Ferguson plc (NYSE:FERG) Q4 2023 Earnings Call Transcript

Ferguson plc (NYSE:FERG) Q4 2023 Earnings Call Transcript September 26, 2023

Ferguson plc beats earnings expectations. Reported EPS is $2.77, expectations were $2.46.

Operator: Good morning, ladies and gentlemen. My name is Emily, and I’ll be your conference operator today. At this time, I would like to welcome you to Ferguson’s Fourth Quarter Conference Call. All lines have been placed on mute to prevent any interference with the presentation. At the end of the prepared remarks, there will be a question-and-answer session. [Operator Instructions. Thank you. I would now like to turn the call over to Mr. Brian Lantz, Ferguson’s Vice President of Investor Relations and Communications. You may begin your conference call.

Brian Lantz: Good morning, everyone, and welcome to Ferguson’s fourth quarter earnings conference call and webcast. Hopefully, you’ve had a chance to review the earnings announcement we issued this morning. The announcement is available in the Investors section of our corporate website and on our SEC filings webpage. A recording of this call will be made available later today. I want to remind everyone that some of our statements today may be forward-looking and are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected, including the various risks and uncertainties discussed in the section entitled Risk Factors in our Form 10-K available on the SEC’s website. Also, any forward-looking statements represent the company’s expectations only as of today and we specifically disclaim any obligation to update these statements.

In addition, on today’s call we will discuss certain non-GAAP financial measures. Please refer to our earnings presentation and announcement on our website for additional information regarding those non-GAAP measures, including reconciliations to their most directly comparable GAAP financial measures. With me on the call today are Kevin Murphy, our CEO; and Bill Brundage, our CFO. I will now turn the call over to Kevin.

Kevin Murphy: Thank you, Brian, and welcome everyone to Ferguson’s fourth quarter results conference call. On today’s call, I’ll cover highlights of our full-year and Q4 performance, as well as a more detailed view of our performance by end market and customer groups. After that, I’ll turn the call over to Bill for the financials and our outlook for fiscal year ‘24. Finally, I’ll come back at the end to give a brief update on our view of market share and some of the significant opportunities we see in the years ahead before Bill and I take your questions. So starting with our full-year performance, our teams delivered strong results in a dynamic and challenging year. We’d like to express sincere thanks to our associates for their unwavering commitment to help make our customers’ projects simple, successful, and sustainable.

Revenue of $29.7 billion was 4.1% above last year, further building on the 25% growth we saw in fiscal year 2022. Our teams delivered solid gross margins and we proactively managed our operating expenses, delivering adjusted operating profit of $2.9 billion, down 1% on prior year, while we grew adjusted diluted earnings per share by 1%. Cash delivery in the year has been excellent, driven in part by disciplined inventory management with net cash provided by operating activities increasing $1.6 billion to $2.7 billion. This cash delivery allowed us to execute against our capital allocation priorities. We returned $1.6 billion to shareholders via dividends and share buybacks during the year. And we’re pleased to welcome associates from eight acquisitions during the year continuing our strategy of consolidating our fragmented markets.

Our balance sheet remains strong at the bottom-end of our leverage range with 1 times net debt to adjusted EBITDA. And we continue to deliver strong overall returns on capital of 35% for the year. Focusing on the most recent quarter, we were pleased to deliver a robust fourth quarter performance against strong comparables. Our balanced business mix continues to serve us well in challenging markets and we continue to take share as we leverage our consultative approach, our scale, our global supply chain, and our strong balance sheet to help improve our customers’ projects. As expected, we saw a slight revenue decline in the quarter, but we’re pleased with revenue stepping up by nearly 20%, compared to the equivalent quarter in fiscal year 2021.

We delivered solid gross margins and remain diligent in managing costs, delivering adjusted operating profit of $814 million, and an adjusted operating margin of 10.4%, and adjusted diluted earnings per share of $2.77, down slightly on the prior year, but representing significant growth from two years ago. We’re proud of these results for both the quarter and the year, which came in toward the top end of our guidance and are confident in the strength of our business model as we go forward. Turning to our performance by end markets in the United States. Net sales compressed for a second consecutive quarter as we lapped strong comparables and markets became more challenged. Residential markets remained impacted by the slowdown in new residential construction in an area serving the project-minded consumer, whereas RMI markets, particularly with our core trade professionals and in high-end remodel, proved to be more resilient.

Our residential revenues, which comprised just over half U.S. revenue, declined 4% during the quarter. As expected, non-residential markets continued to outperform residential due to strength in industrial markets offsetting some softness in more traditional non-residential areas. Overall, net sales in non-residential grew by 2% in the quarter. As we previously discussed, we’ll continue to focus on maintaining our balanced end market mix and while we expect our growth rates will fluctuate over time, we seek to maintain this healthy balance. Shifting now to revenue across our customer groups in the U.S., residential trade plumbing declined by 11% against a 21% prior year comparable growth as declines in new residential construction activity weighed on performance.

While leading indicators such as new residential permits and starts have stabilized, they still remain down on the prior year. HVAC grew by 4% with a two-year stack of 22%, driven by the execution of our HVAC growth strategy. Residential building and remodel grew by 2% on top of a 21% prior year comparable supported by higher-end remodel projects. Residential digital commerce declined by 9% as consumer demand remained subdued. Waterworks revenues were broadly flat on top of a prior year growth comparable of 36%. We continue to benefit from our diversified Waterworks business mix from residential to commercial to public works and municipal exposure. The commercial mechanical customer group declined by 1%, while our industrial, fire, and fabrication, and facility supply businesses delivered a combined 6% growth in the quarter against a 27% comparable, driven by the continuation of non-residential trends such as on-shoring, manufacturing, plant turnaround work, and general industrial activity.

Our breadth of customer groups allows us to bring value to the total project, while retaining a broad and balanced end market exposure. Turning to our performance against the broader end markets for the year in total. We’ve continued to take share across both residential and non-residential end markets. We believe our residential end markets declined approximately 6%, due principally to the weaker new construction environment. We outperformed with organic revenue down 3%. Non-residential demand proved more resilient with U.S. organic revenue growth of 7% outperforming a modestly growing market. We’ve consistently outgrown our markets and believe we’re well positioned to continue organically outperforming our markets by approximately 3% to 4% in future years.

Our ability to grow organically and outperform our markets is our principal focus, and it’s at the core of what we do and what our business model delivers. But leveraging our scale and market leading positions to consolidate our fragmented markets through acquisition adds another dimension to our growth. We’ve made in excess of 50 acquisitions over the past five years, representing a rich mix of geographic bolt-on and capability deals. While we’re acquiring physical assets such as locations, vehicles, and inventory, the real value we gain is from the people, their expertise, and their customer relationships that they bring to the business. We spend a lot of time ensuring we have a good cultural fit and aligned values with the target. And as we present Ferguson to potential targets, we believe we’re the acquirer of choice in our industry, because we provide these acquisitions and their associates access to the best platform and capabilities in the industry and a proven ability to grow their careers far beyond their existing opportunities.

We acquire these companies at attractive multiples and then leverage our scale to drive revenue, gross profit and operating cost synergies to generate strong returns. As I mentioned earlier, this year has been no exception as we welcomed associates from eight high quality businesses bringing approximately $800 million of annualized revenue to Ferguson. We’re particularly pleased to complete three HVAC deals, expanding our geographic reach, while strengthening our relationships with both vendors and customers. There are significant opportunities as we look to service the needs of the dual trade plumbing and HVAC professional, and I’ll touch on this in a bit more detail later on. The two Waterworks acquisitions bolster our market-leading positions in the East as we look to support aging infrastructure in the U.S. The remaining businesses we acquired this year span industrial, commercial, mechanical, and residential building and remodel customer groups, highlighting the balanced approach that we continue to take with M&A.

As we look forward, we maintain a healthy pipeline of future deals as we look to further consolidate our fragmented markets. Let me now hand over to Bill, who will take you through the financials in a little more detail.

Bill Brundage: Thank you, Kevin, and good morning or afternoon, everyone. And let me start with the fourth quarter results. Net sales were 1.7% below last year, driven by a 5.3% organic decline, partially offset by 2.2% from acquisitions and 1.4% from the combined net impact of one additional sales day and foreign exchange. As expected, price inflation stepped down further from 5% in Q3 to approximately 1% in Q4. Gross margin of 30.6% was up 10 basis points over the prior year. Our teams maintained pricing discipline, despite deflation in certain commodity categories. We had a strong own brand performance and we managed inventories down further resulting in some gross margin benefit on the sell-through of order inventory. Cost base has been well contained through our seasonally largest quarter, enabling us to deliver a 10.4% adjusted operating margin, down 30 basis points over last year.

Adjusted operating profit of $814 million was down $35 million or 4.1% lower, compared to prior year. Adjusted diluted earnings per share was 2.8% lower than last year with the reduction due to lower adjusted operating profit and higher interest expense, partially offset by the impact of our share repurchase program. And our balance sheet remains strong at 1 time’s net debt to adjusted EBITDA. Moving to our segment results, the U.S. business delivered another solid quarterly performance against strong comparables. Net sales declined by 1.5%. Organic revenue declined 5.5% on top of a 19.8% prior year comparable. And this was partially offset by a 2.4% contribution from acquisitions and a 1.6% positive impact from one additional sales day. We delivered adjusted operating profit of $804 million, down 3% over the prior year, delivering a 10.8% adjusted operating margin.

Turning to our Canadian segment, markets softened further with some sustained pressure from the adverse impact of foreign exchange rates. Net sales declined 5.1%. Organic revenue declined 2.7% against a strong 14.2% comparable with a 4% decline from the impact of foreign exchange rates, partially offset by a 1.6% contribution from one additional sales day. We have seen similar trends in Canadian markets to those in the U.S with non-residential end markets proving more resilient than residential. The adjusted operating profit of $22 million was $13 million below last year, and we continue to invest in the Canadian business and expect to improve the return profile over the longer term. Turning to the full-year results, net sales were 4.1% ahead of last year with organic growth of 1.5%.

Acquisitions contributed 2.5% to revenue with a further 0.1% net contribution from sales day and the impact of foreign exchange rates. Average inflation during the year was approximately 8%. Gross margin was 30.4%, down 30 basis points as expected against a strong prior year comparable. During the year, we were proactive in managing both labor and non-labor operating expenses to respond to lower sales volumes. As a result, adjusted operating profit of $2.9 billion was 1% lower than last year, delivering a 9.8% adjusted operating margin. And adjusted diluted earnings per share grew by 1%, benefiting from our share repurchase program. We delivered excellent cash flow this year. Disciplined working capital management drove operating cash flow to $2.7 billion, an increase of $1.6 billion over the prior year.

As supply chains have normalized, we managed inventory down by approximately $600 million during the fiscal year, excluding the impact of acquisitions. We continue to invest in organic growth through CapEx, investing $441 million in the business with the increase over the prior year attributable to our multi-year market distribution center rollout strategy. As a result, free cash flow was $2.3 billion, a significant increase of $1.4 billion over the prior year. Our balance sheet position is strong with net debt to adjusted EBITDA of 1 times. We target a net leverage range of 1 times to 2 times and we intend to operate towards the low end of that range through cycle to ensure we have the capacity to take advantage of growth opportunities, as well as to maintain a resilient balance sheet.

We allocate capital across four clear priorities. First, we’re investing in the business to drive above market organic growth. As previously mentioned, working capital had a positive impact on cash flow and we invested $441 million into CapEx, principally focused on our market distribution centers, branch network, and technology programs. Second, we continued to sustainably grow our ordinary dividend. Our board declared a $0.75 per share quarterly dividend, bringing our full-year dividend declared to $3, representing a 9% increase over our fiscal ‘22 declared dividends and reflecting our confidence in the business and cash generation. Third, we’re consolidating our fragmented markets through bolt-on geographic and capability acquisitions.

As Kevin outlined, we are pleased to have welcomed associates from eight high-quality businesses this year. We invested $616 million, bringing in approximately $780 million of incremental annualized revenue. Our deal pipeline remains healthy, and we will continue to execute our consolidation strategy. Finally, we are committed to returning surplus capital to shareholders when we are below the low-end of our target leverage range. We returned $908 million to shareholders via share repurchases this year, reducing our share count by approximately $7 million, and we ended the year with $540 million outstanding under the current share repurchase program. Turning last to our view of fiscal year ‘24 guidance. Given the uncertainty of the market backdrop, there is a broad range of potential outcomes, and taking this into account, we believe revenue will be broadly flat for the year.

This reflects a continued challenging market, particularly in the first-half of our fiscal year, against strong prior year comparables. Our assumptions are based on our end markets declining in the mid-single-digit range, thus outperforming these markets by approximately 300 basis points to 400 basis points, a tail from already completed acquisitions, which we expect to generate just over $500 million of revenue, and the benefit of one additional sales day landing in the third quarter. Overall we are assuming broadly neutral pricing environment for the year. We have provided a range for adjusted operating margin between 9.2% to 9.8% with the midpoint reflecting modest continued normalization largely driven by strong first-half comparables. We expect interest expense to rise slightly to between $190 million to $210 million.

Our adjusted effective tax rate should stay broadly consistent at approximately 25%, and we expect to invest between $400 million to $450 million in CapEx, similar levels to fiscal 2023. So to summarize, we had a strong finish to the year at the top end of our expectations and we remain focused on execution. We believe the combination of our strong balance sheet, flexible business model, and balanced end market exposure positions us well stepping into fiscal ‘24. Thank you and I’ll now pass back to Kevin.

Kevin Murphy: Thank you, Bill. I want to touch very briefly on the latest views of our market share and the total addressable market within North America. With three quarters of our revenue coming from leading positions in a $340 billion market opportunity, we’re confident in our strategy to grow both organically and via acquisition. During the past year, we’ve talked about how the breadth of our customer groups uniquely position us in the markets that we serve. We’re able to leverage our knowledge, expertise, scale, and product breadth to better serve our customers’ project needs in a more holistic way. That means bringing together our core strengths, our value-added solutions, our global supply chain, our digital experience, and our associates across customer groups to help make complex projects simple, successful, and sustainable.

The trade professional is our core customer, but we’re expanding our role to influence and serve the general contractor, the developer, the architect, engineer, and owner. We build relationships with key decision makers that influence the construction landscape. Our multi-customer group solutions and the integration of environmental product solutions generate synergistic value as we bring scale to highly fragmented markets. When we do this, we add value and can sell from the ground up solutions focusing on the entire project rather than just selling products. Our ability to bring together market-leading capabilities in both plumbing and HVAC provide us with a competitive advantage for serving these professionals in capturing growth from the dual trade market for years to come.

The combined HVAC and residential trade plumbing market amounts to approximately $100 billion, of which we estimate nearly $30 billion of the market is serviced by more than 65,000 dual trade plumbing and HVAC professionals. This segment of the market is growing rapidly. We’re focused on expanding our HVAC offering across all of our plumbing markets, executing on both an organic growth and acquisition strategy. We’re further building our capabilities to provide a single point of service to dual trade professionals, while further differentiating our services as we simplify process, harmonize pricing, and coordinate pickups and deliveries. We believe we are positioned with strength to service this dual-trade market, leveraging our expertise to drive efficiencies for our customers.

Turning to non-residential markets, our view of the opportunities ahead with large-scale megaprojects remains unchanged. The data continue to point towards structural tailwinds from megaproject construction spend over the next five years supported by on-shoring activity, recent legislative acts, and the aging infrastructure. As I said before, when we leverage our core strengths, products, and services across our businesses, we add value and have the ability to sell from the ground up solutions focusing on the entire project rather than simply selling products. We continue to estimate our total addressable market for these megaprojects with over $400 million of total construction value to be over $30 billion across our platform over the next five years.

And while it’s still early days from a revenue perspective, we are seeing increasing bidding activity. We believe our scale and multi-customer group proposition strongly position us to capture meaningful growth from these significant and complex projects over the medium term. To close, let me again thank our associates for their dedication to serving our customers. We’re pleased with our team’s execution in the quarter and for the year as a whole. Despite the challenging macro environment, we’re well positioned with a balanced business mix, residential and non-residential, new construction and repair, maintenance and improvement. We have an agile business model and a flexible cost base that allows us to adapt to changing market conditions. Our cash generative model allows us to continue to invest for organic growth, consolidate our fragmented markets through acquisitions, and return capital to shareholders.

We intend to do this while maintaining a strong balance sheet operating at the low-end of our target leverage range. We remain confident in the strength of our markets over the medium and longer term. Our scale and breadth allows us to leverage our competitive position across our customer groups in order to capture opportunities from structural changes in our end markets. Thank you for your time today. Bill and I are now happy to take your questions. And operator, I’ll hand the call back over to you.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Matthew Bouley with Barclays. Matthew, please go ahead. Your line is now open.

Matthew Bouley: Hey, Good morning, everyone. Thanks for taking the question. I guess first, just asking around the, kind of, buildup to your growth guidance in fiscal ‘24, a couple pieces here, but just, you know, what does organic growth look like quarter to-date? And then kind of giving your assumptions around second-half versus first-half, I’m curious what the implied improvement might be in the second-half? And I guess further to that if you could sort of break out your residential versus non-residential assumptions through all that? Thank you.

Bill Brundage: Yes, good morning, Matt. It’s Bill, I will start with that. Thank you for the question. First off, from a quarter-to-date perspective, through August and September to-date, organic decline is about in the same range of where it was in Q4. So Q4 we were down 5.3%m, it’s been a very similar range to that. And that’s to be expected as we entered the year in a very similar market environment to where we exited the year, and the comparables are still quite tough. If you take a look back at Q1 last year we had 13% organic growth last year 15% price inflation. So we’d expect that growth would continue to be pressured as we step into the first-half through the first quarter into the second quarter. And then our guidance does imply for the year getting back to broadly flat that organic would still be down slightly for the year with then the tail of acquisitions and the additional sales day bringing us back to that broadly flat midpoint of our range.

In terms of resi versus non-resi, from a residential perspective, we’re expecting residential to be down in the mid to high-single-digit range. We expect new res to be a bit worse than that, RMI to be a bit better than that. And then from a non-residential perspective, we’re expecting non-residential markets for the year to be down in the low-single-digit range.

Matthew Bouley: Got it. That’s perfect, Coller. Thank you for that, Bill. Second one, I guess jumping down to the margin line, again, on the guidance. So the assumption of a 30 basis point decline and operating margin at the midpoint, I’m curious, you know, how to think about the gross margin within that? And maybe in this question also, if you could touch on, I think you said in Q4 here you had still a little bit of a benefit to the gross margin from sell-through older inventory. So maybe you can kind of quantify that in the fourth quarter and then sort of the expectations around gross margin next year? Thank you.

Bill Brundage: Yes, so to your point, Matt, the guide of 9.2% to 9.8% operating margin for the year, midpoint of 9.5% does imply being down about 30 basis points from where we finished the full-year this year. That’s really driven by strong first-half comparables, particularly Q1. Again, if you look back, I just commented on the growth environment we had in Q1 and the inflation environment we had in Q1 last year, but also from an operating margin perspective, we delivered nearly an 11% first quarter operating margin. So given where organic decline is right now, again about where it was in Q4, we’re expecting to have some margin compression as we step through into Q1, into Q2. So most of that normalization — modest normalization is driven by that strong comparable.

In terms of the gross margin in Q4, 30.6%. Look, we are really pleased with how the teams delivered in a pretty choppy environment. First off, from a commodity pressure perspective, we did seek some pressure on commodities from a pricing deflation point of view. Commodity deflation was down in the high-single-digits in Q4 and our teams maintained really strong pricing discipline. Secondly, we’re pleased with our own brand performance, just under 10% of our revenue was owned brand. And then lastly, yes, we did highlight, we did sell through some older cost inventory. If you look at the inventory reduction for the year, down about $600 million organically, $300 million of that came in Q4. So a piece of that strong 30.6% gross margin was driven by that sell-through of some older cost of goods sold inventory.

And then rather than trying to quantify those specific points, we just go back to the fact that through this normalization period, we’re expecting those gross margins to normalize somewhere in the low-30% range and then get back to a period where we would grow them over time as we execute our gross margin and our product strategy.

Matthew Bouley: Perfect. Thanks Bill, good luck guys.

Operator: Our next question comes from Mike Dahl with RBC Capital Markets. Mike, please go ahead, your line is now open.

Mike Dahl: Good morning, Thanks for taking my questions. Just as a follow-up, can we talk specifically more about the pricing environment? I think it came in as expected in terms of the deceleration to 1% versus 5% contribution last quarter. I think prior quarter, you had talked about seeing some price decline sequentially, specifically on the commodity dynamics. You’re talking about broadly neutral in terms of the full-year, you know, impact from price in ‘24, but can you walk us through in a little more detail what the dynamics are? Are you actually entering the year with slight pressure on price, due to the commodity dynamics and expecting that to improve through the year or how would you characterize that dynamic?

Bill Brundage: Yes, Mike, it’s Bill. I’ll start and then pass it over to Kevin. So to your point, if you look back at last fiscal year, we saw compression of price through the year as we are rolling over difficult comparables. So go back again to first quarter last year, we had price inflation in total of 15% that dropped to about 10% Q2, about 5% Q3, and then as we just highlighted, about 1% in Q4. That 1%, we’re still seeing low-single-digit inflation on finished goods, which again, finished goods are roughly 85% of our revenue. And again, commodities in the fourth quarter were down in the high-single-digit range. As we’ve stepped into Q1, we have seen pricing in total go slightly negative. Again, that’s to be expected if you go back to that 15% comparable from a price inflation point of view in Q1 last year.

But maybe more importantly, if you look at the two-year stack on price inflation, it was close to 30% over two-years in Q1 that we’re facing. So we’re expecting that price to go a bit negative and we’ve seen that. However, as we roll through the year, we would expect to get back to a more normalized pricing environment for the industry, which as we talked about in the past, is likely in the low-single-digit range. Calling which quarter that actually happens is pretty difficult, but we’ve still seen good supportive pricing on the finished goods side of the world.