Victoria Regulatory News (VCP)

Victoria PLC

('Victoria', the 'Company', or the 'Group')

Interim Resultsfor the 26 weeks ended 28 September 2019

Continued Growth and Cash Generation 

Victoria PLC (LSE: VCP) the international designers, manufacturers and distributors of innovative floorcoverings, is pleased to announce its interim results for the 26 weeks ended 28 September 2019.

Financial and Operational Highlights

Financial highlights

·; Revenue grew by 16% versus the same period in the prior year, driven by a combination of organic growth and contribution from the prior-year acquisition of Saloni.

·; Underlying EBITDA margin rose by circa 190 bps (70bps on a like-for-like basis[5]) from the same period last year to a record 18.5%.

·; Significantly lower exceptional restructuring costs in the period of £1.8m, being the finalisation of prior-year operational synergy projects as previously disclosed.

·; Successful completion of debt refinancing in July, including the inaugural bond issue of €330m senior secured notes (£293.8m at the period-end exchange rate). Whilst incurring a higher rate of interest, the new bonds provide significant benefits and protection to the company with a fixed cost over five years, a more flexible and covenant-lite structure, and access to a new, deep and highly-liquid capital market.

·; Increased interest costs from the recent bond issue and the additional borrowings following the acquisition of Saloni in August 2018, together with the accounting impact of IFRS 16, resulted in a 2% reduction in underlying profit before tax. 

·; Net capital expenditure in the period of £17.2m, broadly in line with depreciation.

·; Strong cash generation continues with £23.8m of underlying free cash flow3 for the period, a 6% increase over the previous year, which equates to a 60% conversion from underlying operating profit.

·; Net debt as at 28 September 2019 was £364.3m (excluding lease liabilities), representing 3.3x EBITDA4. This followed the leverage-neutral acquisition of Iberoalcorense, S.L in August and is consistent with the Group's financial policy. Net debt has been adversely impacted by exchange rate movements in the period, causing a translational increase in Sterling terms of £5.9m.

The Board expects the full year result to be in line with market expectations.

Geoff Wilding, Executive Chairman of Victoria PLC commented:

"Victoria has delivered both revenue growth and margin growth in the first half of our 2020 financial year, in challenging market conditions. Alongside these organic-led gains, we also made a small acquisition in Spain, which, following completion of its integration in the first quarter of next year, is expected to contribute meaningful earnings to Victoria due to operational synergies that will result from the integration.

We were also pleased to successfully complete our bond issue in July, as this provides the Group with secure, long-term financing to support our continued organic and acquisition-based growth."

Analyst briefing

There will be a presentation for analysts at 10.00am on Tuesday 26 November 2019 at Buchanan, 107 Cheapside, London EC2V 6DN. A conference call facility will be available on the morning and an audio webcast will be made available later that day on the Group's website at www.victoriaplc.com.

Conference call:

UK Toll-Free: 0800 3589 473

PIN: 53910768#

For additional details and registration for the analyst briefing, please contact the team at Buchanan as detailed below. 

For more information contact:

The person responsible for arranging the release of this information is Michael Scott, Group Finance Director of the Company.

CHAIRMAN & CHIEF EXECUTIVE'S STATEMENT

It is management's role to constantly build the value of the company as defined by its normalised earnings power and cash generation per share. At times this value will be over-estimated by the market and, at other times, under-estimated. Clearly the last year hasn't been the most rewarding period for shareholders in terms of the share price, but Victoria has continued its consistent progress during the first half of 2020 as illustrated by the table below, which summarises the interim operating results for the last five years:

Although these numbers obviously reflect the impact of the various acquisitions we have made, operational synergies have also been an important contributor to overall growth and a primary driver of the significantly enhanced margins of the Victoria group. There is much more to achieve but the benefits of the Company's strategy of achieving scale through acquisitions and then using that scale to deliver operational synergies are demonstrable.

Turning to the results as presented, there are some particular items where shareholders may find additional comment helpful.

Earnings

Underlying pre-tax profits declined by 2% year-on-year due to increased interest charges from the additional borrowings required to fund the acquisition of Saloni in August 2018 and the interest cost of the bond, which is circa 150 bps higher than the bank funding it replaced. Whilst incurring a higher rate of interest, the new bonds provide significant benefits and protection to the company with a fixed cost over five years, a more flexible and covenant-lite structure, and access to a new, deep and highly-liquid capital market.

The adoption of IFRS 16 (as described more fully below) also adversely impacted earnings by £0.4 million for the period.

IFRS 16 impact

This is the first set of financial results presented by Victoria that reflect the mandatory adoption of the new accounting standard, IFRS 16, regarding the treatment of leases.

Victoria, like many businesses, operates with a mixture of operating and finance leases, in particular a combination of owned and rented real estate. As a broad policy, we tend to own our key factories (where the relocation cost would be prohibitive) and lease smaller sites and warehouses (to maintain flexibility as logistics requirements change and to improve our return on capital).

There are several effects of this new accounting standard, relating to the operating leases:

(i) Under IFRS 16, the right to occupy a building (or use an asset) is capitalised on the company's balance sheet as a 'right-of-use' asset and the future rental payments recognised as a lease liability. As a result, the total value of financial liabilities has, in accounting terms, increased, although it must be understood that there is no change in the actual debt owed by the company, nor the method of assessing leverage for bank covenant or credit rating purposes.

(ii) EBITDA will increase, as rental costs no longer appear in the company's financial statements as an expense. Instead there is a depreciation charge against the new 'right-of-use' asset, and a financial charge to unwind the present-value discount of the lease liability. Rental payments will no longer be recognised directly in the income statement, and will instead reduce the lease liability over time.

(iii) Mathematically, IFRS 16 results in a small negative impact on reported earnings initially following adoption - in our case a £0.4 million reduction in profit before tax in the half-year - as the finance cost element reduces logarithmically instead of on a straight-line basis, although over the full period of each lease it will of course be earnings neutral.

The most important thing to remember is that this accounting policy change has absolutely no impact on cash flow and cash generation.

For complete clarity, below is a table setting out the impact of IFRS 16 on key items within the interim results:

Operating margins

Margins have continued to climb, as forecast. It is important to understand the headline increase in EBITDA margin from 16.6% to 18.5% is in part due to the adoption of IFRS 16 (as explained above). On a like-for-like basis, EBITDA margin for the 26 weeks to 28 September was circa 70bps higher than for the same period last year.

The continued growth in operating margins have come from two primary sources:

(i) Firstly, the integration of Saloni into our Spanish manufacturing business and the resulting operational synergies, which have benefited the margins being achieved by our European ceramics division.

(ii) Secondly, the capital expenditure and reorganisation in our UK & Europe Soft Flooring division completed during FY 2019, which have increased our gross margin by 150 bps in that division. Further upside is anticipated.

Some of the gains achieved in the UK and European markets have been offset by the margin decline in our Australian business during the last six months. Also, the acquisition of Ibero had a small negative margin impact as, until it is integrated into our Spanish businesses and the expected synergies realised, it is a lower margin business.

Given the challenging market conditions we are experiencing, we are very pleased to have contemporaneously achieved both revenue growth and margin growth.

Cash generation

Net operating cash flow before working capital movements was again very good at £55.6 million for the 26 weeks ending 28 September.

The Spanish management team have been doing an excellent job of reducing the working capital at Saloni as part of the integration project (there are further gains to come) but this was offset by a temporary increase in working capital in the UK due to Brexit planning (this is addressed in more detail in the Financing section of this Statement). Along with the normal seasonal working capital peaks at this time of year in the soft flooring business, working capital overall increased by £6.8 million.

A further £10.9 million was spent on interest and taxes, resulting in net cash generated from operations of £37.9 million.

Following our financing (including the bond issue) and investing (acquisitions, earn out payments, and capex) activities, the Group had £82.1 million in cash and cash equivalents (net of bank overdrafts) as at 28 September, up from the £60.2 million as at 30 March 2019. Clearly, this is more than is required to fund working capital and the cash is currently being held with a view to potential leverage-neutral acquisition opportunities. If appropriate opportunities do not arise, this cash will instead be used to pay down debt.

Intangible costs

Because we only acquire high quality businesses, almost all our acquisitions are achieving a high return on tangible assets at the point of completion. As a result, their value, and what we have paid, is significantly more than their net tangible assets. As required by IFRS, the difference is shown on our balance sheet as various categories of acquired intangibles and goodwill. This amount has become a substantial figure, £466.6 million in total.

Under IFRS we then amortise these assets (other than goodwill), at a cost of £12.1 million for the half year. However, it is important to understand that this 'expense' costs nothing whatsoever in cash terms (which is one of the reasons our cash generation is much higher than reported earnings), never requires any replacement capex (unlike plant and machinery, which must eventually be replaced with real money - although the annual depreciation charge itself is non-cash), and, finally and somewhat bizarrely, will result in an overnight increase in reported earnings at the point in the future when the intangible asset value has been amortised to zero - even though at that point the business will be exactly the same as it was the day previously.

Exceptional costs

Following some large one-off reorganisation costs in FY 2019, totalling £12.7 million, I'm pleased to confirm operational exceptional costs fell to just £1.8 million in the period to 30 September These costs consisted of the tail end of the FY 2019 restructuring projects that hadn't quite completed prior to the end of our financial year and therefore are expected to fall further during the second half of the financial year.

OPERATIONAL REVIEW

Aside from the small acquisition of Ibero (which, due to its timing, had a slightly negative effect on EBITDA margin and no meaningful impact on earnings for our interim results), we have been focused on organic growth in the current financial year. In FY 2019 we spent £20.9 million on growth capex and £12.7 million on exceptional reorganisation costs and wanted management to secure the benefits of this investment (as explained in the next paragraph).

Within the underlying flooring market, demand comes from both construction and renovation. Overwhelmingly, in all our flooring categories, our products are bought (via various channels) by consumers renovating their homes. We consciously sell very little to the commercial/industrial market (hotels, offices, hospitals, etc) and almost nothing to new home builders. We believe there are two advantages to this: firstly, the renovation market - particularly at the mid-upper market level Victoria's products target - is less cyclical than new home construction, which was one of the main factors that caused Victoria's organic revenues to increase every year during the 2008-10 recession. Secondly, the renovation market is vastly larger than the construction market (in the UK, for example, it is consistently more than 12x the new home construction market). We like operating in larger markets.

Revenue growth was achieved in UK and Europe, while Australia saw a year-on-year decline.

UK & Europe - soft flooring

Although we would not pretend the sales environment was easy in the first half, demand has been consistent for our products and our UK revenues are up 4.0% and gross margin up 150 bps compared to the same period last year. Due to our significant expansion in Europe, the UK now contributes just circa 20% of earnings, but we expect our structural advantage (resulting from last year's investment in new plant, such as the backing line in Wales, and operational reorganisation, which enabled us to reduce employee numbers by more than 200 people) together with on-going self-help measures to continue to deliver performance well ahead of peers over the foreseeable future.

UK & Europe - ceramic tiles

Although some of our competitors who, perhaps, have structurally less efficient plants, are experiencing challenges, Victoria's ceramic tile business has continued to grow organically. Furthermore, we can look forward to the integration of Ibero into our existing Spanish operation. This project is scheduled to begin in January following careful planning since the completion of the acquisition in August and will deliver meaningful operational synergies in 2020. The management team in Spain has very successfully completed the integration of Saloni (acquired in August 2018) resulting in improved earnings and reduced working capital, and we have a high degree of confidence in this outcome being repeated with Ibero.

Our sole business in Italy, Ceramiche Serra, has also continued to grow. Its unique combination of price, design, and quality has hit a 'sweet spot' in the market and, with the new porcelain manufacturing line we installed 18 months ago completely full, we are looking at cost-effective options for increasing Serra's capacity to take advantage of demand for its products. We will update shareholders regarding this in due course.

Australia

As indicated at the time of our AGM, we are seeing the first signs of a revival in the Australian flooring market. Although revenues were circa 6% lower than the same period last year (-5.4% on a constant currency basis), demand has been steadier in recent months and H1 revenue was in fact 5.8% greater than in H2 last year. The Australian management have done very good work in improving operational efficiency at current levels of production and as revenues rise, profits will recover.

Overall, our markets are more challenging than the recent past but we continue to maintain tight control over costs and inventory to ensure that the Group is well positioned to secure more than its share of business and, should selling conditions change, the reorganisation and investment we have undertaken in the last 18 months will result in a rapid lift in earnings.

Market commentators frequently discuss (with varying insight) the value of an 'economic moat' around a business. Investment research firm Morningstar defines the key competitive advantages that provide companies with an economic moat as, inter alia, intangible assets (such as brands and patents), cost advantage, switching costs (the cost a customer incurs in changing to an alternative supplier), efficient scale, and service levels. We believe the concept of a defensive moat is sound and nearly three years ago identified how this might be achieved in our businesses to protect our business from competition and, particularly, in any economic downturn.

In the UK, for example, apart from our brand value (retailers - our customers - are incredibly loyal to our brands, some of which stretch back over 100 years) and scale-derived cost advantage, we identified that superiority in supplying cut length carpet (i.e. carpet that is cut to size for a specific consumer order prior to delivery to the retailer, instead of supplying full rolls of carpet) is an important competitive advantage because it allows retailers to hold less (and even zero) stock while offering a wider range of product. However, properly executed, it also creates an ever-widening defensive moat as retailers come to rely upon this service more and more and it becomes increasingly uneconomic for our rivals to compete. Here's why:

Supplying cut length carpet requires:

(i) substantial investment in logistics capabilities (something we did last year at a cost approaching £10 million) across Britain. This size of investment necessitates a certain scale to be economically viable, which excludes all our smaller competitors.

(ii) a one-to-one relationship with the, literally, thousands of independent flooring retailers (who are, importantly, growing their market dominance over the multi-store retailers) who do not have their own carpet-cutting machinery. This excludes off-shore manufacturers, none of whom have a meaningful sales presence in the UK (and it is vastly too expensive to build one from scratch).

(iii) next day or assured on-time delivery, which excludes off-shore manufacturers who cannot provide this without building their own warehouse complex in the UK, where they individually lack the scale for it to be viable.

The result of developing our economic moat has been continued revenue growth of 4% (following on from 7.3% growth in FY 2019) in the UK in difficult market conditions.

We aim to build our moats every year. That doesn't mean that profit will be more each year, because sometimes it may not be due to economic conditions (although I'm pleased to say that the Board is highly confident it will be this year). However, if the moat is widened every year, the business will, over time, do very well and will develop inherent resilience to competitive attacks.

ACQUISITIONS

As mentioned above, Victoria acquired Spanish ceramic tile manufacturer Iberoalcorense, S.L ("Ibero") in August. Based in Castellon (near Valencia), Ibero is close to the Group's existing Spanish ceramics businesses, Keraben and Saloni and we are confident of developing meaningful operational synergies when integration begins in earnest in January. The price paid was very attractive with the initial consideration being less than 3x the last 12 months EBITDA and, including the maximum earn-out payment, total consideration will still be under 5x EBITDA - before considering the benefits of the expected synergies. The cash payment on completion was funded entirely from Victoria's cash reserves, requiring no incremental borrowing.

Notwithstanding that our emphasis this year has been on organic improvements, we have continued to prospect for opportunities - building our 'deal pipeline' - primarily in Europe, where we have seen a slight softening of price expectations. Despite our recent growth on the continent, Victoria still has an overall market share of less than 1% and there is no dominant (or even significant) competitor. Therefore, the opportunity to grow by acquisition remains very significant.

Acquisitions remains part of our core strategy as it has been my experience in several sectors over many years that well-executed acquisitions selected using very strict criteria and strong price discipline, such as those we have done to date, create significant shareholder wealth as they deliver scale, synergy opportunities, new products, and open new markets - strengthening the Group and creating wealth for our shareholders.

FINANCING

We were very pleased to successfully complete our offering of €330 million 5¼% senior secured notes due 2024 ("bonds") in July this year. The offering, which was leverage neutral, was 3x over-subscribed and the bonds have, very pleasingly, since traded up (i.e. the yield has fallen) indicating investors' confidence in Victoria's credit-worthiness.

Shareholders should, however, note that the bonds are more expensive than the bank debt they replace, by approximately 1.5ppts. Nonetheless, the Board is firmly of the view the additional interest cost is an expense worth paying given the covenant flexibility of the bond structure and its fixed interest rate, which considerably reduces the risk for equity investors in the (albeit unlikely) event of a severe recession across all Victoria's markets or an upturn in interest rates.

The Board believes these bonds provide the optimal mix of cost and flexibility to meet Victoria's long-term financing requirements and place the company on a secure footing for continued growth.

Our working capital (and therefore debt) levels were higher on 28 September than normal due to planning for Brexit, which was scheduled to happen on 31 October. We needed to be absolutely certain we had no shortage of raw materials in our UK business for what is the busiest trading period of the year and we were therefore carrying much more stock than normal to protect our production in the event of Brexit disruption. Of course, again Brexit did not happen, but the raw materials need to be ordered well in advance and by the time the delay was confirmed, we had already stockpiled the raw materials.

The additional stock is now rapidly turning back into cash but, depending on political events, may need to be built up again early in the New Year.

Nonetheless, as we have consistently demonstrated in earlier years, flooring businesses are capable of generating significant cash under normal conditions and, after heavy investment in capex to improve productivity in our factories and resulting restructuring costs in FY 2019, we are returning to our usual high levels of cash generation in the current financial year.

OUTLOOK

Unlike some industries, it is possible to make meaningful predictions about Victoria's underlying market. Most critically, the size of the flooring market itself will continue to grow. As sure as the sun rises, households will keep forming, industry will keep expanding, and the total area of flooring in existence will continue increasing to accommodate this growth. Revenues for flooring manufacturers such as Victoria comes from the construction of new floors and (overwhelmingly) the renovation of an ever-expanding existing flooring market. There will, of course, be periods of stronger and weaker growth but, over time, we can be confident the underlying market will continue to increase with more houses, more offices, more factories, and more retail/leisure space.

To ensure we are always placed to benefit from this expansion, one of the goals we had as part of our acquisition strategy is diversifying our product offering and geographic exposure. Originally a pure carpet manufacturer and distributor, Victoria now sells LVT (Luxury Vinyl Tile), underlay, artificial turf, and ceramic tiles to more than two dozen countries. We are therefore relatively agnostic as to what type of flooring is being bought by consumers, provided it is Victoria product. All we need to do to make sure we are in the right place with the right product at the right price with service to match.

Growth in earnings per share will continue from both ongoing organic improvements and acquisitions. There is no shortage of opportunities both in the UK and Europe - although we take care to only proceed once we are confident the last acquisition has been properly integrated. Our strong positive cash-flow, together with the secure long-term financing provided by our bond issue and long-term bank facilities ensure further acquisition-based growth can be funded. By maintaining very strict criteria and strong price discipline, I am confident acquisitions will continue to be earnings enhancing and an important tool to both strengthen the Group and create wealth for shareholders.

In conclusion, there are a number of key operational actions we will be taking over the balance of the financial year that will contribute to further growth in EPS and free cash flow:

·; Integrate Ibero into our existing Spanish ceramics business.to ensure the Group benefits from operational synergies next year

·; Effect a cost-effective solution to Serra's needs for additional production capacity to avoid constraining its growth

·; Further enhance our UK logistics service, widening our economic moat

·; Deploy the concentrated yarn bank system developed by Quest (our Australian subsidiary) throughout our UK soft flooring business in all new product development. This innovation reduces working capital and produces better production margins

I have a high level of confidence in our operational management to deliver these objectives and therefore, once again, I am pleased to say the Board faces the balance of the financial year with a positive outlook and believes the Company will meet market expectations for the year ended March 2020.