RS Group plc (RS1) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by and welcome to the Electrocomponents Trading Update Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Monday, 8th of February 2021. I would now like to hand the conference over to the first speaker today, Mr. David Egan. Thank you, and please go ahead.

Thank you, Maria, and good morning. This is David, CFO of Electrocomponents. Lindsley Ruth, our CEO, remains based in Texas. And given it's currently 2 a.m. there, I will be hosting today's call. Sorry for those of you that had some challenges coming on to this call and for the slight delay in the start. This trading update covers our performance for the 4 months to 31 January 2021. We have delivered a strong revenue performance, fully reflecting the hard work and commitment shown across our teams during these challenging and ever-changing times. This is no mean feat, as our people have juggled increased pressure on their own personal lives, whilst ensuring that our customers and suppliers continue to receive ongoing service despite lockdowns, border closures and Brexit implementation. Our employees did an outstanding job, and our top priority remains ensuring their health, safety and continued well-being. However, ensuring the safety of our people and giving the best possible service to both our customers and suppliers has come with a higher operating cost. We believe that while this may result in some short-term costs, it is building, strengthening and deepening customer relationships for the medium term. The changes that COVID-19 has brought to our markets and our customer needs has meant that our proposition is resonating even more. This is driven by a surety of supply, given our global supplier base, breadth of our product offer and strong availability, as well as our customers' ability to transact with us with ease through our omnichannel offer. Our relationships with both customers and suppliers have become closer, and we have seen our solutions-led offer becoming increasingly important, both within our core business, but more so with our integrated supply proposition, while we offer -- which we offer through IESA and now through Synovos. We have strong foundations that we've built over the last 5 years, and we are now in a position of strength to capture the opportunities that we see, primarily organically, but also through bolt-on inorganic options that will drive our organic growth faster. Financially, we are strong. We've continued to focus on cash generation and we have a healthy balance sheet. The equity raise in December, mainly to fund the 2 acquisitions of Synovos and Needlers, was to ensure that despite all of the economic challenges being faced, we continue to invest in our proposition, both through capital investment and strategic acquisitions. So now looking at the performance for the 4-month period to 31 January, 2021. We're pleased with the 8% like-for-like revenue growth delivered in the period, which has been strong across the group with market data and peer reports showing we've outperformed the market. We saw high single-digit growth in industrial, which accounts for circa 80% of group revenue and a mid-single-digit increase in electronics. Our private label brand, RS Pro, has grown revenue on a like-for-like basis by 14% in the period and accounts for circa 14% of group revenue. We've continued to develop the product offering to reflect cost of demands, such as test and measurement products, with our sales team focused on increasing RS Pro's penetration across the markets. Digital accounted for 62% of the group revenue in the period and grew 6% on a like-for-like basis. This was slightly below the total group, due to lower sales through our eProcurement solutions from a number of key corporate customers. This was more pronounced in the Americas, which has a significant exposure to the entertainment and education verticals. Pleasingly, we have seen significant growth in website traffic and an 8% increase in web revenue during the period. This has been driven by a strong performance in both paid and SEO channels, the latter reflecting organic growth. We launched our responsive websites on the RS side and continue to improve the user experience with a focus on site navigation, search and content to deliver greater site conversion. Let's take a look at the regions in a little more color -- with a little more color. As we mentioned at the interims, we have flattened the structure within EMEA. Thus, we no longer have subregional data to report, but we will instead provide color on the larger countries. EMEA, which is roughly 2/3 of group revenue, saw like-for-like revenue growth of 7% for the 4 months. There was a strong performance in all Tier 1 markets. And for us, Tier 1 is the U.K., France, Germany, Italy and Iberia. And this built momentum throughout the period into the calendar year-end ahead of Brexit. January has been a little softer, which could reflect some unwinding of the pre-Brexit breached or the result of further lockdown measures. The U.K. delivered mid single-digit growth in the period, as we continue to take market share with strong product performance across all categories. December was strong, potentially due to forward purchasing ahead of Brexit. Trading moved back towards the 4-month average in January. Revenue growth in France was high single digit, driven by corporate customer recovery. In Germany, revenue moved into growth during the period, but softened into January, which is a function of the heavier exposure to OEMs, automotive and electronic subcontractor customers. The expansion of our DC in Germany remained on track for the summer of 2021. IESA revenue has been a little mixed during the period with continuing weaker demand from auto and aerospace customers offset by growth within food and pharmaceutical customers. Pleasingly, during the period, IESA won a number of new European contracts in less cyclical verticals and some of significant size. Go live dates of the new contracts will vary depending on COVID lockdowns. [ Future ] product line of projects remains strong. The Americas region accounting for roughly 1/4 of group revenue saw a significant improvement in trading, delivering 10% like-for-like revenue growth during the period. All sectors, except entertainment and education, were in growth. OEMs, the Americas' largest growth political outpaced overall performance, followed by strength within distribution and heavy industrial and equipment segments. Part of the improvement is due to a wider product offering from the expansion of our DC capabilities and part of it from the sales transformation program, which we commenced last year. This has better aligned our teams to revenue and gross margin growth. The stronger performance by our sales team more than offset the weakness in corporate digital sales, highlighting the strength of our omnichannel model. Asia Pacific, which is about 10% of group revenue, grew by 11% like-for-like. The strongest performance was in Greater China, ANZ and Southeast Asia. The rate of decline in Japan and Korea reduced, driven by a better performance in electronics. Now moving on to gross margin, cost and cash. Targeting a mid-teens adjusted operating profit margin remains our key focus, through improving individual product margins, adding more services and generating operating efficiencies as we leverage our cost base. During the period, our gross margin has benefited from the strong growth in our own brand, RS Pro. However, this has been offset by negative mix, COVID costs and additional inventory provisions. On mix, we experienced product mix with stronger growth of lower-margin products, such as PPE and test and measurement. We experienced some customer mix, and we experienced some regional mix with stronger growth from the Americas, which today currently has a lower gross margin. On COVID-19 related costs, these have continued at least at previous levels. Our freight costs, both inbound and outbound have risen not declined over the last 4 months, with sea freight costs now seeing increases as well as with airfreight. On provisions, we've taken an additional charge of GBP 5 million in the period relating to the earlier mask purchases. We now expect our gross margin in the second half to be similar to that of the first half. On costs, we continue to proactively manage our cost base to deliver savings and efficiencies. The benefits of rise are flowing through and expected to deliver GBP 7 million of savings this year. However, we have incurred and expect to continue to incur additional costs during the second half to both protect our people and provide as good a service as possible to our customers and suppliers. These additional costs are likely to be at least similar to the first half increase of GBP 9 million. These costs, operational inefficiencies within our DCs remain due to COVID social distancing. COVID operational costs remain in some areas of our business. Freight costs continue to remain high and Brexit costs were incurred to maintain customer service during the months of December and January. At this point, we do not see most of these moderating anytime soon. On cash, we have continued to focus on cash generation with customer collections strong during the period. As a result of the cash strength, we contributed half of the GBP 25 million U.K. DB pension funding commitment during the period. The balance will be contributed by the end of FY '22. The acquisition of Synovos, a U.S.-based integrated supply solutions business, similar to IESA; and Needlers, a leading PPE operator in the food and manufacturing vertical, completed during the period. Integration is on track and both are performing well. We're very excited to welcome both businesses into the group. So in summary, our revenue performance has been strong over the last 4 months, and is a testament to the hard effort and work our teams have put in. We know that our offer is resonating and our proposition is gaining traction with more customers, giving us the confidence to continue investing into strategic growth opportunities. Ensuring the safety of our people and giving the best possible service to both our customers and suppliers has come with a higher operating costs, some of which may not ease as fast as originally expected. Looking forward, we remain cautious about the immediate uncertainties of the external environment, but optimistic over the medium term. Our full year profit expectations are unchanged with the stronger revenue growth offset by additional ongoing costs. And finally, we remain confident in the group's prospects and the significant growth opportunities in both revenue and margins over the medium term. And with that, I'll hand you back to Maria, and I'm happy to take Q&A. Maria?

[Operator Instructions] Your first question comes from the line of Henry Carver.

Just one on the gross margin. I just wonder if you could give us a feel of what -- just break down those pressures you're seeing between customer mix, regional mix and anything else?

Sure. So with regards to gross margin and expectations for the second half are pretty similar to those of first half. We've got GBP 5 million flowing through in terms of the mask provisions. It's fairly evenly split between the -- with the 3 elements with regards to the gross margin, geographic mix and product mix, evenly split between those 2.

And your next question comes from the line of David Brockton.

I've got 2. Just firstly, on the freight costs. I just wonder if you can touch out and maybe sort of expand the options that are available to you to help alleviate pressures on freight costs? And also how long those could be implemented? And then secondly, just on U.S. growth, that's clearly been very strong in the period. I just wondered if you can draw out to what extent inventory expansion has played a part there?

Thanks, David, and good morning. So with regards to freight, we have 2 elements. One is inbound freight and then the other one is outbound freight. Initially, the freight costs were increased for products that was going through air. We've now also not seen a moderation in those costs and availability is also somewhat challenging because of lack of commercial flights happening. But we've also seen during the period that we had quite an increase in sea freight. We have had interventions with regards to freight. We put more on to ships. We put more inventory into some of our local distribution centers, and we have modified and changed some of our sourcing options, which has then benefited us. But the flip side is we've then had those cost increases, but equally we've also had volume increases. So as a consequence of that, whilst interventions are moving forward, they will take time. We've also seen volume increases, which has had an overall absolute value cost increase to the group on freight. With regards to U.S. growth, we're really pleased with the U.S. growth being delivered. Part of it is the market is slightly better. But the really pleasing part for us is that with regards to the expansion of the DC, we've had a few more -- we got more product in terms of our offer in stock. We've also seen the sales force step up and the reorganization that took place in August of last year is now starting to pay dividends. And we've also seen a very strong improvement with regards to our web digital program there, which is then driving more traffic and increasing conversion. So again, it's a combination of those 3 factors, which is certainly paying dividends with regards to growth that we're seeing through the Americas. The exit rate January, it is very similar to what we've seen in the Americas through the 4-month period. So again, pleasingly, we're hopeful that the outlook looks strong there.

And your next question comes from the line Rory McKenzie.

It's Alex for Rory here. I have 2 please on the growth. So firstly, just on that exit rate softening in EMEA. Do you think that some of that is just related to more normalization post-Brexit or anything else that you've seen in your customer behavior? What should we think about that? And then secondly, within your customer mix, it looks like your larger eProcurement customers are maybe still weaker than average, given that digital growth of only 6%. So can you talk about the outlook and spending trends there? And whether that's almost still to come back, if you see what I mean?

Yes, sure. And good morning, Rory (sic) [ Alex ] So I think the 2 are very related. In terms of the EMEA and EMEA exit rates, the main softening that we saw in the exit rate was in the DAC region, which for us is mostly Germany. We didn't see any material other softenings with regards to exit rates from any particular country. A little bit here and there, but nothing too material. So for us -- our exposure in Germany is a little more OEM-related, a little bit more -- so that's sort of seeing a deterioration there. It's also then linked to corporate customers. So what we have seen is lower average order values, so shorter frequency to lower order values for some of our corporate customers. And so I think we haven't really seen our corporate customers which uses the eProcurement method more pronounced. We haven't seen that bounce back to pre-COVID levels as yet. So we saw some of this moderation at the early part of COVID and we're now seeing sort of some of this moderation in eProcurement model at the back end of COVID, hopefully. So we would expect that to improve going forward. I can't sort of put my finger on exactly when, but that's sort of what's happening practically on the ground. Customers are ordering less, more of adjusting time type method. And as a consequence, average order values for the larger customers have certainly somewhat declined.

Okay. And then I guess, clearly, the growth is still being good in total. So where have you seen the greatest customer growth so far? I know through last year, you saw a lot of maybe more transactional customers. Do you think [ we're ] now growing in maybe more the stickier customer base? Or have you now seen that, that base is actually stickier than you first thought?

Sure. We're seeing certainly good growth in our standard customers, and we're also seeing good growth in what we call our corporate customers, as well as putting eProcurement to one side. So we are seeing good growth in both the top and the bottom, how we segment our customer base. And certainly, the corporate customers become more stickier the more services that you can offer to them over time. And the key for the standard customers is to give them that brilliant experience all the time every time, so that they continue to come back. So that's why all of the effort has gone into the responsive website on the RS side, improving the customer experience, improving the content, it's all about driving traffic and making sure that, that customer base returns consistently going forward. So it's a multi-pronged approach, but certainly, it's paying dividends for us in terms of the revenue growth.

And our next question comes from the line of Kean Marden.

Just a couple of questions. First, on the acquisitions before Christmas. I appreciate, early days, but how are you progressing with cross-selling between Synovos and IESA across -- with each other but also across the broader group as well. And then on Needlers, what are your intentions to roll out the PPE products, particularly the unlabeled PPE products across the other geographies in 2021? And then a quick question on inventory. So the SKU numbers in the States, will those numbers progressively ramp-up over 2021? Or could we have some step changes maybe as you secure new supply with OEMs?

Sure. So taking the last one first. So with regards to inventory, we do have a program, a targeted program in terms of moving it forward, adding new SKUs and adding inventory into the new DC. It is sort of a supplier-by-supplier and then range-by-range basis. It will be more pronounced. I don't want to call it a step change, it will see -- we will move it forward, but it'd probably be a little bit more pronounced in the first half of '22 versus the second half of '22 -- FY '22. But it will take about 18 months from here on into sort of 18 to 24 months to move it all the way to maximum capacity. What we're trying to balance there is that we don't want to sort of trash our inventory turns and our working capital metrics. We want to get -- we want to sort of keep the balance right, but it's probably more pronounced first half versus second half of '22. With regard to the acquisition -- sorry?

Sorry, just to be clear, that's the fiscal year, David, not a calendar?

Yes, fiscal year, sorry. With regards to the acquisitions, Synovos, we acquired that in mid-January, and it was pretty much a hands-off up until that point because we were going through U.S. approvals. So it's early days for us, but certainly, IESA and Synovos are working together and looking at the go-to-market approach and how we sort of integrate the go-to-market and the customer experience. So that's very much work in progress, but heading in the right direction. Synovos have also commenced discussions with our Americas business through our President in the Americas, and that is progressing well. And then also Synovos are working through our RS Pro and -- own branded product, again, as a synergy benefit there. So all things considered, we're about 3 weeks in having owned it. And we're very, very pleased with the prospects and the opportunities. With regards to Needlers, we find that a little bit longer, mid-December. Those cross-selling opportunities have been -- we're working through those with the RS U.K. business and also Needlers in the U.K. Needlers already have their own brand, about 3 of their own brand products. And so we are looking at what is the right branding approach for those own branded products, but then also looking at cross-selling opportunities. So going well, integrating well. And the culture of the business is just as we thought it was, very good.

[Operator Instructions] Your next question comes from the line of a Jane Sparrow.

Just one on costs that you're seeing in the U.K. post Brexit. So inflation in products being sourced from outside the U.K. and the cost of the extra paperwork and [indiscernible] on products going in and out of the U.K. Obviously, you can't do a lot about them in the short term, but I guess on a 12- to 18-month as you get the German expansion complete, you can address some of those with a bit of supply chain realignment. So do you have a feel at this stage of what the term for -- what the long-term impact is on your sort of [ linear ] cost base that you're actually stuck with as a consequence of the new model post Brexit? And presumably, would you hope to pass on that in pricing, given all of your competitors would also be faced with similar issues presumably.

Sure. Yes. Look, I think it's a little early for us to sort of give a specific with regards to the number. We've obviously had some short-term service disruption, which we've had to put cost in to make sure that we meet customers' expectations as best we possibly can. There's also been some sourcing challenges and some duties, et cetera, et cetera. So I think as we get the -- one of the key reasons for the DC in Germany was to give us that flexibility and that will certainly be very well used, once it's up and running [ from ] the summer of 2021. So I think if we can come back to that in due course in terms of the ongoing element of it. In terms of what are we going to do about that ongoing element, yes, there is an element that we can pass on to customers. But equally, there's an element that we can work better with our suppliers. And that depends on where we source the product, in what currency we source the product. And then what value we extract from the suppliers, win-win situation. So we're looking at all of those opportunities, both in the short term, but also over the medium term, such that we can buy better and retain that margin capture within our business as opposed to [ pure ] pass it on to the customers through price increases. So it's a multi-pronged effect for us with some, I think, sort of some good prospects with both short and medium-term elements associated with it.

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

Thank you, Maria. Well, thank you very much for your time this morning. We will be in touch if you have questions or follow-ups, and please don't hesitate to contact either Lucy or myself, but we'll speak soon. Thank you. Stay safe. Thank you, everyone. Bye-bye.

Thank you, everyone. That does conclude your conference for today. Thank you all for participating, and you may all disconnect.