RS : Trading Update (TRANSCRIPT)

Orient Capital: RS Group plc Trading Update 1 07/07/22

RS group plc Trading Update

Lindsley Ruth:

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 a solutions offer and making it easy for 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 over to David to provide color on our first quarter.

David Egan:

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 percent. Our main own-brand product range, RS PRO, grew revenue by 21 percent. 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 percent like-for-like, with digital accounting for 63 percent of our group revenue in quarter one. And we continue to see a reduction in one-time, low-value customers because we have shifted our commercial focus.

So, moving now to the regions, EMEA, which accounts for 60 percent of revenue, saw like-for-like revenue growth of 16 percent. Throughout the region, we have seen growth in the average order value, helped by an element of price inflation. We've increased the 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 percent 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 for 30 percent of group revenue, saw 24 percent like-for-like revenue growth.

Strong growth is driven by the investments and the changes made to our production and a supportive market -- a proposition and supportive market, sorry. Within the product mix, our core competency in terms of Automation & Control products delivered the strongest growth, with electronics at mid-single digit. Synovos continues to win new contracts. And we're working on several global pitches, including the IESA business running operations in the Asia Pacific for multinational corporations.

The Asia Pacific, which is circa 10 percent of Group revenue, grew by 13 percent on a like-for-like basis. The impact of the Shanghai lockdown reduced revenue growth by circa 4 percent 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 percent 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 margins 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 provide 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.

Lindsley Ruth:

All right, 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. When we talked to you that we were losing 10 percent or £23 million in Asia, and now, last year, we delivered north of 11 percent in terms of profit, and so I'm delighted to announce we acquired Domnick Hunter in Thailand . It's £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, purification and filtration products in Thailand with onsite service expertise. So really an 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 the development of our service solutions in the Asia Pacific and be a key differentiator versus our competition. And we actually saw photos today of our team; David and I saw 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 five, 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 percent of our revenue from digital channels in '21 and '22. We're solving our customers' problems -- with 23 percent of revenue coming from product and service solutions. We're operating more efficiently -- with 28 percent operating profit conversion. And we've invested our model -- both in operations and assets -- delivering a much stronger return on capital at 29 percent. 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-to-margin management and being commercial. We have a profit mindset within this business today.

And slide six illustrates how much we have changed. We're an international business. Nearly 40 percent 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 is relevant with greater end-to-end control. We're focused on knowing and providing what our industrial customers want. We have a more talented, targeted, and relevant product and service offer with our strong own-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 omni-channel, 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.

Male Speaker:

As a reminder, if you'd like to register a question, please press star followed by one on your telephone keypad. If you change your mind, please press star followed by two. And please ensure you're --

Lindsley Ruth:

Jordan [spelled phonetically], any questions?

Female Speaker:

Okay, I'm [unintelligible]. I've got a question that's come in online. On pricing, you talk about low double-digit contribution to the organic growth rates 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 two-year pricing stack across the year, or is there further upside?

David Egan:

Let me take that just partly. 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 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 costs 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 £210-211. And so, you know, 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, you know, our objective is to, you know, 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.

Male Speaker:

Our next question comes from Rory McKenzie of UBS. Rory, please go ahead.

Rory McKenzie:

Firstly, to focus on that underlying real volume growth component, which it sounds was around 6 percent to 7 percent in this quarter, after more like 12 percent to 13 percent 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 improved, which could mean that starts to come down? And can you also discuss how you think about buying inventory at these elevated pricing levels? Thank you.

Lindsley Ruth:

Yeah, so great questions, Rory. I think, you know, first of all, I'd just tell you, availability is improved. So, our availability is back up to where it was before, north of 90 percent, close to 92 percent. So, we're happy with that. Our teams continue to work quite hard on getting products 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 order. So, we're being careful on that front.

In terms of the industry, we're not seeing -- you know, there's certainly signs out there in the markets that the market is slowing, and we'd be naive not to think that. We continue to outperform, and we're growing market share. So, we're growing volumes, 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, you know, there are signs certainly out there in the economy that -- certainly in Europe that there is a slowing. But we're -- you know, as I said it before, you know, we've transformed this company, and we expect to grow, just to be clear.

David Egan:

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 percent in the quarter was a little lower than it was in the past. You know, 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 still remains very strong as well. And then the final point on inventory, you know, we're just managing the inventory as best we possibly can. Our objective is to potentially tweak up the inventory terms a little bit, just to make sure that we don't get, you know, 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, you know, 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.

Rory McKenzie:

That's great. Thank you both very much.

Male Speaker:

Our next question comes from Oscar Val of JP Morgan. Oscar, the line is yours.

Oscar Val:

Yes. Good morning, Lindsley and David. I have a couple of questions. The first one is on inflation on your warehouse and transport costs. You comment that you're seeing on the top line low double-digit. Can you comment on the warehouse and transfer costs that you're seeing there? The second question is on the German warehouse expansion you mentioned hasn't really started to contribute yet. Is there any timeline on when you think you'll get the benefits on volume and costs? And then the final question is a bit more high level, but you have a mid-teens margin target. And clearly, we are 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?

Lindsley Ruth:

So, let me take the last two questions. I think first of all, on the mid-teens operating margin, we expect that there's a slowdown to still deliver a high degree of profit. Now, would it be mid-teens? You know, maybe, maybe not, it depends on how tough the 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 profit in the last two years. And so, I think that's definitely doable.

David Egan:

Yeah, I would concur with that. Our objective is to continue to move, you know, the top-line forward profitably, which is then going to contribute to the margin. You know, 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, 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.

Lindsley Ruth:

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 two years from that expansion. We're still working through some of the minor issues of a new DC, but not significant.

David Egan:

And then, with regards to inflation and transport-related, I guess sort of on an optics perspective, the two big inflationary effects on the optics is weight inflation. So, for us, it's running around 5 percent to 6 percent across the world, and then there's transport, and that's transport outs. 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 gotten any better. So, the guidance that we provided in the past pretty much sticks at this point in time on transport.

Oscar Val:

Great, thanks a lot, both.

Lindsley Ruth:

Thank you, Oscar.

Male Speaker:

Our next question comes from David Brockton of Numis. David, please go ahead.

David Brockton:

Good morning. 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 a 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?

Lindsley Ruth:

Yeah, 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 the opportunities. However, we are slowing down the conversations because of evaluations. We think valuations will go down, especially with P.E.-backed deals, family-owned deals, you know, 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 you know, there's still some great opportunities out there. But as I said in the beginning, our number one 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.

David Egan:

Yeah, 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 -- you know, 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 and make them profitable or not necessarily encourage them into the equation. For our b2b customers, you know, 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, so far, you know, 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 solution side of our strategy.

David Brockton:

Thank you very much.

Male Speaker:

As a reminder, for any questions, that's star followed by one on your telephone keypad. I'm now going to hand over to Tom Truckle of Jefferies. Tom, please go ahead.

Tom Truckle:

Yes. Hi, Lindsley and David. Just calling on behalf of [unintelligible] here at Jefferies. I have two questions, if I may. The first of which is that 6 percent to 7 percent 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 FY23. 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? I would be keen to hear if there's any thoughts on that. Thank you.

David Egan:

So, in terms of the leverage, our capital allocation approach is consistent. You know, we will 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, you know, if opportunities don't come in an appropriate timescale that we will consider other, you know, capital allocation, including buybacks. It's not something that, you know, is high on our agenda, but it certainly we understand the appropriate and the responsibility that we carry. But at this point in time, you know, 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, you know, it was all market share, wallet share gain.

Tom Truckle:

Great, thank you.

Lindsley Ruth:

Thanks, Thomas.

Male Speaker:

Again, for any final questions, that's star followed by one on your telephone keypad. We have no further questions on the line. So, I'll hand back for any closing remarks.

Female Speaker:

I've got one that's coming in 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?

Lindsley Ruth:

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, you know, David and I were in Milan in 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 [spelled phonetically] can arrange something in the not-too-distant future. But the attitude 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 were 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 know, 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 that 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.

David Egan:

I think the only build I'd say is we also had the privilege of being in our [unintelligible] 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 you know; the cultural aspect is live. And it makes a difference. And Lindsley also was fortunate to be in France, probably six or eight 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.

Lindsley Ruth:

Any other questions? Jordan?

Female Speaker:

Not online.

Male Speaker:

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

Sid Sukumar:

Good morning, both. Congratulations, firstly, on a very strong quarter, given the conditions. I just wanted to get -- 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?

David Egan:

So, as I said earlier, I think you know, capital allocation for us will remain organic, in organic dividend, progressive dividend. You know, our pipeline of opportunities in organic 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.

Sid Sukumar:

Thank you.

Lindsley Ruth:

Jordan, any other questions?

Male Speaker:

We have no further questions on the phone lines. So, I'll hand it back.

Lindsley Ruth:

All right. Listen, I 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 number one priority is organic growth, so you can count on us to work hard and continue with success.

David Egan:

Thank you very much.

Lindsley Ruth:

Thank you.

[end of transcript]