Ferguson PLC

NYSE:FERG

Earnings Call Transcript 2021-Q2

[Operator]

00:02 Good morning, ladies and gentlemen. My name is Will, and I will be your conference operator today. At this time, I would like to welcome you to the Ferguson PLC Full Year Results Earning Conference Call. All the lines have been placed on mute to prevent any interference with the presentation. At the end of the prepared remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

00:32 I would now like to turn this call over to Brian Lantz, Ferguson's VP of Investor Relations and Communications. You may now begin your conference call.

[Brian Lantz, Vice President IR and Communications]

00:43 Good morning, everyone, and welcome to Ferguson's full year earnings conference call and webcast. Hopefully, you've had a chance to review the earnings announcement we issued this morning. This is available in the Investor and Media section of our corporate website and on our SEC filings webpage. A recording of this call will be made available later today.

01:04 I want to remind everyone that some of our statements today may be forward-looking, and are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements. Additional information is included under the legal disclaimer in our earnings announcement this morning.

01:22 With me on the call today are Kevin Murphy, our CEO; and Bill Brundage, our CFO. I will now turn the call over to Kevin.

[Kevin Murphy, Chief Executive Officer]

01:31 Thank you, Brian, and thank you to everyone joining us on the call today. Let me begin by saying we could not be more proud of what our thirty one thousand associates have achieved through the challenges of fiscal year twenty twenty one.

01:44 We continue to serve our customers while protecting the health and well-being of our associates. We generated strong growth, particularly in the second half amid industry-wide supply shortages and inflation. We continue to invest in talented associates in our global supply chain, product breadth and depth, and digital solutions, while growing our dividend, investing in high-quality acquisitions and returning capital to shareholders.

02:12 Now, turning to today's agenda, I'll kick things off with the high-level results and some key accomplishments. Bill will provide you with an overview of the numbers, then I'll come back and give you a quick overview of how we're leveraging our strengths in the market. And finally, Bill and I'll be happy to answer all of your questions.

02:32 Ferguson is successful because of our associates and our baseline commitment is to create a safe healthy work environment for all. We will continue to embed safety as a core value driver in everything that we do. We're pleased that our recordable injuries continue to improve with our Group total injury rate and our lost time rate showing strong improvements. Our teams delivered exceptional sales and profit growth in fiscal twenty twenty one.

02:59 Revenue of twenty two point eight billion dollars was fourteen percent ahead of last year and thirteen percent ahead on an organic basis. This accelerated market outperformance was driven by our ability to deliver on our customers' projects amid unprecedented industry-wide supply chain pressure. We remain very focused on continuing to ensure high levels of availability for our customers, as uncertainty around the medium term impact of supply chain pressures and rising price inflation continues.

03:31 Gross margins grew sixty basis points, driven primarily by our ability to service our customers, while managing this price inflation. We've tightly controlled our operating expenses and increased productivity to ensure that the profit growth we achieved outpaced our revenue growth. As a result, we delivered underlying trading profit growth of thirty two percent for the full year and headline EPS growth of thirty five percent.

03:58 Our business continues to drive solid cash flow and be underpinned by a strong balance sheet which enables us to continue to invest in growth. We also returned over one point four billion dollars to shareholders through our ordinary dividend, share buyback and special dividends. Growing the ordinary dividend sustainably through the cycle is an important part of our capital priorities and the Board is recommending to increase the total ordinary dividend by fifteen percent.

04:28 Beyond our financial results, we're also very proud of a number of key accomplishments during the past year that position us for the future. We further accelerated market share gains in a period of challenged industry product availability by using our scale and our balance sheet to invest in the right levels of inventory for our customers. Our associates worked diligently to manage price inflation during a period of significant uncertainty.

04:55 On the acquisition front, we acquired seven high-quality businesses, bringing in approximately three sixty million dollars in annualized revenue, driven by talented associates and local relationships that will help us further drive growth in the future.

05:10 Given our continued performance and strong balance sheet, we are initiating a one billion dollar share buyback program. Having completed the sale of the UK business earlier in the year, we are now solely focused on our attractive North American end markets with a favorable balance of residential and non-residential, RMI and new construction. All of this provides a more consistent demand over time.

05:37 We made good progress on our methodical two-step journey to migrate our primary listing to the United States, matching our exclusive focus on North American end markets. We initiated an additional listing on the New York Stock Exchange in March, following a very supportive shareholder vote of ninety nine point five percent in favor. We are on track to hold our second vote in the spring of twenty twenty two to complete the move of our primary listing to the New York Stock Exchange. So, again, we are proud of our results and accomplishments in fiscal twenty twenty one and we enter fiscal twenty twenty two even more confident in the strength of the company and in our business model.

06:21 Turning to our end markets, residential end market growth accelerated in the second half and experienced double-digit growth for the full year. New residential housing starts and permits continued to show strength in the fourth quarter and residential RMI markets also continued strong growth, as we've seen an acceleration of growth in projects delivered by the trade profession.

06:43 Non-residential end markets returned to growth for the twelve months. As we told you in May, there were bright spots in the commercial market in areas like data centers and distribution, but we're also now experiencing increased activity in areas such as healthcare and education. Industrial activity levels are improving and our contractor customers have benefited from easier access to undertake repair and maintenance work inside manufacturing facilities. And in civil infrastructure, we saw strong public works demand with a reasonable anticipation of future infrastructure work funding down the track.

07:21 Overall, demand from these end markets was strong in the second half of our fiscal year, and we outperformed our end markets by more than anticipated in fiscal twenty twenty one. This strength has continued into the first two months of the fiscal twenty twenty two, driven by the exceptional work of our associates while leveraging the strength and scale of our supply chain.

07:44 Now, let me pass you over to Bill, who will take you through our financial numbers in more detail.

[Bill Brundage, Chief Financial Officer]

07:49 Thank you, Kevin, and good morning or afternoon, everyone. I'm pleased to present the Group's full year results, which demonstrate strong progress achieved during the year. The numbers on the accompanying slides are for the continuing operations of the Group, comprised of the U.S., Canada and central costs.

08:07 Total revenues in the year were up fourteen point three percent and we expanded gross margins by sixty basis points with further expansion in the second half, driven by our ability to service our customers while managing price inflation. Costs were well controlled while we continue to invest in the business, resulting in good operating leverage for the year of sixty basis points.

08:29 Underlying trading profit of nearly two point one billion dollars increased thirty one point eight percent, just over five hundred million dollars with underlying trading margins progressing one hundred and twenty basis points to nine point two percent, which is a record for our business. Headline earnings per share increased by thirty five point five percent, principally due to the strength of trading profit growth during the year.

08:53 Taking into account the Group's prospects and financial position, we are pleased to propose a final dividend of one hundred and six point five dollars. This brings the total full year dividend to two thirty nine point four dollars, an increase of fifteen percent, reflecting our confidence in the business.

09:12 The balance sheet remains strong with leverage of zero point six times, and we have announced today our intention to commence a new one billion dollars share buyback over the next twelve months.

09:23 The U.S. business mirrors the Group results with a strong performance. Total revenues grew thirteen point nine percent with organic growth of twelve point eight percent. Price inflation averaged approximately three percent during the year, picking up from flat in the first half to mid-single digits in the second half. Gross margins were ahead of last year reflecting the value we deliver to our customers, the strength of our business model and our ability to manage inflation.

09:51 We tightly controlled costs and generated strong operating leverage. Headcount and variable costs grew to appropriately support volume growth and we continue to invest in the organic growth of the business in the areas of digital, technology and supply chain. Consequently, underlying trading profit came in at two point zero seven three billion dollars or one hundred and eighty six million dollars ahead of last year with underlying trading margins expanding one hundred and thirty basis points to nine point seven percent.

10:22 We provided a breakout of revenue growth across our largest customer groups in the U.S. As Kevin outlined, we saw strength in the residential end market and our customer groups serving that end market performed well. Residential trade and residential building and remodel grew well and we continue to see particularly strong trends in residential digital commerce, up thirty eight percent for the year due to strong demand from the project-minded consumer and light decorative pro. HVAC, where the majority of our business serves the residential end market grew twenty two percent in the year and twenty seven percent in the fourth quarter.

10:59 Waterworks continue to outperform the market with full year growth of seventeen percent and revenue growth accelerating to thirty nine percent in Q4, driven by a balance of strong public works demand, good residential growth and green shoots in commercial end markets.

11:15 The commercial mechanical customer group was restricted by more challenging non-residential markets in the first half, but saw robust growth in the second half. We continue to see our commercial customers pivoting towards growth areas, such as data and distribution centers, education and healthcare, as work in office and retail continue to lag. The other bucket comprises fire and fabrication, facilities supply and industrial, each of which returned to growth in the second half, but as a group remained slightly down for the full year driven by the industrial contraction earlier in the year.

11:53 The Canadian business delivered a strong operating result, generating revenue growth of twenty one point three percent, of which fifteen point eight percent was organic. Residential end markets, which account for over half of our Canadian business performed well in the period with a particularly strong performance from our HVAC business. We also saw growth in civil infrastructure markets, but industrial markets remain challenging.

12:19 Similar to the U.S. gross margins were ahead of last year and tight cost control led to a thirty three million dollars increase in underlying trading profit. As we focus solely on North American markets, we continue to leverage the considerable expertise, knowledge and know-how from our U.S. associates to enhance operations and customer experience across Canada.

12:44 As we look at the performance in the fourth quarter, total revenues grew by twenty four percent with organic growth of twenty three point six percent in supportive markets. Inflation in the quarter averaged approximately eight percent with upward movement on both commodities and finished goods. Gross margins were significantly ahead of last year driven by tightening supply chain constraints, accelerating price inflation and channel mix improvements.

13:10 We are mindful that the inflation-driven benefit in our gross margins could potentially moderate or reverse in the future. Headcount and variable costs grew appropriately to support volume growth, resulting in underlying trading profit of seven hundred and two million dollars, an increase of one hundred and eighty nine million dollars despite one fewer trading day. We were pleased with the progress of underlying trading margins, which were up one hundred basis points to ten point seven percent.

13:39 As you look at our quarterly sequential performance, you can see the significant step-up in revenue growth in the second half. We delivered good trading margin expansion in each quarter of fiscal twenty one, which accelerated further in the second half. Our over-market growth, expanded gross margins and good operating leverage resulted in one hundred and twenty basis points of margin improvement for the full year to nine point two percent. It's important to contextualize this year's progress, as we think about the performance of the business next year and Kevin will set out our thoughts on the outlook shortly.

14:17 Finance charges were as expected and broadly in line with the prior year. The effective tax rate of twenty four point four percent was slightly lower than the prior year and our guided range, driven by lower levels of non-tax deductible expenses. Exceptional charges for continuing operations were small with costs associated with the U.S. listing, partially offset by adjustments to previously accrued business restructuring expenses.

14:44 I've set out the cash flows on a pre-IFRS 16 basis, which more closely mirrors the U.S. GAAP standards, but there is a reconciliation to the IFRS statutory numbers in the appendix.

14:55 Cash flow from operations was one point seven fifty one billion dollars after a working capital outflow of five seventy six million dollars, driven by continued investments in inventory to ensure we have the best levels of availability for our customers during the time of supply chain pressures and low vendor fill rates.

15:13 The increase in interest and tax was principally driven by the increase in profit. CapEx was a touch lower due to timing of projects, but we continue to invest in organic growth of our business, particularly in technology and supply chain. We have returned over one point four billion dollars to shareholders, which included both the deferred interim and final dividends from twenty twenty, the twenty twenty one interim dividend, as well as the special dividend related to the UK disposal and the recently completed four hundred million dollars share buyback.

15:47 Acquisitions remain a core part of our growth strategy, and we invested three thirty five million dollars, completing seven deals in the year. And finally, the disposal cash principally relates to the sale of the UK business, which as noted, was returned to shareholders via special dividend paid in May of this year. That means, we finished the period with a strong balance sheet and a net debt to adjusted EBITDA ratio of zero point six times. This rises to one times on a pro forma basis if you consider the new one billion dollar share buyback program. And as a reminder, we typically see our leverage seasonally increase during the first half of our fiscal year.

16:27 Lease liabilities, recognized under IFRS 16 were one point one billion dollars, a little lower than last year after we exited the UK business at the end of January. The net pension position returned to a small asset, due principally to changes in actuarial assumptions and an additional one-off contribution of forty million dollars made following the disposal of Wolseley UK. Our balance sheet is strong and we have great liquidity.

16:55 Moving on to technical guidance, we have included the revenue impact of completed acquisitions on the fiscal twenty twenty two full year figures. This includes the three deals we closed in the fourth quarter. We have the same number of trading days in the year ahead as in fiscal twenty twenty one, albeit gaining one day in Q2 and losing one day in Q3.

17:16 The interest charge is expected to be broadly in line with last year, but the one hundred million dollars is a U.S. GAAP number, so it excludes lease-related finance charges that we previously included under IFRS. We expect the effective tax rate to be in a similar range to fiscal twenty twenty one next year. And CapEx guidance is expected to be approximately three hundred million dollars to three hundred and fifty million dollars.

17:44 As previously highlighted, we adopted U.S. GAAP reporting as of August first of this year. This is a logical step in our journey as we focus our operations on our attractive North American markets. The main rationale for this change is to better facilitate comparability with U.S. peers, both on an accounting basis, but also through more closely aligned KPIs.

18:05 We set out our preliminary view of the U.S. GAAP differences during our investor session in July, and we've now updated the full set of reconciliations through fiscal twenty twenty one year end, which we will publish separately on our website today. After taking on shareholder feedback and considering the impact of the transition further, we will continue to add back the impact of acquisition related intangible amortization to our primary profit and EPS metrics, which will more closely align them with our past practice.

18:36 As such, we will report adjusted operating profit and adjusted EPS, which as you can see in the chart above, more closely mirrors our historic underlying trading profit and headline EPS metrics. Acquisitions remain a core part of our growth strategy and we believe being more consistent with past practice is appropriate as we continue our transition to the U.S. We will also continue to publish adjusted EBITDA, which adds back both non-cash amortization and depreciation.

19:09 And finally, we remain committed to our capital allocation priorities. While we operated prudently during the pandemic, we continue to target a net debt to adjusted EBITDA range of one to two times. Investment in organic growth, principally through working capital and capital investments remains the first capital priority. We remain committed to growing our dividend sustainably through the cycle and are pleased to step this up fifteen percent this year. We will then invest in selective bolt-on and capability acquisition opportunities, and finally return surplus capital to shareholders over time when we are below our leverage range.

19:45 So let me wrap up. I'm pleased with the results that the team delivered; strong top line growth, gross margin expansion and operating leverage resulted in strong earnings growth. This combined with solid cash generation, provided us with the ability to continue to execute against our capital priorities. Our balance sheet is strong and we are well positioned as we enter the new fiscal year.

20:08 Let me now turn it back to Kevin.

[Kevin Murphy, Chief Executive Officer]

20:11 Thanks, Bill. Before we close, I'll touch briefly on our core areas of investment that allow us to make our customers and their projects more successful. I left off a moment ago speaking about our end markets. At Ferguson, our purpose is to take our customers' complex construction projects and make them more simple and successful. And over the past decade, we have very intentionally positioned our business to serve an attractive balance of residential and non-residential end markets. Just as important, across those end markets, we're approximately sixty percent RMI and forty percent new construction. We really like this mix for the favorable demand balance that it brings.

20:59 I'd like to focus the next few minutes highlighting the strengths that enable us to consistently outperform in these end markets. There are four distinct competitive advantages that cut across our company, and together enable us to serve our customer groups better than anyone else. They ultimately make our business truly unique and differentiated in the minds of our customers, our suppliers, and our associates.

21:25 Our objective is always to make our customers and their projects more successful, while expanding our role in the value chain. Everything starts with our associates, who are truly the intellectual capital of the business. For over sixty five years, we've invested in recruiting, training and developing the best associates to drive above-market growth that in turn fuels future opportunities for them.

21:49 In a service business like ours, everything starts with training and development within an inclusive environment for all of our associates. And while personal relationships are critical, going forward this will not be enough. And as a result, we're also building the best digitally enabled customer relationships. We are already using technology to make both our customers and our business more productive. We're consistently investing to equip our associates with the tools that drive productivity, while saving time for and cementing the relationship with the customer.

22:24 We bring to bear a scale of global supply chain to maintain the most effective and efficient same day, next day omnichannel availability. We place our products closer to the customer, being in stock for shipping the same day, while further developing the capability for 24x7 customer access to our inventory. This year our supply chain has been a fundamental strength for our business as we've been able to maintain high levels of product availability.

22:54 We employ a focused product strategy, providing a robust offering that includes both branded and own brand offerings, giving customers unrivaled choice for their projects. We seek to ensure through a consultative approach that we provide our customers with the best product solution. We source products from over thirty countries in addition to the U.S. and we drive sales through specification to the trade professional and to the end user. We strategically expand the product assortment to grow the bundle, providing a comprehensive range of products. The result is that, we're more relevant for not only the trade professional, but also the ultimate end user and owner.

23:37 In the next few slides, we will provide some highlights on two of these strengths: product strategy, and supply chain. First, looking at product strategy. While we do not seek to own manufacturing assets, we are going to get as close to the point of manufacturing as we can. We're going to continue to expand our diverse global sourcing organization to make sure that we're driving design, product development and own brand execution. Our product strategy includes both branded and own brand offerings, and with over one million products across our nine customer groups, our extensive range can meet every customer's needs.

24:20 Own brands are important to us as they offer high quality products with excellent availability and industry leading support. A good example of this is Durastar. In November of twenty twenty, we launched a new line of own brand products in the HVAC equipment category. Durastar offers a broad range of residential unitary and ductless HVAC equipment. The initial Durastar offering included air conditioning, heat pumps, gas furnaces, air handlers and coils. We're executing a phased targeted launch strategy and growing geographically into new markets over the next several years.

25:00 This brand, together with knowledgeable HVAC associates, offers us a considerable growth opportunity to expand our HVAC business in combination with the strength of our residential plumbing group, giving our customers even greater choice for their HVAC needs. Creating and launching Durastar enables us to sell in any market across our different customer groups and through any channel. This is a large and attractive market of around fifty billion dollars, in which we generated over two billion dollars of revenue in twenty twenty one.

25:33 Turning to our supply chain. We deliver global scale locally. We bridge the gap between just over thirty four thousand suppliers to serve over one million customers. Our customers require access to a wide variety of products, while expecting exceptionally high fill rate and speed of delivery. Ferguson's supply chain is built around these needs. We will have the most effective and efficient same day omnichannel supply chain in North America by placing our products closer to the customer and being in stock and further developing the capability for 24x7 customer access to our inventory.

26:11 Today in the U.S., we have six point five million square feet inside of ten distribution centers and more than thirty five million square feet in our branch network. This is the foundation of our overall omnichannel strategy. We've established import centers on each coast to ensure efficient replenishment of globally sourced products across the country. This strategy also includes progressively developing our market distribution centers or MDCs in major metro areas as the most efficient means of final mile distribution. Our network of regional distribution centers, pipe yards, import centers, MDCs and branches allows us to put the product closer to the customer, increasing availability, speed of delivery and providing greater operating efficiency.

27:02 I mentioned Denver at the half-year results, which is the first of our future state MDC site, which came online towards the end of our fiscal year. The facility utilizes an automated inventory picking and replenishment system completing sixty percent of all product picks today. The system holds forty nine thousand bins and twenty six thousand products and utilizes energy efficient robots to run these product bins across a modular grid, optimizing space, time, energy and productivity.

27:34 Using regenerative power, each robot uses about one hundred watts of electricity, a tenth of what is used by an average toaster which significantly lower energy costs. The robot picks product day and night, saving on traditional warehouse labor, lighting and heat, while also improving health and safety by decreasing material handling by fifty percent. Over time, we will progressively expand this improved MDC model within major MSAs at a rate of about two to three per year, which is included within our planned CapEx requirements.

28:08 So, in summary, our business is in very good stead. We're extremely proud of how our associates deliver for our customers. We remain focused first and foremost on the health and well-being of our associates and our customers. We're very pleased with the operational delivery, particularly in light of the ongoing supply chain challenges. In addition, our strong cash flow and our balance sheet continue to help us drive incremental growth and value.

28:36 For fiscal year twenty twenty two, we started the new financial year with strong momentum, with organic revenue growth at similar levels to the fourth quarter of fiscal twenty twenty one. We expect a year of good growth overall, but we anticipate a tapering of revenue growth in the second half on tougher prior year comparatives. And we are mindful that the recent tailwinds from inflation on gross margins could moderate.

29:00 For the full year ahead, we expect operational improvements to broadly offset headwinds from inflation in the cost base. Given the strong momentum in the business and the agility of our business model, we are well positioned to have a good year of growth.

29:16 Looking longer term, our teams are executing well to deliver results to build on our strengths that will enable us to outperform in attractive end-markets. We remain focused on better serving our customers and capturing market opportunities through our continued investment in talented associates, global supply chain, product breadth and depth and digital solutions. We look very forward to telling you more about this in our virtual Investor Day on December nine.

29:45 Thank you. I'll now turn the call back over to the operator and answer questions you may have. Operator?

[Operator]

29:56 [Operator Instructions] Our first question comes from Elodie Rall from JP Morgan. Your line is open. Please go ahead.

[Elodie Rall, JP Morgan]

30:15 Hi. Thanks for taking my questions. Good morning to you. So, my first question would be on the evolution of your shareholding base. I know I have asked that question in the past, but given you confirm the listing in spring, I was wondering if you've seen some evolution in the geographic peak of your investor base more recently?

30:40 And my second question would be on the working capital variation that we've seen. So we've seen a large outflow on investment in inventory and supply chain constraints, I guess. So how should we think about it? Do you expect the trend to continue in twenty twenty two or to normalize to previous year's levels? Thanks.

[Bill Brundage, Chief Financial Officer]

31:06 Yes. Good morning, Elodie. This is Bill. Thanks for the questions. First off on the shareholding base, we have not seen a significant move in the geographic split of the shareholding base since the additional listing was live in March. So that's been relatively consistent to this point.

31:25 And then from a working capital perspective, as noted, yes, we have invested about an incremental eight twenty five million dollars year-over-year in inventory to offset those supply chain constraints and limited product availability that we're seeing.

31:41 As we look forward, we don't see anything in the very short term, i.e., for the rest of this calendar year, that would indicate that those supply chain pressures are going to alleviate. So, I would anticipate us running with additional investment in inventory through at least the end of the calendar year, likely into next calendar year. And we'll just continue to take a very disciplined approach around working capital as we always have. And I would expect that to alleviate and us to bring that working capital down once we see those supply chain constraints start to ease.

[Kevin Murphy, Chief Executive Officer]

32:16 Yes, Elodie, this is Kevin. To build on what Bill was saying, when we think about the inventory levels that we're keeping in our branch network most specifically, it really is taking up for those supply chain challenges. So I think at the third quarter we talked a bit about what our inbound vendor fill rate was for our top twenty DC vendors, and it still sits below thirty percent on time and in full. And our branch in-stock rates are still hovering in the mid ninety. So providing good day-to-day availability for our customers. But maybe as importantly as we take our role in the supply chain really seriously, the sporadic nature or the inconsistent nature of inbound fill rate we have to keep the right product for the project as a whole until such time as the project is ready for full delivery.

33:11 I mean, if you think about a typical residential construction project, just in our residential trade business, it can have upwards of two hundred different line items on a single-family home. And so making sure that we have the right product at the right time and are storing it for our customer is a huge part of our value proposition in the supply chain.

[Elodie Rall, JP Morgan]

33:34 Great. Thanks very much.

[Kevin Murphy, Chief Executive Officer]

33:36 Thank you, Elodie.

[Operator]

33:42 Our next question comes from Keith Hughes from Truist. Your line is open. Please go ahead.

[Keith Hughes, Truist]

33:49 Thank you. A question on the statement in the outlook portion of the release. You talk about the headwinds from inflation in the cost base moving forward, offsetting operational improvements. You seem to have done incredibly well so far in terms of passing through inflation to customers based on the results. Do you think that's going to get more difficult? Or what exactly are you referring to there?

[Bill Brundage, Chief Financial Officer]

34:14 Yes, Keith, good morning. This is Bill. I'll start and then Kevin can jump in. To your point, we've been very pleased with our ability to manage price inflation, particularly over the last couple of quarters in the second half of the fiscal year. And you've seen that reflected in the step-up in gross margins. Just thinking about it from a year-over-year perspective, we grew gross margins by one hundred and ten basis points in Q3 over the prior year. And then that stepped up to one hundred and sixty basis points in Q4. So really pleased with the work of our teams in the field. And I think that demonstrates again the product availability that we have and the strength of our supply chain.

34:54 We see those -- as we've seen inflation increase, as we mentioned, growing to eight percent in Q4, we see those characteristics holding true as we enter into this fiscal year. And so, I think there is a pretty supportive pricing environment, particularly in the first half of this fiscal year. As we turn to the second half of the fiscal year, the comparables get tougher, both from a revenue perspective, inclusive of inflation, and those gross margin comparables get tougher.

35:21 So I do think you'll see a bit of a difference kind of half one to half two, but again, we think from an overarching perspective pleased with gross margins and how they've stepped up, really pleased with how that dropped through to the bottom line with one hundred and twenty basis point expansion in trading margin. Again, which is a record for our business at nine point two percent. And we're going to work diligently to maintain that trading margin from a full-year perspective as we move forward.

35:53 And Keith, when you think about the operational cost side of the business, just like many of our competitors and even our customers are feeling the pinch from a labor perspective, and what rising wages look like. There certainly will be some pressures that will largely be offset as we think about productivity, but also in the rising price that Bill referenced from an inflation perspective.

36:17 Typically and predominantly what we're seeing is, pressure on, call it, the less than one year driver and warehouse associate. The culture of Ferguson is extremely strong and so when an associate comes on board and is with us for more than a year, there is a great likelihood that that is a career orientation as we look forward, but that less than one year and the competitive environment for that type of associates out there and it will have some degree of cost pressure as we think about wage growth in our business.

[Keith Hughes, Truist]

36:48 Okay. So this is not about the ability to pass through prices, this is about some of the operational issues, labor and everyone is -- in this industry is dealing with right now. Sounds like [Multiple Speakers]

[Kevin Murphy, Chief Executive Officer]

36:58 Yes. I think, we think about it in two different areas, Keith, the operational cost base as it relates to labor and productivity savings that we will have as we move forward, offsetting that. And then as we think about commodity inflation easing, what that can mean to gross margin overall. But our ability to pass through price in the near term on inflation still remains very much intact. As we talked in the Q3, it's not easy, it has a lot of hard work, it has a productivity drain on our associates as we look to renegotiate and work through with our customers and our customer's customer, but we have no doubt in our ability to continue to do that.

[Keith Hughes, Truist]

37:43 Okay. And then a final question, the -- you talked about some of the fill rates in the nine something percent, right? This is pretty high considering some of the shortages we're seeing across building products. Do you feel like you missed any meaningful revenue in the quarter from shortages or were you able to get at least most of what the demand was?

[Kevin Murphy, Chief Executive Officer]

38:04 We have seen some project delay in terms of shipment waiting on some inventory to come into the system. We do not feel like we missed out on revenue due to supply chain shortages and our relative ability to get product for the customer. In fact, quite the opposite, we've seen enhanced share gains because of that product availability in our associate base and our supply chain. As we look into the near term though, what we're seeing is, customers and our customers' customer placing orders and getting after product ordering cycles earlier to make sure that they have access to product when their project is ready to go.

[Keith Hughes, Truist]

38:50 Okay. Thank you very much.

[Kevin Murphy, Chief Executive Officer]

38:52 Yes. Thank you, Keith.

[Operator]

38:56 Our next question comes from James Rose from Barclays. Your line is open, please go ahead.

[James Rose, Barclays]

39:02 All right, good morning. I've got two please. The first is on the supply chain. When do you think the manufacturer fill rates and general availability levels could get back to normal? And second question is on, when you look at branches on a like-for-like basis, I mean, just in the second half, they are seeing round about fifteen percent volume growth year-on-year and they've already run pretty efficiently. Are you still confident that you've got headroom for further like-for-like growth in the branches without having to add incremental investments?

[Kevin Murphy, Chief Executive Officer]

39:36 Yes. So, James, thank you for the questions. On the supply chain normalization, we keep, as you might imagine, a very, very close eye to when we are seeing that fill rate improve, when we're seeing completion of POs coming into our distribution network more fully. And we haven't seen any easing of that supply chain pressure right now. We believe that continues likely through the calendar year and perhaps into the first calendar quarter of next year, but we keep a pretty close eye on it. And, again, making sure that we have that inventory closest to the customer inside that branch network for fill rates has served us incredibly well in the past several quarters.

[Bill Brundage, Chief Financial Officer]

40:24 And then James, maybe to address your question on headroom and volume growth in the branch network. Yes, to your point, if you exclude inflation, volumes were up roughly fifteen percent in Q4. I think what that's demonstrating is the strength of our overarching supply chain and our distribution center, as well as our MDC, Market Distribution Center and ship hub supply chain environment. So, as you know, we are investing and trying to put product closer to the customers and we are opening MDCs. As Kevin noted, we just opened our Denver MDC. So you'll see us continue to invest in those types of facilities, but overall, we expect to have plenty of capacity to take care of market driven volume growth in the marketplace.

[James Rose, Barclays]

41:16 Okay. Thanks very much.

[Operator]

41:22 Our next question comes from Will Jones from Redburn. Your line is open, please go ahead.

[Will Jones, Redburn]

41:30 Thank you. Three if I could, please. The first, just going back to gross margins, when you think about that step-up from the first half to the second, would you be willing to put any numbers around how much of that was -- what you might call inflation gain, I suppose versus underlying improvement or mix? And then on the issue of mix, when we think through to FY twenty twenty two channel mix, business mix, is there anything you'd point us to think around in terms of positive or negative, so how that might shape up in the year ahead?

42:00 The second was just going back to overheads and admin costs [indiscernible]business issue, perhaps [indiscernible] related to savings in the last kind of eighteen months around travel utilities [indiscernible]which we flagged before. I suspect not, but is there any quantification around that bucket and what you're thinking will come back in July twenty twenty two if indeed you are thinking that?

42:23 And then the last one was just revisiting the point you made on private label. Could you give us a latest update on the share of own brand within the business? And I think in the past, you talked about potentially growing that twice the rate of the underlying market. Is that still feasible? And just big picture, are the manufacturers okay with you as you make the transition? Thank you.

[Bill Brundage, Chief Financial Officer]

42:45 Yes. Thanks, Will. On gross margins, to your point, yes, a good step-up both in Q3, as I said, one hundred and ten basis points over the prior year, and in Q4 expanding one hundred and sixty basis points. I'd say the majority of that driven by inflation in our ability to manage that inflation, and we saw that as inflation stepped up from Q3 to Q4, gross margin stepped up further from Q3 to Q4.

43:10 Channel mix did come into play, particularly in Q4. If you think about what was happening last year during Q4 when we were going through the COVID lockdown periods, we had our counters closed to walk-in traffic for a period of time, as well as our showrooms. As those channels are now fully opened to both buy online, pickup in-store, but also to in-store traffic we've seen that channel mix improvement as those are higher margin channels improved year-over-year.

43:41 I see that continuing as we step into this fiscal year, but we absolutely recognized a thirty one point four percent gross margin in Q4. It does have the benefit of inflation there. Again, I think that continues, there's good pricing dynamics. We see supply chain constraints continuing as we go into the first half of this fiscal year, but as we get to the second half, there could be a tempering of that given the comparables next year.

44:11 And then from an overhead perspective, yes, we have flagged in the past we had some savings on health care and areas like travel and entertainment. As those come back, we do believe that we have efficiency and productivity gains to largely offset those, in addition to the wage inflation headwinds that Kevin talked about. So there will be some step-back in those costs, but we feel that we're well positioned to manage that as we go into fiscal twenty twenty two.

[Kevin Murphy, Chief Executive Officer]

44:40 Yes, maybe to build a little bit, Will, on what Bill was saying. From an inflation perspective, not only were we able to pass through inflation, but as we think about the availability of product, we look at gross margin as the best reflection of the value that we provide in the marketplace. And because of that we were not only able to gain share in excess of what we historically have, but also able to grow gross margins as we were picking up work from customers who perhaps normally didn't look at us as their first source of supply, because of what that capability was. That's hugely important to us, because it also starts to cement further relationships for a more long-term relationship with our company.

45:26 In terms of the channel side, we continue to see showrooms and counters growing faster than the core of our business, which is also beneficial to gross margin as we go forward. But we believe getting back to that, call it, ten basis points a year is important for us.

45:43 If we shift gears to the private label side of the question, we remain roughly flat at about nine percent of our overall revenue base. We continue to look at growth in that area via two means. One is product development and where are those opportunities for us to grow inside of brands that we have or the development of new brands inside of our customer groups. We highlighted Durastar today, that was one.

46:06 But we also grow by acquisition, and we acquired a fantastic company called Amerock in the cabinet hardware business this past year, which also allows us, not just to grow that business more generally, but also, specifically, through our counter and through our showrooms, as well as through our different customer groups and channels. So that's a dual-track growth strategy for us on the private label side.

46:33 On the supplier relationship, we still feel very good. I mean obviously still ninety one percent plus of our revenue is driven with those branded relationships. And even as we look at private label development, oftentimes that's done in conjunction with our OEM suppliers who are making the product for us and allowing us to take it to market under our own brand so that relationship remains solid.

[Will Jones, Redburn]

46:59 Great. Thanks a lot.

[Operator]

47:05 Our next question comes from Kathryn Thompson from Thompson's Research Group. Your line is open. Please go ahead.

[Kathryn Thompson, Thompson's Research Group]

47:14 Hi, thank you for taking my questions today. Tagging on to the really manufacture product or private label initiatives, and I'm glad you brought up about the cabinet side, but that was something I wanted to dig a little bit more in terms of -- I totally get you're expanding the offering, understand the value-add, but what are the major drivers in choosing which categories to focus? When I look at other distributors like a [indiscernible] for instance that have gone a little bit more into the private label side, it's a very specific type strategy, but if you could tighten and help us better understand really the core fundamentals for the categories to focus it will be helpful. Thank you.

[Bill Brundage, Chief Financial Officer]

48:03 Yes. Kathryn, I mean if you take it -- thank you for the question, first of all. If you take it at the essence of what Ferguson is, we really live to make a complex new construction, an RMI project more simple and successful for the customer and for our customer's customer, and we do it from the very beginning of the project to the very end, and the design work all the way through to the first shovel, turning dirt and installing pipe, to the last appliance install as were closing up a project.

48:34 And so, as we think about what categories to get into, it is what product categories are going to make us more relevant for the share of wallet for the particular customer group that we're focusing on. And cabinet is one of the larger areas inside of a kitchen remodel, which is a core part of what we do inside of our customer base. And then we also look at what makes us more relevant on the project as a whole. And that's how we decide around expansion in customer groups. What is that next most relevant thing on a project for an owner or a general contractor that also has margin attributes that allow us to add value in the supply chain and get paid for that value. And so, that's how we think about both expansion in product categories, but also in what customer groups we need to go after in the overall project.

[Kathryn Thompson, Thompson's Research Group]

49:31 And for these -- using the Colorado acquisition as an example, for products such as cabinets, are you -- given the changes in the supply chain, given the changes in the post-COVID world, is there a propensity to focus on more domestic manufacturers, are you thinking beyond the U.S.?

[Kevin Murphy, Chief Executive Officer]

49:53 Yes. So the Colorado actually acquisition you're talking about is Kitchen Showcase and that was not an own brand acquisition, it was a cabinet acquisition principally in the residential new construction sector. The private label acquisition that I was talking about was Amerock, which is in the cabinet hardware side of the business that does a tremendous amount through online activity and our showrooms. So that Kitchen Showcase acquisition as well as the acquisition we made in Florida in the cabinet business is not an own brand acquisition.

[Kathryn Thompson, Thompson's Research Group]

50:32 Okay. As far as private label, is your bogey still in kind of the mid-teens to upper teens in terms of mix?

[Kevin Murphy, Chief Executive Officer]

50:41 Yes. So we don't put it and target on it, we work to grow it at about two times the rate of Ferguson's core growth rate. Again, going back to an earlier question, needing to make sure that those branded supplier relationships that we hold so very dear and have for over sixty five years that it's done in a methodical way. And so that still remains our focus. We didn't accomplish that this year, but over the long haul, we think about two times the Ferguson growth rate is the right place for us to be.

[Kathryn Thompson, Thompson's Research Group]

51:15 Okay. And as we look at the ongoing debate for a U.S. infrastructure bill on the traditional side, what if any changes do you have in terms of what the potential impact could be for you, be it your Waterworks division or elsewhere? And for -- any other color, any other update in terms of what that may mean for Ferguson.

[Kevin Murphy, Chief Executive Officer]

51:46 Yes. If we take a step back and look at what we see right now in terms of demand, the market is still pretty healthy. The indicators from a residential and a non-residential perspective look good. We're very confident in the medium term in terms of what these end markets represent, not the least of which is residential when you think about the under building of housing units as well as what RMI might mean, given a post-COVID world on residential. There is pressure out there clearly from a supply chain perspective, but also from a labor perspective.

52:18 If I take that against an infrastructure bill, assuming that everything goes well and gets passed, we will look to see what is in there and what the details are around the plan. It will benefit us from our Waterworks business, which is growing quite solidly right now at thirty nine percent in the fourth quarter across public works through residential and commercial. We think there's good opportunities for us inside of that. There is indications there will be about one hundred and eleven billion on the water side with good focus on what lead service lines look like. That's a great place for us, there will also be good roadwork, presumably, which will have erosion control, soil stabilization, storm water management attached to it. But it could also be in the areas of school work, airports, good commercial projects that take the whole of Ferguson and provide us with good tailwinds. So we're looking forward to it, but we also need to see what the detail is and what the timelines look like.

[Kathryn Thompson, Thompson's Research Group]

53:24 Okay. Great. Thank you so much.

[Kevin Murphy, Chief Executive Officer]

53:26 Thank you.

[Operator]

53:29 Our next question comes from Yves Bromehead from BNP Paribas. Your line is open. Please go ahead.

[Yves Bromehead, BNP Paribas]

53:37 Good morning. Thank you for taking my questions. The first one was just on the incremental margin. Obviously, it's been a much better underlying environment here, but I think the last time you spoke about sort of your expectations into twenty twenty two, you were obviously already sort of insinuating that the incremental margin will start to come back down from sort of the double digit that you have achieved in twenty twenty one. As we are looking to H2 probably of next year, I know it's quite far away, how should we think about sort of the ongoing level of incremental margin for the Group? Do you expect some normalization, or can you still continue to hit sort of the ten percent plus range?

54:20 And then my second question is, I understand you need more time and details and granularity into the infra plan, but equally it seems that you are quite aware of these sort of amounts that will go in certain categories. When you think about the overall project, what is the total size of the market that directly concerns you? You mentioned the one hundred and eleven million in water, but is there any other thing in there that we can think as this will be incremental demand flows for Ferguson in the next few years? Thank you very much.

[Bill Brundage, Chief Financial Officer]

54:57 Hi, Yves. Good morning, good afternoon, and thanks for the question. I'll start on question one. In terms of incremental margin, and if I just take a step back, to your point, in a typical year, what we try to achieve is growing our gross margin by ten basis points year in, year out, and getting more productivity out of the cost base to drive trading profits faster than sales and to generate incremental trading margin.

55:22 As we've said in the past also, in periods of higher sales growth we're able to leverage that a bit more and drop more to the bottom line and you've seen that this year, both from a labor and cost productivity side, in addition to the expanded gross margins which we've talked about.

55:40 So really pleased with one hundred and twenty basis point step-up in trading margins for the year. As we go into next year, I think, again, fiscal twenty twenty one was a bit of a story of two halves. I think you'll see fiscal twenty twenty two being very similar in terms of strong momentum heading into half one. And then there is tougher comparables coming into play in half two. We expect for the full year, as we've said, that our operational improvements can broadly offset any impact of cost inflation and certainly, for the full year, after stepping trading margins up by hundred and twenty basis points it will be a great result for us to hold on to that one hundred and twenty basis point improvement for next year, and we're going to work very diligently to maintain that. But I wouldn't expect large incremental flow through for the full year on sales growth next year, given the step-up this past year.

[Kevin Murphy, Chief Executive Officer]

56:37 And, Yves, on the infrastructure side, I can't effectively give you a translation of what one trillion dollar bill if passed would flow through in terms of tailwinds to our business. What I will say is, generally speaking, we feel good about the markets, both residential and non-residential, and what their growth characteristics are. Our customers and our business will move to where those green shoots are.

57:02 And so, as this plays out and hopefully gets passed, it will provide a tailwind for us. What -- even a water project might represent in terms of product revenue growth, really depends on what type of project it is, a water treatment plant versus a pipeline, an airport versus school retrofit. So it really does depend. So apologies, I can't give you a more succinct answer on that.

[Yves Bromehead, BNP Paribas]

57:33 No worries. Thank you very much and have a nice week. Bye-bye.

[Kevin Murphy, Chief Executive Officer]

57:36 Thank you.

[Bill Brundage, Chief Financial Officer]

57:37 Thank you.

[Operator]

57:41 Our next question comes from Gregor Kuglitsch from UBS. Your line is open, please go ahead.

[Gregor Kuglitsch, UBS]

57:49 Hi, good morning to you, thanks for taking my questions. So I've got a few, please. So the first one is on the warehouse efficiency. I was quite interested in your comments around Denver, so I missed -- you were sort of implying you're going to change a lot of your warehouses over -- distribution centers over to that sort of new modus operandi with the robots and stuff. So could you just tell us perhaps, sort of high level what's the efficiency, say, with a ten year old warehouse to this and kind of what's the efficiency and how quickly will you renew the fleet basically to get to sort of newest technology?

58:26 Sort of related to that, so you kind of flagged your margins this year will be nine point two -- well, nine point two last year, you are expect them to sort of be stable. Is this sort of overall picture that you think that is the right margin level for the Group? I appreciate last year was like a massive step-up and now you're kind of saying, well, you hold it, or do you think that medium-term perhaps, there is more room to improve? I mean, I guess the example would be, for instance, warehouse efficiency measures in other regions -- that would be the case or not.

58:56 And then finally, just quickly, sorry, just to be clear on the U.S. GAAP and the sort of KPIs that you're talking to. I'm looking at the presentation, it looks a little bit different to what you reported. Am I right in understanding you're essentially moving back to a pre-amortization number on both the earnings and operating profit also under U.S. GAAP, sort of as your KPI that you're going to talk to?

59:20 And I'm sorry, one final question. Regarding the relisting, I appreciate your intention is -- the way this actually works, will you sort of do a soft call with your shareholders and see if you've got the numbers and then go for it, because I guess the risk is if you don't have the numbers it's perhaps a problem to then come back to it later. So I want to understand what you're thinking in terms of actually pressing the go button. Thank you.

[Kevin Murphy, Chief Executive Officer]

59:48 Gregor I'll take the -- this is Kevin, I'll take the first question around the MDC overview. If I take it at the highest level, what we're trying to do is, we're trying to get the best breadth and depth of the product closer to the customer in market. What we do there from an operational efficiency perspective is, we save double touches from our regional distribution center, we save transportation costs in terms of replenishment to the local market and we give best breadth and depth fill rate for our customers.

60:20 Denver is a good example of it, they're averaging, call it, between three fifty thousand and seven fifty thousand square feet, we're going to roll out likely two to three a year, it's inside of our existing CapEx budget, and we're going to go to the major MSAs across the U.S. for local delivery, local pickup and branch replenishment. It's a very strong productivity savings for us. We'll also implement some of the robotic picking technology that we talked about that not only saves labor, but also is very environmentally friendly and efficient. So that's the plan overall, and why we're going about it. I'll let Bill take the second two.

[Bill Brundage, Chief Financial Officer]

61:02 Yes, Gregor. Thanks for the question. From an overarching margin perspective, I think the thing that we're most pleased about with this business it's a long-term sustainable growth in trading margin, and we don't put a ceiling on that. So while we've had a significant step-up and truly an exceptional year, rising to nine point two percent, we don't believe that's the ceiling longer term. We do believe over time we can continue to grow that and get more efficient. And again, we won't put a cap on what that is. But recognizing that we've stepped up a significant portion in a single year, I think we are mindful that holding on to that and diligently working to deliver that in fiscal twenty twenty two would be a great result.

61:45 In terms of your interpretation on U.S. GAAP, yes, you're exactly correct, we are planning on continuing to use a profit metric, both on the profit side and the EPS side that's very similar to our past practice. Just felt that after taking on some shareholder feedback remaining consistent, provided an easier transition for us and our shareholders as we migrate to the U.S.

[Kevin Murphy, Chief Executive Officer]

62:10 Last question on [Multiple Speakers]

[Bill Brundage, Chief Financial Officer]

62:12 Yes. Sure. On re-listing and shareholder feedback, one of the things that we're really proud of is the methodical way that we have gone about this process as a company. And shareholders across the Board during the initial phases of consultation said, they wanted to hear from the Board what was in the best interest of the company. Thought that was fantastic, because the Board was then able to look at us focusing on our North American markets and what's the most appropriate thing for the organization. And we did do extensive consultation with shareholders prior to that initial vote, which passed with strong confidence at over ninety nine percent.

62:49 We continue to have good dialog on a consistent basis with our shareholders and understand where they are in the process. We hope that the methodical way we've gone about this would: number one, allow shareholders and have shareholders continue to hold us as an investment, but certainly offer time for those who can't to appropriately address that situation. We're going to retain the standard listing in London. And so, again, we will talk with shareholders all the way through as we move towards the spring of twenty twenty two for vote number two.

[Gregor Kuglitsch, UBS]

63:29 Okay. Great, thank you. Sorry, one follow-up. On the MDCs, is this -- can you guys tell us maybe a quick -- so maybe you'll touch on this in the CMD how many you've got to give us some context, and whether is this a sort of a new thing or whether you're converting some? I am a little bit confused in terms of the different numbers of DCs you've got at the various -- MDCs, RDCs, and then I think you've got shipyards or pipe yards, so if you could just summarize what's the position it will be great. Thank you.

[Bill Brundage, Chief Financial Officer]

63:57 Yes, Gregor. I'll give a little color on that and then, yes, you can expect us to give some more details as we get into the CMD. But if you think about it overall, we've got ten national, regional distribution centers. The MDCs that we're opening, the first one was Denver, we're opening Phoenix later this year and Houston is underway. So you should expect us to get up to a rolling pace of about two to three per year.

64:21And then as Kevin mentioned, we are retrofitting some of our existing larger facilities with better warehouse layout and design and robotics. So all of that is embedded in our ongoing CapEx cost and CapEx guidance, but that will be continued investment over the next several years.

[Gregor Kuglitsch, UBS]

64:40 Okay. Brilliant. Thank you.

[Operator]

64:46 Thank you all for your questions. I will now hand back to Kevin for the closing remarks.

[Kevin Murphy, Chief Executive Officer]

64:52 Thank you, operator. And thank you all for your time today on the call. I guess, just in closing, we'll close with where we began. We are incredibly thankful for our associates in what they delivered in fiscal twenty twenty one during a really challenging year. And our top priority will always be maintaining their health and well-being and that of our customers and our communities. We're really proud of what the Group was able to do from a revenue growth perspective at fourteen point three percent ahead of last year, and that ramp-up during stronger demand in the second half.

65:28 As importantly, from a gross margin perspective, sixty basis points ahead of prior year, and the ability through hard work and product availability to pass through that price inflation and have a good gross margin result. Maintaining strong cost control, so that leverage, both on the cost base as well as from a gross margin perspective led to that trading profit outperformance.

65:51 So we're really pleased, we're focused on what the near term can bring us, we're optimistic about what that near term is with our Q1 entry at about the same growth rate as our Q4 exit rate. We'll maintain a strong and keen focus on what is happening with supply chain pressures, but most importantly, our ability to take a complex construction project and make it more simple and successful for our customer and our customer's customer.

66:20 So thank you for your time today. I look forward to talking again very soon.

[Operator]

66:26 Ladies and gentlemen, that concludes today's call. Thank you very much for joining. You may now disconnect your lines.