Inchcape plc (INCH) Earnings Call Transcript

Good afternoon, and welcome to the Inchcape, PLC investor presentation. [Operator Instructions] The company can review all questions submitted today and publish responses where appropriate to do so. Before we begin, we'd like to submit the following poll. I'd now like to hand you over to the team at Inchcape.

Good morning, everyone, and thank you for joining us. I'm Duncan Tait, Group CEO, and I'm joined by our Group CFO, Adrian Lewis. Here's our agenda for today. I'll give an overview of our interim results for 2024, and Adrian will then go into more detail on the financials, and I'll come back to discuss strategic progress and the outlook. And after that, we'll take your questions. The presentation is available on our website, and a recording of today's session will be available later today. I'll start with the highlights of the first half of the year. The major news during the period was the divestment of our U.K. retail business to Group 1 for GBP 346 million. I am very pleased the FCA approved the transaction yesterday evening. And as a result, the deal will complete on the 1st of August. This is a major strategic inflection point for Inchcape as we become a pure-play operator in automotive distribution. Proceeds from the disposal will provide additional balance sheet capacity for us to invest in future growth to support our capital allocation policy in the context of a healthy pipeline of bolt-on acquisitions. During the first half, we continued to execute against our strategic objectives, delivering a resilient operational and financial performance with 8% revenue growth in constant currency, 4% organic growth, PBT of GBP 226 million and a reduction in leverage to 0.7x. This performance is evidence of our diversified and scaled business, which helped us to win share in key markets across our regions. In addition, and taking into account our excellent free cash flow performance in the first half and the strength of our balance sheet, we are accelerating the timetable of our share buyback and increasing the amount from GBP 100 million to GBP 150 million. The share buyback will commence on the 1st of August 2024 and is expected to complete during Q1 2025. Looking ahead, in the near term, we are maintaining our expectations for moderated growth in 2024 at constant currency. And over the medium to long term, we expect to return to higher levels of growth, and this will be driven by recovery across a number of markets, the increasing contribution from recently won distribution contracts, bolt-on acquisitions, the development of our technology capabilities and our continued focus on cost management. I joined Inchcape in 2020, and I'm even more excited today than I was 4 years ago about the potential for Inchcape in a fast-moving and dynamic industry. The business is in excellent shape and extremely well positioned for the future. Our success over the last 4 years owes much to the quality of our 18,000 highly talented people around the world. I'm on the road approximately 1 week in 3, meeting our teams across the regions, and I'm always impressed by the enthusiasm, commitment and innovative mindset of our people. We have built a collaborative, entrepreneurial and high-performing culture that provides the bedrock from which we can deliver future success at Inchcape. This culture has also been the driver of our strategic transformation from a retail distribution -- from a retail and distribution business to a pure-play distribution company, as you can see from this slide. Since 2016, we have tripled the number of OEM partnerships and doubled the number of markets in which we operate. Our annualized distribution revenues have tripled and we have more than doubled the new vehicle volumes we distribute. Our performance in the first half is evidence of the strength of being a pure-play distribution business, with CapEx at less than 1% of revenue, return on capital employed of 28% and free cash flow conversion of operating profit of 76%. We are already delivering in distribution, which is capital-light, attracts higher margins, is more cash generative and delivers higher returns than retail only. Let's now look at the macro backdrop and outlook across our regions. As you know, we are focused on small- to medium-sized, more complex but attractive markets, which are higher GDP growth and have low motorization rates. In the Americas, industry volumes are at historic lows in a number of markets, driven by geopolitical and macroeconomic factors. We are seeing some key markets stabilizing, although it's too early to say whether this is the start of a recovery. Certain subregions like Central America have performed well. And overall, for the Americas, we remain positive about the region's structural growth prospects over the medium to long term. In Europe, we are seeing some improvement in order intake in certain markets, although there is mixed demand outlook across the region, with Southern Europe remaining strong with some markets in Northern Europe more challenging. Finally, in APAC, a growth engine for Inchcape with robust volume growth and a positive growth outlook in most markets. To highlight the quality and diversity of our business and its prospect in APAC, we will be holding an In the Driving Seat seminar with a deep dive on the region in November. So overall, a positive growth outlook in our regions against a mixed set of trends. With that in context, I'll now hand over to Adrian to take you through the details of the financial results.

Thank you, Duncan, and good morning, everyone. With the disposal of the U.K. retail business expected to complete later this week, as Duncan mentioned, it has been treated as a discontinued operation, which means the 2023 comparators in the income statement have been restated to exclude the U.K., and we have provided in the appendix of today's presentation our income statement on a continuing operations basis for the full and half years of 2023 and a stand-alone balance sheet for the U.K. business. And hopefully, this will help to inform your modeling of the continuing operations of the group. So now let's start with the headline financials. And during the period, we generated revenues of GBP 4.7 billion, up 8% in constant currency, with organic growth of 4% and a contribution of 4% from acquisitions, and this was partly offset by currency translation headwinds. Operating margins were 6.3%, reflecting organic revenue growth with some regional mix and price headwinds impacting gross margins, mostly offset by cost control driving operating leverage and adjusted PBT of GBP 226 million, which on a constant currency basis was 7% above the prior year. We delivered another excellent period of free cash flow generation, producing GBP 226 million, with a 76% operating profit to free cash flow conversion rate and our return on capital employed was 28%. Net debt reduced to GBP 524 million, driven by a strong working capital performance, and this resulted in a net debt-to-EBITDA ratio of 0.7x. Adjusted EPS was 34.7p. And today, we announced our interim dividend per share 11.3p. And to remind you, this is set at 1/3 of the 2023 full year dividend. And so in summary, our performance during the period is evidence of our strategic progress. The next slide shows the key drivers of our top line performance, and we grew 8% in constant currency with 4% organic growth and a 4% benefit from the acquisitions we made in Asia Pacific last year. APAC delivered strong organic growth of 9% on Europe and Africa, again outperformed the market with 18% organic growth. In the Americas, revenue declined 9% organically, with our volumes down 7% against the 9% fall in industry volumes in Inchcape markets. These growth drivers were offset by a 4% impact from translational currency headwinds driven by the strength of the pound. This slide shows our operating margin performance and operating margins were down 10 basis points in constant currency, with overhead leverage offsetting gross margin pressure during the period. Gross margin pressure arose as a consequence of regional mix, a faster-growing vehicle business, but also some pricing pressures in the Americas, which is a consequence of lower industry volumes. On overheads, we continue to be proactive on cost management, supported by Derco cost synergies and, more broadly in the Americas and across the group, to drive operating leverage. So let's now look at our regional performance in APAC. Revenue grew 24% in constant currency, including organic revenue growth of 9%, and this was supported by market share gains in key markets and a contribution from acquisitions and with new brands in early stages of development. Operating profit was up 41%, with operating margins up 90 basis points to 7.8%, and this was driven by operating leverage and the mix effect of faster-growing, higher-margin businesses. Looking ahead, we anticipate continued growth in many markets with margin growth expected to be partially offset by recently won distribution contracts, including Great Wall Motors in Indonesia and Changan in the Philippines. On to Europe and Africa next, where revenue grew 18% in constant currency, and this was driven by outperformance against the market in Europe, a continuation of order bank normalization, market share growth and new contract wins growing quickly. Performance in Africa remained resilient. Operating profit was up 25% with continued elevated adjusted operating margins of 5.2% despite some dilution of accelerating contract wins. Looking ahead, growth is expected to be supported by some improvement in order take, which will partly offset the effect of order bank normalization over the last 18 months, with operating margins in Europe expected to moderate towards historic levels. And now let's look at the Americas where revenue fell 9% in constant currencies. And the story for this region is that we are proactively managing the business in the context of lower industry volumes. Our market share across the region remained resilient with key markets stabilizing and Central America seeing growth. Industry volumes across the region were below last year by 9%. And while our volumes fell 7%, demonstrating our outperformance. And we also saw a degree of pricing pressure as a number of key markets, which are at historical lows. Operating profit was down 24%, with adjusted operating margins down 110 basis points from half 1 '23, but broadly consistent with the half 2 '23 run rate. Derco synergies and the wider cost programs have proved to be an underpin to operating margin and has mostly mitigated the deleveraging effect of reduced volumes. Derco continues to be transformative for our business in the region, helping us scale across the Americas. And this is highlighted by 3 distribution contracts, one in the Americas in half '24. Looking ahead, we have prudent expectations for short-term volume recovery, but margins are expected to improve in the second half, building on an improved margin exit rate at the end of half 1 '24. This slide shows our income statement for the period. The group delivered operating profit of GBP 299 million, and PBT was GBP 226 million, including a currency headwind during the half. Adjusting items amounted to GBP 31 million, and this was primarily driven by acquisition and integration costs of GBP 23 million and non-cash nonoperational losses arising from hyperinflation accounting in Ethiopia of GBP 8 million. And we also note that on the 28th of July, the Ethiopian government announced a change in the way that it manages its currency to an exchange-based regime. And as of the 30th of June, the net assets in our Ethiopian business was GBP 155 million, including cash of GBP 94 million. Ethiopia was an immaterial contributor to growth in the first half, both in constant and actual currency terms, and in absolute terms, a low single-digit proportion of group profit. And we will continue to monitor the impact of this change, working with our local teams and banking partners. The effective tax rate increased to 32.7% partly due to the impact of mix and a pillar to tax cost. We expect our effective tax rate to decline over time with structural improvements following the U.K. disposal. We maintain a strong focus on cost management, and we reduced overheads despite the increased scale of the business with a ratio of adjusted overheads as a percentage of revenue, reducing to 10.9% from 11.4%. And now moving on to our finance costs. Overall, net finance costs were slightly higher than the prior period, but lower sequentially. And while interest costs are partly linked to the interest rate environment, they are also directly connected to our growth and success as a company. And our net finance costs totaled GBP 74 million for the period. The first element here is net interest of GBP 34 million, which is directly linked to the cost of corporate facilities in the group, and in particular, our corporate debt. This element declined due to a reduction in average debt, which offset some short-term cash funded inventory flows during the period. Looking ahead, net interest will reduce as the organic cash generating capability of the group and the proceeds from the U.K. retail disposal enables us to deleverage. And the second element of interest relates to leases, which is GBP 9 million, and this is linked to our physical infrastructure and will grow as we grow and expand our business. The costs associated with inventory finance were GBP 26 million during the period. We expect this to increase as we grow the business and as we align the commercial operating models of acquired businesses and will reduce if interest rates begin to fall. The final element is the GBP 5 million of fees and FX costs, which have been reducing as we drive structural efficiency. We produced another excellent free cash flow performance, highlighting the cash-generative nature of our business model, with adjusted free cash flow of GBP 226 million, which is an operating profit conversion rate of 76%. This was supported by a strong working capital inflow of GBP 82 million, driven by disciplined inventory management, particularly in the Americas. Inventory fell to GBP 2 billion from the GBP 2.7 billion at the end of 2023 due to an improvement in inventory efficiency across the group and the exclusion of U.K. retail inventory. And as a consequence of our strong free cash flow performance, net debt reduced from GBP 601 million at the end of last year to GBP 524 million, equating to a leverage of 0.7x after dividend payments were made during the period of over GBP 100 million. Looking ahead, we expect leverage to continue to reduce, supported by further strong underlying free cash flow performance and the cash to be received from the U.K. transaction. This provides us with the capacity to continue to follow our capital allocation policy, as you have seen today with the expansion and acceleration of our buyback program. And this slide serves as a reminder to how we allocate capital. In priority order, focused on organic investment, dividend payments of 40% of adjusted EPS and value-accretive acquisitions with a healthy pipeline of bolt-on acquisitions at the current time. The fourth element is -- of our capital allocation policy is share buybacks. And taking into account the excellent underlying free cash flow performance in the first half of the year and the group's strong balance sheet, we are accelerating our share buyback and increasing the amount from GBP 100 million to GBP 150 million, and the buyback will commence on the 1st of August and is expected to complete during the first quarter of 2025. So you can see that our excellent free cash flow performance continues to support capital allocation. And that's all from me. I'll now hand back to Duncan.

Thank you, Adrian. We made further progress during the period in continuing to execute against our strategy. This slide shows the portfolio of some of our OEM partnerships categorized by manufacturer origin. We have a globally scaled, diversified and prestigious portfolio, which is unrivaled across our industry. Our portfolio of OEMs is a key foundation for our business. And we've worked with a number of OEMs like Toyota for over 50 years and have recently expanded into existing and new markets with other long-standing partners like Mercedes. These long-term relationships highlight that we are delivering for our OEM partners on a consistent basis across a range of markets over a long period of time. We also have a number of relatively new partnerships with Chinese OEMs. And we expect to achieve more growth with these OEMs as they seek to leverage our geographic presence and as we look to categories beyond passenger vehicles. Evidence of our success in this regard can be seen on this slide. This shows the new distribution contracts won during the first half and the related markets, including the annual industry volumes of those markets. 3 of these contracts are with Chinese OEMs, in the Americas, where we are further leveraging Derco relationships. In addition, I'm delighted to say that overnight, our team in Australia has won a distribution contract with Foton, the largest Chinese commercial vehicle manufacturer. On the right, we give an update of the development of other contracts won in recent years. And as you can see, we're making good progress. We're driving initial volumes with Great Wall Motors in Indonesia, supported by a strong product range and brand positioning. In the Philippines, we've refreshed our third-party retail network to support the Changan rollout. We've been working with BYD in Belgium for over 2 years, and we continue to support them in driving volume growth in a key EV market in Europe. And finally, we ran a successful launch for Subaru in Ecuador in the period to support the brand road map there. We expect to win further distribution contracts to help us drive market share with more OEM partners in more markets. We continue to enhance our distribution platform through the development of our proprietary data and digital analytics capabilities, which helped to drive superior performance for Inchcape and our OEM partners. Our 2 key technologies are DXP, our customer experience platform, and DAP, our data analytics platform. DXP is a fully functional omnichannel customer-facing platform, which enables us to capture significant customer and vehicle data. DAP provides advanced analytics and machine learning, leverages our data and drives smarter, faster and better business decisions. These elements are supported by a common global technology stack and driven by specialists in our digital delivery centers in the Philippines and Colombia. During the first half, we expanded the breadth of coverage of our core AI solutions into our recently acquired businesses, and we developed and deployed new market-leading AI solutions, including an AI-based quotation capability for repair services. So we continue to make excellent progress in digital and data, which is a key differentiator for the group, helping us to drive better -- helping us to better support and develop OEM partnerships. We see many exciting opportunities for growth and innovation ahead. To sum up today, Inchcape delivered a resilient performance in the first half with a strengthened balance sheet. We increased our share buyback to GBP 150 million with an accelerated time line. We are reaffirming our guidance for 2024 at constant currency. And as Inchcape becomes a pure-play automotive distributor, we are well placed for future growth, supported by a healthy pipeline of acquisitions and contract wins.

Thank you very much indeed for your presentation. [Operator Instructions] Just saw the team take a few moments to review those questions submitted today, I'd like to remind you the recording of the presentation, along with a copy of the slides and the published Q&A, can be accessed via your investor dashboard. [Operator Instructions] I'd now like to hand you over to Rob Gurner, Head of Investor Relations to host the Q&A. [Operator Instructions]

Thank you, Paul. Good morning, everyone, and thanks ever so much for your questions. Really good questions. And many of them, so we'll try to get through them in the next half an hour or so. The first series of questions is around capital allocation. I've got 3 sort of questions that have been received. The first is, can you talk about how you balance your 4 priorities and capital allocation. That's you, Adrian, I think. Second is, can you explain why the buyback amount was increased by GBP 50 million? Again, that's for you, Adrian. And then the third question in this area was, can you talk about the acquisition pipeline, your approach, your focus areas and your targets, for you, Duncan.

Okay. Thank you very much, Rob, and thank you very much for the question. It's great to be here today. Capital allocation is a -- it's clearly articulated, and you heard it in our presentation from yesterday morning. It is set out in priority order. And so our first priority is to invest in our business through the lens of CapEx, and we guide to less than 1% of revenues, and we have, in recent times, been tracking slightly below that. The second thing we do in terms of how we apply capital, we are committed to our dividend policy and you saw us today -- or yesterday rather following that policy with an 11p dividend per share to the interims. And then we have a choice. We do value accretive M&A. And our fourth priority with the funds leftover from that, we return money to shareholders via share buybacks. And we do all of that within our balance sheet leverage limit of 1x EBITDA. We started the year at about 0.8. We finished the first half at 0.7. And we -- and off the back of the very strong cash flows we've seen in the first half of this year, we're continuing to apply that capital allocation policy, which is why we have expanded the buyback to GBP 150 million off the back of that strong free cash flow and in the context of the disposal of the U.K. business, where we expect to receive GBP 350 million of proceeds in the next day or so. So it's a very clear policy. We make sure our acquisitions are value accretive. That means we look for acquisitions that can both expand our footprint in integrated markets and also build scale for us in the markets that we're already in. And that really is one of the priorities that we will continue to pursue in the second half of this year, particularly with expected transactions and outflows from a cash perspective for 2025. And in that answer, I've also hopefully covered the second point about why did we increase from 100 million to 150 million? It was because of the very strong free cash flow in the first half, and we were just simply following our capital allocation policy again. And in the context of all the different priorities we have, we thought that was the most appropriate use of those funds from the first half. Duncan, if I can hand to you.

Very good. Thank you, Adrian. So look, if I talk about the bolt-on acquisitions and the way we think about them and our pipeline. So we specialize in running markets for OEMs in smaller- to medium-sized markets that tend to be faster growing with low motorization rates. This is the number of vehicles per 1,000 people. And if you think about the average in Europe is around 550. Many of the markets that we are targeting, if I give the example of Indonesia has motorization rates of less than 100 in -- and we know that when we get GDP growth, we get TIV growth, total industry volume growth, which will increase motorization over time. So those are the markets we're after. We categorize them into A markets, B markets and C markets. And clearly, we want to be going after deals in A or B markets with really great OEMs. As Adrian mentioned, we are disciplined around what we pay for these -- what we pay for these businesses. And we use organic cash flow to fund our bolt-on acquisition. Now if I give you one example about how this plays out for us, which the example would be Simpsons in the Caribbean, which was a new attractive market for us. That piece of M&A is going very nicely. And then we announced this week that we've won a contract win there with Changan, and we'll run the Changan business to the existing infrastructure in the Caribbean, which makes some nice accretive growth for Inchcape.

And then this is actually a follow-up on that point around acquisition from another attendee of the call. Are there any scale players out there, the size of sort of Derco or near that sort of scale that you'd be interested in looking at? Or you just very much focused on bolt-on acquisition essentially?

Look, we were clear in our messages yesterday that we see we have a healthy pipeline of bolt-on acquisitions. That said, we are one of a very small number of companies that is capable of going after larger deals over time. But the signal we gave you say is pretty clear that we are looking for bolt-on acquisitions as we move towards the back end of '24 and to 2025.

A question on the operational performance. How do you interpret the mixed performance across the regions with strong growth in APAC and Europe, the decline in the Americas? And what underlying factors could be contributing to these regional discrepancies?

Well, if I start off with that, Rob. Look, what we've built at Inchcape is a diversified scaled business. Because what we know is you always have some markets going up as others are coming down. And that's what you can see over the last year or so. But despite that, Inchcape continues to grow. So building a diversified business is really important to us, and that's what we've been able to do, and there is more to come. Adrien, do you want to give some color on the market.

Sure. Yes. Look, I think -- the question, I think, is why are they different? And I think one of -- and to Duncan's point around the benefits of geographic diversity, we're operating in nearly 40 markets as a distributor of -- representing over 60 brands. Some of those markets are running at different paces. So in somewhat -- so in Asia Pacific, for example, and in parts of Europe, we've seen economic growth, and we've seen growth in the number of cars being sold in the marketplace, and therefore, our share of those has also grown. So some markets are seeing very strong growth. I'll cite Greece is a good example of that. The economy in Greece is performing very, very well. The number of cars in the market has grown, as has our business because we're performing in line with and, in fact, ahead of that market. And then you go to somewhere like Latin America where economically, it's been a little bit more challenging. Consumers haven't been -- haven't had quite the same confidence as we've seen in other territories. And if you look at the overall Latin American footprint that Inchcape operates in, our markets are about 9% lower than they were in the first half of last year. Now sequentially, they're materially consistent once you adjust for a better seasonality with the exit rates of half 2 2023. But nonetheless, they are continuing to track at historically low levels, particularly in markets like Chile and Colombia. But over time, those markets will come back. They're set for structural growth with low motorization rates and high on average GDP growth over time. So these markets will come back and the work that the teams have been doing in those markets to scale down the cost base will set us up to enjoy operating leverage as those markets rescale. But certainly, Robert, as part of this -- part of the makeup of our business, not all markets operate run at the same speed and we have different temperatures, as you can see in our organic results. But what you see in -- Inchcape doing is continuing to deliver growth with various differences and managing the various different cycles we see across our portfolio.

Thanks, Adrian. Follow -- a couple of follow-ups on the regions. You're guiding to an improved margin in the second half of the Americas. What gives you that confidence? Let's put it back to you, Adrian.

Yes, sure. I've just touched on it a little bit there, so I won't repeat the bit about the market. But the work the teams have done around the cost base, both structurally bringing Derco and the Inscape businesses together. The physical integration, the example we gave on the call yesterday was, we have 3 vehicle vehicle processing compounds, so when cars are imported into the market they need to be prepared, cleaned and then -- before for they are then sent out into the dealer networks. We have 3 of those under the -- following the Derco acquisition. We've been scaling that into one, reducing our inventory, so it all fits into one site and driving the economies of scale from a single facility. It's a great example. And so we talked in the call yesterday about an improvement in margin in the second quarter, which sets -- which gives us the confidence to see a stronger second half, and that predominantly was a cost-driven improvement in operating margins and reflects the great work the teams have been doing. And we are -- the management team are taking proactive steps to make sure they continue to stay ahead and set the business up for the -- for whatever demand markets they can foresee.

Thank you very much. And Duncan, one for you here, I think. Can you discuss some of the key market trends in APAC, in particular, Singapore, Hong Kong and Australia and what's going on there? And how is the outlook?