet that Adam mentioned earlier. We just clarified what we meant by a target leverage. And we've talked about 0.5x to 1x depending on the point of the cycle. So that's just to give a bit more clarity and guidance on our approach to leverage. We've also recommitted our commitment to the ordinary dividend and we see that as a fundamental part of, I suppose, the cash-generative nature of the business. And as Adam mentioned, in the short term, we're looking to drop cover ratio for our dividends to support the ordinary dividend during this sort of cycle, this down period of the cycle, as we see confidence in the outlook returning later. And then lastly, I suppose it's a restatement of how we see the other elements of our capital allocation. Now whether it be special dividends, share buybacks or in M&A, we are looking to create flexibility in whether the market factors are supporting one of those capital return mechanics or indeed M&A opportunity exists. So I think we're going to look at those based on more of a returns basis. In the past, we've looked at those in a more vertical way. So we're looking at these in the round, looking at the market metrics at the time and the availability of M&A. So certain change to how we're presenting capital allocation. And hopefully, that represents the market conditions we see at the moment. So just to close the presentation with a summary. We're seeing revenue performance broadly in line with expectations. In the medium term, the broadening business base, the continuing delivery of our strategic growth plans will stand us in good stead for a return to improved profitability as the market recovers and we see an improvement in volumes. That brings me to the end of the presentation and I'm also happy to take some questions.

[Operator Instructions] And the first question is, "What did the increased revenue contributions from larger customers and Trican to rollout, contribute to profitability in the period?"

So the volume benefit from trade and nice customers in the first half year was about -- is worth about GBP 1 million of profit. And in larger customers, back flows -- [indiscernible] larger customers grow through to the bottom line, trade counters, as we've talked about before, as we're in the rollout phase that it's dilutive to profit and you'll have seen in the profit we presented GBP 1.8 million of strategic investments in the first half of the year. The majority of that is trade count. And so trade count is diluted to the P&L this year and next year and then year-on-year becomes accretive thereafter. Larger customers supportive to [indiscernible]. So that answers the bottom line.

Great. And what's the current annualized turnover of the trade counters, relative to the aspirations of this being a GBP 200 million activity? And if this objective is achieved, what level of incremental profit will it produce?

Yes, we're about halfway to our target. So we talked about this being a GBP 200 million revenue division of the group and we should be getting towards GBP 100 million of that this year. We talked about 9% revenue growth year-on-year, we're nearly on to a run rate basis, 90-something. So we might well get to 100 right by the end of the year, so about halfway. The other indication we've given in the past is that we'd expect, once it's got to scale and maturity and Adam described, we effectively carry a cost for a period until this ramps up. We do expect that, say, an average site might be a GBP 2 million worth of revenue, at that level would create around about GBP 200,000 operating profit for a site, to around about 10% operating margin. So you can imagine what we've got the scale, and we're looking at our GBP 200 million division. I imagine that will be high single-digit operating margin. So high teens in terms of operating margin, step up where we are now, maybe as much as another GBP 10 million worth of [indiscernible].

Great. And you suggest the downturn in residential figures is due to the larger macroeconomic factors and suppressed spending. Do you recognize any migration to competitors by bricks and mortar retailers, primarily driven by Headlam strategy of rolling out trade counters? And it's increasing support of the man in the van sector, is the anecdotal evidence to suggest that many retailers are feeling this as a direct assault on their business and years of loyalty to Headlam is no longer recognized?

Yes, that's a good question. I've actually spent some time talking to some of our teams about that. So we -- there's 2 things to say. One is that Headlam has always been servicing the man in van, what is the best phrase, so we call them [indiscernible] has been an ideal and long-standing feature of our business for decades. So independent retailer is one core group, the other one is [indiscernible], so that's always been a part of the business. We've also carried out 6 monthly customer surveys to assess their views, thoughts, wants, desires, needs, serve the customers better. And I think one of the things that we have seen change, is a slight change in attitude over the last few years, particularly post-COVID. There's a much more complex and intricate supply chain that ever has been. One of our competitors, for example, is completely integrated and they have not only a retailer in their business. They also have an online retailer as well. So you will find some of our customers will actually buy a lot of our competitors as a distributor, knowing that they've also got a retail business and knowing that they also got an online business directly compete with. So it is not a clear playing field. Having said that, I think we did recognize, I was expecting them to be a little bit of confusion or perhaps clarification needed, when we rolled out trade counters. Most of the trade counters were at white space. I described that as, we're infilling in towns and areas of the country where we don't have a physical presence. So that is aimed at our existing customers. Clearly, what we're trying to do is take share from our competitors and maybe win some business in current on flooring builders. So that's the aim. That's the discussion we've had with our customers. And indeed, some of our sales team charge towards customers about that. Clearly, we do get 1 or 2 customers looking for clarification, to make sure that we're not trying to take their customers, but very much focuses on customer service and offering new service to new customers that we don't currently.

Great. And just to remind you, we've got a couple more questions. [Operator Instructions] So the next question, "With the benefit of hindsight, how would you read the success of the share buyback program? Do you think that the decision to buy up to 50% of the daily volume enhanced shareholder value?"

Yes, it's always difficult. If you look back with hind sight, of course, we try to reframe and reframe the capital allocation both to allow us flexibility at any point in time. It's particularly difficult to pay that assessment, when you've got some quite difficult macro factors, which of course, quite a big movement to share price as well. What we did say was given the share price, given the liquidity that's deploy capital in this way. I think the success enhanced when we increase the speed of it. It was a much shorter sharper process once we move to 50% of the buyback. So I think it is a job that we set out to achieve. Again, would we do it again, what would we do differently. I do think, given our scale as a small cap business, I think having something that's big and meaningful is they will be worthwhile, something that's meaning for buybacks clearly makes more sense, than small amounts going around the edge. If you're in a [indiscernible] business or something, you can clearly set out a program of rolling buybacks. It doesn't really work so smoothly for a small cap business. So again, it's not easy to answer that question directly. But certainly, once the -- we took the breaks off some of the buyback process, it achieved the outcome more quickly.

Great. And at this stage, final question, "In the financial crisis, the basic earnings per share fell to a low of 19.1p in 2009. The equivalent figure in 2023 will be lower, even in nominal terms. Can you comment on why the business is performing less well today than it was back in the financial crisis?

Yes, sure. I mean interesting actually, when you look at volumes, sort of the volume movement back of the global financial crisis and now so peak-trough. We've seen about 20%. So now we move as about 20% of our volumes in 2019 and 2019 actually wasn't [indiscernible]. We saw a similar volume even back in that period 13, 14, 15 years ago. Probably, there is one other big differential between those [indiscernible]. There's almost no inflation. At that time, obviously, we're now seeing some quite unprecedented levels of inflation. We're seeing about 70% payroll inflation in the first half of this year. We're seeing electricity costs in the U.K. more than double and we're taking actions and efficiency actions to mitigate those and those are build in the second half of the year, but it has had a net impact on the first half of this year. So I think it's a combination of volume, similar, but at this time, much more inflation. And I think just to add to that, we've also chosen to invest in broadening the business space and we disclosed in a few of the amount of investments we're making in setting up the trade houses, for example. So that is dilutive to profitability. So we are taking strategic steps to broaden the business footprint out. So when the market returns, we see a stronger recovery. So as Adam said, I think it's a mixture of macro factors and also company choices around the investment that we're making.

And do you have any closing remarks, Chris?

Yes. Look, I think it's pleasing to see that we're seeing some revenue growth, albeit in the new areas that we're targeting. So we can see that those new customer targets that we're focusing on delivery, we see it grow, which is great to see. Volumes are under pressure, certainly in the residential space. So it's a tough market. I have the pleasure of speaking to lots of our competitors, lots of suppliers. I can see, it's a pretty, pretty much challenging picture across the whole of the residential market in the U.K. So that being said, we expect that softness to remain for a period. So all of the investments we're making, the steps forward, do bode well for when that recovery finally happens and the RMI spend will come back. Those volumes will return and it's pleasing to see that we're going to have a broader business base [indiscernible]. So a tough first half. And as we're looking forward to that sort of medium-term recovery.

Many thanks, Chris and Adam. And to everyone listening, you'll now be taken to a web page to give some feedback on today's presentation. If you can't complete it now, you'll receive a follow-up e-mail. We would be really grateful if you could take a few minutes to complete. Many thanks for joining. This is the end of the webinar.