SIG plc (SHI) Earnings Call Transcript

Good morning. Welcome to the interim results for SIG for 2020. I'm delighted to be joined here this morning by Ian Ashton, our new group CFO. He brings great experience. He's a terrific addition to the team, and he's really hit the ground running. Today, we're going to summarize the key events for the first half of 2020, recap the return to growth strategy. And then Ian is going to take us through a financial review of the first half as well as the outlook for the rest of the year. I will then update on latest trading and progress with our plans. And then we're going to open up for a Q&A session. So the first half. As you would expect SIG has been around for a number of decades, it really showed its resilience in quite extraordinary times over the last few months. Our strong EU businesses remained open throughout and adapted to the COVID environment on a continuous basis. And the rapid reopening of the U.K. and Ireland from mid-May onwards, really acted to limit the financial damage that we'd expected from lockdown. And I'd stress at this point that the U.K. business is only about 1/3 of the group as a whole, and that limits the impact of the U.K. lockdown on the overall group. Trading over the summer returned to the pre-COVID levels of around 11% versus prior year. And importantly, back in July, remember, when we completed our refinancing, this is really a defining moment for SIG in our history as we drew a line on the last decade-or-so of cost reduction and contraction, and embarked on a new return to growth strategy. We brought in a new leadership team, and we completed a substantial and successful equity raise. And that was a real reset button and a new beginning. And this has given us both the security in these turbulent times, but also the ability to invest and to reignite growth in the business. And the summer has seen good progress in our plans and we'll go into more of that detail later. I will now go on talk about the strategy. The return to growth strategy is about back to basics. It's about what this business has done well for a number of decades and modernizing it. And I'll start by stressing that we're not a distribution business. We're a local technical sales and service solutions business. It's based on proximity and intimacy with our local customers, on deep expertise in the products of our suppliers, and on a service of really understanding what our customers need. And that, as a whole, allows us to maintain differentiated margins into the long term. The strategy is built on 7 pillars, the first of which critically is our people. It's based on safety in the business, safety for our people. And as you can appreciate, through this summer, that's been a particular focus of the business and of mine personally. It's about restoring the pride our people have in the business and making sure that they're valued by the business. And fundamentally, we look at ESG as a core part of that. And our ESG agenda is being developed and more of that next year. I've been very fortunate through the summer to be able to tour the French business, the German business to see customer suppliers. But more importantly, really experienced professionals in our business around the group. The number two is branch focus. Branches are the beating heart of our business. We're putting in place as part of this plan, much more entrepreneurial experienced local managers where they don't exist. Primarily that's an issue in the U.K., less so outside the U.K. Number three, customers. Again, our relationship with our customers is at the core of our strategy and understanding them more is critical to that. The fourth pillar is superior expertise. Without the expertise, we can't bring the solution sales that we need to as a business. And that's a key focus of our business as we go forward. The fifth pillar is to get much closer again to our customers and to restore that mutual understanding and real intimacy with their issues and then with our issues and our plans. So that we could be faithful to their systems at technology as we bring them to the marketplace. Number six is importantly not about cost reduction. We've got to be efficient, yes, but it's about productivity. We will invest behind our sales force, our operations and our systems to make sure we increase productivity, so we can create more sales from the cost base that we have rather than reduce costs. And the seventh pillar is really to start expressing the core of our business in a more expensive way, not in a contracting way, so that we create a more expansive vision of what we're going to be as a business and create the space to grow. And in that, we're looking to invest to upgrade and enrich our products, our facilities and to extend our geographic reach. In the end, we're looking to build a great growing business on a sustainable basis. Moving on to our growth plan by geography. It's important to stress again that the U.K., which is 1/3 of our business, needs a different approach at the moment. In the end, the same destination, return to growth plan, but it does need a fundamental restoration of expertise, a restoring and focus on branches and a reconnection with customers and suppliers. On the other hand, on the right-hand side of the page, our EU businesses, which is 2/3 of the group, fundamentally in a much better place. There's some work to do to revitalize the German sales effort, but fundamentally, they're ready to kick on. So stepping back, in all of our markets, there are positive market conditions, and we're well positioned to take advantage of them. I'm now going to hand over to Ian to go through the first half financials in more detail.

Thank you, Steve. Good morning. It's a privilege to be here as CFO at SIG. This is my third month, and it's a great time to have started at the company. Despite some of the current restrictions, especially for travel outside the U.K., the energy and optimism within the company is still very evident to me as we start on the journey of growing the business. My initial impressions of the organization of what I hoped and expected they would be. I've joined an experienced and motivated management team that's united in their belief in the new strategic direction, confident that they know what needs to get done and very determined to succeed. I've also joined a very engaged and energized Board. I'm greatly looking forward to working with them, with Steve and with all of my new colleagues. So my first slide, the key financial metrics for the first half. It was clearly a difficult and unique 6 months to June. I'll look in more detail in a moment at all the key elements on this slide. But overall, in the continuing business, we reported a GBP 43 million loss at the operating profit level, driven by a 24% reduction in sales, primarily COVID related and a loss before tax of GBP 125 million after non-underlying items. The total statutory loss includes a one-off gain of GBP 70 million on the sale of the Air Handling division, which completed early in the year. The net proceeds of GBP 152 million from this sale helped reduce net debt to GBP 90 million on a pre-IFRS basis at June, the basis which is probably still the most easily understandable and meaningful to most at this stage. We are, of course, reporting on a post-IFRS 16 basis. I would emphasize the numbers in the last bullet on this slide. After the receipt of the equity proceeds in July, we went into a net cash position. And you can see the recent position at the end of the last full month we reported internally, GBP 29 million of net cash and GBP 268 million of gross cash balances at the end of August. So we are well placed to both weather any further market uncertainty COVID-related otherwise, and also to invest appropriately behind the new growth strategy. On revenue, when I joined the business, it was good to see that it had been outperforming the revised short-term expectations that have been set at the outset of the pandemic. And whilst we clearly cannot read too much into that as a comment on actual performance, it did reflect that there was a new and welcome sense of realism about the setting of targets. Looking at the numbers. The restated 2019 H1 number of nearly GBP 1.1 billion fell 24% to GBP 818 million. The effects of lockdown measures varied by market, but we estimate that in aggregate, our Continental European businesses would have been flat on prior year without the pandemic. Whilst the U.K. decline of 40% was split roughly 50-50 between the COVID effect and the underlying underperformance that the business started to see most clearly in the second half of last year. Timing-wise throughout the half, we saw a decline of 11% in group sales versus prior year in January, February combined, i.e., pre-COVID; a 37% decline during the peak lockdown months of March and April, with the U.K., Ireland and France, notably more affected than Germany, Benelux and Poland; and then an improvement in May and June to a decline of around 22% combined. July and August has seen continued improvement, as Steve alluded to, to an approximately 11% decline over prior year. Steve will talk more about our trading trends in a few minutes. So on gross margin and OpEx, gross margin was down as expected due to the lower sales and lower rates of supply rebates resulting from the lower volumes. The U.K. distribution showed the largest decline. There are some opportunities to fill Johns and his team to improve the margin through the implementation of some increased disciplines around pricing, and this will certainly be an important to focus for his team and indeed for me and Steve. OpEx versus prior year is distorted by some releases in the prior year and some temporary costs this year related to the changes in the U.K. business and the group as a whole. These were largely offset by receipts from furlough schemes. Bad debt reserves did rise in the response to the pandemic, and we will continue to assess those in H2. Overall, the business did a solid job in monitoring and controlling costs in the first half, perhaps despite the headline number. Profit before tax for the continuing business declined from a GBP 17 million profit last year to a GBP 54 million loss. I've set out the details already on this, it is clearly almost all a sales volume-related drop. Our other items, i.e., those nonunderlying items in the continuing business totaled GBP 72 million in the half. The [ ]largest item was an impairment of goodwill in the U.K. business of GBP 42.8 million. This is, to some extent, a somewhat technical charge. When we published our full year 2019 results in May, the impairment reviews had to be based on estimated cash flows from the first of January, ignoring the COVID impact as the pandemic was a non-adjusting post balance sheet event. The impact of the pandemic has now been reflected in the model as has a slightly higher discount rate to reflect the greater market uncertainty. These factors have led to this further impairment. The small profit on disposals and exits relates predominantly to the profit on disposal from the Middle East business in January 2020. Restructuring costs of GBP 3.5 million relate mainly to the U.K., both costs incurred in relation to the final stage of the move to the target operating model and then costs related to the merging of the Exteriors & Distributions business commenced in the spring following the change in senior management. The omnichannel item refers to costs involved in winding up the previous e-commerce strategy. Some of the cash costs related to payments for items charged in other items in H2 2019. Whilst we do believe that digital will be an important part of our business over time, this particular project did not deliver enough to warrant continued investment nor as a result, continued recognition as an asset on the balance sheet. Non-underlying finance costs relate almost entirely to the loss on modification of the private placement notes. Under the relevant accounting standard, IFRS 9, the old and new interest rates are essentially blended and charged over the full term of the notes, past and future. This results in essentially a captured charge in interest. Refinancing costs consist of GBP 7.5 million of legal and adviser fees, offset by a small hedging gain which needed to be recognized in the P&L account. Most of the GBP 7.5 million legal and adviser fees were paid in July and hence, the lower cash costs in the half. Working capital. Working capital increased by approximately GBP 12 million over the half year. There were various moving parts within this, notably a reduction in factoring in our French business of circa GBP 22 million, which drove the overall increase. These factoring arrangements have been in place for some time. The business has typically held back creditor payments at the midyear and full year points quite aggressively. Payments were not delayed to quite the same extent at June as in the past, and that also affected working capital versus prior year. And there will be a further unwind of that creditor stretching at the full year. Other elements of working capital were affected by the old trading in the half, notably, a slight increase in inventory. On net debt, this slide shows the movement from GBP 163 million to GBP 90 million of net debt at June, driven by the Air Handling proceeds, as already discussed. You can see the working capital movement on this slide, including the factoring element within that. The GBP 8 million movement on the left-hand side relates to the asset-backed scheme that we have linked to the U.K. pension scheme. This cash was previously trapped, but is now available for group use. CapEx was GBP 13 million in the half, a lower rate than historically as the business prioritized projects rigorously to conserve cash at the outset of the pandemic. Key point on here is at the most recent month end in August, we have net cash of GBP 29 million and gross cash of GBP 268 million, as I mentioned previously, after the completion of the equity raise in early July. So capital structure, a quick reminder of the key points on our refinancing and equity raise. Our debt facilities are now GBP 233 million in total and comprised GBP 138 million of notes, a term loan of GBP 70 million and an RCF of GBP 25 million. We have not drawn down anything on the latter. So as at the end of August, the last month we reported internally, we had liquidity of GBP 293 million, being the undrawn RCF of GBP 25 million and cash balances of GBP 268 million. We have a minimum headroom requirement under covenants of GBP 40 million and hence headroom of approximately GBP 250 million. On the right-hand side, you may be familiar with the key points around the equity raise. As you know, Clayton, Dubilier & Rice are now our major shareholder, and we also look forward to their involvement and input on the Board, which is already very positive. In terms of outlook, market fundamentals remain sound, although there does remain significant economic certainty in the short term. Compared to the initial estimates of the possible COVID impact, trading was better-than-anticipated in H1. And so full year 2020 sales are now expected to be moderately higher than previously guided in May. H2 is expected to remain loss-making, but at a lower rate than in the first half. And on liquidity, I've mentioned our net cash and gross cash and liquidity position a minute ago, we do expect continued underlying cash outflow in H2, partly due to the unwind of the cash deferrals related to government schemes related to COVID. And we do also expect the unwind of some of the historic aggressive management of creditors, which I mentioned previously. So overall, a net cash outflow expected in the second half. With that, I'll hand it back to Steve.

Thanks very much, Ian. I'm now going to talk a little bit about our trading and give us update on strategic progress. So overall, this next page looks at the revenue trend month-by-month through this year. You can see at the beginning, the group level. You can see at the beginning of the year, we started with our sales already below prior year. This is to you, as Ian has mentioned, to the loss of market share, primarily in the U.K. and the latter part of 2019. You can see that COVID had a very severe, but actually in the end, relatively temporary impact on the group. At its worst, group sales were down to 46% of pre-COVID levels in the prior year. But as you could see also, they quickly recovered as the lockdown eased. And by June, we were only 6% below prior year. And you've seen in the summer, in the last couple of months that we're trading at about 11% below prior, which is approximately the same level as we were at the beginning of the year. So the effects of COVID have pretty much left the business at the beginning of summer. The next notable feature is that the gross margin fell. As a result, primarily in the U.K., it should be said, but as a result of the volume effect on rebates, but also in a business like ours, if you lose discipline in sales and lose market share and you're not selling the solution effectively, that will have an impact on margin. So there's partly a margin discipline issue primarily. It's a U.K. issue and partly a rebate issue. The rebate issue we expect to come back relatively quickly. The margin issue will come back as the U.K. business progresses with its plan, and I'll talk about that in a minute. Coming on to the EU, there you see a much lesser impact. Firstly, at the beginning of the year, the business was trading pretty much in line with prior year. So market shares broadly been held flat across our EU businesses, which after all, are 2/3 of the group. You see a much lesser impact in April of COVID, and that's primarily due to the fact that French business closed for a few days early in April as a result of the government instructions to do so. But I said, it was only a few days, just over a week, but it was actually relatively close. Otherwise, all of those businesses stayed open throughout and traded on a COVID adapted basis well through the lockdown period. And as you can see in the summer, our trading pretty much back to prior year levels. So really strong performance. And in fact, in the French business, very clear signs of market share being gained because the business more proactively managed through the lockdown period and gain share, which is it's held since as a result. Going to the U.K., here's a different picture. As you can see at the beginning on the right, the business began the year trading at 25% down in revenue terms year-on-year. And broadly speaking, that's in market share terms as well. So in the first quarter, it traded on that basis, you could see a much more severe hit in the beginning -- the end of March and certainly into April, the whole industry was impacted. The whole construction industry was impacted to similar levels. But the other thing that's notable here is that the business opened up, I would say, around mid-May, most of the branches were open. As you can see, the sales came back really quickly. And in June, sales were back to 77% of prior. And again, that's roughly the level of Q1. Through the rest of the summer, some signs of share gain and the usual seasonal trends but trading at about 20% below prior year. I'm going to now talk a little bit more about the U.K. market share recapture plan. Firstly, Phil Johns took over the leadership of the U.K. and merged the leadership of the business at the beginning of summer, as you know. His biggest single challenge was to attract back top talent, partly alumni of SIG and partly new people to the business from the marketplace. And I'm pleased to say he's had tremendous progress and success in doing that in the past couple of months. Today, the combined distribution and roofing team comprises 20 new senior recruits. Each one of them is being inspired to come back to SIG and inspired by the return to growth plan and by the leadership in that team. And that's a really big milestone for our turnaround plan. These are first rate experienced winners, in numbers back in the business. In addition to that, we've completely turned the structure upside down back to being branch based, branch driven. And key in that is to reappoint people as branch managers. That role was left behind a couple of years ago and has been reinstated as the center -- central organizing pivot point of the business. So the 324 positions have been filled in the last couple of months. Of those, roughly 50% are great internal candidates, who, if you like, were playing out in position, so they were in operational roles when they're fundamentally commercial and salespeople. They've been put back into the positions where they play best and where they work best. In addition, about 38% of those are experienced winners that we've recruited from the marketplace. In many cases, but not all, with long SIG experience prior in their career. And in that, they're only about 12% of vacancies, and all of the key roles are already in place. As you can appreciate, that is a huge shift for any organization and they're spending a lot of time now bedding down the team. It's a longer process than a month or 2, but at least they're now in place, and that's a really important milestone for the plan. The other point to note is that this involves reuniting many old colleagues. They know how they think, and the footballing analogy is if you pass the ball to the left, you know someone's going to be there. And that's a really important feature of what Phil has been able to do to re -- restore teams that have worked together for many years. Secondly, we've been removing blockages. Removing blockages that stop the ability to sell and to provide service on a timely basis. We've been giving back inventory control and visibility to the frontline teams and the local teams. We've been giving back logistics control and visibility to them as well as pricing, but maintaining a central governance and control over both. The newly appointed account teams are building plans with the key customers again, and some old relationships are being rekindled in the new SIG team. And lastly, we're treating suppliers once again as if they were customers in the same way and giving them the attention and the focus that we maybe haven't been over the past few years. We're also looking at investing in the branch network, either through greenfield or potential small add-on acquisitions to fill gaps in our footprint. Overall, now, we've got the leadership in place; we've got a strong new branch and sales team; they're energized; the plan is on track and they're delivering to plan. Coming to our medium-term financial targets. As you saw at the beginning of the summer, we laid out our medium-term plan. The heart of it is to restore the operating margin at group level back to the 3% levels that you've seen over the past decade. And then within that, because a number of the operating companies are operating at 5% levels within that to start to migrate the group beyond the 3% level. But our ultimate focus here is on revenues and not margin maximization, but getting it to a sustainable level. Secondly, we're reiterating our leverage target below 1.5x, and our dividend cover target, once the appropriate leverage has been established of 2 to 3x. So in summary, the equity raise and debt restructuring is complete. This is a full financial reset for the business. And with it, we bring 2 new board members from Clayton, Dubilier, who are already, as Ian has said, starting to make a really substantive impact on the operating decisions and planning in the business. Secondly, COVID-19 has demonstrated conclusively resilience and adaptability of our business and our ability to minimize the impact of COVID so far. And I've got to give once again, thanks to our people who've shown huge professionalism and commitment. And in some cases, bravery, through really challenging times. I stress again, the U.K. is 1/3 of our business, and therefore, any lockdown measures in the U.K. have a lesser impact at group level financially. Thirdly, our return to growth strategy progresses to plan. I'll state again, this is not an overnight turnaround. This is a rebuild, and it's going to take many months. And so we do not expect to see material financial outcomes from that until we're well into next year. Fourthly, I'm really pleased to see steady trading and a strong liquidity position and a really good start to our return to growth plan. And lastly, the foundations are in place for delivery. Our medium-term expectations remain unchanged. We're in the early stages of a 12- to 18-month plan, and we're highly confident of delivering in the medium term. Thank you very much for your time. I think we'll now take some questions.