Reece Limited (REH.AX) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Reece Limited half year results. [Operator Instructions] I would now like to hand the conference over to Mr. Peter Wilson, Group CEO. Please go ahead.

Thank you, and good morning, everyone. Today, we're going to take you through an overview of the results and a recap on our strategy as well as a review of our highlights for the half and some thoughts on the macro outlook. Please note for consistency, all figures are in Australian dollars unless otherwise stated. We've delivered another strong result in the first half of FY '23, driven by persistent inflation and strong execution by our team. Group sales were up 23% on the prior year to $4.4 billion, ANZ sales were up 11% and U.S. sales were up 34% in Australian dollars, inclusive of positive foreign exchange during the period. Normalized EBITDA was up 25% to $495 million. EBIT was up 18% to $325 million and was impacted by a goodwill impairment in our Metalflex business, which Andrew will talk to later. Net profit after tax for the half was up 18% to $186 million. The Board has declared an interim dividend of $0.08 per share. In short, this was a strong result driven by the market conditions and supported by our resilient business model and operational focus. Turning now to recap on our blueprint. As we've outlined previously, our blueprint guides what we do across all areas of our business. We are a purpose- and values-led organization, and our 2030 vision is to be the trade's most valuable partner. Our 3 strategic priorities help bring that to life. Each of these elements come together to help us deliver on our promise of customized service. Our blueprint guides us over the long term. Today, we do have a clear customer proposition, a trusted brand in ANZ and a growing presence in the U.S. We have a track record of delivering a sustainable level of profitability through the cycle, and we are a diversified business with a long-term focus on the less cyclical R&R market. We operate in what we think are the 2 most attractive regions, and we have a -- and we are well capitalized to support our long-term approach of investing to build a stronger business. Turning to look at the strategic progress in each of our businesses this half. In ANZ, we continued to progress a wide range of strategic activity. Under our operational excellence pillar, we're extremely pleased with our customer Net Promoter Score outcome of plus 60. This is a strong indicator that our focus on the fundamentals throughout the extraordinary period of the past 2 years has paid off with customers. Under our innovation pillar, we continue to focus on enhancing the Reece customer ecosystem, ensuring we stay ahead of their needs. And we've continued to invest in our network, which remains a competitive advantage. Finally, we are very pleased to confirm that Scott Marshall, who is currently the CEO of Supermarkets and Convenience at Metcash, will join us as the ANZ CEO. Scott is a strong leader and a cultural fit, and we are looking forward to welcoming him to Reece later this year. This will allow me to step back to continue to focus on the group CEO role. Turning to look at some of these items in a little more detail. Our network density in ANZ remains a competitive advantage, providing us with the scale that enables our market-leading position and helping us deliver our customer promise. We've continued to invest in the network this half, opening 4 new branches and refurbishing 13, ending the period with 650 branches. We've also completed a bolt-on acquisition in the pools and irrigation space, which will enhance our presence in the industry. Turning to look at our NPS in a little more detail. As I've mentioned, this was a great result at the higher end of our historical NPS as a business. The feedback tells us that our NPS is heavily influenced by service, expertise and a sense of partnership. We've always prided ourselves on being in it together with our customers, and I think this is reflected in the latest results. It is a great achievement, considering the scale of the challenges navigated over the past couple of years from the pandemic to supply chain disruption and weather events. I'm extremely proud of the team who have worked very hard in very challenging circumstances. A key part of delivering our customer promise is being in stock. We've continued to make strategic investments in inventory during the half with a 98.5% in-stock position, allowing us to avoid disruption for our customers. Now turning to look at our U.S. business. The U.S. continued to move at pace to uplift standards across their operations. Attracting and developing talent is a core to delivering our customer promise and remained a priority with new training and development programs being rolled out. We've continued to build out our product mix and introduced new value-added services like trailing Saturday trading and rapid delivery. We've also continued enhancing our digital ecosystem to our customer-facing maX app. Now turning to look at the network and brand rollout in more detail. We've continued progressing our multi-pronged strategy to upgrade and improve our existing network and roll out new branches in refreshed formats across our business units. In particular, we remain focused on increasing our offering to the more resilient R&R market that we are exposed to in Australia and New Zealand and where we believe we have a differentiated proposition. We rolled out 7 new branches, 4 of which are R&R-targeted during the half, and the customer response to the new stores has been positive. We've also acquired 1 branch, bringing our total network to 212. We have a clear pipeline of new stores for the remainder of FY '23, and we see a sustainable rate of organic new store growth being around 10 to 15 per year. Now turning to look at our brand rollout in the U.S. Our plan to move from 12 business brands to the Reece brand is progressing well. A lot of work was completed in the half. And as of the end of January, all of our California branches are now trading as Reece. This is a symbolic milestone, and we are pleased to say that customer response has been very positive so far. This is a multiyear process as we ensure each branch is upgraded to the appropriate standards first. This will enable us to achieve a stronger presence in the local market and enjoy the benefits of a harmonized brand of greater scale. I'm now going to hand it over to Andrew, who's going to go through the financial results for the half in a bit more detail.

Thank you, Peter. Reece has delivered a strong result in the first half of FY '23. Sales revenue for the group were up 23% to $4.4 billion, which benefited from persisting inflation in our product portfolio. When we delivered our Q1 update at the FY '22 AGM, we noted a decrease in volumes across the markets we operate in. During Q2 of FY '23, volumes have continued to contract. Normalized EBITDA was up 25% for the half year to $495 million, and EBIT increased 18% to $325 million, impacted by a $29 million goodwill impairment recognized during the half. Operating expenses in the group increased, driven by wage inflation and inflation across other components of our cost of doing business. Net profit after tax was up 18% to $186 million. Earnings per share for the half year of $0.288 is up 18% on the previous period. Our net leverage ratio as at 31 December was 1.2x pre-AASB 16 EBITDA. Normalized EBITDA margin increased by 14 basis points for the half year, driven by inflation and a favorable foreign exchange dynamic. Now looking at the ANZ region. The ANZ region delivered a strong result during the first half, driven by persistent inflation. Sales revenue for the half year to 31 December 2022 was up 11% to $1.9 billion. From a quality of earnings perspective, product inflation across our range was also circa 11% during the period. Normalized EBITDA was up 18% to $293 million, and EBIT increased 6% to $198 million. The delta between normalized EBITDA and EBIT is due to a goodwill impairment of $29 million relating to Metalflex, which services the heating and cooling sector acquired in FY '14 alongside the larger Actrol business unit. This business unit was impacted during COVID-19 and more recently by irregular cool up weather conditions. Normalized EBITDA margin increased 82 basis points for the year, and this is inclusive of BAC income, which is nonrecurring, with all remaining BAC income to be received in the second half. Now looking at the U.S. region. The U.S. region also performed well for the first half, again, noting the impact of inflation. Sales revenue of $2.5 billion was up 34%. On a U.S. dollar basis, the region was up 23%. It is important to note that product inflation was significant and average inflation for our U.S. business for the half was estimated to be 22%. Volumes for the region softened progressively over the half year, contracting in the second quarter. Operating expenses in the U.S. have increased, driven by wage inflation and inflation across other components of our cost of doing business. Normalized EBITDA was up 36% to $202 million, and EBIT was up 43% to $127 million. Notwithstanding the higher operating expenses, the U.S. region was able to increase its normalized EBITDA margin by 15 basis points. Now looking at the group's cash flow for the half. The group experienced cash inflows from operating activities of $188 million this half versus $84 million of cash outflows in the previous half. The key driver of improved operating cash flows were improvements in net working capital from the previous period. We continue to hold a strategic level of inventory, which is a key part of delivering our customer price. As supply chains continue to normalize, we would anticipate a gradual reduction in our inventory levels. Capital expenditure during the half year was directed towards branch refurbishments and new stores, fleet growth, upgrades and investment into digital capabilities. In line with our strategy, the group also invested $49 million in small bolt-on acquisitions in the U.S. and Australia. During the first half, the group generated $146 million of free cash flow. The group closes the half with a strong balance sheet, which supports our long-term approach and investment agenda. Net leverage ratio is steady at 1.2x. Available liquidity at 31 December was $375 million, which provides the group operational and strategic flexibility. Net debt was up for the half, primarily due to reduction in cash balances from June to December and FX on the conversion of U.S. dollar-denominated debt to AUD. Return on capital employed for the half was 14.5%, noting this measure is calculated based on adjusted EBIT, which is defined in the appendix. Into the second half, we will continue maintaining a disciplined approach to costs. As part of our approach to capital management, we will focus on investing in organic growth, strategic M&A, maximizing balance sheet efficiency and the prudent payment of dividends. I will now hand back to Peter to discuss the macro outlook.

Yes. Thank you, Andrew, and now turning to the outlook. It was well established -- it is well established that the macroeconomic setting is softening, which was evident in our volumes contracting progressively over the course of this half. Looking forward, the environment remains uncertain and difficult to predict. We are preparing for further softening in demand as higher interest rates continue to impact housing markets. We will maintain a disciplined approach to cost while making strategic investments in our priority areas to build a stronger business. And at a fundamental level, the long-term trends underlying both our markets remain positive, driven by factors like growing populations, the housing underbuild and aging U.S. housing stock. While we have seen volumes contract in our U.S. business in Q2, this only strengthens our conviction that our pivot to focus on the R&R market is the right one, albeit it will take some time. With our long-term view, we're able to look beyond this cycle. As we've always done, we will maintain our focus on our customers and on delivering our 2030 vision. In summary, we've delivered another very solid result for the half of FY '23. We continue to believe we are past the peak of the economic cycle, and our expectation is for softening conditions over the remainder of the calendar year. We are well placed to manage the external environment, always maintaining our long-term focus and investing to deliver our long-term vision. Thank you for your time. We'll now take your questions.

[Operator Instructions] Your first question comes from Brook Campbell-Crawford from Barrenjoey.

Just the first 1 on the volume outlook. You talked about the businesses preparing for softer volumes, and I think that's no surprise, right, given what's happening and the broader housing market surprised both your key regions. But what sort of range of volume declines are you thinking about being possible in the second?

Brook, look, as you know, we're not into giving guidance. We never have and we're certainly not going to start now, given the uncertainty. But I think what we can talk about is how we finished Q2 in both regions. So if you look at Australia and New Zealand, the volume in the Q2 was down 2%, and if you look at the U.S., the volume was down 6%. So I mean, that's an indication of what is actually happening to the market. So I don't think we're going to give anything further and hopefully, that helps. And I mean, what I would say though, for both parts, we're still in pretty strong conditions. You still -- it's still pretty much a full employment. It's very hard to get a trade. So there's still a lot of activity for completions of homes and so on. So it's still at high levels, but obviously from the last quarter, you can see that things are beginning to soften.

That's helpful. And the second question just on the U.S. business. Can you provide an update on where you think sort of systems, processes, I guess, sort of business infrastructure overall, where you're at for that business in the U.S.? And I guess I'm just really trying to understand is it where it needs to be in your view? [indiscernible] maintain decent performance in what looks like a softening demand environment.

Well, if you ask me, Brook, we're never really where we need to be. So we're 4 years in basically to what we've consistently said is a really long-term story. So I mean, I've said this is a multi-decade story. So we're poised and we're making progress. We've really focused a lot of the foundational part that really matter, which lots of hard work at the culture piece, basic systems and training. So we are progressing well on the level of activity that the team is doing is fantastic. And so we definitely have lifted, but we've still got a long way to go. So in terms of being able to navigate the next cycle, I think we're better than where we would have been 4 or 5 years ago. But we're not exactly where we want to be with the pivot to the -- having a much bigger presence to R&R, and it's really very small at the moment.

Your next question comes from Lisa Huynh from JPM.

I just had a question on price inflation. Can you just talk about the planned price rises over the next a little while, just given we're starting to see commodity prices roll over?

Yes. So Lisa, it's Andrew speaking. So what we've been able to do, I guess, during this inflationary environment, which is 12 to 18 months old is effectively push price rises through the network, and that's the network both in ANZ and in the U.S. And that's not a situation where we just send out a new effectively recommended retail price. Each customer effectively gets communicated with directly and it's quite a sophisticated way we do it. What happens in a deflationary environment, ultimately, we'll continue to trade and try and make sure that we're maintaining GP.

And look, just to build on that Lisa, look, I think you can see from our -- what we've shown so far that we -- that definitely, inflation is -- it's high. I mean, we've never seen anything like it, and it seems to be fairly persistent still. Obviously, we think it's close to the peak. But if you look at -- we're not seeing a dramatic unwind. So we see this being pretty persistent for -- in our sector for a little while. So we've got a mental that actually has a really good analogy. On the way up, we sort of respond like kangaroos. We move quickly and on the way down, we sort of move like wombats. So that's how we look at it from a philosophy, if that analysis can help. But certainly, we still see inflation persisting.

Right. That's helpful, and that's a good analogy as well. My second question just on the wage inflation. So it looks like employee expenses were up 20% versus the PCP. Can you just break that down between how many heads you're adding versus just general wage inflation in the retail sector overall and just what you're seeing there?

Yes. So Lisa, it's Andrew again. Look, from, I guess, an employee growth perspective, there has been some employee growth, not material. Effectively, the uplift has really been in -- it's been driven by wage inflation. So there's wage inflation across our existing staff in order to try and prevent turnover. And then when we're replacing staff, those staff continue to cost more than the personnel they're replacing. So wage inflation is a very serious, I guess, issue for us to face into. The other thing that we're facing is other parts of our cost doing business, as I referred to on the call. There's inflation across, I guess, every other line item in those expenses, which is hard to manage and is also hard to pass on.

Right. So just as a follow-up, do you think that's the right level going forward? And should we still be thinking about wage costs as a percentage of sales?

Yes. So I think, I mean, for us, wages and salaries are always 70% to 75% of our cost of doing business. It's the nature of our business and the way the business is structured. So yes, that metric is probably -- that won't change. Wage inflation into FY '24 is something that we're obviously considering at the moment, and we'd be hoping that, that moderates. But at the moment, with great unemployment, that may not occur.

Your next question comes from Peter Steyn from Macquarie.

Perhaps a related question but just coming from a slightly different angle. From an inventory perspective, just looking at your stated inventory balances year-on-year up 11% in the context of the price inflation you're seeing. It does sort of give one the sense that perhaps there's already a little bit of a moderation either in units or costs coming through on the inventory side of the business. Just curious which one it is? And how does that play out for GPs over the next 6 months?

Yes. Thanks, Peter. So what we did during the, I guess, the deepest part of the supply chain disruptions in both markets as we increased our levels of safety stock. You would have seen that our inventory levels lifted. And really, that was to make sure that we had our in-stock promise, which is core to our proposition. As the supply chain has started to normalize in certain areas, we've started to reduce those levels of safety stock. And we've been able to effectively start to move our inventory days downwards. So our perspective is really about making sure that we've got the right level of stock for the supply chain we're currently dealing with and also just needing to be mindful of, I guess, the inflation that's currently embedded in there. But we're looking to gradually move that down over the next 18 months as the supply chains normalize.

And as a follow-up to that, Peter, is input costs, so freight and commodities, are those reflected fairly quickly for you? Or is there a fairly big delay in how that flows into inventories and then through the P&L?

Yes. So it's just -- again Peter, it's Andrew. So in relation to input costs like copper, PVC resin, et cetera, there's a fairly sophisticated market around, I guess the way those flow into product pricing. Where there's decreases in prices and those flow through the market, we've effectively got pricing change in both markets that look at what competitors are doing. And then we effectively look at how we're going to deal with those changes to price on an individual customer basis. So it's not as simple as copper is down and we start selling copper across our network at a lower price. As you probably recall, we trade individually with these accounts on a basket of goods basis.

Yes. So the wombats in -- sorry, just last one. Peter, could you explain what you mean by an R&R-focused branch?

Yes, Peter, it's -- the analogy is really, if you go to a typical Reece plumbing branch in this country, that it's targeting the repair-replace-remodel type, the maintenance customer, if you like. So that's how we've built the business largely here. We've got to be exposure. And in the U.S., the -- as we've said consistently over the last 4 years, the business was built around the residential construction and commercial construction. So it's a different exposure. And so they're different segments. And they -- so the best way to do it is to just your typical Reece plumbing store in Australia is built around the R&R customer.

So it's both store experience as well as infill location?

Yes.

Your next question comes from James Casey from Ord Minnett.

Just while we're talking about exposures, can you just remind me of the U.S. exposures, just given what's happening with volumes, just in terms of repair and remodel, new housing and then construction?

Well, how we look at it, James, it's Peter, is -- it's -- the R&R exposure in the U.S. is under 20% so it's small. So -- and to repivot to where we want to go, it's -- we're talking many, many years. It's about the store rollout program and then you're winning 1 customer at a time, which we've said consistently now for 4 or 5 years. So the majority of the exposure is in the end markets, our residential construction and commercial construction.

And what's the split there?

Well, how we look at it, what we normally say is if you look at where plumbing -- if you look at where plumbing work is done in the U.S., it's about 55% done in R&R. And you've got about 30% in residential and -- or 25% in residential and 20% in commercial. So you can split -- the majority of our business is split sort of half and half between those 2.

Yes, okay. Andrew, just on the tax rate. Where do you see that tax rate lending for the full year? I know you don't give forecast but it's a bit of a difficult 1 to predict.

Yes. So just talking through it for you, James. So effective tax rate for the half year was 35%, which is obviously elevated. We sort of see our normal ongoing tax rate as being around 30%. So in the half, there are 2 drivers of that uplift. First, there's a nondeductible FX loss relating to the debt refi. And then there's also the nondeductible impairment expense. So if you back both of those out, we would have been at 30%. So yes, that's the clarity on why we're an elevated tax rate or effective tax rate for the half.

There are no further questions at this time. I will now hand back to Mr. Wilson for closing remarks.

Yes, thanks. Thanks, everyone, for joining the call. It's obviously been a very -- it's been a very solid result. And I'm just very grateful for the effort that our team -- the team had done throughout this period because it's been quite extraordinary. Any sort of frontline worker has done it hard over the last 2 to 3 years, and we've got a lot of those in our business. So they've worked extremely hard and the model has stood up really well. And if you go back before the pandemic started and you look at the growth that we've had, it's quite extraordinary. So I just want to thank all our team members for the efforts that they've put in because they're the ones that have made this possible. So thanks for joining, and we look forward for the next call.

That does conclude our conference for today. Thank you for participating. You may now disconnect.