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

Good morning, everyone, and thank you for joining our Q3 fiscal year '26 conference call. I'll first run, as usual, through a few highlights from our Q3 performance, followed by some comments on our strategic positioning as a now pure-play Pepco business before handing over to Willem, who will run you through the specifics surrounding the sale of Dealz and the resulting strength and financial profile of the group as well as our Q3 trading in more detail. Let me first highlight that unless otherwise stated, all the figures throughout this presentation exclude Dealz and the like-for-likes shown are excluding FMCG. With that, let's turn now to Slide 3, please. Slide 3, we delivered strong revenue growth in Q3, up 8.5% to EUR 1.1 billion and like-for-like revenue growth of plus 5.4%. After a trickier start in April, we returned to accelerated momentum in May and June. This performance was driven by very solid performance in North and South CEE, which both delivered plus 3.6% like-for-like revenue growth as well as strong growth in Western Europe, where we continue to see an exceptional response to our customer value proposition following the exit of FMCG. In Q3, Western Europe delivered like-for-like revenue growth of 15%, reinforcing our conviction to accelerate our rollout in the region for fiscal year '27 onwards. On a 2-year basis, Q3 like-for-like revenue was up by approximately 10.2%. In addition, we announced the agreed sale of Dealz on 3rd of June. This completes our exit of FMCG and our goal of becoming a simplified and streamlined group focused solely on Pepco. I will touch on this more in the following slides. And lastly, as previously announced, we plan to launch an up to EUR 400 million tender buyback, which we remain on track to complete before the end of this financial year. We'll have more news on this in due course. Turning now to Slide 4. I wanted to take a moment to really highlight the strategic milestones we've hit over the past 12 to 18 months in our effort to simplify the group and turn around our performance. We've been clear on our intention to exit FMCG since the Capital Markets Day in March 2025. The start with the Iberian Pepco Plus conversions in March through August last year. We completed the sale of Poundland in June last year, which was a pivotal milestone for the growth trajectory of the group. And last month, we announced the agreed sale of Dealz. As a result, we have now completed our goal of becoming a pure-play Pepco business focused on one highly scalable brand and efficient format with a compelling customer value proposition, strong business momentum, a strengthened financial profile and a focus on delivering sustainable and profitable growth, as well as enhanced shareholder returns. Go on to Slide 5. Let me briefly remind you of the stronghold of a pure-play Pepco company. Firstly, we operate our Pepco stores on very strong economics. We have a standardized format across our geographies and can open new stores in a very efficient way. These stores pay back quickly, generating high returns and significant cash, which is more than sufficient to both reinvest in accelerated growth and enable sector-leading returns for our shareholders. You've seen this through our completed share buyback program, the announced EUR 400 million in tender buyback and our commitment to increase our regular dividend payout ratio over time to approximately 40%. In summary, with our transformation efforts over the past 12 to 18 months, we have now created a self-funding and profitable growth engine. Lastly, on Slide 6 -- over to Slide 6, please. Before I hand over to Willem, I would just like to recap on our strategy for growth as outlined in our March 2025 CMD. Pillar 1 is now complete. Our overall strategy remains unchanged, but we are now able to accelerate from a strengthened platform and drive continued strong growth for the group. We're focused on top line growth through measured expansion in CEE, our accelerated rollout to ensure we win in Western Europe, digitizing and enhancing our customer proposition as well as upgrading our core operating platform, which underpins the success of all our pillars. Continued execution in line with our strategy ensures we are well positioned for growth going forward. With that, Willem, over to you.

Good morning, everyone, and thank you for joining the call. I will talk you through our quarter 3 trading shortly, but let me first spend a few moments on the Dealz exit. Next page, please. Hopefully, you've all seen our announcement on the 3rd of June, but let me cover the key elements of the transaction now as a quick reminder. We have agreed to sale of 100% of our Dealz shares to Modella Capital, a specialist European retail investor for a nominal consideration. This was subject to customary Anti-trust approval, which is now being received by Modella and completion is expected imminently. And we will provide a further announcement and future announcement when appropriate. As part of the transaction, we will provide an 18-month asset-backed facility of up to GBP 20 million. And importantly, we retained the right to 35% of the proceeds of any future sale, providing potential upside further down the line. The sale of Dealz provides many benefits to Pepco, as Stephan touched on earlier. It not only completes our exit of lower-margin FMCG products, it increases our focus on our core Pepco business, drives enhanced profitability and returns on capital and improves our cash generation. Turning now to Slide 9, which shows this more clearly. Here, you can see the comparative financial performance of both Pepco and Dealz and it's clear to see why we are in a stronger position following the sale. In H1 '26, Pepco generated strong like-for-like growth of plus 4.6% versus a negative 8% like-for-like at Dealz and the gross margin of Pepco was almost double that of Dealz. In addition, the absolute EBITDA generated by Dealz was negligible at the group scale, impeding the profit growth of group. There will be some impact of revenue following the exit as Dealz generated around 7% of group revenue, but the material improvement to group profitability and overall financial performance is more than apparent. In the quarter 3 release, which we disclosed this morning, we included detailed financial statements for H1 on a pre- and post- Dealz inclusion basis to allow you all to properly understand and model the shape of Pepco going forward. This data is for H1 as we appreciate that many of you want to understand the impact on half year fiscal '26 and fiscal '25 to assist you in modeling Pepco going forward. For this purpose, we've also provided updated guidance for fiscal '26 for Pepco going forward, but more on that later. Let me turn now to our trading performance in quarter 3. To be clear, what we are showing here is the trading performance of Pepco only. And as at the half year results, we are showing performance in our new geographical split, North, South and West Europe. You can see the countries which make up each region in the footnote at the bottom of the slide. In quarter 3, we delivered revenue growth of 8.5%, driven both by our new store opening program and strong like-for-like growth, excluding FMCG of 5.4% in the quarter. This is driven by a 15% like-for-like growth in Western Europe, further validating our plans to accelerate store openings in the region on fiscal '27 and 3.6% growth in both North and South CEE, a solid performance from both regions in a competitive market. We no longer report it as a stand-alone segment, but for clarity, Poland continued to deliver positive like-for-like of 2.2% in quarter 3. Our like-for-like performance was supported by improved availability, continued focus on our price leadership position, greater full price contribution as well as favorable warmer weather in May and June after trickier conditions through April, which we also were negatively impacted by the timing of Easter, which benefited March this year, and we commented on in the half year results. Across the first 9 months of fiscal '26, we delivered like-for-like growth -- revenue growth of 4.9%. The absolute revenue growth stood at 6.4%. As we've mentioned previously, our reported growth was materially impacted by the exit of FMCG, and you should expect our revenue growth in quarter 3 and quarter 4 to accelerate versus quarter 1 and quarter 2 as we lap prior year periods with significantly lower levels of FMCG contribution. For quarter 3, this is already noticeably visible in our reported results. Turning now to Slide 11, where this is highlighted. I want to take a moment to focus on the trajectory of reported versus excluded FMCG like-for-likes. In the chart on the right, it is clear to see these metrics converging as the prior year FMCG contribution reduces for the year but to the higher levels as we previously had indicated. In quarter 3, there is just 1.2% gap between both metrics. And going into quarter 4, there will be negligible impact from prior year FMCG contribution. So you should expect these numbers to converge even further. As we already disclosed in our H1 results last May, we continue to see stores that have lapped the FMCG exit in Iberia performing strongly. As we move into fiscal '27, we will no longer report 2 LFL metrics as they will be one and the same. On to Slide 12. As I mentioned earlier, the group is in a much stronger gross margin position following the exit of Dealz and the exit from FMCG in Iberia. In the chart on the right, you can see our pro forma margin progression, which for 9-month fiscal year '26 was up 360 basis points versus half year 1 fiscal '25. This is driven in part by the product margin to have replaced lower-margin FMCG sales with higher-margin clothing and general merchandise sales, i.e., mix, but furthermore, supported by continued ForEx tailwinds as well as efficiencies within our supply chain and sourcing. Let me now finish with our revised guidance on Slide 13 before I hand back to Stephan to conclude. Next slide, please. Here you can see a breakdown of our previous fiscal '26 guidance in the gray box on the left and now our new restated guidance for the group, excluding Dealz in the pink box on the right, along with the revised pro forma fiscal '25 base in euros for the key financial metrics, such as Revenue, EBITDA and PAT. This clearly underscores the strong financial performance of Pepco. Crucially, this is not just a guidance restatement as we have upgraded the guidance for several of these metrics, such as gross margin and EBITDA following the strong performance of Pepco year-to-date. Our revenue growth guidance remains the same at 6.8%. As already indicated, we expect to generate accelerated revenue growth in H2 as already visible in our quarter 3 constant currency revenue growth of 8.5%. This is a clear acceleration compared to H1, where constant currency revenue growth stood slightly below the range at 5.5%. We now expect gross margin for fiscal '26 to be around 51% focus on deliver mid-teens EBITDA growth, up from the previous low teens guidance. Our PAT growth will be above 50%, but from a higher base of EUR 234 million, excluding Dealz, and our unlevered free cash flow is expected to be EUR 300 million versus previous EUR 250 million. Our net new store guidance remains the same at 250 stores. We will be updating our midterm guidance and guidance for fiscal '27 at our fiscal '26 year-end results presentation in December. With that, let me hand back to Stephan.

Thank you, Willem. Let me now quickly summarize on Slide 15 before we open up to your questions. I won't cover these points in detail. I think we've addressed and covered them especially throughout the presentation. Instead, I want to focus on the strong execution the team has demonstrated, transforming this group from a multi-brand disjointed proposition to a simplified business with a clear growth trajectory and significantly improved financial position, all of which has been achieved in a very short time period. As we move forward as a pure-play Pepco, I'm hugely excited by our growth prospects. We have achieved a lot already, but there is more ahead as we continue our disciplined expansion in both new and existing geographies. We remain strongly focused on delivering sustainable, profitable growth and, of course, on providing enhanced returns to our shareholders. So with that, let me now hand over to your questions. Thank you very much.

Thank you very much, Mr. Borchert. [Operator Instructions] Our first question this morning will come from Michael Jacks of Bank of America.

Congrats on a strong quarter and thank you for the presentation. My questions relate mainly to sourcing. Firstly, could you please give us a sense for where shipping contracts settled in percentage terms year-over-year? That's my first question. Second question, could you please elaborate some more on the sourcing tailwinds, specifically on the relative contributions from favorable trading terms in China versus structural improvements that you've made to your sourcing operation? And my final question, are there any seasonal factors in Q4 that typically weigh on gross margin relative to Q3?

Yes. Thank you very much for your great questions. Look, we have not disclosed the shipping percentage in that. But what I think I can very comfortably say here today is the following. So first of all, yes, I think we are not the only one stating that the situation in China is quite -- I mean, difficult, but interesting at the same time. So suppliers do have lots of spare capacity. And I think we continue to see, on the one hand, opportunities in sourcing and our gross profit margin expansion to an extent also is based on sourcing efficiencies that we continue to increase. However, going forward, it will be seen how -- which strategic role China has and can play in that respect. So we are continuously looking at a balanced sourcing portfolio for us, particularly for the general merchandise categories. But overall, we are less, we are very comfortable actually with the sourcing situation in terms of intake margin from the China market situation. Shipping, as you know, we do have quite long-term contracts. Again, I cannot disclose the number, but we are very, very pleased with our closed contract for next year. So we are contracted for next year. And again, without disclosing the details here, but we have -- we feel we have achieved a very favorable solution here. Maybe on the margins.

Yes. So for me, you also asked on the gross margin delivery quarter 4 over quarter 3. We have guided on a gross margin around 51%, and I want to be very clear and upfront about that. That's, as you are used from us, slightly prudent. Around can also mean above. I just want to clarify that upfront because I think it's a key metric. Where we are very happy with our gross margin momentum at this point in time. We've been assisted by stock freshness in our stores, which are at historically very high levels as we indicated already in the H1 results presentation. That trend continued. We've seen excellent sell-through in June and May, which helped us continue this very favorable trend on stock freshness. Intake margins are well managed and under control, reflecting the trends that Stephan has already highlighted just before. So we are quite confident on our gross margin delivery trajectory. In particular, also as we are cementing a number of the key inputs, as Stephan just hinted on shipping, we are cementing our favorable rates in a new contract which was a significant step down from historically higher rates. So momentum is sustained. We're having good results on our ForEx hedging, again, well into 2027. We see ex works price in China and other key supplier markets also holding and being favorable to us. So we are confident on gross margin at this point in time for the remainder of the year, as we highlighted in our guidance. So that's gross margin. So seasonal factors, I wouldn't overplay them, but I also would not encourage you to just simply extrapolate. We guide on around 51%. It's prudent. There may be some upside, but the key metric for you to focus on is the mid-teens EBITDA growth where we are clearly committing to that number. Did I answer?

Yes, very clearly. Thank you.

Now we go to Matt Clements of Barclays.

Two, if I can. The first is on Western Europe. The brand and the offer seems to be resonating very well, particularly in Spain and Italy, obviously. Can you give a bit of color about who you're taking share from and how your stores are performing when there's overlap with some of the larger integrated banners like Primark, [indiscernible], Action? That's question number one. The second question would be on digital. It's been 2 months since we last heard from you. You obviously had very encouraging early performance in Poland with the app. How has scale and engagement evolved in Poland? And when will we see the rollout into other markets begin?

Thank you, Matt. Great questions. Let me go to Western Europe first. So you asked on overlap. So look, first of all, I think one thing is very clear. Our value proposition really, I mean, resonates extremely well. I think above our expectations really with the Western European consumers. So that -- and this is really across the board in both categories. As you know, we operate in 2 main categories. So it's really in apparel and in general merchandise where we see those strong performances and the strong acceptance of consumers. The overlap is not of concern really for us. We have -- as you know, we operate in many areas. We have 3 segments in those markets. We, at the moment, do not have any issue really on that. We do measure cannibalization in CEE markets, particularly, but that is not of a big concern for us. Also because we are, as you know, able to operate in much smaller catchment areas. And that is where the focus for us lies really. And you won't find larger boxes, particularly integrated players in those areas. So very, very pleased with Western Europe going forward. Digital, yes, we haven't disclosed numbers this time. We will talk about this in more detail in December. But I can reassure you, we continue to scale up, and we particularly continue to see stronger engagement levels. So the share of sales that goes through the app and the -- either the Zwipe or the coupons is continuously and strongly increasing and is above benchmark at the moment. So we are very pleased with that, but we will discuss that a bit more in detail in December. And we are planning a rollout. We haven't guided which country yet, but we definitely will accelerate our rollout of the systems into countries where competitive pressure is high. So you can imagine it's the adjacent markets, could be Czech Republic, could be others. But we wanted to give ourselves the time for the proof of concept in Poland. setting up further commercial infrastructure around that, refine some of the technologies. Remember, we've just launched it really. And once that's all done, we will accelerate rollout because it's a super scalable, very modern digital infrastructure, so which enables us to do that fast.

[Operator Instructions] We'll now go to Michal Potyra of UBS.

Congrats on the strong numbers. I have 2 follow-up questions, please. So the first one, continuing on Western Europe. If you could maybe provide some color on the EBITDA level profitability in Western Europe and the gap to CEE? And do you believe you can even close that gap? So that's the first question. And the second, a very general question, but maybe you could comment a little bit on the consumer health and demand trends on -- across your key markets.

Okay. Michal, let me start with the first question on Western Europe. Clearly, Western Europe has a lot of potential as we still have infrastructure, which is not commensurate with the forward-looking revenue potential that we see in that market. I clearly alluded to the distribution network that we already for Iberia explained. We opened Guadalajara about now 1.5 years ago. That has helped us bring distribution costs down, but it's operating still below full scale. Therefore, there's more margin potential -- EBITDA margin potential in Spain as we start to see fixed cost attrition and benefits from scale. The same in Italy, where we continue to ship products from CEE into Italy. And you can imagine that, that is not the most efficient way to serve a big market where we have significant expansion plans. We disclosed in the half year that we are very confident on our EBITDA progression in Western Europe. We provided, I think, some information in the slides. There is still a gap, but it's closing. And with all the actions and scale advantages that we foresee in Western Europe building up over the coming years as we accelerate, we expect Western Europe to be at group levels from a financial contribution point of view.

Yes. And I'll take up the second one, Michal, on consumer. And maybe just to add to what Willem said, we've discussed in the last call, our geographic expansion and clearly said we want to focus on the existing markets because the operating leverage potential is so much higher with a now liberated highly simplified structure at scale. And that is why we are confident on the EBITDA development in Western Europe. On the consumer, yes, it's a mixed bag, right? I mean, on the macros, we see obviously positive developments, so inflation coming down or stabilizing. We believe here at Pepco that the disposable income that is available for retail is still much there, but consumers seem to become -- the sentiment numbers are negative. They are difficult and it varies. CEE is a bit better than certain parts of Western Europe, particularly Germany and France. But overall, it really only says that 2 things. One is there is still a wallet to gain from retailers -- for retailers from consumers. But consumers become and have become after so many years of distress, if you want, they have become more selective, extremely selective. So they are looking for real values. They're looking honestly for honesty and truth in the product offering, whether that is quality, whether that is price, pricing strategy. And we feel perfectly positioned in this. So we see more customers coming to us. We see volumes growing, but we also see AUP growing in certain categories. And it shows us that we are able to attract a maybe lower mid-class segment that is trading down to us as well. So therefore, I think going forward, we are, as Pepco at least, quite confident with the consumer sentiment here in Europe for us. I hope that did answer your question.

Maybe if I may have one follow-up question on competition. So we have seen those EUR 3 surcharges implemented for cross-border online trade in Europe, mostly coming from Chinese competitors. And we have seen actually players like Temu adding that additional fee at the checkout. Are you expecting any kind of incremental increase in the demand in your stores on the back of this? Or it wasn't that disruptive to you so far?

Yes. I think -- no, look, I think we had this question on the other side before several times, do we see massive negative impact? We haven't really seen it before. We know there is overlap in our customer shopping behavior, particularly with Temu, less so with Shein, but Temu. So -- but it hasn't really had a negative impact on visiting frequency and basket of those customers who also buy there. So now in reverse, that doesn't affect us either so much. I think we do really follow whether it is Action or Temu or others, we are following a very different shopping journey and a very different value proposition with a very curated to a large extent, not so discretionary assortment and product offer at really, really, really price-leading levels. And I think, therefore, we are not so impacted. But of course, we are looking at it very, very closely. And those are very large players. And one is, of course, passing this on to customers. I don't think that serves them well to do so. But we, of course, know that also in the background, there is a lot of dynamics around setting up local seller models, local distribution models and so on. So we are continuously watching it and seeing what is happening there. But frankly, we neither have had a negative -- strong negative impact nor do we probably have now a positive impact on that.

As we have no further audio questions at this time, [Selena] , I will turn the call over to you for any questions submitted through the webcast. Thank you.

Thanks. So we've got some questions from the webcast. First question from Harry at Vergent AM. How much is the impact on FX on margins? Do you see any pressure to margins in FY '27 from FX? And what is the longer-term ceiling on GPM?