Richelieu Hardware Ltd

TSX:RCH

Earnings Call Transcript 2023-Q2

[Operator]

Good afternoon, ladies and gentlemen, and welcome to Richelieu Hardware Second Quarter Results Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session, which will be restricted to analysts only. [Operator Instructions] This call is being recorded on July 6, 2023.

[Foreign Language]

[Richard Lord, President and CEO]

Thank you, Mercy. Good afternoon, ladies and gentlemen, and welcome to Richelieu's conference call for the second quarter ended May 31st and first half of 2023. With me is Antoine Auclair, CFO. As usual, note that some of today's issue include forward-looking information which is provided with the usual disclaimer as reported in our financial filings.

In the second quarter, we achieved good results and ended the period with a strong position building on our major strengths, namely our multi-access value-added service concept and our ongoing acquisition strategy.

The comparison with the second quarter of 2022 shows a decrease in sales and earnings, but it should be remembered that the first half of 2022 was particularly favorable by exceptional increases in a market context resulting from the pandemic. To put things in perspective, if we compare the second quarter of 2023 to the same quarter in 2019, sales increased by 68% and EPS by 67%.

During the quarter, we completed two acquisitions in the U.S., one in Oregon; Maverick Hardware in Eugene; the other one in Minnesota, Westlund Distributing in Monticello two compatible specialty hardware distributor who extended and strengthened our presence in this market. That makes six acquisitions since the start of 2023, adding in some CAD26 million in annual sales.

In addition, we opened a new distribution center in Minneapolis and continue to make progress with our expansion and modernization projects at our Atlanta, Nashville, Seattle, and Pompano centers, which we expect to complete very soon. This will add some 500,000 square feet to our U.S. network. From a total of 115 interconnected distribution centers in North America, we now operate 62 in the U.S., which accounted for 42% of our total sales in the first half of 2023.

Antoine will now review the financial highlights of the quarter and first half then I will conclude and we will make -- and we will take your questions.

[Antoine Auclair, Vice President and CFO]

Thank you, Richard.

Second quarter sales reached CAD172.4 million, down 3.2% of which 4.7% from internal decrease and 1.5% from acquisitions. It's important to note that in the second quarter of 2022, Richelieu Hardware achieved exceptional internal growth of 16.1%, including a 22.7% increase in the U.S.. In Canada, sales amounted to CAD279.5 million, down 4.3% of which 6.4% from internal decrease, partially offset by a 2.1% positive contribution from acquisitions.

Our sales to manufacturers reached CAD229.9 million, down 3%, and for the hardware retailers, sales stood at CAD49.6 million, down 9.8%. In the U.S., sales grew to $141.9 million, down 7.9%. Sales to manufacturers reached $131.3 million, down 7.2%. In the hardware retailers and renovation superstores market, sales reached CAD10.6 million. In Canadian dollar, total sales in the U.S. reached CAD192.6 million, a decrease of 1.6%.

For the first half, sales reached CAD875.1 million, up 0.3% of which 1.8% from internal decrease and 2.1% from acquisitions. In Canada, sales reached CAD510.4 million, down CAD11.2 million, or 2.1% of which 3.9% from internal decrease and 1.8% from acquisitions.

Sales to manufacturers reached CAD415.4 million, down CAD7.3 million, or 1.7%. Sales to hardware retailers and renovation superstores reached CAD95 million compared to CAD98.9 million, down 3.9%.

In the U.S., sales amounted to $269.6 million, down 2.4%, of which 4.8% from internal decrease and 2.4% from acquisitions. They reached CAD364.7 million, up 4%, accounting for 42% of total sales. Sales to manufacturers totaled CAD249 million, a decrease of CAD3.2 million, or 1.3%, of which 3.9% from internal decrease and 2.6% from acquisitions. Sales to hardware retailers and renovation superstores were down 13.8% compared to last year.

Second quarter EBITDA reached CAD61.5 million, down CAD16.3 million, or 21% over last year, resulting from lower sales and to overall operating expenses returning closer to pre-pandemic level, as well as additional external storage expenses due to a temporary increase level of inventories.

Gross margin remained stable and the EBITDA margins stood at 13% compared to 16% last year. First half EBITDA reached CAD110.6 million, down 16%. As for the EBITDA margin, it stood at 12.6% compared to 15.1% last year. Second quarter net earnings attributable to shareholders totaled CAD30.7 million, down 25.6% mainly due to amortization of right-of-use assets increased resulting from new business acquisition and expansion projects, mainly in the U.S. as well as higher interest expense on bank overdraft.

Net earnings per share were CAD0.55 compared to CAD0.84 last year, a decrease of 34.5%. First half net earnings attributable to shareholders reached CAD53.1 million, down 25.6%. Diluted net earnings per share stood at CAD0.95 compared to CAD1.37 last year.

Cash flow from operating activities before net change in non-cash working cap balances was CAD48.4 million compared to CAD60.7 million last year. Net change in non-cash working capital items represented a cash inflow of CAD23.6 million. Excess inventory started to decline with a positive effect of CAD49.2 million. As a result, operating activities represented a cash inflow of CAD72 million in the quarter compared to a cash outflow of CAD3 million last year. For the first half, cash flows from operating activities represented a cash inflow of CAD88.4 million compared to a cash outflow of CAD40.5 million last year.

For the second quarter, financing activities used cash flow of CAD15.4 million compared to CAD21.5 million last year. Dividends paid to shareholders of the corporation amounted to CAD8.4 million compared to CAD7.3 million in the same period of 2022. First half financing activities used cash flow of CAD35.1 million compared to CAD29.8 million in 2022.

Dividends paid to shareholders amounted to CAD16.7 million compared to CAD14.6 million last year. During the first half, we invested CAD34.3 million for six business acquisitions and CAD14.3 million for the purchase of equipment to maintain and improve operational efficiency as well as for network expansion projects. We continue to benefit from a healthy and solid financial position with a working capital of CAD586.2 million for a current ratio of 2.9:1 and an average return on equity of 18.2%.

I'll now turn it over to Richard.

[Richard Lord, President and CEO]

Thank you, Antoine.

In this transition year, we are actively working in reducing our inventory levels, therefore reducing additional external warehousing space that is impacting our performance. In addition, 2023 is a year of significant investment in our network and these investments will start to bear fruits in 2024. We will remain focused on market penetration, synergies with our recent acquisition and our innovation value-added service and acquisition strategies to deliver good results in the coming quarters.

We will continue to seize and create opportunities. We have the team, the strengths and the asset to consolidate our North American leadership and deliver solid growth over the next period.

Thanks, everyone. We'll now be happy to answer your questions. Hello?

[Operator]

Thank you, ladies and gentlemen. We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Hamir Patel with CIBC Capital Markets. Please go ahead.

[Hamir Patel, CIBC Capital Markets]

Hi. Good afternoon. Richard, are you able to quantify how much the cost of carrying that excess inventory weighed on your EBITDA margins in the quarter? And when do you expect inventories to normalize?

[Richard Lord, President and CEO]

I will let Antoine complete the answer, but just to -- the first lens through, the outside ordering cost is costing as we speak about CAD3 million per year, that's -- CAD4 million per quarter, sorry, yes, and plus the other expenses related to the back and forth of the merchandize that we have to carry between the different warehouses.

[Antoine Auclair, Vice President and CFO]

And we can add to that also the interest on the bank overdraft. So we're talking about over CAD6 million per quarter just for -- to carry these additional inventories.

And to answer the second part of your question, I mean, basically, the inventory started to decline, so we're starting to reduce the excess. We gave -- we told you guys that the inventory should reduce between CAD60 million to CAD80 million this year and we should see another CAD50 million next year to bring us more to a more reasonable level of inventories.

[Hamir Patel, CIBC Capital Markets]

Okay. Thanks, Antoine. And then with respect to EBITDA margins, I know in the past you've kind of put out some commentary around where you see that longer-term figure going. Just given how much the margins pulled back in this quarter, where -- once you through this inventory carrying costs, where would you expect your EBITDA margins to stabilize there?

[Richard Lord, President and CEO]

Yes. This year we should be able to close the year at around 13% EBITDA. It all depends, of course, Hamir, of -- the volume of business. But once we clean up the inventory and we reduce the additional external warehousing, we should be anywhere between 13% and 14%.

[Hamir Patel, CIBC Capital Markets]

13%, 14%. Okay, thanks. That's helpful. And then just with respect to the quarter itself, given you're carrying this warehousing cost, is it -- how much pricing declines did you experience in that 4.7% organic decline in the quarter?

[Richard Lord, President and CEO]

We have not experienced any price decline as such, but sometime for certain items in the inventory, we made temporary promotion. So basically, yes, we -- it does affect our margin, but we don't have any specific prices decrease as such.

[Hamir Patel, CIBC Capital Markets]

Okay, fair enough. And just the last question I had was Antoine, are you able to update us on how the margins at your U.S. locations today compare to the margins at the Canadian asset?

[Antoine Auclair, Vice President and CFO]

It's approximately 75% of the Canadian margins.

[Richard Lord, President and CEO]

And it keeps improving.

[Hamir Patel, CIBC Capital Markets]

Okay. No, that's helpful. And Richard, just given all the modernization initiatives, where do you -- what's the goal for listing that 75% in coming years?

[Richard Lord, President and CEO]

The goal is to increase our sales in the U.S. We have a good performance budget with our managers in the U.S., so basically sales should increase because every one of those investment have been justify because of increases because of the market need because we needed that space basically to continue our growth in the U.S. So we -- and those new investments so far around Antoine, costing what - on a yearly basis something like CAD8 million to CAD10 million --

[Antoine Auclair, Vice President and CFO]

Yes.

[Richard Lord, President and CEO]

-- and this year, we should see the benefit to cover the cost of this.

[Hamir Patel, CIBC Capital Markets]

Okay. And then I guess the longer term, Richard, structurally can you -- if today the U.S. locations are 75% of EBITDA margins of the Canadian locations. Long-term where can they -- can they get up to the same as the Canadian locations? Or is it just a different market and it's going to be structurally to some degree lower?

[Richard Lord, President and CEO]

I think long-term that should be very close, but I would say for the short and the medium term, that should continue to be at 75% because we keep making acquisitions that make 3% and 4% and 5% EBITDA margin.

So basically, we take that three and sometimes four years to get those businesses back to the margin -- close to the distributor margin. But basically, we're very optimistic that margin will continue to improve and we will not stop making acquisitions because it does temporary affect our EBITDA margin.

[Hamir Patel, CIBC Capital Markets]

Okay, fair enough. That's all I have for now. I'll get back in the queue. Thanks.

[Richard Lord, President and CEO]

Thank you, Hamir.

[Operator]

(Operator Instructions) Your next question comes from Zachary Evershed with National Bank Financial. Please go ahead.

[Zachary Evershed, National Bank Financial]

Good afternoon, everyone, and thanks for taking my questions.

[Richard Lord, President and CEO]

Afternoon.

[Zachary Evershed, National Bank Financial]

Do the Canadian acquisitions perform better than the U.S. ones?

[Richard Lord, President and CEO]

No, not exactly. No, we have basically the same situation. When we make an acquisition in Canada, we have exceptional circumstances like we bought, for example, [indiscernible] in Halifax. The performance is very similar to Richelieu but other acquisition that we're making like maybe Cook Fasteners, for example at a lower EBITDA margin, but now that we have made some changes to just to give you an example, with Cook Fasteners in the last three months, we see sales increases by 50%.

So basically that was a good acquisition and EBITDA margin should be probably at the same level that Richelieu is in 2024. In the U.S., it's basically the same situation but could be a little bit more slow in the U.S. because we have to make more changes, sometimes it's a cultural change and introducing new products and that type of thing, but it's moving forward.

[Zachary Evershed, National Bank Financial]

That's a good color. Thank you. And then my usual question on the M&A pipeline, how is it looking, and anything bigger than usual lurking there?

[Antoine Auclair, Vice President and CFO]

Well, pretty much the same thing as Zach as you've seen historically in the pipeline. In Canada and in the U.S., it's still very healthy. So we've completed six so far and we're working on other ones as we speak.

[Zachary Evershed, National Bank Financial]

Fair. Sounds good. Thanks. And how is the pace of sales trending thus far in Q3?

[Richard Lord, President and CEO]

Yes. In the month of June, we have to remember that less year in 2022, we had sales increased. First of all, I think the month of June of 2022 was our best month ever and one if I remember well, and the sales increase compared to '21 was 16%. As we speak today, we see a decrease in 10% on overall sales, which is not bad compared to the performance that we had last year.

[Zachary Evershed, National Bank Financial]

Got you. And you mentioned that you're not seeing any real pricing declines beyond temporary promotions. Are your competitors remaining rational in terms of pricing as they're working through excess inventory?

[Richard Lord, President and CEO]

Yes, I think they have the same situation that we have. So basically, they try to do the best in order to decrease their inventory and maximize their margin as well. I think everybody is prudent, but we don't feel any pressure. We don't see any systematic pressure in order to decrease, for example, the pricing for your entire product line, except temporary situation and temporary promotions.

[Zachary Evershed, National Bank Financial]

That makes sense. And also on your competitors, are you seeing any pinch from higher interest rates on their part, maybe PE-backed players slowing down on acquisitions?

[Antoine Auclair, Vice President and CFO]

No. No major change there. Yes.

[Zachary Evershed, National Bank Financial]

So I do know that it's very lumpy, but could you provide any color on what's happening in the retailers' market?

[Richard Lord, President and CEO]

Yes. The retailers market, as you know, if you look at The Home Depot and Lowe's performance in the U.S., their sales down. I think they have a decrease of something like 5%, which is not that bad, but they're used to grow than this. And what we see in Canada is that they still have excess inventory and they have over present inventory as well. So I think -- and we have -- I think the pace is very slow in Canada.

We see that the retailers just -- we see now in the current month that they're starting to buy again because they were rationalizing their inventory. And we're not making any changes, but the favorable situation that we see with the retailers, for example, we have -- let's say, just to give you an example, in Canada, at least one competitor that disappeared because they have been sold, the service wasn't good enough and the customer switching all the products to Richelieu, and we're gaining in the Fasteners business as well, but those gains are slow because month to month, we gained so much customers per month, but that should bring good result in 2022 though.

So in Canada, we really -- we gained market share and in the U.S., we also are gaining some new customers with new products as well. But all these things and it takes forever to make changes in the stores of our customers. We expect that to have a favorable impact in 2024, both in Canada and the U.S.

[Zachary Evershed, National Bank Financial]

That's great information. Thank you. One last one for me. You have the new investments coming online costing about CAD8 million to CAD10 million. You have about CAD6 million a quarter in costs related to the additional inventory that's going to come off as you gradually work through your excess inventory. Is there -- in terms of timing, is there further downside from where we were in Q2 at 13% level due to a mismatch in additional costs coming in versus costs coming out? Or should we see it tick up from here for the rest of the year?

[Richard Lord, President and CEO]

You should see -- you will -- you should not see a reduction in EBITDA margin. So we're working through the external warehousing, so it should -- you should see some improvement on the margin. Slow improvement because it takes time to resolve to clean up the house with the external warehousing, but you should see improvement unless the volume goes down. So it's distribution, you know, how it works, so if volume reduces, the EBITDA reduces, but no surprise on the cost side.

[Zachary Evershed, National Bank Financial]

Perfect. Thank you very much. I'll turn it over.

[Richard Lord, President and CEO]

Thank you, Zach.

[Operator]

There are no further questions at this time. Please proceed.

[Richard Lord, President and CEO]

Thank you very much. Have a nice day.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.