Ferguson plc

Good morning everyone and welcome to Ferguson's second quarter earnings conference call on webcast. Hopefully you've had a chance to review the earnings announcement we issued this morning. The announcement is available in the investor section of our corporate website and on our SEC filings webpage. A recording of this call will be made available later today. I want to remind everyone that some of our statements today may be forward looking. Such forward looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Additional information is also included in our earnings announcement and in the section entitled Risk Factors in our Form 10K available on our SEC website. Also, any forward-looking statements represent the company's expectation only as of today, and we specifically disclaim any obligation to update these statements. In addition, on today's call, we will discuss certain non-GAAP financial measures. please refer to our earnings presentation and announcement on our website for additional information regarding those non-GAAP measures, including reconciliations to the most directly comparable GAAP financial measures. With me on the call today are Kevin Murphy, our CEO, and Bill Brundage, our CFO. I will now turn the call over to Kevin.

Thank you, Brian, and welcome, everyone, to Ferguson's second quarter results conference call. On today's call, I'll cover highlights of our second quarter performance, and I'll also provide a more detailed view of our performance by end markets and customer groups before I turn the call over to Bill for the financials and for our outlook for fiscal year 23. I'll then come back at the end to share some thoughts on how we're executing our strategy and on the fundamental drivers of our residential and non-residential end markets before Bill and I take your questions. we'd like to express our sincere thanks to our associates as they continue to go above and beyond to serve our customers and to help make their project simple, successful, and sustainable. Our second quarter results were in line with our expectations following the significant step up in performance we delivered in fiscal year 2022. We continue to leverage our consultative approach, our scale, our global supply chain, and our strong balance sheet to help improve our customers' projects The result was 5% revenue growth on top of a 32% comparable. We demonstrated cost discipline to deliver solid profit with the two-year stack for adjusted operating profit increasing 67% and adjusted earnings per share nearly 75%. Our balance sheet and cash generation are strong, and we continue to execute our strategy of investing for organic growth, sustainable growth of our dividend, consolidating our fragmented markets through acquisitions, and returning capital to shareholders. We declared a quarterly dividend of 75 cents per share, implying a 9% increase when annualized over the prior year. On the M&A front, we were pleased to welcome four acquisitions during the quarter. These acquisitions bring annualized revenues of approximately $300 million and span across HVAC, Waterworks, and our industrial customer groups. We're proud of these results, which came in as we expected, and are confident in the strength of our business model as we go forward. Turning to our performance by end market in the U.S. Overall growth has moderated as we came up against increasingly challenging comparables. As expected, residential revenues, which comprise just over half our U.S. revenue, slowed meaningfully during the quarter to 1%. Residential markets were most significantly impacted by the slowdown in new residential construction and in areas serving the project-minded consumer, whereas repair, maintenance, and improvement markets, particularly high-end remodel, showed continued strength. Non-residential growth was 11% higher than prior year on top of tough comparables, with broad-based growth across customer groups, including a pickup from industrial-related end markets. Importantly, we continue to outperform our markets, taking share across both residential and non-residential end markets. As we've discussed previously, we will continue to focus on maintaining our balanced end market mix. And while we expect growth rates will fluctuate over time, we seek to maintain this healthy balance. Turning now to revenue growth across our customer groups in the United States. Residential trade declined by 5% against a 31% prior year comparable growth due to declines in new residential construction activity. Residential digital commerce declined by 10% against a 24% prior year comparable growth due to softening consumer demand. Residential building and remodel grew 12% on top of a 21% prior year comparable with a healthy backlog and strength in higher-end remodel projects. HVAC, where the majority of our business serves the residential end market, grew by 10% with a two-year stack of 43%. Waterworks delivered growth of 6% on top of a prior year comparable of 61%. very pleased with the balanced business mix inside of our waterworks group with both residential and non-residential exposure. The commercial mechanical customer group grew 8% improving sequentially from the first quarter. Industrial, fire and fabrication, and facility supply businesses saw strong growth driven by non-residential trends such as increased industrial construction. It's through our growth platform of nine customer groups that we achieve broad and balanced end market exposure. In aggregate, this allows us to serve our customers' needs in a more holistic way and bring more value to the total project. Let me now hand over to Bill, who will take you through the financials in a little more detail. Thank you, Kevin, and good morning or afternoon, everyone. Net sales were 4.9% above last year, with organic growth of 2.7%. As expected, price inflation stepped down from Q1 to Q2 to 10%. Acquisitions contributed 2.6% to revenue growth, partially offset by 0.4%, arising from the adverse impact of foreign exchange rates and one fewer sales day in Canada. Gross margins of 30.2% were down 40 basis points against a very strong prior year comparable. The modest decline was driven by pressure on certain commodity products and business mix, as non-residential outperformed residential. Non-residential carries slightly lower gross margins, but very similar operating margins as residential. We have proactively managed the cost base, which stepped down approximately $77 million from Q1 to Q2, enabling us to deliver adjusted operating margins of 8.5% in what has historically been our seasonally lightest margin quarter. Adjusted operating profit of $582 million was down $6 million, or 1% over the prior year, but as highlighted earlier, remained 66% above fiscal 2021. Adjusted diluted EPS compressed by 1% driven principally by the slightly lower adjusted operating profit and higher interest expense, partially offset by the impact of our share buyback program. Our balance sheet remains strong at 1.1 times net debt to adjusted EBITDA. Moving to our segment results, the U.S. business delivered another solid performance, compounding revenue growth against very strong comparables. We continue to take market share with net sales growth of 5.4%. Organic revenue growth of 2.6% was bolstered by a further 2.8% growth from acquisitions. We delivered adjusted operating profit of $579 million, an increase of $3 million, or 0.5% over the prior year. Turning to our Canadian segment, markets softened similar to the U.S. with some additional pressure from the adverse impact of foreign exchange rates. Organic revenue growth was 3%. against a strong 13.8% comparable, but was offset by 1.2% arising from one fewer sales day and a further 6.3% due to the adverse impact of foreign exchange rates. Total revenue growth was down 4.5%. In line with the U.S., non-residential end markets performed better than residential in the quarter. Adjusted operating profit of $14 million was $9 million below last year's record performance in our seasonally weakest quarter. Turning to the first half results, net sales were 10.9% above last year, with organic growth of 7.8%. Acquisitions contributed 2.7% to revenue, with a further 0.7% from an additional sales day, partially offset by 0.3% adverse impact from foreign exchange rates. Gross margins were 30.4%, down 50 basis points year over year, against a very strong prior year comparable. We managed both labor and non-labor operating expenses throughout the first half. We managed down overtime, temporary labor, and allowed natural attrition without backfills to reduce the number of FTEs in the business. In addition, we took the difficult decision to take certain targeted headcount reductions. Collectively, these actions reduced our organic, full-time equivalent headcount by approximately 1,500 in the first half. In addition, during February, we have taken action to reduce FTEs by a further approximately 500. While we don't take these actions lightly, they are important to respond to the current market conditions, and we will continue to evaluate our cost base and resource allocation decisions as we move forward. Adjusted operating profit of $1.4 billion was up $91 million, or 6.7% over the prior year, delivering a 9.8% first half adjusted operating margin. Adjusted diluted EPS grew by 9.9%, driven principally by the growth in adjusted operating profit, as well as the impact of our share buyback program. Turning to cash flow, we take a disciplined approach to cash generations. It's an important priority and quality of our business model. Just at EBITDA in the first half was $1.5 billion. As expected, our working capital had a positive impact on cash flow as we have begun to reduce inventory as supply chain constraints start to ease. Inventory, excluding acquisitions, was down approximately $235 million during the first half. Generated $1.2 billion in operating cash flow. an increase of $946 million over the prior year. We continue to invest in organic growth through CapEx, principally invested in our market distribution centers, branch network, and technology programs. The increase over prior year is attributable to the timing of investments related to our multi-year market distribution center rollout strategy. As a result, free cash flow was $936 million in the first half. a significant increase of $827 million over the prior year. Our balance sheet position is strong, with net debt to adjusted EBITDA of 1.1 times. We target a net leverage range of 1 to 2 times, and we intend to operate towards the low end of that range through cycle to ensure we have capacity to take advantage of growth opportunities, as well as to maintain a resilient balance sheet. We allocate capital across four clear priorities. First, we're investing in the business to drive above-market organic growth. As I previously mentioned on the cash flow slide, working capital had a positive impact on cash flow in the first half, and our CapEx investments were focused on our market distribution center rollout, technology investments in both front-end customer-facing capabilities, as well as the modernization of our back-end systems, and investments in our branch network. Second, we continued to sustainably grow our ordinary dividend. Our board has declared a 75 cents per share quarterly dividend that implies an increase of 9% when annualized over the prior year, reflecting our confidence in the business and cash generation. Third, we're consolidating our fragmented markets through bolt-on geographic and capability acquisitions. We purchased five businesses since the start of the fiscal year, bringing in approximately $330 million of incremental annualized revenues. We maintain a good pipeline of potential deals, and we remain focused on executing our consolidation strategy. Finally, we are committed to returning surplus capital to shareholders when we are below the low end of our target leverage range. During the first half, we returned $564 million to shareholders via share repurchases. reducing our share count by approximately $4.6 million. This leaves approximately $400 million outstanding on the share repurchase program at the end of the quarter. Turning to our view of fiscal 23 guidance, the year is progressing as expected, and our net sales growth and adjusted operating margin guidance remains unchanged. As we set out at the beginning of the year, we expect to deliver low single-digit revenue growth for the year. driven by continued organic market share gains and the benefit of completed acquisitions on top of markets, which we expect to decline in the low single digits for the year. We expect growth rates to continue compressing as we move through the year, driven by difficult comps, a reduction in inflation, and slowing in market volumes. After stepping up operating margins by 230 basis points over the last two years, we continue to expect some normalization. delivering between 9.3% to 9.9% for the full year. We will remain disciplined and will continue to review our cost base, flexing it depending on the prevailing conditions. Our operational teams are very focused on volumetric trends in revenue as we make decisions around areas of investment and resource allocation. Interest expense guidance is $185 million to $205 million for the year. an increase of $15 million from our previous guidance due to a small increase in expected net debt levels, and to a lesser extent, an increase in short-term rate increases on floating rate debt. Our adjusted effective tax rate should stay broadly consistent at approximately 25%. CapEx is expected to come in between $400 million to $450 million, an increase of $50 million over our previous guidance, driven by the timing of purchases of certain real estate relating to our market distribution center strategy. So to summarize, the business is performing well, and we remain focused on executing our strategy. We believe the combination of our strong balance sheet and flexible business positions us well for the remainder of the year. Thank you, and I'll now pass you back to Kevin. Thank you, Bill. We continue to drive ongoing end market outperformance while investing to build on our competitive advantages for the longer term. We hold leading positions in large, growing, and fragmented markets with approximately 75% of our revenue generated from our number one or number two market positions last year. Our supplier base is fragmented, our customer base is quite fragmented, and our competitor base is also highly fragmented, with more than 10,000 small and medium-sized, mostly privately held competitors. And while there are macroeconomic headwinds in the near term, markets we compete in have historically grown above GDP. As we've discussed, this comes together in a leading position in a $340 billion North American market opportunity. with a focused growth strategy to achieve balance in residential and non-residential and a balance of repair, maintenance and improvement and new construction. It allows us to leverage scale and attractive profit pools with a less cyclical, more durable business model. We feel very good at a 54% residential and 46% non-residential and a 60% RMI and 40% new construction mix. While most of us are clear that we're in the midst of a residential slowdown, particularly new construction, the fundamentals in residential markets remain attractive, not the least of which is the undersupply of homes. An aging housing stock and the utilization of pros in remodel projects should support residential repair, maintenance, and improvement where we have greater exposure than new residential construction. We believe the residential market is attractively positioned over that longer term. There are a number of emerging structural trends in our markets, particularly our non-residential markets. We believe these trends, driven by megaprojects, onshoring activity, recent legislative acts, and the aging infrastructure, will provide a multi-year tailwind and are very aligned with our competitive strengths. Onshoring trends have created an increasing number of larger projects. We believe our scale and advantage growth platform strongly position us to capture meaningful growth from these significant projects. The pipeline of activity for projects over $400 million equates to approximately $650 billion of expected construction activity over the next five years, covering a breadth of industries from chips and semiconductor plants, electric vehicle and battery plants, biotech and pharma in addition to more generic manufacturing sites. We are able to leverage the combined expertise of our customer groups such as commercial mechanical, waterworks, industrial, fire and fabrication, and HVAC in order to support the needs of general contractors, owners, and engineers, all done while servicing our core customer base. In addition, have been a number of legislative acts passed that provide federal funding and tax incentives across a number of industries the infrastructure investment and jobs act was signed into law in november 2021 covering segments such as roads power transit hubs and water and sewer projects the chips and science act signed into law in august 2022 included 39 billion dollars of manufacturing incentives The Inflation Reduction Act is another broad-ranging act also signed into law in August 2022. It focuses investment on areas such as energy, climate, and healthcare that feeds into a variety of manufacturing sites such as electric vehicle and battery manufacturing. While it's difficult to quantify with specificity, construction activity supported by these acts will be beneficial to our overall non-residential markets over an extended period of time. Lastly, we wanted to touch on some data points around the aging infrastructure in the United States. Average age of commercial buildings now in excess of 50 years. There should be good activity over time with repairs and maintenance activity and, in some cases, the replacement of these buildings. Drinking water and wastewater piping systems in the U.S. are certainly aging and are in need of investment. Our large, broad-based, and diversified waterworks business, combined with our environmental product strategy, should position us well for the future. Plus, let me again thank our associates for their remarkable efforts to serve our customers. As a result, this year is tracking overall as we expected. The first half was strong against challenging comps, and we continue to build on our market-leading positions and our key strengths while investing for future growth. We're well positioned with a balanced business mix between residential and non-residential, new construction and repair maintenance and improvement. We have a flexible business model and cost base that allows us to adapt to changing market conditions. Our scale and advantage growth platform allows us to leverage our competitive positions across nine customer groups in order to capture opportunities from emerging structural trends in our end markets. We're maintaining a strong balance sheet, operating at the low end of our target leverage range, while also focusing on strong cash generation. Despite slowing end markets and more challenging comparables, we continue to position ourselves to outperform fundamentally solid longer-term end market demand. Thank you for your time today. Bill and I are now happy to take your questions. Operator, let me hand it back over to you.

Thank you. For our Q&A, if you would like to ask a question, please press star and then the number one on your telephone keypad. If you change your mind, please press star followed by the number two. When preparing to ask your question, please ensure that your device is unmuted locally. As a reminder, that is star followed by one to ask a question. Our first question comes from Matthew Booley from Barclays. Matthew, please go ahead.