Inchcape plc (INCH) Earnings Call Transcript & Summary

Hello, and welcome to the Deutsche Bank Depository Receipt Virtual Investor Conference, DbVIC. My name is Zafar Aziz, part of the DR team at Deutsche Bank. I'm pleased to announce that our next presentation will be from Inchcape from the U.K. Before I introduce our speaker, a few points to note. Please submit your questions in the questions box below the slides. Once the Q&A session has ended, don't log out. You'd ultimately be transferred into the Inchcape [ booth ] where you can continue the conversation via chat and access shareholder materials. On a final note, all of today's presentations will be recorded and can be accessed by the Deutsche Bank website, adr.db.com. At this point, I'm very pleased to welcome Raghav Gupta-Chaudhary, Head of Investor Relations at Inchcape, which trades on the London Stock Exchange with the symbol INCH and the U.S. on the OTC market as INCPY. Over to you, Raghav.

Thank you, Zafar, and good afternoon, good morning, everyone. Thank you for having me. I'm going to run through a few slides, a short slide deck, just giving you a bit of an overview on Inchcape and the business as it stands today, and then we'll very happily take your questions. Starting then on Slide 2 with a bit of a group overview. So who are we? Who is Inchcape? We're the largest independent global automotive distributor. We've got 2 key business segments, the Distribution business segment and the Retail segment. And the distribution segments accounts for the vast majority of group profits, as mentioned there. We are, as of today, operating in 36 markets with a focus on high-growth markets, you can see that on the right-hand side there on the top right-hand side of the slide. We've got really long-term relationships with the strongest OEM brands, that's the bottom right of the slide. And we've got kind of relationships ranging from over 50 years with Toyota and Lexus to, I guess, one of our youngest kind of long-term relationships that with Subaru, which is kind of 28 years as young as of today. This is a really highly cash-generative business, and I'll show you that in a couple of slides. We strengthened the financial position in 2020, closing the year with GBP 266 million of net cash. And we're pleased to announce our return to the dividend list. When you look back at that history, the group also has a really strong track record of through-cycle resilience. On the next slide, I give a little bit of an overview here of the Distribution business model. It's always really important, particularly for new investors who perhaps don't know us as well and think of Inchcape and think of a car dealer. Inchcape, as a distributor, runs the entire process, right? That's from product planning, brand positioning, the logistics of getting the vehicles into a market, running the national marketing, the websites, et cetera. And also, very importantly, the network management. That is managing those dealers who sold vehicles on behalf of the brand, some of which Inchcape will operate, we operate ourselves, and some of which are done by third parties. And we take care of all of that network management. Some might be familiar with the term "national sales company," and that is what we operate at as a distributor. Now conversely, as a retailer, what you'd be doing, as we do in the U.K. and Russia, where our 2 retail-only market. You do the new and used vehicle sales, you kind of clearly attach some finance and insurance, excuse me, if you can, and also do the aftersales and servicing. So you're really only involved in that 7, 8, 9 days as a retail. Whereas as a distributor, you've got adding so much more value. And as a result, that is higher margin, higher returns and more kind of cash flow generative. So it's kind of an important kind of starting point, I would say, in terms of the story. Let's kind of take you on a little, I guess, walk through recent memory lane as it were showing here the quarterly revenue trend. The bars show that the difference in performance in Distribution and Retail and the black line shows the group organic revenue growth. Now we made a reasonable start to the first quarter, and trading was actually ahead of our own expectations in January and February, first quarter 2020 that is, they kind of come back over a year. And then COVID started to kind of clearly have an impact on our business and in our market. And I guess, peak or trough as it were of that disruption and of our performance was in the second quarter. Our organic decline in April was 76% because many of our markets were forced to close. We weren't able to even operate aftersales services, let alone keep showrooms open. And so that was, I guess, the trough for us. Since then, the title clearly references underlying resilience, organic has -- organic growth has still kind of been negative, kind of declined around 10% in the second half of the year. But we've clearly seen that upward trend, which continued into the first quarter of this year. While it's still below 2019 levels, which is clearly becoming a reference point for many people, that trend of improvement continues, particularly on the Distribution side. I guess it's a real story of geography, as I mentioned, on the Retail side, it's only the U.K. and Russia. And the U.K. was locked down because of COVID for the entire first quarter. But because of many of the improvements in practices and how we've adapted, which we show there in the box on the right-hand side, by being able to offer click and collect services or physically distant delivery, online payment capability, both for vehicles and aftersales and the general rollout of online platforms, that's really helped performance. And so what we're not seeing is full market shutdowns, which is encouraging now for the most part. This shows a quick reminder of some of the kind of the key numbers from a P&L and free cash perspective of what we experienced in the full year to the end of December 2020. Now clearly, I referenced the top line growth or decline, which culminated in a 29% decline in the first half of 2020 and an operating margin of just shy of 1%. You can clearly see the bounce back in the second half, where the organic decline was 9%, and a margin was shy of where we were the prior year in an undisturbed, I guess, period but was still pretty healthy, where we were benefiting from significant cost restructuring program, which will benefit the group structurally going forward. I referenced the high cash generation. We delivered a cash conversion of over 100% in 2020. The general, I guess, expectation or history of this business is a cash conversion of around 60% kind of -- and as such, the 2020 performance was exceptional, but that was clearly on the back of a really low base in terms of profitability. So things to take away from this slide and the last couple of slides, I guess, is the business is on an upward trend. From a recovery perspective, we've taken out cost, and the business is incredibly cash generative. I'll just go through a couple of slides on the strategic priorities and give you a bit of context for this first and this is all about Distribution. On the right-hand slide, we will start with the picture, I guess. I'm showing here the typical retail markets, which are those markets which have total industry volumes, that's what TIB is, new car sales in essence per year, of more than 1 million units. Those are a typical retail market, and for us, that's the U.K. and Russia, but clearly puts a more familiar big, large automotive retail markets, where OEMs essentially operate national sales companies themselves, the carmakers do that themselves, is where they make most of their money. The Chinas, it's the U.S. and it's the kind of the big European markets, Germany, U.K., France. Where we specialize is in those markets that are less than 1 million units per annum. I've given selection of markets there from Australia, which is the largest market, for which we do distribution for Subaru and a number of others, right? And so that less than 1 million units is our sweet spot. And clearly, those are really fast-growing markets where vehicle penetration or motorization rates of the number of vehicles per capita is very low. And so that's kind of, in essence, the growth story for the group. I'm conscious of time and wanting to get to Q&A. So I'll click through. Another aspect of the growth story, aside from the low -- our exposure to markets with low motorization, is the fact that the market is incredibly fragmented, right? So on the right-hand side here, I show global car volumes, which are, in essence, 90 million units a year gets sold or certainly that was the case in 2019. And in markets where there are less than 1 million units sold per year within these regions, they total 17 million, right? And these are much faster-growing markets than the global average for the reasons that I kind of gave about low motorization. The 17 million units, kind of the total of these regions, as I said, they're the typical distribution markets where we would expect to be able to kind of consider to be our addressable market as it were. And as it stands today, we operate in 30% of those markets, or markets accounting for 30% of volumes, I should say. And what you see in gray, kind of circa 70% are new markets where we're not currently in. So there's -- the opportunity for us is twofold. Both growing market share of our existing brands within the kind of the current suite of markets in which we operate in, but also in filling, infilling, as we call it, with new brands within markets we currently operate, right? So that's, I guess, the kind of the opportunity that we have within sites. And then beyond that, clearly, there is an opportunity for M&A, and that is for us to enter new markets, which is happening increasingly, right? So our share of this 17 million is around 1%, right? And that kind of talks to the fragmentation. We -- our new CEO joined business in the middle of last year. And in February of this year, we outlined, I should say, our strategic priorities. For those that know us well kind of clearly as part of the Ignite strategy, which was launched in 2016 under the previous CEO, Distribution was put kind of very much as a focus point, and that continues with Duncan Tait at the helm. Distribution is absolutely the focus, remains our beating heart and is where we see all of the opportunity kind of -- that is certainly within reach. What we're also focusing on more than we have done previously is vehicle lifecycle services, right? And this, as I'll come to in a couple of slides, is essentially all about capturing more of the value in a vehicle life than we currently do. And that's thinking about used vehicles and the aftersales opportunity beyond the first phase or first owner user of a vehicle. Enabling all of that or underpinning kind of the success of both of those 2 key growth pillars, it's clearly people, culture and capabilities. This business has a real entrepreneurial and innovative spirit, but we kind want to drive that even faster and make it a really great place to be able to retain and attract talent. Digital, data and analytics, Duncan has 30-plus years of technology services and experience and background. And so this is absolutely something that even in the kind of 9 or so months that he's been in -- 10 months, I guess, that he's been in the business, that we've seen us really accelerate. And that is something that we think and we hope we'll absolutely be able to drive better performance for our OEMs, which in theory should enable us to grow faster because they will see us as kind of the best partner for them. Finally, efficient scale operations. Being in 36 markets across several continents, there is an opportunity for us to be able to leverage that global scale, which has benefited us during COVID relative to some of our peers. And we expect that will absolutely continue and there is an opportunity within that. In terms of distribution excellence, on this slide, we're showing, in essence, what we're trying to do is acquire customers as we have done for decades, right, but retain that customer. And we think kind of we're sensible and the power that is within the potential use of data will enable us to do that. What our focus is, as we show on the left-hand side, is accelerating our omnichannel platform and the rollout of that platform, which we started in 2018 and rolled it out to a number of markets in 2020 and plan to roll that out into even more to get even more coverage across this year. And secondly, we want to globalize and -- second and thirdly, globalize and digitalize our processes. On the bottom right-hand side, we show the 6 core activities, which may or may not be legible. But we've seen kind of a real opportunity for us to be able to use technology and an opportunity to, I guess, really harmonize the processes that we use in certain regions to make it kind of more of a global, I guess, process, which we've already seen has bear some fruit, and there's an opportunity for us to go faster with that, which is noticeable for the OEMs and will absolutely benefit the group and the relationship. On vehicle lifecycle services, this is, in essence, for us doing more than we have done before as a distributor and being able to capture more of that value. And when we think about the magnitude of the value, we've sized it. We think it's at least the same size in terms of profitability as the kind of the first phase or distribution excellence where we're able to sell the vehicle and you benefit from the metal margin, access to both a healthy and growing used car market, as is the case in many of our businesses or regions, I should say, and markets as well as the aftersales opportunity, which is something that we're really excited about and something that we could -- that the OEMs are really pushing us to do, right? And so there's an opportunity to use those relationships to expand various services and activities by leveraging infrastructure that we have in market today. And that's absolutely something that we have a right to play in, and we can talk about more of that if that's of interest. It's kind of the same outlook slides, of course, just 1 more slide. The same outlooks that we had at our full year results for the year ahead. Clearly, the business has bounced back, but the COVID situation is still very dynamic. We're managing it much better, have much better kind of capability. But nevertheless, it's really difficult to know how certain markets are going to respond as seasons change and they're kind of going into winter on the southern hemisphere, for example. Nevertheless, we expect material growth in profits in 2021 and an improved operating margin. When we think about the investment proposition, hopefully, it's come through. But in essence, this business has got a history of delivering market outperformance, that is, we grow faster than global new car volumes. And clearly, that's helped by our exposure also to high-growth markets. And so think of this business as a GDP -- global GDP plus organic growth business, with great -- as we kind of move up that chain as it were or step-up, with great expansion opportunities. We've done 16 distribution deals since 2016. And as I showed you with that pie chart, the industry that we operate in is still highly fragmented, right? We've seen an acceleration in the M&A, I guess, opportunities that we're seeing and done a number of smaller size deals in recent times, but there's absolutely a really, really great opportunity for us to go further with that. I referenced the leveraging of our distribution scale and, in essence, that is sharing of best practices, as we have been doing over the course of the past year, in particular, but also rolling out digital developments as we did. So the omnichannel stuff started in 2018 in Australia and we rolled out to a number of markets in Americas. It's in all of our Subaru markets. And as I said, we'll be going even further with that. The strong cash conversion should absolutely continue. This is a business which is not very highly capital-intensive with CapEx, excuse me, of less than 1% of sales. And so you should expect that discipline on cash to continue and that delivery of free cash flow to continue. And this is a business, again, that has shown, over time, that it's got a very disciplined capital allocation policy, right? We've got a fairly even balance of dividends, acquisitions and buybacks over the course of the past few years. Pleased to be back on the dividend list. Announced a couple of smaller wins, acquisition and a contract with our Q1 results a couple of weeks ago and the M&A pipeline is healthy. And in the absence of all of that, I mentioned the GBP 266 million of cash on the balance sheet at year-end that continued to build. We've continued to, I guess, deprioritize Retail by exiting part of our Russian retail operations, which should complete in a couple of months, in essence, which is extracted value, and so that balance sheet is in very good health. So hopefully, it comes through -- this business is really well positioned to deliver -- continue to deliver shareholder value through both organic growth and consolidation, but also cash returns.

I'll now move on to Q&A. So one of the questions that has come through is -- relates to our plans to open used car retail locations with fast post-sales or aftersales offerings in the U.K. So this is a good question, and it's a reference to something that the U.K. team has been working on. It's part of our vehicle lifecycle services, I guess, approach. And clearly, for the U.K. team, which is a Retail business. For them, while they do already have a pretty good used car sales business, it perhaps isn't as good as it could be, and that's kind of by their own admission that there was an opportunity for us to do more in what is quite an attractive space. Used car margins generally tend to be pretty healthy. And as such, this is an opportunity perhaps that we haven't leveraged as much. Inchcape, as a brand and as a business, is very much more focused on premium brands and premium marks and vehicles. And as such, we haven't done much on kind of, I guess, lower price point used car sales, which we've done increasingly in the U.K. in 2020. And the view of the team that for very difficult investment in locations where we currently kind of already operate, we can generate really healthy margins, high returns by exploring kind of these used car centers. It's pretty early days. I mean we've had 1 center for several years. I think it was 1 in Bolton. And we do have kind of the data to be able to share, but it's absolutely something that has been successful over the course of the past 6 months. And so you can expect to hear a bit more from us on that. But in essence, that is the U.K. team being entrepreneurial, leveraging kind of existing infrastructure in terms of where our sites are to be able to capture part of the value chain that we haven't done enough. So it's kind of very much combined with our strategy. Another question I've got here is what are the dividend and buyback expectations for 2021? So as I mentioned, capital allocation policy, hopefully, is quite clear. We prioritize investment in the business, which tends to be quite low with kind of CapEx to sales ratio of less than 1%. Secondly, we prioritize the dividend and the payout ratio on that has historically been 40% of net income pre-exceptionals, were adjusted to income. And we expect that to continue. That level of dividend ratio is reasonable. Now clearly, we had to cancel our final dividend in '20 -- that was meant to be paid in 2020 from 2019 earnings because of the COVID situation to preserve liquidity. We also had a buyback that was ongoing, GBP 150 million buyback, which we suspended after having bought back GBP 30 million, right? Again, just as COVID -- the COVID situation was pretty unknown as to what was going to happen. And so while we clearly stand by -- what I would say is we clearly stand by the capital allocation policy, so you expect kind of the business to pay dividend on what it earned in the year, 40% is that ratio. The third priority is M&A, right? And in the absence of value-accretive M&A, we will absolutely kind of consider the appropriateness of doing a share buyback, and that's where I would leave it in terms of that. The next question is how do we participate in used car sales and after sales? So it's a good question. On the Retail side, as I was referencing in my response to the question about the U.K. used car centers, it's more clear in the sense that we have got now a few used car centers in the U.K. and in Russia, whereas we don't have these explicit used car centers in our Distribution markets. And that's partly because we're not doing all of the -- we outsource the kind of the Retail -- we outsource 75% of the Retail in our Distribution markets to other dealers that are not operated by Inchcape, but we manage them and we do 25% ourselves. And essentially, what you need to think about there -- the way to think about it is the branded dealerships, right, which don't have [indiscernible] to sell other used vehicles. We might sell used vehicles of the brands. So take, for example, in Australia, where we got Subaru distribution agreement, we will clearly sell used Subaru vehicles in our retail sites -- on our retail sites, but we wouldn't be selling other branded used cars on our retail sites -- in our retail sites. So the opportunity that we see as a distributor is to be able to help our retail network. So think of this as the 75% that we don't kind of operate ourselves, but we do manage to be able to kind of access the used car market and really market their vehicles that they have in a digital way. So what we've done is really early stages, as I said, the strategy was launched in February this year. But we started a trial in Greece with Toyota, right, where we essentially kind of developed some software which gives all of our retailers an opportunity to be able to advertise, essentially, I guess, think of it as a listing platform, to advertise whichever used vehicles they have on the website, and we take a commission from it, clearly, if it's not our -- operated by Inchcape ourselves but by the third party. So it's a small commission. Where the real benefit comes in for us as a distributor, because clearly, of what we have access to there and where we make kind of a healthy return is on the parts that we get into the network or that we're able to sell. And so if we're able to sell say -- if our retail network is able to sell a used vehicle with finance and insurance, which Inchcape gets a commission on, with an aftersales package, that gives us exposure to the highly lucrative or more lucrative parts market, right? So essentially, what you think about there is a customer continuing to get their vehicle serviced by Toyota in Greece when the vehicle is 3, 5, 6, 7, 8 years old such that us, as Inchcape -- as the exclusive parts distributor, we're able to continue to get that. And that is absolutely an area of the market that is underserved by Inchcape today. So hopefully, that's clear in terms of how we participate in the used car market today. It is something which kind of we're thinking about and reviewing alternative ways. We're clearly operating, as I said, in high-growth markets where digital penetration and kind of very well-developed listing platforms, for example, which is not a key feature of our business today, but it clearly is not a feature in those markets. And so we are exploring other ways in how we might be able to do that. We have a couple of other questions and 2 minutes. So any measures implemented during COVID kind of here to stay long term? So I would reference the COVID restructuring that we did. We took out GBP 90 million of costs, of which we expect GBP 45 million, so half, GBP 45 million will be retained when volumes return to 2019 levels, right? So when you think about that on the business of our sales today, that is a 50 basis point structural improvement in margins for the group when things get back to normal. And what we've essentially done there is reduce our back office, in many cases, reduce the number of layers that we have in the organization and that has kind of really benefited the group from a cost perspective. We've rationalized the footprint. So that is the kind of the stuff that I would say that's here to stay long term. We've also clearly accelerated a lot of what we're doing from a digital perspective, and Duncan Tait, new CEO, is also pushing the business in terms of what it can do with technology and data, right? And so early days and kind of not really much to be able to kind of guide to, I would say, at this stage on that. We will be hosting a Capital Markets Day at some point later this year, when you can expect that we will have a bit more. I'm conscious I'm out of time. But hopefully, that gives everyone kind of a pretty good run-through of where we are and kind of where we're going. Please do feel free to contact me directly on [email protected] if you have any questions. So thank you very much.