Ferguson plc (NYSE:FERG) Q1 2024 Earnings Call Transcript

Ferguson plc (NYSE:FERG) Q1 2024 Earnings Call Transcript December 5, 2023

Ferguson plc reports earnings inline with expectations. Reported EPS is $2.65 EPS, expectations were $2.65.

Operator: Hello, everyone, and welcome to Ferguson’s First Quarter Results Conference Call. My name is Bruno, and I’ll be coordinating your call today. [Operator Instructions] I would now like to turn the call over to Brian Lantz, Vice President of Investor Relations and Communications. The floor is yours. Please go ahead.

Brian Lantz: Good morning, everyone, and welcome to Ferguson’s first 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. 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 also 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 the 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 first quarter results conference call. On the call today, I’ll cover highlights from our first quarter performance and I’ll also provide a more detailed view of our performance by end market and by customer group before turning the call over to Bill for the financials. I’ll then come back at the end to give some closing comments before Bill and I take your questions. Focusing on the first quarter. Our associates delivered solid results that were in line with our expectations as we lap strong comparables. Our dedicated associates have remained focused on execution continuing to go above and beyond to serve our customers, helping to make their projects more simple, successful and sustainable.

As expected, we saw a modest revenue decline of 2.8% in the quarter in a challenging market. We delivered solid gross margins and we’re diligent in managing costs, delivering adjusted operating profit of $773 million, down 10.5% but delivering an adjusted operating margin of 10% and adjusted diluted earnings per share of $2.65. Over the 3 years since fiscal 2021, this represents sales growth of 43%, adjusted operating profit growth of 60% and adjusted diluted earnings per share growth of 74% for the first quarter. Our views on fiscal 2024 guidance are unchanged, and Bill will walk you through this in more detail shortly. We’re confident in the strength of our business model as we go forward. And turning to the performance by end market in the U.S., net sales were down 2.7% as we lap strong comparables and markets remain challenged.

Residential trends have remained broadly consistent with the prior quarter, with markets impacted by the slowdown in new residential construction, an area serving the project-minded consumer. Repair, maintenance and improvement has seen greater resilience, particularly with our core trade professionals and in high-end remodel, but the markets were down in the first quarter as expected. Our residential revenues, which comprised just over half of U.S. revenue declined 7% in the quarter. Non-residential markets outperformed residential due to commercial and industrial activity. Areas such as data centers and manufacturing have held up much better than other areas such as office and retail. Overall, net sales in non-residential grew by 2% during the quarter.

While we expect growth rates will fluctuate over time, our intentional balanced end market exposure positions us well. Shifting now to revenue growth across our customer groups in the U.S. Residential trade plumbing declined by 12% against a 15% prior year comparable growth as subdued new residential construction activity weighed on performance. Leading indicators such as new residential permits and starts have stabilized but remained below prior year. HVAC grew by 4% with a 2-year stack growth rate of 22% driven by the execution of our HVAC growth strategy. Residential building and remodel revenues declined 3% against a 21% prior year comparable. Residential digital commerce declined by 14% as weaker consumer demand has persisted. Waterworks revenues were down 1% against the prior year growth comparable of 27%.

Demand and bidding activity remains healthy and we benefit from a broadly diversified business mix including residential, commercial, public works, municipal, meters and metering technology, water and wastewater treatment plant, soil stabilization and urban green infrastructure. Commercial mechanical customer group grew by 6% in our industrial, fire and fabrications and facility supply businesses delivered a combined flat sales performance in the quarter against a 25% growth comparable driven by the continuation of broader non-residential trends such as onshoring of manufacturing, plant turnaround work and general industrial activity. Our breadth of customer group allows us to bring value to the total project while also maintaining a broad and balanced end market exposure.

Now let me pass you over to Bill to cover the financial results in more detail.

Bill Brundage: Thank you, Kevin, and good morning, everyone. First quarter net sales were 2.8% below last year. Organic revenue declined 4.9% with foreign exchange rates having a 0.1% adverse impact, partially offset by acquisition revenue of 2.2%. As expected, pricing stepped down further from 1% inflation in Q4 to approximately 2% deflation in Q1. This was principally driven by weakness in certain commodity categories as we lap strong comparables. Gross margin of 30.2% was down 30 basis points over the prior year, also impacted by certain commodity categories. Cost base has been well contained with total costs flat compared to the prior year, enabling us to deliver a 10% adjusted operating margin, down 90 basis points over last year.

Adjusted operating profit of $773 million was down $91 million or 10.5% lower compared to the prior year. Adjusted diluted earnings per share was 10.2% lower than the prior year, with the reduction due to lower adjusted operating profit partially offset by the impact of our share repurchase program. And our balance sheet remains strong at 1x 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 2.7%. Organic revenue declined 5% on top of a 13% prior year comparable growth rate. This was partially offset by a 2.3% contribution from acquisitions. We generated adjusted operating profit of $766 million, delivering a 10.4% adjusted operating margin.

Turning to our Canadian segment, markets were soft and foreign exchange rates also weighed on results. Net sales declined 5%, and Organic revenue declined 3.3%, and foreign exchange rates reduced revenue by a further 1.7%. We have seen similar market trends in Canada to those in the U.S. with non-residential end markets proving more resilient than residential. Adjusted operating profit of $23 million was $10 million below last year. Adjusted operating margins of 6.1% were down from 8.3% in the prior year but improved sequentially from 5.4% in Q4. The business continues to generate strong cash flow. As we exited last fiscal year, our inventory levels were more normalized as supply chain constraints had eased. Working capital investments of $219 million during the first quarter were in line with historical seasonal trends.

Interest and tax outflows were as expected, and we continue to invest in organic growth through CapEx, investing $91 million during the quarter, similar levels to last year. As a result, free cash flow was $473 million, a $65 million increase over the prior year. Our balance sheet position is strong, with net debt to adjusted EBITDA of 1x. We target a net leverage range of 1x to 2x, and we intend to operate towards the low end of the range through cycle to ensure that we have the capacity to take advantage of growth opportunities as well as to maintain a resilient balance sheet. We allocate capital across 4 clear priorities. First, we’re investing in the business to drive above-market organic growth. Previously mentioned, we invested $219 million in working capital and $91 million into CapEx during the quarter, principally focused on our market distribution centers, branch network and technology programs.

Second, we continue to sustainably grow our ordinary dividend. Our Board declared a $0.79 per share quarterly dividend, a 5% increase over the prior year, reflecting our confidence in the business and cash generation. Third, we’re consolidating our fragmented markets through bolt-on geographic and capability acquisitions. We are pleased to have welcomed associates from SecureVision of America during the quarter, a leading distributor of waterworks metering solutions in Texas. Our deal pipeline remains healthy, allowing us to continue to execute our consolidation strategy. And finally, we are committed to returning surplus capital to shareholders when we are below the low end of our target leverage range. We returned $108 million to shareholders via share repurchases during the quarter, using our share count by approximately 700,000 we ended the period with $429 million outstanding under the current share repurchase program.

Turning last to our view of fiscal 2024 guidance, which is unchanged. We believe revenue will be broadly flat for the year, reflecting a challenging market, particularly in the first half of our fiscal year against strong prior year comparables. For the year, we assume end markets declined in the mid-single-digit range. We outperformed these markets by approximately 300 basis points to 400 basis points. We have a tail from completed acquisitions, which we expect to generate just over $500 million in revenue and the benefit of one additional sales day landing in the third quarter. Overall, while we saw expected modest deflation in Q1, we are assuming a broadly neutral pricing environment for the full year. We continue to provide 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 of approximately $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 ’23. So to summarize, we had a solid first quarter performance in line with our expectations and our views on fiscal 2024 guidance are unchanged. We remain focused on execution and believe the combination of our strong balance sheet, flexible business model and balanced end market exposure positions us well. Thank you, and I’ll now pass back to Kevin.

Kevin Murphy : Thank you, Bill. Let me again thank our associates for an unwavering dedication to serving our customers. The year has started in line with our expectations, and we’re pleased with execution in the first quarter. As Bill set out, our fiscal 2024 guidance is unchanged. As you will have seen in the release this morning, the Board is evaluating the domiciliation of Ferguson’s ultimate parent company in the United States is a logical next step to enable full alignment of the company’s headquarters and governance with the geography of our operations and leadership team. As we look forward, despite the current challenging macroeconomic environment, we’re well positioned with a balanced business mix between 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 consistently executed on these priorities for many years, and this has supported a long-term track record of outperformance and disciplined deployment of capital. Over the 10 years to end of fiscal 2023, our revenue compounded annual growth rate has been 9.6%, with a 14% adjusted operating profit CAGR, while also returning $11 billion to shareholders in the form of dividends and buybacks.

As we consolidate our markets, we’ve reliably delivered organic market outperformance of 300 basis points to 400 basis points while bringing in approximately 50 acquisitions in the past 5 years alone. Our scale and breadth allows us to leverage our competitive position across our customer groups in order to benefit from emerging multiyear tailwinds in our end markets. Remain confident in the strength of our markets over the medium and longer term and expect to capitalize on these growth opportunities. Thank you for your time today. Bill and I are now happy to take your questions. Operator, I’ll hand the call back over to you.

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Q&A Session

Operator: Thank you. [Operator Instructions] We do have our first question comes from Phil Ng from Jefferies.

Phil Ng : Congrats on another solid quarter in a choppy environment. Appreciating 1Q is your toughest comp quarter. But curious, how did pricing track sequentially in 1Q? And have you seen prices stabilize, especially on the commodity side? And your flat-pricing guidance for the full year, is that predicated on price increases on your finished goods categories and have your suppliers announced any price increases for calendar year 2024?

Bill Brundage: Yes. Phil, it’s Bill. I’ll start with that, and I’m sure Kevin will add to it. In terms of pricing throughout the quarter, it was relatively stable sequentially. So from Q4 to Q1, pretty stable prices. In terms of through the months, commodities stepped down a touch as the comparables were very difficult stepping through Q1 of last year, but relatively consistent, not a lot of movement. And then as we stepped into the second quarter here, again, not a lot of additional movement.

Kevin Murphy : And Phil, thank you for the question. When you think about the different commodity-based products that we sell through they, as expected, aren’t moving in the same direction at the same velocity at the same time. And so we’ve seen differences in what that deflationary pressure looks like. We have seen signs of stabilization though. You look at products like steel that have seen some degree of stabilization and, in fact, some increase. As you play that through into finished goods, now is not the time that we would typically see those annual finished goods price increases, but we do expect them. They have been forecast in terms of seeing that modest increase get back to a more normalized annual cadence. And as you look at that normalized annual cadence that gets into that low single-digit place and whether that is offensive or defensive in terms of what those price increases look like.

We do believe that it provides some degree of a floor under that finished goods side of the business as we approach calendar year ’24.

Phil Ng : Okay. That’s helpful. On the non-res side, the business continues to hold up really well, show pretty good resiliency. Appreciating once again, you’re very diversified here. How do you see trends kind of shaping up in the course of the year? I’m just trying to gauge how you seen like the full impact of the slowdown from office and retail. And you called out bidding activity picking up in mega projects? And how do you kind of see that rippling through your business? So effectively, are you anticipating top line potentially accelerating in the coming quarters?

Kevin Murphy : So it’s really been as expected, and we have seen that drop off in typical knock-on commercial activity like office and retail, and that’s created a pressure environment in the non-res space. What we’ve also seen, though, is, as you’ve seen a drop off in say, distribution center or warehouse activity, you’ve seen a fairly strong pickup and continuation of data center activity, especially with what’s happening in the AI space. And these projects are very good for us across multiple customer groups from underground water, wastewater, commercial mechanical, fire suppression and the like. As you think about the mega project landscape, as we’ve discussed, these are going to be longer projects. The bidding activity continues to be quite strong.

The open order volumes that we’re seeing continue to pick up, and we’re actually seeing and experiencing revenue growth inside of those mega projects. They’re just taking a great deal longer and that was really as expected. For us, it’s as much a catalyst for how we want to operate across multiple customer groups on the whole of the project, as well as being a good support mechanism inside that non-residential space.

Operator: Our next question comes from Ryan Merkel from William Blair.

Ryan Merkel : First off, can you just comment on quarter-to-date trends? And the reason I ask is it seems that the broader macro has slowed a little bit. So I’m just curious if you guys have seen anything.

Bill Brundage: Yes, Ryan. We’ve actually — as expected, we’ve seen our growth rates improve a bit as we’ve stepped into the second quarter. So down about 5% organic decline in Q1. That has stepped up a bit. We’re down in the low single-digit range. And that’s how we expected the year to start to play through as those comparables start to ease as we move through the second quarter and really get into the second half. So we’ve seen a little bit of improvement in those growth trends actually.

Ryan Merkel : Got it. That’s great to hear. And then my second question is just on the HVAC segment, standout performer. What is your outlook over the next 2 years for pricing just given the regulations? What have you heard from suppliers?

Kevin Murphy : So we knew that pricing was going to be supportive as you went through the regulatory changes and whether that’s going to be in that high single-digit piece. We’ll see how it plays out. But if you look at our business, we really look at what is that mix going to be in terms of parts equipment and supplies. And then what’s that mix going to be for us in terms of what ductless looks like versus unitary. So there are a lot of variables inside of that. But clearly, price is going to be supportive as we go through regulatory changes and we look at what is a bit of a more challenging environment from a volume perspective.

Operator: Our next question comes from John Lovallo from UBS.

Unidentified Analyst : This is actually [Matt Johnson] on for John. So first off, can you guys talk about some of the pros and cons with the redomiciling? And can you talk about any potential financial implications here, whether it’s for corporate costs or your tax expense?