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

Good morning, everyone, and welcome to this Pepco H1 results call. I'm Stephan Borchert, the Group CEO of Pepco Group, and I'm here with my Group CFO, Willem Eelman, whom some of you have already met at the CMD. Today, we'll talk about our H1 fiscal year '25 results and a short update on our progress against the value creation plan presented at the CMD. We are now turning to Page 3 of the presentation. What are the key messages of this H1 result call? First, Pepco OpCo delivering on objectives. H1 EBITDA growth of plus 11%, ahead of sales growth with trading momentum continuing into Q3. Measures taken by new management under Barry Williams to improve Poundland performance and group continues actively exploring a potential divestment of Poundland with separation expected by end of fiscal '25. Strong group balance sheet with EUR 150 million improvement in net debt position to EUR 279 million, 0.6x leverage. Fiscal year '25 guidance for Pepco and Dealz maintained, but weaker outlook for Poundland. We're turning to Page 4. Please allow me to take a minute on recapping our CMD. As presented to you at the CMD, we have structured our value creation plan into 5 distinct pillars. First, simplify and streamline the group portfolio; secondly, continue to grow in CEE; thirdly, win in Western Europe; fourth, drive like-for-like sales by refocusing and digitizing our customer value proposition; and number five, upgrade our core platforms. We're making good progress on all 5 pillars. We will highlight a couple of them in the course of this presentation. We're turning to Page 5. Now apart from the adverse situation in Poundland, we see that new Pepco, as defined at the Capital Markets Day, has started to deliver on its objectives. H1 has shown positive momentum with revenue growth of 9% year-on-year, driven by strong volume growth based on our recent price investments with an ongoing positive like-for-like momentum in H1 at plus 2.3% year-on-year, continuing positively into Q3, albeit partly benefiting from the timings of Easter. We've continued to defend our clothing market share in Poland and have kept our gross margin stable at 48%. EBITDA growth was at 9% year-on-year. So while we are within our fiscal year '25 guidance, our ambition is, of course, to see higher operating leverage going forward. You've heard me talking about our volume growth. So our price investment has started to show successful impact over the half year, driving volume and like-for-like recovery at Pepco. But this volume has, of course, to be handled operationally. And due to this year's wage inflation, we see a slight investment in operating costs in H1 impacting EBITDA. Our focus in H2 remains in creating higher operating leverage. EBIT. EBIT growth for new Pepco is slightly behind full year run rate due to one-off strategic investments in corporate, which will not repeat in H2. Please remember that new Pepco includes corporate costs. Supporting this, EBIT for Pepco banner is actually up 10% year-on-year. In addition, we have opened 106 net new stores in H1. As you know from past years, our strong opening pipeline is accelerating in H2. We're now turning to Page 6. We continue to see improving like-for-like performance in our CEE markets. Pepco Poland's like-for-like performance, however, is behind other CEE markets, albeit with an improving tendency. We are not fully satisfied with the situation and have taken further measures on strengthening management capacity, focusing on the store network modernization and in particular, on the identified set of select underperforming stores, improving availability as well as marketing intensity. Just to put some flavor to this, excluding the select set of underperforming stores, our like-for-like revenue growth year-to-date April would be plus 1.7%. With Q3 starting well, year-to-date total revenue growth is positive in low single digits, and our focus lies on further improvements for like-for-like revenue performance in H2. We're turning to Page 7. We've made significant progress in a short time on Western Europe. To recall, we are operating 586 stores in 5 markets, with Spain and Italy being the biggest by far. Our concerted efforts have resulted in a strong like-for-like revenue growth quarter-on-quarter in H1 '25, and we see continued progress going forward in Q3. We announced the conversion of our Pepco Plus stores to regular stores at the CMD. This is well on track and all existing Pepco Plus stores, except for a very minimal number of closures, will be converted by end of fiscal year '25. So far, all converted stores are meeting or exceeding our revenue and store EBITDA expectations. Turning to Page 8. I mentioned the launch of the digital agenda as part of our value creation plan at the CMD. We have since further detailed our implementation plan and some core capabilities are expected to go live before the end of fiscal year, and we will continue to update you on progress. Page 9. As part of our strategic plan to shift away from FMCG and focus on Pepco only, we've made progress with the separation of Dealz. The business has performed well in H1 '25 with revenues up 15% and EBITDA up 25% year-on-year. We have started to implement various work streams to optimize the value of this company and to create a self-sufficient setup. We are now going to Page 10. We have informed you at the CMD on our intention to separate Poundland from our group. Despite the continued weak performance of Poundland, this process is advancing with a select number of bidders, still with the target of an exit within current fiscal year. I will now hand over to Willem, who will talk about our financial performance in more detail. Willem, hand over to you.

Next page, please. Let's move to Page 12. Good morning to all in the conference call. Some of you I've already met at the Capital Markets Day in March this year or in meeting since. But for those of you that I haven't met, I'm happy to meet you in this virtual way. My name is Willem Eelman and I started as Group CFO at Pepco in November -- in February this year, and it has been a very interesting time with the team. Stephan has already shared with you the progress with our strategy as presented at the CMD. I will now focus on the results which we have delivered in the first half of 2025. This page shows the key financial highlights at both Pepco Group level as well as the constituent parts of our business. We're very pleased with the progress made in our Pepco and Dealz banners, where we see continued top line growth with a blend between like-for-like and inorganic growth driven by store openings. Gross margins continue to expand compared to prior year, and we have seen a solid drop-through of gross margin into EBITDA post IFRS 16. This contrasts with the performance in our Poundland banner, where we continue to see negative like-for-like persisting in the first half of the year. As Stephan has explained earlier, measures are being taken to address the weakness in part of the merchandise ranges and sell-out of nonperforming and phase out stock as we prepare for new merchandise consistent with the Poundland heritage for later this year. Next page, please. Like-for-like growth in both Pepco and Dealz continue to show robust results with a material step-up to the negative growth we experienced in 2024, as clearly laid out on this slide. Let me now focus on the margin performance on the next slide. Gross margin improved 30 basis points (sic) [ 20 basis points ] to 43.3% for the period. This consists of 2 materially different performances, where Pepco and Dealz showed an improvement in gross margin by respectively, 180 basis points and 150 basis points, offsetting a material decline in Poundland by 430 basis points. The performance of Poundland was the result of adverse mix and markdowns linked to the stock clearance program together with lower volume-driven rebates. Next slide. Before Poundland, gross margin improved from 43.1% to 44.5% in aggregate. Material contributors were improved to intake margins, reflecting positive negotiation outcomes from our buying teams and ForEx for both banners. In addition, Pepco benefited from a one-off reclassification of the consumption tax into SG&A, approximately 50 basis points benefit in gross margin with an offsetting negative in SG&A cost and increased costs relating to the Red Sea challenges in the prior period. The impact of the 430 basis points decline in gross margin in Poundland, as I explained earlier, then represents a 130 basis points reduction at group level to 43.3%, an improvement year-on-year by 30 basis points. Next slide, please. First half underlying EBITDA post IFRS 16 of EUR 460 million declined by minus 5.5% versus the first half fiscal year '24 at EUR 487 million, driven by the performance in Poundland. Excluding Poundland, EBITDA would have been EUR 438 million, up 9.5% on prior half year period, reflecting the top line growth in Pepco and Dealz and gross margin expansion of 170 basis points across the 2 banners. This was partly offset by increase in the store cost base, which I will comment on, on the next slide. Corporate cost was up by EUR 10 million from the same period last year, driven by investments behind the strategic initiatives in line with the strategy presented to you at the Capital Market Day. We expect this to normalize going forward. Next slide. We have implemented a reset in pricing, driving our discount credentials and offering great prices for our customers, further strengthening our price leadership vis-a-vis competition. This has resulted year-to-date in a material volume growth above revenue growth. But this is a cost driver for store and distribution costs. To underscore, in H1, we see a volume growth in pieces in our Pepco banner of 14% with a minus 5% average unit price decline, resulting in a reported 9% revenue growth. In addition, relatively high salary increases driven by wage rate increases, particularly in CEE and store openings are also 2 drivers in the operating cost line. Next page, please. SG&A were tightly controlled with an underlying increase of 2%, well below salary and other cost inflation. Reported SG&A is impacted, as I already indicated, by a EUR 10 million shift related to revenue taxes, which has been reclassified. Next slide, please. On a 12-month basis, the business has continued to deleverage with net debt reducing by EUR 150 million, driven by an unlevered free cash flow of EUR 165 million. Gross debt was reduced by EUR 30 million to EUR 620 million with a cash balance increasing from EUR 221 million to EUR 341 million at the close of H1 '25. The delivery of unlevered free cash flow of EUR 165 million in the LTM '25 underscored the progress we're making in disciplined capital allocation and is a good step towards our guidance provided in the Capital Markets Day for 2026 onwards of a sustainable unlevered free cash flow delivery exceeding EUR 200 million. That was an ambulance passing by. Next slide, please. Pepco Group continues to have a strong balance sheet with a net debt position of EUR 279 million at H1 fiscal year '25 or a 0.6x leverage ratio pre-IFRS 16, a further progress from the same position at H1 '24, which stood at 1.0x. We're currently reviewing our financial structure -- financing structure and aim to address the financing cost and maturity profile of our external debt in the coming periods. At the Capital Market Day in March '25, the Board announced it had authorized a share buyback capability of up to EUR 200 million to be available for use during fiscal '25 and '27. This allows the Board to consider the potential buyback of shares from time to time in accordance with the relevant authorization from the general meeting. We are currently reviewing -- actively reviewing with advisers, the implementation of the share buyback program, considering the type of buyback best served in the Polish stock market and quantum and timing of any such program. We expect to provide a further update on this in due course. Next slide, please. Pepco and Dealz continue to deliver strong growth momentum in line with objectives. At the CMD in March '25, we outlined the expectation that the Pepco business would see full year '25 revenue and underlying EBITDA year-on-year growth in the high single digits, which remain unchanged. Similarly, Dealz is also expected to deliver in line with previous disclosure with full year EBITDA of around EUR 30 million. For Poundland, the business continues to face further trading challenges since the CMD, resulting in a revised outlook for the current financial year. Poundland now expects to deliver underlying full year '25 EBITDA of around EUR 0 million to EUR 20 million compared to previously guidance of EUR 50 million to EUR 70 million. The downgrade relates to highly challenging trading conditions, which have further been further impacted by clearance of old stock and product availability issues. A turnaround plan is underway to rebuild on our core heritage category strength, particularly in general merchandise, while focus on simpler in-store offer and price points. In terms of store numbers in full year '25, we are now targeting to open approximately 250 net stores across the group with new stores principally focusing on the Pepco brand and primarily in the CEE region. I'll now hand back to Stephan.

Thank you very much, Willem. Yes, we go to the next chart, new Pepco medium-term ambition from '26 onwards. So as we already guided at the Capital Markets Day, we are looking at a revenue growth of at least 7% CAGR and an EBITDA growth of at least 9% CAGR for new Pepco. We confirm a gross margin of 48%, and we intend to open around 250 net new stores per annum. We aim at a greater than EUR 200 million free cash flow, in euro, sorry, and a CapEx of EUR 160 million to EUR 180 million per annum. With that, our leverage, we're aiming at no higher than 1.5x pre-IFRS 16. Next chart, if I then may summarize our H1. We are strongly believing that Pepco and Dealz is delivering on our objectives. Our Board and the group is actively exploring Poundland separation options, and we expect an exit by or before end of fiscal year '25. I have a strong balance sheet with EUR 150 million year-on-year improvement in H1 on net debt. And we focus and continue to focus on shareholder returns with the just alluded on EUR 200 million share buyback capability during fiscal year '25 to fiscal year '27. So in summary, we are executing at pace against the new strategic framework with strong focus on sustainable value creation, and we are now opening for the Q&A. Thank you very much.

[Operator Instructions] And our first question today comes from James Anstead from Barclays.

Just 1 question from me. Regarding Poland, you mentioned the sizable impact on sales growth of the underperforming stores in that market. Can you give any idea of how many stores would be in that underperforming group? And is there anything those stores have in common, whether it's the type of location or the age of the stores? Any color would be very interesting.

James, thank you very much. This is Stephan. Yes. Look, I mean, as Poland is an absolute focus for us, we really look deeply into this. So we have identified a select number of stores, and we do have a pattern. Look, it is clear with a portfolio of above 1,300 shops in such a country that there is a bit of internal cannibalization happening. Also, we are clear that we will accelerate our touch-up and modernization program there. We see that as one of the reasons. But please rest assured, we have clearly identified the number. It's not a very large number in the big scheme of things, but it's a number that is now being addressed with a very intense focus.

Our next question now comes from Alison Lygo from Deutsche Numis.

I was wondering if I could just ask a little bit more in terms of the regional color and just following on from Poland. Obviously, it's a bit of a divergent like-for-like performance as we look across the Pepco regions. I'm wondering if you could talk a bit more about how you're sort of seeing the differences in terms of competitive environment across those markets? And any differences really you're seeing in the consumer in the way they're behaving at the moment?

Thank you, Alison. Yes, it's, of course, operating in any countries, it is definitely a difference there. We see quite strong performance in the southern part of CEE. And as you also see now in Western Europe, Italy and Spain, in particular, I would think that consumer sentiment surely is impacted by the political elements, that is Poland or Romania and others, also Germany. But overall, we feel very well positioned with our price-leading concept to also operate and serve customers in uncertain times. So clearly, Poland, we pointed out because that is an operational topic we're going to put focus on. But overall, we feel that all countries we are operating in right now with all the different stages of maturity, right, but are performing well and have also the chance of performing well in the future. So no major elements to point out really, I would say.

Great. And could I just ask 1 more, if that's okay. So a lot of the story if we look back a year or so was around improving the sort of age and the quality of inventory coming through. How are you feeling about that as we stand today?

Yes, it's a good question. I think we've guided last year or we stated last year on the major stock clearance due to all the disruptions we had with Red Sea and everything. This has, of course, smoothened out better. But I also discussed at the Capital Markets Day that we have to further improve on our end-to-end value chain efficiency, and that's what we are doing. So overall, we feel that in terms of stock freshness, we are making progress. But there is, of course, more to do when we are implementing IT support and all these kind of things. But overall, making progress are in control of our inventory and of our buying processes.

And then just final 1 for me, if that's okay. In light of the, I guess, the disruption we've sort of seen to China-U.S. sort of trade relations and what's happened there, I suppose one of the themes we're seeing a reasonable amount is in terms of the potential opportunity for European operators to be seeing sort of better factory gate prices. And I'm just wondering whether that's something you're benefiting from, something where you see a kind of potential opportunity.

Yes. No, good question. I mean I would say, first of all, there's no direct impact on us really. We are not operating stores in the U.S. and things like that. We are closely monitoring the transport side of things there because with the temporary spikes of reshipping into U.S. and so on, that is definitely a topic we have, but it's by far not as serious as it was at the Red Sea situation. So we are -- we feel we are in control there. On the FOB opportunities, look, I think Pepco has long-lasting supplier relationships in China, and we have always managed to create more efficiencies. And as we said at the CMD, we're going to reinvest sourcing efficiencies into either price or quality of our product. But I think temporarily, there are some opportunities for European retailers, I would say, but I'm not sure how long lasting that really would be. So therefore, I wouldn't put too much emphasis on it.

[Operator Instructions] We just received another question from [ Peter Drost from Verizon Fund Management ].

I have 2 questions. The first one would be a bit more broad. I mean, I do wonder if you've had any interactions with Pepkor South Africa and whether there are any material synergies you would see with that business in terms of the sourcing. I mean this used to be one entity. And if we think more broadly about the Steinhoff stakes, whether you could offer any views on if a tie-up between the companies could make operationally any sense. That's one question. And the other one, maybe just a bit more color on the Poundland transaction. Obviously, we've seen the press allude to a number of potential buyers and the commitment is to carve out Poundland by the end of the year, financial year. But any more comments on that would be very helpful just for us to expect and how this plays out?

Yes. Thank you, Peter, for your questions. Look, on -- let me start on Pepkor. I have to say there are really 0 connections neither on any financial level or on any operational level. So I can't really comment and to say, I think Pepkor has probably also developed and evolved over time in the South African market. So we are really -- I can't really comment on it, to be honest. And on Poundland, yes, as I said before, look, we, as a group, are determined to proceed with our strategic directions to focus everything on Pepco going forward. Please, please, please accept that the processes at the moment very confidential and ongoing. So in this respect, I can't comment much on it. But the group is determined to find a solution for the best possible solution for the group and for Poundland. And we are advancing there, but I can't comment with further detail really.

As there are currently no further questions, I'd like to hand the call back over to you, Mr. Borchert, for any additional or closing remarks.

Yes. Just thank you very much for your interest. Thanks for dialing in to our H1 results call, and have a great day.