Ibstock plc (IBST) Earnings Call Transcript & Summary

Good day and welcome to the Ibstock interim results for the 6 months ended 30th of June 2020 conference call. Today's host will be Joe Hudson, Chief Executive Officer; and Chris McLeish, Chief Financial Officer. At this time, I would like to turn the conference over to Mr. Joe Hudson. Please go ahead, sir.

Thank you, Emma, and good morning, everyone, and welcome to our 2020 interim results presentation for Ibstock plc. Given the circumstances, we're hosting this presentation and questions-and-answers session today remotely, but we hope to be able to welcome you back to our I-Studio in London next time. As usual, Chris will take you through the financials for the first half of the year, and I will talk to you through some of the operational highlights before opening up for questions. It's been an incredibly busy and challenging 6 months for us here at Ibstock, but I'm immensely proud of the way our people have behaved, and I thank everyone for the way they've navigated through a very difficult few months. Through this period, we have managed the safe and controlled shutdown and restart of our manufacturing networks, focused at all times on the health and safety and well-being of our employees and other stakeholders. We've taken significant actions to closely manage both costs and cash flows, which led to the group having positive cash flow in the second quarter. And we are well progressed in the restructuring program, which will give us cost benefits and greater flexibility as we move into the future. We have seen some positive signs of recovery in recent months and we go into the second half of the year very well positioned. Over to Chris.

Thanks, Joe, and good morning. Turning to cover the financial headlines. Revenue reduced sharply in the period, falling by 36% versus a year ago. Both divisions experienced significant declines with the largest reduction within the clay division. Adjusted EBITDA reduced by 84% to GBP 10 million, and I will cover the reasons for this on the divisional slides. We recognized a GBP 41 million non-underlying charge related to the direct impacts of pandemic and the actions that we're taking to restructure our business in response. As the plant network was brought down at the beginning of April, we placed a sharp focus on the management of cash, and the business has done a good in this regard, delivering positive free cash flows in the second quarter. Net debt closed the half year of GBP 103 million, representing 1.6x on our net debt-to-EBITDA measure and giving us over GBP 110 million of available liquidity under our revolving credit facility. Against the current uncertain backdrop, we have not declared an interim dividend and took the difficult decision during the period to cancel the 2019 final dividend. We recognize the importance of dividends to our shareholders and we'll seek to return to dividend payments subject to leverage as economic conditions become clearer. Moving to revenue. We set out, on this slide, the progression of group revenue through the 6-month period. Revenues in the first 10 weeks of the year were, as we expected, modestly below the prior year period. But we saw a sharp fall in the second half of March as the initial impact of COVID-19 was felt. Volumes in April were heavily impacted with clay and concrete volumes down 90% and 70%, respectively, versus the prior year period. From the April low, we have seen steady sequential improvement in both divisions. Joe will cover trading in more detail, but whilst levels of uncertainty remain high, we are encouraged to see continued recovery in demand patterns in July. Turning now to cover divisional financial performance, starting with clay. Revenues were 43% lower with lower sales volumes partly offset by a modest benefit from price. EBITDA reduced by 85% to GBP 8 million primarily driven by the significant volume reduction and the impact of operational gearing. The drop-through from revenue to EBITDA was also impacted by the under-recovery of cost associated with the substantial reduction in inventory in the period, given the lower activity levels at which the network operated. This resulted in around GBP 10 million of costs in the period which are not expected to repeat in the second half. Turning to cover concrete. Revenues were relatively more resilient than in clay, with the April low being around 70% down and revenues for the half as a whole, 15% down on prior year. The revenue of GBP 44 million includes around GBP 7 million from Longley Concrete acquired during the second half of 2019. The division was able to maintain a baseline of activity throughout the lockdown period, benefiting from more resilient demand in certain precast product categories such as fencing. The Longley business, which predominantly supplies flooring into the new build housing market, experienced demand patterns more similar to the clay division and delivered modest levels of profitability in the period. I will now turn to cover the material one-off items reported outside of our adjusted performance. The direct impacts of the pandemic on our business as well as the actions we're taking to restructure our business in response have driven one-off costs totaling GBP 41 million, and I provide a breakdown of these amounts on this slide. Firstly, we recognized a GBP 13 million non-underlying charge in respect of energy position. As part of managing energy price risk, we lock in a substantial proportion of the current year projected energy need in advance. This strategy enables us to manage a key component of our cost base over time. But in the current year, with production volumes now expected to fall well below the levels projected at the beginning of the year, we have surplus gas and power positions in energy markets, which have fallen sharply as a result of the pandemic. The losses on surplus positions covering the 12 months to December 2020 totaled GBP 7 million in the period. Additionally, under accounting rules, we are required to recognize a fair value loss at the half year on the volumes we expect to consume within our factories during the second half of the year. This item totaling GBP 6 million has been excluded from underlying performance at the half year and will reverse in the second half. We will recognize an underlying charge in the second half reflecting the actual cost of energy consumed. Secondly, we have recognized a charge of GBP 8 million, reflecting the cost of severance arising from our restructuring program. I expect a modest further cost in the second half, with the majority of the anticipated full year cost of around GBP 10 million being cash-settled before the end of December. Thirdly, we have recognized noncash write-offs of GBP 19 million related to the fixed assets and certain raw materials at the plants we expect to close as part of this restructuring program. And finally, there were other cash exceptional charges of GBP 1 million, including incremental costs for safety and remote working arising as a result of the pandemic. Moving to the balance sheet. We entered the year with a strong balance sheet. And as I said earlier, we have been sharply focused on managing cash throughout this crisis. We typically build inventories during the first part of the year, which results in a seasonal working capital outflow in the first half. However, as the impacts of the pandemic became clear, we took the actions necessary to conserve cash and protect our balance sheet and delivered a working capital inflow and a solid free cash inflow during the second quarter as a result. We finished the 6-month period with net debt of GBP 103 million, materially below the level at the end of March, and therefore, have liquidity of over GBP 110 million before taking into account any amounts available to us under the government's CCFF program. Additionally, in order to provide appropriate financial flexibility as we navigate the next 12 months, we secured agreement with our syndicate of banks to amend our RCF covenants of both December '20 and June 2021. Turning to the cash flow. Adjusted free cash flow for the period was an outflow of GBP 15 million compared to an inflow of GBP 9 million last year. Overall, working capital was broadly flat in the period compared to the outflow of GBP 20 million last year. We managed inventory well, releasing around GBP 14 million from the balance sheet over the 6 months. This was broadly offset by a net reduction in trade payables as we settled supplier obligations. Capital expenditure in the first half of 2020 totaled GBP 15 million compared to GBP 19 million in the comparative period. Looking forwards, I would expect cash outflows related to non-underlying items to total around GBP 15 million in the second half and expect to settle around GBP 10 million of deferred liabilities under HMRC's Time To Pay provisions. On capital expenditure, we entered the 2020 year projecting spend of around GBP 40 million, of which GBP 5 million related to the initial investment in the proposed GBP 45 million project to redevelop our Atlas factory. In light of the current demand backdrop, we took a decision during the first half to put on hold our investment in Atlas. Given their attractive returns profiles, we intend to progress our capital enhancement projects, which will substantially complete this year. However, we will manage closely other sustaining capital expenditure and now expect capital expenditure for the 2020 year as a whole to be around GBP 25 million. With that, I will pass back to Joe.

Thanks, Chris. Health and safety is, of course, a top priority for us. And I'm really pleased with how our organization was able to deliver a safe and timely shutdown and subsequent restart of our operations across the U.K. We've invested in an additional equipment and put in protocols that more than meet the government guidelines of all of our sites that have reopened. Our back-to-work training sessions were a particularly important part of the safe restart process. We normally do use these sessions after major shutdowns and holiday periods to ensure consistent communication of key messages and health and safety update. Turning now to market positions in the U.K. brick market. As you would expect, total brick volumes have declined significantly since the start of the year, with the majority of the decline due to the lockdown period. Industry inventories increased during Q1, as is normal based on the traditional seasonality of the industry. However, overall, the industry has destocked during the shutdown period as production ceased completely. As you can imagine, Ibstock's inventory levels have followed a similar trend to the overall industry level seen here. We expect that with the reduction in inventories and imported products, there will continue to be a healthy balance of supply and demand with the softer market. On the positive side, the latest housebuilder survey by the NHBC reported a significant improvement in both net reservations and site visits in June versus May. The June year-on-year figures for net reservation are also positive. Looking now at the clay division specifically. The recent investments in our manufacturing capacity, including the opening of Eclipse, the enhancement projects and the increased focus on maintenance, allowed us to manage the network efficiently and respond to a very dynamic situation with COVID-19. We saw a significant decline in volumes during the peak of the lockdown in April. And since then, we've seen a notable difference in the rate of recovery between sales channel, with merchant demand picking up well in early May, but sales direct to housing developers, which make up about 40% to 50% of our volumes, recovering more gradually throughout June and July. Clay volumes were 80% of 2019 levels in July. And that trend continues to improve as developer activity picks up. Now moving on to concrete. This division fared comparatively better during Q2, showing more resilience due to its more diverse end market. Volumes held up better during the lockdown and recovered quickly during May and June, particularly in fencing and building, where we hold a national leadership position. Some products which are more exposed to new build, such as our flooring, walling and roofing products, have seen a slower recovery, but we are seeing more positive trends in recent weeks in these areas. The flooring volumes, in particular, are a good indicator that more foundations are going in and housing starts are improving. Moving on to our restructuring program. As announced in June, we've been conducting a review of our operations. And as a result, we're in consultation with our employees regarding the closure of one concrete factory and 2 brick sites as well as the mothballing of our Atlas brick manufacturing side. In general, these are smaller, older factories with a higher cost and carbon profile. We would have been reviewing the viability of these sites in the coming years, but given the current demand environment, we've had to accelerate these decisions. On the clay side, these closures account for less than 10% of our capacity. And our recent investments, including the enhancement projects that are due to substantially complete this year, give us more ability to flex our capacity across the fleet. The concrete factory, which is closed, was planned as part of the long reinvestment that accelerated during the period. It was a lease site in London, and volumes have been absorbed by our Sittingbourne factory at Kent. In addition to the site closures, we are taking steps to restructure our support functions and looking at flexible working arrangements to help us manage our cost base in line with demand. Overall, we expect these changes to deliver up to GBP 20 million cost savings next year. You're all familiar with our strategic pillars, and recent events have confirmed to us that our strategic focus on sustainable high performance, which includes operational excellence and getting closer to our customers through market-led innovation, were certainly the right ones. We continue to make good progress with our strategic initiatives and operational KPIs around the reliability of our manufacturing fleet and the health and safety of also doing good progress this year on an underlying basis. The COVID crisis has provided an opportunity to also improve digital back-office transactions with customers, and we have continued to work on new product development for the specification market. We will continue to maintain options for organic investment against market trends, and we'll also continue to review suitable M&A should the right opportunities arise. Sustainability continues to be a key focus for the group and of increasing importance to our customers and stakeholders, and our ambition is to be sector-leading in this area. We've recently published our latest sustainability report, which highlights progress across numerous areas. In particular, I would highlight the further 6.5% reduction in carbon intensity during 2019, which is a significant progress towards our 2025 target. The restructuring measures we have announced and associated plant closures will also accelerate our progress in decarbonization in the coming years. As many of you know from our previous sustainability reporting, community engagement is very important to us. With over 30 sites up and down the country and over 2000 employees, we're an important employer in many local communities. I'm pleased to say that our employees' enthusiasm community support did not diminish during the lockdown period, and we continue to do the right thing during these tough times. Many of our sites donated surplus PPE equipment to local NHS facilities and we continue to raise money for Shelter, our charity partner, and have already exceeded our fundraising target for the year. To finish, I'd like to give a reminder of some of the positive fundamental drivers of demand for our products. There is a substantial deficit of housing in the U.K. and conditions and the mortgage market remain supportive, with low interest rates and good availability of credit. We welcome the recent government actions to stimulate activity in the housing market, including the stamp duty holiday and planning reform and the general recognition of the importance of the construction sector in supporting an overall economic recovery. And to conclude this part of the presentation, our strategy remains on track, and we continue to make good progress on our key initiatives. We've taken significant and decisive actions to strengthen the business, closely managing costs and taking steps to ensure we maintain a robust balance sheet. We are well progressed in our restructuring program, which will give us cost benefits and a leaner and more flexible operating structure. Despite the uncertainty in the short term, the longer-term fundamentals remain positive, and the actions we are taking position us well to meet the current challenges and leave us well placed to benefit from the recovery in our core markets. And with that, Chris and I will take your questions. And I'll hand over to Emma, who will give you some instructions about how to do that. Over to you, Emma.

[Operator Instructions] We will now take our first question from Rajesh Patki from JPMorgan.

I have got 3 questions, please. First one, if you can provide some color on how trends have developed on imports over the last few months. And what impact do you see on the industry due to the change, if any? The second one is on cash flow. You've guided for CapEx to be GBP 25 million for the year. How do you see the working capital and particularly the inventory evolve after a flat performance in the first half? And my third question is on the M&A pipeline. If you can provide an update on how the pipeline has evolved and if the number of opportunities in the market have increased due to the crisis.

Okay. Thanks, Rajesh. I'll take the first and the last, and Chris will take the middle. Yes, trends -- imports have actually reduced correspondingly with the market. We have seen a reduction that -- probably by about, I'd say, in the between 30% and 40%. So the moving average target is probably around -- moving average is around GBP 350 million at the moment. And I think you'll continue to see a similar trend of balance with the imports. So that's one of the good things about our industry. We have the buffer of imports with the -- to manage the balance between supply and demand. Chris, I'll hand over to cash flow.

Yes, Rajesh. Chris here. In terms of working capital, the way to sort of think about the monetary working capital, DSO and DPO, I'd expect to stay broadly flat relative to where we were in the first half. When you think about inventory, I mean, we managed quite tightly for cash inventory through the second quarter. I'd expect the balance between production and sales to be more even in the second half. But we will certainly continue to manage that very closely, keep that laser focus on the management of inventory through the second half. In the longer term, I mean, as we've said, we felt pretty comfortable with where inventory levels were broadly as we entered the year. That's the sort of long-run average. And I think the fundamentals remain pretty much as they were. So over the medium term, that's where we'd expect them to settle.

On M&A, in times like this where you have economic turns, you often see business owners reappraising their strategies. So more opportunities to arise. I think we are still focused on making sure whatever we do is very strategically aligned with our core businesses, and we are always focused on the right valuations. Great businesses that come for sale don't always end up being at distressed prices. But we will continue to appraise opportunities that arise in this space in this market backdrop.

We will now take our next question from Priyal Woolf from Jefferies.

I've got 2 questions. So the first one is just in terms of market trends amongst new build housing. So you've obviously mentioned that was a little bit slower to recover, but it's doing a bit better now. Can you just give us a little bit more detail as to whether there's any differentiation there between the larger housebuilders and some of the smaller ones? And the second question I have is obviously inventory levels have been coming down in bricks over Q2. Are there any situations yet or ones that you could have in the near-term, where you've actually been unable to supply because there isn't sufficient inventory at all?

Thanks, Priyal. Yes, I think what you've seen -- obviously the larger housebuilders were more cautious, and they've -- the larger ones have got many regions. They have to align a lot of health and safety practices, COVID-related, to -- with all of their regions. And I think they've been slower and more cautious to ensure that those protocols and practices are in place. I think the merchant activity that you saw in May, June, it's probably a reflection that smaller housebuilders, who are often supported by the merchants, we're moving probably faster. But in, certainly July, second half of July, in particular, and this month already, we are seeing the larger housebuilders come back as a much greater share of our overall daily volumes. So I think that's the answer I'd give there. In terms of inventory, we -- as I said earlier on in my presentation, we work very hard to try and make sure we've got a balanced stock profile to supply the market. And we were able to do that. As we came back up, we had reasonable stock levels. We have destocked. And by and large, we have been able to supply customers. We're trying to work really hard to develop the scheduling accuracy with all of our clients, and that's working quite well at the moment, and people have been very open to partner with us on that. So we haven't had stock-outs. But we are trying to manage the balance between supply and demand, bringing up factories, and we sent that message quite clearly to especially the large housebuilders.

We will now take our next question from Clyde Lewis from Peel Hunt.

I think I've got 3 as well, if I may. Firstly, I suppose, on sort of costs, away from sort of energy, can you just sort of update us as to, I suppose, where the underlying pressures or things are easing, I suppose, in terms of costs, just where you are on that front? I mean in -- the other -- the second I had was on manufacturing. Just in terms of how you're looking at, I suppose, flexing the plants and whether you'll run them, some at full capacity for 2, 3, 4 months and then go on to a sort of a slower shift for a month or 2 and then move that around the group according to sort of, I suppose, more efficient manufacturing. And the third one I had, again, was probably going back to sort of energy. How do you think about sort of forward-buying now of energy? I mean it's obviously -- it's an exceptional period this year, so you've obviously taken a bit of a hit. But how do you think about forward-buying going forward into '21 and '22?

Okay. All right. I'll take the first and third. Joe, you pick up the question on manufacturing. In terms of sort of cost dynamics, Clyde, the sort of variable-fixed split that we talked about historically down to EBITDA in the business, certainly, if you look at 2019, it was around 50-50. You look into the key areas of variable costs, sort of freight materials and energy being the main ones, talk about energy in a moment, but I think we've seen sort of relatively stable cost environments in those other areas. In terms of fixed costs, clearly, employment cost is the single biggest by some distance. And the actions that we're taking, we talk about GBP 20 million cost out in '21. The majority of that will be costs related to employment at factories that are either being closed or mothballed, or to some extent, where we're reviewing some of the labor patterns at other factories. So that will be a sort of a cost that will come out, and that will sort of annualize into the 2021 year, and that's going to be the most significant area of cost removed with a little bit of things like site costs and repairs and maintenance as well that will come out as part of that GBP 20 million. So those are the sort of main parts. But I would say that relatively stable and neutral cost environment across the patch, ex energy.

On our manufacturing flexibility, I mean, our approach, Clyde, was to look at our stock levels and forward-demand patterns, and that's how we manage the reopening of factories. So we were very cautious to make sure that we manage cash carefully, but also manage the balance with what the customer demand would be, so that we wouldn't stock out. We have negotiated with our -- all of our workforce some stand-down agreements to give us more flexibility should there be further downturns. But that -- we don't expect to use that this year, but it's there just in case we have it for the future. We've negotiated with a couple of factories that will make some restructuring in some of those factories to have reduced operational output. Those are smaller factories. And the other factories, we expect to run quite hard, up to high utilization levels for the rest of this year. So we'll see that, but we'll continue to monitor it. Also, got enhancement projects where we still got a couple of factories that are undergoing the final work to upgrade. That gives us a little bit of slack in the capacity here as well. As they come up, they'll be much more reliable. So we'll have, I would say, a newer, refreshed fleet with more efficient assets and in very good shape for the future.

And if I take, Clyde, the last question on energy. As you know, we have pursued a strategy for a number of years now of fixing energy price in advance as we come into the year. And we typically enter the year with something in the region of sort of 80% to 85% energy covered. That was the case this year. And that -- the merit of that clearly is it gives us predictability around one of the key drivers of cost ahead of and going into the discussion with customers around price. So commercially, it gives us certainty and clarity, and therefore, it's very important around sort of managing unit margins as we come into the year. If I give you a little bit of color on 2020. Clearly, we entered the year at a gas price, which was north of sort of 30p per therm, and we saw a very -- a precipitous fall in that through the sort of the COVID period down to below 10p in April and May. And with the level of surplus ownership that we had, that generated the loss that you'd have seen reported as part of our exceptional cost. I think ultimately, as we go forward, the strategy itself is still sound. But I think we will look, in light of the uncertainty around the macro picture going forward, be very careful around the level of cover that we layer in and seek to try and manage that. Also, we'll be looking not just at that, but the manner in which we fix energy prices going forward. But ultimately, it will be a continued strategy to look to seek to try and manage price such that we can go into the year with a good level of predictability around the cost base in that year.

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

I've got a few actually. So the first one is just on operating leverage. So just doing the math there for the basically 2 divisions. And essentially, if you kind of back out the destock and the furlough impact, which clearly is temporary in nature, they kind of come out at 60% drop-through. So my question is do you think that's what you'll also see in the second half, I guess, considering the fact that you're obviously going to -- the furlough drops away essentially. And then I suppose related to that, as we think about '21, is there any reason why that doesn't just simply reverse, assuming there's some element of volume recovery in 2021 versus this year? And then perhaps this is kind of asking the question -- the same question slightly differently. But I guess the question is under -- with the fixed cost reduction of GBP 20-odd million, how much -- I suppose the question is how quickly can you return to, I don't know, last year's broadly or the last couple -- let's take the last 3 years' average EBITDA. In other words, how much volume could you be down? If the market is down 10%, say, compared to last year's level, do you think you can go back to that level? Or is that not possible because you basically -- yes, the costs are out, but you're also losing the gross profit basically from those plants that are no longer producing? And so I don't know if -- those I would say are the two ones. Anyways, and then the final question is an easy one. So this year, you're doing GBP 25 million of CapEx, but that still includes the enhancement project. As we look forward in sort of a reasonable market is down 10%, 15%, where do you think CapEx settles?

Okay. Thanks, Gregor. So the question around operating leverage, you're right. I mean if we normalize for the GBP 10 million of costs arising from the destock, on a like-for-like basis, on a sort of an organic basis, the drop-through was actually around sort of low 50%, something of that order of magnitude. The moving parts in the second half, as you rightly say, the furlough cash, we received GBP 9 million in the first half. We would expect that to come down significantly, both as a function of the fact that a number of our people are now back into the factories and working, so we're back down below 20% in terms of the employees that are furloughed and clearly, the plan tapers off a little bit. So that will come out. We would expect to get the initial benefit through the fourth quarter of some of the changes that we're making through restructuring. So those 2 will largely wash their face. But I think in terms of thinking about the sort of drop-through as we recover back up and as revenue starts to increase, I would think that -- I would expect it to be in the region of sort of 50% rather than that sort of 60% number that you quoted going forward. So that's the way to think about that. In terms of sort of margin going forward, I guess, 2021, if we talk a little bit about the way that we see that, as you can imagine, we have a range of financial scenarios, all of them in '21, less than the 2019 year, so below the levels of sort of pre-COVID activity. And we look, to some extent, to sort of industry projections. So we look at things like CPA forecast, which within their main scenario, talk about sort of an operating scenario that's perhaps 15% to 20% below the 2019 level. So that's a sort of sensible place that I think the industry is focusing on as a sort of mid-case for '21. The recovery of margin will be a function of us taking fixed cost out relative to where the top line settles, and it would be about unit margins priced through. And it's too early to say from a sort of pricing standpoint until we get into negotiations with customers through the fourth quarter. So those are the sort of moving parts as we see margin going forward. But I think into the medium term, we continue to have a belief that the fundamentals of the business and the industry in which we operate remain intact. And therefore, we would look at the margin structure in the longer-term to be pretty similar to the levels that we've had in the past. If I just move on and just deal with your last question on CapEx. So you're right, GBP 25 million is the number that we've guided to. It does include around GBP 10 million for the second year of investment on the capital enhancement projects. We've talked about normalized CapEx pre-COVID being in that sort of GBP 25 million range. And I would expect, over the medium-term, that's where it would settle out. That's essentially retaining operative levels of this existing capacity and moving forward, sustainability and some of the credentials of the network. So GBP 25 million is sort of a sensible place to think about CapEx going forward.

We will now take our next question from Aynsley Lammin from Canaccord.

I've got 3 questions as well. I mean just a quick one. If you could give a bit more color maybe on the RMI trends. The industry has obviously done a good job at getting stock levels down. Just wondered if there was much inventory within the kind of merchant space and the trends you're seeing there more recently. Secondly, on dividends, obviously you're going to review those going forward. But is it fair to kind of rule out any final dividend for this year? Or is that still under review as well when you kind of think about that early next year? And then thirdly, just coming back on Gregor's point about the fixed costs of GBP 20 million coming out. If I correctly understood what you just said, essentially, you're saying that in the medium term, kind of EBITDA margins for the group would get back up to the -- close to 30%, where they've been historically. So it wouldn't be correct to think about if we took 2019 levels of turnover and the new reduced GBP 20 million cost base, that, that would all flow through to a higher margin. You're obviously losing some kind of gross margin mix effects or revenue that gets you back to a medium-term margin of about 30%. Is that correct? Just to clarify that?

Thanks, Aynsley. So yes, RMI has been very good. I think in this period of time, a lot of people have been reconsidering their housing footprint where they're working at home more and for the need to put more extensions on and do work in their houses. So that has been quite positive. We've seen continued good throughput, but we don't see a huge amount of stock in the yards of the merchants. So the stock seems to be selling out well, and that seems to be very, very positive. So I think that's the picture I'd give there. The dividend obviously is a key part of our value proposition to investors, and it's something that we would want to return to, but it's still obviously under review until things become more clear. And I'll let Chris handle the margin.

Yes. And Aynsley, you're right. I mean if you think about where that GBP 20 million is coming out, it relates to the plants that we're talking about closing and mothballing, but it also relates to reduction of labor. At a couple of our other plants, we're actually moderating in the near-term throughput. And we're putting in place flexibility at other plants that would allow us to manage output and capacity according to where we see demand settle out. So essentially bringing that back up as we retain the ability to do will bring fixed costs back in as we do that, but it's the ability to flex down that we're talking about, which gives us that flexibility in the near term. So your hypothesis around margins is the right one, settling at the level that they've been at historically.

We will now take our next question from Yves Bromehead from Exane BNP Paribas.

So you mentioned the 5% reduction in total capacity, but if demand remains well below the pre-COVID-19 levels at around, say, 20%, 15% below, can you just help us understand what would it take for you to cut capacity further? And maybe also, if you could comment on the pricing actions. Historically, there is only 1 pricing negotiation in the clay brick business. Is there any risk, as we get into the second part of the year, that the housebuilder puts pressure on the brick industry to have lower prices? That would be my first question. And just second question on the net debt. Can you just help us towards thinking around H2 '20 as you get some of those cash costs, albeit being some of it exceptional? Just trying to figure out what is the level that you would expect in H2. And my third question on M&A. Understanding that this is difficult times, but with more and more focus on the renovation side of things, I was just wondering if I could pick your brain in terms of if you were thinking about the next 5 years, is there any products that you are not exposed to today that you would like to increase your exposure to sort of play that trend of renovation side of things?

Thanks, Yves. So yes, in terms of capacity, just to help you understand, the permanent closures that we've announced represent about 5% of capacity. But remember, we've also mothballed Atlas, which takes you up to just under 10% of capacity. The combination of that with other more flexible working patterns and operational patterns in a few of our factories will give us more flexibility to flex down, but also the ability to come back up. And remember, we've had our enhancement projects, which give us more reliability. That plus the destocking that we've had, I think, give a healthy balance of supply and demand and an ability to continue to flex back up as the market comes back. So I hope that's explained the capacity situation. Pricing negotiations, obviously it's too early to say because they tend to happen in the last quarter of the year. We are in discussions with a lot of people. They're our strategic partners, so we're talking to them about their businesses, generally, not just around pricing. And we'll be having more discussions later on. But we would like -- we think that there's a value proposition there. It's not just about price, and we would hope that the healthy balance of supply and demand and the buffer of the imports helped us to manage the well, and that's something that we're very focused on. On M&A -- and I'll let Chris handle the debt. On M&A, we've always said we'd like to have leading positions in our core business, which is the housing envelope. We do have our concrete businesses quite exposed to RMI, hence, things like fencing, building that have been very positive in the last 3 months relative to the other parts of the business. But we will be looking at other things to give us -- to make sure that we got leading positions in all of our fields, and there are a couple of areas that we continue to think about. But again, it needs to be high quality, it needs to be value accretive. Chris, maybe you handle the H2 question.

Yes, Yves, in terms of the moving parts on cash in half 2, we talk about an expectation of GBP 15 million of cash associated with exceptional items. So that's essentially the majority of the GBP 10 million of severance associated with restructuring and GBP 5 million on energy payments. CapEx, we talked about GBP 10 million expected cash out half 2 on that. On tax, we took advantage of some of the HMRC Time To Pay provisions. So across income tax and indirect taxes, we'd expect GBP 10 million cash out in half 2 on that. We talked a little bit about working capital. We continue to manage inventory tightly. As I said earlier, DSO and DPO, I'd expect to remain broadly flat. So I'd expect that to be the shape of working capital. Obviously, the unknown is around the progression in EBITDA. And given the sort of macro risks remaining elevated, we're clear that we're not able to give a clear and reliable view on how we trade through the second half, so EBITDA will be the swing factor there. We have talked about the fact that it's clear that the GBP 10 million of costs that we experienced relating to the under-recovery of cost in half 1 will not recur. And clearly, we're encouraged by trends at which we traded in July. But clearly, we're waiting to see where sort of underlying demand settles over the balance of the second half, and that will be a key determinant of trading cash that's generated through half 2.

We will now take our next question from Christen Hjorth from Numis.

Just 3 for me, if that's okay. First of all, I think there's been a change in management of the clay division. I was just wondering if you could provide a bit more color on that and whether a replacement has been put in place. And second one, just so I completely understand on the energy exceptional. Is that full GBP 13 million going to be a cash cost that comes out over the year overall? Just so I'm clear on that. And then finally, you alluded to the fact that COVID has accelerated the fact that sort of your older facilities that you were perhaps going to be having a look at in time, which has probably led to some of these permanent closures. If you look forward over the next 5 years, let's say, could you give a bit of color what's the extent to which other facilities perhaps may need relatively significant upgrades? Or have you looked at it from that sort of CapEx angle?

Thanks, Christian. So yes, it became clear earlier this year that the clay division may not be able to scale to support a whole senior Board-level Managing Director at this time, given the reduction in demand and the need to put certain strategic projects on hold like Atlas. So we had discussions with Kate about the most appropriate future for the leadership of this business and ultimately, since have planned, after a mutual decision for her to depart, Kate has found a role elsewhere. At the moment, I'm the Managing Director of the division, and that will continue for a while. But we have a greatly strengthened team below in that division that we've been working on in the last couple of years. So it's manageable certainly for now. In terms -- I'll let Chris talk about the energy, but I'll just finish with the other aspect. We've done a lot of upgrades to our fleet in the last few years. We've invested heavily. Some of the enhancement projects, which are also energy -- more energy efficient. But I think we're in quite good shape. Sustainability is the key thing for us, so we're looking at both innovative and creative ways to reduce our carbon footprint, and we'll continue to do that. I don't expect it to necessarily require a huge amount of investment CapEx to do that or any major review of the fleet. We've done some of that in the COVID period. We've got a balance now, I think, which is sufficiently upgraded and much more sustainable. Maybe, Chris, you can handle the energy bit.

Yes, Christen. So there were 2 elements within energy. The first one related to the loss on position -- surplus positions that exist as a function of the fact that we will now be consuming less gas and less power in our factories. So that amount, which is shown as GBP 7 million, relates to the entire 2020 year and we would expect cash out on that. There's already been some cash settlement of that, but we'd expect a further GBP 4 million to GBP 5 million of that in the second half. The other piece, which is the accelerated recognition of amounts that we expect to consume in the full year will actually be treated within underlying, both for income statement and for cash flow purposes. And so that will not be an exceptional cash flow that we'd expect to flow out in the second half. So when I talk about GBP 15 million of exceptionals, that's largely the severance costs that we talked about, which we expect up to GBP 10 million. Then the third portion of that relating to the loss that we'd recognized on surplus positions for energy.

We will now take our next question from Jon Bell from Deutsche Bank.

Just one left from me actually here. At what stage do you think you'll have enough line of sight on current trading maybe to revisit your Atlas ambitions? And do you have the cash in place to do this?

Thanks, Jon. Yes, I think it's really important we get through the next few months and reappraise this more in the last quarter of the year. I think Chris has talked a bit about our headroom at the moment. And it really will be a function of looking at -- to see where the capacity -- the demand side will lead because we've got capacity to flex up at the moment. So we'll reevaluate that in the -- probably in the last quarter of the year as we see what happens through October and November. But the beauty of that project, it was quite a fast turnaround project, unlike other brick factories that takes sometimes 4 years to develop. This was a much faster project. It was sort of less than an 18-month turnaround. So we hope we can pull that trigger if we need to. Yes, but we'll -- probably last quarter of the year. We need to see what happens in October, November.

We now have time for 1 more question. So we will now take our final question from Charlie Campbell from Liberum.

It's Charlie Campbell here. I've got sort of 2 or 3, but they're all linked, and I think pretty quick, actually. You've given us some color on trading and obviously sort of July as well. I just wondered what the exit rate of July looked like. I presume that was better than the rate coming in, so maybe better than the average you've given us for July. And then also, related sort of points. Just wondering if you could give us some idea of what the order intake has looked like from housebuilders, whether you've seen a decent pickup in the last few months. And then also whether you could give us some indication of what you think inventory levels look like amongst your housebuilding customers because they presumably destocked as well and whether you think that process is perhaps finished.

Thanks, Charlie. Yes, exit rates were what we disclosed earlier on in the brick business at 80% and concrete was 85%. It is picking up. It's better than that now. I think the order intake is looking quite strong on the housebuilder side now. But again, we are trying to work much more closely with housebuilders to get more accurate schedules because what you found in the brick industry is they were very big order, very big order banks, but a lot of them were canceled because people we were recovering. So I think we're trying to really partner strategically now with them. So I think yes, in inventory levels, there were inventory levels in the yard and on the job sites of different housebuilders, especially they will have destocked. As they started to come up, we are getting stronger, stronger forward demand there, especially this month, it's getting very busy. So it's positive, very positive at the moment. We just need to wait and see how sustained it is, but we hope it will be. I think that was the last question. So I'd just like to thank everyone very much for your questions, very insightful questions. If you need any further help, Robert is our Investor Relations Director, is on hand. You all know him. You can give him a call. But thanks very much, everyone, and all the best for the summer. Take care.

Ladies and gentlemen, that will conclude today's conference, and you may now all disconnect.