Bunzl plc

LSE:BNZL

Earnings Call Transcript 2022-Q4

[Frank van Zanten, CEO]

Good morning, and welcome to Bunzl's 2022 Full Year Results Presentation. It's great to see some of you here in the room today. Richard Howes, our CFO is also here with me, and will take you through our financial results after my introduction. I will then review our performance in more detail, discuss our outlook for the remainder of the year, and provide a brief update on the strategic progress we have made.

But before we begin, I want to take a moment to thank all my colleagues for their contribution to Bunzl's continued success. These very pleasing results continue to demonstrate the caliber and commitment of all the people at Bunzl. They also highlight the ongoing resilience of our business model, and our diversification across geographies and sectors.

I'm incredibly proud of how the Group continues to respond with agility to varying external circumstances, allowing us to continue to grow the business from strength-to-strength. We have been able to maintain our long track record of success by continually innovating to ensure we remain the partner of choice for our customers.

Let me start with the main financial highlights of our results. Over the year, revenue at constant exchange rates grew by 9.8%. This has been strongly supported by price increases, which our teams have worked hard to achieve. Revenue also benefited from acquisition growth, as well as volume recovery growth in the first half. We saw an increase in operating margin from 7.3% to 7.4%, supported by acquisitions and inflation, driving adjusted operating profit growth of 11.1%.

Bunzl remains very cash-generative, and having focused on improving our inventory position in the second half of the year. As supply chain issues eased, we enhanced our cash conversion to 107%.

Our net debt to EBITDA is currently 1.2 times, providing substantial headroom for acquisitions with our pipeline remaining active. Our return on invested capital for the year remained strong at 15% with the strength of our returns supported by our acquisition discipline.

And lastly, a milestone that we are particularly proud of. Today, we are announcing a total dividend that is 10% higher year-on-year, which is our 30th consecutive year of annual dividend growth. We've also made excellent strategic progress during the year. We agreed 12 acquisitions with a total committed spend of £322 million. The actions we took in response to the high levels of inflation and supply chain disruption are reflected in our results.

We continue to grow the percentage of orders processed digitally across the Group to 69%, further enhancing our ability to retain customers and improving our efficiency. We continue to make real progress against our sustainability commitments. In 2022, we received approval from the Science Based Targets initiative for our carbon emissions reduction ambitions, and we have continued to support customers to transition to products more suited to the circular economy.

We also disposed of our U.K. healthcare business in December, with this, reflecting our ongoing discipline around returns focused capital allocation and portfolio optimization. Lastly, 2022 has been another year where Bunzl has demonstrated the strength of its business model in the face of external disruption with our focus on being the partner customers can trust for the essential products they need.

I will now hand over to Richard.

[Richard Howes, CFO]

Thank you, Frank, and good morning, everyone.

All of my comments are at constant exchange rates, unless otherwise specified. With approximately 90% of adjusted operating profit generated outside the U.K., and due to the weakness of sterling, our results were positively impacted by currency translation of between 6% and 7% on average across the income statement.

Starting with revenue. Revenue grew by 9.8% to £12 billion. Underlying growth contributed 6.6% to this. The recovery in our base business contributed 11.6% to underlying revenue growth, driven by strong inflation across our markets, and supported by volume recovery in Continental Europe and the U.K. and Ireland in the first half.

As expected, this was partially offset by a 5% decline in COVID-related sales, due to the continued year-on-year impact of lower disposable glove prices and volume decline. As the business mix has normalized, going forward, we will no longer be separately disclosing COVID-related sales. Acquisitions contributed 3% to revenue growth.

Now turning to the income statement. Adjusted operating profit grew 11.1% to £886 million. Group operating margin increased from 7.3% to 7.4%, reflecting support from inflation, as well as acquisitions and despite a reduction in higher margin COVID-related sales. Net finance costs increased by £13.3 million at actual exchange to £67.9 million, inclusive of a £10.7 million non-cash charge relating to hyperinflation accounting primarily in Turkey.

Including an £8 million impact to adjusted operating profit, hyperinflation accounting in total has impacted operating profit, before income tax by £18.7 million. The Group expects net finance expense in 2023 of £90 million to £95 million. Given the non-repeat of the financial derivative benefits seen in 2022, at a higher interest rate on the floating portion of group debt, which is around 30%.

Adjusted profit before income tax increased by 10.5% to £818 million. The effective tax rate for the period was 24.6%, compared to 22.3% last year, reflecting the absence of benefits seen in recent years from the favorable settlement of prior year exposures.

In 2023, the effective tax rate is expected to be between 25.0% and 25.5%, reflective of the increase in U.K. corporate tax rates. Adjusted earnings per share increased by 7% to 184.3 pence. And given the strength of the earnings growth and the high cash conversion, we are recommending an increase of 11.3% in the final dividend, resulting in a 10% increase in total dividend.

Moving on to cash flow. Cash conversion at 107% reflects a focus on improved working capital in the second half of the year, resulting in a very high level of free cash flow of £706 million. With inventory levels improving significantly during the first half, supported by an easing of supply chain constraints, inventory is starting to normalize towards pre-pandemic levels.

During the year, we paid £191 million in dividends and made a net payment of £31.9 million to buy shares for our employee benefit trust, leaving total cash generation prior to investment in acquisitions and disposal proceeds of £483 million. Cash outflow in acquisitions totaled £264 million, and we received cash disposal proceeds of £49.9 million.

Turning to the balance sheet. Working capital increased by £69 million to around £1.1 billion, driven by currency and acquisitions. And partially offset by an underlying decrease of £54.5 million, as well as the disposal of our U.K. healthcare business. In the second half, underlying working capital reduced by £123 million.

We ended the year with £1.2 billion of net debt, excluding lease liabilities. Net debt to EBITDA on a covenant basis was 1.2 times, compared to 1.6 times at the end of 2021. We have substantial capacity to self-fund acquisitions or other forms of capital allocation. Early in the year, we also completed a $400 million U.S. private placement issue, extending the Group's debt maturity profile.

In addition to net debt, total deferred and contingent consideration relating to acquisitions is £216 million. This equates to the total committed spend, yet to be paid out at the end of 2022. The balance sheet includes the deferred consideration element to this liability and the accrued portion of the contingent consideration. This totals £140 million, compared to a £108 million at the end of 2021.

And return on capital employed or invested capital was 15.0%, compared to 15.1% at the end of 2021, with a higher return from the underlying business offset by the adverse impact from currency and higher invested capital related to recent acquisitions, which temporarily dilute the metric. Returns remained well ahead of the 2019 level of 13.6%.

Our announcement today of a 10% increase in our total dividend marks Bunzl's 30th year of consecutive annual dividend increases. Furthermore, we have achieved this milestone with a 9.6% dividend per share CAGR over that 30-year period. This record is a testament to the resilience of the Bunzl business model, the strength of its cash generation and the success of its compounding growth strategy. We remain committed toward continuing this track record.

Thank you. And I'll hand back over to Frank who will take you through the detail of our performance in more detail. Thank you.

[Frank van Zanten, CEO]

Thank you, Richard.

Let me start by discussing underlying revenue growth over the year. A key takeaway from this slide is that, despite the shifts over the last three years between our base business and COVID-related products, overall, we have delivered a 5% underlying revenue CAGR, excluding acquisitions over this period. This is a strong demonstration of the agility and resilience of the Bunzl Group.

Turning back to the most recent year, within our underlying revenue growth of 6.6%, the base business contributed 11.6% growth. Inflation strongly supported this performance, along with volume growth in Continental Europe and U.K. and Ireland earlier in the year, due to reduced COVID restrictions compared to 2021.

Overall base business revenues are well ahead of 2019 levels, driven by inflation with volumes broadly recovered. As expected, the reduction in COVID-related sales negatively impacted underlying revenue growth by 5%.

This reflects the impact of price deflation on disposable gloves and volume reduction. COVID-related product sales are approximately £200 million higher than in 2019 on an underlying basis with revenues having largely normalized since the highs of 2020 and they are not expected to have a significant impact going forward.

So overall, whilst there's some variation in sector recovery and COVID-related product sales remain slightly higher than in 2019, our base business has largely returned to a more typical mix. Our diversification has enabled the business to deliver strong underlying growth over the last three years, despite meaningful shifts between products and sectors.

Turning to our sector performance. The healthcare, safety and cleaning and hygiene sectors saw a combined underlying revenue decline of 3% over the period due to falling COVID-related sales, but remain 6% higher than 2019.

Within these sectors, we have seen our base healthcare business continued to perform ahead of 2019 levels, with an increasing backlog of elective surgeries supporting performance. Our base safety business saw a pickup in the second half of the year, as the supply chain disruption and labor shortages, which have impacted end markets started to ease.

We expect infrastructure spend projects to be a medium-term support for the sector. Our base cleaning and hygiene business remains impacted by work from home trends, continuing to trade below 2019 levels. However, the return to office working saw some improvement towards the end of the year. Grocery grew 9% year-on-year, supported by significant product cost inflation. Underlying revenues in grocery is now 20% ahead of 2019.

Foodservice and retail saw combined growth of 13%, driven by significant inflation in foodservice and volume recovery in the first half for retail. Total revenues from these sectors are now 22% higher than pre-pandemic level, with most of the increase coming from foodservice.

Let me now give you an update on inflation trends. As we have discussed, product cost inflation has been strongly supportive to growth this year, and remained high through the end of the year. These price increases had been moderating over the course of the year, as larger price rises began to annualize in North America.

We also saw inflation in other markets starting to annualize towards the end of the year. We continue to benefit in 2022 from a lower level of tender activity seen since the pandemic, but we are expecting a higher level going forward.

Turning to our operating cost inflation. Inflation in North America was high, driven by fuel and freight increases, despite some partial offsetting by fuel surcharges. Year-on-year wage increases also moderated through the course of the year with wage inflation by the end of the year only slightly ahead of typical levels. We have seen more benign wage inflation in Continental Europe, but we are starting to see this pickup as expected.

That said, wage inflation in Europe is not anticipated to reach the level seen in North America and is expected to be manageable. The impact of operating cost inflation in 2022 has been more than offset by inflation-driven revenue growth and operational efficiency measures. Inflation dynamics have therefore been somewhat supportive to operating margin.

Now, moving on to our business area performance, which reflects the dynamics we've already discussed. The factors driving strong underlying revenue growth in North America have mostly been covered already with inflation being the key contributor to underlying growth and supportive to margin growth. I'm pleased that we recently concluded negotiations with our largest customer by revenue, to continue to provide them with added value distribution services with improved structural contract terms.

In Continental Europe, the business area's strong underlying revenue growth has been driven by both inflation and base business volume recovery earlier in the year. The hyperinflation accounting impact that Richard mentioned earlier, as well as the decline of COVID-related product sales drove the year-on-year decline in margin. Our businesses have taken actions in the second half of the year to limit the impact of hyperinflation as we move in 2023.

Similarly, in the U.K. and Ireland, very strong underlying revenue growth was driven by both inflation and base business volume recovery earlier in the year. Importantly, the recovery in the base business drove a meaningful improvement in operating margin and return on average operating capital.

In the rest of the world, strong underlying revenue growth in Asia Pacific was offset by a decline in Latin America, resulting from a strong reduction in COVID-related sales. This decline reflects the high proportion of these COVID-related sales in Latin America in the prior year, although underlying revenue and margin in the region remains significantly higher than in 2019.

Turning to our 2023 outlook, which is unchanged from the pre-close. While we see continued uncertainty relating to the macroeconomic environment, we expect slight revenue growth in 2023, driven by both organic growth and announced acquisitions and partially offset by small impact from the U.K. healthcare disposal.

Adjusted operating profit in 2023 is expected to be resilient with operating margin slightly higher than historical levels. Adjusted earnings per share is expected to be moderately lower year-on-year due to higher interest rates and increased effective tax rate.

Turning now to our strategy update. You will be familiar with our very consistent compounding growth model. Organic growth has contributed approximately one-third of our revenue growth over the last ten years. It is driven by activity in our end markets, as well as new business wins, and our development of innovative products and solutions for the customers.

Acquisitions have contributed the remaining two-thirds of our growth, driven by our position as the leading operator of scale in highly fragmented markets, with a strong balance sheet and proven track record. Our strength of performance and cash generation have then underpinned our unbroken dividend track record. Overall, the success of our strategic focus is demonstrated by the strong total shareholder return.

Let me expand on one area of organic growth, new contract wins, with this example of a meaningful contract expansion in North America. We have been working with Tyson Foods, one of the world's largest protein processing companies for many years.

In 2022, our agreement which had previously been generating between $20 million and $30 million of revenue was materially expanded to supply Tyson with a much greater range of products. This win highlights the value of our proposition. We have a national footprint capable of serving each one of the over 100 major location Tyson has across the U.S. and the resources to deliver tailored solutions to each site.

On average, our processor warehouses are only 130 miles away from each of their facilities. Tyson were also reassured by our operational and financial resilience. Supply chain disruption is hugely damaging to the food processing industry, and even one day of delay in receiving key products can shut down whole production lines, spoiling large amounts of food.

Tyson has been impressed by a reputation for reliable supply, particularly over the last couple of years. They were also attracted to our innovative own brand products which we have specifically developed for the food processing industry.

For instance, we have developed a boning knife, which is a high volume product for the industry that last 15% to 20% longer and is safer to use. We are known for our own brands in this space and are constantly working to co-develop more innovative products with our customers.

Finally, Tyson was also impressed by our dedication to achieving cost savings and operational efficiency. Overall, this is a fantastic demonstration of the strength of our value-added proposition and our track record in managing supply chain difficulties, especially during 2022.

Supporting organic growth is our daily focus on making our business more efficient. Over the year, we consolidated ten warehouses and relocated five others which enables us to better utilize our space and optimize delivery routes. We also invested in new technology, automation and sustainability features.

Nearly all of our warehouses are leased which provides us with the flexibility to make these decisions when appropriate. Over the last four years, our average warehouse size has increased by around 11%, reflecting in part our consolidation into larger, more efficient warehouses.

Our focus on improving operational efficiency is all about delivering incremental improvements on a daily basis to support the business, something that is of course particularly important in an inflationary environment. To bring this to life, let me detail one consolidation example that took place this year in California, where we moved one warehouse into another existing facility. The move halved our rental costs, allowing us to optimize warehouse space and avoided a large rental increase.

Furthermore, we invested in automation technology to improve efficiency and further reduce costs. We expect an annual saving equivalent to 17% of full-time employees at the warehouse upon completion of this automation project. Projects like these are taking place across our business every day and have supported the partial offset of cost inflation we have seen in the business.

Turning to acquisitions. Over 2022, we made 12 acquisitions with a committed spend of £322 million. We're also announcing two new acquisitions today, including a German business that builds on the platform we established with the acquisition of Hygi last year. Our acquisitions last year spend nine countries and five customer verticals. This range demonstrates the breadth of our opportunity.

With each acquisition, we are expanding our customer reach and enhancing our own capabilities. Through these acquisitions, we have developed a much stronger platform to grow in Germany, further consolidate the very attractive specialized healthcare market in Australia and New Zealand, enhanced our digital capabilities and expanded our product range expertise with own brand and sustainable solutions.

These 12 acquisitions are high-quality businesses, supportive to the Group's operating profit margin. Our well-established acquisition process remains supportive to our success with many of these acquisitions and relationships being introduced by our local teams. In addition, over the year, we disposed of our U.K. healthcare business, as part of our focus on capital allocation and an optimized portfolio.

I want to take a moment to remind you of our disciplined capital allocation model. Our priorities are to reinvest our cash in the business to support organic growth and operational efficiencies, pay a progressive dividend and self-fund value accretive acquisitions. Our progressive annual dividend growth policy has returned £2 billion to shareholders since 2004, and we are committed to extending our 30-year track record of sustainable annual growth of the dividend.

As mentioned earlier, approximately two-thirds of our growth has been achieved through acquisitions. We have a return on invested capital of 15%, which demonstrates our successful track record of consolidating our fragmented markets in a disciplined way.

Our level of acquisition spend has also grown. Today, we are spending approximately £400 million to £450 million on average, although our actual spend in any one year is determined by number of acquisitions that meet our disciplined criteria and which become available. This compares to an average of £250 million to £300 million a few years ago.

Overall, we have committed £4.7 billion to acquisition since 2004.We see significant opportunities to increase our presence in our existing markets, as well as the potential to expand into new markets. Our acquisition pipeline remains active. While our capital allocation framework favors these three methods of investment, if leverage continues to consistently fall, we would consider other mechanisms for distributing excess cash to shareholders.

Turning to our evolving packaging mix, which is another example of how we are enhancing our customer proposition to drive growth. Packaging overall accounts were around one-third of revenue, with only 2% of our total revenue from consumables facing regulation. We continue to help transition customers to alternative packaging with evolving legislation supporting this trend. Our investments in expertise, data tools and own brand alternatives are paying off.

Revenue from packaging products made from alternative materials is 53% of our total packaging sales. The proportion of group revenue generated through non-packaging products or packaging made from alternative material remains high at 83%, with the Group continuing to have very limited exposure to single-use plastic consumables, where some volume reduction is possible.

Our ability to help customers navigate complex and changing sustainability legislation is an important part of our offering today. For example, the U.K. government recently announced the ban in England on some single-use plastic items. We have expected this change for some time, and have been using our proprietary analytics tools to proactively support customers and minimize their exposure.

To demonstrate this further, we turn to our largest operating company in Australia and New Zealand. Across many of our business areas, a complex patchwork of sustainability legislation is emerging. In Australia and New Zealand, businesses have to comply with three tiers of legislation; federal, state and local. This is a challenge for customers with Bunzl's expertise in the area therefore increasing our competitive advantage.

We have been supporting customers by ensuring they can rely on us to have up-to-date and in-depth knowledge of the changing environment, developing own brand ranges and finally, by using analytics tools to support decision-making. We have also been marketing to and actively engaging with customers to raise their awareness of our services.

For example, we have been supporting Compass Foodbuy Australia through the various single-use plastic banned phases in Australia during 2022, managing to convert 9.5 million individual products to ones made from alternative materials and saving around 30 tons of plastic.

The result of our largest business in Australia and New Zealand have been strong. The chart shows the impact that legislation has had on our sales of food containers and cups which account for around half of their packaging sales. It shows how single-use plastic sales have fallen in response to various bans announced over the last three years, but have been more than replaced by typically higher margin sales of the packaging made from alternative materials, a pattern which is repeating across other packaging categories.

As I mentioned earlier, over 2022, we received approval for our climate change targets from SBTi. This fall-out and extensive mapping exercise of our supply-chain emissions in order to set a new Scope 3 target alongside targets for our own emissions. Since 2019, we have reduced our absolute carbon emissions by 15% and are on track to reach our target of 27.5% reduction by 2030.

For our Scope 3 emission targets, we aim for 79% of our suppliers by spend to have their own Science Based Targets in place by 2027. This supports our long-term goal of achieving net-zero emissions by 2050 at the latest, including our Scope 1, 2, and 3 emissions.

Before we move to Q&A, I want to come back to Bunzl's ability to emerge from challenging periods even stronger. Between 2019 and 2022, we have grown our adjusted earnings per share by 41% at constant exchange rate, despite the external challenges. This success is firstly driven by our people who have worked incredibly hard over this period to support customers, despite the challenging environment. Our success is also driven by a range of factors that contribute to the Group's resilience.

Our decentralized model enables us to respond by - to changing situations quickly, supported by our strong culture of operational efficiency, our global scale, and the flexibility of our supply chains. Our compounding strategy is also resilient with the advantages of joining the Bunzl Group becoming more apparent during difficult times.

Furthermore, our products and services remain essential for customers and we benefit from our portfolio diversification. Around 75% of our revenue is achieved through the more resilient cleaning and hygiene, grocery, foodservice and healthcare sectors.

Finally, the financial resilience of our model is evidence to our consistently high cash conversion and strong balance sheet. As I said earlier, I'm incredibly proud of how the Group responds to challenges, whilst continually focusing on its customers and strengthening the business to ensure we remain the partner of choice for them. My experience over the last few years has only strengthened my confidence in Bunzl and the potential we have for future growth.

Thank you for your attention. We are now very happy to take any questions.

[Simona Sarli, Bank of America]

Good morning, gentlemen and thanks for taking my questions. It's Simona Sarli from Bank of America. So, I have three quick ones. I will take one-by-one. So the first one, can you please comment on your expectations in terms of volumes growth in 2023, considering that you are also mentioning the increase in tendering activities? So, how should we think about the contribution between volumes from existing clients and these incremental activity? And also, how much price increases you are factoring in, in your guidance?

[Frank van Zanten, CEO]

Okay. Here we go. Well, in terms of volumes, what we do see is, obviously, we expect slightly higher sales that we set in the outlook, or what obviously helps there is the acquisitions. But for the underlying business, we see still some inflation filtering through from 2022 into 2023. And, we think the volumes could be a little bit lower, due to tender activity, maybe a little bit of a decline of COVID-related products, but overall positive, mainly due to inflation.

[Richard Howes, CFO]

Yes. That's right.

[Simona Sarli, Bank of America]

Thank you. And, also if you could comment on the margin differential between new tendering activities and existing contracts. And lastly, you were talking about savings from automation initiatives equivalent to 17% of FTEs. Can you comment on timing of such benefits, margin uplift and investment required? Thank you.

[Frank van Zanten, CEO]

Yes. Well, in terms of margin tender activities, it's very difficult to give a - give, like a general answer. What tends to happen is, on average, when we go into tenders, we come out of tenders with retaining the business. So, because our business is quite sticky and to change, you know, a broad range of products in a customer multiple locations is often not something that the customer wants.

So, it's really trying to achieve certain savings for the customer, that doesn't always mean that it leads to much lower margins, because what we often do is also offer alternative products. And one of the alternative products we are looking at are on brand products often and these given even higher margins.

But overall, it's fair to say that when you go out and have a tender and you retain the business, the margins are slightly lower. But because this happens normally over time, all the time, in the mix, you try to rebuild up the margin, so in the mix you don't see that too much. But on the topline, it could have a bit of an impact if that starts to accelerate.

In terms of automation, we've given that example, don't expect in our overall operating costs go - come down by 17%, this was just an example. The best way to compare this with is like running on a treadmill. You need to run hard in terms of making improvements, in terms of operational efficiency on a daily basis, deliver more sales per employee.

And you need to make these improvements almost standstill, because you are also facing inflation in other categories. But certainly, you see over time, rents and certainly, in certain areas of buildings go up. So it's important to constantly find also operational efficiencies as well.

[Rory McKenzie, UBS]

Good morning. It's Rory McKenzie from UBS. Just following up on inflation firstly. I understand you got that carryover from the higher exit rate on pricing, compared to the average for the year. And - but what are you seeing in terms of the current price trends? We're obviously seeing dropping in, but prices like oil was hard to work out. How that feeds through to your products?

And then secondly, you entered into a new contract with your largest customer, which is a fixed price, rather than your more typical kind of cost plus structure. I'm sure that took a lot of debate internally. So can you talk about the pros and cons of that as you considered it? And whether you - I think it could be something you explore with other customers?

And then just finally, your £55.9 million acquisition related charge included some impairments or adjustments to the earnouts. Can you talk through what changed and which acquisition is that related to? Thank you.

[Frank van Zanten, CEO]

Okay. Let me answer the second, the Walmart question. Do you want to take the inflation and the charge-offs?

[Richard Howes, CFO]

Yes, inflation, look, we continue to see annualization of inflation. So, we're not seeing - we are seeing some deflation, but it's small. At this stage, it's in plastics mainly. So think of it - when you think about 2023, think of this as an annualization effect rather than certainly not any more inflation, and we're not seeing any deflation at this point. There will be ongoing deflation, it's small, relating to the COVID products, but we're talking sort of less than 1% probably.

[Frank van Zanten, CEO]

Yes, in that context also good to realize that, we are on average sitting on just over three months of stock, 3.5 months of stock. So, you see that being refreshed relatively quickly over time also. And the sentiment is still that our suppliers have faced quite a lot of labor cost inflation, buildings, or other costs. So, I think, even if - when raw materials were to come down further, then I think they will try to hold on to business, but it depends on how sticky that's going to be, how they can do that.

In terms of Walmart, the largest customer, we were pretty keen to go to a different system with the customer. You may remember, if we go to the period 2018, around 2018, we've seen some margin pressure at the time from deflation. This was following the period that Donald Trump came into office. He reduced taxes enormously, and then the markets - the labor markets got overheated. So, operating costs went up and plastic prices came down. And when you are having a pricing model that is based on a percentage of your product cost, that can be a little bit of a challenge.

Now, over a longer period of time, we tend to be in an inflationary environment. But, when your operating costs go up and you have a customer, which is a large customer in volumes, and they are based on the percentage and your product cost comes down, then obviously, you get a little bit in the squeeze.

So, we found it important that we were changing the model into a pricing structure that was more effectively mirroring our operating cost development, and we've discussed that. And so, we are now not on a percentage of the product costs anymore, but we have a fee per deliveries, but on the boxes that is unrelated to the price of the box.

And so, if deflation were to happen, it wouldn't impact our compensation for doing the work for the customer. So, the risk of deflation is basically being eliminated in that way. So, it's now a fee and there's also an indexation on it. So, it makes the whole collaboration a little bit easier because it's just being updated regularly.

And we have a better visibility in terms of where we are. But it's very good to see also that the customer recognized all the services we provided throughout the U.S., out of our - all our warehouses, and we're pleased that we've been able to basically take risk out and improve the structural terms of the contract.

[Richard Howes, CFO]

And on the acquisition-related cost that, I mean, we do put a charge through the P&L out as through the reported P&L relating to acquisition costs. There's things you expect to see, and there's the acquisition spent costs that we put through transaction costs. There's also the movement on the deferred consideration provision, which I talked about earlier. And there is some truing up of the earn outs, but nothing material.

Let's go to, yes, Suhasini.

[Suhasini Varanasi, Goldman Sachs]

Good morning. Thank you for taking my question. Suhasini here from Goldman Sachs. Just to go back to the outlook question, please. On organic growth that you have put into your 2023 outlook, price versus volume, you've indicated that inflation is annualizing, and the volume bit is having a little bit of a drag, maybe from COVID activity. Just trying to square that off with the commentary that you've given in the press release, which says that, COVID sales have returned to a more typical level and they're £200 million higher than 2019 levels. And also, you've indicated you've won some contracts with expansionary contracts with Tyson Foods, for example. So just trying to square off the volume bit over there.

[Richard Howes, CFO]

Yes. Suhasini, there's - I think that it's worth just backing up and looking at 2022 as well. Volumes have been flat in the second half, which is actually a positive - we have seen some positives in Europe and in the U.K. But we have seen some softness in the U.S. Two areas; one, the retail business where we've managed and exited some business that wasn't as profitable as we'd like. But we've also seen - what we see is a temporary softness in foodservice. And that's - it's probably born out of the strength of demand in the first half and some slight softening in the second half.

So when you think about 2023, firstly on your point about COVID, look, I think we're pretty much down to I wish, the big increases and decreases have happened. But I think there's still some more to come. I mean, broadly, we did about £800 million in 2019. About - just about £1 billion last year. I expect that to be probably £100 million coming off that in 2023, part of that is going to be volume.

Think of the base business for next year - for 2023, being broadly flat. And within that, you've got some of that softness in foodservice coming through into the first part of the year. But then we do have the Tyson contract, which is positive. That's a good win for us. And I think will help soften the effect in 2023.

[Suhasini Varanasi, Goldman Sachs]

Thank you. My second question is on leverage, please. You've indicated that if leverage continues to consistently fall, the Board could consider other mechanisms for distributing excess cash to shareholders. Is this maybe a sign that you've reached the stage where you can continue to do M&A and maybe distribute some extra cash to shareholders or not yet?

[Frank van Zanten, CEO]

Yes. Well, maybe just share in general how we look at the capital allocation. So, the first thing we do is, we invest in the organic existing business, because it returns about 45% return on capital. So it's very, very high returns. Most of that investment goes into warehouse, racking and digital and IT expansion; things that make our business more efficient or more sticky with customers.

The second thing is, we pay a progressive dividend. So every year, a growing dividend. We make strong acquisitions. We've done 12 last year, two this year. If we get to the point where we think we can't spend the cash, and we think we will continue to deleverage basically, we won't hesitate to give money back to shareholders to, for instance, a buyback.

But if I look at the markets, if I look at the opportunity, our overall market share, there's still an enormous amount of potential. So ideally, we would like to spend it on good acquisitions. If you look at our penetration in the U.K and Ireland per capita, and you compare it with Continental Europe, Continental Europe could be five times bigger as it is today. And so, a lot of runway, but if we continue to deleverage and we don't see good opportunity to spend it on the short term, we will look at alternatives.

Let's go over here. Dominic?

[Dominic Edridge, Deutsche Bank]

Hi. It's Dominic Edridge from Deutsche Bank. Just a couple of questions from myself. Firstly, in terms of your margin guidance for this year, it seems somewhat on the conservative side, given if you just look at where you were last year, you then think - you've taken out the U.K. medical business, which was significantly dilutive to your margins. You've also done M&A mainly in higher margin areas.

So, it does seem somewhat conservative. Are there sort of elements that you would be highlighting there from that perspective? And then the second one, in terms of the Tyson contracts, can you just give us an idea of who you are competing against that both, A, who are the existing customers and B, who you're competing against? Because I'm guessing by looking at your footprint, you need other people who are - have got similar footprints of which I believe there are very few. So can you just give us an idea of what was sort of the competitive dynamic was there? Thank you very much.

[Frank van Zanten, CEO]

Okay. Let me answer the Tyson question, maybe you can do the margin. Basically, we were competing with a local, family-owned business with less infrastructure in the U.S. Was doing business with them for a long time. And over - during COVID, we - I think our outperformance was very strong in terms of reliability. Also, people know that Bunzl, FTSE 100, very strong balance sheet.

And during that process of disruption in COVID, I think the realization has grown not only with Tyson, but with a lot of other customers, is that Bunzl is a very reliable player, basically. So we can consciously decide to increase our stock levels, which we've done also during COVID to maintain our service levels. That's why the cash conversion was also unusually high last year, because we have basically reduced our stock levels a bit.

So this is big Bunzl, strong Bunzl, better product range, better infrastructure throughout the U.S. and a customer realizing that they were maybe taking more risk in terms of their reliability with the existing supplier. And we convince them to move, let's say, all the business to Bunzl.

[Richard Howes, CFO]

And Dominic on margin. I mean, look, the - I think the way to think of this is to remind ourselves that we've seen a very benign period for customer tenders. That's a normal course of business for a distributor and for Bunzl in any one normal year, but the last three years haven't been normal.

So, I think - and what tends to happen is - in that process is, we would give some margin and then expect to over time recover that margin through offering an own brand or changing products or those sorts of things.

But I think we should expect, and we've been expecting this for each of the last couple of years that there will be heightened tender activity, I think, particularly because price increases have been high. They've had a hard - they find it hard to baseline that price against which to tender. I think that's changing. I think if you add to that, look, we could well see a catch-up of this in one year.

So, what we may have seen in one normal year, I think we might get two years to three years' worth, and I think that's part of the reason why we are quite cautious on margin next year. Now look, it's still early days, yes? So it could be - we could be wrong, it could come later, but I think it's worth noting that, that is still to come. Green?

[Karl Green, RBC]

Yes, thanks very much. It's Karl from RBC. Just three questions. I'll take them perhaps one-by-one, because they're quite different. Firstly, could you just give us an update on what own label constitute as a percentage of your sales? Just sort of clear on what's been going on there? I think you have referred to it in terms of some of the own label - sorry, the retendering you were talking about before. And a sub-question to that, just in terms of what you've experienced on your ability to pass through price increases there versus the more classic sourcing arrangements you've got with third-party suppliers? That would be the first question, please.

[Frank van Zanten, CEO]

Yes. So, own label, when we talk about own label well, we often combine it with own label imported products basically, which sits at around 26% right now. And so, it has grown again. What certainly helped is that certain branded supplies putting the significant price increases through, which gave us the ability to offer the customer, let's say, a reduced increase or no increase by moving to the own brand, which is good, because it gives us more control. Putting prices up in terms of own brands is not more or less difficult than the branded price developments.

[Karl Green, RBC]

Super. Okay. Thank you. The second question, obviously, you've not given us the numbers today, but it tends to come out in the annual report. What should we expect to see in terms of the Group gross margin when that number comes out just to get a sense as to how that's evolved? I will tuck the third question, because it's quite straightforward.

Just in terms of the normalized monetary policy environment at the moment and thinking about vendors or businesses who might think as they close to retirement, they can get a better risk-free return in the bank. Are you seeing any kind of changes in behavior from vendors, perhaps more willing to have those conversations with you, and if there's any implications for how you might convert that M&A pipeline in Fiscal '23? Thanks.

[Frank van Zanten, CEO]

Last question is about M&A, you may mean.

[Karl Green, RBC]

Yes.

[Frank van Zanten, CEO]

Yes, it's interesting. What I sold our family business in - this is in 1994, so it was a long time ago. But it still means that, I often think a little bit like how people think who own their business. And when we went through the second quarter of 2020, when certain businesses like in the retail and the foodservice sector in that quarter came down by 80%, 90% of sales, which is just unheard of, I knew that there were a lot of owners around the world thinking this, I have never imagined this could ever happen to me. I've got a strong business, I've got a balance sheet.

Our businesses tend to maybe go down in the worst case by 3% or 5% in, like, in 2009. So when your business goes down by 80% or 90%, it does something with you. Certainly, when you have a couple of hundreds of people, employees on the books.

So I knew just from how I looked at things before when we owned the business is that, when things normalize post-COVID and people were getting back to, let's say, the 2019 profitability levels, people will be looking at sort of diversifying their wealth and not having all their money in one basket.

We certainly see that kind of thing happening. I think we see - we have an active pipeline. We have people who are interested in having conversations that I've been in contact for ten, 15, 20 years, where I thought they will never sell, because they have such a family-focused attitude they have. They're still considering now to go and sell the business when generations are changing.

So, I do think the M&A climate is going to be positive. Interest rates are not so relevant in terms of the big majority of the deals we're doing. We buy between, let's say, the six times and eight times historical multiples. What we did see was, when we look at slightly larger businesses, that - currently, the private equity field is slightly different. There is an issue with financing. There may be a little bit less active.

So there could be an opportunity. But the magic word for Bunzl in M&A is always going to be discipline and making sure that you buy the right things and you look at all these graphs and you look at the development, and I think the positive results you see are more from the things you never hear about, and these are the occasions where we say no to an acquisition that defines the success in terms of this of what we are actually doing.

[Richard Howes, CFO]

Hey Karl, gross margins are up. You'll see in the annual report, we're about - up to about 25.1%. I think the way to think of this is, we've had some structural changes in the end markets, and they've offset each other broadly, but you've got foodservice coming back. Grocery has been good. Retail coming back a little bit, introduces more lower margin into the mix. But improvements in safety, improvements in cleaning, hygiene are definitely additive to that and a good performance in health care, definitely additive to margin.

Clearly, we've put prices up and we needed to put prices up in a way that protects our PBIT margins. I think we've achieved that as well. And as Frank mentioned earlier, whenever we can put prices up and introduce more own label into the mix, we would hope to get an improvement at the gross margin level.

So I think we've been a pleasing - I think the team has done very well in delivering that gross margin performance. We've needed it, because there's OpEx inflation around as well, which you see.

[Frank van Zanten, CEO]

So partly is also acquisition mix, obviously, because when you buy safety businesses, obviously, they are slightly higher gross margin percentage as well.

[Richard Howes, CFO]

Annelies?

[Annelies Vermeulen, Morgan Stanley]

Thank you. Hi, Annelies Vermeulen from Morgan Stanley. I just have two left. So firstly, you mentioned some softness in the U.S. retail parts of your business. I'm just wondering if you can comment on how you expect that to develop going forward? Whether that weakness in retail is something we'll expect to continue to see both in the U.S. and in Europe as well? And your view on perhaps some of the more cyclical end markets of your business, given where we are in the world. And similarly, actually, on cleaning and hygiene, with the sort of ongoing working from home and more hybrid working going forward, do you think on a volume basis, actually, that business won't come back fully to 2019 levels?

And then secondly, just on wage inflation, what gives you the confidence that wage inflation in Europe and the U.K. won't hit North America type levels, which I think you mentioned in your comments given a lot of that wage inflation is still coming through in parts of Eastern Europe, for example, running at 10%, 15%. Interesting to see what you're seeing there? Thank you.

[Frank van Zanten, CEO]

Yes, maybe you can take the last question. In terms of retail, I think if you look at the retail sector and then especially in the U.S., I think what COVID has done is accelerated some of the trends there. And we as a business have become a lot more focused and disciplined on risk in that area also. So, if you - if we have to make a trade-off between risk and reward, we are more on reducing the risks in that business. What we've been doing is taking less title to stock, so moving more to charging customers fees, and they need to pay in stock basically. So we have less exposure there.

We still have a lot of retail businesses that are very successful retailers also who have a good, I'd say, omni-channel approach. But, retail is not expected to be a fast growth area from a topline point of view. In terms of cleaning and hygiene, it's interesting that last quarter we saw a bit of a pickup in cleaning and hygiene.

So you do see more people returning for - to work. Let's say, cleaning and hygiene is not only offices. Cleaning and hygiene is everywhere. It can be theme parks, it can be stadiums, it can be hospitals. So it's certainly not only work related.

In terms of turnover, obviously, because we've seen inflation in products also, you compare to 2019, it still looks relatively healthy, but the footfall and the traffic in offices is still down on 2019, although it is improving slowly.

[Richard Howes, CFO]

Annelies, on wage inflation. I mean, we've seen different speeds of this across different economies. So certainly, North America was strong, high inflation, particularly end of 2021 and through 2022. That's moderated, and we exit the year closer to a more normalized level, not at a more normalized level, but closer to it.

On the flip side, we've been seeing very benign wage inflation in Continental Europe. We expect that to increase, and we know we're pushing - we are seeing pay awards that are higher than they were in 2022. I don't expect it to be anything like we saw in the U.S., which was, I think, unusually high and in part driven by the tightness of the warehouse market in that country. So, it won't be that - I think it will be more manageable. Think of the U.K. being somewhere in between.

Sylvia?

[Sylvia Barker, JPMorgan]

I'm Sylvia Barker from JPMorgan. Hi. Good morning. Could I return to your margin guidance quickly, please? So 7.4% in the full year '22, obviously a drag from hyperinflation within that and the help from M&A and the disposal into '23. So, it's quite a big step down towards that 7.1%-sh. So, if we go back to the tender activity, I mean, what is kind of the scope of how many contracts would you expect to get retendered in a normal year? I know that we've not had any, but what scope of revenue could that potentially impact? And how quickly can these tenders actually hit the P&L?

Second question, we tend to think about plastics as comprising about 30% of your cost base. But it's interesting that over half of packaging is no longer plastics. So what about the overall plastics exposure within the cost base? Essentially, with that reduction plus kind of having a lot less cost-plus activity, maybe your sensitivity is actually quite different than it was two years, three years ago.

And then finally on working capital, inventories have started to normalize, but also we had some improvements in receivables and payables in the second half. Could you maybe talk about the trajectory of working capital into '23? Thank you.

[Richard Howes, CFO]

Yes, indeed. So look, we - it's difficult to give you a sense for numbers of tenders that would normally happen, but we take it as a very normal part of what we do. So, it will be - if a contract has been, let's say, three years, clearly, you'd expect it to be - and there'll be a range of these, there are some long ones in that, but I would guess that sort of three years to five years is an average contract. And the last three years have been very benign. So, I think it's fair to assume there will be a catch-up.

The extent and phasing of it, these are happening now. So, don't think of this as something that is going to be back-end loaded particularly, I think it's something that could happen in the first half.

In terms of plastics and our exposure, I think you're right, there is a - we are - broadly 30% of our businesses is in plastics. Within that, we do include the plastics that are recyclable as well. So we would - when we split it out in our pie chart that you've seen, those would have sat in the green part of the pie chart.

I think what does it mean about exposure to them? I mean, typically, these are higher-priced products, which is good for us. And typically, we're finding that as business moves out of plastics into alternatives, these are higher-priced and higher-margin products as well for us. They're typically own label.

So I think it's a positive for us in the medium term. We have to wait really until regulation really kicks in, and we're starting to see it more and more. Most customers probably aren't transitioning pre-regulatory change. So, it is providing, I think, a very positive context for that shift to happen. But I think over time, I mean, your point on cost plus is right. We - that's certainly an area where we should be less affected by deflation should it happen. And as I said earlier, we have seen some deflation on plastics, but not much, not much yet.

[Frank van Zanten, CEO]

Maybe just one addition on tender. We label it as tender, but actually Bunzl is not really a tender kind of business. People are also buying from us, but they are looking at the pricing. So, a lot of our customers - look at restaurants, hotels, they've taken a lot of price increases over the years, couldn't really negotiate about it, because there were supply chain issues. They needed the product. It was not available, not a great circumstance to negotiate basically.

The world is stabilizing now. So, it becomes more - better available. So there's more of an opportunity for people to say, listen, we need to talk about the price or they organize a tender or a comparison or just have a negotiation with the salespeople. Where it's going to be very hard is, how are these discussions comparing to our discussions that we, at the same time try to have with our suppliers if things are happening.

So, margin guidance is actually quite hard to give, but we know and we already see in the different regions that there's more activity than there has been for a long time. Is that going to accelerate? Is it going to come down? What's going to happen with supplier prices? It's all big movements going up and down. But overall, we felt we had to be - we had to be a bit cautious given this situation.

[Richard Howes, CFO]

And Sylvia, on working capital trends. Look, I think we have consciously invested in working capital through the pandemic. I think it's been a definite benefit to us as we've had probably greater availability than some others, because of our ability to invest in inventory. So that serves us, I think, very well.

But as things do normalize, we do need to see the inventory come down. We are running inventory days higher than 2019. So, it's important, I think, for us to see in the second half, they start to turn and see some meaningful reductions in inventory. And that certainly has helped release a chunk of cash into the business. It was about £120 million inflow on working capital, second half versus £10 million last year.

But we've also, at the same time, maintaining the very strong focus on recovering receivables, but are also reflected by inflation, don't forget. So, in terms of the value of these receivables is greater, and we're trying to make sure we get those collected as quickly as we can. What we have seen through COVID is, we've been able to achieve a higher level of creditors through this period, and we don't really want to give up on that.

So, we are going to try and make sure we maintain good creditor terms at the same time as seeing inventory come down. That's something I expect will continue into 2023, but it will take - I think it will take longer than that to get inventory days back to 2019 levels. But it's heading in the right duration.

Gerry?

[Gerry Hennigan, Goodbody Stock Brokers]

Gerry Hennigan, Goodbody Stock Brokers. Richard, just on your comments there around evolving legislation from an environmental point of view and alternative packaging. Are there many others out there with the resources that you would have? And does that provide you a bit of a competitive advantage? And as such, then, should margins not hold up better than maybe you're guiding? And then just finally, on the disposal of the U.K. health care business, was the rationale for that purely that you weren't able to scale it or generate the margin from it? Or was it down to price?

[Frank van Zanten, CEO]

Do you want to take the health care? In terms of legislation what we do see is, when legislation comes in, you see an acceleration of people moving on the change. As said that the example, Australia is a good one. I see it the same in the U.K. We call it a competitive advantage, because we think we are well ahead of what the competition does in terms of our expertise, the people we have hired, and also what our systems are able to report, which is something we haven't seen from competitors. And also the bonds of scale allowed us to build own brand ranges also in sustainability.

Now, is that going to be fundamentally increasing the margins? I don't think so. It's a little bit like the treadmill. It may be a little bit supportive, especially if we move more towards own brands, but it's going to be a longer-term trend.

[Richard Howes, CFO]

Gerry, on health care, don't think of this as a scale point about our inability to scale it. It was already quite a big business. It's - I think we gave you numbers of just over £200 million in 2021. That's about £30 million less in 2022. So a big business that does have scale. It's not - the bigger point, I think, is that we - we see ourselves as a value-added distributor and expect to get for our margins and our returns to be equivalent to the service we provide, whereas the U.K., the NHS, in particular or the category towers, procurement teams are thinking - are making that very difficult for value-added distributors to demonstrate the services you provide. It's a cost conversation, it's a price conversation rather than a service conversation.

So, we felt that this was the right time to make this change. The business still benefited from some COVID benefit in the year, which I think made it a good time to do this. But think of it more of a - we're not actually being paid for the services we provide.

Anymore questions? Okay.

[Frank van Zanten, CEO]

Yes. Thank you very much for joining. All the best.