Ferguson plc

certain risks and projects continuing to press on in light of the interest rate environment that we're in today.

Thanks, guys.

Thanks, Matt.

Our next question comes from Mike Dahl from RBC Capital Markets. Mike, your line is now open.

This is actually Chris from Mike. Just shifting over to margins, I was hoping to get your latest thoughts on the trajectory for margins this year, first half versus second half, realizing the guidance is unchanged, but just your latest views on dynamics there.

Yeah, really no change in that. As we look at the full year, Chris, expecting that operating margin to land in that 9.2 to 9.8 range. As we talked about on our fourth quarter call as we set that guidance out, we're expecting that midpoint, expect some modest continued normalization and most of that coming in the first half of this year. As you just saw, the 10% operating margin down from last year and that was very much as expected. We expect as we go through the second quarter to have a bit of continued pressure given the really strong second quarter we had last year. and then some improvement as we step into the second half as growth stabilizes to Kevin's point that he just walked through, and as we return back to growth and get back to broadly flat revenue for the year.

Got it. I appreciate that, Culler. And then just shifting over to capital allocation with share repurchases kind of stepping down sequentially this quarter. I just wanted to get your latest thoughts on that. capital allocation priorities and how the M&A landscape is looking today.

Yeah, really no change in terms of how we're executing that. Our intention is to operate towards the low end of our leverage range one to two times. We're sitting right at the bottom end of that range right now. And so, as you saw from an acquisition perspective, one small acquisition completed in the quarter, but the deal pipeline is pretty healthy today. So we're maintaining some capacity there to continue to consolidate our markets. But you should expect us to operate towards the low end of that range and continue to execute our capital priorities across that four-step priority order.

Understood. I'll pass it along.

Our next question comes from Will Jones from Redburn Atlantic. Will, your line's now open.

Thank you. Just a couple from me, please. I think on the gross margin, perhaps you could just help us better understand that first half or first quarter gross margin, the 30.2. Would you be willing to draw out what the commodity impacts were against that and what was working in your favor to still deliver that good gross margin despite the commodity effects? And then secondly, just when we think about gross margins with regard to mega projects, just as you go through the bidding process there, any more insights into whether those mega projects might be gross margin accreted or not relative to normal non-res projects? Thanks.

Yeah, well, we were pleased with the team's execution on gross margins in the first quarter, staying above that 30%, delivering 30.2%. And we had expected a little bit of a step down coming out of Q4. You may recall in Q4, we were at 30.6%, but we talked about some one-time inventory gains as we sold through some older inventory. As I think about that 30.2%, yeah, there's a little bit of pressure from a commodity perspective, but the team's really executing well with own brand sales. That continues to be about 10% of our revenue, and that's, as you know, gross margin accretive. And then really good pricing discipline in the field as we're managing through what is a tricky time from a commodity perspective. So really good execution. Yeah, building on that, Will, the team did a great job from an execution perspective. And gross margin pressure was less so of an impact than gross profit dollar was. As you think about deflation in the commodity markets, a lower gross profit dollar on the gross margin is relatively consistent. When you think about the megaproject landscape and the approach, the group is doing a very good job of selling value-added services, selling our product strategy to make sure that our gross margin is relatively consistent as we approach that megaproject landscape. In fact, if you look at our non-residential business today, which is clearly evident in numbers, there are more commodity-based product impacts on the non-residential side, and yet that business is in a growth territory. And so volume growth inside of the non-residential space is something we're pretty proud of as we're sat here today.

Thank you.

Thank you. Thanks, Will.

Our next question comes from Patrick Bowman from JP Morgan. Patrick, your line is now open.

Thank you. Good morning. Thanks for taking my questions. First one, maybe dive into the customer groups a little bit. The commercial mechanical growth improved nicely, I thought, versus the fourth quarter there. Anything particular to call out in terms of drivers? Was it more RMI focus or any particular verticals within that that drove that? And then I'll leave that one there, and I'll go to the next one.

yeah Patrick thanks for the question and from a commercial mechanical perspective you're right, we were pleased with what that growth looks like if I go back to the previous question, it really is in line with with that portion of the discussion. Non residential activity and markets a bit challenged our business mix is got a good split between repair maintenance and improvement and new construction. We have seen good activity levels in places like data center work as well as the mega project landscape and how that commercial mechanical space feeds in quite well with our industrial business for that onshoring of manufacturing activity, electric vehicle production, sustainability build outs and the like. And so it really was that balanced non-residential exposure that was strong for us. And then like I say, to be in a volume growth territory, and to be able to hold gross margins relatively consistent as we move through a deflationary space on commodity-based products, we feel pretty good about where that is. So, again, the balanced nature of the business serves us well, and our ability to sell through into these different growth areas of non-residential is very pleasing for us.

Yeah, helpful. And then maybe a follow-up on the gross margin question. Do you look at that low 30s number now as being, you know, normalized at this stage for, you know, for, I guess, pricing, deflation, et cetera? I'm just wondering if that's something you can, you know, hold in that range now going forward and start to kind of grow from there.

Yeah, Pat, our belief has been over the last several quarters that gross margins would normalize around that 30 percent mark. And so we're, again, pleased with the execution to date. You know, certainly we're not expecting significant additional deflation. That could put some pressure, further pressure on that gross margin in any particular quarter. But we very much feel like that 30% range is a good normalized point from which we can build on into the future as we get back to some market growth and then continuing to take share in executing our strategy. And as that commodity deflationary environment stabilizes and we operate from a more normalized environment, we then intend to build on that gross margin steadily and durably over time by not only implementing our product strategy and driving those things that are important to our company, but also in continuing to build out value-added services that allow us to see that value reflected in the gross margin of our business. So that's not a floor for us. We'll continue to build from there over time just like we have historically.

Great. Thanks for the call. I really appreciate it.

Our next question comes from Catherine Thompson from Thompson Research. Catherine, your line is now open.

Hey, good morning. This is actually Brian Barris. I'm for Catherine. Thank you for taking my questions. I guess to start, can you touch a little bit more on the mega project beating in today's environment and kind of how Ferguson wins here and how you differentiate versus your peers? I know in the past you've talked about kind of getting closer to the engineer or the GC or the owner to kind of be involved in the process to get the right products there. But any more color in the current environment would be helpful.

Yeah, the mega project landscape actually is playing out very much as we expected. We knew this was going to be a slower landscape in terms of what bidding activity looks like and how that bidding activity flows into open orders and how open orders flow into actual revenue and construction. So it really is playing out as expected. We're pleased with what that ramp up looks like. We won't see the full impact of this structural tailwind until we get into the coming years. That said, as we've discussed in past quarters. For us, this is a catalyst for how we want to operate in the future. These megaprojects are large construction projects where scale is beneficial. And bringing the scale of our supply chain and our capabilities to bear inside this market is helpful. We also are getting closer to the engineering community, the ownership and the general contracting level, to make sure that we're solving problems for them across multiple customer groups. And then lastly, although we stay very true to the individual trade that's doing the work, whether that's the waterworks contractor, the fire protection contractor, the commercial mechanical contractor, or the industrial contractor, we do add value by bringing those customer groups together on the site, especially when there's such scale and complexity on some of these projects. And so that's playing out as we had hoped, and we continue to work and invest in what those capabilities look like.

And a follow-up on the Waterworks acquisition announced. Can you use any more color on kind of the acquisition there, the Waterworks metering distributor in Texas, just kind of how that fits into the larger M&A strategy, guys, for you, either on a product basis or a geography basis?

So if you look at our core waterworks business on core products and pipe out and fitting for residential, commercial, and municipal applications, it's been well built out across the whole of the United States, and we maintain a very strong position inside that business. We have in the past many years been working to build out water and wastewater treatment plant capabilities, metering and metering technology capabilities. And so what you've seen with this acquisition is meters and metering technology capabilities in the state of Texas so that we can not only service that market but also get closer to that municipal customer because that relationship serves us well across the whole of our business. And you'll see us continue to work to build out meters and metering technology, urban green infrastructure, and soil stabilization. It's been a key part of our acquisition strategy as we complement what's already a strong business across the whole of the United States.

Thank you. Our next question comes from Sam Darkot from Raymond James. Sam, your line's now open.

Good morning, Kevin. Good morning, Bill. How are you?

Good morning, Sam. Doing well.

Two questions, and these are both kind of follow-ups to a certain degree. Bill, you mentioned that you expect the debt leverage to remain at the low end of the range for the foreseeable future, but You obviously can't always control when really attractive things come to market. I was just curious as to what the organization's bandwidth and appetite is in making larger-scale M&A right now, perhaps away from the core business. I ask this in light of the fact that obviously there's a major energy PVF player that's ostensibly looking into a sale, and you're seemingly one of the only strategic players with a balance sheet to comfortably ingest such a transaction. So I'm just curious as to the interest, maybe not with that particular situation in particular, but in general for larger-scale M&A right now with the organization. Thanks.

Yeah, Sam, I'll start talking a little bit about how we view leverage and capacity from an acquisition standpoint, and I think Kevin will probably weigh in on the strategy side of how we're thinking about customer groups and large-scale M&A. To your point, Operating at the low end of our range gives us quite a bit of flexibility. If you think about roughly a $3 billion EBITDA business, a one to two turn leverage range gives us roughly $3 billion of capacity were we to scale all the way up to two times. We intend to operate towards the low end to give ourselves the capacity to scale up. In general, what you've seen out of us and what our industry lends itself to are 10,000 plus small to medium sized competitors. And so to Kevin's point earlier in the day, we've done over 50 acquisitions in the last five years, mostly in that small to medium size range. Sometimes those are a bit lumpy and they come together. You saw only one this quarter. Sometimes we'll do three, four, five, six in a quarter. So we want to maintain that capacity. To Bill's point, the bolt-on acquisition strategy capabilities as well as geographic has served us well. And quite frankly, the industry is built out that way. When you think about acquisitions, platform acquisition or larger scale acquisition, we will, in fact, look at that as we look at customer group expansion. We very much look at the customer that we need to serve and the capabilities that we need to bring to serve that customer. And then, as importantly or maybe more importantly, how does that fit into the project as a whole and what our relevance is on that project? And you've highlighted energy transition and maybe even sustainability as a catalyst for what we would look at. And so it's fair to say that we continue to look at how our individual customers today, especially in a multi-trade environment, are operating both residentially and non-residentially and how do we best serve them. And so it's always in our mind as to what that next customer group might look like, but today, we're fairly well focused on that bolt-on strategy and how that can complement our business from an organic perspective. So thank you very much for the question, Sam.

Yeah, fair enough. And if I'm allowed a follow-up, Kevin, you mentioned the normalization in inventory and supply chains at this point. Are you seeing any increase in pressure from the independents and regional competitors now that at least – relative inventory availability is not as much a lever point in the business? And where within your business verticals might that occur, if it would?

We've seen normalization of supply chains, you know, with maybe one or two small exceptions. We have a normalized supply chain across our business and across our customer groups. We were very fortunate during the period of supply chain chaos to use the strengths that we have and the vendor relationships and the size and scale that we have to out-gain from a share perspective what our traditional 300 to 400 basis points were. That's normalized, and we expected that to normalize. Do we see any further pressure, both from a pricing perspective as well as from a market perspective, now that supply chains have normalized? No, we don't. In fact, the majority of the deflationary activity, as we discussed, as we talked about earlier, really came from commodity-based input as opposed to what's happening in the overall market. So we don't see any abnormal pressure that we wouldn't normally see inside of these markets.

Very helpful. Thank you.

Thank you, Sam.

We currently have no further questions, so I'd like to hand the call back to Kevin Murphy for closing remarks. Please go ahead.

Thank you, Operator, and thank you all for your time today to take part in the call. We really appreciate that time. And as I close, really close as we began, and that is things are really playing out as we expected, and we're extremely pleased. with the execution of our teams and taking care of our customers and making their projects more simple, successful, and sustainable. We're confident in the medium and long term of these markets, both residentially and non-residentially, and some of the structural tailwinds that we're seeing develop. The strength of our business model will continue on, and we've got great confidence in it. So thank you very much. Please take care, and we'll talk soon. Thank you.