Ferguson FYQ2 Performance Insights

Last week Ferguson shared their FY Q2 performance, which was the equivalent of Q4 2022. Not surprisingly, given the Fed’s interest rate hikes and the resulting impact on the residential market, Ferguson reported deceleration in its sales growth.

After all, continuing to exceed performance over the past few years, given the confluence of supply chain issues, price increases and market activity, was not expected. Their FY Q1 (or 2022 Q3) of 16.6% still was a torrid growth rate.

Report highlights

Net growth, across all segments, of 5.4%, however, over half of this (2.8%) came from acquisitions. So, revenues were flat. Realistically, units were down or flat, so they are benefiting from price increases.

And, it is hard to expect that they lost share, nationally, so, the inference is the remainder of the market is flat to down.

In their report,

• 54% of their business is focused on the residential market, and this business was up only 1%!. With the Fed continuing to increase interest rates, this could be a harbinger of things to come for Ferguson and many competitors. If you’re resi focused, expect a tough year unless you either are in a geographic area having growth, focus on the remodeling / renovation market or have targeted initiatives focused on taking share.
  • 6% of Ferguson’s overall business is direct to homeowner / consumer business (or DIY)
• The other 46% of Ferguson’s business is non-resi, which had an 11% growth. Their commercial market makes up much of this segment and had 9% growth.
• Interestingly, overall, gross margin declined from 30.9% to 30.4%. Is this due to a more competitive market? Inability to pass on price increases? Inability to “add” to price increases? Or perhaps just timing of booking rebates? Further, their adjusted operating margin dropped from 10.2% to 9.8%.
• 5% of overall sales are “Ferguson’s brands.”
• Their 5 most recent acquisitions have annualized revenues of $330 million.
• With its cash flow, which is a significant competitive advantage given that they are looking to spend $400-450 million in capital expenditures, the company is investing into distribution centers, technology, branch expansion and branch remodeling.
  • The company MDC (or an RDC) will be Denver, Phoenix, Houston, Dallas, Washington DC, and Nashville.

Specifically relating to HVAC, this segment is now 11% of their US sales … and growing as well as being an acquisition-driven element of its business. Ferguson believes this is a $70 billion market, that it has 5% market share (hence annualized revenues of $3.5 billion) and is the #3 player in the market.

In their investor presentation where they highlighted market potential and where they see long-term growth, one of the areas they mentioned is legislative acts, which we recently commented on and encouraged distributors, and manufacturers, to seek to optimize their marketing efforts around capturing OPM (other people’s money.)

Ferguson 10-Q Reveals

Given the highlights, I decided to dig into their 10-Q to see if could find additional insights that could be beneficial for you:

• 95.3% of revenues were generated in the US and US operations generated 97.6% of adjusted operating profit. The remainder was generated in Canada.
• Acquisitions during the six months ended January 31, 2023 included:
  • Monark Premium Appliance
  • Guarino Distributing Company
  • Airefco
  • Power Process Equipment
  • Pipelines, Inc

The total investment for the $330 million in revenues was $200 million, of which $53 million was considered “Goodwill”.  89.5% of the acquisition consideration was paid in “cash” with the remainder being deferred consideration. This provides those considering selling some perspective on the model for deals.

The HVAC market is a principal focus for Ferguson. They have identified that there are 65,000 dual trade plumbing and HVAC contractors across North America. This is one of the reasons for the Airefco and Guarino acquisitions.

• The company estimated that price inflation was approximately 10%. Given the low single digit sales increase, net of acquisitions, this infers that unit growth declined.
  • About 15% of the company’s business is “commodities”.
• Given the performance of the residential market, and at least the short-term outlook for the residential market, and Ferguson’s cash flow, which enables it to self-fund acquisitions, it would not be surprising to see Ferguson continue to make non-residentially-oriented acquisitions as well as acquisitions that can benefit from the various Legislative initiatives / rebate program and the Infrastructure bill … so, the HVAC market as well as waterwork and PVF distributors.
  • Some key non-resi end-user markets for Ferguson are electric vehicle, battery, LNG, pharma, semiconductors, refinery turnarounds, downstream chemical, and mining. The company is positioning itself as a One Ferguson approach to these types of owners / contractors.
• Look for Ferguson to “manage it’s labor base” in the coming year. While it will probably make targeted investments, given that it is a publicly held company that will be faced with a tough market and probably declining sales due to the residential market, and the need to meet goals coupled with increased wages, it would not be surprising to see, at least, selective “pruning.” Independent distributors should be on the lookout for “talent” that could benefit them. Further, the companies that they acquire will probably undergo “personnel synergization” to obtain efficiencies. Just some food for thought.
  • During the Q&A with analysts, Ferguson said it has started to reduce headcount and looks at it on a FTE basis, hence reducing overtime first, reducing temp workers and then attrition before undertaking proactive personnel reductions.
• Ferguson’s residential growth came from the renovation market and should be a signal to others to focus on this market. The resi growth over the past 3 months (through January) was only 1% whereas for the 6 months ending January it was 8.1% … a significant drop in the “growth” rate. The non-resi decline was less steep (up 10.7% ending 1/31/23) versus 15.5% for the preceding 6 months.
  • Ferguson shared that only 18% of its business is related to the new residential market.
• Ferguson put increased focus on improving its working capital management, “particularly inventory and receivables.” From speaking with manufacturers, they are seeing a reduction in stock inventory orders. This could be distributors working off inventory that they acquired based upon supply chain concerns; it could be reducing inventory from “back-up” suppliers. Further, as business declines, distributor ERP systems recalculate min/max levels and order accordingly. There is typically a lag-time here … some distributors are more aggressive. On the receivables side, perhaps Ferguson is getting more “focused” on selected customers?
  • In the 10-Q Ferguson mentions a $942 million improvement in net cash provided by operating activities and that this increases as “primarily driven by improved working capital, particularly inventory …, when the company made strategic investments to better serve customers during times of significant supply chain disruption (so, Ferguson is reducing inventory … which is something that HVAC distributors should consider emulating. Also recognize that this will reduce earned rebate income, so negotiate 2023 goals!)

Takeaways

No insights regarding eCommerce activity or business development, but some takeaways for operations …

• Watch, and reduce, inventory, especially duplicative inventory.
• Negotiate returns and/or adjust your min/max in your ERP system but, talk to key customers of specific product categories first so you are not surprised by customer needs.
• Focus on customer receivables
• Negotiate 2023 supplier purchase goals as meeting “growth” goals will be a challenge. Reset your rebate projections.

And focus your marketing / business developments on share-taking strategies (and feel free to reach out for ideas.)