Earnings Call: H1 2020

Oct 9, 2019

Good morning. My name is Robert Forrester, Chief Executive of Virtu Motors plc. I'd like to welcome you to our webcast of our interim results for the six months ended August 31. I'm joined this morning by Karen Anderson, our CFO, who will also be involved in the presentation. Hopefully, you've got a copy of the presentation. Turning to slide one on strategic highlights. This was a very interesting period for the sector in general, and I think the results that we're presenting show somewhat of a victory in a hard fought fight by the group. We focused on what we could control rather than worrying about what we couldn't control, and I think that literally paid dividends. We built a business with a very strong set of business values and strong ethics, and I'll show you some evidence of that. But also really quite sophisticated, uniform systems from showroom through to financial analysis, which is helping us actually to manage what is clearly a scaled business. The group has firepower, with which to not only grow the business with partnering with our major OEMs, but also to invest in a raft of initiatives on omnichannel retailing, which I'll go through in some detail. We're very, very focused of generating cash, which means controlling costs, controlling working capital, and I think that comes through. And that then frees up resources to put through our capital allocation process. And the board is very focused on capital allocation. We have a very strong balance sheet. We continue to generate cash from disposal of surplus properties. And we have been engaging in the share buyback program because clearly, the share price is below where we believe the intrinsic value of the business to be. Turning to financial highlights. It's good to see revenues have grown on a like for like basis, and we saw stable margins with some movement within the different channels in terms of margin, which I'll come on to. Costs have really been very well controlled, and we've got a real focus on cost initiatives, to increase productivity and efficiency across the business and to use technology to do that. And I think we've seen some successes, but there's clearly a lot more to come. The cost initiatives, though, cannot be at the expense of the customer experience in what is clearly a highly competitive marketplace. And I think we've got that balance right. We were delighted, to be honest, to see operating profit up £200,000, on an adjusted basis given the doom and gloom generally surrounding the sector. And while overall profits dipped, they dipped due to increased stocking charges As our manufacturers saw some of their debt ratings come down, we saw increased interest rates, which Karen will go on to discuss. Interim dividend up 9.1%. That think that reflects the confidence in what we do and the future that we've got ahead of us, but also reflects the fact we have been very good at generating cash and that's been bolstered by property disposals. So we probably were in this room three years ago where free cash flow was under pressure due to high capital expenditure numbers. We've been forecasting out capital expenditure. That forecast have proved to be accurate. And our free cash flow increased to £14,600,000 in the six months. Strong control of working capital, lower CapEx. And clearly, we've got a pension surplus, so none of our free cash flows get eaten up by contributions to pension schemes. One of the major things, we'll be discussing with our investors over the next fortnight is our approach to omnichannel retailing. Just so everybody's clear what omnichannel retailing is, it's a multichannel approach to retail and that seeks to provide customers with a seamless shopping experience, whether they're online, whether on desktop, mobile, telephone, or in a bricks and mortar business. The whole thing has got to be joined up, and we're making really good progress. We have a road map in terms of where we want to get to. We have in house software developers, so we don't use any external software developers at all. It's all in house, has been since the inception of the group, and that's really putting us in a very good position. So you can see on this slide three, a social media reach up 355. We're now leading on Facebook in terms of number of followers in the sector. Online retailing, we've been pure online retailers of used cars since May 2017. It is clearly very low volumes in the context of our overall volumes, a conversion ratio of about point naught six percent. But it's very important in giving customers the choice, and they get a long way down that buying process and then come into the dealerships or go online and transact through another methodology. We're doing a lot of AB testing to fine tune that online retailing. Probably one of the most exciting things that we've done in the last six months is the development of Leo the bot. One of our software developing contingents has actually developed a robotic chatbot in house, which can book people in for service using live chat robotics. And we're now up to 400 customers a month using LEO to book their car in for a service, and it's only in its third month. Overall, not just LEO, but other on the on online bookings methodology, online bookings and service now represent 7% of bookings, up from 5% six months ago. And clearly, to to become efficient and drive costs, we've got plans to increase that. LEO being a major part of it. There's also other things LEO can do, which we're working on outside of of online service bookings. It sounds boring, but it isn't. We have reduced the time it takes for web pages to load by 43%, and we believe now we're second in the sector for speed of web loading. And we've done a lot of work around making sure the customer experience online in terms of being able to stack deals and build deals is increasingly similar to the showroom to bring the showroom and online together. Marketing is clearly changing, not actually as fast as you might think. There is still a major role for TV, a major role for radio, and, actually, we still utilize the press, but it's within a unified marketing structure, and clearly, digital is a big part of it. But we have now embarked on attribution marketing, technologies to make sure we fully understand where possible what has made a customer inquire. So we can really nail where we put our marketing spend and make sure we get an ROI. We have actually spent, more on marketing as as the period went on. We've done a brand campaign on the TV, cinema, and radio, which has certainly helped. And when we look at September, you will absolutely see that in in good effect. If we turn to slide four, technological and network change. This slide puts a number of things together, and we've talked about these before. But in we hold the view that the number of outlets in The UK will decline. If we end up with some economic turmoil around Brexit, that would accelerate, but the end result will be the same. There will be less dealerships in The United Kingdom. We would envisage that the larger groups would have a higher share at the end of that process and that sales per sales outlet would go up. We still believe physical dealerships are fundamental to delivery to the customer, but digital is clearly important. That's why we're embarking on this omnichannel retailing. The the challenge I think we've got in the next twelve months, is how the manufacturers and the retailers jointly, deal with the new EU rules around emissions and the consequent fines that can be levied on the manufacturers if they get that emissions mix wrong from a c o two perspective. We are envisaging a number of manufacturers actually targeting those on c o two emissions to make sure they get that mix right, and that's an added complexity that we've not had before. And we also are going to see some changes in vehicle supply because it is likely, we think, that there will be change in mix. Bizarrely, smaller cars actually are disproportionately impacted by the emissions regulations, which strikes innately as odd. But actually, the way the regulations work and the disproportionate cost of putting electric vehicle technology into a small car actually means we'll probably like to see pressure on that small car segment and peak manufacturers seeking to to actually sell more larger vehicles. And how that plays out is going to be quite interesting over the next twelve months. We we will see our way through that as a sector as we always do. We are actually very good at flexibly moving what we do to meet targets. And clearly, that's a big item for the next quarter to see how those targets move. I referred in the opening section to the fact we were values driven business, and and that, in fairness, is a very easy statement for a chief executive to make. However, I I'm confident that I can make it because we've got some evidence to back it up. We set out to build a values driven business when we started the business in 02/2007, and I think we've seen some success. So we have a colleague satisfaction survey. We have 5,500 colleagues. 81 of them filled the survey in in August. 97% of them said they knew the virtue values, which is our bedrock of integrity, professionalism, etcetera. And if you've got a business where they're known, the only beg question is, does the business actually pay any attention to them? And I'm pleased to report that the colleagues 90% of the colleagues thought the directors actively practiced the values. And in terms of a regulated regulated sector, particularly around the FCA where customer outcomes are crucial and where the culture of a business is crucial in delivering customer outcomes, it's a good place to start in having the right value. So we're very pleased with that. In addition, we have set targets on colleague stability to to increase levels of colleague stability. It's vitally important where you've got colleagues delivering to customers that they know what they're doing, that they have the right attributes, that they're motivated. The high levels of colleague satisfaction clearly point to good good things in that direction. But we are seeing higher stability, of, colleagues in customer facing roles, and that's helping us to deliver customer experience. Our customer experience levels, as measured by the manufacturers, are substantially ahead of national average. 74% of our sales departments are above national average. 67% of service departments are above national average. On used cars, around 96% of our customers would recommend us, and they were talking massive sample sizes in terms of that those surveys. And we did win the Autotrader Customer Experience Award couple of months ago, which was externally verified. So I think overall, we do have a strong values, culture. It is of vital importance, for a number of reasons. But the only way this company will be successful is if we have colleagues who are motivated and do the right things for customers. And I think we are well on the way to delivering that. I'd now like to pass over to Karen, who will deal with regulation and also high level view of the financials. Thank you, Robert. So on Slide six, it just summarizes where we currently are with the FCA's investigations into both the motor finance sector and their review of general insurance sales. The group actively participated in the consultation with the FCA in both of these regards, and consultations now closed and effectively we're now in Perda awaiting the FCA's findings. Findings aren't expected to be published till later this year or indeed early into the next year. However, the group has always considered regulatory compliance as a vital part of what we do and in putting the cost and vital of indeed to putting the customer first. So if you turn over to Slide seven, we've set out some more detail as to how we approach our regulated activity in terms of a control framework. As Robert has already pointed out, the group places a very strong emphasis on values, and this is the bedrock of our regulatory control environment and to ensure our colleagues apply the right behaviours and indeed act in the spirit of the regulations. Training colleagues is also very important. We require the specialist in automotive finance qualification to be passed by all of our sales facing colleagues and indeed and by approved persons. Indeed, over 1,500 of our colleagues hold this qualification. It's not easy. I know I've done it. There's a lot of reading material and you do have to study for it. We test the effectiveness of what we do and how we control our regulated activity through both what our internal audit team are tasked with and also through examination of customer feedback, be that from customer satisfaction surveys, be that analysis of complaints or through our extensive mystery shopping programme. Our regulated activity is controlled by our single bespoke electronic showroom system, which is in place and been used throughout the group and has been in place for many years. This system ensures consistency in terms of our regulated process, capture of electronic signatures included. And all sales facing colleagues are also required to sign up to our group finance policy annually or if it changes. Finally, oversight is provided by the group's compliance committee, which formally reports to the board, and detailed monthly reporting on our regulated activity is provided to that committee and to all approved persons for review. If we turn over then to financial performance on Slide eight, The group has applied IFRS 16 leases for the first time this period, and we've used the modified retrospective approach, which means we don't impact the prior year numbers. So for the purposes of presentation, we've presented all our numbers both before and after the impact of IFRS 17, so to aid comparability. Revenue grew £86,700,000 aided by acquisitions. Like for like revenue growth was £35,600,000 or 2.3%. And overall, gross margins were stable year on year with growth in operating profit delivered despite some of the sector headwinds. PBT reduced compared to last year due to growth in finance costs, driven by both increased bank borrowings and consignment vehicle stocking charges. Consignment vehicle stocking charges grew through a number of reasons. Firstly, higher interest rates from some manufacturers. High the high volume of vehicles that were brought into the start of this financial period as as manufacturers started to stockpile against the original Brexit date, and indeed the impact of exchange rates increasing average values of cars that are on funding. We expect the comparatives to ease in this regard in H2. Strong cost control, including the use of systems to enhance efficiency, resulted in a decline in operating expenses as a percentage of revenue. Turning to the balance sheet on Slide nine. The group has a strong balance sheet underpinned by real estate assets and a conservative debt and funding strictures in place. The group had adjusted net cash of 29,100,000.0 before deduction of used car stocking loans at the end of the month at the end of the period. As shown in the table on the right of this slide, this also excludes the lease liabilities that arise under IFRS 16. Tangible net assets per share were 46.1p after adoption of the new standard, which actually had the impact of reducing overall net assets by £9,400,000 at the August. Turning to the cash flow on Slide 10. The reduced capital expenditure previously flagged together with the pension scheme requiring no no contributions generates a strong free cash flow performance for the group for the period. In terms of working capital movements, new vehicle consignment inventory and the associated creditor reduced significantly in the period as that high level of stock brought into the start of the year declined. Discipline over other working capital captions reduced resulted in a very small cash inflow for the balance of those captions. Property disposals for the year to date have generated £3,000,000, including a post pact post period end disposal, And each of these has been achieved at or above net book value. The profits bridge is set out on Slide 11. PBT in the period reduced from £18,100,000 to £17,100,000 before application of the new leasing standard. Interest is obviously a major part of this overall decline because incremental gross profit generation more than offset increased costs in the period. Movement in core gross profit will be explained in more detail later, but do include an impact of an increase in the internal rate charged by our service departments into our vehicle departments, which has the effect of moving some profit from vehicles into aftersales. More detail on the movement in operating expenses is set out on Slide 12. Tight cost control drove a reduction in operating expenses as a percentage of revenue. But overall, like for like, we did see cost increases as a result specifically of investment in aftersales capacity, including the cost of additional colleagues, vehicles and depreciation. This investment, however, as evidenced on the profits bridge, drove incremental profit in aftersales. Occupancy costs rose due to higher insurance rates and energy costs. But the group has put a lot of effort into its risk management processes in order to secure a reduction in its in its insurance costs going forward. Things such as analysis of accidents, ensuring very tight and quick reporting of any accidents that happen, have all benefited us in securing that reduction. We've also benefited from movements in energy markets, will lock in some rate reductions for the second half in terms of energy costs. H two is likely to see some additional investments in marketing in order to boost market share, and in particular, in September, where marketing spend was in excess of last year. I'll hand over to Robert to go through some detail. Thank you. So if we go through each of the major channels in turn. If we take aftersales to start off with, aftersales remains the powerhouse of group profitability clearly. And 42.3% of gross profit was actually generated in the aftersales departments. If we take Service first, which is concentrated on Slide 13, it's great to see like for like revenues up 8.5%. There is a change though which has to be recognized in terms of the internal rate charges that Karen referred to. So 3.5% of the 8.5% was actually due to the service departments charging our vehicle departments more for preparing new and used vehicles, predominantly actually in used vehicles. And you can see in the reconciliation, that equated to £2,200,000 of additional revenue, which flows straight through into the bottom line of the service departments in terms of gross profit. So overall gross profit in the service departments was up 4.6% on a like for like basis, but of which 2.2% came from those changes in internal charges. The thinking behind that increase is that by charging the sales departments more, they would actually fight to retain the same margin levels, and therefore, we'd retain more profitability. This is a one off change that we've made. It probably brings us in line with the rest of the sector, but I actually think has worked as you will see. So Service actually also saw growth in gross profit from a number of other things. We've seen greater technician stability in the period, which is we have more resource to actually sell ours. We've got greater capacity, which Karen alluded to, due to investment. That's the capital expenditure coming through in higher activity. We've got very effective CRM. I've already talked about Leo, the boss, but our contact centers are, we believe, very efficient in generating bookings. And our vehicle health check process in the dealerships where the technicians are identifying work that needs to be done on vehicles and therefore service advisers selling it is increasingly effective, actually, and that's drying driving up average invoice values. We're also clearly still plowing through on service plan sales, particularly on used cars to drive retention, and we are increasing the penetration of our service plan sales into used cars. It's a major focus of the group because it drives future service retention, which is just so important. So overall gross profit up 4.6, of which 2.2 was due to the rate rise. Parts is a really interesting thing this year because clearly, flagged last year there was a reorganization of the Ford Ford distribution network. That has reduced PBT in the period by point six. We'd expect that to be far flatter actually in h two. So the bulk of the the variances come through in h one. But the way those changes work has taken out turnover from the parts departments, but maintained gross profit. So overall, our margin in after sales has actually increased by three sixty basis points, and we think that is a sticker. That will actually continue. So actually, our after sales margins have increased partly due to the parts partly due to internal rate partly due to greater efficiency, but we think that's good. So our aftersales margin actually rose from 43.5 to 47.1%. So when we say high margin aftersales, we're now talking about higher margin aftersales going forward, which clearly is very pleasing. If we turn to used cars, used cars had the ability to be very difficult in this period, due to probably softening consumer demand, which we certainly saw. And and certainly for periods, we saw Google automotive searches in The UK fall below last year's levels, which indicates a softening consumer environment. And we saw significant reduction in used car residual values in the market, in the period from April to August. And you can see that on the bottom left chart where clearly the the green line is substantially below. That has the ability to reduce used car margins. And what's pleasing about these results is the resilience actually of our gross profit generation in in used cars. Our gross profit was down £1,900,000 but £1,600,000 of that was the impact of the increasing charges coming out of the service department. So broadly, we actually held our own in a period of some quite significant problems actually in the wholesale markets. I mean, the conversion ratios, and the values we were getting in the auctions in that period were were very weak indeed for a period. I'm pleased to say actually we're seeing far more resilience now with regards to, residual values. You can see, the cap data for October is actually an increase in values and a higher increase than most years. So certainly seeing more stabilization now, is very much helpful. Auctions are working very, very well. Wholesale values are picking up. We are still seeing weakness in the premium, nearly new segment. That is where actually the margins are under pressure, and they have been for the last six months. And, actually, the margin changes in the year have been pretty stable in volume, but quite weak in premium in certain premium franchises, and we don't necessarily see that changing. That's due to supply push by manufacturers leading to a bubble of nearly new product, which then has to be discounted. These bubbles tend to work themselves out over time. It does raise a question as to how we saw those big declines in residual value over the summer, but we didn't see a great impact on our margin in the business. And I think the only way I can try and explain why that didn't really impact is we were very, very quick to try and drive volume through. So we didn't wanna be sat there with a lot of cars that would depreciate, you know, at a different rate. So we had special events, increased marketing, real focus in the business to drive stock turn and to get out of those cars before they became too painful, and that's what we've done. So we've actually grown our like for like volumes in the period 1.6%, and I think that's a tale of very tight control on stock, control on aged cars. We have very few aged cars in our business. We we have a thirty six hour report which keeps coming out highlighting them all. And I think that strong control really put us in a very good position to actually generate a very resilient used car performance, which could have been much, much worse. If we turn to new vehicles, I think there was a very interesting debate to be had as to why the new car market is down in The United Kingdom. The SMMT, for sure, always put it down to Brexit consumer confidence and uncertainty. I think it's actually a lot more complicated than that. I think we are in the middle of a cost to change issue, which I know certain analysts have picked up on. So we have had a Brexit related currency, devaluation, which is pushing prices up in order for manufacturers to maintain margins, particularly in the volume side of the business, and that's been that's been there for two years and continues. Average sales prices go up. At the same time, that residual value weakness reduces the cost, the value of the part exchange. So the cost per change and the monthly payment goes very much higher. And I think that is leading to consumers just not changing on as quick a cycle as they were four years ago. And I think that's particularly the case in the new car market. We're seeing elongation of customer change times, that's what's driving the softness of the, new car market on the retail side. So I think it's far more complex than just simply blaming it on Brexit. Brexit has an impact through the currency. It is it is actually due to cost of change. So the volumes franchise are certainly much more down on volume than premium. And actually that then ties into why we've got a nearly new glut of of premium product. You can see there from SMMT, this is business and private registrations combined. Volume down 11.4, premium down 2.7. So clearly, volume has been more affected. That would always be the case because with less margin, the volume manufacturers are always more affected by currency. They have to react much quicker and probably, much sharper. And we have seen some just on the SMMT, I think we have seen some reclassifications of business registrations into private registrations. So the private registration data you see in the SMMT, in my opinion, is overstated. I just think the retail market is actually weaker than the SMMT is actually broadcasting it at the moment. Overall, our gross profit was down 1.9. That is pretty well down to volume. Our like for likes were down 10.1. But we are actually seeing higher gross profit per unit, and that's due to mix, more premium. Clearly, our premium dealerships grew share relative to our volume dealerships, so that would make sense. Similarly, impact on margin percentages. Fleet and commercial, we've always been a significant player in the fleet and the commercial. So that's fleet car supply and van supply. We've always been big in it. And where we saw weaknesses in new retail, and I think pressure in that area which may continue, we actually see b to b as a major opportunity. So we have invested heavily in the last eighteen months in the b to b channel, more business centers. We approved got a a fleet director for the first time about eighteen months ago, and all that is working really well. And you can see that actually in the numbers. We also acquired Vans Direct, which is an online van retailer, and that clearly is impacting the numbers, positively. So gross profit overall in this channel in the six months was up 3,300,000.0, which is a big improvement of which 1.2 was on a like for like basis. Obviously, Vans Direct being a big delta with that. Gross profit unit getting up to historically very high levels of £600 a unit, aided by Vans Direct, but also aided by the real growth we've seen in premium fleet. We are becoming very good at premium fleet in in areas like Mercedes Benz, in Jaguar Land Rover, and that is coming through. And actually, that's coming through into strengthening percentage margins as well. And one of the reasons why our overall gross margin was strengthened was partly because of the service improvements, but also because of fleet and commercial. So margin going from 2.8% to 3.4% despite higher selling prices is a very, very good performance. You'll also note in the detail of our announcement, we refer to agency volumes. So we include agency volumes in our overall volumes. Agency is where it's a the transaction is actually dealt with directly between the customer and the manufacturer, which is how some of the manufacturers operate, and we take a handling fee, which actually augments margin clearly, but we've been very successful in that channel. If you look at the year, the six months, fleet car up 13.8% on a like for like basis, a very strong performance in a market that was actually down. Vans, was always going to be peculiar in this period because we had WLTP EU regulations coming into effect on the September 1. So we saw very strong market growth in registrations prior to first September. A lot of that was direct freight supply not really coming through the other channels and also pre registrations. So there was a disconnect between sales and registrations. We actually were up 2%, but the market was up 12.4%, but I was not overly concerned by that. If we actually turn to September, and I think some of those trends we've discussed there will certainly come through here. Despite dark clouds, which to be honest as an organization, we generally tend to ignore on the grounds, I can't do anything about dark clouds. Let's focus on the business itself and make sure our business is right. We actually had a very successful month in September. We actually saw higher overall profitability in September this year compared to last year, which we were absolutely delighted with. Backed clearly up by a strong after sales performance, 11.4% increase in service in the month. We actually opened all our after sales operations fully on Saturday and Sunday in the September, which is actually the first time we've done that because we were getting a lots and lots of part exchanges in as we delivered the new cars, and we wanted them on the forecourts to sell early in October to hit the market. So we actually had all our aftersales departments fully open, which clearly helped the numbers and and was were very, very good thing. And I'd just like to thank our aftersales colleagues for doing that because we had a lot of fun opening that weekend. On new cars, the market actually was up point one in retail, but actually if you take into account the business reclassification into retail, it was actually down in September marginally. We were down 1.6%, which I think was a result. And in used cars, despite the fact we were really pushing hard to hit new car targets and obviously our new car volumes were were I think pretty good, we actually grew used car volumes by 3.5%. And Karen made the comment about marketing. Clearly, we were concerned coming into the summer about where consumer demand would be, where would we be with Brexit, and we took what was possibly quite a brave decision of actually having a strategy to drive September. So we launched in August a brand new brand campaign across our two major brands in England and Scotland, actually focusing on giving the customers a choice between coming to dealerships and going online, and we hit the cinemas and TV with that. We actually spent in September £600,000 more on marketing than in the previous year, which is a brave shot. But it clearly worked because we are absolutely seeing more traffic, and I think we are taking share. £600,000 is a big number. We'll not be replicating that every month for the next, five months. But clearly, have got if we have the right marketing, we think we got a good ROI on it. So we will be continuing that as flagged up. So on the sales side, I think we were happy. The fleet performance was something. The market in fleet cars was up 8.6%, and we grew our like for like revenue, sales volumes 42.8%, which in a mature business is quite a number. And I think that reflects the investment and the effort we've put into growing our fleet volumes, and we were clearly very, happy with that. The outlook, sorry, just on vans because they're negative, quite heavily negative. Obviously, with WLTP coming in, this was entirely predictable actually insofar as there were loads of registrations of nonconviant vehicles pre September, then a dearth of product in September. And a lot of that was franchise related as well in terms of mix. So I wasn't too worried. It was pretty well where we thought we were going to get to. In terms of outlook, I think we've got momentum in the business. I think people are confident with the approach we're taking within the business. We are very, very focused on the basics of making sure our customers looked after when they come in, that we actually do sell them a car, we listen and make sure their needs are met. The after sales businesses are are doing well. So I think we've got good momentum. We will be very, very focused on tightening up processes within the business. We'll be very focused on more cost control. And that's not a negative thing about, you know, blindly reducing headcount far from it actually. It's about becoming a lot more effective and productive and having high productive roles and making sure we use technology to the max across the business and the long term projects in place which will deliver, good things in the next couple of years. And then a very strong control of cash. The the business systems that Karen has developed are exceptional. Our ability to quickly get a grasp of where the issues are within an individual business, an individual department are first class with graphical presentations of individual lines and trends, are brilliant and really paving the way to great control both of cash and and cost. And I think all that really gives us confidence despite the fact that clearly our challenge is on the new vehicle supply. We've clearly got European Union exit. We've got consumer confidence probably linked to that despite the fact we are still growing as an economy and we have, you know, the highest levels of employment we've ever had. So we should forget that. Exchange rate movements coming out of all that, I think, clearly impact, the business. There's no doubt. And then we've got the emissions legislation and the fines coming in the New Year. So that's another hurdle that we've got to get over. But overall, the board believes we remain on track to meet expectations for the full year, which means we can say we're in line. So thank you very much. We're now going to have Q and A in the room. If you're watching the results presentation on the webcast and you'd like to ask a question, please e mail Violet Wilson at camarco dot co dot u k.