Lovisa Holdings Limited (LOV) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Lovisa Holdings Limited FY '20 Half Year Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Shane Fallscheer, Managing Director. Please go ahead.

Good morning, everyone, and thanks for taking the time to dial in. On the call today, you have myself, Shane Fallscheer, Managing Director; and Chris Lauder, our CFO. As you're aware, we published our half year results to the ASX this morning, and we would like to talk you through them. I'll do a page turn through the presentation, and we are happy to take any questions at the end. If we now turn to Page 4, we'll talk through some of the detail. We've delivered a solid result across most markets, with EBIT up 10.7% to $40.4 million excluding the impact of the new lease accounting standard. For the sake of clarity, all of the numbers we will talk to today and included in our presentation are after removing the effects of the new accounting standard so that they are comparable to the prior year numbers which have not been restated. Total sales were up 22.2% as a result of the continued new store rollout with same-store sales at 2.1% for the period. Our gross margin decreased to 79% as a result of lower USD purchase rate continuing through the period, with price increases not able to offset that impact. We continued our global rollout strategy with a net 49 store openings in the half. The U.S. rollout is gaining momentum with 21 stores opened during the period and stores now trading across 8 states as of today. We continue to invest in the structure of the business to support our global growth profile as we roll out new territories, including investment into global operational structures as well as continued investment into e-commerce as we grow our Australian and New Zealand site and launch into more markets. Pleasingly, we were able to hold cost of doing business flat on last year. Cash flow from operations was $46 million and cash conversion at 98%, reflecting the investment into working capital to support the store rollout. Net cash flow reflected an increase in CapEx spend in the period, and with that, the Board has declared a fully franked interim dividend of $0.15, being a reduction of $0.03 from the prior half year, reflecting the high payout level in prior year as we return surplus cash to shareholders and introduce debt onto the balance sheet. If we turn to the financial overview on Page 5, as I noted earlier, revenue for the period was up 22.2%, with comparable store sales up 2.1%. We are pleased that we have been able to deliver both positive comparable store sales during the period as well as strong store sales growth from the new store rollout in an environment where we are still not seeing any major trends in the fashion jewelry sector as we saw a couple of years back. We continued to make important investments into both people and process to drive the growth of the store network and to support what is an increasingly globalized business. And in spite of this, we were able to hold our cost of doing business flat on last year. The new store rollout and significant increase in CapEx spend during the current and prior half resulted in a 48% increase in depreciation, which impacted our earnings, and combined with the lower gross margins due to currency movement resulted in EBIT increasing 10.7% to $40.4 million with earnings of $0.263 per share. If we turn to Page 6, we've spoken to the sales increase of 22.2% to $162.8 million and the factors behind it. This chart shows the progression in the company's sales over the past 6 years. It's very pleasing to be able to continue to present a sales growth chart showing such a consistent increase. At the same time as delivering a strong store rollout, we're also able to deliver piercing services to just under 300 of our stores around the world during the period as well as the targeted price increases to offset currency movement. However, neither of these things were a major contributor to comparable store sales. On Page 7, you will see that we have had growth in total sales across all regions with the exception of Asia, which was impacted by store closures in Singapore in the prior year and weaker comps again, both Singapore and Malaysia. It was very pleasing to see strong sales growth across Australia and New Zealand in the period with solid comps as well as an increasing contribution from online in the face of continuing challenging retail conditions. Our growth in the European and U.S. markets accelerated in the period with 4 new stores in the U.K., 10 new stores in France and 21 in the U.S. South Africa, again, was a standout with sales up 15.9% for the period, aided by both comp sales growth and the benefit of additional stores opened. Turning to Page 8, gross profit of $128.5 million was up 19% at a 79% margin, which represented a 200 basis point decrease from last half year as we began to feel the effects of lower USD hedge rates in the period. Whilst we took action on prices globally to combat the impact of the lower Australian dollar, we were targeted in our approach to ensure that we are able to maintain our brand proposition for our customers and therefore, we were not able to offset the impact on gross margin of the currency movements during the period. As you can see from the chart on the right-hand side of the page, we are a fashion business and therefore, our margins can experience some degree of volatility, particularly in periods where we experienced large fluctuations in currency rates. If we turn to Page 9, we'll talk to our cost of doing business. As we've said previously, we've continued to reinvest in the growth trajectory of our business which has put pressure on our CODB percentage over recent period, and this half was no exception. Pleasingly, though, we were able to deliver overall CODB percentage in line with last year. The rollout of stores in new regions has continued to have an impact on our CODB, with opening costs and higher-than-normal store wages throughout the opening period having an impact on our overall cost of operating in new markets. However, we've been able to deliver on some efficiencies in this area, which has helped to keep our CODB in line with last year. We expect these newer markets to continue to operate at a slightly higher CODB than our more mature markets, however, remain focused on delivering further efficiencies across the business to manage this. We continue to invest ahead of the growth curve to lay the foundations for future growth whilst still remaining focused on keeping tight control of the underlying cost structure of the business. I'll now hand you over to Chris Lauder, our CFO, to talk through cash flow and the balance sheet.

Thanks, Shane. Turning to Page 10, you can see that the company's cash flow was again solid with cash from operations before interest and tax of $46 million and operating cash conversion close to 100% as we continue to manage our working capital well in the face of the ongoing investment in stocking out new stores. We did see a drop in cash conversion from the elevated level at the same time last year, with tradings improvement delivered in the first half of '19 now annualized in the first half of FY '20 combined with a change in timing of new store openings and therefore, working capital was lower compared to December last year. Capital expenditure for this period was $19.8 million predominantly from new store fit outs and refurbishments on existing stores upon lease renewal. Overall, this represents a $7.3 million increase on the prior year as we build scale and grow the store network in new markets with the higher store build costs. Cash dividends were slightly higher than prior period of $15.9 million, leaving us with a net cash inflow for the period of $1.4 million and closing net cash on hand of $12.6 million. Turning to Page 11, you can see that our balance sheet remained strong and we've had significant investments made during the year into the store rollout. Our inventories are up on the same time last year, growing in line with the new store rollout, increased franchise stores and the impact of the circa 8% movement in average USD hedge rate year-on-year, the disciplined inventory management remaining an important part of our business model. As with prior periods, we finished the half with net cash and significant headroom in our covenants and $25 million of financing facilities available to fund the future growth of the business, which have all combined to allow us to declare a $0.15 interim dividend. Whilst this is lower than last year's interim dividend, this reflects the elevated payout ratio used last year to distribute surplus cash to shareholders and introduce a small amount of debt onto the balance sheet. As we continue the store rollout in our growth territories, we will continue to assess on an ongoing basis the cash flow requirements of the store opening schedule and like this one, make future decisions on both dividend and capital structure of the business as required, reminding everyone that we do not target a specific dividend payout ratio. I'll now hand back to Shane.

Thanks, Chris. If we turn to Page 12, a quick update on store numbers. Lovisa finished the period with 439 stores trading with a net 49 stores opening during the period. We now have 65% of the store network outside Australia. In the U.K., we opened 4 new stores during the period to take the total to 42 stores. The rollouts in the U.S. and France continued, with 18 stores now trading in France at the end of the half and 40 in the U.S. across multiple states and a strong pipeline of new stores. As we have said previously, booking quality sites is key and we'll take a measured and diligent approach to moving forward in any market we enter. Turning to Page 13, I will now talk in more detail in relation to the U.S. market. As I mentioned earlier, we were trading from 40 stores in the U.S. at the end of the half year, with 19 stores in California, 7 in Texas, 5 in Florida, 5 in Illinois, 2 in Minnesota, 1 in New Jersey and 1 in Oregon. We opened a further 3 stores in the U.S. since December, including our first store in Arizona, taking us to 8 states in total. Results to date indicate that the Lovisa offer is resonating with the American consumer. Whilst operating costs in this market have been higher than some of our other markets so far, in particular, new store build costs, we are happy with the progress and outcome to date in the U.S.A. even though the expansion continues to put upward pressure on overall CODB and depreciation. We obviously see the U.S. as a significant opportunity and continue to invest in the structure to support this. However, the eventual size and timing of the store rollout is dependent, as always, on being able to deliver quality stores that meet our internal criteria rather than hitting our ambitious store number target. Turning now to Page 14, I will talk to the European market. At half year-end, we were trading from 42 stores in the U.K., 18 in France and 9 in Spain. As we saw in the second half of FY '19, rollout momentum in the U.K. has continued to be slower as we focus on only doing leasing deals in quality locations and appropriate rents. In relation to Spain, we are currently trading from 9 stores as we focus on growing sales and operational improvement in this market. As we discussed at year-end, our performance in this region has been inconsistent to date. And as a result, we have elected to slow any further store openings so we can deliver on the key metrics required to expand in this market. Pleasingly, we have seen some improved results from Spain in recent months. And we will continue to take a cautious approach on taking any new sites in Spain, and we'll continue to focus on the stores that we're already trading in. In relation to France, we continue to be pleased with the performance of the stores we have opened to date and are focused on sourcing appropriate sites to grow this market. We have a leasing manager in place in France to support our growth, and again, we will not sacrifice quality of stores or our operating metrics to deliver on a store number target. As with the U.S., our experience in this market to date has been operating costs have been higher than our average and the store rollout is slower than we're used to. Turning to Page 15. Operationally, we will continue to focus on improving the structure of the business and the way each department operates to best support our growth strategy, including a number of senior roles in the U.S. to support our expansion. We were able to execute on the rollout of piercing services across all of our markets during the period, with close to 300 of our company-owned stores now offering this service and a great customer response to date. We have also been trading online for over a year in Australia and New Zealand and are starting to gain some traction in this channel. We've also now launched e-commerce into the U.K., Europe as well as Singapore. Since the end of the half year, we have severed the relationship with our Vietnam master franchise (sic) [ franchisee ], and we're currently in negotiations with new partners to take over this market. On Page 16, we'll talk to the trading outlook for the remainder of the financial year. Trading for the month of January was in line with that achieved in the first half with comparable store sales at 2.1%. However, with the impact to store traffic due to the publicity surrounding the coronavirus, we've seen a slowing of our trading performance with second half comparable store sales now at 0.7% in negative and year-to-date at plus 1.7%, with our Singapore and Malaysian markets being the most impacted. As you will all be aware, a significant amount of our product is sourced from Chinese factories, and we are reliant on continued production for both replenishment of existing lines as well as to deliver the continued units into our stores that our customers love. As you'll also be aware, our third-party warehouse that supports our Northern Hemisphere and South African stores is in Qingdao, China. The combination of these 2 factors means that we are currently experiencing disruption through our supply chain as the normal ramp-up in production post-Chinese New Year has been delayed. As has our warehouse that supports replenishment to all markets, excluding Australia and New Zealand. Whilst we are seeing teams return to work at our warehouse and across our supplier base, it may be some weeks before full production and logistics capabilities are restored, which is obviously heavily dependent on the ongoing containment efforts being undertaken by the Chinese government. As a result, whilst we're already seeing some impact on our stock levels in stores and our ability to move freight efficiently, the full impact of this disruption is likely to play out over coming months with the ultimate size and impact, therefore, not able to be reliably estimated. We are focused on doing all we can to work with our suppliers to maintain stock levels in our doors and minimize the impact on our business. In addition to this disruption, currency headwinds will continue to have an impact on gross margin through the remainder of FY '20, as our average USD purchase rate is expected to drop below USD 0.70. We continue our focus on expanding our new store network and continue to expect the increase in the store numbers in FY '20 to be higher than FY '19. We've opened 3 new stores since the end of December 2019, taking the store network to 442. We'll continue to invest in our support structures, in particular, in the U.S.A. to support store network growth and the larger business, and we'll continue to review opportunities in new markets. So in summary, on Page 17, we've achieved an EBIT of $40.4 million for the first half of the year at 79% gross margin, being a solid result driven primarily from continued new store rollout and comparable store sales of 2.1% for the period. Gross margins were lower for the period as a result of the impact of the lower Australian dollar. We've been able to maintain cost of doing business in line with last year despite the ongoing investment in support of the store rollout and higher average operating costs of our newer markets. We've opened a net 49 stores and closed the half year with 439 stores trading across 16 countries, and 65% of our stores are now trading outside of Australia, with store rollout momentum continuing in France and the U.S. We are pleased to be able to declare an interim fully franked dividend of $0.15 per share. And with that, we're now happy to open it up to take any questions. Thank you.

[Operator Instructions] Your first question comes from Sam Teeger from Citigroup.

Six months ago, you've indicated that new pilots are around 6 to 24 months away. Is it fair to assume now that new pilots are likely in the next 18 months? Or has the thinking changed around this?

That would be a fair indication, so yes, in the next 18 months, I suppose, would be right.

Right. And okay, can you give a bit of an update on Spain? Because feedback over the last 6 months was that it was improving. What's stopping you from converting from a pilot to rollout now? Was Christmas sales a bit below expectations?

No. Just a conservative approach, to be honest. We just need to make sure -- I mean as I said that we've got -- the positive is that we've got positive sales growth however way we can get to get to a point where we're comfortable to sort of push the button. So it's still watch this space, and we're still focused on the individual store performance before we go any further with it.

Do you feel like you're close? Or is there still a lot of work to do in that market?

I wouldn't anticipate that we're going to be doing much in Spain in the next 6 months other than continuing monitoring what we've got.

Got it. All right. And then just in terms of a like-for-like sales update that you gave for the second half of '20 to date. Just based on 6 to 7 weeks, so just trying to calculate, was February down? Just to gauge what the like-for-likes are running at.

For the end of last week, so however many weeks that was, 6 weeks, 7 weeks, I can't remember.

Okay. And the last question. When will the U.S. breakeven? And did you end up adding the buying team over there, over the last 6 months?

We intend to build a buying team. We haven't started that process yet. On the breakeven question, Chris, how do you want to handle that?

We're not going to tell you when we're going to break even. I mean it's -- as we kept saying, we're investing a lot in the infrastructure behind it to drive the rollout. So that's soaking up a lot of the profit we're making from the stores. So -- and hopefully, within the next 12 to 18 months, we'll be there, but that depends on how fast we -- there.

At the moment -- and the last bit of color I'll give you there is we're dialing in the heads in the support center to make sure that we can move as seamlessly as possible through a rollout of stores. So I think the positive way to look at it is that we're getting the structure right to keep rolling.

[Operator Instructions] Your next question comes from Jo Little from Morgans.

Just a couple of questions. Just trying to think about the gross margin in the second half. Two parts to that then. When did you kind of, broadly speaking, put up prices, I guess, in the first half? And how should we think about the second half hedge rate versus first half, please?

I'll start with the second half hedge rate. As we said, we expect that to drop below $0.70 in the second half. So obviously was a little bit better than that in the first half, so $0.71. So given where the dollar's been at, it'll be just below $0.70. So I think probably last year, we were at about $0.75 or $0.76, I think, from memory. The similar sort of impact in the second half in terms of that gap is what we had in the first half. So I think you can pretty safely assume a similar decrease in margin first half, second half before any of the price impacts flow through.

And Jo, on the pricing impact, so really September, October started rolling through, but by no means as dramatic as they were probably 3 to 4 years ago now. So we're not anticipating a massive recovery from that point of view. We're still looking at what we can achieve per market. And as each market gets bigger and more mature, we can get a better base to measure where we can and can't go. So if there were further gains, it's really about a macro pricing structure in, say, the U.S.A. or Europe and whether that can leverage. But we're also ensuring we stay true to who we are, which is a value-orientated retailer where the customers are happy with our prices.

Yes. Okay. Great. So I guess, previously, you had said pricing could potentially recover maybe half the FX impact. So it sounds like that's still broadly in line with your thinking.

I think in the first half, we didn't deliver that completely so...

But you got the full in the second... yes, okay.

At best, that's what we would be able to deliver...