Ferguson Enterprises Inc (FERG) 2021 Q4 法說會逐字稿

Good morning, ladies and gentlemen. My name is Will, and I will be your conference operator today. At this time, I would like to welcome you to the Ferguson plc Full Year Results Earnings Conference Call. (Operator Instructions)

I would now like to turn this call over to Brian Lantz, Ferguson's VP of Investor Relations and Communications. You may now begin your conference call.

Good morning, everyone, and welcome to Ferguson's Full Year Earnings Conference Call and Webcast. Hopefully, you've had a chance to review the earnings announcement we issued this morning. This is available in the Investors & Media section of our corporate website and on our SEC filings web page. 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 in forward-looking statements. Additional information is included under the Legal Disclaimer in our earnings announcement this morning.

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.

Thank you, Brian, and thank you to everyone joining us on the call today.

Let me begin by saying we could not be more proud of what our 31,000 associates have achieved through the challenges of fiscal year 2021. We continue to serve our customers while protecting the health and well-being of our associates. We generated strong growth, particularly in the second half, amid industry-wide supply shortages and inflation. We continue to invest in talented associates in our global supply chain, product breadth and depth and digital solutions while growing our dividend, investing in high-quality acquisitions and returning capital to shareholders.

Now turning to today's agenda. I'll kick things off with the high-level results and some key accomplishments. Bill will provide you with an overview of the numbers, then I'll come back and give you a quick overview of how we're leveraging our strengths in the market. And finally, Bill and I will be happy to answer all of your questions.

Ferguson is successful because of our associates, and our baseline commitment is to create a safe and healthy work environment for all. We will continue to embed safety as a core value driver in everything that we do. We're pleased that our recordable injuries continue to improve, with our group total injury rate and our lost time rate showing strong improvements.

Our teams delivered exceptional sales and profit growth in fiscal 2021. Revenue of $22.8 billion was 14% ahead of last year and 13% ahead on an organic basis. This accelerated market outperformance was driven by our ability to deliver on our customers' projects amid unprecedented industry-wide supply chain pressure.

We remain very focused on continuing to ensure high levels of availability for our customers, as uncertainty around the medium-term impact of supply chain pressures and rising price inflation continues. Gross margins grew 60 basis points, driven primarily by our ability to service our customers while managing this price inflation.

We tightly controlled our operating expenses and increased productivity to ensure that the profit growth we achieved outpaced our revenue growth. As a result, we delivered underlying trading profit growth of 32% for the full year and headline EPS growth of 35%.

Our business continues to drive solid cash flow and be underpinned by a strong balance sheet, which enables us to continue to invest in growth. We also returned over $1.4 billion to shareholders through our ordinary dividend, share buyback and special dividend. Growing the ordinary dividend sustainably through the cycle is an important part of our capital priorities, and the Board is recommending to increase the total ordinary dividend by 15%.

Beyond our financial results, we're also very proud of a number of key accomplishments during the past year that positioned us for the future. We further accelerated market share gains in a period of challenged industry product availability by using our scale and our balance sheet to invest in the right levels of inventory for our customers. Our associates worked diligently to manage price inflation during a period of significant uncertainty.

On the acquisition front, we acquired 7 high-quality businesses, bringing in approximately $360 million in annualized revenue, driven by talented associates and local relationships that will help us further drive growth in the future.

Given our continued performance and strong balance sheet, we are initiating a $1 billion share buyback program. Having completed the sale of the U.K. business earlier in the year, we are now solely focused on our attractive North American end markets with a favorable balance of residential and nonresidential, RMI and new construction. All of this provides for more consistent demand over time.

We made good progress on our methodical 2-step journey to migrate our primary listing to the United States, matching our exclusive focus on North American end markets. We initiated an additional listing on the New York Stock Exchange in March, following a very supportive shareholder vote of 99.5% in favor. We are on track to hold our second vote in the spring of 2022 to complete the move of our primary listing to the New York Stock Exchange. So again, we are proud of our results and accomplishments in fiscal 2021, and we enter fiscal 2022 even more confident in the strength of the company and in our business model.

Turning to our end markets. Residential end market growth accelerated in the second half and experienced double-digit growth for the full year. New residential housing starts and permits continued to show strength in the fourth quarter, and residential RMI markets also continued strong growth as we've seen an acceleration of growth in projects delivered by the trade professional.

Nonresidential end markets returned to growth for the 12 months. As we told you in May, there were bright spots in the commercial market in areas like data centers and distribution, but we're also now experiencing increased activity in areas such as health care and education. Industrial activity levels are improving, and our contractor customers have benefited from easier access to undertake repair and maintenance work inside manufacturing facilities. And in civil infrastructure, we saw strong public works demand with a reasonable anticipation of future infrastructure work funding down this track.

Overall, demand from these end markets was strong in the second half of our fiscal year, and we outperformed our end markets by more than anticipated in fiscal 2021. This strength has continued into the first 2 months of the fiscal 2022, driven by the exceptional work of our associates while leveraging the strength and scale of our supply chain.

Now let me pass you over to Bill, who will take you through our financial numbers in more detail.

Thank you, Kevin, and good morning or afternoon, everyone. I'm pleased to present the group's full year results, which demonstrate strong progress achieved during the year. The numbers on the accompanying slides are for the continuing operations of the group, comprised of the U.S., Canada and central costs.

Total revenues in the year were up 14.3%, and we expanded gross margins by 60 basis points with further expansion in the second half, driven by our ability to service our customers while managing price inflation. Costs were well controlled while we continued to invest in the business, resulting in good operating leverage for the year of 60 basis points.

Underlying trading profit of nearly $2.1 billion increased 31.8%, just over $500 million, with underlying trading margins progressing 120 basis points to 9.2%, which is a record for our business. Headline earnings per share increased by 35.5%, principally due to the strength of trading profit growth during the year.

Taking into account the group's prospects and financial position, we are pleased to propose a final dividend of $1.665. This brings the total full year dividend to $2.394, an increase of 15%, reflecting our confidence in the business. The balance sheet remains strong with leverage of 0.6x, and we have announced today our intention to commence a new $1 billion share buyback over the next 12 months.

The U.S. business mirrors the group results with a strong performance. Total revenues grew 13.9%, with organic growth of 12.8%. Price inflation averaged approximately 3% during the year, picking up from flat in the first half to mid-single digits in the second half. Gross margins were ahead of last year, reflecting the value we deliver to our customers, the strength of our business model and our ability to manage inflation.

We tightly controlled costs and generated strong operating leverage. Headcount and variable costs grew to appropriately support volume growth, and we continue to invest in the organic growth of the business in the areas of digital, technology and supply chain.

Consequently, underlying trading profit came in at $2.073 billion, $486 million ahead of last year, with underlying trading margins expanding 130 basis points to 9.7%. We provided a breakout of revenue growth across our largest customer groups in the U.S. As Kevin outlined, we saw strength in the residential end market, and our customer groups serving that end market performed well.

Residential Trade and Residential Building and Remodel grew well, and we continue to see particularly strong trends in residential digital commerce, up 38% for the year due to strong demand from the project-minded consumer and light decorative pro.

HVAC, where the majority of our business serves the residential end market, grew 22% in the year and 27% in the fourth quarter.

Waterworks continued to outperform the market, with full year growth of 17% and revenue growth accelerating to 39% in Q4, driven by a balance of strong public works demand, good residential growth and green shoots in commercial end markets.

The Commercial/Mechanical customer group was restricted by more challenging nonresidential markets in the first half but saw robust growth in the second half. We continue to see our commercial customers pivoting towards growth areas such as data and distribution centers, education and health care as work in office and retail continue to lag.

The other bucket comprises Fire and Fabrication, Facilities Supply and Industrial, each of which returned to growth in the second half but, as a group, remained slightly down for the full year, driven by the industrial contraction earlier in the year.

The Canadian business delivered a strong operating result, generating revenue growth of 21.3%, of which 15.8% was organic. Residential end markets, which account for over half of our Canadian business, performed well in the period with a particularly strong performance from our HVAC business. We also saw growth in civil infrastructure markets, but industrial markets remain challenging. Similar to the U.S., gross margins were ahead of last year, and tight cost control led to a $33 million increase in underlying trading profit. As we focus solely on North American markets, we continue to leverage the considerable expertise, knowledge and know-how from our U.S. associates to enhance operations and customer experience across Canada.

As we look at the performance in the fourth quarter, total revenues grew by 24%, with organic growth of 23.6% in supportive markets. Inflation in the quarter averaged approximately 8%, with upward movement on both commodities and finished goods. Gross margins were significantly ahead of last year, driven by tightening supply chain constraints, accelerating price inflation and channel mix improvements. We're mindful that the inflation-driven benefit in our gross margins could potentially moderate or reverse in the future.

Headcount and variable costs grew appropriately to support volume growth, resulting in underlying trading profit of $702 million, an increase of $189 million despite 1 fewer trading day. We were pleased with the progress of underlying trading margins, which were up 100 basis points to 10.7%.

As you look at our quarterly sequential performance, you can see the significant step-up in revenue growth in the second half. We delivered good trading margin expansion in each quarter of fiscal '21, which accelerated further in the second half. Our over-market growth, expanded gross margins and good operating leverage resulted in 120 basis points of margin improvement for the full year to 9.2%. It's important to contextualize this year's progress as we think about the performance of the business next year, and Kevin will set out our thoughts on the outlook shortly.

Finance charges were as expected and broadly in line with the prior year. The effective tax rate of 24.4% was slightly lower than the prior year and our guided range, driven by lower levels of nontax deductible expenses. Exceptional charges for continuing operations were small with costs associated with the U.S. listing, partially offset by adjustments to previously accrued business restructuring expenses. I've set out the cash flows on a pre-IFRS 16 basis, which more closely mirrors the U.S. GAAP standards. But there's a reconciliation to the IFRS statutory numbers in the appendix.

Cash flow from operations was $1.751 billion, after a working capital outflow of $576 million, driven by continued investments in inventory to ensure we have the best levels of availability for our customers during the time of supply chain pressures and low vendor fill rates. The increase in interest and tax was principally driven by the increase in profit.

CapEx was a touch lower due to timing of projects, but we continue to invest in organic growth of our business, particularly in technology and supply chain. We returned over $1.4 billion to shareholders, which included both the deferred interim and final dividends from 2020, the 2021 interim dividend as well as the special dividend related to the U.K. disposal and the recently completed $400 million share buyback program.

Acquisitions remain a core part of our growth strategy, and we invested $335 million completing 7 deals in the year. And finally, the disposal cash principally relates to the sale of the U.K. business which, as noted, was returned to shareholders via a special dividend paid in May of this year. That means we finished the period with a strong balance sheet and a net debt to adjusted EBITDA ratio of 0.6x. This rises to 1x on a pro forma basis if you consider the new $1 billion share buyback program. And as a reminder, we typically see our leverage seasonally increase during the first half of our fiscal year.

Lease liabilities recognized under IFRS 16 were $1.1 billion, a little lower than last year after we exited the U.K. business at the end of January. The net pension position returned to a small asset due principally to changes in actuarial assumptions and an additional one-off contribution of $40 million made following the disposal of Wolseley U.K. Our balance sheet is strong, and we have great liquidity.

Moving on to technical guidance. We have included the revenue impact of completed acquisitions on the fiscal '22 full year figures. This includes the 3 deals we closed in the fourth quarter. We have the same number of trading days in the year ahead as in fiscal '21, albeit gaining 1 day in Q2 and losing 1 day in Q3. The interest charge is expected to be broadly in line with last year, with the $100 million as a U.S. GAAP number. So it excludes lease-related finance charges that we previously included under IFRS. We expect the effective tax rate to be in a similar range to fiscal '21 next year. And CapEx guidance is expected to be approximately $300 million to $350 million.

As previously highlighted, we adopted U.S. GAAP reporting as of August 1 of this year. This is a logical step in our journey as we focus our operations on our attractive North American markets. The main rationale for this change is to better facilitate comparability with U.S. peers, both on an accounting basis but also through more closely aligned KPIs. We set out our preliminary view of the U.S. GAAP differences during our investor session in July, and we've now updated the full set of reconciliations through fiscal '21 year-end, which we will publish separately on our website today.

After taking on shareholder feedback and considering the impact of the transition further, we will continue to add back the impact of acquisition-related intangible amortization to our primary profit and EPS metrics, which will more closely align them with our past practice. As such, we will report adjusted operating profit and adjusted EPS, which, as you can see in the chart above, more closely mirrors our historic underlying trading profit and headline EPS metrics.

Acquisitions remain a core part of our growth strategy. And we believe being more consistent with past practice is appropriate as we continue our transition to the U.S. We will also continue to publish adjusted EBITDA, which adds back both noncash amortization and depreciation.

And finally, we remain committed to our capital allocation priorities. While we operated prudently during the pandemic, we continue to target a net debt to adjusted EBITDA range of 1 to 2x. Investment in organic growth principally through working capital and capital investments remains the first capital priority. We remain committed to growing our dividend sustainably through the cycle and are pleased to step this up 15% this year. We will then invest in selective bolt-on and capability acquisition opportunities; and finally, return surplus capital to shareholders over time when we are below our leverage range.

So let me wrap up. I'm pleased with the results that the team delivered. Strong top line growth, gross margin expansion and operating leverage resulted in strong earnings growth. This, combined with solid cash generation, provided us with the ability to continue to execute against our capital priorities. Our balance sheet is strong, and we are well positioned as we enter the new fiscal year.

Let me now turn it back to Kevin.

Thanks, Bill. Before we close, I'll touch briefly on our core areas of investment that allow us to make our customers and their projects more successful.

I left off a moment ago speaking about our end markets. At Ferguson, our purpose is to take our customers' complex construction projects and make them more simple and successful. And over the past decade, we have very intentionally positioned our business to serve an attractive balance of residential and nonresidential end markets. Just as important, across those end markets were approximately 60% RMI and 40% new construction. We really like this mix for the favorable demand balance that it brings.

I'd like to focus the next few minutes highlighting the strengths that enable us to consistently outperform in these end markets. There are 4 distinct competitive advantages that cut across our company and together, enable us to serve our customer groups better than anyone else. They ultimately make our business truly unique and differentiated in the minds of our customers, our suppliers and our associates. Our objective is always to make our customers and their projects more successful while expanding our role in the value chain.

Everything starts with our associates, who are truly the intellectual capital of the business. For over 65 years, we've invested in recruiting, training and developing the best associates to drive above-market growth that, in turn, fuels future opportunities for them. In a service business like ours, everything starts with training and development within an inclusive environment for all of our associates. And while personal relationships are critical going forward, this will not be enough. And as a result, we're also building the best digitally enabled customer relationships. We are already using technology to make both our customers and our business more productive. We're consistently investing to equip our associates with the tools that drive productivity while saving time for and cementing the relationship with the customer.

We bring to bear a scaled global supply chain to maintain the most effective and efficient same-day, next-day omnichannel availability. We place our products closer to the customer, being in-stock for shipping the same day while further developing the capability for 24/7 customer access to our inventory. This year, our supply chain has been a fundamental strength for our business as we've been able to maintain high levels of product availability. We employ a focused product strategy, providing a robust offering that includes both branded and own brand offers, giving customers unrivaled choice for their projects.

We seek to ensure through a consultative approach that we provide our customers with the best product solution. We source products from over 30 countries in addition to the U.S., and we drive sales through specification to the trade professional and to the end user. We strategically expand the product assortment to grow the bundle, providing a comprehensive range of products. The result is that we're more relevant for not only the trade professional but also the ultimate end user and owner.

In the next few slides, we'll provide some highlights on 2 of these strengths: product strategy and supply chain. First, looking at product strategy. While we do not seek to own manufacturing assets, we are going to get as close to the point of manufacturing as we can. We're going to continue to expand our diverse global sourcing organization to make sure that we're driving design, product development and own brand execution. Our product strategy includes both branded and own brand offerings. And with over 1 million products across our 9 customer groups, our extensive range can meet every customer's needs.

Own brands are important to us as they offer high-quality products with excellent availability and industry-leading support. A good example of this is Durastar. In November of 2020, we launched a new line of own brand products in the HVAC equipment category. Durastar offers a broad range of residential unitary and ductless HVAC equipment. The initial Durastar offering included air conditioners, heat pumps, gas furnaces, air handlers and coils. We're executing a phased, targeted launch strategy and growing geographically into new markets over the next several years.

This brand, together with knowledgeable HVAC associates, offers us a considerable growth opportunity to expand our HVAC business in combination with the strength of our residential plumbing group, giving our customers even greater choice for their HVAC needs. Creating and launching Durastar enables us to sell in any market across our different customer groups and through any channel. This is a large and attractive market of around $50 billion in which we generated over $2 billion of revenue in 2021.

Turning to our supply chain. We deliver global scale locally. We bridge the gap between just over 34,000 suppliers to serve over 1 million customers. Our customers require access to a wide variety of products while expecting exceptionally high fill rates and speed of delivery. Ferguson's supply chain is built around these needs. We will have the most effective and efficient same-day omnichannel supply chain in North America by placing our products closer to the customer and being in-stock and further developing the capability for 24/7 customer access to our inventory.

Today, in the U.S., we have 6.5 million square feet inside of 10 distribution centers and more than 35 million square feet in our branch network. This is the foundation of our overall omnichannel strategy. We've established import centers on each coast to ensure efficient replenishment of globally sourced products across the country. This strategy also includes progressively developing our market distribution centers, or MDCs, in major metro areas as the most efficient means of final-mile distribution. Our network of regional distribution centers, pipe yards, import centers, MDCs and branches allows us to put the product closer to the customer, increasing availability, speed of delivery and providing greater operating efficiency.

I mentioned Denver at the half year results, which is the first of our future state MDC site, which came online towards the end of our fiscal year. The facility utilizes an automated inventory picking and replenishment system, completing 60% of all product picks today. The system holds 49,000 bins and 26,000 products and utilizes energy-efficient robots to run these product bins across a modular grid, optimizing space, time, energy and productivity. Using regenerative power, each robot uses about 100 watts of electricity, 1/10 of what is used by an average toaster, which significantly lowers energy costs.

The robot picks product day and night, saving on traditional warehouse labor, lighting and heating while also improving health and safety by decreasing material handling by 50%. Over time, we will progressively expand this improved MDC model within major MSAs at a rate of about 2 to 3 per year, which is included within our planned CapEx requirements.

So in summary, our business is in very good shape. We're extremely proud of how our associates delivered for our customers. We remain focused, first and foremost, on the health and well-being of our associates and our customers. We're very pleased with the operational delivery, particularly in light of the ongoing supply chain challenges. In addition, our strong cash flow and our balance sheet continue to help us drive incremental growth and value.

For fiscal year 2022, we started the new financial year with strong momentum, with organic revenue growth at similar levels to the fourth quarter of fiscal '21. We expect a year of good growth overall, but we anticipate a tapering of revenue growth in the second half on tougher prior year comparatives, and we're mindful that the recent tailwinds from inflation on gross margins could moderate. For the full year ahead, we expect operational improvements to broadly offset headwinds from inflation in the cost base. Given the strong momentum in the business and the agility of our business model, we are well positioned to have a good year of growth.

Looking longer term, our teams are executing well to deliver results and build on our strengths that will enable us to outperform in attractive end markets. We remain focused on better serving our customers and capturing market opportunities through our continued investment in talented associates, global supply chain, product breadth and depth and digital solutions. We look very forward to telling you more about this in our virtual Investor Day on December 9.

Thank you. I'll now turn the call back over to the operator and answer questions you may have. Operator?

(Operator Instructions) Our first question comes from Elodie Rall from JPMorgan.

So my first question would be on the evolution of your shareholding base. I know I've asked that question in the past. But given you confirmed the listing in spring, I was wondering if you've seen some evolution in the geographic split of your investor base more recently.

And my second question would be on the working capital variation that we've seen. So we've seen a large outflow on investment in inventory and supply chain constraints, I guess. But -- so how should we think about it? Do you expect the trend to continue in '22 or to normalize to previous year's levels?

Yes. Elodie, this is Bill. Thanks for the questions. First off, on the shareholding base, we have not seen a significant move in the geographic split of the shareholding base since the additional listing was live in March. So that's been relatively consistent to this point. And then from a working capital perspective, as noted, yes, we have invested about an incremental $825 million year-over-year in inventory to offset those supply chain constraints and the limited product availability that we're seeing.

As we look forward, we don't see anything in the very short term, i.e. for the rest of this calendar year, that would indicate that those supply chain pressures are going to alleviate. So I would anticipate us running with additional investment in inventory through at least the end of the calendar year, likely into next calendar year. And we'll just continue to take a very disciplined approach around working capital, as we always have. And I would expect that to alleviate and us to bring that working capital down once we see those supply chain constraints start to ease.

Yes. Elodie, this is Kevin. To build on what Bill was saying, when we think about the inventory levels that we're keeping in our branch network most specifically, it really is taking up for those supply chain challenges. So I think at the third quarter, we talked a bit about what our inbound vendor fill rate was for our top 20 DC vendors, and it still sits below 30% on time and in full. And our branch in-stock rates are still hovering in the mid-90s, so providing good day-to-day availability for our customers.

But maybe as importantly, as we take our role in the supply chain really seriously, the sporadic nature or the inconsistent nature of inbound fill rate, we have to keep the right product for the project as a whole until such time as the project is ready for full delivery. I mean, if you think about a typical residential construction project, just in our Residential Trade business, it can have upwards of 200 different line items on a single-family home. And so making sure that we have the right product at the right time and are storing it for our customer is a huge part of our value proposition in the supply chain.

Our next question comes from Keith Hughes from Truist.

A question on the statement in the outlook portion of the release. You talked about the headwinds from inflation in the cost base moving forward, offsetting operational improvements. You seem to have done incredibly well so far in terms of passing through inflation to customers based on the results. Do you think that's going to get more difficult? Or what exactly are you referring to there?

Yes. Keith, this is Bill. I'll start, and then Kevin can jump in. To your point, we've been very pleased with our ability to manage price inflation, particularly over the last couple of quarters in the second half of the fiscal year. And you've seen that reflected in the step-up in gross margins. Just thinking about it from a year-over-year perspective, we grew gross margins by 110 basis points in Q3 over the prior year, and then that stepped up to 160 basis points in Q4. So really pleased with the work of our teams in the field, and I think that demonstrates again the product availability that we have and the strength of our supply chain.

We'd see those -- as we've seen inflation increase, as we mentioned, growing to 8% in Q4, we see those characteristics holding true as we enter into this fiscal year. And so I think there's a pretty supportive pricing environment, particularly in the first half of this fiscal year. As we turn to the second half of the fiscal year, the comparables get tougher, both from a revenue perspective, inclusive of inflation, and those gross margin comparables get tougher.

So I do think you'll see a bit of a difference kind of half 1 to half 2. But again, we think from an overarching perspective, pleased with gross margins and how they've stepped up, really pleased with how that's dropped through to the bottom line with a 120 basis point expansion in trading margin, again, which is a record for our business at 9.2%. And we're going to work diligently to maintain that trading margin from a full year perspective as we move forward.

Yes. And Keith, when you think about the operational cost side of the business, just like many of our competitors and even our customers are feeling the pinch from a labor perspective and what rising wages look like, there certainly will be some pressures. That will largely be offset as we think about productivity, but also in the rising price that Bill referenced from an inflation perspective.

Typically and predominantly, what we're seeing is pressure on, call it, the less than 1 year driver and warehouse associate. The culture of Ferguson is extremely strong. And so when an associate comes on board and is with us for more than a year, there is a great likelihood that, that is a career orientation as we look forward. But that less than 1 year in the competitive environment for that type of associates out there and it will have some degree of cost pressure as we think about wage growth in our business.

Okay. So this is not about the ability to pass through price. This is about just some of the operational issues of labor and everyone that's on this industry is dealing with right now, it sounds like, is what you're saying.

Yes. I think we think about it in 2 different areas, Keith. The operational cost base as it relates to labor and productivity savings that we will have as we move forward offsetting that, and then as we think about commodity inflation easing, what that can mean to gross margin overall. But our ability to pass through price in the near term on inflation still remains very much intact. As we talked in the Q3, it's not easy. It's a lot of hard work. It has a productivity drain on our associates as we look to renegotiate and work through with our customer and our customers' customer, but we have no doubts in our ability to continue to do that.

Okay. And then final question. You talked about some of the fill rates in the 90-something percent range. This is pretty high considering some of the shortages we're seeing across building products. Do you feel like you missed any meaningful revenue in the quarter from shortages? Or were you able to get at least most of what the demand was?

We have seen some project delay in terms of shipment waiting on some inventory to come into the system. We do not feel like we missed out on revenue due to supply chain shortages and our relative ability to get product for the customer. In fact, quite the opposite. We've seen enhanced share gains because of that product availability and our associate base and our supply chain.

As we look into the near term though, what we're seeing is customers and our customers' customer placing orders and getting after product ordering cycles earlier to make sure that they have access to product when their project is ready to go.

Our next question comes from James Rose from Barclays.

I've got 2, please. The first is on the supply chain. When do you think the manufacturer fill rates and general availability levels could get back to normal?

And the second question is on when you look at branches on a like-for-like basis, I mean, just in the second half, they're seeing around about 15% volume growth year-on-year, and they're already run pretty efficiently. Are you still confident that you've got headroom for further like-for-like growth in the branches without having to add incremental investments?

Yes. So James, thank you for the questions. On the supply chain normalization, we keep, as you might imagine, a very, very close eye to when we're seeing that fill rate improve, when we're seeing completion of POs coming into our distribution network more fully. And we haven't seen any easing of that supply chain pressure right now. We believe that continues likely through the calendar year and perhaps into the first calendar quarter of next year. But we keep a pretty close eye on it. And again, making sure that we have that inventory closest to the customer inside that branch network for fill rates has served us incredibly well in the past several quarters.

And then James, maybe to address your question on headroom and volume growth in the branch network. Yes, to your point, if you exclude inflation, volumes were up roughly 15% in Q4. And I think what that's demonstrating is the strength of our overarching supply chain in our distribution center as well as our MDC, market distribution center, and ship hub supply chain environment.

So as you know, we are investing and trying to put product closer to the customers, and we are opening MDCs. As Kevin noted, we just opened our Denver MDC. So you'll see us continue to invest in those types of facilities. But overall, we expect to have plenty of capacity to take care of market-driven volume growth in the marketplace.

Our next question comes from Will Jones from Redburn.

Three, if I could, please. The first is just going back to gross margins when you think about that step-up from the first half to the second. Would you be willing to put any numbers around how much of that was what you might call inflation gain, I suppose, versus underlying improvement or mix? And then on that issue of mix when we think through to FY '22, channel mix, business mix, is there anything you'd point us to think around in terms of positive or negatives for how that might shape up in the year ahead?

The second was just going back to overhead and admin costs. And like all businesses, you've had some COVID-related savings in the last kind of 18 months around travel, utilities, health care, which you flagged before. I suspect not, but is there any quantification around that bucket and what your thinking will come back in, in July '22, if indeed you are thinking that?

And the last one was just revisiting the points you made on private label. Could you give us the latest update on the share of own brand within the business? And I think in the past, you talked about potentially growing that at twice the rates of the underlying market. Is that still feasible? And just big picture, are manufacturers okay with you as you make the transition?

Yes. Thanks, Will. On gross margins, to your point, yes, a good step-up both in Q3, as I said, 110 basis points over the prior year and in Q4, expanding 160 basis points. I'd say the majority of that driven by inflation and our ability to manage that inflation. And we saw that as inflation stepped up from Q3 to Q4, gross margin stepped up further from Q3 to Q4.

Channel mix did come into play, particularly in Q4. If you think about what was happening last year during Q4, when we were going through the COVID lockdown periods, we had our counters closed to walk-in traffic for a period of time as well as our showrooms. As those channels are now fully open to both buy online, pick up in store but also to in-store traffic, we've seen that channel mix improvement as those higher-margin channels improved year-over-year. I'd see that continuing as we step into this fiscal year. But we absolutely recognize a 31.4% gross margin in Q4 does have the benefit of inflation there.

Again, I think that continues. There's good pricing dynamics. We see supply chain constraints continuing as we go into the first half of this fiscal year. But as we get to the second half, there could be a tempering of that given the comparables next year.

And then from an overhead perspective, yes, we have flagged in the past, we had some savings on health care, in areas like travel and entertainment. As those come back, we do believe that we have efficiency and productivity gains to largely offset those in addition to the wage inflation headwinds that Kevin talked about. So there will be some step-back in those costs, but we feel that we're well positioned to manage that as we go into fiscal '22.

Yes. And maybe to build a little bit, Will, on what Bill was saying. From an inflation perspective, not only were we able to pass through inflation. But as we think about the availability of product, we look at gross margin is the best reflection of the value that we provide in the marketplace. And because of that, we were not only able to gain share in excess of what we historically have but also able to grow gross margins, as we were picking up work from customers who perhaps normally didn't look at us as their first source of supply because of what that capability was. That's hugely important to us because it also starts to cement further relationships for a more long-term relationship with our company.

In terms of the channel side, we continue to see showrooms and counters growing faster than the core of our business, which is also beneficial to gross margin as we go forward. But we believe getting back to that, call it, 10 basis points a year is important for us.

If we shift gears to the private label side of the question, it remained roughly flat at about 9% of our overall revenue base. We continue to look at growth in that area via 2 means. One is product development and where are those opportunities for us to grow inside the brands that we have or the development of new brands inside of our customer groups. We highlighted Durastar today. That was one. But we also grow by acquisition. And we acquired a fantastic company called Amerock in the cabinet hardware business this past year, which also allows us not just to grow that business more generally but also specifically through our counter and through our showrooms as well as through our different customer groups and channels. So that's a dual-track growth strategy for us on the private label side.

On the supplier relationship, we still feel very good. I mean, obviously, still 91% plus of our revenue is driven with those branded relationships. And even as we look at private label development, oftentimes, that's done in conjunction with our OEM suppliers who are making the product for us and allowing us to take it to market under our own brand. So that relationship remains solid.

Our next question comes from Kathryn Thompson from Thompson Research Group.

Tagging on to the really manufactured product or private label initiatives, and I'm glad you brought up about the cabinet side because it was something I want to dig a little bit more in turn, too. I totally get you're expanding the offering, understand the value add, but what are the major drivers in choosing which categories to focus? When I look at other distributors like a PoolCorp, for instance, that have gone a little bit more into the private label side, it's a very specific type strategy. But if you could tighten and help us better understand really the core fundamentals for the categories to focus, that would be helpful.

Yes. Kathryn, I mean, if you take it -- thank you for the question, first of all. If you take it at the essence of what Ferguson is, we really live to make a complex new construction and RMI project more simple and successful for the customer and for our customers' customer. And we do it from the very beginning of the project to the very end. And the design work all the way through to the first shovel turning dirt and installing pipe to the last appliance install as we're closing up a project.

And so as we think about what categories to get into, it is what product categories are going to make us more relevant for the share of wallet for the particular customer group that we're focusing on. And cabinets is one of the larger areas inside of a kitchen remodel, which is a core part of what we do inside of our customer base.

And then we also look at what makes us more relevant on the project as a whole. And that's how we decide around expansion in customer groups, what is that next most relevant thing on a project for an owner or a general contractor that also has margin attributes that allow us to add value in the supply chain and get paid for that value. And so that's how we think about both expansion and product categories but also in what customer groups we need to go after in the overall project.

And for these -- using the Colorado acquisition, as an example, for products such as cabinets, are you -- given the changes in the supply chain, given the changes in the post-COVID world, is there a propensity to focus on more domestic manufacturers? Or are you thinking beyond the U.S.?

Yes. So the Colorado acquisition you're talking about is Kitchen Showcase, and that was not an own brand acquisition. It was a cabinet acquisition, principally in the residential new construction sector.

The private label acquisition that I was talking about was Amerock, which is in the cabinet hardware side of the business that does a tremendous amount through online activity and our showrooms. So that Kitchen Showcase acquisition as well as the acquisition we made in Florida in the cabinet business, not an own brand acquisition.

Okay. And as far as private label, is your bogey still in kind of the mid-teens to upper teens in terms of mix?

Yes. So we don't put an end target on it. We work to grow it at about 2x the rate of Ferguson's core growth rate. Again, going back to an earlier question, needing to make sure that those branded supplier relationships that we hold so very dear and have for over 65 years, that it's done in a methodical way. And so that still remains how we're focused. We didn't accomplish that this year. But over the long haul, we think about 2x the Ferguson growth rate is the right place for us to be.

Okay. And as we look at the ongoing debate for a U.S. infrastructure bill on the traditional side, what, if any, changes do you have in terms of what the potential impact could be for you, be it your Waterworks division or elsewhere? And what -- any other color or any other update in terms of what that may mean for Ferguson?

Yes. If we take a step back and look at what we see right now in terms of demand, the market is still pretty healthy. The indicators from a residential and a nonresidential perspective look good. We're very confident in the medium term in terms of what these end markets represent, not the least of which is residential when you think about the underbuilding of housing units as well as what RMI might mean given a post-COVID world on residential.

There is pressure out there, clearly, from a supply chain perspective but also from a labor perspective. If I take that against an infrastructure bill, assuming that everything goes well and gets passed, we will look to see what is in there and what the details are around the plan. It will benefit us from our Waterworks business, which is growing quite solidly right now at 39% in the fourth quarter across public works through residential and commercial. We think there's good opportunities for us inside of that. There's indications that will be about $111 billion on the water side, with good focus on what lead service lines look like. That's a great place for us.

There'll also be good road work presumably, which will have erosion control, soil stabilization, storm water management attached to it. But it could also be in the areas of school work, airports, good commercial projects that take the whole of Ferguson and provide us with good tailwinds. So we're looking forward to it, but we also need to see what the detail is and what the timelines look like.

Our next question comes from Yves Bromehead from BNP Paribas.

The first one was just on the incremental margin. Obviously, it's been a much better underlying environment here. But I think the last time you spoke about sort of your expectations into 2022, you were obviously already sort of insinuating that the incremental margin results come back down from sort of the double-digit that you've achieved in 2021. As we look into H2 probably of next year, I know it's quite far away, how should we think about sort of the ongoing level of incremental margins for the group? Do you expect some normalization? Or can you still continue to hit sort of the 10% plus range?

And then my second question is I understand you need more time and details and granularity into the infra plan. But equally, it seems that you are quite aware of the sort of amounts that will go in certain categories. When you think about the overall project, what is the total size of the market that directly concerns you? You mentioned the $111 billion in water. But is there any other thing in there that we can think as this will be incremental demand flows for Ferguson in the next few years?

Yes. Yves, thanks for the question. I'll start on question 1 in terms of incremental margin. And if I just take a step back, to your point, in a typical year, what we try to achieve is growing our gross margin by 10 basis points year in, year out and getting more productivity out of the cost base to drive to drive trading profit faster than sales and to generate incremental trading margin.

As we've said in the past also, in periods of higher sales growth, we're able to leverage that a bit more and drop more to the bottom line. And you've seen that this year, both from a labor and cost productivity side in addition to the expanded gross margins, which we've talked about. So really pleased with the 120 basis point step-up in trading margins for the year.

As we go into next year, I think, again, fiscal '21 was a bit of a story of 2 halves. I think you'll see fiscal '22 being very similar in terms of strong momentum heading into half 1 and then those tougher comparables coming into play in half 2. We expect for the full year, as we've said, that our operational improvements can broadly offset any impact of cost inflation. And certainly, for the full year, after stepping trading margins up by 120 basis points, it'd be a great result for us to hold on to that 120 basis point improvement for next year, and we're going to work very diligently to maintain that. But I wouldn't expect large incremental flow-through for the full year on sales growth next year, given the step-up this past year.

And Yves, on the infrastructure side, I can't effectively give you a translation of what $1 trillion bill, if passed, would flow through in terms of tailwinds to our business. What I will say is, generally speaking, we feel good about the markets, both residential and nonresidential and what their growth characteristics are.

Our customers and our business will move to where those green shoots are. And so as this plays out and hopefully gets passed, it will provide a tailwind for us. What even a water project might represent in terms of product revenue growth really depends on what type of product -- project it is, a water treatment plant versus a pipeline, an airport versus school retrofit. So it really does depend. So apologies that I can't give you a more succinct answer on that.

Our next question comes from Gregor Kuglitsch from UBS.

I've got a few, please. So the first one is on the warehouse efficiency. I was quite interested in your comments around Denver. So I missed -- you were sort of implying you're going to change a lot of your warehouses over distribution centers over to that sort of new modus operandi with the robots and stuff. So could you just tell us perhaps sort of high level what's the efficiency, say, with a 10-year-old warehouse to this and kind of what's the efficiency or how quickly will you renew the fleet basically to get to sort of newest technology?

Sort of related to that, so you kind of flagged your margins this year will be 9.2% as well. They were 9.2% last year. You're expecting to sort of be stable. Is this sort of overall picture that you think that is the right margin level for the group? I appreciate last year was like a massive step-up and now you're kind of saying, well, you hold it. Or do you think that medium-term, perhaps there's more room to improve? I mean, just I guess the example would be, for instance, warehouse efficiency, various other reasons why that would be the case or not.

And then finally, just briefly, sorry, just to be clear on the U.S. GAAP and the sort of KPIs that you're talking to. I'm looking at the presentation. It looks a little bit different to what you reported. Am I right in understanding you're essentially moving back to pre-amortization number on both the earnings and operating profit also under U.S. GAAP sort of as your KPI that you're going to talk to?

And then sorry, one final question regarding the relisting. I appreciate your intention is the timing. The way this actually works, will you sort of do a soft poll with your shareholders and see if you've got the numbers and then go for it? Because I guess, the risk is if you don't have the numbers, it's perhaps a problem to then come back to it later. So I want to understand what your thinking is in terms of actually pressing the go button.

Gregor, I'll take the -- this is Kevin. I'll take the first question around the MDC overview. If I take it at the highest level, what we're trying to do is we're trying to get best breadth and depth of product closer to the customer in market. What we do there from an operational efficiency perspective is we save double touches from our regional distribution center. We save transportation costs in terms of replenishment to the local market, and we give best breadth and depth fill rate for our customers.

Denver is a good example of it. They're averaging, call it, between 350,000 and 750,000 square feet. We're going to roll out likely 2 to 3 a year. It's inside of our existing CapEx budget, and we're going to go to the major MSAs across the U.S. for local delivery, local pickup and branch replenishment. It's a very strong productivity saving for us. We'll also implement some of the robotic picking technology that we talked about that not only saves labor but also is very environmentally friendly and efficient. So that's the plan overall and why we're going about it. I'll let Bill take the second 2.

Yes. Gregor, thanks for the question. From an overarching margin perspective, I think the thing that we're most pleased about with this business is a long-term sustainable growth in trading margin, and we don't put a ceiling on that. So while we've had a significant step-up and truly an exceptional year rising to 9.2%, we don't believe that's the ceiling longer term. We do believe over time, we can continue to grow that and get more efficient. And again, we won't put a cap on what that is but recognizing that we've stepped up a significant portion in a single year. I think we're mindful that holding on to that and diligently working to deliver that in fiscal '22 would be a great result.

In terms of your interpretation on U.S. GAAP, yes, you're exactly correct. We are planning on continuing to use a profit metric, both on the profit side and the EPS side. That's very similar to our past practice. Just felt that after taking on some shareholder feedback remaining consistent provided an easier transition for us and our shareholders as we migrate to the U.S.

And the last question on relisting and shareholder feedback. One of the things that we're really proud of is the methodical way that we have gone about this process as a company. And shareholders across the board during the initial phases of consultation said they wanted to hear from the Board what was in the best interest of the company. Thought that was fantastic because the Board was then able to look at us focusing on our North American markets and what's the most appropriate thing for the organization.

And we did do extensive consultation with shareholders prior to that initial vote, which passed with strong confidence at over 99%. We continue to have good dialogue on a consistent basis with our shareholders and understand where they are in the process. We hope that the methodical way we've gone about this would, number one, allow shareholders and have shareholders continue to hold us as an investment, but certainly offer time for those who can't to appropriately address that situation. We're going to retain the standard listing in London. And so again, we will talk with shareholders all the way through as we move towards the spring of 2022 for vote #2.

Okay. Great. Sorry, one follow-up. On the MDCs, is this -- can you just tell us maybe a quick -- so maybe you'll touch on this in the CMD, how many you've got to give us some context and -- or whether this is sort of a new thing or whether you're converting some? I'm a little bit confused in terms of the different numbers of DCs you've got at the various MDCs, RDCs, and then I think you've got shipyards, pipe yards. So if you could just summarize what the position is would be great.

Yes. Gregor, I'll give a little color on that. And then, yes, you can expect us to give some more details as we get into the CMD. But if you think about it overall, we've got 10 national regional distribution centers. The MDCs that we're opening, the first one was Denver. We're opening Phoenix later this year and Houston is underway. So you should expect us to get up to a rolling pace of about 2 to 3 per year. And then as Kevin mentioned, we are retrofitting some of our existing larger facilities with better warehouse layout and design and robotics. So all of that is embedded in our ongoing CapEx cost and CapEx guidance, but that will be continued investment over the next several years.

Thank you all for your questions. I will now hand back to Kevin for the closing remarks.

Thank you, operator, and thank you all for your time today on the call. I guess, just in closing, we'll close with where we began. We are incredibly thankful for our associates and what they delivered in fiscal '21 during a really challenging year. And our top priority will always be maintaining their health and well-being and that of our customers and our communities.

We're really proud of what the group was able to do from a revenue growth perspective at 14.3% ahead of last year and that ramp-up during stronger demand in the second half. As importantly, from a gross margin perspective, 60 basis points ahead of prior year and the ability through hard work and product availability to pass through that price inflation and have a good gross margin result, maintaining strong cost control so that leverage both on the cost base as well as from a gross margin perspective led to that trading profit outperformance.

So we're really pleased. We're focused on what the near term can bring us. We're optimistic about what that near term is with our Q1 entry at about the same growth rate as our Q4 exit rate. We'll maintain a strong and keen focus on what is happening with supply chain pressures, but most importantly, our ability to take a complex construction project and make it more simple and successful for our customer and our customers' customer.

So thank you for your time today. I look forward to talking again very soon.

Ladies and gentlemen, that concludes today's call. Thank you very much for joining. You may now disconnect your lines.