RS Group plc (RS1) Earnings Call Transcript & Summary

Good morning. I'm Lindsley Ruth, Chief Executive Officer of RS Group, formerly Electrocomponents, and I'm joined by David Egan, our Chief Financial Officer. Welcome to our Q1 trading update to June 30, 2022. Firstly, I'd like to thank our people who continue to work hard and have delivered another strong performance. Our people are the most powerful driver of our success, and we never underestimate the value they bring to all of our stakeholders. In recognition of their contribution, we have proposed an all-employee journey to greatness share scheme so that everyone benefits from delivering our strategy and we've continued to outperform the market. Our ability to source product has enabled us to maintain strong availability of our broad product range at a time of continued industry supply chain constraints, being focused on solving our customers' problems, especially through our solutions offer and making it easy for our customers to order through our omnichannel platform allows us to deliver a fast and responsive service and our customers to operate more efficiently. First, I'd like to pass it over to David to provide color on our first quarter.

Thanks, Lindsley, and good morning, everyone. Let me go through the details of our first quarter to the 30th of June 2022. Like-for-like revenue grew 18%. Our main own brand product range, RS PRO, grew revenue by 21%, and that was helped by improved inventory availability and targeted sales campaigns, and that was despite some diluting revenue mix effects. Web revenue grew by 20% like-for-like with digital accounting for 63% of our group revenue in quarter 1. And we continue to see a reduction in onetime low-value customers as we have shifted our commercial focus. So moving now to the regions. EMEA, which accounts for 60% of revenue, saw like-for-like revenue growth of 16%. Throughout the region, we have seen growth in the average order value, helped by an element of price inflation. We've increased line depth, and we've seen higher order frequency, which over a sustained period suggests growth in share of wallet. Germany was strong, driven by the investments in our people, digital capabilities and product range. To date, the benefit from our expanded distribution center has been limited as we bring that online and bring more inventory into that distribution center. U.K. and Ireland, which accounts for roughly 40% of the region's revenue delivered a steady performance, helped by a greater focus on higher-value customers and a more commercial pricing model. IESA continues to win more new contracts, and we're seeing a recovery in revenue from some of our larger existing customers within that model. The Americas, which accounts to 30% of group revenue saw 24% like-for-like revenue growth. Strong growth was driven by the investments and the changes made to our production and a supportive market -- proposition and supportive market, sorry. Within the product mix, our core competency in terms of automation and control products delivered the strongest growth with electronics at mid-single digit. The Novus continues to win new contracts, and we're working on several global pictures, including the IESA business, running operations in Asia Pacific for multinational corporations. Asia Pacific, which is circa 10% of group revenue grew by 13% on a like-for-like basis. The impact of the Shanghai lockdown reduced revenue growth by circa 4% in the quarter. And there was also a negative effect from limited availability of single-board computing products within the region. We are gaining share within the industrial product market and benefiting from a more commercial operating model. So across the group, inflation remains a key feature. Price inflation contributed a low double-digit percentage point in the first quarter, broadly in line with what we saw in the fourth quarter of last year, with the remainder of the 18% like-for-like revenue growth being delivered by volume. We've improved our pricing and discounting model to reflect the market conditions whilst maintaining our competitive position. This has led to a slight improvement in our gross margin during the first quarter. Strong cost control and operating leverage is helping offset the inflationary pressures running through the business. We've continued to invest in our operating model to be able to take advantage of future growth opportunities that we see now and also into the future. And we remain a robust cash-generative business with strong cash generation during the quarter. Our supplier relationships, industry experience and strong understanding of our customers' businesses, means that we can put in place detailed plans for when supply and demand changes. We've tightened our inventory commitments, focusing more on higher volume products and are working closely with suppliers to ensure we have flexibility in our orders. And we believe our experience data and wisdom provides us with greater insight than our competition -- competitive set. So looking forward, we're actively monitoring the potential impact of increasing economic and geopolitical uncertainties on our markets. Although we are mindful that the second half might be more challenging given our strength, and year-to-date, we expect our full year revenue and adjusted operating profit to be slightly ahead of current consensus estimates for full year '23. And I'll now hand you back to Lindsley.

Thank you, David. Our strategy is to accelerate our organic growth. And today, we've announced our first acquisition in Asia in a long time. And it wasn't long ago. We talked to you that we were losing 10% or GBP 23 million in Asia. And now last year, we delivered north of 11% in terms of profit. And so I'm delighted to announce we acquired Domnick Hunter in Thailand. It's GBP 10 million on a debt-free cash-free basis at the end of the quarter. They are a leading distributor and service provider of major air compression, pure vacation filtration products in Thailand with on-site service expertise. So really important supplier of Parker Hannifin products, which is a very important supplier for us, I think, moving forward. Adding this company to the group will significantly accelerate development of our service solutions in Asia Pacific, and be a key differentiator versus our competition, and we actually sell photos today of our team. David and I sell photos of our team in Thailand and the combination is quite exciting for the group, and it demonstrates our commitment to the Asia Pacific region. As David said, on Slide 5, we're facing increasing economic uncertainty. We're mindful of this, but we are well positioned to take advantage of this challenge. Since David and I joined, we have transformed and significantly strengthened our group, embracing the trends within this rapidly changing market. And as I've said before, I think the biggest change in the group is our ability to adapt to change and our ability to pivot as a company. We're a totally different group from that, which faced the global financial crisis in 2008-2009. We've embraced the digital revolution with 62% of our revenue from digital channels in '21 and '22. We're solving our customers' problems with 23% of our revenue coming from product and service solutions. We're operating more efficiently with 28% operating profit conversion, and we've invested in our model, both in operations and assets, delivering much stronger return on capital at 29%. And by the way, we have extensive data insight and wisdom with over 100 billion total records and 150 data points per customer, allowing us to better understand our customers and their behaviors. And most importantly, we are much better at price and margin management and being commercial. We have a profit mindset within this business today. And Slide 6 illustrates how much we have changed. We're an international business. Nearly 40% of revenue is in the Americas and APAC. That will continue to increase over time. We have country responsibility and accountability, which drives a local offer that's relevant with greater end-to-end control. We're focused on knowing and providing what our industrial customers want. We have more talented, targeted and relevant product and service offer with our strong owned brand, our people, RS PRO, providing a quality value alternative to the brands. We have less exposure to the more cyclical electronics market, which is different from 2008 and 2009. We're a omnichannel bringing digital together with our technical expertise and support, and we're a solutions provider. Unfortunately, many people don't get this, but all has been driven by the change in mindset, culture and ambition around the group. It's our people. Our people have driven our transformation. While we remain alert to a very difficult macroeconomic environment, increasing inflationary pressures, we have an improved pricing model, strong cost discipline driving operating efficiencies. We tightened our inventory commitments. Our strong supplier relationships provide flexibility and we have profitable growth initiatives as detailed within our journey to greatness. So in summary, we transformed and strengthened our group significantly over recent years, and our performance has demonstrated our ability to adapt quickly to external pressures, turn challenges into opportunities and outperform. We are confident we are well positioned to deliver continued profitable market share gains and attractive returns. And with that, I'd like to invite your questions.

[Operator Instructions]

This is Lucy from IR. I've got a question that's come in online. On pricing, you talked about low double-digit contribution to the organic growth rate in the fourth quarter and then the first quarter of this year. How sticky is this pricing? Is it due to the wider inflationary environment? Or is it RS Group's pricing power? And can we expect to annualize the 2-year pricing stack across the year? Or is there further upside?

So let me take that to start with. So pricing, what we've seen in Q1, low double-digit and the balance was then real volume growth, which we're actually very pleased with. We've been -- we've also seen a slight uptick with regards to our gross margin. So we've been able to pass on the cost increases from our suppliers and also the input cost of transport of that product coming into our distribution centers. So for us, we've got good pricing power as we see it at this point in time. You need to also bear in mind that our average order value is still GBP 210, GBP 211. And so again, the cost increase to our customers is relatively minimal versus the overall spend that our customers are making within their facilities and their sites. So overall pricing power remains strong, and we believe that we can continue to pass on those cost increases as they continue to occur for us going forward. In terms of as we look forward, I think sort of the best view we have is that our objective is to manage the gross margin and manage the operating margin and to cover those inflationary effects, both cost increases, but also the other inflationary effects that are running through our business as best we possibly can. So our objective is to maintain that margin as we go forward.

Our next question comes from Rory McKenzie of UBS.

Firstly, to focus on that underlying real volume growth component, which it sounds was around 6% to 7% in this quarter after more like 12% to 13% in Q4. Does that slow down just reflect the comparators? Or are you seeing any signs of customers reducing orders or operations in some segments? And then secondly, with price inflation clearly still being so high, are you yet seeing any signs of availability improve, which could mean that starts to come down? Can you also discuss how you think about buying in inventory at these elevated pricing levels?

Yes. So great questions, Rory. I think first of all, I'd just tell you, availability has improved. So our availability is back up to where it was before, north of 90%, close to 92%. So we're happy with that. Our teams continue to work quite hard on getting product on the shelf. However, I will say that we want to watch our inventory closely. So we're starting to shut down the funnel a bit in terms of what's on our order. So we're being careful on that front. In terms of the industry, we're not seeing -- there are certainly signs out there in the market that the market is slowing. And we might be naive not to think that. We continue to outperform, and we're growing market share. So we're growing volume, growing market share. And I think that has a lot to do with our culture. So we know that, but we have to be sensitive to the fact that the market -- there are signs certainly out there in the economy that certainly in Europe, that there is a slowing. But we're -- as I said before, we've transformed this company, and we expect to grow. Just to be clear.

Just a little build, Rory. In terms of availability, our availability has improved. We haven't seen any material change with regards to supplier availability and supplier performance at this point in time. In terms of demand, demand remains robust around the group, whilst yes, our absolute volume growth of 6%, 7%, 8% in the quarter was a little lower than it was in the past. We are sort of operating against tougher comps, but we are continuing to take market share gains. And so I think we're well placed demand remains solid. Supplier performance is not necessarily improving, supplier demand on their order books also based on the channel, it still remains very strong as well. And then the final point on inventory. We're just managing the inventory as best we possibly can. Our objective is to potentially tweak up the inventory turns a little bit just to make sure that we don't get caught if there is any changes with regards to the cost of that -- those products coming into the system at some point in the future. But equally, if prices do come down, we want to be able to use our balance sheet and go in and procure that inventory at a reduced cost, which also then creates opportunities in the future. So again, I think it's for us, it's turning challenges into opportunities, which I think is one of the key changes, cultural changes and mindset changes of the group over the last number of years.

Our next question comes from Oscar Val of JPMorgan.

Yes, I have a couple of questions. The first one is on inflation on your warehouse and transfer costs. You comment that you're seeing on the top line, low double digit. Can you comment on the warehouse and transfer costs, what you're seeing there? The second question is on the German warehouse expansion. You mentioned it hasn't really started to contribute yet. Is there any timeline on when you think you'll get the benefits on volume and cost? And then the final question is a bit more high level, but you have a mid-teens margin target. And clearly, we're facing a bit of a tougher industrial and economic backdrop. Do you think you can hit that margin target in the midterm, even if we go into a slowdown?

So let me take the last two questions. I think, first of all, in the mid-teens operating margin, we expect that there is a slowdown to still deliver a high degree of profit. Now would it be mid-teens? Maybe, maybe not, depends on how tough recession, if there is a recession, but we plan to grow. So we're not far off from that now. And I think we will continue to perform. If you look at Asia, as an example, we went from loss-making to a profit in the last 2 years. And so I think that's definitely doable.

Yes, I would concur with that. Our objective is to continue to move the top line forward profitably, which is then going to contribute to the margin. We will deal with challenges and obstacles as they come at us. As I said, I think it really comes down to our resilience and turning those challenges into opportunities. It's still a very large market and our position is very, very low. Our market share position is very low. So I think there's still plenty to go at, and that's what we intend to do.

I think, Oscar, as far as the German DC, distribution center, it's been a difficult period to expand our products, but we're looking at it, we're focused on it. So we'll get the benefits over the next 2 years from that expansion. We're still working through some of the minor issues of a new DC, but not significant.

And then with regards to inflation and transport related, I guess, sort of on an OpEx perspective, the two big inflationary effects on the OpEx is wage inflation. So for us, it's running around 5% to 6% across the world. And then there's transport, and that's transport out, those inflationary effects have stabilized. So yes, we have seen cost increases on an annualized basis, both in terms of the rate and also fuel surcharges. But at this point in time, we haven't seen that sort of get worse, but it hasn't necessarily got any better. So the guidance that we've provided in the past is pretty much sticks at this point in time on transport.

Our next question comes from David Brockton of Numis.

Three questions, please. Firstly, could you comment on the exit rate relative to the quarter? Secondly, I think you referenced through the script, there were fewer transactional customers, which I presume is fewer B2C customers. But I just wonder if you can just talk about whether the sort of the business customer gains of recent years are sticking and are you still growing that number? And then the final question is just sort of a general question around the M&A pipeline, I guess, in a period of higher geopolitical and economic uncertainty. Are you seeing things slow in terms of moving through that pipeline? Or are they accelerating?

Yes. Let me take the third one. David can take the first two, right. I think on the M&A pipeline, it's as solid as it's ever been in terms of opportunities. However, we are slowing down the conversations because of valuations. We think valuations will go down, and especially with PE-backed deals, family-owned deals, probably not a whole lot of change but we're being careful and mindful of not paying last year's price this year. So we're being careful on that front. And there's still some great opportunities out there. But as I said in the beginning, our #1 priority is organic growth. Our success to date over the last 6, 7 years has been organic, and we're going to continue to focus on that.

Yes. I think just one quick build. We are still very busy. So the pipeline is very robust and strong. Our teams are very busy. So we are active, but we're just taking a -- we have discipline, and we'll maintain that discipline on the M&A front. With regards to exit rates, the exit rates in June were very similar to what we saw through the quarter. The only real change there was we saw stronger growth in China, as China -- the DC in Shanghai came back online, but otherwise, I think, relatively consistent throughout the quarter. And then with regards to customer numbers, the main change there is B2C, again, continued emphasis on our part to either obtain a margin from a -- and make them profitable or not necessarily encourage them into the equation. For our B2B customers we are seeing stickiness on our customers because it comes down to availability and the service and the offering that we have for them. So far, we're actually very pleased with the stickiness and the progress. And as we then bring more solutions into the offer, for us that then makes that customer journey even more sticky going forward. So that's why the big emphasis on the solutions side of our strategy.

[Operator Instructions] I'm now going to hand over to Thomas Truckle of Jefferies.

Just calling on behalf of Kean Marden here at Jefferies. I have two questions, if I may. The first of which is that 6% to 7% volume growth, are you able to break down how much of that was wallet share? And how much of that was end market demand? And then my second question comes to the balance sheet. We're forecasting negative leverage for FY '23. And clearly, given where the share price is now compared to where it was just a couple of months ago, in the absence of any significant M&A would there be any other capital allocation policies that may come to light whether that be buybacks or otherwise would be keen to hear if there's any thoughts on that?

So in terms of the leverage, our capital allocation approach is consistent. We'll continue to invest organically into the business. We want to grow the business inorganically with sensibly sized and targeted acquisitions. We have a progressive dividend policy, but we also recognize that if opportunities don't come at an -- in an appropriate time scale that we will consider other capital allocation, including buybacks. It's not something that is high on our agenda, but certainly, we understand the appropriateness and the responsibility that we carry. But at this point in time, our pipeline of opportunities from an M&A perspective, as Lindsley just said before, is very, very solid, and we would hope to be able to convert some of those into live transactions over the coming periods. And then in terms of the end market, I think for us, it was all market share, wallet share gain.

[Operator Instructions] We have no further questions on the line, so I'll hand back for any closing remarks.

I've got one that's coming from -- through the Internet again. So Lindsley, you talk about people and culture being very important. And obviously, the labor market is quite stretched at the moment. How do you keep people in this environment?

Yes. Well, I think what's critical is we have a resolution that's going to vote in the next couple of weeks around journey to greatness. And we want all of our employees to share in the reward of this company, to share in the performance. And I think David and I were in Milan and Warsaw last week. And I got to tell you, the change in our culture is significant. And I wish we could have all our investors and analysts go see our locations and hopefully, Lucy can arrange something in the not too distant future. But the attitude that our people have today and the purpose of which they see in the business and which they bring to the business every day. In fact, we are in Milan. And the leadership team in Milan actually did a presentation on each individual. They started with their family and then they talked about their background, and then they talked about their purpose. And all of them talked about growth ambition, and they talked about inspiring others and making a difference. And it was special. You can't -- I think you have to feel it. You can't see it. You can't describe it. But to me, I think our people are critical to this journey that we're on. And the way we treat our people and the way we've treated our people during the pandemic, I think with respect and everything we're doing is the right thing. And our people -- it's just amazing to see the difference in terms of what's happening today, but rewarding our people is really important.

I think the only build I'd say is we also have the privilege of being in our Corby office in the U.K. a couple of weeks ago as well. We had a mega sales day, the office was full. The distribution center, it was great walking around the distribution center. And I think the culture -- the culture aspect is really, it's live and it makes a difference. And Lindsley also is fortunate to be in France probably 6 to 8 weeks ago as well. And so again, we're getting out there with our people and our customers and really trying to drive that ambition and drive that culture change continued.

Any other questions? Jordan?

Not online.

We have another question registered on the phone lines. Sid Sukumar of J.O. Hambro.

Congratulations firstly on a very strong quarter, given the conditions. I just wanted to get -- I wondered if it was possible for you to comment on whether you would consider an enhanced cash return rather than acquisitions given the current environment and priority of organic growth?

Sure. As I said earlier, I think capital allocation for us will remain organic, inorganic dividend, progressive dividend. Our pipeline of opportunities on inorganic is very strong but we understand our responsibility. So we will look at all capital allocation opportunities. But at this point in time, we believe that we can deploy that capital sensibly and appropriately on the M&A side of things. So it's not off the agenda, but it's -- we're very much prioritizing the organic and the inorganic approach for us at this point in time.

Jordan, any other questions?

We have no further questions on the phone line. So I'll hand back.

All right. Listen, thank you all for listening to the call today. I think the key points are, we're a very different company from what we were in '08, '09. You can count on us to deliver our best efforts to make a difference, and we plan on growing. And we're going to continue to do the right things for this business. And our #1 priority is organic growth. So you can count on us to work hard and continue with success. Thank you very much.

Thank you.

This concludes today's call. Thank you for joining. You may now disconnect your lines.