Howden Joinery Group PLC

LSE:HWDN

Earnings Call Transcript 2018-Q4

[Andrew Livingston, CEO & Director]

Good morning, everyone, and welcome to Howden's Results for the Full Year 2018. Thank you for taking the time to join us here in the room or if you're listening on the webcast. In addition to Mark Robson and me, I'm pleased to welcome others from the team, including Andy Witts, our COO of Trade; and Rob Fenwick, our COO of Supply. I'll begin with an overview of 2018 and then some areas of the business that I'm particularly focused. Mark will then review the 2018 numbers in detail. I will then take you through our initiatives, and then we've time for questions. I'm pleased with the results for the year and particularly how we traded in the second half. Underlying trading matched my expectations when I took over 10 months ago in April. The significant increase in volumes in the first half of the year came at some cost to margin. And in the second half, following the April price increase and improved margin management at depot level, we found a more profitable volume between -- balance between volume and price. Period 11 was a success. We intended to buy some depot teams effectively on lead generation ahead of the peak. And our product offering was right for people's budgets. Our new distribution facility at Raunds performed exceptionally well during its first Period 11, with deliveries 100% on time in full, which underpinned high stock availability in these peak weeks. Given the high depot returns on investment and the right-size opportunities, we were able to increase the number of depot openings to 33, with 19 in 2017 and 23 in 2016. Given the high depot returns on investment and the right-size opportunities we launched our new web platform ahead of Period 11, raising visibility and awareness to the end consumer, thereby supporting our trade customer. And we achieved this with no traffic disruptions, which was no mean feat. The new format trade book was launched as an early initiative to make navigation around it easier and to show the extent of our full range more clearly. It's been well received by depots and trade customers and now has a run rate of over 1 million copies per annum. Three new issues each year to creates a more business rhythm as new products are now launched in depots in synchronization with this book. The latest copy is on your seat. The aim of Howdens is clear. We're here to help trade create exceptional results for their customers and profit from doing so. When our customers succeed, we succeed. A key feature of Howden's success is that we're trade-only. Building trusted trade relationships is central to everything we do. Our depot managers' attitude and entrepreneurship set us apart. They bring a determination to succeed, have a can-do attitude and are commercial, and you have to be all these things when dealing with entrepreneurial customers. We select and incentivize our managers and their teams to be so. We believe the builder is best placed to coordinate the kitchen project, backed by Howden's support and resources throughout the entire process from design to after sales support. This is more so the case as the scope of the kitchen project often extends to structural work in the home. We stand for key convenience and service for trade, the right kitchen designs at trade product quality and confidential trade prices. With around 700 stock depots, we provide help locally with choosing measuring and planning of a kitchen, the coordination and delivery of product, and we provide trade accounts to builders. We view home visits as vital, and we do not charge for them. We ensure that through local stock, the missing items are not an obstacle to the job being finished and the builder being paid. Our model is a powerful combination of locally empowered depot management teams, served by a dedicated supply chain, which is both cost-effective and critical to our in-stock offer. The manufacturer quality cabinets in Runcorn and Howden is a cornerstone of our competitive advantage, both in terms of cost and security of supply. The trade has a preference for pre-constructed cabinets because they're quick to fit their square and they're easy to adjust, they're made in our U.K. factories and we have product leadership in the stock ranges. We continue to hold our trade customer feedback sessions regularly, which enable us to identify any areas we need to improve our offer. These are proving popular, with more customers turning up than invited on several occasions. And this just goes to show how our builders appreciate that we're listening to them. They view the relationship as a business partnership, so it's in their interest to invest their time to help us make it even easier for us to serve them in their serving of their customers. Their insights focus on the need for Howdens to ensure high local stock availability. It's a key part of our service. Provide an online accessibility, speed up our picking times, and improve our display environment for their customers. I meet with managers in regions weekly. Typically, Andy Witts and meet with regions -- in regions with groups of about 70 managers at a time. And Andy and I have strengthened these meetings and made them more interactive and ensure that input and new product is given by managers. Through these sessions operational focus of the businesses is maintained, and sales and margin targets are confirmed and tracked. These regional meetings are critical to the heartbeat, energy and momentum of Howden's, and we always have discussions over occurring meal together after. We have a number of initiatives with the potential to improve volumes and profits across the business, and I will focus on three, and then talk about our international operations. The first is to evolve our depot models and use space more efficiently. The second, improve range management to help customers' buying decisions and to access supply chain benefits. The third to use digital to raise brand awareness and support the business model. I've reviewed our international operations, and we've reached some clear decisions. Now I'm going to go through each of these four after Mark talks us through the numbers.

[Mark P. W. Robson]

Thank you, Andrew, and good morning, everybody. Reviewing the financials for the year, let me start by looking at some of the headline numbers from the income statement. Moving from left to right on the top row to begin with. As you can see, Howden Joinery's U.K. revenue rose by GBP 105 million to GBP 1,477 million, an increase of around 8% on 2017. Group sales also increased by around 8%. Gross profit rose by GBP 44 million to GBP 932 million. The percentage gross margin of 61.7% being down from 2017, as we gave the depots more flexibility on margin from spring 2017 and did not increase prices until April 2018. Moving on. Operating costs before GMP equalization, more of which in a moment, rose by GBP 34 million. Operating profits were impacted by continued investment across the business, including new depots, investment in digital, the move to our new distribution center in Raunds, additional depreciation and inflation. In respect of GMP equalization, following a high court ruling in October 2018, employers with defined benefit pension schemes have been required to adopt the method to equalize benefits from men and women in relation to guaranteed minimum pension provisions. This is for pre-1997 service. After this one-off charge of GBP 4 million, operating profits were GBP 240 million. Now moving down to the second row, with net interest and other finance charges of GBP 2 million, mainly due to an increase in the charge for pensions. There was a profit before tax of GBP 238.5 million, GBP 6.3 million higher than in 2017. Excluding the GBP 3.8 million GMP equalization charge, profit before tax would have been GBP 242.3 million, GBP 10.1 million higher than in 2017. Looking at cash flow in the year. This included a GBP 28 million contribution to the pension deficit, capital expenditure of GBP 44 million and share repurchase expenditure of GBP 62 million. Overall, we had a net cash outflow of GBP 10 million, meaning that we ended the year with GBP 231 million of net cash. I'll now go into some of the detail behind the headline numbers. Let me start by talking about revenue. Howden's U.K. turnover of GBP 1,477 million increased by 7.7% on a total basis and was up by 6.3% on a same depot basis. In Continental Europe, turnover of GBP 34 million was up by GBP 2.2 million. Sales in our French depots rose by 4.4% in euros.Let me now talk you through the movement in PBT from GBP 232.2 million in 2017. Gross profit rose by GBP 44 million. This is the net effect of several features, as shown on the chart on the right-hand side. If we bridge from 2017's gross profit of GBP 888 million, there was a net benefit of GBP 107 million, which had two factors: Firstly, it reflects a GBP 10 million impact from our operators. This resulted from giving the depots more flexibility on margin as well as not increasing prices until April 2018; Secondly, increased volumes and the mix changes increased revenue by GBP 117 million, as we saw some positive volume impact from lower pricing. Partly offsetting this, there were a number of factors that impacted the cost of goods sold. There were additional costs arising from the volume and mix changes, totaling GBP 55 million. We saw a modest impact from exchange rate movements in the year. Also affecting cost of goods sold, we saw higher input costs, resulting in a net decrease to gross profit of GBP 10 million. Together, this gave a net rise in gross profit of GBP 44 million to GBP 932 million. Gross profit margin was 61.7%. If I now turn to the other factors that contributed to the movement in PBT, reverting back to the chart on the left, operating costs, which I will expand on in a few moments, rose by GBP 34 million, GBP 38 million, if we include the impact of GMP equalization. Net interest and other finance charges were broadly the same. So the net result was the profit before tax rose by GBP 6 million to GBP 238.5 million. Let me now explain in more detail the main movement in operating costs from 2017, which you will remember, included an additional GBP 8 million of costs in respect of week 53. Costs associated with the 33 depots that we opened in 2018 and the incremental costs of the 19 depots that we opened in 2017 totaled GBP 9 million. Cost increases for all the depots were GBP 20 million, mainly reflecting increases in headcount, delivery costs and pay inflation. There were cost increases incurred to support growth, which totaled GBP 9 million. This included the costs of the first phase of our new distribution center in Raunds and digital upgrades. Other operating costs increased by GBP 4 million. This meant that operating costs before GMP equalization rose to GBP 688 million. As we've seen, a further GBP 4 million of one-off charge was incurred in respect of GMP equalization, giving an overall increase of GBP 38 million. Let's briefly turn to the remainder of the income statement. Profit before tax GBP 238.5 million, including the one-off GBP 4 million of GMP equalization costs. This led to a tax charge of GBP 48.1 million, the effective tax rate being 20.2%. This gave profit after tax of GBP 190.4 million. This result gives earnings per share from continuing operations of 31.3p compared with 29.9p in 2017. Turning to dividends. The board has recommended that we will pay a final dividend of 7.9 pence per share. This will be paid in June 2019 with the cost of GBP 47.6 million. Let me now turn to cash flow. From a position of having net cash of GBP 241 million at the end of 2017, we ended 2018 with net cash of GBP 231 million. Looking at the change, since the end of last year, let me draw your attention a few items that explain the movement. Net working capital increased by GBP 50 million, more of which in a minute. Capital expenditure totaled GBP 44 million and included new depots and/or investments in digital. Tax payments were GBP 45 million. As I've already mentioned, we spent GBP 62 million repurchasing shares. There was a GBP 16 million contribution to the pension scheme over and above the charge through the P&L account. The net result of these and other movements was a cash outflow of GBP 10 million, meaning that we ended 2018 with net cash of GBP 231 million. As I've already said, net working capital increased by GBP 50 million. Within this, stock increased by GBP 18 million, mainly due to new kitchen ranges and depot openings. Debtors grew by GBP 48 million, reflecting the impact of the final 3 days of Period 11 trading, which in 2018, fell into November. This date did not become due until after the year-end. Partly offsetting these moments, creditors rose by GBP 16 million. Before moving on from cash, as you will know, it is our policy that we target a prudent capital structure. This means that we should be able to operate throughout our annual working capital cycle without incurring bank debt. In February 2017, we announced our intention to return GBP 80 million to shareholders via a 2-year share repurchase program. At the beginning of last year, we had GBP 32 million of this program remaining. In March 2018, we announced a further GBP 60 million, 2-year program. As I've already said, in 2018, we spent GBP 62 million repurchasing shares, thereby completing the February 2017 program, and we have GBP 30 million of the March 2018 program remaining. This means that in 2018, we have returned GBP 131 million to shareholders, including dividends. This compares to GBP 116 million returned in 2017. Looking at our net cash at the end of 2018 of GBP 231 million, we have new excess cash of around GBP 50 million. The board has decided that it will return GBP 50 million via a further share repurchase over the next 2 years. Let me quickly bring you up-to-date with the balance sheet position of our pension scheme. At the end of 2017, the deficit stood at GBP 109 million. A number of factors had caused this to change by the end of 2018. Firstly, from the P&L, there was the current service charge, administrative and interest costs of GBP 24 million. Secondly, GMP equalization costs increased the deficit by GBP 4 million. An increase in the discount rate reduced liabilities by GBP 105 million. The group made a cash contribution of GBP 42 million. Finally, with asset returns being GBP 46 million lower, the overall deficit by the end of 2018 was down by GBP 73 million to GBP 36 million. This, of course, is the balance sheet deficit calculated under IAS 19. As you know, in 2015, we agreed a funding program with the plan's trustees. This was for payments equivalent to GBP 35 million per annum to June 2017. It was agreed that the group would make an interim payment of GBP 25 million for the period July 2017 to June 2018. In June 2018, we announced that we had reached a new agreement with our trustees to pay GBP 30 million per annum for up to 5 years until June 2023. Also under the agreement, deficit contributions will be suspended if the scheme's funding position reaches 100% of the scheme's funding basis for 2 consecutive months and resumed if the funding position falls below 100%.Let me finish with some brief comments about trading in the first 2 periods of 2019 and the outlook for the rest of the year. The first 2 periods of the year saw U.K. sales rise by 4% with 1 less trading day in 2019. Adjusting for this, sales were up 5.1%. On the same depot basis, sales were up by 2.4% in the first 2 periods. Adjusting for the 1 fewer trading day, sales were up by 3.5%. Clearly, there are currently various market uncertainties and a number of factors that need to be considered in forecasting this year's margin and overall result, including the impact of foreign exchange rates. There will be further operating costs of around GBP 15 million in 2019 in respect of the closure of our Dutch and German businesses, digital upgrades and additional depreciation. These cost increases are in addition to the impact of the ongoing growth of the business, inflation and new depots. Capital expenditure is expected to be around GBP 60 million for 2019, including digital upgrades, new depots and the next phase of Raunds. We have also announced that the group has reached agreement to extend its existing bank facility until December 2023. On the subject of Brexit, we're mindful of the potential impact on our business. As a consequence, we are adjusting our stocking policy for at-risk items, resulting in an additional GBP 15 million of inventory. We're flexing our inbound supply routes, and we're also pursuing appropriate logistics accreditations, including authorized economic operator status. On that note, I'll hand you back to Andrew.

[Andrew Livingston, CEO & Director]

Thank you, Mark. A constant theme from both customers and depot managers is that builders are busy. They say they concurrently see around 2 or 3 jobs ahead of them. And they appreciate the Howden service model, stock designed to delivery and how it supports their business. These services mean reduced time for the builder, selling the job, more time for them to do the work and to make money. Our strategy is to grow the business by developing Howden's core strengths, building customer scale and increasing frequency. So I'm going to take you now through the 4 initiatives. And the first is depot evolution. Howden's has reported year-on-year sales increases for a number of years using a depot format layout that has broadly remained unchanged since the business since the business was founded in 1995. Following space constraint issues in one of our London depots we relocated last year, we began thinking about how we warehoused product in the most efficient way to maximize space. We found a way to rerack product vertically and trialed it in that depot and it led to significantly improved densities. We then went and reracked a further 18 depots to validate the results. Each time, we found improved warehouse space utilization by around 25%, well above our expectations. We also noted reduced picking times. So given this new space opportunity, we broadened our thinking to consider how to best create a depot environment to do business with our customers. So we built 2 model depots in our old distribution space in Northampton. One on the right is our average 10,000 square-foot format and the other significantly smaller at around about 6,000 square feet. And taking account of the builder and depot manager feedback, and of course, 23 years of Howden's experience in trading, the priorities were to increase the space available to kitchen displays so that trade customers can confidently offer their customers the opportunity to visit, to see the range and to see the quality. We're not building big showrooms but an effective environment. In this model depot here, you can see that we're showing 6 kitchen families. The second thing is to create an open office area where the manager and the business development teams are out in front and can communicate with customers more easily. We've located the coffee machine to help draw the conversations. We've introduced a picking area behind the trade counter where a broader kitchen-related hardware range has just started being tested in around 20 depots. And we're looking to see if we can bring in new trade customers and increase frequency of our existing customer base. We believe that more conversations lead to closer working relationships with customers and gives a better understanding of what work they're doing. But we also wanted to improve both the visibility and the standard of our design facilities. A window makes a lighter and more connected environment for the staff, and it reminds our customers that we offer a design service. In the warehouse, we've adopted the new racking methods and it makes it considerably easier for the teams to get around the warehouse and reduce picking times. And these format improvements have been made with no material change to the fit-out costs of the depots, which still remain at GBP 350,000. We're confident that the new format is an improvement on the current at the same cost. So it was adopted for 18 of the later depots that we opened at the end of last year. So we're now testing to understand the rollback opportunity into the main estate. We've recently completed the conversion of 3 of our older depots, Park Royal in North London. It was a 1995 depot. Swansea and Guildford 1996 depots, both just completed conversion, and are starting to trade. They didn't stop trading during the revamp. Six more existing depots will be converted by Andy and the team in August so we can continue to learn. And then we will continue to trade these 9 depots throughout Period 11 and the rest of the year before drawing any conclusions to the sort of returns we can expect. They look great. And Andy and I are very pleased with the early feedback that we're getting from both the depot teams and the customers. The improvements in densities achieved from the reracking vertically in this way also enables us to put our full offering into a smaller space of around 6,000 square feet. Our model shows that this small format increases the potential for both in-fill depots in rural locations and more in big cities. Our recent site search experience suggests that there are more smaller units available than larger ones in areas where we would want to open up a depot. Consequently, we now believe that there is an opportunity for around 850 depots in the U.K. compared with our previous view of 800. Moving on to range management. Our design facility at our Howden factory was created so we could keep innovating, testing product and understanding trends. And we see the trend for industrial continuing, and in fact, growing in sophistication. So we've developed a linear look, a minimal modern style with clean lines. And it's best illustrated by our Balham ranges, which combines a hand-less frontal with a choice of metal trims. Gray and navy colors remain popular, and we've introduced charcoal. These synthetic technologies continue to improve, offering affordable alternatives to real wood finishers. New emerging colors are blue, green and warm neutral tones, so we're currently rolling out to depots, sage green, denim blue and pebble Shaker ranges. Our own appliance brand, Lamona, is the largest integrated appliance brand by volume in the U.K. 20 new products will be launched this year, offering new technologies and innovations in steam cooking and an induction hub cooking. And the hub picture that you see here has an integrated extractor. We've developed our thinking about how to best offer third-party branded appliances to customers. And to have control over the service levels and provide a wider choice, we're developing a centrally stocked offer which the depots can draw upon. Kitchens are becoming more complex, and consumers are expecting more choice. New kitchen ranges each year represents a significant portion of sales as product life cycles shorten. At the end of 2018, we had over 70 kitchen ranges on offer, each comprising around 100 SKUs within. 5 years ago , we had around 40. Local in-stock availability has always been the key point in competitive difference. And our customers see reliable stock levels as vitally important to the running of their businesses. Managing the number of kitchen ranges efficiently is crucial for best availability and profitability. We've made some progress in this area. Last year, we sold an increased amount of new product with the introduction of fewer kitchen ranges which performed better, 18 new kitchen ranges in 2018 compared to 27 in the prior year 2017. So going forward, we'll be reviewing the number of stocking points in each depot and in primary warehouse location. By rebalancing our stock offer, we believe we can continue to offer the product options customers expect and make it simpler for depots to deliver the expected service levels demanded, and will also ensure timely discontinuation of underperforming ranges and the management and clearance from the business. My third point is digital. We see digital as a means to reinforce the Howden's model and the strong local relationships that exist between depots and their builders. So we're building a capability in the coming years with 3 objectives: to improve communications between Howden's trades people and their customers; secondly, to increase builder and consumer awareness of Howden's to help our customers sell the Howden's product; and to streamline and improve operating processes in the business, freeing up time for depots and depot staff and customers to use more productively. During 2018, we launched our new web platform. It's a step-change for Howdens. It's scalable, it's data-driven. A key feature is that it's mobile friendly. Our customers are always on the move. The migration was completed with no adverse effects. Weekly traffic to the site, of which over half is now from smartphones, is growing an average by an annualized 17%. Online brochure requests have increased by 35%. The contacting of depots through the website has improved as we simplified the process, which has led to a higher quality of leads in the depots. Whilst recognition of the Howden's brand is high within the trade, it's lower amongst consumers. And Howdens.com has not been well structured in the past for online kitchen searches. Our search engine optimization announcements this year are starting to move howdens.com into more prominent positions and, thereby, raising brand awareness within consumers. And it's not just about better visibility, it's also better search. Our customers will be able to refine their style and product selections more easily, enabling a more detailed discussion of their needs with the builders and our designers. We've significantly -- we've also significantly increased our social media activity. Many trades rely heavily on their mobile devices to manage their businesses. And it's arguably their most used tool every day, increasingly used to manage transactions, to manage invoices and to find stock. So we think mobile first. Our digital program aims to put the trades persons' local depot in their pocket. Later this year, we will test a secure customer area of the website where the trade can manage their details, view account information and pay bills at any time. Developments will also allow faster and easier access to information supporting in-depot conversations, allowing us to streamline our operating processes so that we can respond more quickly to customers, freeing up time for depots' staff and customers to use more productively, faster information, quicker transactions. And finally, turning to our international operations. We commence trading in France in 2005 and subsequently opened further trial depots in France, Belgium, the Netherlands and Germany. And at the end of 2018, we had 24 trial depots across 4 countries. Having reviewed our international operations, I believe there's potential for a viable business in France. The French market is different to the U.K.'s today. It has a higher proportion of freestanding kitchens than the U.K., and therefore, the integrated kitchen market is slightly smaller than that of the U.K. However, it is GBP 1.6 billion in France versus GBP 2.1 billion in the U.K. But the proportion of kitchens sold via retail, DIY and specialist shops is much higher. It's 91% in France and around 50% in the U.K. When Howdens started, however, the U.K. had a similar procurement of kitchens to that of France today. And given what I see, how our depots are performing in their local areas, we're confident that the French customer -- the French trade customer and the consumer can see the price, the service and the cost benefits of buying a kitchen through the trade. Sales in our mature French depots are on average similar to those of their comparable U.K. counterparts at EUR 2.1 million a year. These depots have an average gross margin of around 58% and all make a positive contribution at depot level, albeit at a lower rate than the U.K. Our trade customers in those depots appreciate the quality of the product, the price, its immediate availability and the knowledge and service that our staff gives them. Our historical approach has been to open one depot in a large city. And we've learned that clustering depots perform better together. This is because word-of-mouth between our customers and the ability to establish a quality, trusted brand locally is easier. Clustering also helps build the Howdens know-how and culture within our business teams. So we plan to develop France by clustering depots in cities. In particular, this targeted approach will test our ability to reach local scale and establish accounts more quickly and our ability to develop Howden trained teams locally and efficiently. Although timing is subject to the outcome of Brexit negotiations, we plan to open around 4 city depots in the target areas this year. After a recent successful test, the operations will now be rebranded from Houdan to Howdens to gain advantage from the U.K. brand equity, the U.K. online search and reputation and the business efficiency benefits from one brand. And this branding will be completed by July of this year. In order to focus on France, we've decided to close our single-depot operations in Germany and the Netherlands, and the depots ceased trading last month. The Belgian depots remain in place, making a positive contribution and a run from within the field -- the French field structure. I've outlined 3 longer-term opportunities and our thinking on our French operations. So turning to this year. We've implemented a price increase in January and we aim to continue developing margin whilst working with suppliers and keeping product costs down. In 2019, we plan to open around 40 U.K. depots, including 5 in Northern Ireland. The latter group will be opened on the same day because we want the competition to be fully aware that we've arrived. We remain cautious on market conditions. Given the economic uncertainties and particularly the impact that Brexit may have, we've increased stock levels in certain high-volume products as part of our Brexit contingency planning which includes options for supply via alternative ports. Comparative same-day sales for the first 2 periods are up 5.1%. Our lead bank and our surveys are in line with where we would want them to be. I'm confident in our business model through any changing economic conditions. And I'm really pleased with the response to the initiatives we have outlined by depot managers, by field teams and everyone else in the business. Finally, before I open up to questions, I'd like to mention our first Howdens Expo. To showcase our 2019 ranges and our plans to all our 9,000 staff, we built the Howdens Expo in part of our old distribution center in Northampton. And we've done this to give our staff a full of view of the product ranges we sell and also give our staff the opportunity to meet some of our suppliers, but also to show our staff the new formats, showing the relative sizes and how the new formats work in reality. So we'd like to invite you to the expo on the 4th of April if you could make it. I'd like to thank you very much for listening to me. And we'll now open up to questions for Mark and I, if you just wait for the microphone as we do this. If you could please state clearly your name and your organization before asking the question. Thank you.

[Andrew Livingston, CEO & Director]

Great. Who's first?

[Unknown Analyst]

It's [ Neil Hodge ] from UBS. I have 3 questions, actually all on the -- kind of the new hardware range that you've been testing in some of these stores. The first one was, can you give us some color on how that range compares to what you would have in a traditional Howden depot? The second one is, so you've done about 20 stores so far. What's the early read on that in terms of customer reception and take up? And the final one was, what is the cost of retrofitting a depot to host the extended range of hardwares?

[Andrew Livingston, CEO & Director]

Thanks for your question. Howdens has always sold hardware. We've always had a good business in hardware. Over half our baskets that we sell have got a hardware item in them. So I like it as a category because it drives repeat business. And yes, we've done a test and that's all this is, the 20 depots for test. And you'll see when you come to the new format, you'll see we've created a space behind the depot counters so it's easy for the depot staff to go and pick it and bring it back, and it doesn't interfere with the rest of our operations. We cast our net wide on the number of SKUs, and we've done that purposefully. We do not expect all of the 3,000 SKUs that we put in to be successful. Typically, we've got about 800 SKUs in our standard range. So we spread the net wide, not expecting it all to work. We're learning. We've done this in 20 depots. The retrofit that I've shown up there for the 3 depots is around about, given it's our first 3 that we've done. And they're 1995, '96 depots, so cost us the full bank money wise. So they're GBP 250,000 a piece where we've gone back and retrofitted. To answer to question about just retrofitting hardware, we've no plans to do that just yet. I think what we'll just try and understand is what sells from that range and then try and roll it back into the range. It may require some extra space, it may not. We may do something tactically, we're just not there at that point in our thinking.

[Robert Eason, Head of Research]

Robert Eason from Goodbody. Two questions. First just on the digital strategy. And I think it was your last slide on it, and you want to improve your connection with the consumer. How do you view the risks of that in terms of kind of just opening up Howdens more and more to the consumer and their expectations on what they're going to find? Pricing visibility, and all of that comes with that because that's the expectation on the consumer side. So just kind of your view on that, and what that means for the consumer. Secondly, just more kind of a financial orientated. If you just go back to that operating cost bridge, can help us with what that operating cost bridge could look like in 2019? I know you've given us the GBP 15 million associated with some of the investments, but just kind of old depot underlying growth in your cost base. If currencies stayed where it is now, what sort of kind of headwind, tailwind that is in terms of your gross profit bridge as well?

[Andrew Livingston, CEO & Director]

Okay. So I'll do the first and Mark will do the second, thanks. Yes, I think we've been extremely clear in the business and in our digital development plans that anything we do in digital is only in support of how we currently trade. So it's in support of our model. When a consumer is going to buy a kitchen nowadays, that first port of call is in online generally. They may go around and collect brochures from depots, but they go online. They'll go on Pinterest, they go on social media sites. And I think we -- well, I know we under-participate on natural search. We don't spend a lot on paid search with Google. But on natural search, we are under weight. And so the work that Andy Gault and the team have been doing is to up-weight our capability around natural search and the facets that we're able to offer. So -- and consumers will be able to go online and find what they want much easier. They won't see pricing. That doesn't -- that would break the model, so we won't do that. It's about generating leads and getting customers to come and perhaps visit a depot and make contact with us in some way, or put an inquiry, and that goes into the depot. The second piece was about making it easier for the builders to work closely with us. And I don't see that as any different from what we're doing now or where we go. So we're not breaking the model in any way. We don't have click and collect, but we do have very trusted customer relationships where our customers phone up depots. We're sort of almost, in our archaic way, very advanced on some of that. So yes, I see a space where our customers can go in and see how they're getting on with us in terms of accounts, accounts billing, settling up and that sort of stuff. And then we'll build up the path as we go along and update you as we go. Mark?

[Mark P. W. Robson]

Yes. Bridging operating costs, 2018 to 2019, I think the most helpful way to do it is probably to point out the things -- the key movers. One will be the GBP 15 million you referred to. We're increasing the number of depot openings, as Andrew's described. That will cost about GBP 20 million. We've got a couple of cost reductions coming through "cost reductions". One will be in terms of a bridge, the GMP equalization, one feature in 2019. Neither will the ongoing costs of Holland and Germany, which are of similar scale by coincidence to that GMP equalization. Then you've got inflation of about 3% to 4%. So it's more like 3 for the payroll and more like for 4 for the rent roll and other things in between the 2. So those are really all the bricks you need to get to at the moment what we expect op cost 2019 to close out. In terms of ForEx, at today's rates compared to '18, we're more or less neutral, maybe -- as we all know in the last couple of days, sterling's been particularly strong so we might even get a benefit of GBP 1 million or so. But more or less flat. In terms of doing the calculation, EUR 0.01 movement in the euro moves our gross profit by GBP 1.7 million sterling, and a USD 0.01 movement in the U.S. dollar moves it by GBP 400,000.

[Andrew Livingston, CEO & Director]

Howard?

[Howard David Seymour, Director of Equity Analysis]

Howard Seymour from Numis. Slightly taking upon question on the costs but in a different way. Firstly, you alluded to the 40 -- circa 40 of new depots. Andrew, you alluded to sort of smaller formats. Is the incremental number of new depots we assume are the smaller formats or traditional? And secondly, sort of the rollout, the rerack and et cetera, which is a pilot, how do we look on that both in terms of the costs of that and the numbers going forward because obviously does that fit out cost dynamic in there as well?

[Andrew Livingston, CEO & Director]

Yes. I think we haven't fixed a view yet on the 40 in terms of sizes between the 2. I think what Andy and the team were really pleased about is that we've got 2 options and we can go into B8 industrial estates and have our choice being there being more important than not being there, if that makes sense. I suspect it will be more of a weighting towards the smaller size. The fit-out costs is similar between the 2. The smaller format, when you see on the 4th of April, has got a sort of more detailed mezzanine in it, which takes up some cost and there's sort of similar tech put in between both size depots. So we'd say both. I don't think we're able to give a better color in the proportion between the 2 at this point. Regarding the rollback, yes, we said it's about GBP 250,000 to do the full refit as you've seen it in the pictures up there. To rerack is a lot less money, but it is disruptive for the depot, so we continue to learn how to do that. And I think, Howard, yes we've done these 3. We're pleased with what customers are saying as initial feedback. They're saying it's very much Howden's. It's up to date. The teams absolute love it. But it's such early days. And obviously, it's all proved in the numbers on whether we can get a return on the capital that we're spending, but we look optimistically at how that goes about. In terms of doing it, this business, because of Period 11, you've only got a certain window to get in and do stuff. So we wouldn't do any more this year, even if we wanted to, we just wouldn't. We'd back off around July time. The business is entirely focused on delivering Period 11. And then we pick up tools again post Period 11 through the Christmas period, and then January should look different.

[Aynsley Lammin, Analyst]

Aynsley Lammin from Canaccord. Just 2, please. I just wondered if you can give any kind of numbers in terms of the depot targets you have in France on a 3- or 5-year kind of medium-term view? And then also, just on the kind of like-for-like, it's obviously held up nicely, 3% for the first few weeks of this year. I just wondered if you could give any more color on kind of what the depot managers are saying about your consumer confidence. What the customers' expectations are for the full year?

[Andrew Livingston, CEO & Director]

Yes, I'll do the second one first. Brilliant thing about this business is getting out with the depot managers, which you do every week or twice a week, so you're in front of 70. And it's not dissimilar to a room like this, where -- when you hear the live feedback and it's not genetic feedback, it's local market feedback about how depot managers are feeling. So it is real stuff. And I think they feel good. I think they feel they're not missing anything. They feel the builders are busy, despite all economic uncertainty. And I think they're confident in the proposition, even more so confident in the range and our ability to price. And that would be evidenced in the lead bank. In terms of your question on France, we'd started off by saying that we will tackle Paris. And we're not putting a 3- to 5-year view. And I think we'll open that out more as we see. The constraint about opening in France, if you like, is about building capability in the teams to Howden standards. And what I don't want to do is build a business in France that is not absolutely Howden's culture through and through. And to be fair to be the team that have developed it there -- when I go out and spend time with depot managers in France, I feel the Howden's culture. Really quiet, and I come back in a Friday night from -- I feel quite excited by having been there with them. We know we can get properties. We know the prices. We know the trading patterns. We've got to make sure that we can build the culture and the business in the right way. And that's why I am still holding back on the question with you, and that's really what I want to test by building it out in a viral way in France, if you like.

[Alexander Mees, Head of UK Small and Mid Cap Research]

It's Alex Mees here from JPMorgan. Two questions, please. Just firstly, the like-for-like performance so far this year, 3.5%, I think underlying. I just wondered, given the price increase in January, whether you could break out how much of that is price and how much volume. And secondly, I wonder if you can just comment or give some color on the competitive environment at the moment, how you're seeing your competitors price against you?

[Andrew Livingston, CEO & Director]

Yes, try and do the first one.

[Mark P. W. Robson]

Yes. I think if you take the normal sort of rule of thumb of breaking down our sales, you'd take that 3.5% of like-for-like and very round numbers. You'd knock off about another 2% to get to mature like-for-like. So you're left with a small number, 1.5%. Now we are keeping quiet for the time being about what proportion of the list price rise we've retained because it's too early to say. But I think what you can say is if there is volume increase at the moment, it's inevitably small because we've only got 1.5% to play with and some of that could well be for us.

[Andrew Livingston, CEO & Director]

[ Jeff ] over there in the corner. Yes, sorry, you're right. I didn't answer the second part of the question, which is the trading environment. Yes, I honestly don't think we're seeing anything different than in July. There's very few names popping up in the room when we talk to depot managers. I think it's pretty consistent, to be fair. [ Jeff ]?

[Unknown Analyst]

Two questions, please. Firstly, I'll ground you on going back to your gross profit flowchart. Mix and volume looks to have been quite different gross margin profile to the 62% or so you run at. What's going on there? And second one for Andrew, you've been in the business a year. How comfortable are you with the P&L structure of the business, 60-something gross, 16 EBIT, super-high return on April? Are you comfortable that you're well enough invested? Is there some change in economic model that you would engineer if you could?

[Andrew Livingston, CEO & Director]

Will you do the first part?

[Mark P. W. Robson]

Yes, yes. Yes, [ Jeff ], you're right. If you look at those 2 bricks together and do the math, you're coming in at a lower margin than you'd expect, and that is the effect of discontinued product. So some of the product we moved through in '18 was ranges that were exiting. This will be more of a feature as we go forward, addressing the issue that Andrew described. We're trying to reduce our range for a number of reasons, again, that Andrew described. So it will be more of a feature, moving discontinued product, but we think it will be within the normal bound of our margin movement. So it will be about 0.5% effect sort of thing. So it's not going to be overly dramatic.

[Andrew Livingston, CEO & Director]

And answer to your second question, [ Jeff, ] yes, I've been around a year, and I am comfortable with the P&L structure the way it is. I think about sitting in a room in front of a group of depot managers and if I didn't think they could take on their competitors in their local market setting I'd be concerned. But I don't -- I don't sense that. They've got room to take business as they see profitable. And I think there's enough room in all of that for us to develop other product categories as well. But this business is absolutely about moving kitchen volume and kitchens. I think I'd be intrigued to see how we get on with the depot revamps and how far we're going to take that. Yes, so more to report on that later.

[Charlie Campbell, Housebuilding Analyst]

It's Charlie Campbell at Liberum. I'm afraid I've got 3, if I may. First question is in terms of the range, why not electric drills for example? Second question, just -- you talked about in 2018, particularly, about the gross margin slipping as branch managers were given more freedom to price. Do you think you've seen the end of that effect? Or do you think we should be thinking about further effects to come as people make further decisions to narrow that growth? Or has that already happened? And on the capital return, one might argue that it's a bit cautious given the strength of the balance sheet. And is that caution a function of the stocking that you see that you need around Brexit? Or is it that you can see the scope of CapEx increasing as you reconfigure branches and so on going forward?

[Andrew Livingston, CEO & Director]

Okay. To go to the range things, I don't think Howden should compete in product categories where it doesn't have a competitive advantage. I don't think we would have a competitive advantage selling electric grills. I think that market is served very well by others. But you've brought me towards that category. And sort of -- in answer to the question, I would say I would see a business in partial accessories because it's consumable, builders need them from time-to-time, and if they're doing the job, it's a completer. And why wouldn't they take it if they're only finding out about their kitchen and they just want an update. We're trade-only. And a number of the other formats is a mixture between trade and retail customers going into other formats or trade, dedicated to trade so why wouldn't I take that. So I think the short answer to your question is where we have competitive advantage. We're trialing bathroom furniture at the moment. I think we have something to offer in that space. I think we've got a lot to offer in the kitchen space, work top space and so on. And the consumable test, and I wouldn't want anybody to get distracted around it. The consumable test is a test, and it's a test to drive frequency. It's -- and that's what it is. Second part of the question, I think...

[Mark P. W. Robson]

Yes. It was on the effect of gross margin -- relaxation of the hurdles within the depots really. As we see it at the moment, that phase is behind us. So we're on -- if you like, back on the horse now of developing margin with annual price rises, controlling our costs, enhancing the service. On the balance sheet, yes, I think our caution is the ongoing issue that we have for the time being off-balance-sheet financing through the depot leases. So in our case, by 2020, that will be on balance sheet. But hideously crude numbers, we've got about GBP 0.5 billion worth of liabilities through those leases. We've also got a pension fund deficit, as you've seen, which swings around fairly violently. So I think that's what -- that's how we would justify the caution around staying out of bank debt through the working capital.

[Andrew Livingston, CEO & Director]

We're actually out of time, but we'll take one more. And there'll be more opportunity on the 4th of April as well.

[Ami Galla, Senior Associate]

Ami Galla from Citi. Just a couple of quick questions. Firstly, on the point of clearance of ranges, you're talking of a bit quicker refresh. Does this mean that there could be potential price benefit from deploying new ranges more frequently? My second question is on COGS inflation. If you could give us some broad numbers as to what is the underlying level of inflation you expect in 2019. And third one really on fit-out costs for depots in France. How different is it versus the U.K. depots?

[Andrew Livingston, CEO & Director]

Yes. There's very little -- the third one's very easy. Very little difference between the two. Your first question around price benefits from new range changes. Range change is costly. I mean it does have enhanced margins at the start of the range, but I wouldn't particularly point to any range -- margin enhancement from additional new ranges coming through. I think what it does do, it means you're on the front foot with customers. You've always got the right type of product for them. Yes, but the range cycle, we're pushing it in a minute, feels about right. I feel we've probably got a few too many ranges, but not massively off. We want to have a well-stocked broad range in the offer, but I don't like duplication across range. So that's really what I'm pointing to. The third part, I can't remember what your question was.

[Mark P. W. Robson]

Yes. On cost of goods, yes, 2018, you can see a net number there of 2% up on cost of goods. That's, if you like, hiding a 4% underlying increase. But 2%, half of it, very round numbers, addressed through Rob's team and the various savings projects. So underlying 4%, savings of 2%, net 2%. Typically, we've seen 3% to 4% upward pressure, and very often, we make good progress on the various savings projects. So yes, 3%, 4%, I think, will be a good rule of thumb.

[Andrew Livingston, CEO & Director]

Okay. Thanks, very much indeed.

[Mark P. W. Robson]

Thank you.