Reece Limited (REH) Earnings Call Transcript & Summary

[Operator Instructions] I would now like to hand the conference over to your first speaker today, Mr. Peter Wilson, Chair and CEO, Reece Group. Please go ahead, Peter.

Good morning, everyone, and thank you for joining us for our first half year results call. I'm Peter Wilson, and with me today is Sasa Nikolic and Andy Young. This morning, I'm going to provide an overview of the results and then recap the strategy. Sasa will provide an operational update. Andy will then run through the financial results in more detail, and then I'll provide an outlook, and we'll open it up to Q&A. So please note that all figures in this presentation are in Australian dollars, unless otherwise stated. Turning now to an overview of the half year result. Our performance was certainly mixed. There were some good, some solid and some challenged. Our result clearly reflects the complexity that we outlined last year. Housing affordability continues to be a key issue in both our regions, resulting in soft demand settings. Group sales were up 6% to $4.6 billion, largely supported by network expansion. Group like-for-like sales were flat, reflecting a subdued backdrop. EBITDA declined 6% to $448 million, while EBIT declined 14% to $262 million. Softer earnings and ongoing investment impacted the group's return on capital ratio, which is down 222 basis points to 10.8%. The Board declared an interim dividend of $0.0544 per share. And while the half year tracked broadly as expected in the current environment, we do want to do better. We are focused on building a stronger business for the long term, whilst at the same time, operating more efficiently. So if we now turn to recap on our strategy. As I've outlined before, everything we do at Reece is guided by our blueprint from purpose to promise. Our purpose, building a better world for our customers by being the best inspires us and together with our values is how we live the Reece way. Our 2030 vision is to be our trade's most valuable partner and the commitment to our blueprint, especially in these challenging periods, enables us to deliver on our customer promise and succeed in the long term. Turning to our strategic priorities. We do have 3 clearly defined pillars. Operational excellence is about being the best at the basics every single day. Innovation is critical to keeping us ahead of our customers' needs. And investing for profitable growth enables us to continue to expand our presence and improve our business for the long term. I'll now hand over to Sasa, who will provide some more detail on activities in each region.

Thank you, Peter. Starting with our branch network in Australia and New Zealand. Our network density remains a key competitive advantage, helping us to deliver our customer promise. We continue to enhance the network through targeted infill and upgrades. During the half, we added 4 net new branches and completed 17 refurbishments. Moving to the next slide. Our success in ANZ is grounded in our team and their deep relationships with our customers. This half, we have continued to invest in and broaden our offering, launching new product ranges and designs that enhance quality at competitive price points. In the digital space, we combined Shadowboxer and our existing team together into one digital experience team, boosting collaboration, productivity and accelerating customer-focused innovation. We also introduced new digital tools to make complex projects easier to manage and help our teams serve customers better. Finally, we continue to invest in our people, making strong progress in rolling out core leadership training programs to our people leaders. Moving now to the U.S. We have continued to roll out branches to expand our U.S. presence, making life easier for our customers. During the half, we added 19 new branches to our network, bringing the total to 286. We continue to see a run rate of 10 to 15 new branches per year as a sustainable level of annual growth. In some periods, we will deliver outside this range based on capacity and development time frames. Turning to the next slide. Developing our U.S. team is a critical factor to our long-term success. We are focused on supporting our network growth through an experienced team, well versed in local knowledge and market dynamics. This half, we continued to invest in development programs to deepen trading skills and leadership capabilities. Alongside this, we launched a range of new initiatives to make life easier for customers, including rapid delivery and a Spanish-enabled version of our app Max. We further enhanced our digital capabilities with tools that streamline quoting, reduce turnaround times and enable our teams to deliver a better customer experience. I will now hand over to Andy to provide more detail on the first half results.

Thank you, Sasa, and good morning, everyone. Sales revenue for the half was up 4% to $2.1 billion, supported by modest volume growth, although sales performance remains mixed across states. EBITDA declined by 4% to $261 million, and our EBITDA margin contracted by 104 basis points. Costs remain elevated in the ANZ region. The market for talent remains competitive, and we've continued to invest in our employee proposition to support retention and growth. We've also invested in digital projects, which are an important part of delivering our strategy and investing through the cycle to build a stronger business. In addition, our operational expenditure continues to experience some inflationary pressure in areas such as labor, IT and property costs. Despite these headwinds, our cost run rate is trending down as we exit the half, supported by tight management of FTE and discretionary spend. EBIT was down 7% to $179 million, with our EBIT margin at 8.7%, down 106 basis points year-on-year. Turning now to the U.S. region. U.S. sales were up 6% to USD 1.7 billion, driven by incremental sales from continued network expansion. On a like-for-like basis, U.S. sales declined by low single digits during the half. The residential new construction sector remains soft with housing units under construction still down year-on-year in the Sunbelt region. EBITDA was down 9% with our EBITDA margin contracting by 120 basis points. This reflects higher costs from elevated network expansion over the past 12 to 18 months and some ongoing operating cost inflation. We anticipate year-on-year cost growth to remain elevated through the remainder of FY '26 as these new branches mature. EBIT declined by 26% to USD 55 million, and our EBIT margin was down 143 basis points, inclusive of higher D&A from ongoing growth investments. Turning to the group cash flow position. The group generated net operating cash inflows of $199 million for the half. Our CapEx to sales ratio was 1.8%, supporting network expansion, branch refurbishments and technology investments. During the half, we also deployed $401 million of capital to support share buyback activity. Gross interest expense for the half year was $31 million. And based on current drawn debt, we anticipate gross interest expense in the range of $65 million to $75 million for full year FY '26. Moving to the balance sheet. Our group net working capital to sales ratio was 20%, an increase of 1% since 30 June. The uplift in net working capital is driven by seasonality in receivables and payables. Our net debt position increased to $1 billion, driven by lower operating net cash inflow and partial funding for our share buyback program. The group's balance sheet remains strong with a conservative net leverage ratio and capacity to fund future growth. Moving to the next slide. Returns have been impacted by the soft market conditions and elevated costs from increased network expansion. Despite this, we remain focused on our long-term investment strategy and disciplined approach to capital deployment. We take a long-term view through the cycle and expect to see our return profile improve as the market recovers and the impact of new growth investment moderates. Turning to our capital allocation approach. The allocation and deployment of group capital is guided by a well-defined capital management framework. Our first priority is to invest in the growth of the business, both organic investments and strategic M&A. Our second priority is to maintain a strong balance sheet, retaining flexibility for growth. Our third priority is to provide returns to shareholders via ordinary dividends. And when we have surplus capital or excess balance sheet capacity, we will consider returning capital to shareholders. During the half, we have executed on this framework, returning a total of $401 million of capital via our off-market and on-market share buyback programs. I will now hand back to Peter to provide some comments on the outlook for the remainder of FY '26.

Thank you, Andy. And starting with the ANZ region, we have seen signs of a housing market recovery emerging this half, but this is geographically mixed. Housing affordability does still remain a challenge. We are also cautious about the pace of the near-term recovery and the impact of the recent interest rate rise. Turning to the U.S. In the U.S., the residential new construction sector is still experiencing weak demand, especially in the regions we operate. Competitive dynamics also continue to present headwinds, and we've had a challenging start to the second half with extreme weather conditions in January. Improving housing affordability will be critical for increasing demand. We don't expect a substantial change in performance in the second half, but we continue to take a long-term view on the opportunity in the region. As a result of this outlook in both regions, we are anticipating group EBIT for the full year FY '26 to be within the range of $520 million to $540 million. To conclude, it has been one of the more complex periods that we have ever experienced. But we continue to focus on our long-term strategy and our approach. We are working harder than ever before to stay one step ahead of our customers' needs while running our business more efficiently. We do operate in large attractive markets with compelling long-term fundamentals, and our priority is always to build a stronger, more resilient business. Thank you. We will now open the line for questions.

[Operator Instructions] And your first question today comes from the line of Peter Steyn from Macquarie.

Peter, perhaps just honing in on ANZ and reflecting on the competitive environment that you mentioned, a lot of focus on employee value proposition. Could you give us a sense of what it is that you believe you need to do or continue to do in that space and how you think your particular position in the market can withstand some of the pressures that are obviously relatively new found in Australia?

Pete, yes. well, look, I think I mentioned that at the full year, just obviously, with the new owners of Tradelink, which is an owner that we know well, and we obviously respect deeply and have a pretty strong knowledge and understanding and relationship with them. So look, when it comes to Australia, really, our entire focus is really focusing on ourselves, just to execute our strategy and keep building our capabilities so that we can play our own game and withstand whatever gets thrown up our way. So we've got -- as everybody knows, everyone knows the Australian model pretty well. We've got a very strong market position here. We got a strong model with strong capabilities. So I mean, I'm feeling pretty comfortable with where we are in Australia. I mean the big challenge that we've got to solve for, like I think that's every Australian company, is how we navigate the future, embedding and leveraging AI so that, that runs right throughout our entire business. So that's probably what keeps me up more at night than the question, Pete. So yes, so look, Australia is always -- we've -- I mean, we came from a single or 2-store operation. We are used to competing in quite fierce environment. So I mean, that's pretty normal. We focus on our own game. But I think the bigger challenge for us, which I think applies to every single Australian company is how we embed and leverage AI, which is going to have profound impact on everything we do.

I may just go to the other side of the ocean here to just get your perspective on the U.S. trading context. Given your exposure to the sort of mid and smaller end of the new construction market, it looks like a low single-digit volume performance is actually a really commendable one. So just your perspective on what the network expansion did to your comparative experience there, but more specifically the evolution of the competitive position vis-a-vis some of the peers there because it does feel like you're actually doing a little better than perhaps certainly we expected.

Maybe what you're saying there, that's probably to do with the -- that's our strategy really, which is that organic store rollout. We say there was quite -- a lot of stores have been opened in the last number of years. So I think that is what is driving the growth there. In terms of the end markets there, we were pretty clear, I think, in the half year. In our regions, it's still quite soft. So how would I describe it? I think it gets back to the whole -- I mean, we've talked multiple times here. I mean we've used the term, and I think a lot of people have that the housing market is relatively frozen. So it really is an affordability issue in the U.S. So you've still got over 50% of the outstanding mortgages have got -- they're below 4%. So that effectively is 200 basis points below what you could get a new mortgage for now. So yes, the long-term mortgages have fallen a little bit since we last spoke. So you're in the early 6s there. But for any real substantial recovery, you've got to see some affordability changes. And a big part of that is the mortgage rate. So we'll see how that all plays out. But I think most of what you've seen from us is linked to the store expansion, the store rollout. And that's part of our strategy. We're sticking to what we can control. A lot of the environment part, the external part is out of our control. So hopefully, that gives you a little bit of color there.

And the next question comes from the line of Keith Chau from MST Marquee.

Maybe one either for you, Peter or Andy. Andy, you mentioned earlier on the call for ANZ, and this relates to something you can control inside the business rather than externalities. But I think in the last result, it was mentioned that the cost run rate was a bit too high for the ANZ division. So there was going to be some trimming of that spend, and it certainly seemed as that is the case. So Andy, when you talk about the cost run rate is trending down due to FTE and discretionary spend, just wondering how much further have you got to go on that one? And if you can give us an indication of the order of magnitude of benefits because it certainly seems like that's helped the margin in the period, and it sounds like it is indeed sustainable.

Okay. Keith, I'll hand that to Andy to -- I think that's who you're directing that to. So over to you, Andy.

Thanks, Peter. Thanks, Keith. Look, I think we're not going to give an outlook on the cost run rate, Keith. But what I would say is, as I said in the presentation, there's ongoing inflation pressure in the ANZ cost base. We are working to offset that, but we haven't been able to mitigate the full impact of that in the half. But that said, we are continuing to drive those initiatives and just balance that with ongoing investment in the business. I think that's the sort of right focus for us to control what we can.

Okay. Maybe if I can stick one level higher and just...

Also Keith, just to add, I think what Andy would probably -- well, I'm saying that there will be a follow-up question is, the majority of that cost structure, it comes from the new store expansion with depreciation and all that sort of stuff. But I'd say, Andy will probably -- that will be a follow-up on down the track, no doubt.

Yes, definitely at the group level, it's expansionary. And then in ANZ, you've got a little bit of that, but it is also driven by the investment in the business, Keith, and then the operating cost inflation that we're continuing to see.

Okay. So if we go maybe a couple of levels higher then just at the EBIT margin level. I know this is -- I'm not asking for you to do our homework for us, but just trying to get a gauge of whether you believe that the first half margin outcome represents the bottom for the ANZ division? And from here on, then we should see some margin expansion, particularly given the end market demand is improving a bit as well.

Keith, I'll take this. Look, we have definitely had -- it's been a complex period for us, which I indicated in August. What I would say is like we will always be this -- I mean, look, there are signs of starting of a housing market recovery, I would say, minus Victoria. So that's when I said geographically mixed. We have to be cautious just as that is starting to emerge. We've got an interest rate rise. And it's not just one. It's been clearly indicated that there's multiple on the agenda. So I mean, that's the caveat to all of that. I mean, we focus on trying to optimize our margin, but it's a culmination of balancing in between the customer demand, shareholder demands and then just the competitive environment. So I think we've probably done more. We don't normally do this with a guidance and it doesn't mean we're going to keep doing it. When we feel it's some level of uncertainty out there, which there is for a lots of people, we felt it might be better to give a guidance for the second half just to make it easy for you guys. So that's probably as much as we're going to share, but it's not like we've got this huge recovery and we're off to the races. So we're just starting to see green shoots and then the interest rate rise hit. So that's why I'm saying it's complicated. And I don't know if that -- I mean, I think we've been more helpful on this half than in previous. But that will still be just horses for courses, Keith. So trying to be a bit helpful on this.

That's good. And then maybe just one quick one on the U.S. It certainly seems as though the competitive backdrop has settled. And Sasa, I think you mentioned you guys will be looking at targeting 10 to 15 stores even though you're running ahead in the first half even for your full year target. So does that mean for the store rollout in the second half, you take a breather kind of bed down what you've got or you can still -- or is it a case that you can still be opportunistic in the second half?

I we might answer this in 2 parts. I'll do a high level, and I reckon Sasa has just arrived back last week. And I've said this from day dot from 8 years ago when we did it. And maybe some of my stuff, maybe I was a bit too vulnerable. I was taking out of contracts at fraction at the August one. But look, when we acquired MORSCO, we were very clear what we were getting, and we were eyes wide open. We did a very thorough DD, and we've studied it for a long time. We knew that this was a multi-decade story, and we knew that America is the biggest, the most competitive market in the world. It is structurally different to Australia. It has big resource competitors. It's got large independence, and it's got a very strong manufacturing base, which is largely owned by very, very big family, multigenerational businesses that control lots of the margin. We shared a fair bit what was going on with Fortiline. That definitely -- we've learned a lot. It definitely surprised us at the time, but we've learned that how we're going to have to compete and fight back, and it's more BAU now. So we're quite comfortable with how we're going to respond. And we'll be taking a multi-decade time frame. So we'll see who actually outlast in that competitive threat. But in the meantime, Sasa can probably talk to how we look at the sustainable rate of stores. So over to you, Sasa, you've just come back and a bit jet lagged.

Thanks, Peter. Keith, look, we had a very good first half in terms of rollout. And that is part, as you described, opportunistic and the timing and with softening, we do get to accelerate. We do have a solid pipeline in H2 also. So when we look out there, but not at the same rate as H1. And I will reiterate, we are looking at that 10 to 15 in the long term, but there will be periods where stars aligned and we have the capability now to be able to accelerate.

And your next question comes from the line of Brook Campbell-Crawford from Barrenjoey.

Just the first one for me on the U.S. If we go back to the last half, I think you guys are sort of saying that there's some share challenges in the plumbing segment in the U.S., where I think you're sort of suggesting that lack of scale was a disadvantage when market activity is low. It certainly seems like that's kind of turned around and now you seem to be performing at least in line with the market, if not better. Can you just provide some comments in terms of what's changed, like what you've done to kind of improve your share performance in the plumbing segment in particular? Because I think you've said waterworks is more BAU, but just the plumbing segment in particular.

Brook, no, I reckon I don't think much has changed in the -- I think we're holding our own. So no, I don't think any significant -- obviously, we're opening stores in plumbing. So that does -- but that really wouldn't make that much difference in the 6 months. So look, the residential new construction is soft, I think that's well known because of the whole -- the mortgage part and the fact that the housing market is relatively frozen. It's not like it's fallen off a cliff. So it's not like we're talking GFC part. But the part that's plumbing that seems to be going well is in the commercial part with the data center. And we're in states, we're getting some of that work as well. So I think I wouldn't say any dramatic change since August. Just maybe there's a bit more focus from the team sometimes when you deliver these somewhat disappointing performances that we did identify in August, it can needle your team and you get more focus. So we're definitely trying to -- we're focusing on what we can control. So I wouldn't say any dramatic change there at this point, Brook.

That's fair enough. Just a last question for me on inventory. Looking through the accounts, it looks like there's a $9 million reduction in the allowance for slow-moving inventory in the half. Can you just confirm, does that sort of flow through to the underlying EBIT performance as that provision unwinds a bit? And then maybe some color on what actually sort of drove the change would be great.

I'll give that to Andy. Over to you, Andy.

Thanks, Brook. Yes, there is a reduction in that provision, Brook, in the half. And I think if you remember the comments we made at the full year, we talked about the provision has increased as we've seen some of the sell-through rates reduced. We've actually had a little bit of volume uplift, particularly in ANZ, you would have seen in the first half of this year. So that's allowed us to revise those provisioning levels. So yes, it does flow through, and we'll just continue to sort of monitor that level and look at what happens from a volume perspective to see what further happens in the second half of the year.

Your next question comes from the line of Harry Saunders from E&P.

Thank you for providing that second half guidance, that's helpful. Just firstly, wondering if you could talk through the drivers in a bit more detail of that ANZ margin improvement versus that second half? And perhaps where do you think you could take this to sort of mid-cycle versus the historical levels, which were about sort of 10% to 12% if we look over the last decade or so? I mean, are there any structural changes now such as competition that need to be factored in?

Thanks, Harry. I'll hand that to Sasa.

Harry, look, from an ANZ perspective, to answer the second part there, we have historically had very good margins. And this market, we have a good business. But as Peter has already answered, it's very complex. It's very challenging. It's a patchwork out there across the states. And so we won't be making any calls around the historical levels to get out there nor will we be making calls around peaks and troughs. What we can say is we do control what we can control, and the team is focused on continuing to manage the things that are within our control and provide that customer experience that Reece is renowned for out in the market. And we believe if we do those things, then the margins take care of themselves.

A follow-up, I'll ask it anyway, just on the U.S. margins. If we look where they're sitting now versus around that sort of 5% level over the last few years before the sort of deterioration last year, I guess what will we need to see for you to take margins sort of back to that level or beyond that level? I mean, is it around sort of those stores maturing given you added a lot of stores? Or is there more to it than that?

Harry, look, there's a whole bunch of things. As we said in the operational updates, we're very focused on developing our leaders at a local level that understand the market, put the training around leadership in there. We spoke about trading skills investment. And it is time for these new branches that we've put in quite a few in a short period of time to mature. And that is what we see as the U.S. strategy that we've been consistent from for a very long time.

And just last one for me. I guess where would you see CapEx more normalized now given that sort of lower rate in the first half, please?

I might start, Harry, and then hand it over to Andy. Look, when you look at the CapEx, obviously, there's the timing of when we recognize the CapEx versus when the store starts trading. So that is to take into account some of the half-on-half or year-to-half view in the reduction. Look, we sit here thinking that our level of CapEx is probably at that normalized level, but I'll invite Andy to add a little bit more color there.

Thanks, Harry. As you know, Harry, it's not guidance, but we tend to target somewhere in that 2% to 3% range. And look, each year, it just depends on how much network expansion we tend to have that drives that. But I think, as Sasa said, there's a little bit lower in the first half, but a lot of that CapEx around those new branches was occurred in the back end of '25. So that's why the number looks a little bit lower, and we'd expect to be somewhere in that range again for the full year.

Harry, we're not looking to -- we've always through these cycles, we continue to invest. And normally, in history, we normally come out stronger through these cycles because of that commitment to investing. So we're going to keep doing that. I mean it might be different this time because I think we're entering a world that we have never seen before. So it may not go exactly like it did last time, but we continue to invest to build capabilities because that is the only way we're going to get a chance to get to where we want to get to in the U.S. over the long period of time. And there'll be a few hiccups like we had last year.

Your next question today comes from the line of Sam Seow from Citi.

Just quickly on ANZ. I noticed you've talked to volumes being positive, but you've probably moved away unless I missed it from like-for-likes. Is the right assumption there that price was negative? Or am I just reading too much into that?

Over to you, Andy. That's too hard for me to answer.

Sam, look, I think the volume performance like-for-like was pretty similar for ANZ versus the first quarter. So we said at the first quarter, we had some low single-digit growth. That's really held across the half. And in terms of the price/volume sort of mix there, there's very little price impact in that result for ANZ that's largely volume.

Got it. But just trying to clarify. So your like-for-like sales in ANZ were positive in the first quarter but -- because you haven't talked like-for-like for the half. So just kind of trying to understand the moving piece there.

So I think, Sam, what you need to say, in our commentary, we're definitely seeing the beginnings of a housing recovery, right? So you've got housing starts and commencements. They're going in the right -- they're positive. So that's definitely positive for Australia. I'd say there's definitely green shoots there, minus Victoria. So there's not green shoots in Victoria. The rest of the states, so that would be that. And the only thing is we do have to be cautious because just think you're getting started, this looks different to the last time or the last cycles. We've already now had an interest rate rise. We forecast more to come. Now that will actually have an impact.

Okay. Well, maybe then just talking about the second half. Thanks for the guide. Really appreciate it. But given obviously, the U.S. has had that weak start, does it kind of imply that a meaningful step-up in the ANZ second half business? Or is there something -- your country is being relatively muted?