Pepco Group N.V. (PCO) Earnings Call Transcript & Summary

Good morning to everybody, and welcome to the Quarter 3 Trading Statement for Pepco. On the call, we also have Neil Galloway, CFO, who will also join us on the Q&A. And as you know, this is a short tradings update and therefore, is only focused on top line and store openings. So what I'll do is I'll give you a quick quarter 3 trading overview. So overall, we've delivered a resilient performance against challenging macroeconomic backdrop for quarter 3 so far. Group revenues are up strongly in the 9 months year-to-date with a growth of 19% year-on-year at a constant currency basis, with Pepco reporting an impressive 29% year-on-year increase. Net new store openings were 159 in quarter 3, almost the same number that we opened in the first half. As described, we always expected openings to be weighted to quarter 4, and we remain confident of meeting our target of a minimum of 550 stores for the full year. Quarter 3 group revenues were up 12.5%, with Pepco up 15% and Poundland Group up 9%. Poundland and Dealz have benefited from the strong demand for FMCG leading to a like-for-like growth of plus 9% in quarter 3, and this momentum has continued into quarter 4. Like-for-like sales were impacted for Pepco during quarter 3 due to a difficult April and May, particularly in Central Europe, and as we mentioned, half 1 -- as we mentioned in half 1 update last month. In Pepco, in Central Europe, customers are going through a tough time, particularly in Central Europe. We're dealing with ongoing high levels of inflation. And in addition, trading was boosted in April, May last year as we saw an influx of refugees from the Ukraine war as well as rescue packages being sent from a number of our countries back into Ukraine. Good news is Pepco has seen a recovery, a like-for-like in June, and that positive recovery, positive like-for-like has continued in the start of quarter 4. To help offset some of the trading challenges and inflationary challenges, we have further increased our focus on driving further efficiencies in our cost of doing businesses -- in business. We remain absolutely committed to helping our consumers on a budget by offering great range, value and convenience. And we know it's more important than ever of maintaining price leadership, which has enabled us to take market share. So in summary, we're on track to meet our guidance for the full year. And while consumer environment remains challenging, we are well positioned to deliver future success as inflationary pressures ease. And we're continuing to deliver on our strategy of becoming bigger, better, simpler and cheaper. And finally, just a bit of housekeeping. As mentioned at the half 1 results, we're planning to do a modeling session in October in Warsaw along with some store visits to Pepco and Dealz. You should have received your invites by now. And if you haven't, please contact the IR team for further details. I'll now hand over to questions and answers, where Neil and I will be happy to answer your questions.

So our first question is from Nicolas Katsapas from BNP Paribas.

Katsapas from BNP Paribas Exane. I have 3 questions on the top line. Just to confirm, because it wasn't expected in the statement, but you have held your guidance for the full year with respect to sales because you only mentioned EBITDA. And then related to that, perhaps you could help us put in some of the detail for Q4. Q4 has been positive, you say, for both Pepco and Poundland, but are you anticipating an acceleration from what it is at the start of Q4 into the rest of Q4 or any of those divisions? Or perhaps a deceleration with respect to Poundland? And then maybe you could help give some color on category performance. FMCG has been quite strong and drove a strong performance in Poundland, but what's the expectation for the categories over the rest of the year and into the start of next year?

Okay. Neil, do you want to take the first 2 questions?

Yes, I think we -- as in the statement, we've confirmed the sort of EBITDA guidance for the full year. As we mentioned, the sales environment has obviously been softer. In terms of the acceleration, deceleration of like-for-like that we came off to negative in April, May, as we said, sort of turned positive in June. And as Trevor said, it's positive in the start of Q4. I don't think at this point, we're sort of giving a forecast view on the movement for the rest of the quarter. So we're not giving a sort of forward view on where like-for-like will end up for the quarter. So I think that's I think all we would say in terms of the outlook on sales. Trevor, I don't know if you want to pick up the category?

Yes. I'd just say, look, in Poundland, the FMCG has been strong, both on a like-for-like basis and a volume basis. The Clothing and GM has been softer, but still pretty reasonable. And in Pepco, if we were looking at the April and May, we saw a softer on Clothing as Ukrainians come in and buy basic clothing and send in some rescue packages. And I think there probably was a little bit of weather, and that's turned into -- come back in June and start quarter 4 into a sort of normalized like-for-like position. GM was just a small positive, and that will go -- is a little bit softer at the moment because I think when the Ukrainians come across, there was, first of all, buying better clothing. And then as they sort of found houses, there was a bit of buying off of some GM for their homes. But again, we're expecting that to sort of normalize again as well.

Just maybe a follow-up then because you've held the EBITDA guidance. So does that mean you sort of -- you have room for maneuver, if you -- on the top line, if -- because I mean -- maybe I presume you don't -- sorry, go ahead?

Yes. Look, I think we said high teens sales sort of growth for the full year. So we're not moving away from that. I think the other comment we've made at the half 1 was in relation to the gross margin trajectory where, as we said, we expect that the second half trajectory to improve on the first half and certainly through Q3, gross margins ahead of where it was at half 1. So again, obviously, we're not, as we said at half 1, going to call any exit rates on gross margin given the consumer environment. But I think directionally, we will sort of confirm what we said at the half 1 position on the gross margin trajectory and outlook.

[Operator Instructions] We'll take our next question now from James Anstead from Barclays.

Trevor, Neil, 3 questions as well, if that's okay. I'll make them quick-ish. Firstly, when you look back at 2022 with the benefit of a hindsight, do you think the boost from the influx of refugees from Ukraine was very much focused on calendar 2Q, i.e., the third quarter you're now reporting? Or is that something that boosted later quarters just as much? So in other words, is this issue around Ukrainian comps, something you expect to dissipate quite a lot from this next quarter onwards? That would be the first question. Secondly, I appreciate it's really hard to get reliable market share statistics on short periods and, of course, you're present in lots of different markets. But how do you get confident that the sales weakness is a market issue rather than Pepco-specific? And the final one would just be, I don't know, are you seeing any kind of signs of changing consumer spending in Western Europe in the way you are seeing in Eastern Europe? Those would be my 3, please.

Okay. In terms of the first question, look, I think what we saw was in April and May last year, when Ukrainians coming across quite obviously, lots of emotions, lots of support for the Ukrainians coming across and lots of support for rescue packages going into Ukraine. But in fairness, various governments quickly sorted that out. So those rescue packages didn't continue all the way through or the rescue packages ended up being financial packages rather than product packages. So we do expect that impact to dissipate. And I say that with a fair amount of confidence because we can already see that in June and early part of July, we're not -- we're back to a positive like-for-like. So we -- so I think the fact that I'm saying we can see anticipation shows in the numbers. I think also there was a lot of Ukrainians that come into places like Romania and Slovakia and obviously, Poland that were quickly moved on to other countries and a number of the countries in the Western markets that we didn't operate in. In terms of the -- so that's the first question. I think it's always very difficult because I think the last 3 years' worth of like-for-like is still very difficult to ever have a period that's clean. So I gave you the commentary on anticipating moving on because we can see the numbers now, and we know that people moved on into other countries. In terms of the market, we've got 2 sets of data that we kind of use. We don't have certainly on GM and Clothing, the kind of data that one might be used to in the U.K. with [ RGG ] and Nielsen's. But the data that we've got shows that we've been growing market share in all of our countries quite solidly. And I think I mentioned half 1, which wasn't that long away, that we can see in Central Europe, where we're not having massive openings where you expect us to grow market share if we've got massive openings. So we're very consolidated in Central Europe, and we're growing market share. So that would mean that our products and our prices remain very competitive for our consumer and against our competitors. The other data that we see, which is you have to really look through maybe 1 or 2 years' worth of performances when you see your competitors' data. I think when you see the data, you mustn't take comfort or sort of the opposite of comfort too quickly. You need to look at what happened at that time last year to see sort of real sort of market performance against your competitors. So really, we look at the data that we do get, and we look at how our competitors are performing. And from what we can see, we -- Pepco remains very relevant to consumers and the small negative like-for-like is purely because of the -- as we've described, the Ukrainians and the rescue packages. I probably wouldn't be saying as confident if we weren't now in a situation where we had positive like-for-like, but we do. And in terms of Western Europe, we probably saw -- I think in Western Europe, I think, it's sort of mortgage rates have gone up and down. You've seen a bit of tightening of consumer and then sort of confidence coming back. I mean if I gave you an overall view of the landscape, we do an assessment, very detailed assessment of Romanian market, Polish market and Italian market around how are the customers feeling and how are they responding to the different pressures and what they're doing. And the good news is that in Poland and Romania, consumers believe that they've now hit the bottom. And I think some of that is because inflation is starting to go in the right way. But what we can't see yet is consumers deciding to change their shopping patterns in Romania and Poland as it stands at the moment, but they certainly now feel like they've hit the bottom and are more confident going forward. And in Western -- in Italy, they were in the same position, they were losing confidence, but they've rebounded back quicker and are starting to be prepared to change their shopping patterns. So I think in summary on that, when we look at Romania and Poland through all of the inflationary pressures, they lost a bit of confidence and decided to do shop differently. And they've now think they've hit the bottom and starting to become more confident about the future, but they haven't [ changed ] trends. They're not prepared to change their shopping patterns yet. However, in Italy, the market that we do a deep dive on, they got quicker to the point of we've hit the trough, and they're already starting to make decisions of changing their shopping pattern to represent a more confident picture for them.

We'll take now our next question from Simon Bowler from Numis.

3 for me as well, if that's okay, and I'll go one at a time. Firstly, I was wondering if you can just kind of talk a little bit around kind of inventory levels within the business, kind of whereabout there often and how comfortable you are with the composition of inventory given the slower trading that you've seen over this quarter?

Neil, would you want to start that, and then I'll finish it?

Yes. Look, I think in terms of stock, as we said, I think you just saw half 1, we've had better stock management generally, clearly, with softer sales. It's something we're looking at a continual basis. I think to remind people, we've obviously got a strong track record of managing stock sell through the business, and we're not generally stocking sort of fashion items there. It's sort of basic core lines and have a good track record of stock markdown as well in terms of managing actually the business. So -- and I think, as you know, for the Pepco business through PGS, we obviously have strong relationships directly with suppliers. So there's a number of levers we have to manage stock, but it is something we are continuing to stay abreast of. Trevor will give some more color on it.

Yes. So [ if I look ] across the whole business, I think going through the Easter period, I think we come out pretty clean across all of the opcos. I think in the summer period, the high summer, the things that you only sell in summer were sold. We had actually a good sell-through. I think some of that's helped. We're in a lot more hotter countries of Spain and Italy and Portugal now. We will have a bit of summer stock left over, but nothing that we need to worry about. This is a white T-shirt -- a short sleeve white T-shirt, we'll have some of that left over, but not anything that we need to worry about. It's not a markdown. We'll just keep it till next year because it's not a -- certainly not a fashion item, it's just sort of a white T-shirt or a pair of shorts. And it's not going to cause either -- a problem with -- a cash flow problem in the warehouses. And then to be honest, we've got used to this through the last 2, 3 years, where we've been open and close, open and close. We're quite good now at handling what items should we reduce and what items should we keep.

Okay. Great. And then second one was, obviously, within Pepco, you've made a number of kind of end-to-end supply chain changes. And I was just wondering, do you think kind of now you're through the other side of that? Does that kind of new supply chain make it easier, harder, faster, slower to react to changes in demand or kind of no difference from where the business was before those changes were [ put through ]?

I think it -- so one of the things that we have done is we've reduced the sort of the overall time from planning all the way to selling to consuming, and we've probably taken probably 6 to 8 weeks out of the total time. But if I was honest, we were probably an outlier in terms of -- we had probably the longest sort of plan to buy -- sorry, plan to sell. So I think there's still more to go. So certainly, if you take out sort of 6 weeks' worth of time, it makes things easier. What we have definitely improved is our reaction time from consumer spending in the store versus the stock coming out of the DC. That has improved considerably, and that makes it a lot better that when we do have a slowdown in sales, like we did on the normal summer stuff, then the stock will be held in the DC, not in the store. So it makes it efficient and effective for us to manage it. But the whole period is less, so it makes it overall better, but we've got more to go. But the thing that we have worked on is, how do we actually speed up the [ sow to the pick ] to get in the stock back to the store. And that certainly meant the inventories in the store are much more suited to what's not selling and what is selling.

Okay. And then final one is my modeling on this might be terrible, but this was definitely precedent for that. But in order to hit your kind of guidance, it looks to me that kind of gross margins need to be up, kind of, call it, at least 200, probably kind of near 300 basis points in the second half. And I know you're not explicitly kind of commenting or guiding on kind of gross margins at this update. But just wondering if any comments around whether that's a sensible sort of ballpark or any color on the timing of some of these kind of freight rate benefits coming through in your numbers that can kind of help us bridge the margin gap that looks to be required to get us back on the full year guidance.

Neil?

Yes. Look, I'm certainly not going to comment on your modeling, Simon, if that's okay. In terms of -- and I'm also not going to call an exit rate on gross margin for the fourth quarter or full year, other than the sort of comments I've made already. I think there are a couple of things we have referred to, [ but I'll refer ] it again. We had some, I guess own goals on costs in the first half, and we've got some cost initiatives going on at the moment within the business to try and tap the cost of doing business given we had, as you saw in the first half, some inflationary and other cost, particularly calling out transport that were higher than one would have liked. And so those are other factors that also play through to the full year in terms of performance.

Okay. I guess without kind of quantifying anything, you talked a little bit around the timing over which kind of freight rate benefits start to come through given obviously, kind of hedging and other contracts you would have had in place. We don't see what the kind of spot rates have done. But it's not something that's kind of already within numbers? Is it something that's sitting on the stock that's on your balance sheet at the moment? Or does that unwind more gradually over the next kind of 12 months?

There is some benefit within what we said, as we said last year, given the sort of calendar buying cycle. Obviously, we're lapping some of that. So there's some benefit, but that will improve, as we said, again, at the half 1 going into 2024. If you look at the input margins or the buying margin from what we bought, so that will improve into 2024. There is some of that in this year. But as we kind of said at the half 1, we knew it was going to be a low point at that point in half 1. So there's some of that coming through. Some of it is in stock that's in the business or on the way to business and the improvements going into 2024.

If I could just sort of summarize this a little bit. So we can see what we purchased and what the margin was in the first half. We can see what the margin is for the purchase that we've made for the second half. We can actually see what was purchased and the margin for autumn/winter, and we can see what's happening with our initial planning on the orders for spring and summer, and it is nicely progressive. And because we can see it, because we -- a lot of the volatility is taken out in terms of containers, which were improving on each of the buys, with commodities improving on each of the buys, which is why we think we're now ready not just to do a modeling session with you guys, but do a modeling session because actually, the whole environment is far more stable and far more clearer around commodities, containers and therefore, the margin. So that's why we think it's a good time to do the modeling session in October. So when we talk about it, we won't be just doing the modeling, but we're even talking about it because actually we can see some real clarity of what's happening with the things that have affected us over -- or affected all businesses over the last year or 2 years. And what I would say is they're progressive. What still remains for us to maintain is price leadership is absolutely key. We've held it for the last 3 years. We're not going to let it go just because containers and commodities have improved. We want to maintain price leadership. And we can see what the margin rates are, the input margins, margin rates. But one of the things we want to always hold the write-off is depending on what happens with consumers, depending what happens with our competitors, we will maintain price leadership. And it would be silly of us not to do that as we can start to see these things far more normalizing going forward, but we need that final lever to make sure that we maintain price leadership.

We currently have no questions coming through. [Operator Instructions] There are no further questions. So I will hand you back to Trevor to conclude today's conference. Thank you.

Thank you very much, guys. Hopefully, you're sharing us that quarter 3 so far is a solid performance. We're back on this positive light in Pepco, and we're maintaining our outlook for the 550 stores minimum. And I look forward to seeing you at the full year statement. And hopefully, as many of you can meet us in Warsaw for the modeling session in October. Thank you very much.