Luceco plc (LUCE) Earnings Call Transcript

Good afternoon, ladies and gentlemen, and welcome to the Luceco half year results investor presentation. [Operator Instructions] And if you could give that your kind attention. I'm sure the company would be most grateful. I'd now like to hand over to CEO, John Hornby. Good afternoon.

Thank you very much, Marc. Hello, everybody, and welcome to the interim results presentation for Luceco PLC 2023. Slightly ahead of where we thought we would be in the summer. Revenues of GBP 101 million. However, that is a reduction on last year of approximately 5% and adjusted operating profit of GBP 10.8 million, which is approximately 6% below last year. There was, however, in the first half, approximately GBP 5 million, which was the end of the customer destocking. So without that, the performance would have been a couple of million pounds better at the operating profit level. Adjusted EPS of approximately 5p, which is 14% down year-on-year. However, we have a very unleveraged business with a balance sheet of 1.3% in terms of the net debt ratio, which should be below 1% at the year-end. The business has improved as the year has gone on. The first quarter we were experiencing the destocking and the second quarter was significantly stronger. The markets in which we operate, however, are weak. Some of the non-residential infrastructure businesses we have, however, had outperformed. But overall, the decline in revenue has been less than expected as the noncyclical businesses have outperformed. And input costs, particularly freight and other raw materials have been subsiding and our gross margin as a result of the price increases that we put through in 2021 and 2022 was significantly higher in the period. Some of the businesses that we have bought recently, particularly the EV business and the DW Windsor lighting business has performed strongly in the first half. And the EV business is an exciting proposition with a strong pipeline of new products. So the outlook for the rest of the year. In July, we thought that our trading would be in line with last year. We now think it will be approximately GBP 1 million ahead of last year, and that's an upgrade to the guidance that we had issued before. However, we do remain mindful of the uncertain macroeconomic environment and the potential impact this may have on our business next year and beyond. And with that, I will hand over to Will Hoy, who will take you through more of the financial numbers.

Thank you, John, and good afternoon, everybody. Let me start by pulling out some of the key themes in our numbers. Overall, revenue decline of 5%. And on a like-for-like basis, 5.8%. We've seen a slowdown in underlying demand in the DIY sector, which drives about 30% of group revenue. But demand from other areas of the construction market has remained relatively robust. Our gross margins have continued to recover following the lows of 2022 as much of our raw material bill and our freight costs have reduced. This has in part been offset by higher operating costs, especially wage inflation. We said earlier this year that our median pay rise was 7.5% coming into 2023. And Overall, just about maintained operating margin at 10.7% to the prior year. We were pleased to be able to confirm that the post-pandemic destocking which was such a theme of the second half of 2022 appears to have come to an end during the first half of 2023. I'll get into the numbers in detail on the next slide. Income statement, Slide 7. Reviewing the income statement, you can see that revenue came in at just over GBP 101 million. That was 5% lower than the first half of 2022, less of a decline than we had anticipated. The reduction in DIY demand was expected. Against that, we have enjoyed a stronger performance in the LED space and especially in lighting projects. The high cost of energy is encouraging demand for energy-saving lighting projects. Gross margin for the half was 39.4%. Pleasing to see this recovering back to levels we expect at Luceco. This recovery is more of a feature of the easing of input cost pressure, including freight, which has returned now to pre-COVID cost levels. Most key raw material costs, perhaps with the exception of copper, which is proving somewhat zippy. Production volumes have recovered at our manufacturing facility. And as a consequence, overhead recovery levels are improving. They will naturally be allowing between this happening, and it's showing fully in our cost of sales, because the improving cost profile has to work its way through our inventories. Overheads were GBP 29 million, with the majority of the increase year-on-year attributable to the higher wage and salary costs implemented towards the end of last year and a return to more normal sales and marketing activities, which were constrained during the COVID period. Inflation has been running at higher levels, especially in the U.K. and there is consequent upward pressure on payrolls. Adjusted operating profit was GBP 10.8 million, slightly ahead of that anticipated in our July trading update. Our tax rate has stepped up somewhat in the first half of 2023. We continue to take advantage of various government incentives. As we said earlier this year, there were some one-off benefits in the 2022 tax rate. The increase in the tax rate to just over 18%, together with approximately GBP 400,000 increase in our finance charge led to a reduction in earnings per share of approximately 14%, the 5p for the first half. This slide provides a bit more detail on the drivers of our revenue performance. The most significant change to our revenue for this half compared to the first half of 2022, occurred in our retail space and especially our portable power offering. Retail suffered as the U.K. consumer turned away from residential DIY, facing the pressure from the increase in the cost of living and so reduced discretionary spend power. The hybrid channel recovered during the first half of 2023 from the customer destocking experienced in the latter part of 2022. However, the retail side, we're still suffering from destocking during 2020 -- the first half of 2023. Efforts over recent years to rebalance our revenue towards professionally installed products, particularly those installed in nonresidential settings, allowed us to mitigate the slowdown in DIY and benefit as the high energy prices drove strong demand for LED retrofitting. Professional wholesale and projects now make up over 50% of our sales, helping to cushion us somewhat from the short-term consumer demand changes. There's been much comment recently concerning new house building. It's difficult for us to be precise about our exposure to this space because we don't have the perfect site of who are wholesalers sell to. We do though estimate that our overall exposure to new house building is under GBP 10 million of sales. The recent acquisitions and closures is not larger positive given the improvement from our recently acquired EV business. in this chart is that 2022 saw the end of our German and French operations, which delivered sales of nearly GBP 3 million in H1 2022. This slide shows the key drivers of our adjusted operating profit performance. Overall, the story comes in 2 parts for understanding the like-for-like operating profit increase of 7%. And I'll pick this up in more detail on the next slide. Currency has been a headwind during the first half. And from the forward contracts we have in place, we can see that it will continue to be so for the remainder of this year. Without currency impact or on a constant currency basis, we would be ahead of the adjusted operating profit level by about GBP 1 million in the half. The small effect of acquisitions and closures reflected here is similar to the comment I made on the last slide. Looking more deeply into our P&L comparison back to 2022 shows the continuing progress in gross margins. It's pleasing to see that our gross margins are back towards the 39-plus percent. This has been delivered through raw material cost reduction, the improved trade market, favorable product mix and efficiencies at the Jiaxing manufacturing facility, now able to operate at more sensible volume levels and so make better use of the automation equipment that has been installed there over the last few years. This improvement was, in part, countered by the increasing cost of living, especially in the U.K. and as a return to more normal levels of variable pay. Together, these increased our payroll by just under GBP 3 million this first half. We did mention earlier in the year that the median pay rise for the U.K. was about 7.5% with actually the lower earners gaining over 10%. Luceco has historically enjoyed higher sales in H2 than in H1. Last year was an exception to this as customer destocking affected the normal seasonality. We expect this year to follow the more normal pattern. But of course, we do remain cautious given the uncertain economic world we're operating in. Finishing up on the numbers, this slide summarizes our working capital, cash flow and debt performance. In short, as we mentioned in our July trading update, our business has returned to normal post the customer destocking seen heavily in 2022 and continuing to some extent into the first half of 2023. The customer destocking reduced our sales below the level of the natural market demand. The lower quarter 4 sales meant much lower trade debtors at the 2022 year-end. The end of the post-pandemic destocking means sales have returned to more normal levels for the second quarter of 2023. And so our trade debtors naturally have returned to more normal levels. The cash flow consequence of this has been an outflow of some GBP 11 million from trade debtors normalizing. Our overdue debtors metric has not deteriorated, and our inventory has been well controlled during this transition. With the exception of 2021, which is affected by the phases of the pandemic, Luceco typically experienced a working capital cash outflow during its first half of each year. 2023 is a typical year in this respect, only amplified by the recovery in our trade debtor position I just mentioned. The cash outflow we see in the first half of 2023 is therefore, unusual in scale, and we expect positive cash flow for the second half of this year. With that, I'll hand back to John to talk through our business review and outlook. Thank you.

Thank you, Will. I'll just add that on cash flow, the average free cash flow margin over the last 5 years since 2019 is approximately 10%. On $1 billion of sales, we've generated about GBP 100 million of free cash flow, and the average operating margin is 13.5%. In terms of the markets in which we operate, it's a mixed picture. So you can see in the top left, the consumer and the spending on the DIY home improvement sector, that, as we now experienced an enormous boom during the lifetime period of COVID. As we came out of COVID, the start of the graph of the green line on the left-hand side, you can see the market was very weak. It has been improving a little bit on a year-on-year basis, and actually went positive in June before we think probably bad weather weakened the market again in July. I mean, my personal feeling is that the consumer for our products is a little bit stronger than they were before. Certainly, on a like-for-like basis, what we're seeing when we monitor sales out of our large customers, the position has improved to bear as we entered the second half. Moving down to the chart on the bottom left, you can see that residential RMI that we estimate is approximately 55% of our business. That market is forecast decline at 8% this year. So a significant decline. And on -- sorry, new residential housing forecast decline even more near 20%. But fortunately, as Will said, that is only a relatively small part of our business, less than 5% of our sales going to new housing construction. On the infrastructure side and the nonresidential RMI side, the markets are about flat. And these are the noncyclical areas of our business that have been performing strongly. So DW Windsor, Kingfisher Lighting, our own internal the Luceco Lighting projects team have all had a very strong first half. Overall, we think our market in the U.K. is down by about 5%. And we believe we will outperform that market decline this year. Overall, our sales this year will be significantly up on last year, but you need to consider that last year's sales were reduced by GBP 20 million of customer destocking. And this year, sales will be reduced by approximately GBP 5 million of customer destocking. But if you look through the customer destocking, we think our sales this year will decrease by approximately 2%, and the market is down somewhere between 5% to 6%. So we believe that we have gained market share and outperformed the market, especially in these nonresidential areas of our business. The graph on the right-hand side shows the overall construction market which in the U.K. has remained relatively stable. How do we grow this business? Historically, NPD, new product development, moving into adjacent product categories has been a key driver of our growth. The EV charger market, we entered by a small acquisition earlier last year, and we have been investing a lot in the team, in the technical know-how and in the product range and we believe that we can significantly grow our market share of a market which is forecast to grow at 50% between 2023 and 2025. Furthermore, changes in the regulatory environment are boosting the electrical sales in the residential space. And within Lighting, ever increasing efficiency of LED lighting means that the ROI on a retrofit is becoming a much shorter. We also point to the climate emergency and the electrification that is going on in the residential space. And although we don't make or install things like heat pumps and solar panels, we do make the connectors, the inverters and the other infrastructure that is needed around those products. And finally, M&A. As I said, the business generates approximately 10% free cash flow margin per year. And we paid 40% dividend, but that does leave cash for acquisitions. Since IPO, we have made 3 acquisitions. The first one I'll talk about is Kingfisher Lighting, we bought for less than GBP 10 million in 2017, where we had operating profit of GBP 1.2 million. This year, we'll have operating profit of nearly GBP 2.5 million. So -- and we've owned the business for just under 5 years. The DW Windsor business that we bought in 2017, also performing strongly. And the [ EV ] business although it's early days, is also performing strongly, and it's an exciting area of future growth. As I said before, NPD, new product development, innovation and range extension has been a very significant driver of our growth. And you can see here some of the examples of activities that we are and have been involved in. I would particularly point to further work in the EV space and the 3 phase protection range. Currently, we only have a single phase low-voltage offer, but it's a big cash for us worth approximately GBP 20 million per year. And we'll be launching an expansion into 3 phase in the second quarter of next year. We've been investing ongoing in our relationships with the contractor base trying to market more and more to our customers' customer, although we actually invoice the contractors, and we don't do it on a commercial basis the end users of our products. So trying to get beyond the customer, to the customer's customer and to form a relationship via social media, et cetera, has been a big focus for the business. Investments in people, as Will said earlier, we gave a significant pay rise at the beginning of this year. and we've invested in over 4,000 training sessions for our staff. In terms of the climate emergency, we are now operationally neutral as a business within our own operations. So the -- what I mean by that is that any energy that we use ourselves, we either get from renewable sources or we buy offsets. Turning over to the -- a bit more information on the outlook, the markets in which we operate, as I say, housing is down, but the rest of the markets are relatively stable. And that leaves us to be relatively optimistic for the outlook for this year. We have the FOB order book up until the end of October and its FOB i.e., where we supply the big customers directly from China, where most of the volatility in the revenue line has historically set. Normally, we're a second half business, as Will said. Last year was the first year in a very long time. In fact, the only year I can ever remember when the first half was stronger than the second half because the second half was severely impacted by customer destocking. This year, I'm expecting a return to more like 53% in the second half against 47% in the first half, and we have an order book up until the end of October, at least on the FOB side that would support that view. In terms of gross margin, we expect that to improve in the second half. And overall, therefore, we expect a significantly stronger second half than first half, both against first half comparator but also even more so against the comparison of the second half of last year, which was very weak. Having said that, our market -- our core market are obviously weak, and we remain mindful of what the macroeconomic environment may bring for next year. and into the future. So with that, I will hand over to any questions.

Please let me just give you a few moments. John, Will, thank you so much for updating the investors. [Operator Instructions] John, Will, we just see you've had a number of questions from investors this afternoon. Thank you, everybody, for your engagement thus far. I think you've touched on the matters perhaps before after the questions came in. If I could hand back to you, John, maybe just to read out any questions where you feel it's appropriate.

Yes. Thank you. First question from Tom. Your investment in the EV market following the acquisition of Sync, can you see further investment in that market? Is Sync a fully integrated and is it meeting our expectations? I can't rule out further M&A in EV. I think it's unlikely. It would probably be outside of the U.K. if we wanted to buy an EV business internationally, they are not easy to come by. So I think it's very unlikely but not impossible. In terms of further investment, though, yes, we are investing a lot in the product range. We are investing a lot in the technical support. We will be investing in warranty engineers of our own. We will be investing in a commercial operation outside of what we have already. I mean, basically, what we've done currently is integrated the business and using our existing commercial teams to sell into the electrical wholesale channel. There are lots of other channels where we're not as yet operating. So we've owned the business for just over a year. The first sort of phase of that was to really understand the product, understand the market and the technical complications, and it is quite a complicated product and expand the product range. So now that we've done that, we're going to be a bit more on the front foot. From a sales perspective, we've recently recruited a very high-quality individual from one of our competitors. And we have very high hopes for this business in the future. Has it met our expectations. I think the market hasn't met our expectations. So the uptake of EV cars is slower than everyone was forecasting and anticipating. However, I think our performance in the market is pretty much in line with our expectations. But as I say, the market is weak. Okay. And the next question from Nick. Obviously, organic growth is critical, but what are your views on new acquisitions and any particular area of focus. Will, do you want to talk a bit about acquisitions?

Yes, sure. I mean we -- as we both mentioned in the call so far, we have a good core business that's cash generative we do pay out a sort of dividend ratio but that does leave plenty of cash flow to invest in order to grow organically or through M&A. We're perhaps a little bit more enthusiastic about the outside world at the moment and perhaps some others. So we are looking at some acquisition projects now, and it would be nice to be able to bring one of those home perhaps later this year. And the sort of things that we're looking at are things that would have strong synergies with our existing model. So either things that we could perhaps manufacture in our facility or perhaps near adjacent products that would ideally go into the distribution network that we a very good relationship with. So I guess, watch this space, we're back out looking, and we feel like there's a number of opportunities for us to go after.

Thanks, Will. What sort of market share does Luceco have [ this ] mark in each of its end markets. And how does this limit the run rate of growth in these areas, either organic. I mean we operate in so many end markets...

We have perhaps just interrupting John. We have attempted to do a market share, and it is in the -- it's probably in small tech, but in the appendices is sort of about Slide 25 onwards. We've quoted an approximate market share in some of the categories, but we've not told that might limit things, yes.