Ferguson plc (FERG) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to the Ferguson 2020 Half-Year Results Call. My name is Felicia and I'll be the operator assisting today. [Operator Instructions]. Please note that there can be a time delay between the conference call and webcast. If you have joined via conference call and would like to view the slides, we recommend you download them from www.fergusonplc.com. I will now hand over to your host today, Kevin Murphy, Chief Executive, to begin. Kevin, please go ahead.

Thank you, Felicia. Good morning, and welcome to this 2020 half year results conference call. You've got Mike and I presenting this morning. Naturally, we originally planned to be in London together during the presentation today with you face to face. On Friday, we decided to change this meeting to a call in light of the coronavirus pandemic. This was really in line with the principles we are operating in the business as we've stopped all international and all non-essential domestic business travel for the time being. As a result, Mike and I are on two different continents. And I hope you'll forgive us if we're a little less polished today, as in recent days we've been 100% focused on safeguarding our associates and operations in the business. So, today, we'll mainly focus on the half one results and the current situation regarding coronavirus. We scaled back our planned presentation on strategy and will present this in more detail at a later date once the current situation is clear. We're also acutely aware that all of you have a lot on your plates too, and we don't want to take up too much of your time. We will, of course, allow plenty of time for your questions at the end. As this is the first set of results since the handover from John Martin, I want to start by saying how proud I am to lead this great company. Some of you will be aware that I've been with Ferguson for over 20 years. I joined when we sold my family's business Midwest Pipe & Supply to Ferguson in 1999. I've been given some fantastic opportunities to work in a wide variety of operational roles in my time. This included 10 years as COO of the company, managing the P&Ls for the various businesses before taking the Ferguson Enterprise's CEO role three years ago. While we're not covering strategy in detail today, I did want to make a few comments on our future direction. Our strategy is delivering. And going forward, we see it as being about evolution, not revolution. This means we will continue to focus on driving all our resources and knowledge to make our customers projects better because they dealt with our company. This is the essence of Ferguson. And we'll provide the best service in our industry based on a foundation of attracting, developing and retaining the best associates. We will be our customers' trusted advisor, giving them unrivaled choice of products, sourcing the leading brands in all of our categories, including our growing portfolio of high quality own brands. We will drive scale in our business, ensuring our customers have access to products and advice where and when they need them, offering them a true omnichannel experience, so doing business with us is as frictionless as possible. We'll use technology to make our business more productive and equip our associates with tools to drive efficiency while saving time for the customer, all the while never being afraid to experiment, innovate and disrupt ourselves. When we return to the normal operating environment, we'll hold an investor day to set out these priorities in more detail and to introduce some of the key leaders inside Ferguson. Given the current situation, we haven't confirmed the date for the event, but we're going to keep this under review. So, first, let me give you the highlights for the first half, and Mike can take you through the numbers. Our financial priorities have not changed. And our track record is consistent with nine straight years of sales and profit growth. As markets moderated last year, we adjusted our business rapidly while continuing to gain share. In the first half, we were pleased to generate 4.3% revenue growth, including 5% in the US, with almost all our business groups and our region's continuing to grow. Given the environment, the team has done well to maximize our top line, while balancing the need to defend our gross margins. Incrementally growing gross margins sustainably over time based on our product strategy and our consultative approach is very important. We strongly believe that gross margin expansion is the best reflection of the value that we provide. Our gross margins were in line with last year. And looking ahead, we feel very good about our ability to continue to drive our margins ahead even when we experience lower market growth rates. On the cost side of our business, productivity will continue to be a focus. We were really pleased with the operational delivery here in the first half. We have tightly-controlled costs, particularly labor, which is 60% of our OpEx base. In doing so, we've been able to post strong underlying trading profit growth, which in the first half was up 4.6%, including 5.7% in the US. It's worth mentioning that the drop in headline EPS growth was expected and was mainly a result of the higher effective tax rate due to the Swiss tax reform. Our business generates attractive returns on capital. It's also cash generative, which gives us the foundation and basis to invest in profitable growth opportunities, both organic and through M&A. Over the past 10 years since the downturn, we've worked hard to maintain a strong balance sheet. This has served us well, and we remain 100% committed to maintaining it. We generated $465 million of cash in the first half and our strong cash position means we've been able to fund our growth plans alongside growing the interim dividend well ahead of earnings growth. In February, we also stepped forward on another $500 million share buyback, which to date we've completed about $100 million. Ferguson is successful because we have the best associates and our baseline commitment is to create a safe work environment for all. We're committed to embedding safety as a core value driver in everything that we do and we've worked hard in the past three years in particular to drive better performance. I'm pleased that our recordable injuries continue to improve, with our group total injury rate and our lost time rate showing strong improvements in the first half. We're making progress in our journey to become first in safety, but we will not be complacent here. We invested $141 million in some great acquisitions in the first half, including S. W. Anderson in New York, which builds out our HVAC offering in this large and attractive market, giving our customers greater choice. We're also very excited to have completed Columbia Pipe & Supply which will build our commercial business in Chicago. The Chicago metropolitan area is the third most populous in the United States, and Columbia is a great fit with our existing business, building out our positions in some attractive cities across the Midwest. Most importantly, we welcome 375 dedicated associates who have developed deep, trusted relationships in the market over many years. Own brand remains a key strategic focus in half one and represented 8.9% of group sales, but the economic importance is about two times that due the stronger gross margin profiles. We've also made good progress in the demerger of the UK, which is on track for completion in calendar 2020. Finally, we've made good progress on consultation with shareholders regarding the listing structure. Shareholders have been very gracious with their time and the board is discussing the feedback. We will set out firm proposals on the recommended path forward later this spring. In summary, we're pleased with the start we've made for the 2020 financial year. With that, I'm going to hand it over to Mike who will take you through the numbers.

Thanks, Kevin. And morning to everybody and thanks for your interest in clearly busy times. I'm therefore going to be somewhat briefer than in normal circumstances. The numbers on this slide are for the ongoing group, being the USA, Canada and central costs. I show the UK as non-ongoing separately and later. You can see we've had a good first six months. I'm particularly pleased with the gross margin progression in the second quarter. That brings the year-to-date performance in line with the last year. Put that alongside good cost control means we've continued to grow our trading profit faster than our revenue. And we've taken further market share in the US. Ongoing underlying trading profit of $747 million, up $33 million or nearly 5%. Headline EPS up 1.6% due to that increasing trading profit, offset by the higher tax rate as previously guided. Balance sheet in good shape, 1.1 times levered at half year. And recommended, the final dividend is increased by 7%, and that reflects our ongoing confidence in the business model long-term through cycle. With regards to that revenue and underlying trading profit growth, I've expanded on this chart the revenue growth of 4.3% and the profit growth of 4.6% into its component parts. You can see organic revenue growth. That grew by 2%, translating to 3.4% profit growth due to good gross margins and tight cost control and acquisitions contributing 2.3% to revenue, growing our trading profit 1.2% with the profit here shown net of integration and acquisition costs. Our largest region, the US, delivered a strong performance. We continue to grow the wider market in the US, deliver good revenue growth. Gross margins, well managed through good pricing discipline and vendor alignment. And we continue to manage cost base in the new lower growth environment that we faced. Underlying trading profit came in at $740 million. That's $40 million ahead of last year, with trading margins of 7.9%. Bottom line growth of nearly 6% exceeds the top line growth of 5%. So, great delivery in that low growth environment. On the next chart, I've explored the revenue growth geographically across the Blended Branches, which is our largest business unit. Revenues up significantly in the East, boosted particularly by the Blackman acquisition, with moderate growth in central and lower growth in the West, which is up against tougher comparators. Waterworks continued to grow well, supported by strong growth in single family residential sector and growth in our HVAC business was good. E-business revenues ahead and industrial revenues lower due to weaker market conditions. Canada continued to face a challenging market environment. Resi markets, which represent about 60% of our mix of business in Canada, remained weak. The combination of lower revenues and slightly lower gross margins all dropped straight through to the bottom line, which gave the decline in trading profit. But I would say that Canada remains a good profit pool for us to get after. Also, the non-ongoing business. And in the UK, markets remained weak. We saw a pleasing performance in the second quarter, with trading profits progressing. Revenue overall for the half declined 3.2% with repairs, maintenance and improve it markets remaining subdued. Gross margins ahead due to both product and customer mix from us walking away from low quality business, with underlying trading profits up in Q2 versus the prior year Q2. We continue to actively manage the cost base in the UK and we announced the closure of the Worcester distribution center in the last couple of months. We expect the UK demerger is on track to complete by the end of this calendar year. In preparation for that demerger, we're pleased to announce that Gareth Davis has agreed to be the chairman of the demerged group upon completion. Gareth, as you know, has a wealth of experience and was chairman of Ferguson plc for the last nine years. We also appointed Simon Oakland as Chief Executive Officer of Wolseley UK in January after a short period at the helm as the interim CEO. Simon brings extensive experience in strategy, finance and operations to this role. He was formerly the CEO of Ferguson's Canadian business, and also head of our corporate development. And Simon Gray will be the Chief Financial Officer once the entity is demerged and is currently the CFO of the subsidiary today. Financing and tax, those charges were as expected. The increase in finance charges principally due to the average level of net debt being a touch higher than the prior half. And also, we have the impact here of $27 million shown separately to do with IFRS 16 implementation. Effective tax rate for the year higher, as we've already said, due to the Swiss tax reform. Cash on the next slide, I've set out on a pre-IFRS 16 basis, so we can all make sense of it and assist comparability. The reconciliation to the statutory numbers is included in the appendix on the website. We had good cash generation, good disciplines around cash. These continue to be an important quality of the business and the priority for the business. Cash from operations, you can see $465 million. That's after seasonal working capital outflow of $381 million. CapEx, a little lower than last year as the comparator carried the additional investments in the Perris distribution center in Southern California. So, that's now up and running. And you can see the $141 million investment we made in bolt-on acquisitions in the first half. That clearly doesn't include Columbia Pipe & Supply, which Kevin talked about, because that happened after the period end. We also returned through $350 million of capital to shareholders, which you can see there in the form of buybacks. That was completed. That was the completion of the one that we announced last year. The current $500 million buyback, which was announced on the February 4, as Kevin has said, we've completed about $100 million as we all gather here today. In terms of capital structure, that means we finished the period with a strong balance sheet, good liquidity, net debt to EBITDA of 1.1 times. We're clearly in a good place with liquidity and a strong balance sheet as we are enter the world which is clearly in an uncertain phase right now. Lease liabilities, I've included under IFRS 16. They're $1.4 billion. If you added those in and calculated a new net debt to EBITDA ratio including those, that would give a ratio of 1.6 times. So, moving on to technical guidance, most of our guidance remains unchanged from six months ago. We have an additional day – just to remind you of – in Q3 trading. I've also included and updated the acquisition number. Revenue guidance is up. That's mainly due to the Columbia acquisition, but the profit from Columbia is likely to be offset by integration costs in the remainder of the year. So, no movement on the $20 million trading profit guidance previously given. CapEx guidance here is under normal circumstances. I think you might expect that to be a touch lower depending on how the world turns out over the next few months. And I'd expect exceptional charges of approximately $50 million, with the increase from H1 driven principally by the UK demerger costs. Tax, interest and CapEx, all unchanged, as I said. So, a good set of numbers for the six months. Trading was clearly in good shape. We were about to reaffirm guidance and clearly we need to come on to the outlook, which Kevin will touch on as I hand back to him. Kevin, over to you.

Mike, thank you so very much. Over the past 10 years, the group has exited a number of non-core businesses and we now have a much stronger, simpler, more focused business, with excellent positions in some very attractive markets. When we complete the demerger of the UK this year, we'll be focused solely on North America, with excellent positions in markets where we're well equipped to win. We're in great shape to capitalize on the opportunity to consolidate these markets, particularly in the US, and gain market share profitably. We now have a clean business and can concentrate solely on converting this large and attractive opportunity. Our industry is fragmented, which does create opportunities. We first focus on organic expansion and then selected bolt-on acquisitions across all of our business groups. We generate benefits of scale in areas like distribution, in technology, strengthening customer relationships that are uniquely local. We are always focused on ensuring the best human relationships exist together with the best digital relationship. As well as the group being more focused, today we also have a much more balanced business in the US. You can see from the chart on the right that we're much more focused on repair and remodel today than at any time in our history. This makes us a much more resilient business going forward. As an example, our Waterworks business pre-2008 was heavily focused on new single family residential construction work as there were 2.2 million new housing starts at the time. Today, we have a much more balanced business and we compete in a number of areas in addition to new residential construction, including commercial, public works, municipal, water and wastewater treatment plants, meters and metering technology and soil stabilization. This change in mix is represented across all of our traditional business groups. I know you've seen this chart many times before, but it is a great reminder of the opportunities that we have in the US, and more importantly, how we focus our teams on the very specific needs of these customer types. The chart shows our non-strategic business groups with our estimated market share in each bar. The important area of the chart is the gray portion of each bar, which shows how fragmented our markets are and how large our market opportunity really is. All of these verticals are attractive and we generate strong growth in returns in each one. We serve over a million customers that rely on us for high levels of availability on a broad range of products that are ready for pickup and delivery when and where they need it. We have approximately 42,000 suppliers that give us access to a broad range of quality products. While these products are incredibly important, an equally essential part of our value proposition is the expert knowledge that our associates bring each and every day. We are a relationship business. We aim to provide our customers a consultative experience, striving to be their trusted advisor that represents the customers' best interest across all our product brands to deliver their project. Our logistics network connects these suppliers to our customers. And as such, we need to be our suppliers' best path to market. Our customers interact with us through multiple sales channels on a 24/7 basis, which is often a combination of branches, showrooms, transactional website, call centers, inside sales teams and outside sales professionals. This omnichannel approach allows our customers to access products and advice wherever and whenever it's required. The branch remains the focal point of our operations, with 1,500 branches in 50 states, driving over three quarters of our revenue from a pickup and delivery standpoint. The differentiated service offering happens at multiple levels inside the customer journey. Our people will work to offer an error-free takeoff service and the industry's best quotations, which are helping our customers to build their jobs. From a sourcing standpoint, we will represent a balanced product strategy to ensure the best gross margin profile for products that are also the most appropriate for the customers' design. We offer a customized solution that helps customers in the construction process, saving them time and money. We offer same day next, day delivery of the broadest and deepest range of products in the industry, bolted together with technology solutions that will deliver true project management. These services are even more important today in what is a severely constrained labor market in the trades. So, in summary, Ferguson is a simpler, stronger and more profitable business today. We're focused predominantly on North America, addressing a large and attractive market with leading market positions. Our customers operate predominantly in the repair and remodel space, and we have an advantaged business model, which is and has evolved in line with our customers' needs. We have a clear strategy, which we're executing at pace. As we sit here today, we feel very good about the long-term prospects of the business. Let me switch gears and give you an idea of what we're seeing in respect to short-term trends. We are very pleased with our first half results in our delivery. And since the start of our second half, we had really strong momentum in the business. Our markets were steady with good single family residential momentum. Our open order volume was growing and it sat at record levels. Revenue growth in February and March was good and growing. The situation surrounding COVID has placed us in unchartered territory, making the outlook quite difficult to predict, which I'll come to in a minute. We're still early in the crisis, but I wanted to give you a feel for some of the actions we are now taking inside the business. First and foremost, we're looking after our associates. We are taking social distancing very seriously to protect all our associates and our customers, as well to do our part to mitigate the spread of the virus. We, therefore, are implementing plans for any and all branch associates who can work remotely to do so. We must spread our associates base as best we can. We've implemented a remote work policy for our national sales center and our headquarters associates. We have implemented an international travel ban and all non-essential travel domestically. We've detailed business continuity plans, which we're reviewing constantly to ensure that we can secure products, operate DCs, ensure pickup and delivery, collect cash, and operate our sales order channels, including branches, which our customers rely on. We take great pride in the fact that our operations play an incredibly important and valuable role with our customers. Our communities and industry rely on us, particularly in the area of repair and replacement. We take this very seriously. We're aggressively promoting the use of a Ferguson mobile experience for our customers, which we think will be an invaluable tool, most notably in the current environment. We feel good about the cost side of our business, particularly labor, and we'll stay very close to the cost base in the coming weeks. For now, we'll be mindful about capital decisions including M&A and we'll be measured on a capacity expansion decision. So, moving to the outlook, given the strength of the first half numbers and the good trading momentum that we had into March, we intended to confirm our full-year trading profit outlook for 2020. It's just too early to understand the impact on current trading from COVID-19. It's a dynamic situation and recent impacts of government actions to contain the spread of the virus and societal reactions, alongside any potential actions we will take to mitigate them, are not reflected in the existing forecasts and it's just too early to quantify them. Ferguson remains well positioned for long-term success operating in attractive and fragmented markets, with a robust business model and backed by a very strong balance sheet. In summary, sat here today, our business is in good shape. We're pleased with the operational delivery, given challenging markets, and we'll continue to focus on execution. There will be no radical change in our strategy. We're working hard on the UK demerger and expect to complete the transaction this calendar year. You should expect to hear from the board later in the spring on the subject of listing domicile. And we'll manage the business very carefully in the short term as the impact of COVID-19 unfolds. I want to thank you for your attention. And now, Mike and I will be happy to clarify anything that's unclear, take any questions and comments that you may have. Operator? I'll hand it over to you.

The first question we have from Paul Checketts from Barclays Capital. Paul, Your line is now open.

Morning, guys. I've got three questions, please. Kevin, if you looked at the 60% of sales that is RMI, to the extent that is possible, how do you think that would split between repair, maintain and improve? I ask because I guess there are varying degrees of discretion within that customer spend. That's the first one. And the second one, if I look back over the last eight years or so, you've typically outgrown peers by about 2% to 4% on the sales line. How do you think that will behave in a downturn? And to what extent will the strategy allow you to capitalize on the strength of the balance sheet? And then lastly, Mike, could you just give us a run through of where you stand with regards to liquidity, please? Thanks.

Paul, can I trouble you to repeat the second question? We're having real trouble hearing you.

Yeah, certainly. Let me try this. Is that better?

Yes. Thank you.

Okay. Yeah, the second question I was asking, if I look at the sales performance versus peers over the last few years, I sort of come out at a level that where you've outperformed them by about 2% to 4% in terms of sales growth per year. How do you think that would develop in a downturn? Do you think you'd take more share? Was it about the same? Perhaps you could flesh out how the strategy could change and how you might fare compared to others?

Yeah. Paul, thank you for the question. I'll start with the RMI side from a 60%. perspective. Yeah, that split is difficult to get at in terms of what is true break, fix versus what is renovation and pure repair model. Now, the good part about that is, from a contractor base, whether you're talking about waterworks, plumbing, commercial, there is fluid movement in terms of what work those contractors can do and many shift what their focus is depending on what that available workload is. And so, it's tough to get at in a pure product sense, whether you're talking about digital channels or whether you're talking about pure play branch order channels. But like I say, the good news is that momentum can shift as the market shifts over time. I think as you look at – the second question in terms of market outperformance and sales growth, probably get at that a couple different ways. As we look at the first half, I think we did a good job of balancing over market growth, gross margin, especially in an environment with tariffs and with commodities moving to deflation and just making sure that we delivered on the value that we provide and then also making sure that we had good cost base actions to make sure that we deliver trading profit growth ahead of sales growth in a slow growth market. As I think about us in a downturn, and I look back to comparisons in 2008/2009, I really am pleased with where we are from a balance sheet perspective and our ability to go out and grow over market with good solid inventory positions and a solid branch network nationwide and our ability to continue to take share as we move through a downturn and then exit what will hopefully be more of a V-shaped recovery. So, I'm actually more bullish on our ability during this downturn than if I reflect back to my time with 2008/2009. If that answers your questions, I'll turn the third one over to Mike on the liquidity side.

Kevin, thanks. Yeah. Paul, on liquidity, again, I'd echo Kevin's comments. We feel in a good place, strangely not knowing what the future holds. Why is that? Because we've got a good business model, great management, and we're well placed when the recovery comes. That's why we're looking after our associates today and our customers and the societies we operate in. It is fundamental that we do that. In terms of your question on liquidity, we have around – and I'll keep the numbers approximately right to make the note-taking easy. We have approximately $4 billion of facilities. About $2.5 billion of that has no financial covenants on it. That is made up of an RCF of $1.1 billion. That's a facility that we've just signed. That replaced the old £800 million facility. So, that $1.1 billion RCF is a 5 plus 1 plus 1 facility. No financial covenants. We have a receivables facility of $0.6 billion. That's December 21, but gets refreshed regularly and is clearly to cope with our working capital peak to trough and we have the USA bond which is $0.75 billion. That's 2028. Okay? So, $2.5 billion of no financial covenanted debt. And then, we have about $1.5 billion of USPP. That has a variety of maturities up to 2027. That does have a leverage covenant on it on all of those different maturities of 3.5 times. In terms of debt maturity, if I can just sort of move to maturity and away from your liquidity question, the only maturity we have coming up in 12 months is $281 million of the USPP that is due back end of this year. You can tell by the size of facilities, and if you look at our net debt, which is under 2, we clearly are in good shape to repay that and cope with not only the uncertainty that I think the world could throw at us, but also to be in a good shape, Paul. I think job sites will reopen. I can't tell you when. If you can tell us, great. But it is really, really important for our customers and our business and the longevity of this business that we keep this business in really good shape, so that when the locks come off the gates, we are there ready to get going again and take advantage of this and be one of the stronger ones when those locks come off the gate. So, that's how we're thinking about it, Paul. And therefore, if I could, just touching on Kevin's point, and I'm sure he may want to expand, certainly, in the next little while, we're not going to be running this business to – I've seen some people this morning sort of stripping costs out the business and we're not going to be running this business to deliver a Q4 number. We're going to be running this business to be a strong business and supporting our customers and associates. So, now, clearly, we'll keep that under watch as the world changes, but right now we are feeling in a good place, liquidity, balance sheet and strength of business model. I don't know if you want to touch on that, Kevin.

Yeah. So, if I think about where we are today, the business from a cost base perspective is in a very good place. And to Mike's point, we need to make sure that we're very measured in terms of what that looks like as we go through Q3, Q4. So, today, in the US, we're actually down 2% in full-time headcount versus prior year, with good solid organic growth rate. And if I think about the progress that we made coming out of or into the second half of the year, as I said, growth rates were quite solid. And even through Friday of this past week, good solid accelerating growth rates. Now, we know that things are going to change, to Mike's point, about shutting down job sites, just availability of people versus self-quarantine and the actions that are happening inside of society. But generally speaking, the health of the business is in a very strong place right now.

That's great. Thanks. Very clear.

Our next question comes from Paul Roger from Exane BNP Paribas. Roger, Your line is now open.

Hi. Good morning, gents. Thanks for taking the call and obviously for hosting the call in these circumstances. I think I'll probably just have two questions. You've talked a bit there in the answer about potential contingencies and not wanting to do anything for just the short term. But, presumably, you have given some sort of thought to what happens if it is quite a severe downturn. And I wonder if you can just give us a bit more detail maybe on the type of actions you could take, not necessarily just on the FTE headcount, but maybe also thinking about things like CapEx, potential working capital where obviously you did a very good job in the last crisis. Is there scope to cut that? So, just give us some idea about how Ferguson might respond. And then, the second question – and again, don't want to be too bleak here. But, obviously, nobody really knows what would happen with the virus. Just wonder if you've given any sort of sensitivity on the impact of weaker demand on profitability. And maybe, for example, you can give us an idea of what you think a 10% drop in volumes could do to trade and profit when it comes to the operating leverage and everything. Thank you.

Yeah. Paul, why don't I start with some of the sort of financial answers, so I won't be too nerdy, hopefully, and then Kevin can talk about some of the actions as we think forward. Paul, in terms of CapEx, short term, life is clearly about all the things we've talked about. We'll take sensible actions on CapEx. If you think short term, we've guided to $300 million to $350 million. Could that be – we've got some capital commitments. We could probably take $50 million off the lower end of that guidance if we have to. But, again, we'll just need to be measured. And again, we always say maintenance CapEx for this business. And again, sort of depends how hard you yank the lever in truth, Paul, but if you had to, you could model $150 million next year. But it sort of depends on severities. Again, we're very cognizant, it's early days yet, and we've got a good business. In working capital, I think normal cycle, I think, as you know, Paul, we would absolutely expect working capital to flow back. I think the interesting one with this downturn, different to the two others that, certainly, myself and Kevin have dealt with in the past, this one could be pretty sudden pretty quickly for a period of time, and then snap back very quickly. That's quite different to most economic cycle downturns and recoveries. You generally go sort of a bit slower in and a bit slower out if you sort of take my drift. Therefore, again, if I oversimplify, our debtor book and our creditor book is pretty balanced. It's inventories really. And again, there's a balance there of making sure we have the right inventories when the sites opened for our customers. But you might not see inventories drift down as quickly, and therefore, you might not get as much cash flowing in if jobs just stop. So, I think inventory is a bit of a hard one to know. But, again, it is our job to manage that balance sheet to make sure we've got cash coming in if we need it, if the cycle is worse, but also that we're well positioned as that recovery comes through. I think in terms of modeling the business – and then I'll hand over to Kevin – we've talked about this before, Paul, you can run the math. What we've seen in the past, you run 10% off our top line. Again, keep it really simple. If you take the top line of $20 billion of sales, take 10% off of that, take a gross margin of, call it, 30% to keep the math simple. We've said in a sustained downturn, of which that is yet to be proven, we could take about half of the costs of the loss of gross margin out. So, if you've done the math, you lose about $600 million gross margin, about $300 million of costs come back, you clearly get your tax back. So, that's about a third of the $300 million. So, you're left with sort of a $200 million on earnings. However, your cash is much better because, again, if it's sustained downturn, you will get working capital coming back at you, you can control your CapEx. And I haven't even talked about reducing M&A spend because, again, I think that strangely if you're a bit more positive today than most people are in the world, M&A might be an opportunity as the world self-corrects, and we clearly want to be well-positioned for that. So, those are the sort of normal numbers, Paul, on a 10% downturn. I'm not sure we're in a normal economic cycle here. It doesn't feel like that to me in terms of slow out and slow back. But none of us really know that. So, I think keeping a strong balance sheet, keeping a level head, doing the right thing for the long term is what you're hearing from us today. Kevin, do you want to touch on some of the other actions we could take and how are we thinking?

Sure, yeah. And, Paul, thank you. Pleasure to have the call today. Thank you for joining us. I know this probably goes without saying, but feel the need to. The first thing that's on our mind right now is the care for our associates and they have delivered for us, they continue to deliver, this is a people and relationship business at its core today. We'll bridge this with a digital relationship ever more so by the day. And quite frankly, this is a good time to be even accelerating what that marriage of a digital relationship and a human relationship means. If I think about where we sit today, as indicated, I feel like the business was good and solidly fit for purpose as we even went through, like I said, March 13. You look at the organic revenue growth inside the US at 2.6%, but delivering 4.6% trailing profit growth, it was good delivery on a good cost base. Now, that said, as Mike indicated, we clearly would look at from an OpEx perspective, what that labor looks like CapEx, M&A, working capital, and all the things that Mike touched on already. How do we think about understanding what that recovery is going to look like, what the downturn is going to look like? I think this one is different, as Mike indicated. We certainly want to judge what's happening from a time perspective. We want to understand what's happening in our sales per day. To Paul's earlier question, how much of that business inside the RMI sector is moving towards break, fix and what that impact on the top line is. We're going to keep our ear very close to the market, market by market, business by business, to understand what's happening in construction activity. Things are happening at a very quick pace today. We heard that Boston, for example, was shutting down construction sites effective immediately. Those kinds of things are happening, but they're not happening everywhere. And so, we're wanting to make sure that we understand exactly what's happening. That said, if we do find ourselves in a more prolonged downturn, if the recovery is going to take substantially longer, I think that you've seen, historically, our ability to take action inside the United States, particularly. I think if you look back at 2008/2009, in terms of what we were able to do with working capital, what we were able to do with our labor costs, what we were able to do with our location count starts to point to the direction that we can react and will react quickly. Additionally, if I look back at what happened half one last year. And our growth rates in the market slowed substantially. And we had originally thought that it was a more weather-related issue. Learned very quickly that it wasn't, that it was more market. And as our market drifted more towards a flat result, we took action on the cost base, right-sized the business and were able to deliver trading profit. So, I think we've shown historically that we can get after that. We're in a better position today because of the strength of the balance sheet to outperform, but we'll take action as we need to when we go through this downturn.

That's great. Thanks a lot. And take care. And all the best.

Thanks, Paul.

The next question we have is from John Messenger from Redburn. John, your line is now open.

Hi, thank you. Can you hear me okay, Kevin, Mike?

Yeah.

We can, John.

Sorry, three, if I could. One, you just gave a bit of a flavor there, Kevin, in terms of Boston and how the authorities are behaving on this. Just give us a flavor, what is the kind of behavioral impact on what's happening onsite in terms of difference between, say, an industrial and multifamily versus single, your industrial locations, I guess the non res? I assume things like hospitals and schools have pretty much closed off to you. Just to have a bit of a flavor, are certain locations kind of continuing as normal? Or is this impacting everywhere? I'm just thinking outdoor work maybe carries on, indoor does not, just a bit of a flavor there if you could. Second one was just on – you typically have a seasonal workforce that comes in, I guess, really from now through – to cover you through the summer months. Would it be fair to assume that, I guess, all of those additional hiring things are effectively off, which will take out some of your extra normal cost profile across Q2 and Q3 – sorry, Q3 and Q4? Just to understand if there are things that should already start to get through and that clearly you're not going to put more cost in right now. But in terms of some offsets, is there a seasonal factor that we should all bear in mind that gives you a bit of resilience in Q3 and Q4? And then, the final one, you mentioned 8.9% as the own label. Clearly, it's a big ingredient for the future. Can I just understand where was that in the half year a year ago? What do you think is a own label future profile? Is it 15% of sales that one day you think you could work towards or is that maybe going too high, Kevin? Thank you.

Great. John, thank you. And, Mike, feel free to jump in as I go through these three. First of all, what's happening in the market and what we're seeing behavioral impact, multi versus single commercial how we're thinking about that, I guess, what I would say to you is that there is no real consistency across the US, both outdoor versus indoor. What we are seeing in consistency is more on the industrial side, as you might imagine, in terms of making sure that they are containing their facilities and some work is slowing from that perspective. In fact, we've had an industrial contract where we're working through some things and we had to pause because they're producing products for coronavirus testing and we needed to – they need to focus 100% of their efforts on production. So, we're not seeing a tremendous amount of consistency. And it is happening in a very dynamic way. But like I said, even through Friday, we saw good sales growth, not just maintenance. And so, there is activity that's still happening. We just are keeping very close. With every one of our business groups, all nine of our business groups, and all of our regions, we have a daily feed that we work through to understand what's happening in the market, what are some things, job by job, so that we can understand where we're at and our managers can understand what they need to do in terms of staffing levels and what they need to do in terms of social distancing and how they can spread their workforce. So, it really is a very granular and very focused effort. But right now, it's a bit too early to tell what we're going to see in terms of project work because of that lack of consistency. What we are seeing is some good solid instruction by the general contractor community and what's happening onsite in terms of maintaining a safe environment and making sure that we mitigate the spread of disease. Really detailed descriptions of what work rules need to look like. I can't emphasize enough that we believe that our branch network fulfills an essential purpose in the marketplace. So, just as recently as yesterday afternoon, we saw some activity in the Northern Cal, San Francisco area around shelter in place and what is considered to be an essential business operation. One of the carve-outs that I saw in that note was hardware and plumbers. And so, how we fit into that local landscape is critically important; at the same time, maintaining health and safety for our workforce. In terms of seasonal and how that workforce add would happen, I think suffice it to say we are going to be very, very cautious. Our first and most important area focuses on our existing associates and making sure that we have continuity plans for that group. And so, I think you can assume that we will be very cautious as we enter the spring and summer selling season to make absolutely sure that we've got a good path forward and an understanding of where the market is going before we add additional labor. In terms of the own label and the growth rates and where we're going, from a growth rate perspective, we focus on making sure that we grow at to 2x what the Ferguson core growth rate is. And we're in excess of that today. But I need to emphasize, it is a balanced product strategy, John. And so, when we look at this, we work with our branded manufacturers, which are 90% of what we do today, to make sure that we have exclusive SKUs, licensed SKUs, we have areas of focus from a product standpoint where we grow faster than market, we both share in what that reward looks like. And the most important thing is that we continue to develop a workforce that can go out and guide customers as to what product is best for their job and also best for Ferguson. And that includes own brands. Do we put a cap on it? No. But it is balanced with that branded supplier that is such a key part of our relationship in the marketplace today. Does that get at what you were looking for, John?

Yeah, absolutely. Many thanks, Kevin. And best of luck to you all. Thank you.

Thank you very much.

The next question comes from Keith Hughes from SunTrust. Keith, Your line is now open.

Yeah, thank you. Two questions. I guess, first, I totally reflect your comments about different the reaction here in different cities in the US. Can you just give us an idea – are there certain parts of the country, the US or in Canada, that you overweight to their economic activity where you just have more business and will be more affected as things get worse there?

If I just take the United States – because if I look at Canada, we've got good growth opportunities inside of Canada and we are going to be focused. And I pick this in a balanced way with what's happening with the virus right now and what's happening from a reaction. But in Canada, we've got some good profit pools to go after. One of the areas that we have not been as good in is in, for example, the high rise residential market in Ontario. We need to make sure that we're better equipped for that. But it is very much a growth story as we come out of whatever impact the virus will have in Canada. It will be a focus on growth and over market growth. As I look south of the border in the US, we really look at what our market opportunity is even down to the granular level, Keith, of the zip code. In terms of what hot markets are out there and where we think we can make some good growth, as you might imagine, some of the high growth areas from a state perspective in California and Texas and Florida and the like, are good growth markets for us. Florida has been very solid. And in fact, to this point, our Florida growth rates across all of our different businesses have been very solid through the middle of March. And so, that will prove to be a good solid growth area for us as we go forward. But the way in which we approach it is, we look at what our market shares are really by the zip code, by the type of business that we're addressing, and we know what opportunities we have to grow organically. How do we add people and skills? How do we add potentially branches? And then, how do we augment that with M&A? But really, we're going to need to keep our ears very close to the market as we go forward to understand where some opportunities are to add some resources.

So, I think if I read through your answer, your penetration in the smile states is probably greater than it is in the northeast. Is that a fair statement?

Yeah. And it really, again, depends on the business, for example. New residential construction, we're going to have a good focus on that Florida market. We've got some good growth opportunities in Texas. We've got some great growth opportunities inside of our HVAC business where we still have a tremendous amount of opportunity for growth. And then, Keith, you look at our facility supply business, we still have negligible market shares, and it's growing at a fairly substantial pace for us today. It's a bit more recession resistant than the rest of our businesses. It's got a good gross margin profile, and we've got a tremendous amount of runway to expand. So, it really does depend on each of the businesses.

Okay. And second question, your organic growth in the United States was 2.1% in the quarter. It had been running about 3% for the last several quarters. So, I guess, my question is, number one, you talked very positively on February/March sales through last Friday, understanding that's probably going to change. The number the last six weeks, was it above that 2.1% in the US?

In fact, it was accelerating. And that's why I say, absent coronavirus, we were sat here looking at residential permit activity, new residential starts, open order volume and backlog, sales per day activity, sales force momentum in the marketplace, we were ready to charge ahead. And granted, this is my first time talking with you on half year results, but I tell you, we had great momentum and felt very good about the health of our business during the first half. I think we did a very nice job across our businesses making sure we maintain good cost discipline, good gross margin protection, while we gained share. I felt very good half two about our ability to stretch our legs. We just have to now see what this impact is going to be from a coronavirus perspective and how quickly we can get back to work in the country, so that we can start rebuilding America. And quite frankly, feel pretty well positioned for that. Just hope we can get through this very quickly.

Right. And I'd sneak one more in. On China – sourcing from China, was there an impact in the numbers here – or what you saw in February, any delays on product, higher cost, things of that nature that played a role in the numbers?

Keith, I'm sure there wasn't. Interestingly enough, we were really focused on what was going to happen from a China perspective. As you know, 9% or so of what we do is own brand. We had good solid inventory positions as we looked at Chinese New Year and we got our – our partner manufacturing facilities were back on track. And even though, in the very near term, following the outbreak in China, we had some problems from a trucking standpoint, specifically northern China, that got fixed and righted pretty quickly. And so, from an inventory perspective, both branded and own brand, we felt like we were in great position. This has obviously changed from a supply chain concern story and from a supply side to a demand concern. And so, no, we feel very good about product availability right now.

Okay. Thanks very much.

[indiscernible] cleaning supplies.

And toilet paper probably. Thanks.

That's exactly right. Our facilities supply business on the JanSan side of the world is a bit stretched right now.

Thank you.

Operator, we're approaching the hour mark. I think we've got time for one more question. And I would say to everyone who sent questions in on the webcast, we're sorry we're not going to get to those today, but we have got those and we will come back to you. If you do have any follow-up questions, please contact Mark and the IR team, they'd be happy to answer any questions throughout the rest of today. So, over to you, operator, to introduce the last question.

The last question comes from Kathryn Thompson from Thompson Research Group. Kathryn, your line is now open.

Thank you for taking my questions today. Three questions for you. And I'll give them in order. First, could you explain Waterworks as a leading indicator and give a further explanation of the projects and/or geographies that are helping to drive this growth? And how much visibility you have in this segment? Second, could you explain better how we should think about costs, even absent global dynamics that we're dealing with right now, particularly as we look into the second half versus the first half? And then, finally, and perhaps the most important question, you definitely have touched on the 2008 crisis and how you're better positioned today versus you were then. But maybe could you pull the string a little bit more for a deeper comparison and contrast, helping us understand that you are supporting the parent company with star [ph] free cash flow at the time? What are you planning? What are the first priorities for you in this recovery, assuming that it happens in terms of either putting capital towards buying back stock or buying companies or really your capital allocation priorities as we muddle through this global crisis? Thank you.

Kathryn, thank you. Great to hear from you. I think maybe I'll lead off, Mike, and then you jump in as we get down towards three or – certainly, stop me. Waterworks in terms of being a leading indicator, we have a very good balanced business inside that waterworks customer type. If you look at where we are today, it really is, as I highlighted earlier, new residential construction, subdivision work, it's commercial work, it's public works infrastructure projects, municipal spend directly with public water authorities, meters and metering technology and geosynthetics and soil stabilization. If I think about where the growth was coming from, we had probably the best momentum. And some of this is anecdotal because our contractors, as I indicated in the very first question to Paul, our contractors move from project type to project type and can shift what their impact is or their emphasis is. But it was good, solid, single family residential new construction work, which gave us additional confidence in what was going to flow down the line in our residential trade business. And that was really broad based. It was across most of our markets where that subdivision activity was happening. And again, the good part was it was balanced with our municipal and public works spend. So, we really focused on making sure that in the individual geographies, when we have good residential new construction work with our Waterworks business that that information, that connection flows together with our new construction residential trade plumbing business, our showroom builder business, our HVAC business as that need for product flows through the construction supply chain. On the costs, half one/half two, clearly, we have a better comp profile, given the slowdown in our market growth rates as we walked out of half one of last year, but we still need the growth on top of that. I don't know, Mike, if you want to comment on anything from a market comp half two standpoint at all.

Really just to reiterate, we were in great shape. We'll have to see how it now plays out. But as Kevin said, we had a – I love the phrase, we were ready to stretch our legs. I like that one. We were definitely ready to stretch our legs into the second half. Clearly, we need the full support right now.

Kathryn, Mike says I speak American. So, he sometimes likes those phrases. From an 2008 crisis position, compare and contrast, yeah, I think we're in a very, very different place. So, if I look at when we walked into 2008, 2009, we were coming off of a very strong new residential growth inside the US. I highlighted earlier the 2.2 million housing starts in the US as we started to walk into 2008, 2009. We were also very much focused as a new residential construction company. We are clearly a different organization in terms of what that balanced business mix looks like today, and I feel very good about where we sit with that balance and that diversification. In terms of where we were from a balance sheet perspective, we were in a different place. I think that a lot of our associates understood what net debt to EBITDA 3.5 times net and what are the actions that were taken pre-2008/2009 versus where we sit today with a good solid balance sheet, good solid liquidity and our ability as we go into what perhaps will be a downturn, perhaps a bit more sustained, although that is way too early to tell. We will be able to focus on making sure our branches have good organic growth capabilities. The last time we went into a recession, we were a bit heavy in terms of what the people side of the business was. Last time when we entered the recession, we had an extra 30 days in the cash to cash cycle. We're a more fit for purpose business. We are going to make sure that we have the right levels of inventory to grow organically, which is our first capital priority. We need to make sure that we continue to grow the dividend, in line with earnings growth through the cycle, which is second. We will have the opportunity as we come through this cycle to do solid both-on M&A as well as M&A that gives us capabilities, that will really enhance what our branches are able to do, that will enhance what our digital channels are able to do. And then lastly, as we have surplus capital, we've shown that we will return that to shareholders promptly. So, that's the way I look at it today. I think we're in a much better position than we were entering 2008/2009. And we just need to stay close to the business as we go through this very different situation.

Thanks very much.

Operator, I think that's it.

There are no further questions.

Yeah. Thank you very much for the time today. Very much appreciate your patience with Mike and I. We never intended to be on two continents for my first half one. And so, appreciate the time that you've spent with us and we'll be glad to follow-up with any questions or concerns as we do a more technology-related roadshow. Thank you very much.

Ladies and gentlemen, this concludes today's call. Thank you all for joining. You may now disconnect your lines.