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

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

Good morning, and thank you all for joining us on our FY '23 results call. Today, we will take you through an overview of our results for the year, a reminder of the Reece blueprint, a review of our operational and financial highlights and then some high-level thoughts on the outlook for FY '24. We've delivered another strong performance this year in a softening macro environment. Group sales were up 16% on the prior year to $8.8 billion, with a positive contribution from inflation, while demand softened from the peaks of recent years. ANZ sales were up 10% to $3.9 billion and U.S. sales were up 12% in U.S. dollars. Normalized EBITDA was up 16% to $975 million. Adjusted EBIT was up 19% to $668 million. Adjusted NPAT was up 11% to $405 million. The Board has declared a final dividend of $0.17 per share, bringing the total dividend for the full year to $0.25. Turning now to recap on our strategy and blueprint. As we've outlined previously, our blueprint does guide what we do across all areas of our business. We are a purpose and values-led organization, and our 2030 vision is to be our trade's most valuable partner. Our 3 strategic priorities help bring our vision to life. Each of these elements come together to help us deliver on our promise of customized service. Today, we've got a clear customer proposition, a trusted brand in ANZ and a growing presence in the U.S. We've got a track record of delivering a sustainable level of profitability through the cycle, and we are a diversified business by geography, customer and end market with a long-term focus on the less cyclical in our market. We operate in what we think are 2 of the most attractive regions and we are well capitalized to support our long-term approach of investing to build a stronger business. Now turning to look at sustainability, where we are at the very early stages of executing our strategy. During FY '23, we set emissions reduction targets in our first sustainability report, and we've made progress operationalizing our strategy, building out a roadmap to achieve our targets and completing our first project in the Reece Foundation, an initiative that we're really proud of. We know that we've got a lot more to learn in the area, but we are committed to playing a role in driving sustainable change. We will do this the Reece way by always being customer led. And now turning to look at the strategic progress in our business this year. We've made good progress operationally in FY '23. After a couple of years of trading at peak levels, we took the opportunity to go back to basics by focusing on our customers and our people. We've been beating down the many changes and significant growth over the past 5 years and preparing the business to head into a phase of stability. We're focused on core programs like selling skills across both regions, and this is an absolute fundamental for our business and require constant attention to enable the continued success of the Reece model. And as labor markets remain tight, we focused on both attracting and retaining new talent and rolling out a range of new development programs. This played a major role in helping us to bring the Reece brand to life through our people. And of course, we've continued to focus on strengthening our customer service proposition, both for today and into the future through services and digital tools. Turning to ANZ. Our network density remains a competitive advantage. It provides us with the scale that enables our market-leading position and helps us deliver our customer promise. We've increased the rate of store openings this year following COVID, opening 9 new stores, closing 2 branches and acquiring 3 branches with a small bolt-on acquisition in the [ full ] space, which we completed at the end of October. We've also refurbished 21 branches. Turning to the U.S. We continue to upgrade and improve our existing network and roll out new branches in refreshed formats across our business units. We remain focused on increasing our offerings to the more resilient R&R market. This is still a very small part of the U.S. business today. But in time, it's an area where Reece can have a differentiated proposition for our customers. In FY '23, we rolled out 15 new branches with a positive customer response. We have a clear pipeline of new stores for FY '24, and we continue to see a sustainable rate of organic new branch growth being around 10 to 15 stores per year. We also completed 10 refurbishments. We made a strategic acquisition of a small 12 branch refrigeration and air conditioning wholesaler in Texas, which adds refrigeration to our U.S. HVAC business. And finally, we began our brand rollout with California now trading as Reece. The brand rollout is now heading east across Arizona, Nevada, North Carolina and Georgia. Before I pass to Andrew, I think it's worth taking a moment to reflect on our journey so far in the U.S. Since we acquired MORSCO 5 years ago, the team had systematically begun to uplift all aspects of the business. Some of this is very visible like the physical upgrade of branches, the expansion of our network, rolling out the Reece brand and the recent launch of our online platform, maX. But equally important is hiring, training and developing our team to understand and embody the Reece way and are ready to deliver on our customer promise. This is evident in the more than doubling of our senior branch team who are now home-growing team members setting the standard for serving our customers every day. There's still a very long way to go in the U.S., but we are putting in building blocks in place to help drive our success into the future. For 2030, we will be trading at one unified Reece brand across the U.S. with the bigger network and a deeper set of capabilities across our team, delivering our customer promise and enabling our vision of being our trade's most valuable partner in that market. 5 years in, the rationale for the acquisition is still intact, and we are making good progress. I'm now going to hand across to Andrew who will take you through our financial results in more detail.

Thank you, Peter. In FY '23, the group achieved sales revenue of $8.8 billion and adjusted EBIT of $668 million across nearly 900 branches in Australia, New Zealand and the U.S. Over the last 5 years, the group has navigated significant macro challenges. Reece has benefited over this time by having a long-term lens and deeply disciplined operational culture. We continue to focus on our long-term investment strategy and a disciplined approach to capital management. One of our key metrics to measure long-term success is through return on capital employed, which is calculated using adjusted EBIT. This year, we were pleased ROCE increased 200 basis points to 15.3%, which is the highest level since the acquisition of MORSCO in FY '19. Now on to the financial highlights of FY '23. Despite softening product volumes throughout the year, Reece has delivered another strong result in FY '23. Sales revenue for the group was up 16% to $8.8 billion, which was positively influenced by a favorable FX dynamic due to the strengthening U.S. dollar and inflation across our product portfolio. On a constant currency basis, sales for the group were up 11% from FY '22. Normalized EBITDA was up 16% for the year to $975 million and adjusted EBIT increased 19% to $668 million. Adjusted EBIT excludes nonrecurring BAC income of $16 million and a $29 million impairment recognized in the first half. Adjusted net profit after tax was up 11% to $405 million. Adjusted earnings per share for the year of $0.63 is up 11% on the prior year. Our net leverage ratio as at 30 June was 0.9x. Normalized EBITDA margin was maintained at 11%, with a small increase of 7 basis points. Operating expenses grew due to inflation across components of our cost of doing business and compensation increases. The Board has declared a final dividend of $0.17 per share, taking the total dividend for FY '23 to $0.25 per share. Now on to the ANZ region. The ANZ region delivered a solid result in FY '23. Sales revenue was up 10% to $3.9 billion. From a quality of earnings perspective, it is important to note that sales growth was positively influenced by product inflation across our range, averaging 9% during the period. Volumes were up 1% compared to the prior year, with demand moderating throughout the year. Normalized EBITDA was up 9% to $573 million, while normalized EBITDA margin decreased 8 basis points for the year, and this was inclusive of BAC income, which is nonrecurring, with no further BAC income expected in FY '24. Reported EBIT increased 3% to $408 million, whilst adjusted EBIT was up 11% to $421 million. The delta between reported EBIT and adjusted EBIT relates to the exclusion of $16 million of BAC income for the year and a $29 million goodwill impairment relating to Metalflex. The Metalflex business unit services the heating and cooling sector and was impacted during COVID-19 and thereafter by a regular cool weather experienced in Australia during the first half of FY '23. During the year, the ANZ region continued to experience inflationary impacts on our cost of doing business, including energy, transport and logistics. Wage inflation was more pronounced during the second half of the year due to the timing of compensation increases. We remain cautious on the outlook for the ANZ region. And as such, we're prudent in assessing our inventory valuation and accounts receivable balances. Now on to the U.S. region. The U.S. region produced another strong performance for FY '23. On a U.S. dollar basis, sales revenue of $3.3 billion was up 12%. It is important to note that product inflation had a significant positive impact on U.S. sales growth. Average product inflation for the year was 14%, which moderated progressively to an average of 6.6% in the second half compared to the first half where product inflation was 22%. Volumes for the region softened progressively throughout the year and contracted 4% in the second half compared to the prior comparative period. Normalized EBITDA was up 19% to $269 million, and the U.S. region increased its normalized EBITDA margin by 51 basis points. EBIT increased 26% for the year to $165 million. In line with the approach taken in the ANZ region, the U.S. region was also prudent in assessing inventory valuation and accounts receivable balances. Now looking at the group's cash flow. The group's net working capital to sales ratio improved 300 basis points to 19%, leading to operating cash inflows of $766 million versus $222 million in the previous year. As global supply chains continue to stabilize throughout FY '23, we focused on normalizing inventory levels whilst remaining in stock across both regions. In line with our strategy, the group invested $146 million in small bolt-on acquisitions and investments in the U.S. and [ area ] This included the acquisition of a full supplies company in Australia and the refrigeration and air conditioning wholesaler in Texas. Capital expenditure was directed towards branch refurbishments, the Reece rebrand in the U.S., new store openings, fleet upgrades and investment into our digital capabilities. Based on drawn debt as at 30 June 2023, we would expect interest expense to be in the range of $65 million to $75 million for FY '24, and we would expect the effective tax rate to return to 30% in FY '24, noting this is subject to LIFO adjustment relevant to our U.S. tax expense. During FY '23, the group generated $690 million of free cash flow, a significant improvement from FY '22. Now looking at the balance sheet. The group closed the year with a strong balance sheet, which supports our long-term approach and allows us to continue to invest for profitable growth. Net debt was down to $725 million and the net leverage ratio is currently under 1x. Available liquidity at year-end was $944 million, which provides the group operational and strategic flexibility. In FY '23, we continued our disciplined approach to capital management, focusing on investment in organic growth, strategic bolt-on M&A, maximizing balance sheet efficiency and the prudent payment of dividends. The group's net tangible asset ratio was 2.41x, and as mentioned earlier, ROCE for the year increased to 15.3%. I will now hand back to Peter to discuss the outlook.

Thank you, Andrew. We know there is a heightened focus on the demand setting in our sector looking ahead to FY '24, but we want to be clear that it remains too early to tell where this will end. The complexity of the current macro environment is well understood, and I think this is reflected in our business today. Across our customer base, trading is mixed with many factors at play. A clear trend line is not yet evident. We will not be providing further color on FY '24, except to say that we are planning for inflation to continue to moderate and volumes to continue to decline. A period of consolidation after an extraordinary phase of growth will serve Reece well. It's an opportunity to recalibrate and bed down what we've put in place in the last few years in the U.S. We do have a culture of continuous improvement, which helps us to run our business efficiently and allows us to take a long-term view. And we will continue to invest in our priority areas to build a stronger business, which will benefit us when conditions improve. In summary, we've delivered another strong result in FY '23. We are well placed to manage a softening external environment in FY '24, always maintaining our long-term focus and investing to deliver on our 2030 vision. Thank you for your time, and we'll now take your questions.

[Operator Instructions] Your first question today comes from Lisa Huynh from JPMorgan.

I mean, I guess the comment around trading in mix across the customer base at the moment, I guess, can you just talk about where you're seeing the differences and I guess, to what extent? Just a little bit of color on that comment would be great.

Lisa, thanks for the questions. It's Peter. Look, I think everybody knows we don't give guidance, we're not -- obviously not going to do that now. I think what we're comfortable to say is, like what I just said then, I mean, we are expecting inflation to moderate, and we are expecting our volumes to decline. So I'd say we are in broad alignment with what our peers are saying about all the end markets across both regions, and we're expecting all our end markets to be in decline this year. So it really is across the board. So I mean, that's probably as much as we're going to say on that. And I do think there is potential for some margin pressure as well. So it's definitely a different environment than what we've been experiencing in the last few years.

Yes, sure Peter. I appreciate, got. I guess you did -- I guess, you kind of moved on to my next point around margin pressure. So [indiscernible] did pick up in the second half. It looks like it's largely due to training, but how should we be thinking about, I guess, that line going forward for the next 12 months?

Yes. Look, I'll take that one, Lisa. So just -- I guess, just in terms of the half year cost analysis, you would have seen that cost of doing business stepped up in ANZ, probably a little bit further than it did in the U.S., although it did step up in both markets. And really the key driver in the second half was to do with wages and salaries. So we have a 1 November pay-rise cycle. So the second half effectively where all of the pay rises that came through on 1 November last year. A little bit of additional headcount. And because we've got higher EBIT in both markets, we've also got high provisioning or, I guess, accruals for our profit share. So I guess that's the key driver of wages and salaries. And then really across other costs, as I said earlier, we've got inflation across all our costs of doing business. So in particular, IT costs, consulting costs, effectively, everything's got inflation baked into it. So that's why you saw that second half uplift in cost of doing business.

Okay. Sure. I mean, I guess following on from that, gross margins continue to step up. Can we talk about the contribution from mix. Yes, the potential, I guess, step-up in private label as we kind of come into a tougher volume environment?

Yes. So if you look at the reported GP, later it's sort of gone from 27.9% to 28.4%. So I guess that's the 50 bps you're referring to. So what we've got in the Australia, New Zealand business is a very well-established private label program. We call it VAP, value-added products. We don't disclose what percentage of the mix that is, but it is a differentiator for us in this market. And in the U.S., they've basically got very minimal VAP. So that's a 20-year journey we've been on here in Australia and New Zealand. So they're starting their journey there in the U.S. now, but we wouldn't expect that mix to be material for quite some period of time.

And just to build on, Lisa, and we don't actually -- look, the U.S. is structurally different. The way the manufacturers are set up is different. So you cannot -- what we've got in Australia will not actually be replicated in the U.S. even if you go fast forward 20 years. So that's just to build on that.

Yes, sure. Forgive my ignorance. Why is it structurally different in the U.S.?

Well, like if you look at Australia in terms of most categories in industries, Australia is structurally different. Just dynamics are different. You've got lots of very large dominant manufacturers that control will be parts of what goes on in the U.S.

Okay, sure.

Going right throughout the business. And there is absolutely no doubt that we benefited from inflation. So that's been a positive contribution for us. It's helped us with the growth. And obviously, with that, we've managed our costs pretty well and all -- it's come together to produce what is a pretty good result for the year. [Audio Gap]

Got you. From the comments you've made, I wouldn't suggest that the lack of inflation on a go-forward basis is a particular concern for you, though.

So I think the dynamic we're really mindful of, Peter, it's Andrew here, is -- the U.S. is seeing a contraction of volume. So we've got a 4% average debt for the half that we called out. We don't necessarily say that's the trend line. We think that, that could continue to contract further in the first half. And inflation in that market is moderating very rapidly. So we've had a 22% first half inflation number that came through for the second half at 6.6%. There is definitely downward pressure on that. So if inflation gets closer to 0, whilst our volumes are continuing to contract beyond.

The cost environment still from your perspective and productivity is continuing to lift?

I think maybe we need to be very -- just look, without giving too much away, there is cost inflation in both regions and quite significant. So you just -- we're not -- we just -- I've signaled that we expect volumes to decline, and we see margin pressure. So we do see significant inflation coming through in both regions this year.

Got you. Just a really quick question on your interest guidance, Andrew, the 65 to 70...

Just give some guidance around -- the only 2 data points that we are willing to give guidance around are where we think that bank debt interest rate is -- so our interest expense is going to be and where our effective tax rate is likely to be next year.

And would your leases be exposed to variable rate structures as well, noting that they went up of fair bit in the cash expense?

Across the portfolio, we've got a portfolio of some owned and obviously, a lot of leased premises. We've got standard lease arrangements in place. So the actual rent inflated dynamic is different by lease, but there is inflation on the rental part of our portfolio as well.

I'll leave it there. Appreciate it, Peter.

Thanks, Peter.

Your next question comes from Campbell Crawford from Barrenjoey.

Just on your comments around demand deteriorated throughout the year, improved rather than getting worse throughout the course of FY '23. So can you just give a comment really on...

For the upcoming year. then we definitely -- everything we're seeing shows that volumes are going to decline in ANZ for this. We are consistent and in line with what everybody else is saying and seeing. We'll be in decline this year.

Okay. And that particularly in California, as you call out, can you sort of bring to life a bit perhaps what you're seeing there with those new stores, some sort of metrics you could share just so we can better appreciate what sort of improvements in store performance you're seeing from all these investments that have gone into rebranding?

Brook, I just actually got back last week. So I've just -- I've now seen all the stores in California. So they're all now a certain standard, and that's obviously what we've committed to. And so it started in California and look -- yes. The stores look good. The branding looks great. You feel quite proud when you're driving down freeways and you can see the Reece sign on some of the buildings. So we're definitely really pleased, and I think it's been great for our people. It's 4 brands now in California, and it just makes -- from the long-term perspective, makes the bit ANZ easier to lead image being under one brand. But ultimately, it's more the long term than the short term, Brook.

Yes. Understood. So just to confirm, there's no sort of notable difference...

Everything in it, it's all definitely long term. So clearly, just for what it's worth, we've rebranded a couple of times in Australia, and it's a big investment and you don't -- there's no immediate benefits. It's not like we're not a retailer where you upgrade and you get uptick straight away. It is about the long-term standards and what we stand for.

Your next question comes from Harry Sanders from [ ANP ]

Firstly, just wondering if you could talk through a bit more perhaps your volume and price trends in July and August for the 2 regions or at least in the fourth quarter?

Yes. So Harry, we are expecting to contract further in the second half.

Got it. And just perhaps also, could you talk through your remodel market exposure in U.S. versus new construction and the repair market, those specific areas and just perhaps the new construction areas you're exposed to, given that's most of that there.

Thanks, Harry. I think you are new on to the part. We've explained this over the journey. Most of the U.S. is exposed to the residential and commercial construction. We've got a small exposure to the R&R part, and that's obviously what we are wanting to pivot more to over the long term. What I've consistently shared if you look at the end market where plumbing work is done in the U.S., about 55% is in that R&R space. That 25% is in residential and 20% in commercial/infrastructure. But in our business, it's around the 20% given where some of our other business units have been. So we're -- it's a very...

So second half -- look, most of it is in the second half. So I'll probably have to give you the second half data point. I don't have it in front of me.

Okay. Just a final one. Could you outline the M&A pipeline in the U.S. and perhaps what areas you might be targeting?

Well, the whole thesis that we announced 5 years ago that obviously the U.S., a large fragmented market and for us, we're obviously in the Sun Belt, and there was no [Audio Gap] and through acquisition. We're comfortable both ways. Probably preference is organic as it's culturally better. There is not -- we are constantly getting looks at different opportunities. We're really disciplined. Yes, there's nothing on the agenda at the moment. But in the long term, there will be lots and lots of little potential acquisitions. But we're in a fortunate spot that it doesn't really matter which way it goes, but our preference, obviously, from a culture perspective is the organic way.

Your next question comes from James Casey from Ord Minnett.

Peter, can you just clarify the guidance you're providing, is that industry guidance or company-specific guidance?

James, I'm not giving guidance, just to be clear, and we never have and we're not going to at this point. All I'm just saying is that we are expecting it to get tougher. Volumes to come off and the...

Adjustments you've made [Technical Difficulty] Are they now complete with kind of that removal of safety stock?

Yes. So James, Andrew here. So in terms of the increase to our stock obsolescence provision for the year, so it's up $37 million. We had increases in the provision across both ANZ and the U.S. As you know, you would have seen our inventory levels have come down relatively materially. We're pretty happy about that. But we've actually had a really good look as we go into what we think are tougher conditions around what type of potentially slow-moving or obsolete inventory we've got in both markets. And we had excess [Audio Gap] we had return policies. So we've decided just to increase our provision because we think it's the right thing to do the current conditions.

One. Just on Slide 17, you've got the group return on capital employed chart. Are you willing to split the 2 numbers?

Not at this stage, James, I think we're there. At a very high level, and Andrew might add something. Traditionally [Audio Gap]