Lovisa Holdings Limited (LOV) Earnings Call Transcript & Summary

As you are aware, we published our half year results to the ASX this morning. So we would like to talk you through them. I will now do a page turn through the presentation, and we are happy to take any questions at the end. Before we get to the discussion on the results, I would like to start by talking to the strategy of the business. I'm thrilled to join Lovisa at a time where the business is performing well and is very well positioned to move to its next phase of global growth. Slide 4 sets out the keys of our success today and our focus for the future. Our strategy continues to be focused on the continued global expansion for our physical and digital store network and ensuring that we are investing ahead of the curve to be able to execute on our growth objectives in both existing as well as new markets. My focus in the first few months I've been here has been getting to know the business and ensuring the structures are in place to ensure we are positioned to grow. And I look forward to being able to begin to put that into action. If we turn to Page 5, we will talk through some of the detail of the first half of fiscal year '22. After a challenging start to the financial year with markets going through various stages of temporary closure due to the impact of increasing COVID case numbers, we saw most markets trading well when we were able to open, and this resulted in comparable store sales for the period up 21.5% on prior year. This, combined with the benefit of 126 more stores than the same time last year resulted in total sales for the half year being 48.3% up on the first half of fiscal year '21. Our cost of doing business was well managed in face of the continued disruptions to the business during the half, finishing at 51.8% to sales and delivering EBIT of $49.1 million, up 59% on the year prior. For sake of clarity, all the profit numbers we will talk today and included in our presentation are after removing the effect of the new lease accounting standards, so that we are more easily comparable with prior years. Our global rollout remains a key focus with a net 42 new stores opened in the period and 126 more stores trading compared to December 2020, following the beeline store acquisition in Europe in fiscal year '21; and further U.S. store rollout with U.S. market trading 81 stores at half year-end. Cash flow from operations was $54 million and cash conversion at 93%, reflecting investment in inventory and settlement of deferred rent payments from prior years. At the end of the period, we held $52.7 million of cash and no debt. As a result, the Board has announced an interim dividend of $0.37 to be paid in April. If we now turn to the financial overview on Page 6. As I noted earlier, revenue for the period was up 48.3% with comparable store sales, up 21.5% on the same period last year. Gross margins were higher, benefiting from favorable currency movement with the CODB well managed despite trading disruption during the period and continued investment in structures, which resulted with our EBIT being up 59% to $49.1 million. The strong performance for the period meant that we were able to finish the half once again with a very strong balance sheet position. If we turn to Page 7, we can see the strong sales performance for the half year that shows a return to the sales growth trajectory we had been on pre-COVID with benefit of stores network expansion combined with strong comparable store sales, driving the overall sales growth of 48.3% on prior year and 44% above the first half of fiscal year '20, which we achieved despite temporary store closures during the period. On Page 8, you will see our sales by region. The first quarter was heavily impacted by temporary store closures in Victoria and New South Wales in Australia, as well as in New Zealand and in Malaysia. Pleasantly, Australia and New Zealand markets were able to recover well after stores reopened and delivered strong comparable store sales growth to offset the impact of the sales disruptions. This was also the case in South Africa with the market recovering well from disruption early in the half to deliver a growth of 37% on prior year. Sales of our Asian markets continued to be slow to recover as a result of low tourism and continued local movement restrictions, resulting in a lower foot traffic. And this, combined with the impact of temporary store closures in Malaysia resulted in sales from our Asian regions being down 11.6% on prior year. Our European business grew substantially comparing to prior year with the addition of 87 stores acquired in the fiscal year '21 as part of the beeline acquisition, and further stores opened in France and Belgium, taking sales for the region to $68.5 million, over 30% of the total group sales. The strong sales performance in this market was achieved despite trading conditions in parts of Mainland China continuing to be disrupted by COVID restrictions throughout the period. The increased store network in the U.S. and good comparable store sales growth helped to deliver a 108% increase in sales in that market as trading conditions improved. Turning to Page 9. Gross profit was $171 million at 78% gross margin, up on last year by 110 basis points with the impact of continuing high freight costs being offset by the benefits of favorable U.S. dollar exchange rate in the half compared to prior year. If we turn to Page 10, we will talk to our cost of doing business. Cost of doing business for the half year was slightly higher than prior year at 51.8% to sales, impacted by continued higher logistic cost and general cost inflation, in particular in relationship to labor, as well as the impact of temporary store closures during the period with significant less waste subsidy and rental abatements available globally than in the prior year. The outcome also includes further investment in team structures to help drive future growth opportunity. I will now hand over to Chris Lauder, our CFO, to talk through cash flow and the balance sheet.

Thanks, Victor. Turning to Page 11. You will see that the cash generated by the business has again been strong with cash from operations before interest and tax of $54 million for the half year. Operating cash conversion was 93% for the half, lower than prior periods due to the catch-up on some of the rent payments that had previously been deferred and additional investment into inventory to help mitigate supply chain risks. Capital expenditure for the period was $14 million, predominantly from new store fit-outs, which represents double the spend in the prior period as the store rollout resumed after being delayed through the first half of FY '21, with 41 new company-owned stores built for the period. Cash tax payments were down on prior year at $3 million with installment rates lower due to the lower tactical profits in prior year and final tax installment for FY '21 due to be paid in the second half. Cash taxes are also lower relative to profit as a result of the increased share of profit being generated by newer markets where historical tax losses therefore exist and therefore no cash tax payable. These factors combined to deliver closing net cash of $52.7 million, a $10 million increase on the position at December 2020, and a $78 million increase on June 2021, with no debt at the end of the period. Turning to the balance sheet on Page 12, you can see that it remains strong, which has allowed the Board to announce an interim dividend of $0.37 per share, payable in April, franked at 30% as a result of the lower Australian taxes being paid at present. As we have said previously, the Board will continue to assess dividend levels each half year and determine the appropriate level of dividend based on profitability, cash flows and future growth CapEx requirements in the context of prevailing economic condition. The Board does not currently have a specific dividend payout ratio, and will continue to base dividends on the cash flow primarily and the structure of the company's balance sheet. I'll now hand back to Victor.

Thanks, Chris. If we turn to Page 13, a quick update on store numbers. The key driver of future growth for Lovisa continues to be in our global store rollout, with 73% of our store network now trading outside Australia. We finished the period with 586 stores trading with a net 42 new stores opened for the year and 126 more stores than December 2020, including the 87 European stores acquired and converted to Lovisa in fiscal year '21 as part of the beeline acquisition. The pace of organic rollout increased during the period, however, remains constrained by labor shortages and logistics challenges, in particular in the U.S., which has also impacted on stores build costs. We now have 165 stores trading across Europe, and 81 in the U.S. across 19 different states at the end of the half year. Acceleration of the global store rollout remains our priority, and we are investing in the right team to deliver this. Turning to Page 14, I will talk to the progress we have made in recent times in relation to digital. Our focus on our digital capabilities accelerated over the past 2 years as COVID impact restricted our ability to trade from physical stores, which drove very strong sales growth in this channel. With website servicing all of the company-owned markets, we operate in local currency and local language. We have a solid platform from which to grow this part of the business, with online sales continuing to improve and up 36% on prior year, while cycling 2 years of a strong growth through fiscal year '20 and '21. We have made good progress here. Our online business is still in its infancy, and we continue to invest in our digital platforms, team and fulfillment capability to deliver in this space, while remaining focused on maintaining the profitability levels of our online sales. On Page 15, I will talk to the trading update and outlook for the coming financial year. Trading for the first 8 weeks of the second half has seen a continuation of the strong performance of the first half. With comparable store sales for this period up 12.51% on fiscal year '21 and total sales up 61.7%. Cost pressures in global logistics as a result of worldwide shipping capacity constraints have continued. And we continue to focus on opportunity for expanding both physical and digital store network, with structures in place to drive this growth in existing and new markets. Our balance sheet remains strong and available cash and debt facilities support continued investment in growth and have added a further 3 stores since the end of the half, taking the store network to 589. As a result of the current uncertainty in the global economic environment, we are not in position to provide any further information in relation to outlook of the business. So in summary, on Page 16, our sales recovery has been strong across most markets, which helped to offset the impact of temporary store closure earlier in the half, with comparable store sales up 21.5% for the period and total sales up 48.3%. Progress continues to be made in digital, with increasing contribution from online sales and opportunity for further improvement to be made. Cost of doing business remain under control despite cost headwinds from inflationary pressures on wages and logistics and the impact of temporary store closures, allowing for continued investment in team structure to support building the platform for future growth. Our global expansion accelerated on prior year with a further net 42 new stores opened during the period and a total network of 586 stores at half year end. All this combined to deliver EBIT of $49.1 million, up 59% on prior year, with our strong cash flow and balance sheet position allowing the Board to announce an interim dividend of $0.37 per share to be paid in April, an increase of $0.17 per share on prior year and leave us with a strong position to accelerate our growth plan. So with that, I want to thank you for your time today, and we are happy to take any questions.

[Operator Instructions] The first question comes from Marni Lysaght with Macquarie Capital.

So 2 questions for me. My first one just relates to, I guess, putting your foot on the accelerator in terms of driving store rollout. You speak about having leasing teams in various jurisdictions. How well versed are these leasing teams in terms of, I guess, breaking into new territories like, could you really be thinking seriously about, say, markets like China or India in the next 12 months?

Thank you for your question. We don't disclose kind of a new market. But at the same time, what I can tell you here is that, yes, we have some experts on real estate across the world, and as a global company and some people are more specialists in America, some other in Europe, and some other in Australia or Southeast Asia. So definitely, I think we'll continue with this strategy on putting experts in every region.

My second question is just around, I guess, what's a sensible way of thinking about new stores per annum? I'm sorry if you've addressed this already on the call. I've been in and out of the call. But just in terms of is it sensible to think that there could be upside to, I guess, how we have traditionally thought about your business in terms of annual store rollout, and you mean you've got the debt facilities that you use should you really need to accelerate your growth.

Well, I mentioned that one of our priorities will be digital and the second one as well, I mean not in order 1 and 2, will be the rollout of stores. And so definitely, as we mentioned to you, we opened 42 stores in the first half of the year, and 126 stores if we accounted for a year. So like this, you can see, well, that I mean we are rolling out stores significantly and it will be one of our priorities for the future.

Our next question comes from Alexander Mees with Morgans.

Congratulations to you both. Great results. Three questions, please. Firstly, just on gross margins. They obviously benefited from a favorable hedging position in the first half. I just wonder if you can articulate what that hedging position looks like in the second half. And I guess related to that, you said that constant currency gross margins were flat. I'm just wondering how you managed to offset the impact of higher freight costs, and was that a surprise?

Yes, so just from a hedge rate to the second half. It will be pretty consistent with the first half. So remember, it's around that same level, around $0.74. And I think from memory last year, it was relatively flat in the second half compared to the first half. So we should see similar sorts of tailwinds from that aspect in the second half. In terms of the freight costs, the constant currency margin was slightly down. And obviously, there's a lot that goes into margin. So yes, I think we probably do a little bit better than what we were expecting too from that perspective, but yes, there's still plenty of pressure there on gross margin for the second half, a little bit of price upside in the first half, but not a huge amount. And we'll get a little bit more of that coming through in the second half. So we expect to see a similar sort of pattern for half 2.

Secondly, you opened 18 stores in the U.S. in the first half. I'm wondering, can we expect at least that number again in the second half? Obviously, there are constraints there. But presumably, the pace is picking up.

Hopefully. I mean, we did 18 stores in the first half and I mean we don't say how many stores we will do in the second half, but I mean it will be a disappointment if we don't get at least 18 stores in the second half in the U.S. market.

And then just finally, Victor, I wonder if there's been any changes to your senior leadership team since you joined, and if so, who they are?

Well, yes, I mean, we hired some people in the senior leadership and basically more in the regions, in Europe and in the U.S. in order to cope with the significant growth that we are going to try to achieve over the next few quarters or few years.

So no country manager in China just yet.

None so far.

Our next question comes from Wilson Wong with Jarden.

Can you just provide some detail just around the first half comp sales growth in the U.S. and Europe?

No, we don't disclose comps by market. So I mean, you can try and back tell from the total sales growth and growth in the number of stores, but we avoid closing to that level of granularity, other than to say that particularly the U.S. came out of lockdown pretty strongly, and the market has traded well for us, as you can see by the market breakdown that we put in the announcement. Europe was also trading strongly on a comp perspective. Mainland Europe, which I think we conveyed Mainland China when he was ready to get out, just in case anybody got excited by that, he actually meant the Mainland Europe. We had a lot more disruption in Mainland Europe through the period than some of the other markets with lockdowns and trading and restrictions on a number of customers in stores in some markets. So it's probably a little bit harder to get a read on trade there, but still we have very strong numbers out of Europe.

And just on your cost of doing business, I guess, excluding the higher-than-usual which is fixed costs, so what do you sort of see as a normalized cost of doing business as a percentage of sales?

Yes, we don't give guidance on what actually we expect that to be because at the moment it's extremely difficult to actually land on that. But I guess the things that had an impact on that number -- oh, I guess, maybe just to start with, our objective is always to keep that number either flat or going down as a percent of sales. So that's what we do try to target. Obviously, the last couple of years have been a bit unusual because of the impact of closures and temporary closures because of COVID and the various impacts on cost structures with logistics and the like, as you just mentioned. But there are a few things that are going to impact. One in particular will impact on the second half, but didn't really impact on the first half, and that's the cost of Victor's package. He has only been with the business for a bit over a month in the first half, whereas we'll get the full impact of that in the second half. We did call out that there was an impact in the first half of the reversal of Shane's LTI when he exited the business. So that largely offset the cost of Victor's package in the first half. So when you're thinking about cost of doing business in the second half of the financial year, you just need to have a look at the structure of that LTI arrangement and the fact that, that will have an impact. Outside of that, there's not much else to cover.

And just on the inventory, is that $90 million increase, I think 25% increase in the half. So how much of that was due to increasing stock intentionally, I guess, in response to the supply chain risks?

Yes, a bit of it. Obviously, we want to make sure that we've got enough stock available to sell because the sales are in good shape. So with the risk of disruption more so than the necessarily actual disruption, we just made sure that we were in stock a little bit heavier than what we otherwise would be. And yes, I think that's a prudent approach to take. Obviously, more stores trading means that we're holding more stock around the world and we've got a warehouse in Poland now, which we didn't have a year ago. So that just means we're holding more from that perspective as well for a short while.

And just my last question. I know you haven't disclosed in the past, but I guess, percentage of group sales that are now online.

We'll not disclose that.

Our next question comes from Shaun Cousins with UBS.

Victor and Chris, just a little bit more of a question on store growth. I don't know further to Alex's sort of question. We infer in terms of looking into the second half '22, is there reason to believe that you can better the 42 stores that you opened in the last 6 months, noting you've only done 3 so far into calendar '22, but that can be lumpy. And then how do we think about store growth in fiscal '23? Can it actually sort of accelerate, particularly as some of the issues in the United States moderate then, please?

Thank you for your question. Once again, I will be disappointed if we don't do during this second half at least 42 store openings. And regarding fiscal year '23, we don't disclose. But I mean, as I mentioned, we have 2 priorities, digital and the rollout of stores. So definitely, I think we will open stores on fiscal year '23. And I think also, at least, we will try to open as many as on the second half of fiscal year 2022 on first half of fiscal year '23.

Understood. Okay, and maybe just specifically around the United States, how are you seeing growth in stores skewed between existing states, new states, the broader landlord appetite for this format? And could you maybe talk a little bit about the labor and logistics issues? Are those issues getting worse, deteriorating? Or are they just challenged? And any sort of visibility on when those issues may be resolved, please?

What I can tell you is that at this moment we have 83 stores in the U.S., as we mentioned. And basically huge potential. We are already in 19 states. So our product has resonated to customers in every state, or at least in 19 states, and I think has a tremendous potential for us. And our product is really engaging with customers. And also, we are building a strong digital capability over there. So definitely, it's a great potential. And I think we will continue betting for the U.S. market.

And just finally for me, can you just talk a little bit about you obviously started quite strongly, 12% up for the first 7 weeks. I think you did 12% in the first 7 weeks second half '21 as well. Can you talk a little bit about or call out what regions or countries we're doing better than the others, please?

Yes, Chris here, Shaun. I think I covered this on the last question a little bit. But I think, generally, if you look at the splits of the markets that we've already published, you can see that U.S. is obviously trading strongly. Australia is trading well on a comp basis. It doesn't look like that when you look at the headline numbers because we had a bit more lockdown in the first quarter of this financial year compared to last year. So that's Australia and New Zealand region. The headline number doesn't look as strong, but I guess the 1 region that is probably dragging us back a lot at the moment is Asia. So if you look at the numbers there, they're well down on the prior year. As Victor said in the presentation that with the lower tourism and some of the restrictions on numbers in stores and that sort of thing of the net market back. Outside of that, we're seeing still trading around most of the other markets.

And sorry, Chris, just to be clear, sorry, so we could infer that the broader trends that you saw in the first half '22 countries and regions that are doing well, they have continued on for the first 8 weeks of the second half '22. Is that right?

Yes. We haven't seen any major issues during the period.

Our next question comes from Mark Wade with CLSA.

I want to pick up on the phrase Victor, you use when you're talking about putting the right structures in place that drive the growth in those new and existing markets. Can you just elaborate on what you have in mind there and how that will potentially avert any constraints that otherwise would be in place on the business?

Being a global company, you need some resources on every aspect of the business, and this is something important. We are in Australia, but I think, as I mentioned before, we are hiring several people in Europe and in Americas in order to cope with our continuous growth over the next -- or expecting growth over the next years. And what I can tell you is that I think, for example, as we were mentioning, we were hiring some local specialists from real estate and also some management people who are going to help us to cope with that growth in every region.

And do you think, under the current structure, as it stands today, is there a breaking point store cap wise, hypothetically?

No. I don't think so. You know, one thing that I want to tell is that, I mean, it's a very exciting story. And basically, we are trying to define how -- I mean, the potential of the company is unbelievable. And I think we have to continue doing whatever we are doing, focusing particularly on the rollout of the stores and the digital. And this is how we are going to continue over the next few quarters or few fiscal years. And I think it's very exciting. Once we open any stores, customers are happy, they like our product, and I think we have a strong product. And this is something which I believe is very important for the future.

I think what we've been trying to say over the journey is we'll continue to invest in the support structures to drive the growth and do that ahead of the curve. So I'm not sure if your question was more directed to the existing resources and how far can we grow with those. We don't look at the business that way, so if you are trying to say that what investments do we need to make to achieve the growth we want to get at, so...

Yes, I think it's just different sides of the same coin and I'm really trying to get comfort here that you've got a whole lot of fashion brands out there, which have struggled for one reason or another when they've expanded aggressively overseas and just really what makes Lovisa so different. So that's really where I'm coming from there.

What I'm saying is that we will continue. I think it's not an aggressive expansion. It's a very calculated expansion, more than very aggressive. And we know that, I mean, we resonate to customers in the U.S., so we will continue opening stores in the U.S. And that's the whole point. It's very calculated growth in order to continue being profitable. So this is how I am seeing the globalization or speeding up the globalization of the company.

Our next question comes from Sam Teeger with Citi.

Does the establishment of 2 franchise networks in Cyprus and Lebanon indicate the company now has a greater willingness to franchising? And should we expect more going forward?

No, not necessarily. I think we will evaluate any new markets whenever we believe we need to go direct or we need to go with franchise. But definitely, we believe it's an opportunistic market and we have the right franchise partner and why not to try and see how we are doing over there.

The franchise partner there for those 2 markets was freelance franchise partners. So it was more of an opportunistic just picking up those markets separate to that deal, as a complement to it.

And then, Victor, right now, what proportion of your focus is on Lovisa's existing markets? What proportion of your focus is on assessing new pilots and maybe even acquisitions? Just the appetite towards the 2 latter?

Well, my focus is almost on everything, particularly, as I mentioned, I think definitely, product is very important for us. Actually, we are a product company and we will continue being a product company. And at the same time, my focus is on existing markets because, I mean, as you see we are growing significantly on a number of stores, on digital, et cetera, on those markets, and also evaluating the potential markets that we are going to open in the future.

In terms of potential new markets in the future, is there a criteria in terms of what kicks the box for you guys to put down a pilot and how might that have changed under you compared to Shane.

We don't disclose that. But having said that, I mean, I think we will evaluate every market and when is the right time to enter that market. And afterwards, we'll disclose whenever we open the market, and we will let you know. But I mean definitely, knowing my strategy in previous companies, at the end of the day, you will see some new markets and makes sense and how we are going to open new markets. But they will be case by case, and we will really think about how to open those markets. But I think what we have to right now is focusing as well on the existing market where I think we are performing significantly well or better than in the past. And I think that's a great thing to continue focusing on.

And in terms of existing markets in Germany, no new stores were added in that market during the half. Can you talk to us about how Germany is going versus your expectations? Should we expect more stores in Germany? Or based on beeline performance to date, would you prefer to focus you still roll out in other markets such as the U.S. where the product really appears to be resonating more strongly with consumers?

Well, as you can see by our growth in Europe, I mean, we continue growing significantly, also in the U.S. So I mean, we don't go specific on market by market. But I mean, as you can see, it's a nice story what is happening with us and growth data in Europe, the same as in the U.S. And we opened many stores over the last year in Europe, and we continue opening some stores. So at the end, I think European market has a lot of potential for us, the same as the U.S. market.

And Sam, I mean, it's the same strategy that we have in any other markets, there will be stores there that we close because we're not happy with them and we'll open more stores, store-by-store case-by-case basis.

And by city, in a way, and Europe as well, is kind of a little bit of a rollout of per city and per country.

And Chris, before you mentioned the price rises you took in the first half, roughly within the half did you take the price rises, and getting more price rises are needed in the current half.

There wasn't a lot in the first half, and that was kind of towards the back end. So it didn't really have much of an impact on the first half. The majority we've done literally in the last month. Again, it's too early to tell what impact that will have because increased prices and getting volumes in that game. So yes, we're not really calling out any impacts that we expect from that. It's really designed to offset some of the cost pressures in the business and make sure that we're driving the profitability of the business.

Our next question comes from Sam Haddad with Bell Potter.

Congratulations on the strong results. My question is in regards to your discussions with landlords. Would you say across all your geographies that discussions are productive in terms of new site locations and that landlords have got a strong appetite for the Lovisa offer and that the probably constraint at this point is more on the supply side in terms of store products reaching destinations in time.

I think what we are trying to do is partnering with the major landlords in every region in order to see and overseeing any opportunity for our rollout in every market. So definitely, it's kind of a strategy. It's not really I think there are big landlords there with a lot of shopping malls. And yes, we try to partner with them. And I think that is the strategy for anyone who wants to roll out the stores in any particular market.

So it's fair to assume a sort of a backlog of stores that you want to open, and once supply chain delays alleviate, then we'll see quite a rapid ramp-up.

I think that's what Victor is saying there. We're not giving you any guidance on what the store roll out is going to look like. There's been constraints on getting deals done on getting stores opened in the last year, to be honest. We're hoping, from a process perspective, we're better at managing some of the logistical challenges and cost pressures and things. But ultimately, the speed will be what it will be. As Victor said before, we'll be disappointed if we don't open more stores in the second half than we did in the first half. But outside of that, there's not really much more we can tell you.

And just for our education, can you talk about the landlord structure in some of the potential new markets such as China? Would it be like a fragmented landlord structure? Or is it more like with 3 or 4 dominant players in that market, which would make it more scalable?

No, it's a good question. No, it's very fragmented. It's not like in the U.S. where you have big landlords. And there, you have more fragmentated -- of course, there are several major landlords, maybe top 5, but later on it's quite fragmented.

My final question is just on the rent outlook. What are you seeing in terms of leases? Is there any opportunities to improve on rent as a percentage of sales? And could that help offset any inflationary pressures on labor?

Yes, good question, Sam. It's probably not one that we can really answer with any degree of clarity on, because it's a store-by-store negotiation in every case. We don't go down to that level of detail. We're getting some good deals done, but other sites, landlords are wanting more at it. It's a difficult environment at the moment for everybody to negotiate because nobody really knows where the world is going to go.

Our next question comes from Joseph Michael with Morgan Stanley.

Just 1 question from me just around, I guess, your headquarters here in Australia now that more than 70% of your stores are outside of Australia. Just wondering, is there any merit to shifting headquarters to North America or Europe to sort of help reduce execution risk?

No, not really. No. We are going to put some people in Europe and in the U.S., but definitely, our headquarters will remain in Australia. And I believe it's an important thing to say that I think we believe that Australia is our home country, and definitely, all the knowledge, all the DNA is kept here, and I think it's very important to continue having the headquarters over here.

There are no further questions at this time. I'll now hand back to Mr. Herrero for closing remarks.

Okay, thank you very much for your time, and looking forward to our one-on-one with all of you. Thank you.