Morning everyone, thank you for joining us on the webcast or conference call for GWA's half year results for the year end of 31st of December 2020. I'm Tim Salt, GWA's Managing Director, joining me on the call today is Patrick Gibson, GWA's Group CFO. On slide two before we begin, I just want to draw your attention to this disclaimer slide. For tonight's results presentation, I'll first provide an overview of our group results and key themes, Patrick will then detail our group financial results for the half year, including P&L, balance sheet, and cash flow. I'll conclude with an outlook for FY 2021. On slide four, I'll begin with an overview of our half year results in the context of what we have seen across the various geographies in which we operate.
In terms of the first half results, we have continued our disciplined approach to managing the business during the housing market cyclical downturn in Australia, and disruptions across all our geographies due to the COVID-19 pandemic. Importantly, we've maintained our leading market share position in Australia and grown share in both New Zealand and the United Kingdom. Our focus on operational discipline means we remain on track to deliver the supply chain savings as part of the overall AUD 9 million-AUD 12 million savings target. Despite the decline in revenue, our Australian New Zealand EBIT margin was consistent with the prior period. This discipline, together with our continued strong cash generation, means we've been able to declare a AUD 0.06 per share interim dividend, fully franked, which is up from AUD 0.035 paid for the second half last year.
We are pleased with both the performance of Methven and how our integration plans have been implemented. Cost synergies remain on track to deliver a total of over AUD 3 million in FY 2021, and as I will explain later, we have now commenced an additional program in New Zealand and the sale of our China plant, which together will deliver an additional AUD 3 million in annualized cost savings from FY 2022. We continue to successfully execute our strategy for growth, which is focused on superior water solutions. Our relationships with merchant partners is driving core range extensions for both Methven and Caroma products. While we've also launched new products in sanitary ware and colored tapware. Our touchless intelligent bathroom system, Caroma Smart Command, has now been installed in 77 sites with a solid bank of additional projects in the pipeline.
We're generating margin accretion in Methven and in the United Kingdom, even in a market heavily disrupted by COVID-19. We're consolidating and simplifying our operations in Asia, including a new local management team. As a result of these initiatives, GWA is very well positioned to leverage the expected improvement in market conditions. We saw an improvement in the market in the second quarter, and as you have seen, lead indicators such as detached housing approvals, home lending, and house price points point to an increased residential detached completions in Q4 and into FY 2022. Our commercial order book remains strong and growing. However, the current temporary slowdown in some commercial projects being drawn down has required us to pivot towards key growth sub-segments in education, aged care, and healthcare.
Our balance sheet remains robust, and given our cost base, GWA has significant operational leverage to an improvement in the building cycle when revenue momentum returns. In summary, while the market remains challenging for the period, we continue to focus on those elements within our control. As signs of increased market activity are emerging, that has positioned GWA well to capitalize on these improving conditions. On slide five, this slide demonstrates the improvements in revenue from the first quarter to the second. Overall revenue improved +1.6% in Q2 compared to Q1 FY 2021. In Australia, we saw signs of recovery in builders and merchant sales in the second quarter. However, this was impacted by the slowdown in the commercial project segment, particularly in New South Wales and Victoria. We did not experience any material further customer destocking, however, as anticipated, merchant restocking did not eventuate.
Sales in the first half FY 2021 in New Zealand increased by 3.1% on a local currency basis, and we benefited from the integration of our sales team and also from strong stock availability compared to some of our competitors. Sales in the United Kingdom were up 5.7% on a local currency basis in the half one FY 2021, with our margin enhanced despite the ongoing impact of COVID-19. I think this is a good result and a testament to our team in the U.K. On slide six, while the last slide demonstrated revenue by market, this slide illustrates our first half revenue with our main customers in Australia, our largest market, which accounts for around 77% of group revenue. Again, just to emphasize here, customers are shown in random order and notation. That means that the description A to E does not denote the size of the customer.
The key point is those customers with greater exposure to the retail-focused merchant channel have performed more strongly than those more exposed to the commercial channel, which has been impacted by the temporary delays to some projects in this segment. On slide seven, our strategy continues to focus on profitably winning market share regardless of market conditions. Pleasingly, we maintained share in a down market, where there has been some pressure on pricing and trading down to lower margin product. The slowdown in residential construction activity in Australia has been well documented, and we saw market decline in detached and multi-residential construction during the first half. The increase in detached residential approvals in Q2 FY 2021 is encouraging. However, it's important to distinguish between approvals and completions, given the normal nine to 12-month lag between approvals and completions. We've included a slide on this point in appendix.
Delaying commercial project completions resulted in market activity decline by approximately 17% nationally, with a significantly greater decline in New South Wales and Victoria. The largest segment, renovation and replacements, both residential and commercial, have continued to demonstrate more stability than detached and multi-residential housing. The residential R&R is stronger than commercial R&R. In total, we estimate a decline of approximately 6% in our addressable market in Australia to December 2020. I'll now hand to Patrick to discuss our financial results in more detail.
Thanks, Tim. I'll start with the waterfall chart we typically present to set out the key drivers of earnings over the half. These are normalized results. They exclude significant items relating to costs associated with the integration of Methven. Firstly, volume and mix. As Tim already mentioned, volumes were impacted by weaker market conditions, particularly in the commercial segment and the ongoing impact of COVID-19. That decline in commercial also adversely impacted mix, as the commercial segment is generally a higher margin segment for GWA. Australia is also a higher margin market for us compared to the U.K. and New Zealand, so the relative decline in Australia also adversely impacted mix. Price. We took a 5% price increase from August, which partially mitigated the impact of the weaker Australian dollar on product cost purchases in the half.
However, we did not realize as much price as we expected due to the slowdown in the commercial project segment that Tim talked about earlier. Foreign exchange. Through our foreign exchange hedging, we were able to mitigate some, but not all the impact from the weaker Australian dollar for the half compared to the prior corresponding half. The average Australian US dollar rate was $0.69 in first half FY 2021, versus $0.71 for the prior corresponding half. Net cost changes reflect our continued strong operational discipline, which mitigated a significant amount of the earnings decline for the half. This includes successfully delivering AUD 2 million in savings as part of the overall AUD 9 million-AUD 12 million cost out program by FY 2021, and AUD 1.5 million in Methven synergies in the half. Other tactical cost savings contributed AUD 2.4 million.
The final red bar represents an accrual for staff incentives, which was not included in first half FY 2020. Our first half performance in FY 2021 was impacted by the challenging market conditions but was in line with expectations. Adjusting for the staff incentive, normalized group EBIT margin in first half FY 2021 was consistent with the full year EBIT margin for FY 2020. Slide 10 presents the results on a normalized basis. That is, before significant items. The revenue decline reflects the weaker construction conditions in Australia, not fully offset by growth in our international business. EBIT margin was impacted by the market decline, COVID-19, sales mix across geographies, segment mix, and weaker commercial sales. The EBIT margin for Australia and New Zealand, however, was in line with the prior period.
As I said on the previous slide, group EBIT margin was impacted by the inclusion of an accrual for staff incentives for the half, which was not accrued for in the prior corresponding half. Slide 11 shows the results on a reported basis after significant items, and we've included it here so you can reconcile the result back to the Appendix 4D. Our ongoing strong cash generation and financial position enabled the board to declare a fully franked interim dividend of AUD 0.06 per share. The dividend reinvestment plan will be offered for the interim dividend at a 1.5% discount. The DRP is not underwritten. Turning now to cash flow from operations. This is a very strong result. Given the impact of COVID-19, we've maintained a particular focus on cash management in the half, and that has been reflected in the very strong operating cash flow performance.
Cash flow from operations was AUD 49.7 million, compared to AUD 42.2 million for the prior corresponding half. Cash conversion remains very strong, with a cash conversion ratio of 118%. Working capital and debtor management is a continuing focus, with days sales outstanding at 31st of December 2020 improved on the prior corresponding period. Capital expenditure for the half was AUD 5.5 million. That's down on the AUD 8.2 million for the prior corresponding period and reflects our continued prudent approach to cash management. We remained focused on initiatives to drive cost efficiencies and revenue-enhancing opportunities, including a seed investment of AUD 2.8 million in a third-party overseas venture. Cash restructuring and other costs of AUD 0.9 million relate primarily to Methven integration costs. GWA remains in a strong financial position to manage in the current uncertain environment.
A net debt as at 31st of December 2020 was AUD 125 million compared to AUD 144.8 million as at 30th of June 2020, with leverage improving from 1.9x down to 1.7x . In November 2020, we completed the refinancing of our syndicated banking facility. That comprises a single three-year multi-currency revolving facility of AUD 227 million, which does not mature until November 2023. We'll also maintain a separate AUD 40 million one-year multi-currency revolving bilateral facility, which matures in October of 2021. Our credit metrics remain consistent with investment grade, as you can see on the slide. I'll now hand back to Tim.
Thanks, Patrick. On slide 15, our growth strategy continues to be customer and consumer focused, underpinned by internal cost and capability improvements. It's a strategy that supports our purpose of making life better through products, services, and technologies that create superior solutions for water. Today, I'll provide an update on our continued progress on the integration of Methven, an overview of innovation driving our brands, and an update on Caroma Smart Command. We acquired Methven in April 2019 and have been progressing our integration plan since that time. We're pleased with how the integration has gone and the further diversification, scale, and capability Methven brings to our business. Cost synergies remain on target, with AUD 1.5 million realized in the first half, and we remain on schedule to deliver AUD 3 million for FY 2021, bringing the overall total across FY 2021 to over AUD 6 million.
We have completed the integration of the sales structure and consolidation of the Australian distribution network. Our focus now moves to the final stage of integration. This includes consolidating our New Zealand distribution network from two warehouses to one, which will enable efficiencies and single invoicing to improve our customers' experience. We're also progressing the sale of the Methven China assembly plant, which is expected to complete in Q3 FY 2021. We expect one-off costs of around AUD 4 million will be incurred in FY 2021, of which AUD 2.1 million pre-tax were incurred in the first half. Annualized benefits of around AUD 3 million are expected to flow FY 2022 onwards. Our Tap and Showerware Center of Excellence in New Zealand is building a strong pipeline of new products with the market-leading Methven Shower IP now being used in Caroma new shower launches this year.
The addition of Methven provides us with enhanced geographic diversification, which continues to be a strategic growth opportunity for the group. Around 23% of our revenue now comes from outside Australia. In our international business, we're leveraging Caroma product to go to market with a whole of bathroom solution. We're also leveraging our IP and technical capability, as Patrick mentioned, with a third-party overseas venture, which is at the early stages, and we'll be able to talk more about that later this year. On slide 17, our key focus of our growth strategy is centered on product innovation. We've established centers of excellence in Auckland and Sydney to harness our local technical design and sourcing capability in taps, showers, and sanitary ware. Our rolling three-year innovation and new product pipeline is prioritized against specific market opportunities.
While we've launched more than 1,500 new SKUs in the last three years, around 3,000 SKUs have been removed from the portfolio. Our focus on hygiene and touchless solutions is important in the current environment. For example, we've launched GermGard, which is an antibacterial glazing for our sanitary ware and toilet seats to capitalize on consumers' heightened concerns over safety and hygiene following the COVID-19 outbreak. We have further touchless tapware innovation planned for H 2 FY 2021. We've launched a number of new initiatives under the Caroma brand, including GermGard sanitary ware, colored tapware, and showers incorporating the Methven IP across both Australia and New Zealand. We've also extended our Methven tap and showering range to take advantage of further identified opportunities. Our local design and technology expertise continues to be a key point of difference for the group. On slide 18.
The momentum behind our touchless intelligent bathroom system, Caroma Smart Command, continues, and we're encouraged by the ongoing strong reception in the market. In the current environment, the system's touchless features, which offer customers a safe and hygienic solution, is resonating well. The system has been installed in 77 sites across Australia and New Zealand. While COVID-19 delayed the anticipated rollout into some sites during the half, predominantly in retail and airports, our Caroma Smart Command order bank is growing, and we maintain a solid new product pipeline with a number of product, technology, and cloud interface enhancements in development. To date, 33 sites have been migrated to our new cloud data capture solution, with further migrations expected in the second half. Importantly, this is a first small step to create an ongoing fee-for-service solution.
We've completed the first pilot installation in Asia, with further activity planned over the next year. I'll now provide a commentary for the full year FY 2021. Recent lead indicators in Australia, be that consumer sentiment, dwelling approvals, new housing loans or housing turnover and HomeBuilder and state government incentives point to increased detached residential completions and renovation and replacement activity in Q4 FY 2021 and into FY 2022. Our commercial order bank remains strong and is 16% above the level at December 2019. Though we have pivoted to the key segments of education, health, and aged care, our order bank in those segments is up 25% since the end of June 2020.
We remain strongly positioned in the commercial segment. However, commercial and multi-residential completions are expected to remain subdued in the second half of FY 2021. Growth is expected in New Zealand, the U.K., despite ongoing COVID challenges, and Asia.
For FY 2021, our focus remains on generating profitable share growth through customer and consumer initiatives. These include targeting new commercial segment growth opportunities and embedding new products, be that sanitary ware and colored tapware with key merchants. It also includes enhanced consumer engagement, leveraging our digital communication strategy and channels, and the touch-free hygiene benefits of Caroma Smart Command. We'll maintain our focus on operational and cost discipline and are on track to deliver strategic supply chain savings of AUD 4 million and targeted Methven integration savings of AUD 3 million in FY 2021. In the second half of this year, we will commence the implementation of a new ERP/CRM system to improve customer experience and to replace multiple legacy systems. We'll continue to control the controllables with a specific focus on discretionary spend, working capital, and capital expenditure.
GWA is well-positioned, given our strong operational leverage to increased market activity in Australia, and we continue to capitalize on our momentum across our international operations. Ladies and gentlemen, that concludes the presentation, and we are happy now to take your questions. Thank you.
Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star two. If you're on a speakerphone, please pick up the handset to ask your question. Your first question comes from Mitchell Sonogan from Macquarie. Please go ahead.
Good morning, Tim and Patrick. Thanks for taking my questions. Can you hear me?
Yep. Very clearly, Mitch. Go ahead.
Yeah. Thanks. Just a quick question first on the outlook. For the second half, you've talked about the addressable market expectations to be down either 4% or up 2%. Can you clarify is that half-on-half versus PCP? Also just thinking about the second half incorporating all the movements in FX and cost out, how should we be thinking about the second half EBIT margins on that guidance that you provided there? Thank you.
Thanks. Do you want to take that, Patrick?
Well, why don't you talk the market piece and I'll talk about the FX cost out piece.
Yeah. The outlook second half is a year-over-year comparison, Mitch. The change I think we face in the second half is really what we're not sure about yet is when the benefits that we know are coming on detached housing and the renovation, when that approvals shift through into completions, and that's why the range is probably fairly broad in the second half. As I said in the presentation, we expect an uptick in quarter four based on the significant sort of growth that we've seen in approvals of both reno and new buildings literally in December, primarily. That, we think, will show up in Q4, but it could move into Q1 FY 2022, and that's why there's a relatively large range there.
In terms of margin, Mitch, for the second half. Look, we have included, I think it's slide 23, some updated assumptions. Basically, FX was adverse year-on-year, AUD 3.7 million in the first half. We are forecasting that to be less adverse in the second half. We think about AUD 5 million for the full year. We will see some benefit there relative to the first half. In terms of cost out, we delivered the AUD 2 million in the supply chain cost out program, which is AUD 9 million-AUD 12 million by FY 2021. We expect that to be AUD 4 million for the year, the run rate will continue. Similarly, the AUD 1.5 million delivered on Methven integration savings in the first half, that run rate will continue, and we should see AUD 3 million there for the full year.
I think the other comment is that we would expect to see more price benefit come through in the second half, just predominantly due to the usual lag effect in the builders segment, where it takes about six months from announcement for that to work through an impact in the marketplace given the contracts builders have with their consumers. Look, I suppose the one offset that we are also seeing is some adverse freight costs due to a shortage of shipping and containers. That's really an industry-wide, in fact, country-wide issue at the moment. We are expecting a little bit of headwind there. Look, overall, when you put it all together, subject to any major swings in mix, I would be expecting to see some improvement in margin in the second half.
Okay, great. Patrick, just while I've got you there, just a quick comment on the gross margins, if you could, from the PCP down 23 basis points. Is that more mix or is that going to be some of those freight costs coming in? Can you just step through that a little bit more, please?
Sure. Look, in the first half, that adverse margin movement, there's a little bit of on cost from freight there, but that's going to be more of a headwind in the second half than the first half. The real driver there is the adverse mix that I talked to, that's driven really by predominantly Australia. There's a couple of building blocks to this. Firstly, commercial segment is down, as Tim talked about, and that's generally our highest margin business. Equally, the builders segment is up, and that's a significantly lower margin segment for us. Australia, coupled with, if you like, the volume decline in commercial, has driven that. Then as we've seen growth in other geographies such as New Zealand and the U.K., while those markets, the margins are improving, historically they are lower than Australia. It really is all mix.
It's not about terms drift or anything like that, Mitch. It's a large mix factor impacting that first half.
As we said, Mitch, I think our commercial order bank is up strongly, so we haven't forgone those sales. They're just delayed at the moment. We know that we will get those back into the business at some stage. It's just a question, as I've mentioned before, of when the commercial segment starts to pick up again. I suppose if you like, it's a timing or a phasing issue that we face at the moment, particularly in the second half of this year before we see any rebound in that commercial segment.
Okay, great. Just the final one from me, Tim. I'm just thinking about the residential alterations segment. Be able to give us a bit more flavor, I guess, about how you're seeing things state by state and maybe the discussions that you're having with your customers, given the improving approvals over the last three to six months. Like are they starting to get more bullish? Just a bit of an update on how they're seeing things.
Look, I think, as you say, the approvals piece, I think, has gone through a sort of. It was very significant. If you look at HomeBuilder, I think of the 75,000 HomeBuilder applications up to the end of December, some 20% of those were actually driven by renovation opportunities. I think there's no doubt that there is momentum there on the back of HomeBuilder. I think it goes much broader than that, Mitch. I think it's actually the availability of free money and all of those other factors I talked about earlier around housing prices picking up and housing turnover starting to pick up. All of those things, I think, are driving some increase in interest in that renovation space.
We think that, probably more in line with HIA, we think that this year the reno activity will probably be up about 3% overall. Really that's in line with HIA, where they're coming from. You're seeing quite an interesting mix there, where in New South Wales and Vic, you're seeing a good growth in value of those renos, which I think is interesting. Whereas in Queensland, we're seeing quite an uptick in the number of renovations, as you've seen in the ABS data. The value of the renovations in New South Wales and Vic is quite a bit higher than it is in those other states. You're seeing a different mix playing through on some of these.
From a customer perspective, I know a lot of the work that we're doing at the moment has been to talk to in the presentation about getting new products into market. A lot of the work that we're doing around a Caroma colored tapware, around getting new showers on both Caroma and Methven into our customers, getting those ranged and displayed in their showrooms is an important part of what we're doing as we look to take advantage of those opportunities. I think there's good alignment between ourselves and our customers on A, the opportunity that R&R presents. I also think that for many of those customers who are also suffering in the sort of where the commercial downturn has impacted their business, like us, they're looking for other growth opportunities.
I think we're well aligned across all our major customers with the need to drive increased activity in the R&R space. If you were to walk into one of the major big box retailer at the moment, you'd see that we're actually got a display there of bathrooms, a complete bathroom solution, which is actually driving really good incremental volume for us and for them, for that matter. There are plenty of things that we're doing in the first half, which we think will give us benefit as we roll into the second half, both in terms of customer ranging, but also that new product development rollout that I've just talked about.
Perfect. Thanks a lot, Tim and Patrick. That's all from me.
Thanks, Mitch.
Thank you. Your next question comes from Lee Power from CLSA. Please go ahead.
Hi, Tim. Hi, Patrick. Just on the AUD 9.5 million of that FY 2020 short-term cost reduction, can you give us an idea of how much of that returned in the first half?
Yeah. Look, you'll recall that we said of that AUD 9.5 million , it was AUD 6.6 million was related to STI.
AUD 3.3 million of it, if you like, returned in the first half, which was STI related.
Yeah.
I'd say, there's probably, as you saw, we had some other tactical savings. We probably saved another AUD 2.4 million from just lower T&E and vacancies and recruitment costs and things like that we had thought we would be spending in the first half. Broadly speaking, I'd say really only probably about AUD 4 million came back in the first half of that AUD 9.5 million .
Okay. The commercial order book, I get that it's growing and I guess it's always hard to put a timing on when it returns. Do you think that recovery in commercial goes hand in hand with restocking? Are they now so closely tied that we could see 2022 get this double bump of restocking and commercial?
I think, Lee, there's no doubt that at some stage there will be the uptick. As we've talked about before, as momentum comes back in the market, customers want to make sure they've got plenty of product to take advantage of sales opportunities, and that becomes their focus rather than cash flow or working capital management themselves. I think the answer is yes, we would expect to see an uptick at some stage. I think the really hard thing at the moment in commercial is really trying to put a definitive timeframe on when that will come back into the market. In the short term, as I mentioned, what we've tried to do is, as we've recognized that maybe offices will be slower in their recovery and maybe same for multi-res, if you're looking at the projections for those going forward.
We've actually looked to pivot some of our focus around aged care, around health and education, where we know two things. One is that there's going to be increased public spend in that area, but also that the turnaround time for some of those projects are somewhat shorter than they would be for those major commercial developments. We've tried to re-emphasize, if you like, where we're focused, and that's why we're seeing our aged health and education up some 25% from the end of FY 2020 because of the extra effort that we put in there, and that we've got dedicated people now hunting against opportunities in each of those three segments across New South Wales and Victoria, and that's giving us some benefits.
In answer to your question, I think yes, there will be an uptick at some stage, but what we're not committing to at the moment is when that will happen. I think there's a little bit of time to go before that full confidence in commercial comes back. What I do know is that when it does come back, we are incredibly well placed to take advantage of it because of, A, the strength of that order bank, but B, the shape of the order bank that we now have as well.
Okay, excellent. Patrick, just on price. It sounds like, I guess before it was price was enough to offset FX. Is that still the case or maybe not anymore?
Yeah, no, I would expect for full year that price will fully offset FX, because we will see a higher rate of price recovery in the second half and a lower rate, if you like, of incremental FX on costs. Overall for the year, we should still be good there.
Okay. Just one last one following on currency. You mean with $0.78 now, how should we think about that in the longer term, thinking FY 2022? Are you going to put that back into reinvestment or are you happy to run higher margins? I think in the past you've talked about sticking around 100 basis points range around margins. Whether that kind of thinking has changed at all.
No, you're right. We've said ±50 basis points to 100 basis points over the medium term. Look, that metric is still valid. I think what we've seen frankly, is a bit of a perfect storm with the COVID impact, particularly last year and lockdowns, shutdowns in New Zealand and the U.K. We've seen that impact and confidence in the first half this year, which has impacted that commercial segment. You couple that with the HomeBuilder and stimulus boosting the builder segment. It's a bit unusual. That's why, as I said to Mitch, that's what's driven that gross margin temporary decline. Look, to answer your question, I would expect margins to improve over time. We've always talked about maintaining that group margins in the low 20s, and that still remains valid.
Look, specifically on FX, it is going to be still a headwind for us this year, but at the moment we've lowered our cover for FY 2022 on the expectation that most people are forecasting further strengthening. At the moment we're 48% hedged in terms of our requirements at about AUD 0.73. Look, obviously, we'll continue to roll forward and if rates stay at AUD 0.77, AUD 0.78, that will continue to improve. We should see a benefit on FX in FY 2022 versus FY 2021.
Okay. Thank you. I'll leave it there for the moment. Thanks.
Thanks, Lee.
Thank you. Your next question comes from Raju Ahmed from CCZ. Please go ahead.
Hi, Tim. Hi, Patrick. Can you hear me?
Yeah.
We can hear you.
Okay. Fantastic. Thank you. A couple of questions from me. The first one is, if you divvy up FY 2021 into four quarters, do you feel that you've passed the low point, or is that low point still to come in Q3 ?
We believe that we've sort of hit the low point and there should be some modest upside from here, Raju, and I think a lot of that talks to the recovery that we're seeing in that consumer or med space. We think that we would expect to see a I wouldn't expect a V curve on this or a V shape, but certainly, we'd expect to see modest increases and momentum building as we go into Q3 and into Q4 over this second half.
I'm not trying to put numbers into you, but what I'm trying to get my head around is, given your expectation of a potentially better Q4, and I can understand that, is it a case of saying that the second half revenues and EBIT underlying basis will be both better than the first half? Is that a rational comment?
Yeah. I think that's a fair assumption. I think also the other piece to remember in the second half that we haven't really talked to yet, the Australian market, I think, is improving, and we will benefit from that. I think it's also worth remembering that we are lapping significant lockdowns in New Zealand and the U.K. last year as well, Raju. We will obviously get the benefit of that. I think, as I said earlier, we're trading well in both of those markets anyway, in terms of good top-line momentum and also winning some share there. It's actually quite encouraging. I think then as we go into the second half, it gives us more of a base to springboard from. We do expect on that basis, the second half to be stronger than first, and certainly that momentum carrying through.
Q3 will be pretty good in obviously New Zealand and the Sorry, Q4 is probably going to get most benefit actually as well because the lockdowns were in April in New Zealand, so you start to see that playing through a little bit at the end of March, but also into then mainly April and a little bit in May. Just to be 14% of our business in New Zealand and 8% in the U.K., so we've still got to make sure that we're doing all the things that we need to do in the Australian market, and I think that's where we also feel more confident than we were in the first half. Yeah.
Okay. That's good to hear. The second question group is more focused on the macro. You've talked about seeing demand in the horizon with the HomeBuilder and the other government stimulus packages. I'm just trying to get a holistic picture whereby, if you've got Many builders tell me that there's a pull forward in demand as a result of the HomeBuilder scheme in particular. If you've got that pull forward now or coming up in the next couple of months, how do we then think about what does the other side look like? What does that mean for expectations around that restocking you talked about from the earlier question? How do we overlay that with the commercial outlook? When does that demand flow back through in terms of big commercial projects? How do we look at 2021 calendar year given all of the above?
Well, that's a million-dollar question at least, Raju. I think the way that we're thinking about this at the moment is that there are two parts to the demand that's being driven in the second half. I think one will be around resi detached housing new build, and the other one will be around in our renovation and replacement space. I think both of those look as though they're set for an uptick in the second half. This is just we'll give you our view of the world and that, but at the moment, if you look at someone like BIS Oxford, they're saying that there's going to be a significant uptick coming in in Q4, and I think then a decline setting in beyond that as it's all been pulled forward.
I'm probably a little bit less optimistic about this massive peak followed by a massive trough. I think that labor availability and tradies will actually start to play out on some of this because I think we're going to potentially see a bit of a convergence crunch because the tradies that work on renos and work on detached new builds are not necessarily the same ones who work on multi-res. There is some overlap or in commercial, a plumber who works on commercial jobs can't necessarily down tools there and go into a detached housing space. I think we're going to see a bit of a crunch on availability of labor potentially, which will probably a good thing to dampen down what we see happening in the end of this year.
The converse of that is that I think that will actually be more encouraging as we then move through into the first half of FY 2022. I don't think we're going to see quite as much of a peak and trough as perhaps some of the market forecasters are talking about at the moment. If you've ever done a renovation yourself or attempted to build a house as well, some of the hoops you have to jump through with local councils and whatever else, I think we're potentially, if it's all coming as a crunch at one go, I think we're going to see that sort of demand for labor and approvals is actually going to put a bit of a natural dampener on, which will probably put a bit of a cap on how much acceleration we get in the second half.
I think we will see upside, as I said earlier, from Q3 into Q4, but I don't think it's going to be that sort of boom and bust cycle that some are predicting at the moment. The commercial one, I think, is a much harder one to predict at the moment. As I said, we expect commercial to remain subdued in the second half of this year, because unless something is in the pipeline now or unless it's actually already under development, there will potentially be a lag until we start to see that return.
I would expect that you start to see some uptick for us probably Q1 into Q2 FY 2022, not because of the big jobs that we've got in the order bank, but because there are a lot more smaller jobs that we're picking up at the moment that we're changing the mix, as I mentioned earlier. I've probably much got more of a view around residential being flatter in terms of the peaks and troughs, and then commercial rising slowly from here. I think, hopefully, we don't see a return to lockdown like we've got in Victoria, because that doesn't help anybody in terms of confidence. I do expect then to see a slow return on commercial over the course of the coming months and quarters, and that's how we're sort of thinking about our business at the moment.
Okay, that's very helpful. Thank you. The last question, this will be a quick one, is you talked about Methven margin improvement. Has it been all or mostly on the back of the integration benefits, or have you seen top-line improvements driving margin expansion through operating leverage as well?
Yeah, it's you, Patrick. I'd say it's really a combination. We've seen top-line growth, as you can see in the U.K. and in New Zealand on slide, I don't know what number it is, three or four, I think. Slide five. That's contributed. The integration savings are well on track for that AUD 6 million by the end of this year, which is above what we already targeted. We've now flagged that we will get additional benefits in 2022 flowing from that consolidation of distribution in New Zealand and changes that we announced in China. We ended last year at somewhere around, we estimate, about a 12% EBIT margin in Methven, and I'd estimate that's up to over 14% now and well on track to get to the high teens that we've always said is our aim by FY 2022, 2023.
Okay, that's very helpful. That's it from me. Thank you.
Thanks, Raju.
Thank you. Once again, if you wish to ask a question, please press star one. Your next question comes from Peter Wilson from Credit Suisse. Please go ahead.
Thank you. Morning.
Morning
start with just a few on costs. To follow your earlier comment, Patrick, around freight rates, can you give us an idea of how much freight is as a proportion of your costs, and how much those spot rates have gone up and how you manage that? How much you've contracted versus how much you're exposed to those spot rates?
Yeah, look, I'll start. Tim, you might want to speak as well. Look, approximately 6% of our product costs would be freight costs, and the majority of that's international freight. We bring in something like 4,000 TEUs annually, so we're a fairly big importer. Having said that, we do club together with other importers to contract at what we hope are good rates. The answer to your question really depends on how much is contracted and how much is spot, and whether the shipping companies continue to allow people to contract significant volumes in
We would probably be contracted, I would say about 85% currently. Whether shipping companies will offer that as we go forward into FY 2022, I don't know. When I say there'll be own costs in the second half, I think it'll be probably in the order of AUD 11 million or so for our business. I think the big unknown is what does it mean for FY 2022? Spot rates at the moment are already up probably about 5x or 6x .
We're about 4,500 to TEU.
Versus probably-
1,000.
1,000. International, it's not so important for us, but international air freight is probably up from AUD 2 or AUD 3 a kilo, to probably AUD 8 or AUD 9 a kilo. We're pretty well-placed, we think, for second half. What we just don't have a crystal ball on is what will happen in 2022. The only thing about this is it's a global issue. It's not a building industry issue. It's not an Australian issue. They're the same issues are happening in, particularly on the rates from Asia to the U.S. and into Europe and the U.K. at the moment. It's going to affect everybody. I imagine if it continues and if supply of ships and containers doesn't balance back in the short term, then I suspect it will be inflationary, and lead to people needing to price to recover it.
A bit of a long answer, Peter, but does that help?
It does. Unfortunately, I missed part of it due to, I think it's a poor quality line. When you were just talking about how much the spot rates are up compared to your contracted rates. Can you just, I guess give?
Spot rates are up probably 5x or 6x what contracted rates are currently. Having said that, as I said earlier, the majority of our rates at the moment are contracted, so it's not having a huge impact yet.
We're well-positioned on stock as well.
We're well-positioned on stock. We saw some of this coming and it's one of the reasons we Inventory was slightly higher in December than it otherwise would have been because we brought more in when there was more availability of shipping.
Okay. 85% contracted this year. What would you be into next year?
I don't know because that negotiation doesn't take place until next year, and very much will depend on what's available in the marketplace.
What we do know is, though, that to the point Patrick made earlier was part of the group that we're part of has got very good global scale. Therefore, we're pretty confident that the rates that we will be able to get will be as attractive as anybody else, if not better, coming into market. I don't think we'll be at a disadvantage either on a price or availability basis as we try and strike this new deal.
I mean, this basically will impact anything coming in in a container into Australia, which, at the end of the day, is most things. It also is impacting, it does not impact us so much in this regard, but it is impacting export because there is actually less containers available in the right places for people to export in.
We did see in the first half, Peter, as I mentioned to Raju, that we actually got a benefit in New Zealand in the first half because our product availability was much stronger than many of our competitors. We've taken advantage of that, sort of the supply chain that we've got at the moment and that product's availability to continue to drive benefit with customer, and that's been quite useful. We expect that'll carry on in the second half as well.
Okay. I guess based on your experience and the increases in rates that you've seen in markets in the past, if you're looking to FY 2022 and the quantum of the increase in freight costs you expect, and then compare that to the relief you're getting on FX, do you think that we should see the quantum as roughly similar, or do you think the, sorry, the freight rates are going to more than offset the FX tailwind?
I can't give you an outlook for 2022 at this early stage, Peter, given this is a market macro factor. I think as Tim said, we'll be relatively well-positioned for whatever it is. As you've said, we will have benefits in year-on-year FX if things continue the way they are, and we'll obviously have our cost out programs as well. I haven't got a crystal ball on 2022 freight rates at this point.
The reality is, though, Peter, we're going to have to pass price through because as I say, this won't be just a bathroom products or just a building industry issue. This is, as Patrick said earlier, it's going to be an Australia and New Zealand issue. Everyone, I think, will be looking to push price through in the market if we don't see these rates come down. I think the reality is that while we don't know what the future holds at the moment, I think there's a lot of probably hype in the numbers and we're obviously, as Patrick said, we brought products in early with an expectation that some of these numbers were going to go up.
I don't think Asian supply partners and their governments will actually allow this situation to carry on because it's not going to just put a dampener on Australia, it's going to put a dampener on many economies. I think there will be a solution that will be found for this. We're already seeing in China that they're ramping up production of containers to build availability. I think it's something that we're very conscious of at the moment, but it's not something that we want to overreact to either, because I think we need to understand, to Patrick's point, what the future holds. Certainly it doesn't look good at the moment, but I think there'll be remedial actions to improve the situation.
I think that's right. Hopefully by August, Peter, we can give you good clarity to your question.
Government is very aware of this as well, both in New Zealand and in Australia. I don't think it's a surprise for anybody at the moment. I mean, it may be a surprise how quickly it's come on, but everyone's aware of it, so I'm sure there'll be actions taken at a national level.
Okay, understood. I'm a little bit confused on your selling expenses. Selling expenses were down, was it AUD 9 million in the first half? Sorry, AUD 6 million. A little bit confused, I guess, in the context of Lee's earlier question around the non-recurrence of the FY 2020 saving and selling expenses. I guess the question is, the selling expenses in first half 2020, is that a sustainable level or should we still expect more cost to come back in FY 2022?
You're looking at the stats, are you, Peter, for that?
I am, yeah.
Yeah, sure. Yeah, there's a number of things in that bucket. I referred to, for example, we had saved AUD 2.4 million of tactical cost in the first half. You see that in the waterfall effectively. That's really savings coming driven by predominantly not having the T&E that we expected in the first half. Holding onto vacancies, not filling those, so managing that and no professional fees and recruitment and so forth. We've always said as part of that AUD 9.5 million , we expect that to come back into the business. I expect that to happen certainly in 2022. Absolutely. The other big numbers that work through into that are, as I said, AUD 1.5 million of savings in integration from Methven.
That's not all from selling, but we did integrate our sales team across ANZ with the Methven team, and that has driven some of those savings. Those were planned and just part of the AUD 6 million integration related to Methven. Those will be sustainable and continue. I guess roughly I'd say maybe half of it will come back and half of it will stay out year on year. Look, it's probably a slightly distorted comparator here. You've only got six months. I think we'll probably see it less extreme though full year when things even up.
Some of that cost came out in the second half last year as well.
Okay. On the sale of the Methven China plant and the benefits you're expecting, AUD 3 million benefits. The one-off costs are AUD 4 million full year, AUD 2.1 million this year. Were they taken above the line? Are the annualized benefits relative to those one-offs or are they on top of the one-offs?
I'll try and break that down. In first half this year, you'll see we had one-offs of AUD 2.2 million pre-tax. In the second half, you'll see on that assumption, slide 23, we've set out that we think significance for the full year will be AUD 6 million. It'll be AUD 3.8 million in the second half. The bulk of that is related to two things. One, the warehouse consolidation that Tim talked about in New Zealand, and the sale of the assembly plant in China, and the balances related to ERP kicking off. Those are, if you like, below the line and insignificant items. Then as we called out that, yes, there will be an annualized saving of AUD 3 million in FY 2023 related-
FY 2022, sorry, related to that Methven part of that, which was about AUD 3 million out of the AUD 3.8 million expected in the second half. Does that make sense?
Yeah, it does. That's fine.
Effectively a very quick payback on those changes that we're making, which will obviously give us long-term margin improvement in Methven as we've spoken about.
Yeah. You're talking a AUD 3 million improvement versus your adjusted EBIT this year?
Correct.
Yeah. Okay. This is the last one from me. In terms of the market, you spoke about this a little bit before, but in terms of the residential R&R piece, what do you think the res R&R growth was in the first half of FY 2021, and what are you assuming into the second half and then into FY 2022?
At the moment, we've aligned with pretty much where HIA have come out, which is for the full year, I think they're forecasting something in the region of a 3% growth. We think that that will be slightly stronger in the second half relative to the first half. The first half is plus one or two, the second half will be a little bit stronger than that, as we said. That's more aligned to that one as it relates. At the moment, I think it's a little bit too hard if you're looking forward to FY 2022. I think in R&R, generally in that resi space, you're normally +2% , +3% , -2%, -3% . You tend not to see the massive boom and bust, although they vary. HIA are pulling it down marginally in FY 2022.
I think if it is, it's only down 1% or something like that. I think it's pretty much going to be holding relatively flat, and I think that's reflecting that same drag forward potentially around HomeBuilder. At the end of the day, if not all of that plays through, then we may see a slightly slower growth in the second half and a slightly higher growth into FY 2022. We think that's roughly where it will end up. At the moment, it's still, I suppose, a little bit up in the air.
Do you not think the sales performance of your major customers suggest that R&R was in fact a bit stronger than that this half? I guess you had your relatively weaker sales for most of your major customers.
No, we're very comfortable actually with where we've landed with our major customers, because what you've got to look at for every one of our sales is you've got to look at whether that's in resi, whether that's in commercial. Obviously, a lot of the downside that we've had in the first half has been around the commercial sales. If you take some of our major customers, I'm not going to quote their numbers, but we're very confident that we're growing at or ahead of their position within front of wall. With our major customers, we're actually very comfortable around that.
I think when you look at some of our customers, you've got to split their business up front of wall, back of wall, water, and then some other players, such as Reece, for example, who've got civils and they've got refrigeration and they've got HVAC and whatever else. I think you have to look at their business in totality and then try and strip out what they're doing on front of wall. That's how we try and compare ourselves to market. Certainly, we're confident that we're going okay on that.
Why do you think front of wall asset category would be one of the few categories, I guess, which isn't participating in this home improvement boom that we're seeing?
I wouldn't say it wasn't participating. You have to think about share, and I'd say that we are holding our own in what we know. From our perspective, the customers where we're in that trade area, I'm very confident that we are actually participating in it with them. As I said earlier, don't forget, commercial was around 32% of our business. It's come down this year, but that's been a double-digit decline in the first half, which has had a major impact not only on us, but obviously we sell everything that we sell through that to a merchant, so that has a flow-through amount. If you look at that commercial versus what we do in resi, our resi, I think with every customer, when I say resi, either merchant sales or residential new build sales, we're actually up in the first half.
The challenge has been that in the commercial, that's been the anchor in terms of how we're performing in each of our customers. The slide, I'm not sure which one it is, one of their customer, slide six gives a little bit of an indication of that, Peter, where it doesn't really matter who's who, even if you look at customer one there, we know that that residential sales and merchant sales are strong, we know that that's been held back by some obviously slowing commercial sales. The one at the bottom on the left-hand side is customer D, is obviously a customer which is pretty much exclusively focused on commercial. It's all to do with where they play in the market in terms of how we play through the customer.
Okay, got it. I'll leave it there. Thank you.
Thanks, Peter.
Thanks, Peter.
Thank you. Your next question comes from Lisa Huynh from Citi. Please go ahead.
Hi, all. I just had a question on the commercial order book. I guess you've talked at length about the weakness in commercial, and understand it's fairly uncertain at the moment. Can you just talk to us about what you see as some of the catalysts you're looking out for in your business, specifically in the education, aged care, and health space, to see some of that order book convert into sales on the horizon?
Yeah. Good question. I think there's a couple of things about it. First one is I think the whole COVID-19 piece has played out in a way to an advantage of this, because I think it's going to create renovation opportunities in that commercial space in a way that I think will put more of an emphasis on reno rather than new build. If you go into any public area, whether it's a hotel or whether it's a school or anywhere around Asia, you'll see that most of the facilities are actually touchless. Whereas in the high-end places particularly. In Australia, whether it's schools, whether it's aged care, whether it's health, there's still actually a lot of touch products that you need to manually flush or turn the taps on and off.
We think that the major short-term benefit will be this conversion around safety and security for patrons, whether that's a person in an age care facility or whether it's somebody visiting a retail shopping center. We're already seeing quite an increase in inquiries and demand for touchless solutions. I think that's the piece that's going to be interesting across not only age, health, and education, but I think more broadly as well. From my perspective, we're already seeing that playing through. Within our order bank, tapware has actually increased as a percentage of our order bank. It's gone from only about 18%-19%, at the moment, but we expect that to continue to increase over the second half.
I think more broadly, as I said earlier, I think we're seeing a mix shift from those large-scale jobs to those smaller jobs, that renovation as opposed to new build. From our perspective, we expect that to continue through with increased inquiries in that space and increased conversion into sales there. That's why I mentioned earlier, our education, health, and age is up about 25% as an order bank versus at the end of FY 2020. We expect that conversion to sales to be a lot quicker. In a way, what we're trying to do between the peaks and troughs of those big jobs, actually fill it in with a lot more smaller stuff.
From that perspective, they're the lead indicators that we look for, which is that order bank around some of those areas where we know it's more replacement and renovation, and shifting mix within that order bank. I think we're comfortable with the progress that we've made to date. We've got a lot more to do and we've got new touchless tap ranges coming out in the second half of literally a couple of months' time. We're going to continue to drive more of those because we think that the market has already made that shift, and we need to make sure that we've got sufficient product offerings with different price corridors to capture that opportunity more fully. That's how we're thinking about the shift in that order bank at the moment.
Okay, sure. I guess that shift towards the smaller projects, in terms of the renovation piece, would I be correct to assume that that's typically higher margin because there's probably less overheads attached to those types of contracts?
It's an interesting one. It's very dependent by the individual job, to put it bluntly, because sometimes in healthcare and aged care, people are willing to pay a premium for a service solution and an ongoing benefit of knowing that you fix problems and that whatever happens, that you'll be there for replacements and whatever else. Education may tend to be a little bit more focused on landed price. It does vary a little bit, but generally, I think the principle is that commercial is a higher margin segment for us. Within that, individual jobs may vary up and down, quite frankly. Some will be above the average for commercial and some will be a bit lower. Certainly, we don't expect it to be margin dilutive going into some of those smaller jobs.
Every job is quoted, so it's not like there's a standard price book. It depends on many factors as Tim said.
Okay, sure. Got it. Just last one, just quickly on Methven. I think you might have touched on it before, but can I just confirm that for Methven, the margins were up x integration synergies?
Well, that margin, I think when we bought it, Methven had a 6%-7%.
Just over that.
6%, as high as sort of 6.8% EBIT margin. Closed last year up at about 12%, and at the end of the first half, Lisa, it was in and around 14%. That's coming not just from integration savings, but also from top-line growth. As I said earlier, we're on track to get to those high teen margins FY 2022, FY 2023 and have line of sight on that now, particularly with those other savings we spoke with Peter Wilson about on the last call.
Okay, sure. Got it. That's it from me. Thanks, guys.
Thanks, Lisa.
Thanks, Lisa.
There are no further questions at this time. I'll now hand back to Mr Salt for closing remarks.
Well, thank you, everybody, for your time this morning. We appreciate it. Obviously, if there are further follow-up questions, we're more than happy to take any of those as we can, and Martin Cole's here to help us organize that. Thanks for your time this morning. Have a good day, everybody. Thank you.