RS Group plc (RS1) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by and welcome to the Electrocomponents H1 Trading Update Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today. And I will now like to hand the conference over to your speaker today, David Egan. Please go ahead, sir.

Thank you, Sandra, and good morning. I'm David Egan, Chief Financial Officer of Electrocomponents plc. Lindsley remains based in Texas. And given it's currently 2:00 a.m. there, I will be hosting today's call. So thank you for joining us. This trading update covers our performance for the 6 months to 30 September 2020, ahead of our publishing our interim results on the 10th of November. Overall, we are encouraged by the resilience of our business during this challenging times. As a business, we have reverted from crisis mode to business-as-usual, albeit with new norms. We're still working -- still closely monitoring the rapidly evolving COVID situation to ensure that we continue to balance the needs of all of our stakeholders. Our people continue to do an outstanding job, and our top priority remains their health, safety and well-being. Despite the challenges and the new norms, it is a testament to all of our teams that our group employee engagement scores are at a record high. Our broad omni-channel offer, global supply chain, digital leadership and highly committed teams has driven a resilient market outperformance. We have continued to take market share as we have focused on delivering customers and suppliers a reliable and consistent service. Our distribution centers remain open and our office-based employees are able to work flexibly, either from home or at our offices whilst adhering to local guidelines and ensuring we have all the necessary protective equipment and social distancing measures in place to keep our people safe. Despite all of the COVID challenges, our customer Net Promoter Score improved year-on-year in all regions during the first half. We, as a group, remain in a financially strong position with a healthy balance sheet. We've seen good levels of cash generation during the first half, increased our liquidity levels and continued to robustly stress test our business. And finally, we're highly focused on ensuring we use our position of strength to seize opportunities, drive market share gains where we can, increase our efficiency and continue to create value for shareholders. So let's look more specifically at our Q2 and first half performance. Overall, we are pleased with the resilience the business has shown throughout the first half. Group revenue declined by 7% on a like-for-like basis in the first half. We saw a significant improvement in Q2 at minus 4% versus Q1 at minus 11%. All regions exited September on an improving trend. This is a strong result given this uncertain market backdrop. We've continued to outperform the market and drive market share gains. This has been driven by our core underlying product offering, not through large one-off COVID-related PPE sales. Our group's performance has been led by the recovery, particularly in Europe and the strong performance in RS Pro. RS Pro, which makes up around 14% of group revenue, returned to positive growth in the month of June. It also includes strong growth in back-to-work kits. The brand has continued to outperform the group, with a revenue increase of 8% on a like-for-like basis in Q2, delivering 2% growth overall for the first half. Digital, which accounts for around 62% of group revenue, performed in line with the group trend over the first half. Digital outperformed the group in Q2. Performance was affected at the start of COVID due to a falling corporate customer demand, but this has improved in recent months, and we've also improved our offer and digital customer experience. This has led to good growth in both website visits and new B2B and B2C customer numbers. EMEA, in particular, has led the performance with positive growth seen coming out of Q2. Moving on now specifically to the regions. Firstly, EMEA, which accounts for around 64% of group revenues, saw like-for-like revenue decline of 8% for the first half, an improvement in Q2 to minus 3% from the minus 13% decline seen in Q1. The U.K. has remained resilient with a significant improvement in momentum throughout Q2. All 3 key sub regions saw recovery as lockdown restrictions eased with France, Italy, Ireland, Spain, Scandinavia all performing well, although Germany has remained more difficult as a result of exposure to the OEM, automotive and electronic segments. The improvement in Europe has been most pronounced in Southern Europe, which saw the most severe lockdown and decline in April, but has also delivered the strongest recovery as restrictions lifted. In Southern Europe, Q2 revenues increased 4% on a like-for-like basis. In EMEA, we have outperformed the market and gained market share due to our digital proposition, the breadth of our range, inventory availability and the value-added solutions that we offer. The expansion of our DC in Germany remains on track for summer of 2021. This is an exciting project that will provide increased capacity and greater automation. Looking now at the Americas. This region accounts for around 26% of revenue, and we saw a decline of 8% on a like-for-like basis for the first half. We've come out of Q2 on an improving trend, reflecting gradual signs of recovery as manufacturers slowly restore operations, albeit all remaining cautious. The situation with regards to COVID in the Americas differs on a state-by-state basis. However, all of our regions saw improving trends in September by the West, which was affected by wildfires. America's digital performance and new customer numbers have shown improving trends during the quarter, which, again, is very pleasing. Initiatives are on track to broaden our product and services and customer numbers in the Americas. Our newly expanded and highly automated distribution center in Texas is now operational. This will enable us to significantly expand our offer, improve our customer proposition and drive efficiency and market share gains. Finally, Asia Pacific, which accounts for around 10% of revenue. This region saw a 2% like-for-like decline in the first half, but the trend improved from Q1 with the revenue now only down 1% in Q2. We continue to see growth in Greater China and Australia. However, this is being offset with some weakness in Japan and Southeast Asia where lockdowns remain restrictive. Now moving on to gross margin, cost and cash. Gross margin remains a key focus, and we continue to take actions to maintain and, where possible, improve our gross margin over the medium term. Good pricing initiatives and mix benefits helped deliver an underlying improvement in the buying-in gross margin, but this was more than offset by some additional inventory provisions and higher inbound freight costs, both of which are COVID-related. We expect our first half gross margin to be down circa 60 basis points year-on-year. We will provide you more color at our interim results presentation on the actions and initiatives we're taking to address the decline and recover some of this during the second half. Outside of gross margin, we've experienced some additional COVID-related costs in areas such as outbound freight and labor inefficiencies. The impact of these COVID-related costs in the first half was around GBP 9 million. We expect at the current run rate for these to ease slightly in the second half. We continue to proactively manage our cost base. We are accelerating activity right across our business to drive a more scalable and efficient model, which includes the DC expansion projects I've talked about previously. We are making good progress on work to further simplify our operating model. The primary objective here is to simplify, go faster and drive automation and scalability ultimately to deliver growth. It is expected to drive further significant savings in labor and nonlabor activities over the medium term. We have just commenced consultation with our employees, and we'll be able to give you more details on this work at our interim results in November. Our ultimate aim with all of our initiatives is to grow our business and to drive towards a mid-teens operating profit margin for the group. We have a strong balance sheet and continue to take actions to conserve cash. At the end of September 2020, our total committed facilities, excluding the Bank of England CCFF is GBP 446 million, of which around GBP 290 million remains undrawn. Finally, although our forward visibility remains very limited and we remain cautious with respect to the ongoing COVID situation and its economic effect, we are accelerating strategic initiatives to ensure we come out of this crisis stronger. We're making good progress on improving our performance in digital, growing our value-added solutions business and expanding our range. Digital remains a key focus and competitive advantage for the group. We have begun to launch our new RS responsive websites to help accelerate performance over time. The expansions of the DCs in the U.S. and Europe will open up new opportunities for range expansion. We remain highly confident in our strategy and believe we remain well positioned to drive further market share gains, increase operating efficiencies and generate long-term value creation to take advantage of the significant growth opportunities we see. And with that, I will open it up to Q&A. Thank you, Sandra.

[Operator Instructions] We have one question from the line of Henry Carver. Sorry. Okay. I'll open the one from Sanjay Vidyarthi.

Yes, it's Sanjay at Liberum. Just a question on acquisitions. My sense is that there's been a fair amount of activity in the U.S. markets recently post-COVID. And I'm just wondering how your thoughts, if any way, changed or how you see the opportunity in the markets right now from an acquisition perspective.

Sure. Thanks, Sanjay. Look, I think sort of our primary objective remains the organic side of our business, but inorganic side is also important. We've been very much focused on pipeline and looking at creating relationships. There is certainly a lot of activity happening in the marketplace. We are certainly actively within the marketplace, exploring opportunities, but we remain very, very disciplined with regards to our strategy and also financial value return. So look, I think we want to participate, but it's not at any price and any cost, and it's got to fit strategically. So pipeline is solid and strong, and we'll -- but we'll continue to remain very disciplined.

So would you say that the main kind of hurdle at the moment is valuation rather than whether the business is the right fit or not?

I think it's both. Both are of equal importance. Our priority remains value-added solutions, then product, then geography. From a geographic perspective, certainly, the U.S. is important, but there are other geographies that are important as well. But I think both are vitally important. We've looked at quite a lot in the past and just haven't been able to either make them work from a strategic perspective or values. So I think that will remain, but we -- it's important that, but again, our primary objective is organic growth because we still see plenty of runway there.

Okay. And second question, if I may. Just in the U.S., would you say that your market share is kind of broadly flat? Or did you gain share there? If you can discuss the dynamics in that market in terms of market share.

Look, I think there's probably -- in part, probably a little bit of market share gain; in part, sort of flat. So I think sort of overall, pretty neutral, I'd say, in the U.S. There is anecdotal evidence to suggest that MRO market is certainly down double digit, but we are not pure-play MRO. We are more automation and control. So I think sort of pretty much held our share in the Americas, but certainly, the MRO market has been a little bit more impacted.

Next question comes from the line of David Brockton.

Two questions, please. I appreciate you haven't given the exit rates, but I think you flagged on the call is the U.K. saw a significant improvement through the quarter. And I was just wondering about Germany. I wonder if you can give us a feel for the extent to which that improved through the quarter. That's the first question. And then the second question just relates to RS Pro, that's clearly been very strong through the quarter. Any insight into any particular regions that are driving that, please?

Sure. Certainly, from -- so from the U.K. perspective, yes, we did see an improving trend in the U.K. The U.K. was back to flat for the month of September, flat growth for the month of September. So that is good. Again, what we're seeing in the U.K. is quite a lot of our corporate customers coming back online, which, again, is linked also to our digital performance through Q2 as well. Germany, haven't really seen any material change in the performance of Germany through the quarter. Again, I don't think that's anything different to what's actually happening in the marketplace, particularly our focus on manufacturing OEM and automotive. Really, those trends are not necessarily improving within that particular market. We haven't seen any real change or improvement throughout the quarter. And then RS Pro, again, it's pretty much across the board. We're very pleased with RS Pro. We came back into growth in the month of June. That growth has continued for each month through Q2. It is across the world, that improvement. A little bit more pronounced in EMEA versus the other 2 regions. But again, we are seeing good momentum in each of the 3 regions. A lot of it is being driven by data. A lot of it is being driven by some additional products and focus areas. So again, momentum is solid, and we see good prospects for RS Pro going forward.

Next question comes from the line of Sam Bland.

Two questions for me, if I can, please. First one is just, obviously, I guess, 4% revenue decline in Q2. Just get a sense of what the -- your feeling is for the level of market revenue decline in Q2. Just trying get an idea on what the market share gain looks like. And I guess the second question is, again, on that minus 4% revenue decline. Have you got some idea of the split between the electronics revenue decline and the -- what you're seeing on the industrial side as well?

Thanks, Sam. In terms of Q2 revenue in the market, again, it has varied a little bit by territory around the world. But if we just -- if we stick to Europe and the Americas, certainly, our view is that the overall market has declined by double digit, and then we've got sort of real and anecdotal evidence from our suppliers, from customers and also from information that's in the marketplace with regards to competitors. So I think sort of from an MRO perspective, industrial perspective, it's certainly been quite significantly impacted. And that's why we're very confident to say that we certainly outperformed quite considerably the performance in those markets. In parts of Asia, it's a little bit more mixed in Australia or similar trends. China is hard to predict, I don't know. And in other parts of Southeast Asia, it's a little bit hit and miss because of the lockdowns opening and closing. So -- but certainly, in the key 2 markets, Europe and the Americas, I would say, it's declined double digit. Specifically on electronics, our electronics business -- sorry, our MRO business has performed stronger than our electronics business. Our electronics business has pretty much tracked the overall market demand for electronics, which is high single-digit declines.

[Operator Instructions] And the next one comes from the line of Rory McKenzie.

It's Rory here. Two for me on the top line first. Given, David, that the trends improved through the quarter in all regions and you had obviously a minus 7% exit rate for Q1 in June, is it fair to say you're nearly back to seeing year-over-year stability at the moment? Or is that a hope to come quite soon? And then secondly, in terms of the market share gains, can you maybe give us more detail on the rate of new customer additions, whether that's B2B or B2C, and also whether you've seen any evidence of accelerating wallet share gains at larger customers as maybe they're looking to procure more digitally or to consolidate their procurement?

No problem. Thanks, Rory. So in terms of the exit rates coming out of September and are we back to year-on-year stability, I think that's probably a little bit too early to call. I think it does vary on the markets. If you look at Southern Europe and Southern Europe's performance, where it's in positive growth, yes, probably that comment is fairly true. I'd say in other parts of Europe and also other parts of the Americas, I'd say it's a little too early to call that. I think also the outlook as we see it is quite unpredictable with lockdowns happening here, there and everywhere. Scotland only going into further lockdowns overnight. So I think we're cautiously optimistic in terms of the future, but we are cautious because there are things that are outside of our control. With regards to customer numbers, we have seen increases in customer numbers. It's been more pronounced in B2B and standard customers as we would define them. So that's customers that are being driven through the web and through our marketing channels. So we're seeing good increases in paid, we're seeing good increases in web traffic, and we're seeing good increases in customer numbers. And that's across our territories. In terms of the corporate customers and wallet share, I think we're seeing 2 trends here. One is we are definitely -- customers want to back suppliers that have good, solid continuity of supply, particularly corporate customers. So they're looking more and more at their suppliers and their supply chains. And those that have strength and also contingency plans are certainly winning more share of wallet, and we're seeing that. But I think we're also then seeing new customers, and this is where the IESA model comes in for our largest corporate-type customers. We're seeing strong demand for the IESA-type model, and people as prospects coming into that model. And so I think we're seeing multiple facets here, standard customers increasing, corporate customer, share of wallet increasing and corporate new customer opportunities. That development pipeline is also -- remains strong and solid for us.

Okay. Great. And then just one, if I can, on the margins. Can you explain the drag from inventory provisions? Given your inventory only turns 2.5x a year if -- anyway, isn't it a bit soon to be taking kind of extra provisions there? I'm just wondering what's caused that and what the outlook is.

Sure. So look, yes, we have taken some inventory provisions that have impacted the gross margin, largely COVID-related. There's a couple of factors there. A couple of buying patterns have modified in the early stages. Yes, we do have inventory turns of 2.5x, but again, it's quite -- well, it's a very mathematical methodical calculation that we arrive at. And so we've just had a shift in demand patterns, which has then necessitated the need for some additional inventory provisions. But the other one is that we've also seen some products, particularly PPE-related. And whilst PPE is a very small percentage of our overall revenue, we have seen a glut of product coming on to the market, which has then reduced the price. And so we've just had to reduce our net realizable value. So we've taken an inventory provision for that. So we wouldn't call this a problem. We just say it's a one off that's -- as a consequence of COVID and some changes in patterns.

And the last question comes from the line of Jane Sparrow.

David, it was just one on the gross margin, again, following on from Rory's question. On the freight cost element of that, it feels like the market drivers there aren't necessarily going to change in the second half. And you sort of said about taking some actions to improve the gross margin in the second half. So I just wondered, are you sort of talking about price increases? Or is there something you think is going to change in the market there that's going to ease in the second half for gross margin?

Sure. So again, look, there's a couple of things we're doing. One is the underlying gross margin, and that's very much focused on price and buy -- so selling price and buy price. And again, we'll talk more about that in November, but that's sort of a key element of initiatives there. On the freight itself, on freight-in costs, we don't expect freight rates to come down anytime soon, whether that be inbound freight or outbound freight. So what we're looking to do on the gross margin piece is sourcing differently. So sourcing locally, if applicable and/or trying to minimize -- or having different routes of transport rather than using, air, wheel, use ship. So we're looking at all different options there. So some of it is very much an outward looking gross margin improvement, and others are very much an inward looking in terms of the cost base. And we would expect to see improvements on both, and we'll provide great clarity in November.

Next question comes from the line of Henry Carver.

David, just a quick couple. Another one on market share. Could you just give a feel -- obviously, you are taking share on a sort of wider stepping back a bit basis, is this where the larger players you have, the sort of the inventory they have, the online capability are taking share from the smaller players? Or are you also seeing share gains from your kind of, I guess, the closer peers to you? That was the first question. And then secondly, just in Asia Pac, is -- has the sort of, let's call it, quieter trading environment giving you a chance to sort of improve your efforts there or sort of -- has it helped or hindered your efforts to improve this kind of Net Promoter Scores on your efforts to improve the Asia Pac business? Or has it made life more difficult?

In terms of market share and peers, look, it's difficult for us to ascertain exactly where the market share is coming from. What we can say is that we know we're taking market share from both the bigger players, but also the smaller players. And that's coming through as a consequence of our strength of our digital capability, our distribution center network, our people and our value-added solutions. And so I think it's sort of -- it's a bit more of an across-the-board approach there. In terms of Asia Pacific, we're actually very, very pleased with the progress that's being made in Asia Pacific. Sean Fredericks, our President out there, is doing a great job. We're seeing Net Promoter Score improve in that region. We're seeing operating efficiency improve in that region. And again, I think whilst the numbers don't necessarily -- headline numbers sort of show it, I think the extent of the lockdowns that we're experiencing in the short term in-and-out and close-and-open approach, particularly in Southeast Asia, is having an effect. But once we get through this, I think the foundations of our Asia Pacific business is just getting stronger and stronger. And so we certainly are confident as we look beyond the current COVID challenges.

Next question comes from the line of Kean Marden.

Could we just come back to the inventory provision, first of all? So is the right way of thinking about this, that it's possibly about GBP 1 million or GBP 2 million of the total PPE costs in the first half? And will this benefit profitability in the future? So if you've written down the carrying value because customer buying patterns have changed, but then they then normalize and you effectively sell that inventory for full price, then presumably, you've got a bigger credit coming back through to the P&L. So just whether with the magnitude and the thought process around that is correct. And then secondly, just a few quick ones. So it looks like the tone of your language regarding the German distribution center may have changed a little bit. So I think the tone earlier this year suggested that opening that maybe had slipped a little bit into sort of later 2021, but the language now moves back to mentioning sort of summer. So I appreciate we may be arguing over a month or 2 here, but just whether actually you managed to catch up a little bit on that program. And then thirdly, a slightly tricky question, but some -- is your surplus Brexit inventory level still appropriate at this level? And given the scenarios that might play out over the next few weeks, how may you have to flex that in the future?

Got it. So just working backwards. In terms of Brexit, as you may recall, we certainly brought in GBP 20-odd million, GBP 25 million, GBP 26 million of inventory at the last trigger point. We unwound that inventory post the -- that sort of position. As we now move towards the December 31 position, we are certainly looking to bring some Brexit contingency inventory into the system, not to the same level than it was before. It would be the best indication, but it's probably going to be -- best view at the moment would be somewhere between GBP 15 million to GBP 20 million of additional inventory. We would expect to be in a position to be able to burn the most -- the vast majority of that inventory off prior to our year-end at the end of March. So it's more of a -- it's a timing issue through the quarters. In terms of the German DC and the timing, look, it's progressing well. We are -- I guess, it's how long do you think summer is going to last. So I think it's sort of -- we're still thinking around July, August time frame, where we can start to the early stages of the commissioning of the German DC. And then with regards to the inventory value. On the PPE side, look, it's a handful of millions, a small handful of millions. In terms of is there potential benefit going forward, there could be, but I can't promise that at this point. So I think we'll just keep that as a watching brief.

There are no more questions at this time. Please continue.

Well, look, thank you so much for your time. And as I said, we will update you when we do our interim results on the 10th of November. Thank you very much.

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