Good morning, everybody. Thank you very much for coming. And welcome to our, interim results presentation. You've got, Mike and I presenting this morning. Our chairman, Gareth Davis, is over here too, Tessa Banford's over there, an orthodontic director, Nice to be with us here this morning.
So thank you. We're going to follow a bit of a different format this morning. We want to put this set of results into some context and the initiatives that we're pursuing into the context of the progress that we've made over the last few years. We believe that will help underline our confidence in the further development and growth of the business well into the future. But firstly let me share with you the highlights of the first half.
We've made good progress in the development of our strategic initiatives and we'll come back to those a little bit later. Our most significant operating priority this half was to deliver great service and availability to our customers to continue to drive profitable growth. And the overall organic growth rates in our planted branches business in the United States you can see from the chart was 9.7 percent with all of the regions growing strongly. Together, those blended branches, regions plus waterworks account for 2 thirds of our group. Overall, the group's gross margins were slightly ahead, trading profits were 8% ahead of last year despite 1 less trading day and also the impact of some of our investments, which Mike will take you through later.
We continue to convert those profits effectively into cash funding significant organic growth initiatives and acquisitions. We also netted more than $250,000,000 of disposal proceeds and we ended the half year with net debt of one point one times EBITDA, which will improve on further in the second half. That's enabled us to fund dividend growth of 10%. Now those are the highlights Mike's now is going to take us through the financial performance and also the work that our team has been doing to move our tax domicile back to the UK.
I'm pleased to present the group's half year results for the 6 months just finished and we have had a good start to our financial year. Revenue for the group was again driven by strong growth in our U S. Business. We generated decent gross margin progression 10 basis points up. Ongoing trading profit $744,000,000, up $53,000,000.
That's up 8% in constant currency. Headline EPS up nearly 20% and it's worth also noting that we had 1 fewer trading day in the first half of the year and reflecting our confidence in the strong balance sheet, the excellent track record of cash generation we've increased the interim dividend by 10%. You can see the balance sheet remains in good shape at the end of the half at one point one times levered. So moving to the revenue and trading profit growth slide, On the left, I've bridged the revenue growth. That's from the 9865,000,000 year to the 10,666,000,000 in half 1 this year.
After adjusting for the FX, which you can see decrease revenue by 70,000,000, you can see the constant currency growth of 8.9 percent. That's split into the organic growth of 6.5%, we lose about 0.5% due to the trading day that I mentioned and acquisitions added 3%. On the right, you see the corresponding effect on the trading profit bridge from the 691 to the 744 that we've just delivered. Foreign exchange costing us 2, taking us to the $6.89 organic flow through adding $51,000,000 of trading profit. The trading day was worth about $12,000,000 the other way and acquisitions added 16.
That number is net of transaction and integration costs. Revenue growth in the U. S. Remained strong in half 1, good markets Inflation running at around 3%. You can see that the revenue comparatives clearly get tougher as we move into the second half.
In the UK on a like for like basis, broadly flat inflation, within that number is about 2 to 3%. Canada revenue growth reduced through the period, resi markets slowing as a result of the rising interest rates government measures to restrict the mortgage credit there, inflation again in Canada running at around the 2% to 3% mark. Do expect to see lower organic growth in the second half, John will give you our take on the markets as we look forward a little later. Now let me just move into the regional results, and importantly, our USA business, our largest region, first which delivered a good performance. We continue to outgrow the wider market in the USA, all our businesses delivering strong revenue growth During the first half, there was a small benefit in gross margins arising from the recent owned brand acquisitions somewhat offset by the dilutive impact of the very strong growth in the second half.
Labor cost inflation was around 3 a half percent. Distribution costs were impacted by higher inflation. During second quarter headcount growth was also too high. And since December, we've reduced associate numbers by about 600 full time equivalents That was probably worth something like $10,000,000 to $15,000,000 of higher costs in the second quarter. And clearly given our guidance, on revenue in the outlook statement today will continue to tightly control cost growth through the rest of the year, particularly labor given that it represents about 60 percent of our operating costs.
So overall trading profit $700,000,000 $53,000,000 ahead last year, trading margins at 7.9%. I've split the breadth of that organic revenue growth out in the US on page 9. You can see that it's pretty broadly based geographically across the business units. For blended branches, we generated 8.4 in the east, just over 10 in the west, and 9 point 2% growth in the central region. Revenue growth in E Business Standalone was lower as planned as we continue to consolidate the paperclip advertising spend across fewer trading websites.
Waterworks continues to grow well. HVAC And Industrial both particularly had strong performances. And the end markets in the US on the next slide here we've shown the market growth and also our organic growth against those numbers for the first half. Residential markets grew well driven by good RMI markets that represent the majority of our revenue, though this growth did moderate slightly in the second quarter. Commercial markets remained good, market growth of around 5%, infrastructure market growth moderated, slightly but was growing at reasonable levels.
And overall, you can see our outperformance against those markets continued at good levels. So having covered the US, let me move on to the UK and in the UK, the market remained weak and at best flat against a weak RMI market. Revenue in the UK was lower at constant currency due to the impact of the branch closures and the exit of the low margin this that we did last year. Gross margin is slightly ahead due to the improved product mix and trading profit at $30,000,000 was some $8,000,000 lower This splits roughly 2,000,000 of FX and about 3,000,000 for our, was the UK business and 3,000,000 for our soak.com business, which is our B2C business. Since the end of the first half, we've actually sold the soap business, which was a non core online consumer business, phenomenal value.
I've included on the charts the revenue and trading profit impact of that business. In the core business, we've also exited the National Distribution Center and disposed of it and relocated the support services office. In Leamington Spa in December as we had planned to do. Canada Canada achieved 2.1% organic revenue growth in the first half. Markets weakening progressively through the period, mainly due to those residential markets, Residential Markets in Canada, just to remind you, represents about 60% of our business mix there.
However, really pleasingly, despite that market backdrop, gross margins were a little bit ahead. Costs were well controlled, and therefore you can see a good uplift in the profit of $6,000,000 to $39,000,000. Very pleasing in Canada to see us getting onto the margins and onto the cost curve, despite the markets being softer. So moving on to exceptional items, here you can see whilst they are negligible overall, there's a number of moving parts, You can see on the slide the proceeds from the sale of Vasco, that was the Dutch plumbing and heating business, which we completed in the period, We made a 38,000,000 gain on that disposal. We had UK restructuring charges totaling 31,000,000 and that brings to an end the spend on this month period.
Following the end of the period, we also have received a further $45,000,000 roughly of disposal proceeds from UK noncore assets as part of the restructuring program. Finance and tax charges as expected, and expecting the effective tax rate for the year as previously guided to 22 to 23% as we benefit this year, from the USA tax reforms. And as previously guided, We expect this to move up to 25 percent to 26 percent from next financial year, financial year 2020, mainly due to the Swiss tax reform. Turning to cash flow, good strong cash generation. That continues to be a feature of the business.
Cash flow from operations $287,000,000 after a normal seasonal working capital outflow. Capital Investment. That includes the additional investment into the new Perris distribution center in Southern California that will be completed later this year. We also completed a number of attractive acquisitions in Half 1. You can see the cash outflow there on the slide of $589,000,000, mainly in the USA and included a couple of slightly larger transactions Joan Stevens, a rough plumbing owned brand business and Blackman, of which John will touch on later.
The cash received from disposals predominantly related to the Dutch Plumbing and Heating business and also some surplus Nordic property disposals. And you can see the total of those being generating a cash inflow of 255,000,000 in the period. All that means that we finished the period with a strong balance sheet, net debt to EBITDA just over one times levered, The net pension asset is now in surplus on an accounting basis, 154,000,000. So that follows as putting in additional funding contributions to the UK scheme, in the second half of last year, and our minimum lease operating commitments remain unchanged at 1,100,000,000. And as normal, I'd expect us as a business to de lever a touch through the second half towards the end of the financial year.
So having covered the results, let me just cover a couple of other financial like items in the press release this morning. Firstly, we have announced our intention to move Ferguson's tax domicile back to the UK from Switzerland. You'll remember that the company moved its tax domicile to Switzerland in 2010. Since then, the benefits of the Swiss tax domicile have reduced over time and with the recent announced changes there, but are now being proposed in Switzerland, it makes it less competitive for us to remain there going forward. The proposal requires a scheme arrangement and shareholder approval at a general meeting in April.
And if approved, the effective date would be 10th May 2019 and clearly will distribute further details in due course. It's anticipated that after the implementation that the group's effective tax rate would remain exactly in line with previous guidance of 25% to 26% for financial year. 20. And finally, and I can feel the excitement in the room IFRS 16. A number of other companies will have been talking to you about this.
And, whilst the standard does not apply to Ferguson until next year, We're a late adopter because of our year end, so our first financial year will be next year. I did want to give you an early view of where I think the numbers will land, which we've included on the slide. The standard just to remind you has no impact on the group's financial or business plans. It has no impact on the capital allocation policy of the group and it doesn't impact any of our cash payments or our credit ratings. At this stage, as I say, the numbers are indicative.
They are subject to change because they are somewhat 6 months early. But of course I'll update you with firmer numbers as we get to the year end presentation and clearly into next year, we can take you into more detail. Technical guidance for the year. Most of this remains unchanged, as you would the trading days in the second half are the same as in the second half last year have included the impact of the completed acquisitions mostly in the USA to give you the full FY19 full year figures and the full year trading profit there have split between the gross number and the impact of acquisition and sort of transaction and integration costs. I'd now expect the M and A activity pipeline to be much more modest in the second half of the year with a much more normal level of activity that we see in our pipeline.
So let me conclude. We've ranked a good first half over $50,000,000 of trading profit improvement year on year, a good solid first half performance. We continue to generate good cash flow We have a strong balance sheet and both of these fundamentals remain key strengths of our business.
Thanks Mike. A riveting Surf on IFRS 16 there. Thank you. Now today we thought it'd be a good time to on the development of our business and the attractions of our business model. What is attractive about our business today?
So on this chart here, I think there are 4 things to mention. Firstly, in the top left here, in most of our markets, the market structure itself is very attractive. There is a real need for our services. On the top right, just a reminder, we are differentiated by the services that we offer. We offer highly value added services to our customers.
Bottom right We have the opportunities available for growth in our core markets are absolutely fantastic. And bottom left, we are able to consistently generate market leading returns. I'll touch on each of these in turn onto the market structure. We used this chart last time to demonstrate the fragmented nature of the markets that we operate in and the market leading positions that we occupy in the majority of them. Just a reminder, our business is primarily focused on repair, maintenance and improvements market.
This typically involves smaller non discretionary projects with quite short lead times. The RMI market has also traditionally been a less volatile market than the new construction market. And RMI now accounts for 60% of our revenue. The second key attributes, we are differentiated. This slide from last year is also a reminder We don't just sell products.
We have a differentiated service offering providing support for our customers' projects. Delivered by the best associates And if we cannot touch on the the growth opportunities, our underlying markets have really good demographics. Population growth and other social factors support the expansion of home formation. And consumers demand more comfortable and better appointed homes and buildings over time. We've also built a really enviable sales culture in the business which captures more than opportunities to support organic growth are actually quite modest.
There are plenty of opportunities too for profitable bolt on acquisitions. We will have excellent opportunities for profitable growth in our core markets for many, many years to come. If we look at where our growth has come from in recent years, this is the picture since 2010, we've grown by 7.3 percent per year. That's across the group for all the ongoing businesses. Market growth has accounted for just over 3% per year of that growth with the U.
S. Of course being somewhat higher. We've always shared the objective with our team, that we should grow profitably in excess of the market, and we've consistently taken market share by growing between 2.53 percent faster than the market. And we've also completed selected bolt on acquisitions those have added between 1% 2% growth each year. Now the protection and growth of our gross margins is also an important attribute of our business.
We've aligned with the right vendors and carefully managed our mix whilst developing our own brand, and that's ensured that we can add value to our and also recover that value in our pricing. We've usually achieved gross margin improvements, as you can see from the chart, between 10 and 20 basis points per year over many years. Now since 2010, we've also grown training profits by a growth rate of 16 percent per year. That flow through to trading profit is a function of both growth gross margin improvements and productivity enhancements. We continue to believe for our company that double digit flow through is a good performance.
In decent market conditions. Moving on to returns, we don't very often show a chart like this, but this shows our return on capital over the last 10 or 11 years, we are a very results focused business. We've improved returns substantially by a combination of driving profitability and careful balance sheet management, most notably making sure that we've got the right inventory in the right place at the right time and that we're also commercially astute in the management of our trade receivables book. Now over the last 10 years, we've exited a number of weaker of subscale markets where decent returns were not available and we returned $3,500,000,000, a surplus cash to our shareholders in the process in excess of a 2,300,000,000 ordinary dividends. Today, we have a much stronger simpler, more focused business with excellent positions in the markets where we are well equipped to win.
We think we're in a great place now to capitalize on those opportunities to consolidate and gain market share profitability. Now we'd like to just touch on a number of initiatives that we are driving today, in the business. Denver is a large and profitable market where our team have made fantastic progress in gaining market share over several years today. We've got over 70 branches in the region. We're servicing them from distribution center facilities more than a 1000 miles away and a mountain range.
We're constantly looking at our logistics networks, including tracking every replenishment journey and every final mile delivery we make, whether that's internally or via carrier. That's what all those strange spider lines are on those on the map. Now we're building a new facility in Denver and this will consolidate 4 existing sites and provide next day replenishment to our branch network and same day delivery to customers across the region. That will significantly enhance customer service. And the economics of this are quite straightforward.
The whole of the operating costs of this facility will be offset by the reduction in freight costs that we currently incur. That's very similar to the economics if you remember of the Selena DC that we opened in Ohio in 2014. Now people don't always associate distribution with innovation, but as we've talked before, we are trying to break the mold on this one with our innovation unit co located in San Francisco and Atlanta. The example here on the chart, supply.com is a plumbing and heating products business, selling those products to professionals across the country. We provide personalized account management from a call center and we fulfill orders from distribution center.
There are no branches and there are no field sales. The business is growing more than 30% per year and is now doing more than $120,000,000 a year. We've talked before about our sharpened focus on own brand products. These expand the choices the range available to our customers and capture a greater share This is a range of decorative plumbing products launched in Canada during the year designed specifically for the local Canadian market. It's really nice quality product sourced from overseas and available both in our showrooms and our branches.
That rollout supported by specific marketing measures, including a transactional website, all developed using resources from within our group. Ownbrand sales now accounted for 8% of sales in the first half, up more than 1% on last year and growing every month. We continue to find some really nice bolt on acquisitions. We've talked before about the huge New York, New Jersey, Marcus. This was a region in which were substantially underpenetrated a few short years ago, but we have been busy and it's worthwhile reflecting on the last few years of growth.
In 2012, we bought Davis and Warshaw. This was the market leader in residential and commercial plumbing in Metro in New York and we followed that by Carl's, which is an appliance business to add on to our residential showrooms business. We supported the business by building new distribution centers. You can see upstate New York, not quite to scale, I'm afraid the Kopsaki one there, and we also built a market distribution center on New Jersey for fulfillment of orders within the city. In 2017, we added Ramapo.
And then more recently, we've added Woolworth in New Jersey based HVAC business. Blackman is our latest acquisition. This is a significant expansion for us in Long Island with 23 branches a number of really nice showrooms in great locations and a distribution center expanding our service proposition in this significant market. Blackman generated $240,000,000 of revenue last year in the plumbing, heating, HVAC, and waterworks categories. Now you can hardly see Manhattan on the map, but that is partly because of the size of our docks.
As with all acquisitions, the hard work starts with integration. We've had over a 100 associates working hard on integrating acquisitions this year and will incur acquisition and integration costs of $15,000,000. But looking through all the short term pain, What are we doing? We're building the best plumbing and heating business in this fantastic market which will yield substantial returns in the years ahead. In the UK, our new team has brought a real operational focus to the business, defining a consistent new product range across the network.
Improving inventory availability and focusing relentlessly on customer service. We're focusing on our core plumbing, Eating And Infrastructure businesses. And we've exited the peripheral low return activities including BCG last year. As Mike mentioned, the Soap B2C business, as well as our fabrication activities. At the same time, we continue to lower the cost base to ensure that we generate the best returns available from the business.
Today, growth has been pretty elusive, but our team is now starting to see some real momentum and we do expect to see better financial returns now Moving on to the current market backdrop and our outlook. We track data points from numerous economic industry and research sources as well as surveying our own customers and clearly measuring our own order books. It's fair to say, over recent months that some indicators have softened. This chart from Zelman is probably a decent proxy for market sentiments in the US as we move into spring with the growth rates for building products having moderated over recent months. So how do we expect to operate in the coming months?
First of all, we're going to keep our focus on availability and customer service to continue to take market share profitably. We'll actively manage our cost base, which Mike's talked about across all cost categories and we're going to be very targeted with our capital investments and acquisition plans. And of course, we expect to continue to be highly cash generative and continue to follow our prudent capital allocation policy. Just touching on that, we set out a decade ago our very simple views on the balance sheet. The principle that we established was to maintain net debt at no more than 1 to 2 times EBITDA which you can see in those tram lines on the chart and we've operated at the lower end of those limits ever since.
One day there'll be another downturn And at that time, we want to be able to continue to focus on customer service on availability on the operations and strategy of our business. With a rock solid balance sheet. We continue to think that those limits are about right, We're at one point one times in January, we're at less than one times today. And as Mike said, we expect to continue to bring that down over the rest of the year. We've also significantly reduced our reliance on landlords, bringing lease commitments down to just over $1,000,000,000.
And I hope we've been good stewards to our retirement funds of our associates eliminating the accounting deficits and derisking pension schemes along the way. Now on to the outlook. After strong revenue growth throughout the first half, Our growth rate has moderated recently in line with market conditions. We expect to continue to grow in the second half with organic growth rates likely to be in the range 3% to 5%. We expect to deliver trading profit towards the lower end of expectations for indeed for your attention.
Mike and I are very happy now to clarify anything that's unclear and take any questions and comments that you've got. That was very quick.
I've got the mic
So I
It's Paul Checketts from Barclays. Can I just ask a couple of, I suppose, obvious questions, but if you thought about back to the last time we, we heard from you guys, what is it that's changed to lead you to reduce your outlook for revenue growth and perhaps you could enlighten us a bit in terms of the verticals how they're trending? And then the second is that there are obviously potential implications for the drop through margin, the flow through margin in a lower growth environment, is it conceivable that in the second half with lower growth that actually that flow through could increase?
Thanks. Slide at the first bit, you
said the second bit? Yes. Look, I think what changed. Firstly, if you took our organic growth rates in the first half was 6.5%, okay? And we're guiding in the second half to between 3% 5%.
And the first thing that's changed, if you recall from that Zelman chart, that shows volume and price. I think that there is likely now in the second half to be quite a lot lower inflation pulled than there was in the first half very widely documented, I don't need to tell you about that. Call it 1%. I don't know, but but we have to take a view into the future. Secondly, Canada, you've seen the Canadian growth rates have come off.
Now we think that is wholly related or primarily related to the slowdown in residential. We are more residential in Canada, actually, anywhere else in the group. The team is doing a great job, yeah, and we're very positive. But we've seen those growth rates come up. That accounts for about 0.5%.
The third the third thing I would reference is an in just now we had a very strong we had very strong industrial growth in the first half. We expect that to be a little bit lower in the second half and that will contribute possibly about 0.5% reduction, but I don't want anybody to feel negative about industrial. This is a good business. It's growing very well in the first half. We just so happened to have some project work that's clearly boosted those, boosted the growth rates So I think if you take those three things together, that probably adds up to 2.5%.
And then I think if you look at some of the other sentiment around, just slightly we saw, I think, Mike, in your numbers Resi was just off slightly came down from 7 to 6 in the first half. That probably accounts for the rest of it, Paul. So those are the things that I would say directionally are the the things that have most impacted our view as we've sat here and look forward for the rest of the year. Flow through, Mike?
Yeah, flow through. So, there's there's no change certainly long term, Paul, in terms of our business model or our thinking. So, you know, in decent markets, as John has said, we would expect you know, flow through of high single digit, low double digit I think with the growth rates that we're talking about for the second half, I wouldn't be, you know, that will clearly be a challenge for us in the second half. It's clearly our job to make sure we get as good a flow through as we can, but do I think it will be as high as low single digit think that's unlikely given the 3% to 5% guidance, but you know it is our job to continue to work that hard, make sure we control those costs particularly around labor.
Thanks.
3 questions, please. So first one is on just coming back to the second half. You can flesh out a little bit, the US specifically. I mean, obviously, with the proportion of the group, I'm guessing it, it mirrors the slowdown, but equally, I think in the UK, the shutdown of the wholesale business kind of comps out. So I want to understand where you see the U.
S. Growth specifically for the second half maybe maybe within a range. That's question number 1. Question 2 is on acquisitions. So you spent in the neighborhood of 600,000,000.
Can you just give us an annualized profit number of that, 600,000,000 spend because obviously some is within the period. So just to get a sense where the multiple was, perhaps pre synergies. And then if you care to elaborate where you think that ends up in due course with synergies, And then the third question is something that I think has been discussed many times in the past, but hasn't been talked about, more recently, which is obviously the fact that you're now in 90% -plus U. S. Business.
And to what extent do you have reassessed or assessed a relisting in the U. S. Obviously, you're moving to tax domiciled. The group is simplifying, but I want to understand perhaps you can reiterate what, your thinking is on that ability. Thank you.
Okay. Can I can I take 1 and 2, 1 and 3 and you take 2? Sure. Does that make sense? Look, I mean, the U.
S. Versus the U. K. Growth, I'm not sure. I mean, the U.
K. Isn't big enough to influence that growth rate probably much in this in the second half. So I think sort of 3% to 5% organic growth in the second half that incorporates our views of where the UK is likely to be in that as well. Gregor, and it doesn't substantially distort that number. It is worth, you know, it is worth saying because, I got asked this this morning about, well, you know, what have other distributors seen over time and it is it is interesting.
We did we did quite a lot of work internally to look at you know, we look at all the other distributors numbers. We look at all the home center numbers in the in the U. S, the Lowe's and the Home Depot and those people. If you look at their Q4 17 versus Q4 'eighteen, actually home depot was 7.2. They came in at 3.7.
Loews have been 3.9 they came in at 2.4. Watsco which is a direct competitor of ours, they were 6% in Q4 'seventeen, three percent in Q4 'eighteen. Masco, which is clearly a very large supplier of ours, Masco's plumbing division, they were 9% 2417, 4% Q4 'eighteen. So still all of these businesses still getting good growth, but not quite the supercharged growth that we were seeing people in the industry was seeing and by the way those are only a few, but we've got there are plenty of other examples, but you know those businesses. Just look on on the listing side, I'm afraid the analysis remains the same as it was before, which is this is not something which is in the gift of the company.
Our shareholders would have to approve a delisting and relisting with a 75% majority. And they would have to, some of those, you got to remember most people who hold our shares have a mandate. That's the agreements that they have with their with the people who own them to operate somewhere. So a lot of UK investors have got a mandate to invest in UK funds. UK investors have got a mandate to invest only in international funds.
The same is true in the US, the same is true in any other country. I know because I have previously in a former life had to operate within a mandate. You don't go outside your mandates because otherwise you're going to get sued obviously by your owners. So it's really every individual shareholder would have to decide whether or not they were able to own the shares if we were to delist and relist in the new in the new territory. And I don't think that is quite as straightforward as it seems to be on paper.
Gregor,
all right?
Mike, sorry, go on
on M and A, on acquisitions, there is clearly some profit that moves into next year. I think the way should think in the way we think of M And A is we clearly only buy good quality businesses. I think we've been very clear about that. We are not turnaround experts. We don't buy distressed businesses.
We buy good quality businesses. We're probably paying and have paid, and again, there's some landings, some of the numbers, so you can't can't actually get to the multiples either because in the Blackman there's there's quite a piece piece of land and we would probably be paying, you know, 8 or 9 times right now, that's quite for a good quality business. Blackman also has some quite large integration costs. It's a it will take some time for the profits for that business to come through. I think we also and still firmly guide to 2nd year return on investment of 15% that absolutely still holds And therefore, you know, that tells you that we get synergies.
Each business is different, so our own brand acquisitions quite different to a Blackman, which is a bit more traditional business, they will have different synergies and therefore different terms of multiples in terms of synergies. But we'd expect normally to on a traditional business, couple of turns, off the acquisition price as well. That's what we'll have panned. Okay. Thank you.
We've got 8 to 9 and I might sort of two, two, two turns after all we'd aim to get that back down as it's set up pretty quickly. Yeah, we say in the 1st year post integration.
Good morning. Arnaud Lehmann Bank of America. 3 hopefully quick questions Firstly, just to follow-up on Gregor's question about U. S. Listing, you have an ADR, which I believe is level 1 and there were talks at one point you might move to level 2.
I appreciate that might to incremental costs for you, but is that an option to make it a bit more liquid, I guess, and expand your U. S. Shareholder base. Secondly, on the tax rate, just to be clear, your guidance is 25%, 26% including the relocation to the UK, it would have been higher if you stayed in Switzerland. Is that correct?
And the last one in terms of, I guess, the U. S. Outlook, you said maybe it's a little bit slower, which is fine. How does that change your view of working capital management? Do you are you in a position to somehow reduce inventories and accelerate cash flow generation?
So in a lower growth environment should we expect operating cash flow to accelerate?
Second. You take 1 and 2. Oh, that's right.
Yeah. That's worrying.
Let's what we said tonight's bike. So
I think your first question was about do we propose to move level 1 ADR to level 2? The answer is no. Most if you look in the history even over the last few years, most companies have moved from ADL level 2 down to level 1. So the trend is very much the other way unless you're on a journey to somewhere else. And given that John just said, we're not on a journey to somewhere else, we don't see the benefit for our shareholders of moving to that.
In terms of the tax guidance, you're absolutely correct, the tax guidance for FY 'twenty is 25% to 26% is as previously guided. With tax guidance, we generally quote the income statement. There is also the cash. I think you should assume that staying in Switzerland longer term would have given us a larger cash tax bill. So yes, being in the moving to the UK is a better outcome for shareholders.
But no change to the SaaS guidance as previously given.
And on the working capital, we use a mechanism internally and bear in mind all layers of management have an incentive based on achieving working capital targets. Those working capital targets are not spot targets at the end of the year because then you get wild swings or can get wild swings, they are targets that are based on every month's end. So we are motivated to ensure that we continually have working capital right up in in line of sight all the time. I think the way in which you should think about our working capital is pretty much proportionate to our grows. Okay.
And because we do, you know, you can occasionally get we have one day, one day of cash, which our cash to cash cycle, one day in our cash to cash cycle broadly speaking is $50,000,000. Our performance is usually within 1 or 2 days of that identity. So if you think it's within $50,000,000 or $100,000,000 always have been proportionate to growth. Now I think 2 other things happen with working capital. Number 1, there is a fixed element of working capital because we've got, you know, we've got a fairly fixed distribution center network, for example, we're putting some more working capital in in 1 or 2 areas such as our own brands, because that has to come all the way from overseas and just the supply chain is longer.
So that will edge things up. But of course, we should also become more efficient over time in that. So I think, you know, all of that should net out. You should see if we're growing it that 3 to 5%, we should need 3 to 5% more working capital. Just to let you know, I mean, at the half year, we were out by about a day, Mike.
So we are we are slightly shy this year of where we need to be now that's mainly timing on own brand acquisitions and those types of things. So but it's we're talking about fairly small numbers there. Okay?
Thank you. Howard Seymour from Numis. 2, if I may. Firstly, John, you alluded to the growth that you've had historically over and above the market. Ia, 2 to 3%.
And just thinking, I mean, obviously, can't tie you down on this, but as you look into the 2nd half, is there any reason why you should do less than that? Because safely say 3%. The assumption is the market's flat in the second half, which is quite a big fall off. So just thoughts on market share gains first in the market. And I suppose your your your views on whether you perceive.
I'm I'm gonna suggest not giving what you put up there. Whether this is the peak of the market or just a a slowing back to a normal situation. And then secondly, just one tip to make us on the first quarter call, we alluded to the drop through sort of 7% is obviously a lot less than that in the second quarter and seem to be, you know, less than I think any of us would be looking for I assume that's been expected inflation costs for input costs. And therefore, why do those not repeat into the into the second half if they're unexpected then? Okay.
Thanks, Howard. Look, look, I mean, on the outperformance against the market, no, there is nothing that I see or that we see more broadly in our business that suggests that that outperformance would suffer any erosion, okay, and that's true across all of our nine business units. So if we are right about the 3% to 5% then you should expect the market growth to be lower than it has been, and Howard, that's what I would say. You know, in terms of the peak, if you look at the underlying market conditions, to us, the underlying market conditions, actually look pretty, look, look pretty good. If you look at New Resi, you know that chart, you've seen it, it's 1,200,000, 1,300,000 sort of permit starts completions, whichever way you measure them and that's stayed fairly consistent for some time.
If you look at existing house volumes, that's plus or minus 5,500,000 it was down in January. It was up in February fine. The long term picture is 5,500,000. If you look at pricing, you know, Case Shiller's still up four point 7, I think, in February. Actually that's a reasonably sensible.
Do we want it at 14.7? I don't think so. 4.7 is fine. Sure. It's off from, I think, the peak was 6.5 spring last year, fine, but 4.7% Aliceboro growth and all 20 metropolitan areas were, you know, continued to have some rises.
Housing affordability remains good. If you look at the, the Raymond James Affordability Index, close to its 30 year average. So all of that stuck in residential, the JCHS LIRA still looks okay. Yeah, it's moderated slightly, but it still looks okay. Commercial, I think similarly, and if you look at, if you look at the Zelman, non residential indicators, they're still showing commercial growth at sort of 5% or 6%.
So those indicators suggest that the market is going to continue to grow. Good. Get
you on to your slide, Flazer, a couple of comments really. One is I touched on the the labor. The the, as we exited the end of last year, clearly we were in very good markets and therefore we were continuing to add labor. We had in quarter 2, as I said, about 600 equivalent heads too many, which we have since taken out. That's actually a cause and effect.
So with the markets being good, we add the heads so that we don't miss out on the growth. Of course, as the markets turn, and weakened slightly in Q2. The good news is in the US, you can take the labor out and we've taken that out without any redundancy costs, restructuring costs, it does, however, take you 6 to 8 weeks to do that. You've got to remember we operate over more than 1500 branches across the whole of the US. So these are small numbers in lots of locations and to get that through, taking attrition as well so we get a normal turnover.
It takes us about 6 to 8 weeks to take up labor out That did result in what's the internal disappointment in the first half is a good set of numbers. The internal disappointment is about that $10,000,000 to $15,000,000 if we could have clicked our fingers and taken the labor out quicker, we would have. That affects the flow through, Howard. The other one in the Q2 the year before did have exceptionally high gross margins. So I think if you look at the year average, it's a better, I think, you know, we don't manage flow through by quarter we managed the business long term.
I think if you'd look at the 2 components, the gross margin for last year for the business was 29.4%. The gross margin for Q1 this year was 29.6 and the gross margin for Q2 this year was 29.6. So it sort of tells you it's not in the gross margin, it's seeing the costs and it's really around that labor issue and we need to clearly continue to monitor that labor very tightly as we move forward given our outlook this morning. Does that help? You've got the trading day as well, but I think you will have you will have captured that.
John Messenger from Redburn. It's I think it's 2, if I could. Maybe just sticking with with costs and and what happened. During the months, kind of your total cost base grew by about 13.5%. 3% probably relates to acquisitions.
So your underlying cost base grew by 10. Headcount wise underlying, it was kind of 0.5 of growth, 3% of headcount growth from acquisitions again, just Can you help us understand what are the big packets of cost that are inflating in there and that you will highlight labor cost at 3 a half? But to go from 3 and a half across what looks like a relatively flat net headcount change. What is it? Is this is this 3rd party logistics what is it in the distribution costs that are really jacking up in terms of sizable cost increases?
And when does that start to abate, I guess? Or or what if what if it do you control to an extent. 2nd question was just on on the guidance, if we assume the group does just a tad above that bottom end of the range of say 1590. It implies 846 in the second half. Last year was 803 on the continuing.
You've said this 29,000,000 effectively of extra acquisition EBIT coming in the second half. It implies about 14,000,000 of organic in terms of profit change. Can I just check you number 1, agree the maths? Number 2, what is really, you know, and maybe it comes to the point if 3 to 5 is the growth rate and if that is the growth rate next year, coming back to Mike's comment about drop through gearing against that sales backdrop would be hard to deliver. Yeah.
What do you need in 2020s if if we believe the world is going to be 3 to 5 again, what will you be doing differently in 6 months time to make sure that the drop through gearing is better than 5 or 6.
Why don't you want to start? Well, why don't why don't I sort of have a Why don't I do a sort of, an an overwatch? Because so I think, John, the the point the point the point you've made is well made. We came out in a very strong growth period middle of last year, okay? And we are putting in heads to make sure we've got drivers We've got cancer staff, we've got warehouse associates, we've got inside salespeople, we're doing the right trading So that has a momentum to it.
It does. You might say it's a you might say it's Chris's moved business, but if you look at that chart that Mark was putting up there before about the term growth. Sure there are a few wrinkles along the road in that because it's not a it's not quite such a perfect curve as you came up with Mark, but well done. You know, my point really was we came into the year with very strong growth, and and we want and when I'm talking to the team, I want them to capture every bit of market growth that's available. Howard's question, you know, are you calling the peak?
No, I'm not calling the peak of anything. What we're doing is we're managing the business as closely as we can. Now to Mike point, it does take you 6 or 8 weeks, it does in any business, frankly, to correct the heads. We're way a bit bullish at the start of the year. I think yes, with the benefit of hindsight Mike's giving you you know, our view of sort of the degree of that disappointment.
If we were in a 3 to 5% organic growth environments, I guarantee you we will cut our cloth absolutely accordingly, okay? And I still got to believe if we're in that type of environment longer term, I think there'll be less labor inflation. John, if I can say that, I think that'll be the case. But the other the single largest factor by a country mile is the number of is the number of of associates So although this year we went up and we dropped off a little bit, there's seasonality in there as well because remember in the middle of winter, we should have fewer associates. So So we went up to 600 down to 600.
That's the bit that little peak that we should have managed frankly a little bit better. But make no mistake if we're in a 3 to 5 percent organic growth environment, we will still expect to generate sensible profit growth, all right?
In terms of your your acquisitions, yes, I mean, we've given you those numbers. It clearly depends, you know, where where you put between 3 5% growth, what number you come out with and your flow through. Do you remember there was some costs credit in Canada last year for the East Coast settlement as well? Think they're net of your numbers. So again, it'll be somewhat better than your 14 on a underlying basis.
Baz John says, you know, our job is absolutely to work that flow through in a in lower growth markets.
There's nothing geographically in the UK or beyond the 6,000,000 reversal in Canada that we need to think about
in terms of nothing
because you're confident. You're sounding more confident on the UK if anything. John?
Look, I mean, with the UK, John, I am very impressed with the team's focus, you know, a real focus They are in patience, they are executing, and, and I think that will pay we'll pay dividends. There's more there's there's lots more to do but now we are starting to lap where we took those fairly decisive actions prior to the new management team coming on board last year as it happens. And so yes, I would be cautiously more optimistic on the UK,
John. Thanks.
Amigala from Sidoti, just a couple for me. Just getting into that course part again. You you've talked about managing the course on the headcount front more actively in the second half. To what extent are you capping your potential growth into the second half and into 2020 by managing it so strictly? And I mean, you've talked early about how sales associates are the biggest driver for outperformance in the US and how should we think about growth in that perspective?
My second question, just a couple of technical ones. Can you give us numbers around to, around what integration costs has been booked in the numbers in the first half. And on UK, what are the sort of cost savings that we should be thinking about coming through the numbers in second half?
Yes, look, I mean, to the first question on the are we capping our growth? Absolutely not. Now this is this is a question of making sure that we have the right level of associates in order to capitalize on the market opportunity. Yes, that's a balance that we always have to take whatever because if you imagine that, we have to do that in every location, in every zip code around the business anyway. That's a constant, constant, constant rebalancing.
We wouldn't do that. Mike and I would rather be sat in front of you today saying, no, calling a higher growth rate, we're putting more people in, if that was the right thing, that's what we would do, honestly. So now there is no way that we would choke off growth in our business by reducing associates. The point there is for the associates that we do have, we have to generate the right efficiency, we have to generate the right productivity, the right flow through, the right, whether that's salespeople, the number of calls, the number of visits the conversion of of tenders into, you know, into orders or whether that's the number of picks that are that are warehouse associates are those are the number of drops that are driving us. All of those efficiency stats have to be in the right ballpark.
Go on. Sorry. And then the yeah.
So integration costs, the 1st half was 7. Second half, I'd expect 8, that's the total of the 15, so pretty well split. The UK cost base, I mean, the UK cost base, the issue in the UK I think John has already said is not just getting some top line traction, but also getting that gross margin moving. That's the challenge really in the UK, the fundamental challenge for us and the UK management team. So we will move costs accordingly and if we can grow that top line or grow gross margins.
Either all, I'll take, you know, in terms of gross profit, that's what we're after there.
Thank you.
It's Phil Rosebo from Bernstein. Just a couple of questions. The first one on the opportunity, I guess at these times when things go down, a lot of the small businesses sort of say, okay, I'm not going to go through another downturn. It's time to sell. And I sense from other companies that there is a lot more I guess in the pipeline potentially.
Is this something that you can use to if you like change the nature of your growth and go perhaps a little bit above the 1% to 2% that you normally guide to on bolt on. So just liked your views on the capital allocation point there. And the other one, sorry, just to get back to the Swiss tax domicile change, you know, that's a big move. There must be some savings in terms of closure of the Zug office. Just can you give us a little more sort of the returns logic of that decision as opposed to just sort of saying that we'll avoid further tax rises in in the future.
Sure.
Yeah, look, on the on the pipeline, it's interesting. I'm not sure what will happen to the pipeline if there is a more prolonged moderation of the growth rates, Phil, it's not something we've really seen so far now to be fair, the sort of midpoint of last year through to sort of fairly recently when we completed the Blackman transaction. We have had a few more acquisitions that we've wanted to step up and get done. To Mike's point earlier, the the pipeline now, there is less in the pipeline now. But, you know, will that be, is that just a consequence of the fact that we've completed them and we are still out there working, we're still out there talking to vendors, but there is just just less.
I think Harking back to the last downturn, there were relatively few businesses put on the market at that time, I think, as a lot of vendors saw their own profitability coming down. And my own experience of these things is a lot of vendors don't like to put their businesses on the market if their profits are under pressure. So I don't know, but I think that the point of having a very strong balance sheet is to maintain optionality. It's to make sure that we have absolutely zero risk of needing cash calls and that type of thing. And but also to maintain optionality to do those acquisitions if they arise at whatever point in the cycle.
What I would say right now is it doesn't matter of allocating more capital to acquisitions. We have got our hands full on integration, you know, the hundred people, I mean, it is phenomenal for us to have 100 people working primarily on, rolling out our systems through through the Blackman acquisition, it's only a 240,000,000 acquisition. I know it sounds like it's it isn't it's quite substantial for us. And making sure that we, that we reap the rewards from that acquisition and others like Robert Sinha at West as well. That we did fairly recently.
There's only 8 branches in Idaho, but it still needs integrating and doing properly and bringing into our structure. They take quite a lot of work. So we've got our hands full on those at the moment. We'll see what else comes along.
Thanks, Phil. We only have a smaller office in Switzerland So there aren't significant cost savings. We have a very small services offices in Reading, as some of you know, for about thirty people in it most days, the work can be done out of the, the UK base. So there isn't a significant cost saving, so it is about having the right commercial logic for the tax domicile of the company. We've clearly sold a number of operations in continental Europe over the last few years.
And therefore, we're sort of out of Europe commercially and therefore having the tax base where we have the the listing and the commercial support to do it from makes sense going forward. And actually the UK in terms of the G20 is actually a good place for us to be as well for our shareholders.
Do you want to pass it along?
Good morning, everyone. It's Robert Jason from Goodbody. Just in relation to the U. S, I think in your presentation, you called out kind of flatter gross margins in the second half. So my question is, just with the kind of the softer outlook in in terms of the top line, in terms of the pace of growth, you know, are you seeing any change of behavior from a competitive standpoint among your competitors.
Is there any regions that stand out in that context, if there are any? And just on the on the UK, you know, you're constantly getting rid of kind of noncore businesses, which makes sense. Two questions in relation to this in terms of can we assume that year on year we're going to get back to growth in the K business now given Evan that's been done. And are we getting closer to, like, you have to appreciate we're looking externally in are we getting closer to a strategic decision on the UK, given what you're doing from a noncore perspective, given what you're doing from a visuals of the profits in that business, because as you said, on the flip side, no business wants to sell when their profits are going down. So same logic can apply to the UK business, on that front.
So they're kind of my 2 areas of questions.
I hate being quoted that quickly. Look, you know, on the on the gross margins, now it is actually the margins are very consistent across regions and very consistent. The growth in gross margins over time between our business units is also very consistent. The only thing that I could point to with regard to gross margins over the last year with the benefit of hindsight, I think some of tariffs and some of the pricing, they they take a lot of work because you have to reprice stuff constantly when when things like pricing and tariffs changing. So that's a frustration.
It's an irritation. It creates a lot more work. It creates a little volatility in a month or 2's margin number. So it doesn't alter the, the attractions in our business from a competitive perspective, no, there's no, there's no indication of any other competitive factors in gross margins and we're still as we're still as optimistic as we ever were about long term, we ought to be taking 10 to 20 basis points per year in gross margin improvements. On the UK, I think it's, I think the observation that I would make, and I've made this and shared this with our teams, myself and Mike.
We need to see the UK getting back to sustainable gross margin performance. Okay, without that, then I would be glum. Now I do think now we've got a better team, a better engine in order to execute that than we've had, but I think that is fundamental to a business being part of our group. We have to generate proper returns on capital. Actually the returns on capital in the UK whilst they are low, they are still we still do make a positive and decent return, just not as attractive as it is in the States.
So we need to get back to taking market share and doing it profitably, and I think fundamentals of that, to Mike's point, is that we get the gross margin performance moving forward. I certainly wouldn't say today, anything other than I am optimistic that the current team is making good progress in getting good momentum in the market. And the other piece of course is we are aware of the other changes that are going on in our competitive landscape in the UK market. We need to understand how those shake out as well. Thank you all very much indeed for coming along.
Thank you.