Pinewood Technologies Group PLC (PINE) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining us on the Pendragon 2021 Interim Results Call. Today we'll be going through the results for the first half of the financial year, taking a look at how the business has performed, and giving you a further update on the significant progress we're making against our strategy. I'm Bill Berman, and joining me today is our Group CFO, Mark Willis. I'll begin by going through the performance in the first half across each of our divisions, and then I'll bring you up to date on how our strategic initiatives are progressing. After that, I'll hand over to Mark, who will take you through the financial performance in detail. Mark will also touch on some guidance and the outlook for the remainder of the year, and then we'll open things up for questions. I remain impressed by how our digital propositions keep evolving, and by how both our associates and our customers have responded to these changes. From the start of the year until the 12th of April — a stretch of more than 3 months — our showrooms were closed. Even so, the digital developments we made in 2020, along with further capabilities we brought in, meant that in spite of that closure we were able to complete over 40,000 vehicle transactions in the first quarter, using a combination of home delivery and click and collect.

Customers had the confidence to transact effortlessly and smoothly thanks to how strong and high-quality our multichannel proposition is. When we reopened in the second quarter, we could maximize the benefit from the unprecedented conditions in the used car market. Our advantages in our vehicle sourcing supply chain let us maintain vehicle inventory levels amid challenging supply conditions, which means we can meet the levels of pent-up demand and maximize our margin opportunity. Our performance in both the new and used car markets, along with the benefits from the significant changes we made to our cost base and further strong results in both Pinewood and Pendragon Vehicle Management, delivered an underlying profit before tax of GBP 35.1 million in the first half. Mark will give a little more detail on the outlook at the end of the presentation. But in summary, we believe there is still a high degree of uncertainty over the remainder of this year, with shortfalls in new car supply driven by supply chain constraints currently impacted the key month of September, potential disruption from COVID-19 and the timing of a correction in used car pricing. Starting with Franchised UK Motor, revenue grew by 64.6% on a like-for-like basis, recovering well against the first half of 2020, with our business better positioned to perform during this year's lockdown.

That growth, along with our capacity to meet stronger customer demand, could only be delivered thanks to progress in our digital capabilities and the hard work of our associates. With new capabilities and solid operational performance, we were able to beat both the new and used car markets. In new, like-for-like volume rose 42.7% while the market was up 39.2%. And in used cars, we posted like-for-like volume growth of 38.3% against a market up 33.3%. Because we can draw on a broad range of used vehicle sources — part exchange, our Sell Your Car proposition, our OEM relationships, our leasing business and various other channels — we were able to keep our used vehicle inventory in place despite tough supply conditions. That let us sustain good volumes across the half and make the most of our ability to sell into rising used car prices, especially during the second quarter. You can see this in the better margin in gross profit per unit, with a used GPU of GBP 1,418, significantly higher than the prior year. New margins were stronger too versus last year, with gross profit per unit climbing to GBP 1,620, up from GBP 1,256. Our cost restructuring was mainly focused on the UK Motor division, cutting costs by GBP 45 million versus the same period in 2019, before the pandemic — a successful result of both our selective store closures and a more efficient store operating model.

So taking everything into account, UK Motor posted an underlying profit of GBP 37.6 million, and that came about through the margin and cost-management gains generated by our strategy, together with favourable market conditions. In H1 2021, Pinewood grew total net user numbers by 3% excluding Pendragon — a solid outcome given that conditions for growth stayed difficult, with dealers reviewing headcount and implementation held back by restrictions on physical travel. Within Pinewood's international markets, net user numbers rose 14%, and that international growth was powered by system installations in the Nordic markets, helped by hiring overseas and by setting up a new team on the ground in Sweden to support further expansion. We expect the strong increase in international user numbers to carry on through the second half of 2021, even with the travel constraints caused by the pandemic. We keep putting money into hiring new development resources to support long-term growth. User growth, together with the reversal of the discounts given to customers last year, drove revenue up 12% to GBP 12.1 million. Operating profit rose 13.6% to GBP 6 million. During H1 2021, Pinewood kept investing in the functionality of its DMS platform.

The work covered building out online sales tools and capabilities, along with platform architecture and security. We're excited to keep concentrating on growing OEM support internationally — particularly as Pinewood DMS earned U.K. certification under BMW's Retail Integration Services and also took on a global partner role to steer further development. In the first half of 2021, Car Store posted an underlying operating profit of GBP 0.3 million, versus an operating loss of GBP 1.7 million in H1 2020. Just like the franchised dealerships, Car Store showrooms shut from 1st of January through the 12th of April, with only limited aftersales capability. There was less opportunity to offset operating costs via service activity, even though the business could still sell cars remotely by leveraging the group's digital developments. Consequently, Car Store booked a loss of GBP 0.7 million in Q1 before swinging back to profitability in Q2 with an underlying profit of GBP 1 million. All in all, I'm happy that the established Car Store locations now contribute consistently to group results. Although keeping a close eye on trading performance has been essential to this improvement, the team has also been focused on developing our used car proposition ahead of the relaunch of this part of our business.

I'll go deeper into this when I walk through the strategy shortly. Pendragon Vehicle Management turned in a very strong performance during the period, with operating profit rising 72% to GBP 8.1 million, compared with GBP 4.7 million in the first half of 2020. As we flagged at the 2020 results, PVM's fleet size has come down relative to this time last year, reflecting lower levels of new business during the pandemic and the decision we took to exit the body-shop sector. A smaller fleet led to a reduction in recurring income during the first half. That said, this was more than offset by a 90% year-on-year increase in disposals of defleeted vehicles. Strong market conditions for used vehicles, particularly in the second quarter, supported high levels of profit on disposal of motor vehicle. While the order book remains strong, supply chain constraints on new cars are likely to affect PVM as well, restricting the ability to issue new business in the immediate term. We are confident about the long-term prospects for fleet size growth as these constraints ease. Finally, US Motor. I'm pleased that we have now successfully concluded our U.S.

With the disposal program now wrapped up — we finished selling the Los Angeles and Santa Monica sites during the first half of this year — that chapter of our business is closed. All told, we brought in proceeds before tax totaling GBP 106 million, versus the GBP 100 million we had originally targeted. Now I'll walk you through how our strategy is progressing. As a reminder, our vision is to transform automotive retail through digital innovation and operational excellence. To get the group there, we settled on 3 strategic priorities for growth: first, unlock significant value in the Franchised UK Motor division; second, grow and diversify our software business, Pinewood; and third, the disruption of stand-alone used car sales in the U.K. For each of our growth priorities, there are 3 underlying objectives: those that have been progressed and have started to deliver value; those that are currently in development; and those that are on the road map for future development. The group is making good progress when it comes to strengthening existing competitive advantages as well as creating new ones in the evolving U.K. automotive retail landscape. UK Motor operates from a far leaner cost base with substantially improved efficiencies; continues to act as a cost advantage source of supply of stand-alone used cars; has a greater reliance on an internal and external data in order to strengthen our digital capabilities and an improved internal decision-making; has a broad portfolio targeting multiple customer segments, with significant representation across the U.K.

Our physical footprint, now and going forward, is going to be a vital asset for meeting customers' omnichannel demand. Pinewood has taken excellent strides to outpace its rivals even further by building out enhanced digital capabilities, so the group can push forward its digital and physical ecosystem and add to group profitability in the U.K. and internationally. Lastly, the stand-alone used cars disruption, which launches late this year or early next, is something only Pendragon has, thanks to the vertically integrated assets and capabilities inside our group. We'll gain from infrastructure spanning up to 150 locations for vehicle collection, carries no OEM dependency, permits higher levels of strategic freedom, and will drive upside in both volume and margin. Our strategy is aimed at restoring and improving underlying profitability and establishing a foundation for sustainable profit growth. Financial improvement carried on into the first half of 2021, with underlying profit before tax of GBP 35.1 million. That upside was supported by the strategic initiatives progressed thus far and the related improvements to our customers' journey, operated model and cost base. Further out, once market tailwinds fade, we remain confident in our target of reaching underlying profit before tax of circa GBP 85 million to GBP 90 million in full year '25.

Although multiple factors played a part across the 12 months spanning half 2 of 2020 and half 1 of 2021, underlying profit came in at GBP 74.3 million, and that gives us confidence in what the newly reshaped business can deliver going forward. On the next slide you'll see a summary organized by strategic priority: a, the initiatives already advanced and generating value — 33 projects successfully implemented group-wide to reinforce omnichannel strength, push margin upside and open up further cost opportunities; b, the initiatives now in development — 24 initiatives aimed at upweighting our pricing capabilities so we continue toward operational excellence and reposition our used car proposition; and c, the initiatives earmarked for future consideration — additional levers focused on operational excellence, further growth of Pinewood and scaling the used car physical estate, drawing on what we learned from our concept store. I'll now walk through how progress on the in-development strategic initiatives benefits our customers, the group and our shareholders. Unlocking significant value in the Franchised UK Motor division is our first strategic priority. With the goal of accelerating digital innovation, Pinewood has made progress strengthening our omnichannel capabilities.

Evanshalshaw.com and Stratstone.com can now handle transactions, so buyers may purchase used cars online using cleared funds. Finance payment functionality is live on Evanshalshaw.com. Applicants can apply through the website and get automated, real-time decisions so they can finish the transaction. As things stand, EH customers can pair their online vehicle purchase with insurance products, which adds margin for the group whenever transactions are completed 100% online. We are working toward matching capabilities at Stratstone.com. Last, Sales+ is new functionality inside the Pinewood ecosystem that lets our store associates manage the sales process digitally and efficiently. Several actions were taken in the first half to improve conversion of both part exchange and Sell Your Car vehicles. Our store associates now get automated valuations through a single group tool, backed by better data. The omnichannel capabilities and conversion levers I have described were incubated and fully scaled inside the stand-alone used car division before rollout across UK Motor. We will keep using this approach to drive change throughout the group at pace. To sum up, these enhancements put us at the forefront of the U.K. automotive retail sector.

They’ve played a major role in helping to substantially offset the effects of the third national lockdown during Q1 and come out of it stronger in quarter 2, beating the market. UK Motor’s second goal is to pursue operational excellence and best practices. Several improvements have been made to our used vehicle warranties after a thorough competitive review. A 3-year product has been launched to sit alongside the existing 1 and year 2 products. Consistent with the advantages of what we offer relative to our peers, we adjusted the pricing on our current products. Our regional leadership structure has been altered to sharpen operational focus. Second, we’ve overhauled our internal processes and made adjustments aimed at improving margins on those vehicles that fell outside our stocking profile and our center trade. UK Motor’s third objective is to run on a lean and efficient cost base. As we said before, we restructured our store estate and store operating models. We’re confident these revised structures have produced the benefits we set out earlier and will stay in place. Several initiatives for UK Motor are presently being developed. We are assessing a group-wide platform for vehicle acquisition management and pricing.

With Pinewood's technologies in place, we'll develop the ability to put data to work, make vehicle acquisition processes better, and automate how inventory is managed. On top of that, we'll build dynamic used pricing capability, drawing on internal as well as external data to fine-tune pricing on used vehicle inventory, which affects margin and turn speed. We're currently shifting toward one finance system spanning our digital and physical assets. When that's done, it will deliver some gains in customer data transfer and lender response times. It will also serve as an enabler for future finance activity, including rate for risk and new car finance online. Last, building on the current Sales+ platform, a number of further releases are planned from now through the end of the year. Through automating deal optimization, these releases will drive efficiency, and they'll further improve our OEM integrations along with the utilization of third-party data. A group-wide program is underway, aimed at process and procedure improvements that affect vehicle preparation, speed and quality, as well as the subsequent spin on rectification. This program will also strengthen the digital presentation of vehicles. The team is working on interventions to maximize both the quantity and conversion of vehicle health checks performed in our workshops.

We’re going to improve the customer journey so that it offers extra payment functionality. With used warranties, the next step is moving away from a single product—where the only variable is term—toward products that are tailored and tiered. We’ll soon start a trial offering customers warranty products that differ according to the vehicle’s age and mileage at the point of sale, and those will be priced differentially. Last, in line with the goal of driving operational excellence and best practice, a hub-and-spoke trial for Sell Your Car is now underway. Conversion at these locations is tracking well ahead of the rest of the estate. That trial is supplying incremental used car supply. On a lean and efficient cost base, and in addition to the progress cost levers mentioned earlier, we are close to finishing the transformation of our finance function within UK Motor. Dealership teams have been centralized within our existing shared service center. That centralization has been supported by process standardization, investment in automation technologies, and the new business partner capability. Pinewood has made excellent progress in enabling and strengthening the group’s omnichannel capabilities. Group-wide digital payment functionality, insurance products online, as well as multiple Sales+ releases, have been developed and delivered by the team at Pinewood.

We've already put these capabilities into practice successfully in UK Motor, with stand-alone used serving as the incubator. Right now, the team is focused on several development initiatives that were mentioned earlier. Stand-alone used cars are going to be relaunched shortly. As part of that relaunch, the website will be rebuilt to enhance the look, feel and flow, with added functionality such as the ability to include a part exchange in the omnichannel transaction. On a stand-alone basis, Pinewood has 2 objectives. The first is to deliver the substantial existing pipeline of international orders that the division has built. Internationals have grown by 14% over the first half. As I said earlier, this is an incredible step forward in light of the travel restrictions that have been imposed as a result of pandemic. The second is to deliver further geographic expansion. Existing relationships have the potential of further orders from both dealer groups and OEMs to be the single in-market DMS provider. Pinewood is now one of the only 2 global partners to support BMW's retail integration strategy. Congratulations to the team for the growth that this will drive over time. Our third strategic priority is the disruption of used cars in the U.K. The U.K. is the most attractive used vehicle market globally.

Used vehicle sales represent a total market of roughly 7 million to 8 million annually. Given the age and mileage profile that fits our target customer segments best, our addressable market comes to about 4 million cars a year. For Pendragon, the addressable used market exceeds the entire U.K. new car market. We think Pendragon holds a significant advantage here. By drawing on the complementary attributes of the wider group, we can secure a steady supply of suitable stock. Alongside a high level of brand referrals within the group, the omnichannel capabilities achieved so far and those in development will let us convert further scale advantages into a differentiated used car proposition and drive higher margins. Our new vision and brand will launch in late Q4 2021 or early Q1 2022. Customers will see clear propositions spanning buying, selling and aftersales — including, but not limited to, group stock availability and collection locations, a personal adviser supporting the end-to-end customer journey, part exchange capability on the website, in-house rather than third-party home delivery capability, and interest-free aftersales options. We are targeting 8 further locations developed over the period to full year '25 to drive incremental volume for the group.

Our first concept store—the one that will shape how we expand going forward—opens in Chesterfield early next year. Selling used cars anytime, anyplace, and in whatever manner the customer prefers. Your car, your way. To sum up, I'm very pleased with what has been accomplished in the first half of 2021 toward delivering the group strategy. The initiatives we've moved forward have played a major part in largely offsetting the effects of the third national lockdown in the first quarter and a stronger in quarter 2, beating the market. Our cross-functional team keeps up a rapid pace of change, with plenty of initiatives in development to generate additional stakeholder value in the second half and beyond. The Board and I stay confident about the opportunity our strategy offers and about how the group is positioned amid the shifting consumer and competitive landscape. We still target underlying PBT of circa GBP 85 million to GBP 90 million by 2025, along with the substantial shareholder value creation that drives. Lastly, I want to thank our 5,100 associates for their hard work and dedication throughout these unprecedented times. Without them, we could not have achieved everything we have. I'll now pass things to Mark, who will walk us through the first half financial performance in a bit more detail.

Thank you, Bill, and good morning to all of you. On the first slide, you'll see an overview of our key financial metrics, and it shows positive momentum both versus last year — which, as we know, was affected by the COVID-19 pandemic — and versus a more directly comparable stretch in 2019. I'll walk through each of these metrics on the slides that follow. To sum up, though: while having a smaller store estate has meant lower revenue than in 2019, the gross margin rate improvements the business has delivered, along with the substantial cost base changes that together offset that lower revenue, produced an underlying profit before tax of GBP 35.1 million — more than GBP 65 million better than in each of the 2 prior years. Now let's move to the summary group income statement. We'll begin with revenue, which grew strongly against last year, a period heavily affected, obviously, by the severe restrictions of the first national lockdown. Overall, revenue growth was 49%, and 62.6% on a like-for-like store basis. That's a particularly creditable outcome for the reasons Bill already set out, given that stores were physically closed for 14 weeks during the period, versus 10 in the same period last year.

Gross profit rose 56.1%, and the gross margin rate went up from 11.1% to 11.6%. I should point out that supply and demand behaved differently in the first quarter versus the second, and that had an effect on the gross margin rate, especially for used cars. To add a bit more detail here, UK Motor gross profit per unit was roughly GBP 500 per car lower in Q1 than in Q2. Supply stayed at high levels, while underlying demand fell because people remained at home throughout the lockdown period. So in Q1, the GPU came to approximately GBP 1,100. In Q2, with demand rising and supply getting tighter, gross profit per unit climbed to about GBP 1,600 per unit, which produced an overall H1 UK Motor used GPU of GBP 1,418. Now to costs. As Bill mentioned earlier, the successful delivery of a restructured store estate and the more efficient payroll operating model brought in during the second half of last year drove a substantial cut in operating costs, improving operational leverage. Total underlying operating costs of GBP 159.3 million gained from GBP 10.1 million of furlough grants and rate relief in the half. Even after adjusting for that, underlying operating costs were still down by over GBP 75 million relative to the pre-pandemic 2019.

Gross profit is only GBP 24 million lower, and the GPU decline was driven by a GBP 27 million reduction stemming from the U.S. asset sale. Underlying interest costs came in at GBP 16.8 million, which is GBP 3.4 million lower year-on-year, mainly because of a GBP 3 million decrease in vehicle stocking plan interest tied to lower inventories. Taking all these movements together, underlying profit before tax for the period was GBP 35.1 million. The group also booked non-underlying costs of GBP 4.3 million in the half, made up of a GBP 5.4 million charge for impairment of right-of-use assets, which relate almost entirely to impairment of 3 leases in California that stayed with the group after the disposal of the U.S. assets. All of these remaining short-life leases are in good locations and are currently being marketed for sublet. Termination and severance costs were GBP 0.9 million, and these mainly relate to moving finance processes from dealerships to a centralized shared service center as part of our ongoing program to operate from a lean and efficient cost base, plus pension costs of GBP 0.5 million, all of which were partly offset by gains of GBP 2.4 million on the sale of business and property, plant and equipment, mainly arising from a combined profit of GBP 2.0 million (sic) GBP 1.0 million on disposal of the U.S.

Properties in Santa Monica and Los Angeles, plus gains from selling a modest number of other freehold sites. Once non-underlying items are accounted for, the group posted a total profit before tax of GBP 30.8 million — that's GBP 82.8 million better than the prior year's loss of GBP 52.0 million. On the next slide you can see how quarterly results swung around as the COVID situation changed. It shows how performance was weighted between Q1 and Q2, capturing first the lockdown hit and then the lift from pent-up demand. Even though we were physically closed during the first quarter, by cutting the cost base and strengthening multichannel capabilities we still managed a substantial gain over Q1 FY '20, posting Q1 underlying PBT of GBP 10.8 million. Robust trading, better volumes and fatter margins in the second quarter, combined with the new cost structure, gave us underlying profit before tax of GBP 24.3 million in Q2. Now let's turn to cash flow for the first half. The group ended with adjusted net cash of GBP 9.5 million, which represents an inflow of GBP 109.9 million measured against the full year '20 closing net debt of GBP 100.4 million. Cash generated from operations came in as an inflow of GBP 114.8 million, versus an inflow of GBP 76.3 million in the same period a year earlier, and the rise mostly stems from the better underlying operating profit of GBP 62.7 million delivered by the strong trading performance.

On top of that, we saw a working capital inflow tied to a short-term VAT timing benefit of roughly GBP 35 million, and that came about because new car inventory dropped during the second quarter. That timing benefit sits alongside the ongoing benefit from deferring VAT payments made in half 1 2020 and from the government support scheme, which stood at GBP 29 million as at June. So taken together, at the half year the group's net debt position gains from a total VAT timing impact of approximately GBP 64 million, and that will unwind during the second half of FY '21. Contributions to the defined benefit pension scheme rose from GBP 2.6 million to GBP 6.3 million, with payments into the scheme going back to the levels agreed in 2019, after the unwind of an agreement with the scheme trustee during the first half of last year to defer payments from the first half into the second half because of the initial impact of the pandemic. Net capital expenditure was an inflow of GBP 24.9 million, combining GBP 28.8 million of cash received from the disposal of the U.S. assets and a small number of U.K.

Turning to properties, we also saw a GBP 3 million inflow from fewer fixed asset vehicles, partly offset by a GBP 6.9 million outflow for capital expenditure. Capital expenditure stayed low in the period, since we remain cautious through the Q1 lockdown and because a number of projects are weighted toward the second half of FY '21. Lease payments and receipts rose by GBP 5.8 million to GBP 19 million; that increase reflects the reversal of last year's half 1 timing benefit from the temporary shift to monthly rent payments early in the pandemic. Last, on the financial statements, an overview of balance sheet movements: net assets rose by GBP 59.7 million versus December 2020, reaching GBP 186.4 million as at 30th of June 2021. The key movements I want to flag for commentary are a GBP 139.8 million reduction in inventory to GBP 469 million, as new car inventory fell by approximately GBP 170 million, driven by global supply chain constraints, exemplified by the ongoing chip shortages. That reduction was partly offset by roughly GBP 40 million of added value in used vehicle inventory, as the average value of a used car in stock appreciated by circa 15% in the period, since strong demand for used cars pushed up both the average cost of a used car in stock and the retail value.

At present, we anticipate that levels of new car inventory will stay lower across the second half of FY '21. There's a reduction in payables of GBP 94.6 million, tied to lower vehicle creditors stemming from the drop in vehicle inventory, partly offset by the rise in the VAT creditor as set out in the cash flow. And finally, the net liability for defined benefit pension scheme obligations has fallen from GBP 75.5 million at FY '20 to GBP 34.9 million at H1 '21. That GBP 40.6 million decrease is made up of contributions of GBP 6.3 million, net interest of GBP 0.5 million and a net actuarial gain of GBP 34.8 million in the period. Lastly, let's turn to a couple of guidance items and a summary of the outlook. So to guide on cash movements, we expect a high level of CapEx in the second half of up to GBP 50 million as we progress a number of larger developments, although I would caveat that this remains subject to the availability of certain materials such as steel. As previously discussed, there is approximately a GBP 64 million timing VAT benefit that will unwind in the second half. In terms of outlook, a high degree of uncertainty remains over the remainder of the year.

Through July, August, and September, we have begun to observe shortages in the supply of new cars. And as things stand, we anticipate that this will persist at minimum for the rest of this year. Counterbalancing that, margins on used cars have stayed robust, and when any normalization of those might occur is still not clear. We are also keeping in mind that COVID-19 could go on having an effect both within the U.K. and via additional disruption to global supply chains. Given these considerations, a range of possible outcomes for the full year still exists, and at present we expect underlying profit before tax to fall within GBP 55 million to GBP 60 million. To sum up, we are pleased with the progress we keep making against our strategy, and we believe the right plans are in place for us to deliver our long-term financial targets. Thank you. Bill and I will now take any questions.

<<operator_script>> Our first question now comes from Sanjay Vidyarthi at Liberum.