Halfords Group PLC

LSE:HFD

Earnings Call Transcript 2019-Q3

[Operator]

Hello, and welcome to the update call. [Operator Instructions] And just to remind you, this call is being recorded. Today, I'm pleased to present Graham Stapleton, Chief Executive. Please go ahead with your meeting.

[Graham Stapleton, CEO & Executive Director]

Thank you. Firstly, many thanks for joining us this morning for our trading update. I'm Graham Stapleton, the CEO of Halfords Group. And joining me on the call is Loraine Woodhouse, our CFO. I'm going to speak for about 5 minutes or so, and I will then invite questions. As you will have seen from our statement, we reported a like-for-like sales decline of 1.7% for the 14-week period to the 4th of January. We experienced contrasting results with our Autocentres business continuing to grow, with like-for-like sales ahead 1.4% compared to more challenging conditions within our Retail business. Our sales this quarter were lower than we had anticipated and reflect 2 key factors. Firstly, the impact of extremely mild weather impacted our Motoring sales and weak consumer confidence that affected our sales of discretionary big-ticket items amidst some additional investments to remain price competitive in certain categories. Within Retail, it was our Motoring business that experienced the largest sales shortfall with a like-for-like decline of minus 3.4%. A number of categories within Motoring are heavily impacted by weather. This winter was unusually warm. For example, December this year was the second warmest since 1988. And importantly, there were no days where the U.K. average minimum temperature was less than 0. To bring this to life in a product sense, sales of winter consumables, like de-icer, antifreeze, screen wash and scrapers, were down by significant double-digit percentage. Sales of less discretionary and non-weather-related products and services have performed well, for example, Motoring consumables such as oil. We also saw encouraging early results from the space optimization work in the autumn with very strong growth in car security and scooters, for example. However, this was not enough to offset the weather impact. Our Cycling business is broadly flat against the comparative of 8%, but was more impacted by falling consumer confidence and increased uncertainty, specifically in areas where spend is discretionary and can be deferred or avoided. We saw sales declines, for example, in mainstream adult cycling. We did see positive growth in children cycling accessories, and whilst this is encouraging, this is insufficient to entirely offset other key category declines. Looking more broadly at profitability, our operating costs and gross margins over the quarter have been well controlled. However, reflecting the impact on revenue of the milder weather and our assumption that the weak consumer confidence will continue, we now expect our full year profit for this year to be in the range of GBP 58 million to GBP 62 million. Given the relatively short period of poor trading, it is difficult to roll the impact of what we are seeing into FY '20. But at this stage, we now expect FY '20 profits to be at a similar level, i.e. broadly flat on the current year. I should flag, however, that we are in an extremely uncertain economic environment and our trading experience over the next few months will allow us to update our guidance for next year when we report our full year results in May. Notwithstanding the fact that profitability will be lower, Halfords remains a very cash-generative business, and as you know, we have a strong balance sheet. We anticipate that free cash flow this year will be up on last year, and over the medium term, we still expect to grow cash as we outlined at our Capital Markets Day. We are encouraged by early progress in our cash and cost-efficiency programs and this, combined with our ongoing confidence in the underlying strength of the business, gives us the confidence to maintain our dividend policy. Despite the challenging market, we also firmly believe that our new strategy, inspiring and supporting a lifetime of Motoring and Cycling, is the right direction for the business. As you would expect, however, with lower profitability near term, we are very focused on ensuring that we invest in the right areas over the next 12 months. To be more explicit, there is likely to be a greater emphasis on cost-efficiency programs, and conversely, lower investments in projects with a longer financial return. Our overall ambition doesn't change, but we need to ensure that we are adapting our plans to the environment we are in. We will talk more about the progress against our strategy when we update you on our full year in May. We now welcome any questions.

[Operator]

[Operator Instructions] And the first question comes from the line of Jonathan Pritchard from Peel Hunt.

[Jonathan Pritchard, Retail Analyst]

Very straightforward one, really. I completely understand the downgrade to this year's number, weather completely extraordinary, as you've expressed. But I absolutely don't understand why we're taking such a knife to next year. I understand you might want to fine-tune it to a degree because of like-for-like expectations with limited visibility on consumer confidence, but we've taken, well, 15%, 20% out of numbers today. What has changed fundamentally between 3 months ago and now, on the basis of some poor weather and some sticky consumer confidence?

[Graham Stapleton, CEO & Executive Director]

So I mean, good question. I think where we are at the moment is, is that we have seen the back end, the very back end of quarter 2 and into quarter 3, a decline in customer confidence. And that has started to impact on the more discretionary high-ticket items. It's also meant more price investment in some of the categories that we sell as customers seek out better pricing and value. And what we are -- what we cannot see at the moment is any positive sentiment to offset that going into next year. And therefore, what we are planning at the moment is the same sentiment running through the entire year rather than 6 months of the year. So I don't know if that makes sense. So yes, we will, obviously, counter average weather next year, albeit we've had an extraordinary year this year with a very hot summer and then a very mild winter. We're all planned for average weather because it's all we can do. But I suppose what we're saying is, is with what we've seen last quarter and the back end of the quarter before, we are more cautious about customer sentiment than we were in the first half of this year. And that's what you see reflected in the number.

[Jonathan Pritchard, Retail Analyst]

Okay. And just to come back, if I may, just quickly on the Cycling pricing. Has a competitor been particularly aggressive on that? Are there people sort of taking prices down that you've had to respond to? Or how is that sort of game playing out?

[Graham Stapleton, CEO & Executive Director]

No. I mean, bike prices, as far as we can see, are pretty flat. We haven't seen what we would potentially have expected with Evans discounting significantly. We haven't seen as much. In fact, what we believe -- and they're, obviously, the biggest competitor from a physical retail perspective we look at, is that they are in very tight supply on bikes from some of their supply partners. So they've not been able to aggressively discount into the market. So we're not -- we're not seeing the price pressures there, but we are seeing price pressure in areas like technology and child seats. Those are the categories that we have our price match policy. We have had it for some time. It's not new. And we had to ensure we retain competitive for customers in those categories because they are traded on price as well as service and quality.

[Operator]

And the next question comes from the line of Kate Calvert from Investec.

[Kate Calvert, Retail Analyst]

Just on your guidance that you believe you'll be able to increase free cash flow this year versus last year despite the forecast cut. Are you expecting some shift in CapEx to achieve that? So is there some extra benefits coming through in things like working capital?

[Graham Stapleton, CEO & Executive Director]

Yes. I mean -- Kate, happy New Year to you, too. The -- it is a combination of things. We talked at the CMD about the fact we have some visibility to working capital improvement through various programs. We started them in last quarter and some of those benefits are going to come through in this financial year. We will be spending less capital and it's likely that that's the case next year as well on the back of a bit more prudent view of the investment plan.

[Operator]

And the next question comes from the line of Adam Tomlinson from Liberum.

[Adam Stuart Tomlinson, Analyst]

Just a couple from me, please. First, I think in relation to your earlier comments around cost efficiencies and a focus on that, just where you see the potential opportunities there. And thinking back to your previous guidance around the H1/H2 split, any changes in terms of different magnitudes there in terms of cost growth? And then a second question on Autocentres, still some good momentum there in terms of growth. Can you just give a little bit of color in terms of previously you've talked about 2% of Retail customers only shopping on the Autocentres side? Any progress that's been made in terms of that cross-selling opportunity? And I think previously you've talked about the MOT offer, the good takeup there, which had to be stopped because it was, in fact, so good. And any, I guess, any benefits you're seeing from that on an underlying basis?

[Graham Stapleton, CEO & Executive Director]

Yes. Well, let's take the cost one first. So I think we forecasted that our costs would improve significantly in the second half. I think at the last update we talked about a 3% growth in costs in the second half versus the 8% in the first. We are absolutely on track to deliver that. We're very, very confident on cost. They have been well controlled, particularly in light of the challenging trading. We think there is -- there are more cost and efficiency gains to be had next year. We mentioned that at the CMD. We are still confident that, that is the case. And we've got the -- I think, the program, the good news is, obviously, the program will start 6 months into this financial year, so we're able to really get some significant traction next year. In terms of Autocentre, we are pleased with the performance in Autocentre because that still suffers similar headwinds to that of our Retail business in Motoring and it managed to get -- keep a like-for-like growth. And we expect that business to grow profits again for the second year running, which is good. And we still think, as we said in the strategy, there is more potential there for Halfords in this current climate and market. In terms of cross group, we have seen an increase in the cross group promotional activity. And what we've got back in terms of the MOT campaign, 25% of the MOTs that people registered for have been booked and delivered. And for each MOT at the moment, we are averaging an additional GBP 30 additional spend on the MOT itself, so it's not actually free in that respect. So we remain very, very confident about the opportunity to grow that Autocentre business through our Single Customer View CRM strategy. We also introduced interest-free credit into the Autocentre business this month in preparation for peak, which we think will have a significant impact on conversion of customer because, obviously, we'll be able to offer a finance provision for people that are in a really tight squeeze on their MOT or servicing needs and expenditure. So we remain confident in Autocentres.

[Operator]

And the next question comes from the line of Matthew McEachran from Nplus1.

[Matthew Neil McEachran, Senior Research Analyst of Retail]

A couple of questions from me, if that's okay. Just coming back to the CapEx point. You stated that you're kind of pulling back on some of the longer payback projects. Could you just give us some help as to what we should be assuming this and next year as it stands? I mean, should we be pulling GBP 5 million to GBP 10 million out of both years or sort of greater amount next year? What's the kind of flavor?

[Loraine Woodhouse, CFO & Director]

Matthew, so it depends what you've got in is the short answer, but I think we've given a range of GBP 40 million to GBP 60 million. And we're still going through the planning for that, so I wouldn't want to give you a definitive number. But I think you should be thinking towards the bottom end of that range rather than the top.

[Matthew Neil McEachran, Senior Research Analyst of Retail]

Yes, okay. And in the current year? I think the previous guidance is around GBP 30 million, so presumably that's also coming back down a wee bit.

[Loraine Woodhouse, CFO & Director]

A little bit. I suspect the current year is less flexible because, clearly, we've got things in train. But yes, we'll be prudent towards the end of the year.

[Matthew Neil McEachran, Senior Research Analyst of Retail]

Okay. And -- okay. I mean, if there's -- let's just, for the sake of argument, assume that you got a GBP 20 million delta on your CapEx next year, maybe it's not quite as much as that. I mean, presumably, that in itself is part of the rationale for the revised guidance, going back to the first question on the call.

[Loraine Woodhouse, CFO & Director]

Yes. I mean, one of the reasons that we are more confident on cash is clearly that we know we have some working capital opportunities, which we're working through. We know we have CapEx phasing that we are working through. So even with a profit gap of up to GBP 10 million, we know we've got ways of managing our cash through the medium term.

[Matthew Neil McEachran, Senior Research Analyst of Retail]

Yes, but -- sorry, yes, so I beg your pardon. Sorry, I should have clarified the question. So the first question was really around the severity of the downgrade for next year and what are the moving parts there when it sounds like part of it is actually due to you pulling back investments in growth.

[Loraine Woodhouse, CFO & Director]

Oh, I see, I'm sorry. No, really, the -- effectively, the driver of next year is very simply the ongoing revenue softening that we're assuming on the back of consumer confidence. The investment, yes, we will likely look to rephase some of that, but not that many of the investments we would see impacting next year that will likely impact the year. So next year, it's just an assumed softening at this stage of the underlying business.

[Matthew Neil McEachran, Senior Research Analyst of Retail]

Yes, okay. Second question was on the margin. I mean, you've got 2 negative dynamics going on. You've obviously got the adverse mix effects of weakness in Car Maintenance, and then you've got the higher promotional activity in the market. Could you give us a sense as to what the change needs to be to prior guidance for the full year in terms of gross margin movement? Or just kind of what's the delta on the gross margin now?

[Loraine Woodhouse, CFO & Director]

So I think we've -- I don't think we've given a lot of guidance specifically on gross margin. Gross margins were up in the first half, I think 80 bps from memory. The expectation, given those 2 dynamics you just described, have to be that margins softened in the second half, I believe. So it's hard to say. We would hope we would still see some upside over the full year for gross margin, but we still have a quarter to trade, clearly.

[Operator]

[Operator Instructions] And the next question comes from the line of Tom Musson from Liberum.

[Wayne Mervyn Brown, Research Analyst]

It's actually Wayne here. Just 2 from me. On CapEx, can you just give us an indication as to what are those projects that you will not be investing, which have a longer return to profile just so we can get a flavor of what those actually look like? And secondly, just on profit guidance. Clearly, I understand the rationale of kitchen sinking in the forecast, but just give me an indication. If, for example, we get a Beast from the East in the next 3 months or there may be an uptick in consumer sentiment next year, I mean, all moving parts, we don't quite know what will happen, would you revise guidance upwards or would you use that as a delta to potentially go and invest in areas in the business that you would actually want to and actually speed up the strategic direction? Just to get a sense of what your triggers could potentially be from a forecast perspective next year. And if you would use some of the delta or some of the guidance potentially back into the business next year just to try and get the strategy moving faster?

[Graham Stapleton, CEO & Executive Director]

Well, I think -- just taking your last question first, which is we put a range in for guidance for this year deliberately in terms of its arrangement, GBP 58 million to GBP 62 million, with average weather probably more in the center of that guidance. So I'm not sure if we had -- I'll be honest with you, when we look at the forecast at the moment, it is more leaning towards average than it is another Beast from the East, when we look at the Met Office data. But then, obviously, if we do have a better winter period, then we may well be towards the upper end of that range rather than in the center. If we have a continuingly very mild and it's 11 degrees this weekend, just to make sure everybody is aware of where we are, then, obviously, the opposite is true, hence, the range. That probably answers that. In terms of the...

[Wayne Mervyn Brown, Research Analyst]

Yes. What I was trying to allude to, if necessarily there was an opportunity that there was actually a little bit of extra fat within the profit as we move forward the next few months, you wouldn't necessarily use that as an opportunity to say actually, yes, we know where our consensus is, but that actually gives me a little more room to go invest back into the business and accelerate the strategy, which you announced a few months ago, but you will actually let that flow through depending on whatever the situation in the market would look like.

[Graham Stapleton, CEO & Executive Director]

I think so. In terms of the chase to capital priorities, we are still working -- I think Loraine said we're still working through that prioritization. So we're not at a stage yet where we could really explain all the changes. We also haven't been through that with the business either yet. So we need to -- we're not really -- all we've really tried to do, I suppose, in my statement at the beginning, is to give an indication as to the type of programs that we're likely to push on with and those that we're likely to review. So if we got programs that take a long time to return, we're going to be a bit more prudent. So for example, opening a significant number of performance cycling locations, where they pay back in 2, 3 years, we might be less likely to do that than we were when we were explaining the plan. But then on the -- conversely, there may be some other things that we want to do because they pay back much more quickly more. We accelerate that part of the plan. And we're still -- we're not saying is that we're not -- I don't want people to think that we are not going to invest in the strategy next year. We are still -- we -- even if we're at the bottom end of the guidance that we gave, that's still a significant amount of capital and we're confident that gives us a chance to really push on with the strategy, not to the extent, obviously, that we said at CMD but enough to get going.

[Operator]

And the next question comes from the line of Geoff Ruddell from Morgan Stanley.

[Geoffrey Frith Ruddell, Managing Director]

Just a quick question about the guidance for next year. Does it include IFRS 16?

[Loraine Woodhouse, CFO & Director]

No, it doesn't. We will -- when we come out of our prelim, we will give an indication of the impact of IFRS 16.

[Geoffrey Frith Ruddell, Managing Director]

But is that likely to be positive or negative from a profit -- pretax profit perspective?

[Loraine Woodhouse, CFO & Director]

Not finalized yet, but my expectation is it would likely to be negative as it will be for most retailers, I suspect.

[Operator]

And the next question comes from the line of Adam Cochrane from Citi.

[Adam Gareth Cochrane, Director]

In terms of the -- 2 bits -- a bit of clarification, how much of your product range is discretionary and big ticket? You referred to it a few times. Can you just give us some ideas of what proportion of the range that is and what sort of item? And then secondly, the service-related revenues, the differentiation, et cetera, that provides. I'm assuming that the growth in service elements, it still continues to be a relative area of strength.

[Graham Stapleton, CEO & Executive Director]

Yes. I mean, let's start with services first. Services, we -- the amounts I think we said at CMD, it's about 1/4 of what we do now in services. So I think we said somewhere between 23% and 25% when we were talking at the CMD and that remains roughly where we are now. So a big chunk of the business, it's a very big services business that we've got already in this -- in Halfords. And obviously, we're looking to make that significantly bigger in the strategy because we see as a huge opportunity for growth in terms of our market share and how it could grow and also defensiveness because, obviously, there's less direct competition in this space. In terms of how we performed, our Cycling services business has performed very well over the last quarter and it reflects the fact we've repositioned the cycling proposition services. So without giving any numbers away, it would be -- it's at least double digit in terms of growth year-on-year, which we're very pleased with. Motoring, however, obviously, has an impact as -- because we are not selling the winter motoring products. So as I said, I think, early on the call, if we are not seeing the number of battery failures in cars, we don't see the fitting that goes with them. We also seen a dryer quarter than we would normally see as well with less rainfall and that, obviously, then has an impact on fitting windscreen wipers, blades, et cetera. So where we've -- so we're pleased with our Cycling performance. We've repositioned the services range, but Motoring has been impacted by the weather as the product part has. In terms of discretionary/nondiscretionary, without -- I'm sort of reluctant to give too much detail in this bit away, so I'm not really totally specific on the percentage. But to give you a sense of the types of things that are in each bucket, if you look at discretionary, the way that we look at discretionary, it things like mainstream adult bikes, it's car tech, it's Travel Solutions, it's those -- they are the big sort of discretionary purchases that people are deciding to be a lot more cautious and careful about, and thinking about, do I need to buy that now or could I wait? I think one of the reasons why Autocentres has been less impacted is if you look at garage services and MOTs and services, you have to have an MOT, you have to get your car serviced. It's less discretionary, and therefore, that's one of the reasons why that business is still growing.

[Adam Gareth Cochrane, Director]

Have you seen any evidence of trading down within the range to Halfords' own-brand battery compared to a Bosch or whatever it is? And that's something we're sort of seeing across some other retailers, customers choosing the cheaper option within the range. Is that something you recognize as well?

[Graham Stapleton, CEO & Executive Director]

Yes. I mean, there is no doubt that customers are looking at the value options more than they were. Absolutely in line with lots of other announcements that certainly I've been reading over the last few weeks. What that -- I think with our business, the advantage that we've got with lots of what we do, so for example, the bulbs, blades, batteries, the big categories where that might be the case, is we still are able to attach a service to that, that people are less able to compare and contrast. So we are -- we have a little bit more defensiveness, if you like, against that pull-down.

[Operator]

[Operator Instructions] And as there are no further questions, I'll hand back to the speakers.

[Graham Stapleton, CEO & Executive Director]

Just thank you very much, again, for joining the call today. We look forward to updating you again in May. Thank you.

[Operator]

This now concludes our conference call. Thank you all for attending. You may now disconnect your lines.