Midwich Group plc (MIDW.L) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to the Midwich Group 2024 Half Year Results Presentation. We came into this year expecting the first half to be relatively challenging compared with 2023. And so it's proved to be. Nonetheless, we've had some significant achievements in the period. Our group revenue grew by 8% on a constant currency basis to a new group record. Our gross margins also achieved a record for the period of 17.3%. Our North American business performed strongly, but other markets, particularly in the U.K. and Ireland have been soft, and we saw some price erosion in mainstream product areas caused by oversupply. Our technical sales grew strongly. I think this year, our focus on technical products and our entry into the U.S. and Middle East, particularly, have helped to mitigate some of the mainstream product pressures. We kept our overheads under control. But as the period develops, we realized we needed to make some adjustments to our cost base to have gone through a realignment exercise. This will have some positive impact this year, but of course, the main benefits will be seen next year. The 2023 acquisitions have been integrated and performing well overall. We've made 2 small acquisitions so far this year. Although we have a lot to do in the second half of the year, it's traditionally our stronger half, and we continue to believe that we can achieve our full year expectations. As I mentioned, our group revenue increased to GBP 646 million or 8% on a constant currency basis. After stripping out the impact of last year's acquisitions, you can see that our organic revenue actually declined by around 1%. Our revenue growth was made up of a decline in mainstream products at 10%, but a growth of 13% in our technical product areas. The gross margin of 17.3% was the highest we've ever achieved. After overheads, our operating profit was down 15%, which triggered an action to take cost out of the business. Cash conversion of 13% is normal for the first half, our leverage of just under 2x was as we expected, and we've maintained our interim dividend, reflecting the board's confidence in the business and prospects. In terms of the current landscape, we've not seen much change from what we reported in March. We continued to see softness in many markets with ongoing strength in the Live Events segment. Our order books remain stable, our market shares are high. Market Intelligence suggests an expected improvement in H2 with the reversal in mainstream price erosion. At the start of H2, we've seen growth in our organic sales, which is a positive feature. The next slide is a reminder of why we're here and what our differentiators are. Our role is to help our customers to win and then deliver successful projects on our manufacturers to reach a broad market. Our peak 2 differentiators, we have deep vendor relationships, they're broad, long, close, symbiotic and unique. And as an example of the results of this, we are exclusive or #1 distributor in 80% of the relationships with our top quality vendors. We also give consistently high customer service. This is key to the success of our business. Our team is responsive. We're knowledgeable. We understand the needs of our customers, and we operate effectively. And as an indicator of how this has been successful, the relationship with all our top 50 customers have been in existence for at least 10 years. So there's quite a lot of market data in our sector. So I've tried to hold in on some elements that are relevant to our business. If you start on the left-hand side, this is a very high-level view of distribution sales across the whole hardware technology sector. So this includes mostly IT products, which we don't sell, but it does give a general trend, and it will be indicative of how our broadline competitors are bearing. You can see a big spike in sales in 2020 with significant IT infrastructure, working from pounds spend. Growth in '21, '22 is much lower with significant drop in '23, within 2024 expected to be broadly flat. In all relevance to the market, we saw a decline in the COVID year but then strong growth in the 2 years followed by -- following -- followed by 2 flattish years. Turning to our particular market on the right. I've looked at the large format display segment, and these are quite significant parts of our overall business. The graph at the top looks at volumes, so unit sales and the graph at the bottom looks at the value of sales by quarter. You can see a decline in volume and value in the first 3 quarters of last year then a spike in volume but a drop in value, indicating significant price erosion. This difference continued into Q1, was expected to be less in Q2 and then both volume and value growth in H2 with the gap closing by the year-end. As the market returns to normal, this supports our belief for a stronger second half of the year. The next slide, focus on the Pro AV market as a whole. This comes from recently published AVIXA data. The numbers include market that we don't operate in, of course, including India and China, where growth has been and is expected to be strong. Firstly, I'd note the overall market is expected to grow by 5.3% a year over the next 5 years. The table on the left splits the market by 4 interesting segments. Core control is a market where manufacturers generally sell direct. This showed a spike in sales in '23 following a shortage of products in the previous year. Traditional AV is our core market and shows an expected compound growth rate of 3.1% over the next 5 years. IT/AV overlap includes our unified comms business. This is expected to grow stronger over the next 5-year period. And finally, we have businesses -- a number of businesses that operate primarily in the event tech sector and this is expected to grow at the fastest rate of all. Final market data slide looks at information that's very pertinent to our business. Our best measure of performance in the market is to look at our share of the business of our vendors. This graph looks at our share of business of the top 20 vendors in the markets we operate in. So you can see that we have 40% or more of the business of most of our top vendors, which I think gives indication of a very strong share of their business.

Thank you, Stephen. Just turning to the group P&L. So as noted by Stephen, we are pleased with our overall revenue growth in the first half and our further market share gains against challenging mainstream market backdrop. Whilst markets have been charging over the last 12 months, it's worth pausing to note the progress made in recent years. Group sales of GBP 315 million in H1 2019 to more than double since the pre-COVID period. Record gross margins of 17.3% reflects the continued strategic focus on shifting our sales mix both organically and through M&A towards higher-margin technical products. Over recent years, we've seen good progress in net margins. This trend temporarily reversed in H1. Of the overhead growth in the period, the vast majority related to the impact of prior year M&A, we've also continued to make further investments expanding our Middle East business and our North American businesses. Adjusting for these, we saw core overhead inflation around 5%. And in recent months, we've also started to see people cost pressure starting to ease. Mindful of the impact of operating leverage and the market challenges continuing beyond as of previous expectations, we've acted to reduce costs. We've now largely completed our headcount and cost-related reduction activity. This will generate about GBP 3 million of savings this year with an annualized impact of over GBP 5 million from early 2025 and we've got exceptional costs are expected to total about GBP 3 million with GBP 0.5 million incurred in the first half of this year. Interest costs have increased in recent years. And despite strong cash management, we expect further increase in H2, reflecting the additional borrowing for M&A-related activities in the year. Full year adjusted interest costs are expected to be around GBP 10.5 million. We've got fixed interest for about 40% of our debt with the balance floating, and we'll look to fix more win rates start to come down, which we've seen the signs of. We have a conservative approach to tax planning and the increase in the effective tax rate of the year to 27% simply reflects geographic mix, together with the introduction of corporation tax in the UAE and the estimated impact of the BEPS Pillar II minimum tax regulation requirements. It's also worth noting that adjusted EPS in the period was impacted by a successful equity raise in June 2023. Although net earnings have temporarily [indiscernible] from the period, we also recognize the importance of dividends to our shareholders and the interim dividend of 5.5p will be payable in October. Just turning to the balance sheet. Our balance sheet was impacted by the 7 acquisitions in the year to June 2024, which resulted in the increase in noncurrent assets. Despite these acquisitions, we achieved an overall reduction in net working capital period-on-period with net working capital percentage of annualized revenue falling to 13.4% at June '24 from 13.8% in June '23. As ever, our operating cash generation is seasonal with a modest inflow of 13% of adjusted EBITDA in H1, which is in line with our expectations. Our average full year cash conversion over the last 5 years has been 87% of adjusted EBITDA and I expect about 70% to 80% for the full year this year. Adjusted net debt increased by approximately GBP 50 million from the end of December. This was largely a result of deferred acquisition payments, normal working capital seasonality and further investments in the group's ERP system, which went live in its first country in June '24. I've included a detailed cash flow bridge in the appendix. We saw leverage at just under 2x. Stephen said that June and expect this is expected to reduce about 1.8x, 1.9x by the end of the year, including the recent acquisitions and is comfortable with all of our group covenants. Our medium-term target remains leverage in the 1.5x to 2x range and we expect our cash generation to systematically reduce leverage over time before further M&A. As noted on the slide, we paid out around about GBP 20 million on acquisitions and deferred payments in H1, including requiring the remaining 20% of our Middle East business. We've also acquired recently Dry Hire Lighting in the U.K. And including this, we expect to spend about GBP 10 million on M&A-related payments in the second half of the year. Again, we've added some modeling assumptions in the appendix. Just looking at the regional view. So turning to EMEA, which is our biggest region. On a constant currency basis, revenue in the region was flat year-on-year. Organic sales declined by 2.9%, reflecting a reduction in mainstream product sales, largely offset by technical product revenue increasing. The softness in corporate's education demand seen in late 2023 continued during the first half of the year, though we believe that we've held or improved market share in our key markets. As Stephen noted, Market Day suggest an improvement in mainstream revenue in the second half of the year. We also saw further market share gains and strong performances from our Southern European and Middle East and pro audio businesses. And we believe that these overall trends demonstrate the strength of both our diversity by product and diversity by geography within the portfolio. Our Saudi Arabian business is building scale with its leading brand lineup. It's early days, but this business contributed well in the period and is perfectly positioned to future growth in this exciting developing market. And strong technical product growth helped increase overall gross margin in EMEA to 16.7%. Adjusted operating profit held up well given the impact of the challenging mainstream market and further investment in the Middle East. And the acquisitions completed in '23 have now been integrated and are contributing well. Over the page to the U.K. and Ireland. As Stephen said, market demand continued to be quite subdued in the period, with revenue flat on the prior year. We have our highest market shares in this region and third-party data supports an assessment that remained challenging in the first half. Previous market expectations expected a stronger recovery coming into '24, and this resulted in a degree of oversupply and associated discounting. So despite volumes, [indiscernible] our market share is holding up well in the period with a reduction in overall mainstream product sales and value terms. Stronger demand in markets such as live events, entertainment and hospitality supported further growth in technical products, and these now represent over 2/3 of U.K. and Ireland revenue. And after an exceptional performance last year, gross margins held up really well in the period at 17%. Overheads in the U.K. and Ireland increased as expected, reflecting the impact of acquisitions and labor cost inflation. And this is obviously one of the areas we've made our cost reductions more recently. Stronger mainstream product demand and the impact of additional new brands combined with these targeted cost reductions are expected to result in stronger operating profit performance in the second half of the year. The 2 deals we did at the end of last year, now we have been fully integrated, and we've also added a small lighting rental business in July [indiscernible]. Going on to North America. So North America is the single biggest strategic market for the group's future growth plans and we made further strong progress in the period. Revenue in North America increased by 69% in the first half, reflecting both the full year contribution of SF Marketing in Canada through acquired last June and further market share gains in the United States. Organic revenue of around 17% was driven by demand for unified communication solutions, an increase in customer wallet share and higher project activity. Since entering this market in early 2020, our focus in North America has been on expanding our sales and business management teams organically to gain market share through high service levels and also to win new brands. We accelerated this to the acquisition of The Farm in January this year. This sales focused business, which is now fully integrated, at 2 new locations on the West Coast and also 20 new salespeople to the team. The record gross margins in the region at 19.7% attributable to the positive mix impact of the acquisitions in the last 12 months. [indiscernible] margins were stable year-on-year. And adjusted operating profit in North America was significantly ahead of the prior year at GBP 5.3 million. Finally, just looking at Asia Pac, which is our smallest region, representing only 4% of revenue. It's also the region with the highest mix of mainstream products, about 60% of sales. Revenue in this region was down 4% on the prior year. Our business in this region has faced headwinds over the last few years both on a slow post-pandemic recovery and the high-margin project activity and also some signs of oversupply in the display market. We've added a number of new brands in the last 12 months. These are now beginning to gain momentum in the region with a return to growth in the second quarter of the year. Demand for large projects also showed signs of improvement, although it hasn't really turned into revenue yet. The Asia Pac gross margin, 15.8%, reflected in the higher mainstream product mix. And whilst the operating loss of GBP 0.5 million was below previous levels, is expected to recover to previous levels over time as the new management team and the new brands start to build traction.

Thank you. Our M&A strategy and activity has been an important part of our success over many years. We look for businesses with a strong reputation, a good technical skill sets, strong vendor and customer portfolios and with a culture and ethos that fits with our own. We were very acquisitive last year with 7 completed transactions. Overall, these businesses have performed well. We expect to complete 2 to 4 this -- transactions this year, which is the usual number that we've tended to do in the year. In January this year, we bought The Farm in the U.S. This brings us an experienced technical sales team, particular strength on the West Coast, strong services proposition and an excellent reputation with the customers and vendors and also particular expertise in the audio and technical video market. The business has settled in well. In July, we brought the remaining 70% of DHL, a provider of trade across rental solutions to U.K. live events market. This complements our coverage U.K., the [ ESCO ] business. We have a good pipeline of transactions and expect to complete 1 to 2 more probably small-ish deals later this year. I believe we have a strong investment proposition. We have a market-leading position. Our strategy is clear, consistent and successful. Our team is strong, experienced and engaged. Our financial track record is also strong, and our market strength means that we perform well even in a tough market. I won't propose to go through all of these points, so you can read them. The final slide really is a reminder of the key drivers for long-term growth in the business. Firstly, we operate in a market which is expected to achieve a 5-year average growth rate in excess of 5% and where we have generally outpaced the market. We have a track record of engaging in M&A, and we use this to expand our business to give us access to new geographies and to new product markets. Our long-term gross margin growth focus makes business more profitable and defensible. And finally, we will actively look to manage our cost base appropriately. Combining all these factors together should ensure that we deliver long-term EPS growth. So as a reminder, we expect our -- we're still confident in achieving our full year guidance to the market. Thank you.

Thank you very much, Stephen. We will begin with any questions from the room.

Please look at Page 15. [indiscernible] North American margins were great progress in the first half. If you think [indiscernible] to start, was [indiscernible] margin, maybe thinking not that [indiscernible] down than the other geography we will want in? And then if that was the case, [indiscernible] correctly, what precisely is it that SFM, The Farm have done to push that uptake in the last 2 [indiscernible]?

I think our expectation, which I think has been proven is that the margins -- the gross margins in the U.S. are slightly lower than they are in the rest of the group or rest of the world, and this is just down to volumes of sales, but it's more efficient to operate a business of some scale in the U.S. So our expectation is that we can still achieve a good strong net margin even with a slightly lower gross margins in the U.S. business. And margins there have stabilized at a little bit below.

Yes, this time last year, it was about 14.5%, which really is quoted the starring margin and then asset marketing is a highly technical business, so it brings much higher gross margins.

Yes. The Farm contribution was quite small since it's quite a small business. So I wouldn't think that would move the dial very much in terms of the whole region. So the bigger impact on the gross margin is really down to the self-marketing -- marketing product mix.

Two questions from me. Again on look out the gross margins up [indiscernible]. In due course, the markets recover and I am thinking about the you [indiscernible] on margins should we see that [indiscernible] volumes in recent [indiscernible]?

That's a leading question. I mean, we've got a very high -- there's a very high concentration of the technical products and [indiscernible] audio brands in the asset marketing business. I've never -- we've never really given an indication where we think gross margins could get to a return to a very interesting question. We have continued to grow the most -- well, [indiscernible] COVID, we've grown the gross margin each year. There is further scope to improve that margin depending on how the product mix of the business moves up time. Could we get the business to that level, I don't know, but we'll keep growing, trying to grow each year. So...

Then [indiscernible] margins both on P&L. Just thinking about costs, you take that business in the [indiscernible] annualized run rate sales, presumably, that is looking to date into a [indiscernible]. Do you [indiscernible] them to active business, partial society [indiscernible].

Yes. I think -- I mean, what you've probably seen is some reduction in the mainstream resources we've got, but we've continued investing in the period in [indiscernible] and North America and the Middle East. So there's just a slow pivot over time as we can deploy resources in the areas that are growing. So I don't think we'll necessarily look to invest a lot more in the short term in the mainstream that [indiscernible] is obviously critical to all JV projects, but we're just balancing more than anything else.

No more questions?

Stephen, did you get impatient -- to the market place on [indiscernible] useful buckets. You could call additional overlap in [indiscernible]...

[indiscernible] to pay for it.

Is it possible -- the answer might be no but is it possible to kind of map that on to the range to [indiscernible] business by the technical traditional product that sort of just for...

Yes. I mean this was a slightly new analysis for me in terms of the way AVIXA represented the numbers. I think core control or control systems such as press and the like. Those products have generally gone -- manufacturers generally got to market directly, a very few go through distribution. So that's trying to have a bit of the market, but we can almost ignore it from our business. So Traditional AV, I think, includes most of our business from Main Street, some of the technical product areas. The IT/AV overlap is quite an interesting one. And a few years ago, we've traditionally seen a lot of the video conferencing market has been quite IT distributor-focused and supplied. And we always supplied another products into a conferencing setup. But in certainly late '19, 2019, '20, we started through acquisition [indiscernible] than other businesses. We started getting much more into that full solution. So that there is an overlap there between our [indiscernible] now become a fairly large part of our business and what the Traditional IT market. So I think for us, this really sits in that UC&C unified communications market. And it's quite interesting having made a big investment a few years ago. There's some good growth post-COVID probably flattened out a little bit. Some expectations, it might come back quite strongly in the next couple of years. I've heard that from a few people.

UC...

Yes, yes, yes. So that's kind of the overlap. But I think the interesting thing about that is the sort of 5 term expected growth rate is something above the average for that sector. So that's quite an interesting sort of trend and expectation. And then the event tech, I think, is what we'd call live events or installed entertainment products. And again, it's long term, quite strong growth prospects for that sector. We're quite well represented in there, but we still got -- we've got more opportunity to expand further into that part of the market. We've done major investments in businesses that are in that market over the last few years, and they've done very well, you know our business in the Middle East and Italy, Spain had a very good year last year. That's continued into this year. So they're performing very well. So it's an area that's certainly of interest to us. And again, that's got the highest expected long-term growth prospects.

So very correctly named. Only, the first one. The other 3, 60% in technical is everything in the [indiscernible] plus everything on TAV -- [indiscernible].

I think that's fair.

Yes. And then the other 40% is sitting in that [indiscernible] based impact?

Yes, yes, yes. So as far as what this says is where we've been investing, particularly in the last few years, is where the market is expected to grow.

Your comments on the [indiscernible] does that mean you said or read anything for pushing that?

For us, [indiscernible] has been a very interesting start, and we're doing some good business very quickly already there. Our main business in the Middle East still is out of [indiscernible].

Thank you very much. Moving to online questions. I would like to remind any attendee joining by the webcast to please submit any questions via the Q&A tab at the bottom of your screen. The first question is, perhaps can I please check where buyback might be of interest given where the share price currently is.

Buybacks, I don't know, they are very popular at the moment. And the share price is below where it has been since 2017, I think. It is of interest. I think as a Board, we did get approval at our AGM earlier this year to look at share buybacks. We just need to get our head run where the best place for us to deploy our capital is. We still have good acquisition opportunities. We've got other uses of capital in the business. So I expect it's something we will do at some stage in the future, but I can't give you a date as to when that might -- that might happen.

And as there are no more questions online or in the room, I'd like to pass back to Stephen for any closing remarks.

Yes. Thank you. So a challenging first half of the year for the market and challenges for us. I think we've achieved some really significant milestones in the first half of this year, some great margins and good revenue growth, really, really pleasing performance in North America, particularly. But also, I think all our people and all our businesses are performing extremely well in a tough market in many cases. So I'd just like to congratulate them on keep up all the good work. Thank you.

Thank you very much, and thank you to everyone for joining us, both online and in the room. That might bring this presentation to an end. Thank you very much.