Ferguson Enterprises Inc (FERG) 2019 Q2 法說會逐字稿

Good morning, everybody. Thank you very much for coming, and welcome to our interim results presentation. You've got Mike and I presenting this morning. Our Chairman, Gareth Davis, is over here too. Tessa Bamford's over there, another non-exec director. Nice to be with us here this morning, so thank you.

We're going to follow a bit of a different format this morning. We want to put this set of results into some context and the initiatives that we're pursuing into the context of the progress that we've made over the last few years. We believe that will help underline our confidence in the further development and growth of the business well into the future.

But firstly, let me share with you the highlights of the first half. We've made good progress in the development of our strategic initiatives, and we'll come back to those a little bit later. Our most significant operating priority this half was to deliver great service and availability to our customers to continue to drive profitable growth.

And the overall organic growth rates in our Blended Branches business in the United States, as you can see from the chart, was 9.7%, with all of the regions growing strongly. Together, those Blended Branches' regions, plus Waterworks, account for 2/3 of our group.

Overall, the group's gross margins were slightly ahead. Trading profits were 8% ahead of last year despite one less trading day and also the impact of some of our investments, which Mike will take you through later.

We continued to convert those profits effectively into cash, funding significant organic growth initiatives and acquisitions. We also netted more than $250 million of disposal proceeds. And we ended the half year with net debt of 1.1x EBITDA, which we'll improve on further in the second half. That's enabled us to fund dividend growth of 10%.

Now those are the highlights. Mike now is going to take us through the financial performance and also the work that our team has been doing to move our tax domicile back to the U.K.

Thanks. Good morning. I'm pleased to present the group's half year results for the 6 months just finished, and we have had a good start to our financial year.

Revenue for the group was again driven by strong growth in our U.S. business. We generated decent gross margin progression, 10 basis points up. Ongoing trading profit, $744 million, up $53 million, that's up 8% in constant currency. Headline EPS, up nearly 20%. And it's worth also noting that we had one fewer trading day in the first half of the year.

And reflecting our confidence in the strong balance sheet, the excellent track record of cash generation, we've increased the interim dividend by 10%. You can see the balance sheet remains in good shape at the end of the half at 1.1x levered.

So moving to the revenue and trading profit growth slide. On the left, I've bridged the revenue growth. That's from the $9,865 million in half 1 last year to the $10,666 million in half 1 this year. After adjusting for the FX, which you can see decreased revenue by $70 million, you can see the constant currency growth of 8.9%. That's split into the organic growth of 6.5%, we lose about 0.5% due to the trading day that I mentioned and acquisitions added 3%.

On the right, you see the corresponding effect on the trading profit bridge, from the $691 million to the $744 million that we've just delivered. Foreign exchange costing us too, taking us to $689 million. Organic flow through adding $51 million of trading profit. The trading day was worth about $12 million the other way, and acquisitions added $16 million. That number is net of transaction and integration costs.

Revenue growth in the U.S. remained strong in half 1. Good markets. Inflation running at around 3%. You can see that the revenue comparatives clearly get tougher as we move into the second half. In the U.K., on a like-for-like basis, broadly flat. Inflation within that number is about 2% to 3%.

Canada revenue growth reduced through the period. Resi markets slowing as a result of the rising interest rates. Government measures to restrict the mortgage credit there. Inflation, again, in Canada running at around the 2% to 3% mark. We do expect to see lower organic growth in the second half. John will give you our take on the markets as we look forward a little later.

Now let me just move into the regional results. And importantly, our U.S.A. business, our largest region first, which delivered a good performance. We continued to outgrow the wider market in the U.S.A. All our businesses delivering strong revenue growth. During the first half, there was a small benefit in gross margins arising from the recent own-brand acquisitions, somewhat offset by the dilutive impact of the very strong growth that we saw in the industrial business. Overall, I'd expect gross margins to be flat in the second half.

Labor cost inflation was around 3.5%. Distribution costs were impacted by higher inflation. During the second quarter, headcount growth was also too high, and since December, we've reduced associate numbers by about 600 full-time equivalents. That was probably worth something like $10 million to $15 million of higher costs in the second quarter.

And clearly, given our guidance on revenue in the outlook statement today, we'll continue to tightly control cost growth through the rest of the year, particularly labor, given that it represents about 60% of our operating costs. So overall, trading profit $700 million, $53 million ahead of last year. Trading margins at 7.9%.

I've split the breadth of that organic revenue growth out in the U.S. on Page 9. You can see that it's pretty broadly based geographically and across the business units. For Blended Branches, we generated 8.4% in the East, just over 10% in the West and 9.2% growth in the Central region.

Revenue growth in eBusiness stand alone was lower as planned, as we continued to consolidate the pay-per-click advertising spend across fewer trading websites. Waterworks continues to grow well. HVAC and Industrial both particularly had strong performances.

And the end markets in the U.S. On the next slide, here, we've shown the market growth and also our organic growth against those numbers for the first half.

Residential markets grew well, driven by good RMI markets that represent the majority of our revenue, though this growth did moderate slightly in the second quarter. Commercial markets remained good, market growth of around 5%. Infrastructure market growth moderated slightly, but was growing at reasonable levels. And overall, you can see our outperformance against those markets continued at good levels.

So having covered the U.S., let me move on to the U.K. And in the U.K., the market remained weak and at best flat against a weak RMI market. Revenue in the U.K. was lower at constant currency due to the impact of the branch closures and the exit of the low-margin business that we did last year. Gross margin slightly ahead due to the improved product mix, and trading profits at $30 million was some $8 million lower. This splits roughly $2 million of FX and about $3 million for our Wolseley U.K. business and $3 million for our soak.com business, which is our B2C business.

Since the end of the first half, we've actually sold the soak business, which was a non-core online consumer business, phenomenal value. I've included on the charts the revenue and trading profit impact of that business. In the core business, we've also exited the national distribution center and disposed of it, and relocated the support services office in Leamington Spa in December as we had planned to do.

Canada. Canada achieved 2.1% organic revenue growth in the first half. Markets weakening progressively through the period, mainly due to those residential markets. Residential markets in Canada, just to remind you, represent about 60% of our business mix there. However, really pleasingly, despite that market backdrop, gross margins were a little bit ahead. Costs were well controlled. And therefore, you can see a good uplift in the profit of $6 million to $39 million. Very pleasing in Canada to see us getting on to the margins and on to the cost curve despite the markets being softer.

So moving on to exceptional items. Here, you can see, whilst they are negligible overall, there's a number of moving parts. You can see on the slide the proceeds from the sale of Wasco, that was the Dutch Plumbing and Heating business, which we completed in the period. We made a $38 million gain on that disposal. We had U.K. restructuring charges totaling $31 million, and that brings to an end the spend on this restructuring phase in the U.K.

We've also sold down some of our shareholding in our Swiss associates at the end of the 6-month period. Following the end of the period, we also have received a further $45 million roughly of disposal proceeds from U.K. noncore assets as part of the restructuring program.

Finance and tax charges, as expected -- I'd expect the effective tax rate for the year, as previously guided, to be 22% to 23% as we benefit this year from the U.S.A. tax reforms. And as previously guided, we expect this to move up to 25% to 26% from next financial year, financial year '20, mainly due to the Swiss tax reform.

Turning to cash flow. Good strong cash generation, that continues to be a feature of the business. Cash flow from operations, $287 million, after a normal seasonal working capital outflow. Capital investment, that includes the additional investment into the new Perris distribution center in Southern California that will be completed later this year.

We also completed a number of attractive acquisitions in half 1. You can see the cash outflow there on the slide of $589 million, mainly in the U.S.A., and included a couple of slightly larger transactions: Jones Stephens, a rough plumbing own-brand business; and Blackman, of which John will touch on later.

The cash received from disposals predominantly related to the Dutch plumbing and heating business and also some surplus Nordic property disposals. And you can see the total of those being -- generating a cash inflow, $255 million in the period.

All that means is that we finished the period with a strong balance sheet. Net debt-to-EBITDA just over 1x levered. The net pension asset is now in surplus, on an accounting basis, $154 million. That follows us putting in additional funding contributions to the U.K. scheme in the second half of last year. And our minimum lease operating commitments remain unchanged at $1.1 billion. And as normal, I'd expect us, as a business, to delever a touch through the second half towards the end of the financial year.

So having covered the results, let me just cover a couple of other financial-like items in the press release this morning. Firstly, we have announced our intention to move Ferguson's tax domicile back to the U.K. from Switzerland. You'll remember that the company moved its tax domicile to Switzerland in 2010. Since then, the benefits of the Swiss tax domicile have reduced over time. And with the recent announced changes there that are now being proposed in Switzerland, it makes it less competitive for us to remain there going forward.

The proposal requires a scheme arrangement and shareholder approval at the general meeting in April. And if approved, the effective date would be the 10th of May 2019. And clearly, we'll distribute further details in due course. It's anticipated that after the implementation, that the group's effective tax rate would remain exactly in line with previous guidance of 25% to 26% for financial year '20.

And finally, and I can feel the excitement in the room, IFRS 16. A number of other companies will have been talking to you about this. And whilst the standard does not apply to Ferguson until next year, we're a late adopter because of our year-end, so our first financial year will be next year. I did want to give you an early view of where I think the numbers will land, which we've included on this slide.

The standard, just to remind you, has no impact on the group's financial or business plans. It has no impact on the capital allocation policy of the group. And it doesn't impact any of our cash payments or our credit ratings. At this stage, as I say, the numbers are indicative. They are subject to change because they are somewhat 6 months early. But of course, I'll update you with firmer numbers as we get to the year-end presentation. And clearly, into next year, we can take you into more detail.

Technical guidance for the year, most of this remains unchanged. As you would expect, the trading days in the second half are the same as in the second half last year. I've included the impact of the completed acquisitions, mostly in the U.S.A., to give you the full FY '19 full year figures. And the full year trading profit there are split between the gross number and the impact of acquisition and -- sorry, of transaction and integration costs.

I'd now expect the M&A activity pipeline to be much more modest in the second half of the year, with a much more normal level of activity that we see in our pipeline.

So let me conclude. We've banked a good first half, over $50 million of trading profit improvement year-on-year, a good solid first half performance. We continue to generate good cash flow. We have a strong balance sheet. And both of these fundamentals remain key strengths of our business.

Thank you. I'll hand back to John.

Well done. Thanks, Mike. Riveting stuff on IFRS 16 there, thank you. Now today we thought it'd be a good time to reflect on the development of our business and the attractions of our business model.

What is attractive about our business today? So on this chart here, I think there are 4 things to mention. Firstly, in the top left here. In most of our markets, the market structure itself is very attractive. There is a real need for our services. On the top right, just a reminder, we are differentiated by the services that we offer. We offer highly value-added services to our customers. Bottom right, we have -- the opportunities available for growth in our core markets are absolutely fantastic. And bottom left, we are able to consistently generate market-leading returns. I'll touch on each of these in turn.

On to the market structure. We used this chart last time to demonstrate the fragmented nature of the markets that we operate in and the market-leading positions that we occupy in the majority of them. Just a reminder, our business is primarily focused on repair, maintenance and improvements markets. This typically involves smaller, nondiscretionary projects with quite short lead times. The RMI market has also traditionally been a less-volatile market than the new construction market, and RMI now accounts for 60% of our revenue.

The second key attribute, we are differentiated. This slide from last year is also a reminder, we don't just sell products. We have a differentiated service offering, providing support for our customers' projects, delivered by the best associates in our industry and highly valued by our customers.

And if we can, I'll touch on the growth opportunities. Our underlying markets have really good demographics. Population growth and other social factors support the expansion of home formation. And consumers demand more comfortable and better-appointed homes and buildings over time.

We've also built a really enviable sales culture in the business, which captures more than our share of that growth. And incremental investment opportunities to support organic growth are actually quite modest. There are plenty of opportunities too for profitable bolt-on acquisitions. We will have excellent opportunities for profitable growth in our core markets for many, many years to come.

If we look at where our growth has come from in recent years, this is the picture. Since 2010, we've grown by 7.3% per year. That's across the group for all the ongoing businesses. Market growth has accounted for just over 3% per year of that growth, with the U.S., of course, being somewhat higher.

We've always shared the objective with our team that we should grow profitably in excess of the markets. And we've consistently taken market share by growing between 2.5% and 3% faster than the markets. And we've also completed selected bolt-on acquisitions. Those have added between 1% and 2% of growth each year.

Now the protection and growth of our gross margins is also an important attribute of our business. We've aligned with the right vendors and carefully managed our mix, whilst developing our own brand, and that's ensured that we can add value to our customers and also recover that value in our pricing. We've usually achieved gross margin improvements, as you can see from the chart, of between 10 and 20 basis points per year over many years.

Now since 2010, we've also grown trading profits by a growth rate of 16% per year. That flow-through to trading profit is a function of both growth, gross margin improvements and productivity enhancements. We continue to believe for our company that double-digit flow-through is a good performance in decent market conditions.

And moving on to returns, we don't very often show a chart like this, but this shows our return on capital over the last 10 or 11 years. We are a very results-focused business. We've improved returns substantially by a combination of driving profitability and careful balance sheet management, most notably, making sure that we've got the right inventory in the right place at the right time, and that we're also commercially astute in the management of our trade receivables book.

Now over the last 10 years, we've exited a number of weaker or subscale markets where decent returns were not available. And we returned $3.5 billion of surplus cash to our shareholders in the process, in excess of the $2.3 billion of ordinary dividends. Today, we have a much stronger, simpler, more focused business, with excellent positions in the markets where we are well equipped to win. We think we're in a great place now to capitalize on those opportunities to consolidate and gain market share profitably.

Now I would like to just touch on a number of initiatives that we are driving today in the business. Denver is a large and profitable market, where our team have made fantastic progress in gaining market share over several years. Today, we've got over 70 branches in the region. We're servicing them from distribution center facilities more than 1,000 miles away and a mountain range. We are constantly looking at our logistics networks, including tracking every replenishment journey and every final mile delivery we make, whether that's internally or via carrier. That's what all those strange spider lines are on those -- on the map.

Now we're building a new facility in Denver, and this will consolidate 4 existing sites and provide next-day replenishment to our branch network and same-day delivery to customers across the region. That will significantly enhance customer service. And the economics of this are quite straightforward. The whole of the operating costs of this facility will be offset by the reduction in freight costs that we currently incur. That's very similar to the economics, if you remember, of the Celina DC that we opened in Ohio in 2014.

Now people don't always associate distribution with innovation. But as we've talked before, we are trying to break the mold on this one with our innovation unit colocated in San Francisco and Atlanta. And the example here on the chart, Supply.com is a plumbing and heating products business, selling those products to professionals across the country. We provide personalized account management from a call center, and we fulfill orders from a distribution center. There are no branches and there are no field sales. The business is growing more than 30% per year, and it's now doing more than $120 million a year.

We've talked before about our sharpened focus on own-brand products. These expand the choices, the range available to our customers and capture a greater share of the value in the value chain. Frederick York, which is shown on this chart, this is a range of decorative plumbing products launched in Canada during the year, designed specifically for the local Canadian market. It's really nice quality product, sourced from overseas and available both in our showrooms and our branches. That rollout supported by specific marketing measures, including a transactional website, all developed using resources from within our group. Own-brand sales now accounted for 8% of sales in the first half, up more than 1% on last year and growing every month.

We continued to find some really nice bolt-on acquisitions. We talked before about the huge New York, New Jersey market. This was a region in which we were substantially underpenetrated a few short years ago. But we have been busy, and it's worthwhile reflecting on the last few years of growth.

In 2012, we bought Davis & Warshow. This was the market leader in residential and commercial plumbing in metro New York. And we followed that by Karl's, which is an appliance business, to add on to our residential showrooms business. We supported the business by building new distribution centers. You can see upstate New York, not quite to scale I'm afraid, the Coxsackie one there. And we also built a market distribution center on New Jersey for fulfillment of orders within the city.

In 2017, we added Ramapo, and then more recently, we've added Wallwork, a New Jersey-based HVAC business. Blackman is our latest acquisition. This is a significant expansion for us in Long Island, with 23 branches and a number of really nice showrooms in great locations and a distribution center expanding our service proposition in this significant market. Blackman generated $240 million of revenue last year in the plumbing, heating, HVAC and Waterworks categories. Now you can hardly see Manhattan on the map, but that is partly because of the size of our dots.

As with all acquisitions, the hard work starts with integration. We've had over 100 associates working hard on integrating acquisitions this year. And we'll incur acquisition and integration costs of $15 million. But looking through all the short-term pain, what are we doing? We're building the best plumbing and heating business in this fantastic market which will yield substantial returns in the years ahead.

In the U.K., our new team has brought a real operational focus to the business, defining a consistent new product range across the network, improving inventory availability and focusing relentlessly on customer service. We're focusing on our core plumbing and heating and infrastructure businesses. And we've exited the peripheral low-return activities, including BCG last year, as Mike mentioned, the soak B2C business, as well as our fabrication activities.

At the same time, we continue to lower the cost base to ensure that we generate the best returns available from the business. Today, growth has been pretty elusive, but our team is now starting to see some real momentum. And we do expect to see better financial returns now in future.

Moving on to the current market backdrop and our outlook. We track data points from numerous economic industry and research sources, as well as surveying our own customers and clearly measuring our own order books. It's fair to say over recent months that some indicators have softened. This chart from Zelman is probably a decent proxy for market sentiment in the U.S. as we move into spring, with the growth rate for building products having moderated over recent months.

So how do we expect to operate in the coming months? First of all, we're going to keep our focus on availability and customer service to continue to take market share profitably. We'll actively manage our cost base, which Mike has talked about, across all cost categories. And we're going to be very targeted with our capital investment and acquisition plans. And of course, we expect to continue to be highly cash-generative and continue to follow our prudent capital allocation policy.

Just touching on that. We set out a decade ago our very simple views on the balance sheet. The principle that we established was to maintain net debt at no more than 1x to 2x EBITDA, which you can see in those tramlines on the chart. And we've operated at the lower end of those limits ever since. One day, there'll be another downturn. And at that time, we want to be able to continue to focus on customer service, on availability, on the operations and strategy of our business with a rock solid balance sheet. We continue to think that those limits are about right. We're at 1.1x in January, we're at less than 1x today. And as Mike said, we expect to continue to bring that down over the rest of the year.

We've also significantly reduced our reliance on landlords, bringing lease commitments down to just over $1 billion. And I hope we've been good stewards to our retirement funds of our associates, eliminating the accounting deficit and derisking pension schemes along the way.

Now on to the outlook. After strong revenue growth throughout the first half, our growth rate has moderated recently in line with market conditions. We expect to continue to grow in the second half, with organic growth rates likely to be in the range 3% to 5%. We expect to deliver trading profit towards the lower end of expectations for the full year.

Now that's it from me. Thank you very much indeed for your attention. Mike and I are very happy now to clarify anything that's unclear and take any questions and comments that you've got.

That was very quick, right?

That was quick.

It's Paul Checketts from Barclays. Can I just ask a couple of, I suppose, obvious questions? But if you thought about back to the last time we heard from you guys, what is it that's changed to lead you to reduce your outlook for revenue growth? And perhaps, you could enlighten us a bit in terms of the verticals, how are you there trending. And then the second is that there are obviously potential implications for the drop-through margin, the flow-through margin in a lower growth environment. Is it conceivable that in the second half, with lower growth, that actually that flow-through could increase?

Shall I take the first bit and you take the second bit?

Yes.

Look, I think what's changed, firstly, if you took our organic growth rates in the first half, they're 6.5%, okay? And we're guiding in the second half to between 3% and 5%. The first thing that's changed, and if you recall from that Zelman chart that showed volume and price, I think that there is likely now in the second half to be quite a lot lower inflation pull than there was in the first half. It's very widely documented. I don't need to tell you about that. Call it 1%, I don't know, but we have to take a view into the future. Secondly, Canada. You've seen the Canadian growth rates have come off. Now we think that is wholly related or primarily related to the slowdown in residential. We are more residential in Canada actually than anywhere else in the group. The team are doing a great job, yes, and we're very positive, but we've seen those growth rates come up. That accounts for about 0.5%.

The third thing I would reference is, in industrial, now we had a very strong -- we had very strong Industrial growth in the first half. We expect that to be a little bit lower in the second half. And that will contribute possibly about 0.5% reduction. But I don't want anybody to feel negative about Industrial. This is a good business. It's grown very well in the first half, we just so happened to have some project work that's clearly boosted those -- boosted the growth rate. So I think if you take those 3 things together, that probably adds up to 2%, 2.5%. And then I think if you look at some of the other sentiment around -- just slightly we saw, I think, Mike, in your numbers, resi was just off slightly, came down from 7% to 6% in the first half. That probably accounts for the rest of it, Paul. So those are the things that I would say directionally are the things that have most impacted our view as we've sat here and look forward for the rest of the year. Flow-through, Mike?

Yes, flow-through. So there's no change, certainly in the long term, Paul, in terms of our business model or our thinking. So in decent markets, as John has said, we would expect flow-through of high single-digit, low double-digit. I think with the growth rates that we're talking about for the second half, I wouldn't be -- that will clearly be a challenge for us in the second half. It's clearly our job to make sure we get as good a flow-through as we can. But do I think it will be as high as low single digits? I think that's unlikely given the 3% to 5% guidance. But it is our job to continue to work that hard, make sure we control those costs, particularly around labor.

Gregor?

Three questions, please. First one is on -- just coming back to the second half. If you can flesh out a little bit the U.S. specifically. I mean, obviously, with the proportion of the group, I'm guessing it mirrors the slowdown. But equally, I think in the U.K., the shutdown of the wholesale business kind of comps out. So I want to understand where you see the U.S. growth specifically for the second half or maybe within a range. That's question #1. Question 2 is on acquisitions. You spent in the neighborhood of $600 million. Can you just give us an annualized profit number of that $600 million spend? Because obviously, some is within the period, so just to get a sense where the multiple was perhaps pre-synergies. And then if you care to elaborate where you think that ends up in due course with synergies. And then the third question is something that I think has been discussed many times in the past, but hasn't been talked about more recently, which is obviously the fact that you are now a 90% plus U.S. business. And to what extent you have reassessed or assessed a relisting in the U.S. Obviously, you're moving the tax domicile. So the group is simplifying. But I want to understand, perhaps you can reiterate, what your thinking is on that possibility.

Okay. Can I -- can I take 1 and 2 -- 1 and 3 and you take 2?

Sure.

Does that make sense?

Yes.

Look, I mean, the U.S. versus the U.K. growth, I'm not sure -- I mean, the U.K. isn't big enough to influence that growth rate probably much in the second half. So I think that sort of 3% to 5% organic growth in the second half, that incorporates our views of where the U.K. is likely to be in that as well, Gregor. And it doesn't substantially distort that number. It is worth saying, because I got asked this, this morning about, "Well, what have other distributors seen over time?" And it is interesting. We did quite a lot of work internally to look at -- we look at all the other distributors' numbers.

We look at all the home center numbers in the U.S., the Lowe's and the Home Depot and those people. If you look at their Q4 '17 versus Q4 '18, actually, Home Depot was 7.2%, they came in at 3.7%. Lowe's had been 3.9%, they came in at 2.4%. Watsco, which is a direct competitor of ours, they were 6% in Q4 '17, 3% in Q4 '18. Masco, which is clearly a very large supplier of ours, Masco's plumbing division, they were 9% Q4 '17, 4% Q4 '18. So still -- all of these businesses still getting good growth, but not quite the super-charged growth that we were seeing people in the industry. And by the way, those are only a few. We've got -- there are plenty of other examples, but you know those businesses.

Just look, on the listing side, I'm afraid the analysis remains the same as it was before, which is this is not something which is in the gift of the company. Our shareholders would have to approve a delisting and relisting with a 75% majority. And they would have to -- some of those -- you would remember, most people who hold our shares have a mandate, that's the agreements that they have with their -- with the people who own them to operate somewhere. So a lot of U.K. investors have got a mandate to invest in U.K. funds. Some U.K. investors have got a mandate to invest only in international funds.

And the same is true in the U.S. The same is true in any other country. I know because I have previously, in a former life, had to operate within a mandate. You don't go outside your mandate because, otherwise, you're going to get sued obviously by your owners. So it's really every individual shareholder would have to decide whether or not they were able to own the shares if we were to delist and relist in the new territory. And I don't think that is quite as straightforward as it seems to be on paper, Gregor. All right? Mike, sorry, go on, on the acquisitions.

Yes. So on M&A, on acquisitions, there is clearly some profit that moves into next year. I think the way you should think and the way we think of M&A is we clearly only buy good quality businesses. I mean, we were very clear about that. We are not turnaround experts. We don't buy distressed businesses. We buy good quality businesses. We're probably paying and have paid -- and again, there's some land in some of the numbers, so you can't actually get to the multiples either because in the Blackman, there's quite a piece of land. And we would probably be paying 8x or 9x right now. That's quite -- for a good-quality business.

Blackman also has some quite large integration costs. It's a -- it will take some time for the profits for that business to come through. I think we also and still firmly guide to second year return on investment of 15%. That absolutely still holds. And therefore, that tells you that we get synergies. Each business is different. So own brand acquisitions quite different to a Blackman, which is a bit more traditional business. They will have different synergies and therefore different turns of multiples in terms of synergies. But we'd expect normally to take, on a traditional business, a couple of turns off the acquisition price as well.

Clearly -- 8x to 9x is including the synergies or excluding?

That's what we will have paid.

So we've got 8x to 9x. And on Mike's sort of 2, 2, 2 turns. After all, we'd aim to get that back to 6x, 7x pretty quickly. Yes, we say in the first year post integrations.

[We're already in the second], yes.

Arnaud Lehmann, Bank of America. Three hopefully quick questions. Firstly, just to follow-up on Gregor's question about U.S. listing. You have an ADR, which I believe is level 1, and there were talks at one point you might move to level 2. I appreciate that might lead to incremental costs for you, but is that an option to make it a bit more liquid, I guess, and expand your U.S. shareholder base? Secondly, on the tax rate, just to be clear. Your guidance is 25%, 26% including the relocation to the U.K. It would have been higher if you stayed in Switzerland, is that correct? And the last one. In terms of, I guess, the U.S. outlook, you said maybe it's a little bit slower, which is fine. How does that change your view of working capital management? Do you -- are you in a position to somehow reduce inventories and accelerate cash flow generation? So in a slower growth environment, should we expect operating cash flow to accelerate?

Did you want to take any of those? Or should I take all 3?

You take 1 and 2. I'll work out the...

Excellent. That's worrying.

Well, that's what we'd say [tight], Mike.

So I think your first question was about do you we propose to move level 1 ADR to level 2? The answer is no. Most -- if you look in the history, in over the last few years, most companies have moved from ADR level 2 down to level 1. So the trend is very much the other way. Unless you're on a journey to somewhere else. And given that John's just said, we're not on a journey to somewhere else. We don't see the benefit for our shareholders of moving to that. In terms of the tax guidance, you're absolutely correct. The tax guidance for FY '20 is 25% to 26%. That is as previously guided. With tax guidance, we generally quote the income statements. There is also the cash. I think you should assume that staying in Switzerland longer term would have given us a larger cash tax bill. So yes, being in the -- moving to the U.K. is a better outcome for shareholders, but no change to the tax guidance as previously given.

And on the working capital, we use a mechanism internally -- and bear in mind, all layers of management have an incentive based on achieving working capital targets. Those working capital targets are not spot targets at the end of the year because then you get wild swings or can get wild swings. They are targets that are based on every month end. So we are motivated to ensure that we continually have working capital right up in line of sight all the time. I think the way in which you should think about our working capital is pretty much proportionate to our growth, okay? And because we -- you can occasionally get -- we have 1 day, 1 day of cash which -- our cash-to-cash cycle, 1 day in our cash-to-cash cycle, broadly speaking, is $50 million. Our performance is usually within 1 or 2 days of that identity. So if you think it's within $50 million or $100 million always as being proportionate to growth.

Now I think 2 other things happen with working capital. Number one, there is a fixed element of working capital because we've got a fairly fixed distribution center network, for example. We're putting some more working capital in, in 1 or 2 areas such as own brands because that has to come all the way from overseas and just the supply chain is longer. So that will edge things up. But of course, we should also become more efficient over time in that. So I think all of that should net out. You should see, if we're growing at that 3% to 5%, we should need 3% to 5% more working capital. Just to let you know. I mean, at the half year, we were out by about a day, Mike.

Yes, we were.

So we are slightly shy this year of where we need to be. Now that that's mainly timing on own brand acquisitions and those types of things. So -- but it's -- we're talking about fairly small numbers there. Okay?

Howard Seymour from Numis. Two, if I may. Firstly, John, you alluded to the growth that you've had historically over and above the market, i.e. 2% to 3%. And just thinking, I mean, obviously can't tie you down on this. But as you look into the second half, is there any reason why you should do less than that? Because say if we say a 3%, the assumption is the market's flat in the second half, which is quite a big falloff. So just thoughts on market share gains versus the underlying market. And I suppose your views on whether you perceive -- I mean, I suggest not giving what you put up there, whether this is the peak of the market or just a slowing back to a normal situation. And then secondly, just wanted to make -- because on the first quarter call, we alluded to the drop-through, was our assumption. There's obviously a lot less than that in the second quarter and seemed to be less than, I think, any of us would be looking for. I assume that's unexpected inflation cost or an input cost, and therefore why do those not repeat into the second half if they're unexpected then?

Thanks, Howard. Look, I mean, on the outperformance against the market, no, there is nothing that I see or that we see more broadly in our business that suggests that, that outperformance would suffer any erosion, okay? And that's true across all of our 9 business units. So if we are right about the 3% to 5%, then you should expect the market growth to be lower than it has been, Howard. That's what I would say. In terms of the peak, if you look at the underlying market conditions, to us, the underlying market conditions actually look pretty good. If you look at new resi, you know that chart, you've seen it, it's 1.2 million, 1.3 million sort of permits, starts, completions, whichever way you measure them, and that stayed fairly consistent for some time.

If you look at existing house volumes, that's plus or minus 5.5 million. It was down in January. It was up in February. Fine. The long-term picture is 5.5 million. If you look at pricing, Case-Shiller is still up 4.7% I think in February. Actually, that a reasonably sensible -- do we do want it at 14.7%? I don't think so. 4.7% is fine. Sure, it's off from I think the peak was 6.5% spring last year, fine. But 4.7% house price growth, and all 20 metropolitan areas were -- continued to have some rises. Housing affordability remains good. If you look at the Raymond James affordability index, that's close to its 30-year average. So all of that stuff in residential, the JCHS LIRA still looks okay. Yes, it's moderated slightly, but it still looks okay. Commercial, I think similarly. And if you look at the Zelman nonresidential indicators, they're still showing commercial growth at sort of 5% or 6%. So those indicators suggest that the market is going to continue to grow.

Good. To answer your flow-through. Now flow-through, a couple of comments really. One is I touched on the labor. The -- as we exited the end of last year, clearly, we were in very good markets, and therefore, we will continue to have labor. We had in quarter 2, as I said, about 600 equivalent heads too many, which we have since taken out. That's actually a cause and effect. So with the markets being good, we had the heads, so that we don't miss out on the growth. Of course, as the markets turned and weakened slightly in Q2, the good news is, in the U.S., you can take the labor out. And we've taken that out without any redundancy costs, restructuring costs.

It does, however, take you 6 to 8 weeks to do that. You've got to remember we operate over -- more than 1,500 branches across the whole of the U.S. so these are small numbers in lots of locations. And to get that through -- taking attrition as well, so we get a normal turnover, it takes us about 6 to 8 weeks to take that labor out. That did result then -- what's the internal disappointment in the first half? It's a good set of numbers. The internal disappointment is about that $10 million to $15 million. If we could have clicked our fingers and taken the labor out quicker, we would have. That affects the flow-through, Howard.

The other one, in the Q2 the year before, we did have exceptionally high gross margins. So I think if you look at the year average, it's a better. I think you know we don't manage flow-through by quarter. We manage the business long term. I think if you'd look at the 2 components, the gross margin for last year for the business was 29.4%. The gross margin for Q1 this year was 29.6% and the gross margin for Q2 this year was 29.6%. So it also tells you it's not in the gross margin, it's actually in the costs. And it's really around that labor issue. And we need to clearly continue to monitor that labor very tightly as we move forward, given our outlook this morning. Does that help?

Yes, definitely.

You've got the trading day as well, but I think you will have captured that.

John Messenger from Redburn. I think it's 2, if I could. Maybe just sticking with costs and what happened. Doing the math, it's kind of your total cost base grew by about 13.5%. 3% probably relates to acquisitions. So your underlying cost base grew by 10%. The headcount wise, underlying, it was kind of 0.5% of growth, 3% of headcount growth from acquisitions again. Just can you help us understand what are the big packets of cost that are inflating in there. In that you highlight labor costs at 3.5%, but to go from 3.5% across what looks like a relatively flat net headcount change. What -- is this third-party logistics? What is it in the distribution costs that are really jacking up in terms of sizable cost increases and when does that start to abate, I guess? So what of it do you control to an extent?

Second question was just on the guidance. If we assume the group does just a tad above that bottom end of the range, let's say, 15 90. It implies 8 46 in the second half. Last year was 8 03 on the continuing. You've said there's $29 million effectively of extra acquisition EBIT coming in the second half. It implies about $14 million of organic in terms of profit change. Can I just check you'd, number one, agree with the maths? Number two, what is really -- maybe it comes to the point, if 3% to 5% is the growth rate and if that is the growth rate next year, coming back to Mike's comment about drop-through gearing, against that sales backdrop would be hard to deliver. What do you need in 2020s? If we believe the world is going to be 3% to 5% again, what would you be doing differently in 6 months' time to make sure that the drop-through gearing is better than 5% or 6%?

Where do you want to start?

Why don't I sort of have a...

Okay.

Why don't I do a sort of a...

And I'll draw it together, yes.

Because -- so think, John, the point you've made is well made. We came out in a very strong growth period middle of last year, okay? And we are putting in heads to make sure we've got drivers, we've got counter staff, we've got warehouse associates, we got inside salespeople and we're doing the right training. So that has a momentum to it. It does. You might say, it's because of the [movement of the] business. But if you look at that chart that Mark was putting up there before about the long-term growth, sure, there are a few wrinkles along the road in that because it's not a quite such a perfect care that you came up with, Mark, but well done.

My point really was, we came into the year with very strong growth. And we want them -- when I'm talking to the team, I want them to capture every bit of market growth that's available. Howard's question, are you calling the peak? No, I'm not calling the peak of anything. What we're doing is we're managing the business as closely as we can. Now to Mike's point, it does take you 6 or 8 weeks. It does in any business, frankly, to correct the heads. Were we a bit bullish at the start of the year, I think yes. With the benefit of hindsight, Mike has given you our view of the sort of the degree of that disappointment. If we were in a 3% to 5% organic growth environment, I guarantee you, we will cut our cloth absolutely accordingly, okay?

I struggle to believe if we're in that type of environment longer term, I think there'll be less labor inflation. John, if I can say that, I think that'll be the case. But the other -- the single largest factor by a country mile is the number of associates. So although this year we went up and we dropped off a little bit, there's seasonality in there is well, because remember in the middle of winter, we should have fewer associates. So we went up the 600, down the 600, that's the bit, that little peak that we should have managed frankly a little bit better. But make no mistake, if we're in a 3% to 5% organic growth environment, we will still expect to generate sensible profit growth. All right?

And just on that bridge for the -- in terms of the...

Yes. Go ahead, sorry.

Yes, in terms of your acquisitions, yes, I mean, we've given you those numbers. It clearly depends where you put between 3% and 5% growth, what number you'd come out with and your flow-through. Do remember, there were some costs credit in Canada last year for [the East coast] settlement as well. I think they're net of your numbers. So again, it will be somewhat better than your 14 on an underlying basis. But as John says, our job is absolutely to work that flow-through in lower-growth markets.

And there's nothing geographically in the U.K. or beyond the $6 million reversal in Canada that we need to think about in terms of...

Nothing.

Because you're confident -- you sounded more confident on the U.K., I think, John.

Look, I mean with the U.K., John, I am very impressed with the team's focus, a real focus. They are impatient, they are executing and I think that will pay dividends. There's more -- there is lots more to do. But now we are starting to lap where we took those fairly decisive actions prior to the new management team coming on board last year as it happens. And so yes, I would be cautiously more optimistic on the U.K., John.

Ami Galla from Citi. Just a couple from me. Just getting into that costs part again. You've talked about managing the cost on the headcount front more actively in the second half. To what extent are you capping your potential growth into the second half and into 2020 by managing it so strictly? And I mean, you've talked earlier about how sales associates are the biggest driver for outperformance in the U.S. And how should we think about growth in that perspective? My second question, just a couple of technical ones. Can you give us numbers around to -- around what integration cost has been booked in the numbers in the first half? And on U.K., what are the sort of cost savings that we should be thinking about coming through the numbers in the second half?

Yes. Look, I mean, to the first question, on the are we capping our growth, absolutely not. Now this is a question of making sure that we have the right level of associates in order to capitalize on the market opportunity, yes? That's a balance that we always have to take whatever -- because if you can imagine that, we have to do that in every location, in every zip code around the business anyway. That's a constant, constant, constant rebalancing. We wouldn't do that. Mike and I would rather be sat in front of you today saying, "No, we're calling a higher growth there, we're putting more people in." If that was the right thing, that's what we would do, honestly. So no, there is no way that we would choke off growth in our business by reducing associates.

The point though is, for the associates that we do have, we do have to generate the right efficiency. We have to generate the right productivity, the right flow-through, the right -- whether that's salespeople, the number of calls, the number of visits, the conversion of tenders into orders, or whether that's the number of picks that a warehouse associate does or the number of drops that a driver does. All of those efficiency stats have to be in the right ballpark. Go on, sorry? And then the...

Yes. So integration costs first half was $7 million, second half, I'd expect $8 million, and that's the total of the $15 million, so pretty well split. The U.K. cost base, I mean, the U.K. cost base, the issue in the U.K., I think John has already said, is not just getting some top line traction, but also getting that gross margin moving. That's the challenge really in the U.K., the fundamental challenge for us and the U.K. management team. So we will move costs accordingly. And if we can grow that top line or grow gross margins, either/or, I'll take in terms of gross profit. That's what we're after there.

It's Phil Roseberg from Bernstein. Just a couple of questions. The first one on the opportunity, I guess, at these times when things go down, a lot of the small businesses sort of say, "Okay, I'm not going to go through another downturn, it's time to sell." And I sense from other companies that there is a lot more, I guess, in the pipeline potentially. Is this something that you can use to, if you like, change the nature of your growth and go perhaps a little bit above the 1% to 2% that normally guide to on bolt-ons? So just like your views on the capital allocation point there. And the other one, sorry, just to get back to the Swiss tax domicile change. That's a big move. There must be some savings in terms of closure of the Zug office. Just can you give us a little bit more sort of the returns logic of that decision as opposed to just sort of saying that we'll avoid further tax rises in the future.

Sure. Yes, look, on the pipeline, it's interesting. I'm not sure what will happen to the pipeline if there is a more prolonged moderation of the growth rates, Phil. It's not something we've really seen so far. Now to be fair, the sort of midpoint of last year through to sort of fairly recently when we completed the Blackman transaction, we have had a few more acquisitions that we've wanted to step up and get done. To Mike's point earlier, the pipeline now, there is less in the pipeline now. But will that be -- is that just a consequence of the fact that we've completed them? And we are still out there working, we're still out there talking to vendors, but there is just less.

I think harking back to the last downturn, there were relatively few businesses put on the market at that time. I think, as a lot of vendors saw their own profitability coming down. And my own experience in these things is a lot of vendors don't like to put their businesses on the market if their profits are under pressure. So I don't know. But I think that the point of having a very strong balance sheet is to maintain optionality. It's to make sure that we have absolutely 0 risk of needing cash calls and that type of thing. But also, to maintain optionality to do those acquisitions if they arise at whatever point in the cycle.

What I would say right now is it isn't a matter of allocating more capital to acquisitions. We have got our hands full on integration. The 100 people -- I mean, it is phenomenal for us to have 100 people working primarily on rolling out our systems through the Blackman acquisition. It's only a $240 million acquisition. I mean, it sounds like it's -- it isn't. It's quite substantial for us. And making sure that we reap the awards from that acquisition. And others like Robertson out West as well that we did fairly recently. There's only 8 branches in Idaho, but it still needs integrating and doing properly and bringing into our structure, they take quite a lot of work. So we got our hands full on those at the moment. We'll see what else comes along.

And on tax, Phil, we only have a small office in Switzerland, so there aren't significant cost savings. We have a very small services offices in Reading, as some of you know, that's got about 30 people in it most days, and the work can be done out of the U.K. base. So there isn't a significant cost saving, so it is about having the right commercial logic for the tax domicile of the company. We've clearly sold a number of operations in Continental Europe over the last few years. And therefore, we're sort of out of Europe commercially. And therefore having a tax base where we have the listing and the commercial support to do it from makes sense going forward. And actually, the U.K. in terms of the G20 is actually a good base for us to be as well and for our shareholders.

Can you pass it along?

It's Robert Eason from Goodbody. Just in relation to the U.S., I think in your presentation you called out kind of flatter gross margins in the second half. So my question is, just with the kind of the softer outlook in terms of the top line, in terms of the pace of growth, are you seeing any change of behavior from a competitive standpoint among your competitors? Is there any regions that stand out in that context if there are any? And just on the U.K., you're constantly getting rid of kind of non-core businesses which makes sense. Two questions in relation to this in terms of, can we assume that year-on-year we're going to be -- get back to growth in the U.K. business now given everything that's been done? And are we getting closer to -- like you have to appreciate we're looking externally in, are we getting closer to a strategic decision on the U.K. given what you're doing from a non-core perspective, given what you're doing from the visuals of the profits in that business? Because as you said, on the flip side, no business wants to sell when their profits are going down. So the same logic can apply to the U.K. business. And on that front, so they're kind of my 2 areas of questions.

I hate being quoted that quickly. Look, on the gross margins, no, it is actually -- the margins are very consistent across regions and very consistent the growth in gross margins over time between our business units is also very consistent. The only thing that I could point to with regard to gross margins over the last year with the benefit of hindsight, I think some of the tariffs and some of the pricing, they take a lot of work because you have to reprice stuff constantly when things like pricing and tariffs are changing. So that's a frustration. It's an irritation. It creates a lot more work. It creates a little volatility in a month, or 1 month or 2's margin, so it doesn't alter the attractions of our business. From a competitive perspective, no, there is no indication of any other competitive factors in gross margins. And we're still as optimistic as we ever were about -- look, long term, we ought to be taking 10 to 20 basis points per year in gross margin improvements.

On the U.K., I think it's -- I think the observation that I would make, and I've made this and shared this with our teams, myself and Mike, we need to see the U.K. getting back to sustainable gross margin performance, okay? Without that, then I would be glum. Now I do think now we've got a better team, a better engine in order to execute that than we've had. But I think that is fundamental to our business, being part of our group. We have to generate proper returns on capital. Actually, the returns on capital in the U.K., whilst they are low, they are still -- we still do make a positive and decent return, just not as attractive as it is in the States. So we need to get back to taking market share and going it profitably. And I think fundamental to that, to Mike's point, is that we get the gross margin performance moving forward. I certainly wouldn't say today anything other than I am optimistic that the current team is making good progress and getting good momentum in the market. And the other piece, of course, is we are aware of the other changes that are going on in our competitive landscape in the U.K. market. We need to understand how those shake out as well.

Any more? Good.

Is that it? Thank you all very much indeed for coming along. Thank you.