Electrocomponents PLC

LSE:ECM

Earnings Call Transcript

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to today's Electrocomponents' Trading Update Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Tuesday, 8th of October 2019. And I would now like to hand the conference over to your first speaker today, Mr. Lindsley Ruth. Please go ahead, sir.

[Lindsley Ruth, CEO & Director]

Thank you very much, Carl, and good morning, everyone. This is Lindsley Ruth, CEO. I'm joined by David Egan, our CFO of Electrocomponents plc, from bright and sunny Heathrow this morning. This is a trading statement covering the first half of our financial year to March of 2020. Overall, we're pleased with our outperformance in the first half. We continue to deliver good growth and market share gains in spite of a tougher-than-expected market backdrop and increased uncertainty in some of our key markets. Our relentless focus on the customer, digital leadership and sales force effectiveness continues to be key in driving outperformance, and we're pleased with how our teams continue to execute at a high level. Importantly, while we're extremely focused on managing our performance in the short term, we also remain committed to investing for the long term, and our destination 2025 strategy. And during the first half, we've increased our investment in our strategic initiatives. We continue to invest in infrastructure. We continue to invest in inventory. We continue to invest in talent. And we continue to invest in systems, which will enable us to scale our business and drive sustained outperformance and higher returns in the future. We've made great progress on this in the first half, and we will be able to update you more on this at our interims in November. So let's first focus on revenue and performance. Group like-for-like revenue growth was 5% in the first half. Q2 growth picked up to 5% versus Q4 -- or Q1 for the fiscal year, 4%. So 5% growth in Q2 versus 4% growth in Q1. Growth continued to be driven by strong performance in Industrial as we continue to drive share gains in our key regions. We also saw a rebound in our Raspberry Pi revenue post the launch of Raspberry Pi 4 at the end of June. Pi added around 1 percentage point to group growth in the quarter. Electronics, excluding Raspberry Pi, continued to see mid-single-digit declines, so not as bad as the overall market. However, we're pleased by the progress we're making to strengthen our electronics offer, so we will be well positioned for a recovery in this market. RS Pro, our own private label, saw an acceleration in growth in Q2 and significantly outperforming the group with growth of 10% for the first half. Digital revenues grew broadly in line with the group across the first half. Looking regionally. Europe, Middle East and Africa, EMEA, which accounts for around 64% of revenue, saw 5% growth in the first half, with growth improving to 6% in the second quarter in spite of difficult market conditions. This is a really strong result given the weakening PMIs that we've seen in some of the key markets, particularly in Germany, across the first half, and the U.K. with ongoing uncertainty surrounding Brexit. Our focus on improving our offer and driving value-added solutions means we continue to have good momentum and to drive market share gains in this region. Our Americas business, which accounts for 26% of revenue, grew by 3% in the first half, with a recovery in growth to 7% like-for-like revenue growth in Q2 versus a flat performance in Q1. So again, 7% growth in Q2 versus flat performance in Q1. While we saw a slightly more supportive market backdrop in the quarter, although quite mixed week to week, we also believe our actions to reinvest and reinvigorate our sales force have been key in driving market outperformance and share gains. There remains further work to do in areas such as sales force effectiveness, broadening our inventory offer, our RS Pro, our own label business, and expanding our value-added solutions capabilities. However, our team in the Americas is highly engaged. So I'm excited about the opportunity to continue to drive improvement in the Americas as we move forward. Finally, in Asia Pacific, which represents around 10% of our revenue, we saw 2% like-for-like revenue growth during the first half and 3% across the second quarter. We continue to see strong double-digit growth in Southeast Asia and Australia and New Zealand, offsetting declines in Greater China and for us, in Japan, which is 84% electronics to us. We're working to localize and improve our offer in these markets, and we'll talk more about some of the changes we're making to accelerate performance at our interim results in November. Now moving on to gross margin, costs and profit. Firstly, on gross margin, as highlighted in the first quarter, we expect gross margin to be down by 80 basis points year-on-year in the first half. Foreign exchange had a negative impact of around 20 basis points. The balance of the decline is primarily due to mix and specifically relates to lower growth in higher-margin categories such as connectors and electromechanical products as well as OKdo, the business we launched earlier in this year, which is focused on SBC and IoT and a higher trend towards lower-margin products with many categories. So that's impacted the other 60 basis points of our decline related to product mix. It's important to note that we have seen a stable gross margin overall in our industrial sector as well as in our own private label. Looking to the second half, we expect a more modest year-on-year decline in gross margin and strong growth in OKdo will be partially offset by initiatives on purchasing and pricing. Gross margin remains a key focus, and we want to stabilize and improve our group gross margin over time. However, our ultimate aim remains to grow our business and drive towards a mid-teen operating profit margin. So although gross margin is important, we're relentlessly focused on getting to that mid-teen level of operating profit. So moving on to cost and investment. During the first half, we have continued to tightly manage underlying operating costs while increasing investment in our strategic initiatives. We've increased investment in areas such as electronics. We've increased investment in value-added solutions, in technology, in automation and our supply chain to build a business capable of driving scale and growth over the longer term, and this is all part of what we call destination 2025, our 5-year business plan. We also continue to work on programs across the business to accelerate savings and to drive increased efficiency. We always have to look for ways to operate for less. These activities will finance a higher proportion of our strategic operating investment during the second half of the year. We recognize that our profits that fund our long-term investment. The phasing of cost and the shape of our gross margin trajectory across the year means that, as we highlighted at Q1, we continue to expect to see a higher weighting of profit to the second half of this current financial year. So taking all of this together, we have placed considerable focus on improving our offer in the first half, our offer around solutions as well as products, and we'll continue to optimize our model to make it more efficient so we can invest where appropriate to position ourselves well for the longer term. We're pleased by our performance in the first half. In some regions, we have seen more uncertainty in our markets. However, we continue to capitalize on opportunities to drive growth via market share gains and continue the good momentum we have built. Overall, we remain confident and on track to make good progress during the current year and the years to come. Carl, we'll now open it up to Q&A, please.

[Operator]

[Operator Instructions] Okay. Sir, would you like to take our first question now?

[Lindsley Ruth, CEO & Director]

Absolutely.

[Operator]

Okay. Our first question comes from the line of Mr. Henry Carver.

[Henry Carver, Analyst]

Just a quick one, really, on the -- just on the Americas. Interested in the comments there around the kind of mix of the end markets. Just wondered if you could add any color as to sort of which ones are performing better than others really at -- now more than that.

[Lindsley Ruth, CEO & Director]

Yes, yes. Thank you, Henry. I think we're seeing -- certainly, in terms of -- from a geographic standpoint, Canada is not as strong as the U.S. We don't have a large presence in Mexico, so we've been seeing growth in Mexico over the last 2 years just because we've been investing in those areas. I think for us, in general, we've seen probably a stronger, from a geographic standpoint, stronger performance on the coast, the West and East Coast, as opposed to Central, the central region. But in general, I would say, we've seen a mixed bag. We're not big in automotive. We're also not big in defense. So I know a lot of companies are seeing benefits from defense and a downside to automotive. So I think the general industrial market today is very mixed. And then, of course, you see that in the results announced by many of the large industrial conglomerates.So for us, we're not really -- we'd look at the market, but I see this as a significant opportunity for us to go and what looks to be potentially a lot of recessionary pressures are taking place, and we could be having 2 recessions at some point in the not-too-distant future. I think it looks to be an opportunity for us on the buy side of the business in terms of acquiring talent, acquiring new lines and products and an opportunity for us to strategically invest wisely and outperform the market and take share. So I think we're well positioned right now to increase our sales head count intelligently. The bottom line still matters. And I think we're in a great position regardless of what happens in the market.And I think we're so well positioned right now from a balance sheet perspective that we're going to see a lot of companies struggle over the next, I think, few quarters to 2 years. And this is an opportunity, I think, for us to seize the opportunity in the moment to go accelerate our growth and outperform and take market share. So a long answer to your question, I think, in short, it's really mixed across the board. And in some areas, the customers are doing quite well in the down market and very much like us. So we still only have 93,000 customers in the Americas. And contrast that with close to 200,000 in Northern Europe, we know we've got a long way to go. We're still a real small player in a big market.

[Operator]

Okay. Our next question comes from the line of Chirag Vadhia.

[Chirag Vadhia, Research Analyst]

Just 2 questions from me. On the gross margins, could you quantify the inventory size that's been associated with the changes in the gross margin and if you're looking to see it once again stabilize or increase? And secondly, on the sales force changes in the U.S., just wondering how you remunerate your sales force in that team.

[Lindsley Ruth, CEO & Director]

Yes, let me take the second part first, and then David can talk on the inventory side. As far as the sales force is concerned in the U.S., they're commission-based sales force so they have a base plus a commission. That commission is paid out timely. I don't want to go into a lot of details about what that structure is on the call because sometimes I think more competitors read this transcript than our own employees.But as far as our commission structure, we do pay for performance and I think we have a very fair compensation structure in the Americas for our sales force. We do have kickers around the world for our private-label business. So there's an incentive to sell more on private label. We'll continue to do that on a worldwide basis, not only for the salespeople, for managers as well. So pretty comfortable with the right plan. And any time you bring on new salespeople, it's a bit subsidized for a period of time so you have to give some guarantees. And so in the initial, it takes 18 to 24 months typically to get a salesperson where they're up in providing a return to the company. So that's on average what it takes in the industry. But we're happy with that approach today, and I think we've got the right model in the Americas from a sales commission standpoint.

[David John Egan, CFO & Director]

From a gross margin perspective, we've had less of an impact with regards to the inventory provisioning that we called out in the first quarter. We continue to bring in inventory into the system, particularly around the whole electronics side of our business. So again, we see this as an opportunity to broaden out our offer and also to acquire inventory in a market downturn environment, so we've continued on that particular approach. But the overall impact on the gross margin as a consequence of the provisions has been certainly less. The main impact on the gross margin, as Lindsley called out, has been more around FX and also product mix.

[Operator]

Okay. Our next question comes from the line of Sam Bland.

[Samuel James Bland, Research Analyst]

Just one question from me. I just -- honestly, there's -- group's done 5% like-for-like. Sounds as if electronics is weaker, so implicitly Industrial is stronger. Just wondered internally how you square that against the macro backdrop and PMIs, which are looking quite weak. I mean, is your view that you're basically just taking quite a lot of shares at the moment? Maybe just give more color on that.

[Lindsley Ruth, CEO & Director]

Yes. You're welcome. And realize when we say electronics, we're excluding Singapore computing when we talk about the electronics decline and what's happening in the market there. So Singapore computing for us, specifically Raspberry Pi for us as well as the other Raspberry Pi partner and Premier Farnell and Avnet, both companies are doing well. And Raspberry Pi is doing very well with their Pi 4 product launched. Excluding that, the electronics market is down, although there are signs of a slow recovery right now. So I wouldn't say particularly we've hit bottom, but we're not far from it. And I think we'll start to see a tick up in the overall industry and market in the next couple of months. Of course, that all depends on what happens with the U.S.-China trade war and if there's a resolution on that, which we can all have our own opinion on, but we'll see. As far as us, I think you know that we're taking market share today. We see no reason why we can't continue to take market share. We can never take our capabilities for granted and we can't become complacent. And I think to a certain extent in Q1 in North America, we became complacent. And we can't -- complacency kills, and we can't allow that to seep in. We'd never think we're doing that great. And so I would expect us to continue to outperform the market. I think the industrial market has become more uncertain. Certainly, the U.K. with Brexit, there's a lot of uncertainty in terms of what's happening, and then we all read the news every day and can see what's happening in various companies. And I look at it, whatever happens, we've got a very positive attitude, not look on our capabilities, and we believe in our destination 2025 strategy. We have a high degree of certainty in terms of being able to accomplish what we've committed to and with our Board and our own employees. And we feel very good about the position we're in. Now that's not to say that we can't -- we've got to still be intelligent on how we manage the business, and we've got to be cost conscious. And the thing is, maybe we got to look at pushing out and delaying what happens in the overall market and we've got to be smart about how we do things. But we do expect to continue to outperform. So I would say the bulk of what you're seeing is actually more than 90% market share gains around the world today.

[Samuel James Bland, Research Analyst]

That's great. And would you say, particularly in Europe, those market share gains means that in Europe, is it new product, new product lines? Or is it more about a sort of internal sales force regeneration and changes? What do you think has driven the market share gains in Europe?

[Lindsley Ruth, CEO & Director]

No, I think there's a variety of factors. We continue to acquire more customers online. Digital is a major differentiator for us. We're very well positioned from a digital standpoint. We have -- unfortunately, there's a high cost of doing business associated with digital and pay per click and digital marketing and search engine optimization, all the things required today for a B2B business to do business online. So that's a big book as value-added solutions is a significant focus for us. The product teams and category teams are making sure we have the right product available on the shelf. Our availability now is north of 92%, which is fantastic and definitely an all-time high, at least in the last 5 years but back to the levels back where we used to have them more than a decade ago. And I think we're -- it's not just sales force effectiveness and the sales team, it's really the entire team and the entire organization and the credits of the leadership that we have in Europe around the world for the outperformance. And as we know, the European markets today are tough and the 2 biggest markets in Germany and the U.K. are not in the strongest situations. There's contraction taking place and more than 2/3 in the markets attract PMIs around the world. And so that's a reality. I think it gets worse before it gets better. But we expect to continue to outperform.And the one thing we just have to be careful within our side is it's -- #1 priority for us is the health and well-being of our employees. And we want to make sure that we're not pushing people too hard at different times, and we're very aware of the state of our employees. And culture is very important for us and making sure the well-being of those employees are at the top of the list. And so we're making sure our employees are taken care of, but we continue to expect high performance within the organization. So we're very happy with where we're at right now.

[Operator]

Okay. Our next question comes from the line of Kean Marden.

[Kean Marden, Equity Analyst]

Could I follow up first with just some questions at the balance sheet, please, which I appreciate this is just a trading update, but if you can provide us with a little insight into balance sheet and free cash flow in the first half? I suppose, in particular, the phasing of the CapEx deployment this year between H1 and H2 would be particularly helpful. And then also relating to balance sheet. Are we now at a point where suppliers are becoming a bit more discerning about the state of the balance sheets of the distributors that they're dealing with and what opportunities that might give you? And then a couple of other quick areas. Firstly, on Raspberry Pi 4, how does turnover scale from here after the initial launch? So are we likely to see that 1% tailwind to like-for-like growth continuing for the next few quarters? I think we probably know the answer to this, but just to check, Lindsley. And in practice, what do you change if we do enter recession in the U.S.?

[Lindsley Ruth, CEO & Director]

Yes. So good questions. I'll let David do the balance sheet comment on that. And as far as Pi 4, we expect the momentum to continue in the second half. What we're seeing within Raspberry Pi is more of a movement towards the higher gig in terms of memory, the higher memory types of versions, which tells us people are using it for more complex applications. And I think just stay tuned because it's exciting, I think, in terms of what they've got in their road map as they move forward. And they're moving up more into that personal computer, that traditional PC space, where there's a lot more things you can do with the Pi, which then means that it can be applied more instead of just obvious kind of playing around at home and doing different things that are cool and within their houses and small businesses to where it can be. It's got great and significant value add to industrial applications. So I think we'll see more industrial use as we move forward over the coming 12 to 24 months. As far as suppliers are concerned, and David will address the balance sheet side, definitely, I think suppliers, when you get into these types of markets, start to look at the health and well-being of the companies they deal with. And for us, the balance sheet strength, I think not just the strength in balance sheet, but the strength we have in capability, the strength that we have in our people, makes us a very attractive partner for many suppliers that we currently don't do business with. And even though we have more than 2,500 suppliers, there's still a couple of hundred that are on our target list. We haven't announced the number of suppliers we signed so far this year, but just in electronics alone, we've signed a pretty significant number of suppliers as well as key lines that really want us to be their partner in the industrial space, where we have a very strong foothold. So a very attractive partner to lines like analog, different analog lines and the electronics space. And so I think it's definitely a buying opportunity for us. And there will be certainly a short-term impact on turns as we continue to invest in inventory, and David can talk through that. So that I'm encouraged on overall. So I think we're in a pretty good place there. As far as the Americas, what do we do different if there is a recession there? I mean obviously, a recession always creates a buying opportunity. So you got to look at the prices, et cetera, when there's really a couple of things I would say on that front. Number one, we have to -- the only business in the world today where I would say, and this is my own personal opinion, where we don't lead on value would be the Americas. And we need to -- we get into way too many price discussions with customers in the Americas, and that's because we haven't built out our suite of value-added solutions in the same level we've done in the rest of the world. So big priority for us in the Americas is to put our organization through the mental carwash and our sales force to be able to learn how to sell on value and not on price. And so for us, I do expect to see gross margin improvements in the Americas over time. And we've seen some of that in the last 2 years, but not to the degree that we'd like to see. So I think value-added solutions, value-added selling is an area that we can invest in through the market through downturns. Two, I think we have to -- we've got an opportunity to work closely with suppliers now and more closely than ever before because I think a lot of the smaller regional players will be significantly impacted by a downturn than we are. So it presents an opportunity for us to have even greater market share gains in areas like automation, control products and those particular areas in the industry. I think anytime you get into a recessionary downturn, it's a good time to go out and look for talent because talent tends to become available. People aren't hitting their bonuses, they get a little frustrated where they are, maybe they're not treated the right way, and we want people to know they've got a home here. And we're working on our culture around the world to be more inclusive, to be the place where it's not just a great place to work today, but 5 to 10 years from now. This isn't just a high-performing organization, but this is a cool place to work. And we want to be a part of this journey with this team and with this organization. So those are the 3 things I'd just say as far as recession in the Americas. In regards to the balance sheet, David?

[David John Egan, CFO & Director]

Yes. With the balance sheet, we'll give you a full update, obviously, as part of the interim. But in terms of [ discount ] trajectory, no change to our guidance with regards to CapEx for the full year. If you -- and if you're looking at the first half, second half split, as we said in the first half, we've been investing in inventory, so there's obviously an inventory investment that's occurred in the first half. And the CapEx investment is more second half-weighted as we have 2 major warehouse distribution centers being built at the same time. So that is just directionally how it looks at this stage.

[Operator]

[Operator Instructions]

[Lindsley Ruth, CEO & Director]

All right, Carl, we can close it out there, if you don't mind. And thank you, everyone, for taking the time to be on the call today. As always, we're available for any questions you might have. And for those of you on the call that are going to join us at the interims, we look forward to seeing you next month in person. And thank you very much for taking the time to be on the call today.

[David John Egan, CFO & Director]

Thank you.

[Operator]

Okay. That does conclude our conference for today. Thank you for participating. You may all disconnect. Speakers, please stand by.