Edited Transcript of INCH.L earnings conference call or presentation 30-Jul-20 7:00am GMT

London Jul 31, 2020 (Thomson StreetEvents) — Edited Transcript of Inchcape PLC earnings conference call or presentation Thursday, July 30, 2020 at 7:00:00am GMT

Redburn (Europe) Limited, Research Division – Partner of Non-Food Retail, Luxury & Sporting Goods Research

Good morning, everyone. This is Duncan. Thank you for joining us for our 2020 interim results. I’m joined by Gijsbert, our CFO; and Raghav, Head of Investor Relations.

In a moment, I’ll provide some introductory remarks before handing over to Gijsbert, who will take you through the presentation. I will then come back and give you some of my initial high-level thoughts on the business before we open the lines for your questions.

Let me start by expressing my sincere thanks to all of my colleagues at Inchcape for their dedication during this challenging environment. Having joined the business in June, I’ve witnessed our teams collaborating and working incredibly hard to help navigate the business through this period. This is evidenced by our top line outperformance versus the market, but also by the quick and decisive actions that were taken in managing inventory, liquidity and addressing cost. We are entirely focused on executing our plans to steer the business through this dynamic environment so that we will come through the other side, leaner and stronger.

With my ability to travel around the markets to visit our operations being limited by the virus, I have had a lot of time to listen, ask questions and absorb some great insights from conversations with my new colleagues around the world, our OEM partners and many other key stakeholders. I am impressed by the Inchcape people. During the COVID crisis, they have faced up to the challenges and executed. They’ve also mobilized to support the communities we serve.

In Europe, we provided vehicles to the Red Cross. In Asia, we launched a public awareness campaign during the early stages of the pandemic. And in Americas, we provided vehicles to the Ministry of Health in Chile. These are just a few examples of what we’ve done in recent months, and I look forward to seeing greater engagement with our communities around the globe.

Needless to say, the effects of COVID on our business have been material, with many of our operations impacted by either partial or complete shutdowns, resulting in revenue and operating profit significantly below the prior year. In my first 2 months, I’ve seen markets come out of and some go back into lockdown. It has been impressive to see the group sharing best practice and resources to ensure we can trade under these highly dynamic conditions.

While a few of our markets are still facing disruption, we have observed an improving trend since April as many of our operations were permitted to reopen. With the effect of this crisis likely to result in a prolonged economic impact, the group responded by acting quickly and decisively to develop a comprehensive cost restructuring program. This is firmly underway. Gijsbert will provide you with some of the details shortly, but what I will say is that the plan is extremely robust. The savings will be achieved across all regions and at the center, too. This is a broad-based initiative, and we are striving to create a leaner organization fit to capitalize on attractive growth opportunities in automotive distribution.

In spite of the challenges faced in the first half, we carefully managed our cash flow and the group’s balance sheet remains strong, which is a testament to the hard work of our teams and the close collaboration with our OEM partners.

Let me now hand over to Gijsbert, who will take you through the presentation.

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Gijsbert de Zoeten, Inchcape plc – CFO & Executive Director [2]

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Thank you, Duncan, and good morning, everyone. Let’s start with the income statement on Slide 4.

At the headline level, group revenue during the 6 months period was down 29% on an organic basis versus the overall market volumes down 38%. This top line outperformance that Duncan spoke about highlights the diversification and relative resilience of our revenue streams, which continues to support our performance.

In January and February, prior to the imposition of lockdowns, our results were encouraging. In March, as the virus spread, we closed our operations in a number of markets. Closures peaked in April. And since then, we’ve seen group revenue performance sequentially improve as trading resumed across more markets. As of today, we are open in 30 markets and 3 remain shut.

As markets were shut, our inability to trade weighed significantly on profitability. As a result, group operating profit came in at GBP 28 million compared to GBP 180 million in the prior year. Following the onset of the virus, the group quickly adjusted work and practices to maintain a safe environment for our colleagues and customers as well as taking various cost-mitigating measures. And these measures helped support our profitability during the second quarter. And in June, we generated a positive operating profit across all regions barring Americas where closures of certain markets continue to weigh. The decline in operating profit flowed through to group PBT, which fell to GBP 9 million.

In light of the challenges and uncertainty caused by COVID, the group has conducted a review of its goodwill and other asset values and determined it appropriate to book an impairment of GBP 185 million. This is entirely noncash, and the majority relates to goodwill and site impairments within the retail segment. Other exceptional charges amounted to GBP 13 million relating mainly to restructuring costs.

We canceled the final dividend in April as a prudent step to protect liquidity in an extremely uncertain environment. Given the low level of earnings in the half and limited visibility, we have decided not to declare an interim dividend.

Turning to distribution on Slide 5. Overall revenues came in at GBP 1.7 billion, a 29% decline year-over-year on an organic basis. In spite of the global challenges, the distribution segment generated operating profit of GBP 46 million. However, margins contracted 400 basis points as market closures weighed significantly.

We are a geographically diverse business and the performance varied by region, as we show on the next slide. As this distribution profit waterfall shows, Asia was the biggest contributor to the operating profit decline. We suffered from a double whammy here with the impact of COVID and the deterioration of the Singapore vehicle certificate cycle. And while our operations in Hong Kong have remained opened throughout, the protests have contributed to a continued subdued level of demand.

In Australasia, our profits in the first couple of months were actually up year-on-year as we benefited from an easier comparator given the supply constraints in the first half of 2019. And while Australasia has remained open throughout the period, we started to see an impact from COVID in April, resulting in a much reduced level of business activity, which weighed on profits. And we also suffered from a GBP 10 million transactional currency headwind.

In Europe, the impact of COVID started to be felt in mid-March, and a combination of closures and generally lower business activity contributed to a reduced profitability. We also saw an impact on profitability from discounting as we pushed out old stock in some of our markets.

In Americas, closures happened relatively early on as government acted quickly and applied strict curfews. The duration of the lockdowns in our largest markets, Chile and Peru, weighed heavily on our profits. The situation in Americas has been very volatile, with some markets having to shut shortly after reopening.

And finally, turning to our operations in Africa. Ethiopia, which is the largest contributor, remained open and was profitable throughout the period. The year-over-year performance was supported by the fact that the prior year comparator was depressed by the limited availability of foreign currency, which restricted our ability to import goods.

Now moving to retail. Revenues came in at GBP 1.3 billion, representing a 30% year-over-year decline on an organic basis, adjusted for the significant retail disposals we did in 2019. The fall in revenues is explained by both the U.K. and Russia being closed for more than 10 weeks. These 2 markets account for the majority of the segment. Given the inherently lower margins and the relative lack of flexibility of costs, the retail segment recorded a loss.

Operating losses amounted to GBP 18 million during the period compared to GBP 20 million of profit last year. But the impact of closures in Q2 hides the strong performance of our Russian business during the first quarter. And in the U.K., our operations were shut ahead of a very important period in March, which heavily impacted our profitability. Pleasingly, the U.K. and Russia had a strong restart after a period of closure with both markets recording profits in the month of June.

Moving on to changes in cash flow on Slide 8. The group has done an exceptional job of managing cash flows and particularly working capital during the crisis. Free cash flow during the period came in at a GBP 5 million outflow. The year-over-year movement is owing to the significantly lower operating profit being largely offset by meaningful improvement in our working capital position and near halving of net CapEx and lower outflows related to tax and interest payments. Now we had expected a larger working capital outflow during this period. However, working in collaboration with our OEM partners enabled us to manage our inventory levels and financing terms.

The strong management of inventories is highlighted by the GBP 260 million reduction versus last year and a significant reduction even versus year-end. Importantly, following the easing of restrictions, inventories continue to be managed closely, and the heightened levels of working capital discipline will be maintained across all markets.

Another measure we have taken to bolster our cash flow was the reduction of capital expenditure. We quickly took the decision to delay all nonessential CapEx. And for the 6 months period, CapEx was GBP 16 million versus GBP 31 million in the prior year. Just to remind you, Inchcape remains a capital-light business where the majority of current investment is focused on IT projects.

The suspension of share buyback and the subsequent cancellation of the 2019 final dividend also helped to preserve cash. This enabled us to finish the period with a strong balance sheet position. Excluding leases, we ended the period with a net cash position of GBP 89 million compared to GBP 103 million net cash at year-end.

Now looking more closely at the liquidity position on Slide 9. The group has a conservative approach to the way it manages its balance sheet. As of the 30th of June, the group had an available cash of GBP 480 million and GBP 530 million of headroom in our RCF. So total liquidity was over GBP 1 billion. In order to provide us with greater flexibility, we applied and were successful in becoming an eligible issuer under the U.K. CCFF scheme. We’ve drawn GBP 100 million of the CCFF during the period. However, as our markets have reopened, the group’s financial position has strengthened, and we have repaid this in July. Just to note, the facility remains open to us until the end of the year.

Now let’s move to Slide 10, which provides a status update on our key markets. The disruption to our business from COVID started in late January, although this was contained to a few markets in Asia. And as we disclosed at our full year results, the financial impact at the time was relatively small. And it wasn’t until the middle of March that operations outside of Asia started to close, reaching a peak mid-April when only 25% of the group’s 2019 revenue base was able to remain open for business. Since then, a number of our markets have started to reopen. And as of today, we’re open in 30 markets with only 3 remaining shut. That translate into a 95% of the revenue base being open as of today, albeit at a lower level. As noted, our markets in Americas were worst hit. And as of today, Chile, Costa Rica and Panama are closed.

On Slide 11, we show the evolution of the sales trend, providing monthly detail for quarter 2. And as the chart shows, the group sales dropped in April in line with the peak of our market closures and has subsequently improved as our markets have gradually reopened. One encouraging trend that we observed throughout Q2 is the relative resilience of aftersales, which has outperformed vehicle revenues growth by circa 20%. This is 20 percentage points. As is the case with all these trends we are currently seeing, it’s difficult to say how long this will persist. However, provided we are permitted to operate, we expect our Aftersales business will continue to offer resilience for the group’s performance, enabling us to offset some of the pressures on vehicle volumes. What we’ve shown here is the quarter 2 trend. But of course, I’m very clear to say the situation remains dynamic.

Now let’s turn to the market context for our restructuring on Slide 12. What we show here is the forecast for new car volumes in Inchcape’s markets, as forecasted by IHS. And according to their latest estimates, new car volumes across our markets are expected to fall 29% in 2020 and rebound 14% in 2021. It’s important to highlight, this slide shows the estimate of one automotive industry forecaster, the accuracy of which has been variable in recent years. And the forecast here is for the evolution of new car volumes.

Inchcape revenues and its growth has outperformed that of total industry volumes for several years. And this is owing to the diversified revenue streams, which in addition to new car volumes, includes both used cars and aftersales. We fully expect this revenue outperformance will continue.

Against this backdrop, we decided to undertake a major cost restructuring program. This is a direct response to the COVID crisis. And during the review, we performed a comprehensive assessment of the organization as well as a detailed evaluation of our footprint. We are targeting to reduce group overheads by more than GBP 90 million versus 2019 pro forma level. And once completed, this will reduce overheads by more than 11%.

Our aim has been to deliver cost reduction with a fast payback, and the cost-out is linked to our expectation of lower business activity. We do, however, expect at least 50% of the overhead reduction will stick when revenue recovers.

The savings will be achieved across 3 areas: firstly, a reduction of our workforce; secondly, addressing third-party expenditure; and thirdly, the closure of a number of underperforming sites. It’s important to say that we do not expect our sales potential will be materially impacted by these measures.

We believe that the reduced overheads exposure will help to protect the group profits in a lower volume scenario and against potential future shocks. The anticipated restructuring charge of GBP 70 million, of which GBP 50 million will be a cash cost, the majority of which will be incurred in the second half. The process is well underway and we anticipate will be largely completed by early next year.

I’m now on Slide 14. We’ve been talking to you about our digital investments since 2018, and I’m pleased to say that during this difficult environment, we reaped the benefits of our investments to date, and we decided to accelerate our plans by rolling out digital tools to other markets. On the customer-facing side, this included further development of the digital customer journey. In the first half, we developed our omnichannel platform with the launch of a mobile-optimized website. We also completed testing in Melbourne on the multi-market, multi-brand, multi-language platform, which is now ready to be rolled out to other markets.

On the noncustomer-facing side, investments in tools like Salesforce have enhanced our lead generation capability and improved conversion and also enabled us to reach out to customers in spite of closures.

Across the group, to give you a data point, we’ve taken more than 9,000 orders from digital leads during the first half of this year, a feat that would not have been possible without the investments we’ve constantly made in recent years. In addition to this, we focused our marketing teams to deliver improvements to our websites, which has helped to improve our organic search rankings. We’re now delivering similar lead volumes with 20% lower paid for search, thus increasing our marketing efficiency.

And as the world was going into lockdown, our digital team rolled out a chat functionality to better facilitate distant selling across 20 websites in 10 of our markets in less than 4 weeks. And this example of the speed of implementation is only possible because of our investment in digital infrastructure.

We’ve had over 5,000 customer interactions since the launch of chat, and we’ll begin rolling this out to other markets. And as Duncan will come on to shortly, we view the use of data and digital at the core of how this business will operate. We see an opportunity to develop and build into the group better use of analytics to help drive decision-making, and the progress that we’ve made in recent years gives us a solid foundation for that.

Let me turn to Slide 15 and M&A. Inorganic growth, as you know, is a key pillar of our growth story, and it comes in different forms for Inchcape. It ranges from large platform deals that can step change the momentum in the market through to smaller deals, which can help us to leverage our existing infrastructure or to gain entry into a market. The acquisition of Daimler’s Colombia business was a significant milestone for our acquisition strategy insofar that it was the first time an OEM had sold its own national sales company to us. This opens up a new way for potential growth opportunities that we had not anticipated when devising our acquisition strategy.

And today, we announced a contract win to distribute JLR vehicles in Poland which complements our existing business with them in Europe. The Polish operation is expected to add in excess of GBP 100 million of revenue. And given it’s a contract win, there’s no goodwill associated with the deal. However, we have agreed that JLR will take a 30% stake in the European venture.

It is a fact that the global distribution market is extremely fragmented, and this means that there are many more opportunities for Inchcape. And based on what our M&A teams are seeing, the pipeline continues to be exciting.

Turning to Slide 16. Inchcape is a very cash-generative business and has a track record of disciplined capital allocation over many years, and you can expect the same level of rigor and prudence to continue. As a priority, we invest in the business first. And given the relatively capital-light model, this tends to be a small bucket. And in recent years, we put more emphasis and capital behind the higher-growth distribution segment and the development of our digital capability. In addition to this, we’ve made proactive decisions to prune our existing portfolio.

The second priority is dividends. We canceled our 2019 final dividend amid the uncertainty caused by COVID to preserve cash within the group, but we’re very conscious of the importance of dividends for shareholders. And what we can say today is, in the absence of any further material disruptions to our operations, the group expects to resume making shareholder distributions in line with the performance of our business.

The third pillar is value-accretive M&A. And as outlined in the previous slide, this remains a key aspect of our policy.

Finally, after all of the previous 3 priorities have been considered, we will continue to return excess cash to shareholders. Underpinning all of this is our view that the maximum leverage ratio that we would consider appropriate for the group is 1x EBITDA on a pre-IFRS basis.

Now before I hand over to Duncan, let me make a brief comment on the outlook. I think it’s fair to say that the situation remains dynamic across the globe, with markets coming out of lockdown only to subsequently face restrictions. But it remains too early to call out a trends, not least because of the distortion of pent-up demand. It’s therefore still too early to provide a forward-looking view of the company’s performance in 2020. Nevertheless, as highlighted by our performance in the first half, we’ve performed very well in the face of market conditions by outgrowing the markets and showing resilience in cash generation and liquidity. And we expect this will continue.

In addition, we will make the business leaner and stronger. And clearly, there are many opportunities for us, including M&A, that we’re ready to capitalize on.

Now let me hand over to Duncan.

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Duncan Tait, Inchcape plc – Group CEO & Director [3]

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Thank you, Gijsbert. My journey at Inchcape began in February when I was approached about the role. At first, I was intrigued, but this quickly turned into interest and excitement as I met people across the business and did my own research. One of the things that appealed to me about the opportunity was the very exciting prospects for this business in the backdrop of transformational change that the automotive industry faces. I genuinely believe that Inchcape has an opportunity to thrive in the years ahead.

Now you will all recognize Slide 19. This is the one that I spent time thinking about before I joined. There is nothing on this slide that this business will not continue to deliver on. There are absolutely some areas where we can accelerate progress, but fundamentally, Inchcape is well placed to drive growth and cash returns for shareholders. The investment proposition will remain unchanged. With distribution at the core, our focus will be to ensure the business continues to deploy capital towards the opportunities that exist in this attractive global market.

Given the shift in focus of the group towards distribution, which in 2019 accounted for over 90% of our profits, we have been reclassified by the London Stock Exchange as a business support services company. We feel that this is more appropriate for our business. Inchcape has shown that it has a sustainable business model. The weighting to markets with a clear structural growth story, the focus on continually optimizing operational performance, the consolidation opportunity and solid cash generation should enable the group to maintain its long track record of delivering attractive shareholder value.

Now before we open the lines to your questions, I’d like to share some of my initial high-level thoughts on the business. My arrival at Inchcape has come at a unique time for the world economy and at an exciting juncture for the automotive industry. COVID-19 has been dubbed the great accelerator. And we at Inchcape will use our scale and act at pace to ensure our business stays ahead of the developments elsewhere.

Those of you who have followed us for some time will be familiar with the Ignite strategy. In his last investor call, my predecessor, Stefan, was clear that there is more gas in the tank. I agree with him. The distribution growth focus and derisking of our retail portfolio is firmly established in the DNA of this business, and Ignite continues to resonate with our key stakeholders and Inchcape colleagues.

Ignite positions us to be the world’s most trusted automotive distributor. I think we have an opportunity to go further. My initial thoughts to accelerate the progress are in 4 areas: to dial up Inchcape’s use of data and digital to drive further efficiencies and growth in the existing business; to continue to drive consolidation in automotive distribution, with an eye on attractive bolt-on deals to grow our revenues and leverage our existing footprint; to globalize our core processes and utilize shared services and automation so we can improve profitability and returns; and to accelerate the development of the Inchcape way, our unique delivery model, by further investing in the skills and capabilities of our people. I look forward to sharing our plans in due course.

Underpinning all of this and one of the fundamental pillars of the success of the business is the strength of the relationships with our partners, the OEMs. This was evident during the recent crisis with a close collaboration that enabled us to manage inventory levels. In my first few weeks, I made it a priority to speak with all of our key partners. I came away from those meetings with a clear feeling of how much our partners value the service we provide as well as the opportunities they foresee for us to further grow our businesses together.

Inchcape is the world’s largest independent automotive distributor. Our unique position gives an opportunity for us to use our scale to be the best, the best partner for our OEMs, the best distributor for independent dealers and the best in the eyes of our customers. While the months ahead still present a high level of uncertainty, we are determined to come through this crisis as a leaner and more efficient business ready to capitalize on attractive growth opportunities. I’m convinced we have the right plans to be able to achieve this.

Today, the primary focus for the group is to execute on the plans we have in place for the months ahead. The steps we are taking will lead to a leaner and more resilient group as we continue our path to be the world’s most trusted automotive distributor. Gijsbert and I will now happily take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from the line of Sam Bland from JPMorgan.

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Samuel James Bland, JPMorgan Chase & Co, Research Division – Research Analyst [2]

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I’ve got 2 questions please. The first one is on your revenue outperformance versus the end markets. Could you just talk about what you think is driving that outperformance? Is it sort of brand mix, and your brands are generally gaining share? Or is it something a bit more company-specific? And the second question I have is on cash flow. Obviously, pretty encouraging result given the situation. And I think net debt improved by about GBP 300 million since mid-May. Just talk about what drove that. And do you think you’re kind of past the worst maybe on the working capital and cash flow outlook?

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Duncan Tait, Inchcape plc – Group CEO & Director [3]

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Thanks very much, Sam. I’ll take the first question. And then Gijsbert, if I can — if you could add any clarification comments to my first answer. And then if you could take the second one, please. So Sam, I tell you, I am really impressed with this business’s capability to execute. I mean despite the backdrop of really dynamic marketplaces that Gijsbert referred to, we have a team who can execute. And we’ve been sharing best practice across the group to make sure that we can open safely when these markets reopen and trade immediately. And likewise, when the markets close, we can do that safely and prepare for our reopening. So we are in the rhythm of doing that, and I foresee that continuing.

And then the other point I would say is we’re in markets that tend to grow faster than the global average, and we have a fabulous stable of OEM partners. And I think the Ignite strategy has enabled us to execute accordingly. Gijsbert?

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Gijsbert de Zoeten, Inchcape plc – CFO & Executive Director [4]

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Yes. No. Absolutely. Great question, Sam. I mean what I would add maybe is that compared to others, all our markets are open. So we’ve kept our full network open, and we’ve done that while some of our competition have not opened their full networks. And maybe more specifically also, the Aftersales has really driven part of that outperformance. In terms of cash flow, indeed, a performance ahead of the expectation that we had. In simple terms, we are almost past the hump that I spoke about, where we would still have stocks coming in, and we’re not selling all that much. I think the speed of the selling in Q2 has really driven this. So in a way, we are now sort of past that hump. And on a go-forward basis, it’s about careful management of our stocks.

And clearly, we have some 8 stocks that we need to manage carefully. But from a cash perspective, the working capital, worst, as you call it, has passed. So bar any future other shocks, we shouldn’t see any further humps.

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Operator [5]

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The next question comes from the line of George Pilakoutas from Numis.

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Georgios Alexandre Bela Pilakoutas, Numis Securities Limited, Research Division – Analyst [6]

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First one is a bit more color on some of the regions, if you could. Hong Kong, could you — a basis on kind of what the outlook is for the second half of this year and next year on the number of permits that are going to be allowed given some were suspended in the first half. Hong Kong, could you kind of comment on how business is going there? There’s clearly political disruption and currently seems kind of to be being hit again by COVID. Is there anything that you can kind of give us on more recent trends and I guess perhaps even more generally how you feel about doing business in a country given the political backdrop? And then Latin America, just — I mean Chile in particular, any idea on when that might be open?

Then I have a question on the IHS forecast. I guess it implies that 2021 is kind of 19% below 2019, which I imagine is quite a bit below global TIV forecast. Is that Singapore weighing that down? I guess it just feels a little bit pessimistic, but maybe you could kind of give us a bit more understanding why that might be the case.

And then finally, on M&A. I guess maybe, Duncan, if you could elaborate on bolt-ons, is that kind of similar to the JLR Poland, i.e., kind of contracts in existing markets? But more generally, how you’re seeing the backdrop there, conversations are independents struggling, are OEMs coming to you? Are you seeing your M&A team getting a lot busier?

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Duncan Tait, Inchcape plc – Group CEO & Director [7]

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Okay. Thanks very much, George. And good to e-meet also. I’ll make some comments on the first question around Hong Kong and the markets. Gijsbert, if you could take question two, please. And then we’ll both make some answer to your point 3.

So I would say, in general, our markets are dynamic. I’ll give — before I answer the 2 specific points you made. If you look at — I’ll give you 3 examples. Let’s talk about Australia, Chile and maybe Costa Rica. So in Costa Rica, clearly, they closed when COVID happened, then reopened. And then, of course, closed again because their borders are quite porous, and they were seeing the virus spread with human movement across the borders. In Chile, Chile closed. It reopened again. And a few weeks later, closed again. And we do hoped that it will close. We’ve seen some promising signs that it will open again over the next few weeks. But that situation is dynamic.

And then if you look at Australia, where the government managed the whole COVID situation really well. You’ve seen an outbreak in Victoria and Melbourne over the last few weeks. They’ve got to level 4 lockdown, not level 5 yet, which restricts all movement. And clearly, that will impact our volumes. So the market remains dynamic, and it is COVID that, by and large, is driving our performance or our ability to open.

In Hong Kong, the virus is spreading again. There’s restrictions now on people’s movement. Restaurants are only open, for instance, for takeaway. No eat-in. So that clearly will impact our business somewhat. On the political front, my job and our job at Inchcape is not as politicians. We’re here to execute our business and deliver for our OEMs in the marketplace. So we’ll keep well away from the political side.

And then in Singapore, the team is executing really well. Clearly, the certificate of entitlement auctions that take place every month didn’t happen very much during the second quarter. There was an auction during July, and we believe that the catch-up of the months that we’re missing will happen over the next year or so. So I think the big thing in Singapore is what happens to the general economy. And we’ve yet to see that, but the Singaporean economy clearly has been hit somewhat. So I’ll let Gijsbert add any color to that.

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Gijsbert de Zoeten, Inchcape plc – CFO & Executive Director [8]

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Yes. Thanks, Duncan. So on this IHS numbers, being 29% down for this year and 14% up next year, I mean, just repeating what I said, it’s just a forecast of — and it is an indication. But it shouldn’t be mistaken for an outlook that we have. It is a simple weighing of our Inchcape markets by turnover, and it’s not Singapore that’s driving this down. In fact, the COE cycle is coming to the end of the negative, if you like, into the next year, as we have been indicating before. And if anything, to the point that Duncan was making, it could be a bit more COE certificates on the market because they didn’t come into the market for 2 months during this year.

I guess the element that I could highlight in terms of regional angle is Latin America. It’s clear that it has been more — worse hit. And the general expectation is that it will take longer for Latin America to come out of this. So I guess that’s clearly the factor to bear in mind when you look at our number, notwithstanding, of course, the longer-term outlook in Latin America that is fantastic with a very low car penetration and the like and a very good position that we have and have strengthened recently. M&A, Duncan?

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Duncan Tait, Inchcape plc – Group CEO & Director [9]

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Yes. Thank you, Gijsbert. So a good question, actually. I think the — if you look at the big picture, the OEMs have a lot on. They have the 4 major disruptive trends that are going on in the industry against the backdrop of what happened in diesel, for instance. So enormous focus required to navigate those businesses into a very successful future for them. And that means there is opportunities for Inchcape to take some of the responsibility in the markets where they may find it a little bit more difficult to operate in. So that’s the basic premise that we have. We have seen increased interest from OEMs for us to look at businesses in those markets. And clearly, you know that we’ve done these platform deals before. I remain interested in platform deals where we can use M&A as an entry point into a market.

But then at the same time, these bolt-on deals, which are much less capital-intensive, give us the ability to then get new revenue streams that we can leverage with the same overhead structure. So they’re quite accretive for us. The JLR deal, I think, is really good for us. So GBP 100 million of annual revenue is where we forecast we could get to on that deal, required very little capital of them, working capital for stock. That, by the way, will start in the next financial year for us.

And then we’ve also taken some other business, which we haven’t announced, where we’ve taken some other brands that sit within an OEM portfolio and again leverage that through an existing infrastructure. So I think they’re quite attractive. We are looking for the 3 types of opportunity. We are very interested in continuing to work with the OEMs in that regard, and we remain very much alive to the opportunity.

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Gijsbert de Zoeten, Inchcape plc – CFO & Executive Director [10]

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Probably the only thing to add is that if you were in doubt, given the strong balance sheet, there’s no need for a pause in M&A. It’s gone back quicker than we had anticipated. We knew it was also going to come back. It’s a resilient and cash-generative business. But as you’ve seen from the numbers, from that perspective, we are M&A-ready.

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Operator [11]

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(Operator Instructions) And the next question comes from the line of Andrew Nussey from Peel Hunt.

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Andrew Nussey, Peel Hunt LLP, Research Division – Analyst [12]

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It’s Andrew Nussey from Peel Hunt. A couple of questions, if I may. First of all, looking at the sort of great accelerator slide. Clearly, the behaviors of the OEMs are going to be key to realizing the full potential there. So I mean I guess beyond sort of the M&A and looking to consolidate end markets, is there any anecdotal evidence that you’re picking up from them now in terms of how their behaviors are going to change with you as a result of COVID-19 moving forward, so more on an organic basis rather than through M&A?

And the second question, June, in terms of new cars, it sounds like it was obviously better than you expected, given the speed of selling an inventory. I’m just wondering if you can share any insight to how July has been shaping up to date.

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Duncan Tait, Inchcape plc – Group CEO & Director [13]

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Thanks, Andrew. Right. Let’s — I’ll talk about the first question and Gijsbert second, if we could. So I think in terms of this acceleration, it’s certainly getting, I think, OEMs and us to examine the future of how car ownership will be and particularly to look at the lifetime value of a vehicle and, of course, of a customer. So we’re working with one of the OEMs to look at the 3 phases of car ownership, from the first purchase of a new vehicle to the second phase as a used vehicle and then onto the third again as a used vehicle, and how we can use data and collaboration between Inchcape and OEMs to better serve customers and, of course, to benefit Inchcape and the OEMs. So those conversations are live. And I think they — that one is illustrative of the way we’re thinking about a lot of our relationships with OEMs.

So I think the OEMs are alive to the opportunity of the lifetime value of customers and the vehicles. I’ll — Gijsbert, I don’t know if you want to add anything to the first point. And could you take number two?

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Gijsbert de Zoeten, Inchcape plc – CFO & Executive Director [14]

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Yes. So the short answer is that July trading was broadly aligned with June trading. To give it a bit more color, Australia has been a bit weaker to the story that Duncan was laying out. Melbourne, not spreading fortunately to Sydney yet, but a bit weaker. LATAM is the same. There was a question when you expect Chile to open. There is actually some good news there that in the coming days, we will be able to get activity in Chile, which is great.

U.K. is actually continuing the strong June performance that we’d seen. And Europe overall is also similar to June. Hong Kong is not great, but there’s not an enormous impact yet of protests or indeed COVID restrictions. And as regards to Singapore, the COE availability that we were talking about, so actual deliveries of cars were happening, after 2 months not happening, in July. So overall, broadly in line with June. And the last point I would make is that aftersales also continues strong.

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Operator [15]

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The next question comes from the line of James Zaremba from Barclays.

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James Edward Zaremba, Barclays Bank PLC, Research Division – Research Analyst [16]

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Yes. 3 questions, please. One, just on the JLR deal just so I understand it. So you’re effectively awarded a contract, in terms of any asset transfers, things like that, can you talk about what kind of setup cost is involved? So talk a little bit more about that. I guess what is the market status at the moment that you’re taking over effectively a going concern distribution business?

And then one on just the impairments, not of goodwill, but I suppose at the site. Is that an impairment of freehold valuations? Or is that something else? And then if it is a freehold, I guess, what is the current balance we have on the balance sheet?

And I guess the last one is just on the kind of cost savings. And I suppose, if I’m playing devil’s advocate, it seems like all those savings are things competitors can do. So I guess what gives us confidence that 50% can be retained in a better market?

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Duncan Tait, Inchcape plc – Group CEO & Director [17]

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Okay. Thank you, James. Go.

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Gijsbert de Zoeten, Inchcape plc – CFO & Executive Director [18]

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Yes. So I mean the JLR deal, let’s not make it too complicated. We’re taking over a dealership of an ongoing situation where we obviously can’t comment, but JLR was wishing to make a change, and we have won that in a competitive context. And more broadly, JLR participate with the remaining business that we have with JLR in the adjacent countries in the Baltics and Finland. And in that sense, we forged sort of a partnership in that space.

In terms of impairments, site impairments you’re specifically after, again just to be clear to all of us, it is all about retail sites, and it’s about underperforming sites. And you can well understand that the trigger for all of this was COVID, and we had to go through each site and make projections about the future. So it is very much those future cash flows where you have to be very cautious from an accounting perspective where COVID and a recovery stage sort of don’t help and fundamentally trigger the impairment. So it’s not an outlook on retail that has deteriorated. Let me be clear to make that point to you.

We’ll take your question on the exact value of assets off-line, James. Suffice it to say that the majority of our sites in the U.K. are owned by us, which in the past has underpinned also the good values we’ve been able to extract as and when we were pruning the portfolio. As regards to savings, I mean, look, Inchcape is a very cost-conscious company. And I can imagine when you see a large number like GBP 90 million, and you say, “Oh gosh, what’s that? And how is that certainly possible?” I think if you sort of stand back, yes, cost-conscious but also clearly geared towards growth, a growth trajectory and where — we’re clearly now looking at a different trajectory. So that sort of prompted us to look at variable cost, which you would expect. And it’s, by the way, well underway.

But also to look again more structurally at both our organization, which we’ve not done for a number of years. So you’re talking about spans and layers and that sort of boring detail, if you like, but that can really help structurally to reduce the cost as well as underperforming sites, where we are very careful that we don’t damage the growth potential of our business. So we expect those latter 2, our organization and as well as the network, to be structural, if you like. And therefore, we’re stating that we expect circa 50% of our GBP 90 million not to come back if the volumes eventually come back to previous levels.

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Operator [19]

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The next question comes from the line of Geoff Lowery from Redburn.

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Geoff Lowery, Redburn (Europe) Limited, Research Division – Partner of Non-Food Retail, Luxury & Sporting Goods Research [20]

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3 questions, but relatively quick. Firstly, can you help us understand the big year-on-year movement in your gross margin percentage? We obviously see the Aussie dollar, yen headwind but equally both distribution and aftersales grew in the mix. So I was hoping for more help understanding the big gross margin move.

Second, in terms of the cost plan, does that alter your view of an approximate 10% drop-through from sales to operating profit? Just wondering if there were any sort of puts and takes around that. And specifically, and finally, on the cost program, how much of the GBP 90 million do you think benefits this year’s P&L and how much builds into next year, please?

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Duncan Tait, Inchcape plc – Group CEO & Director [21]

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Thanks, Geoff. Gijsbert, you’re proving very popular on this call. These are yours.

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Gijsbert de Zoeten, Inchcape plc – CFO & Executive Director [22]

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Okay. Well, gross margin, as you say, I mean — so there is a regional difference. And you’ve highlighted Australia and the Aussie dollar, but there’s also, I guess overall, the mix of our Asia business in the totality is explaining some of the reduction. The other part is there is an element of fixed cost, if you think about technicians in our Aftersales business, which does weigh on gross margin when volumes are lower. It’s limited, but that certainly explains it.

And then there is some element, and I’m — I want to stress, it’s limited. There is some elements of discounting that we’re doing to get rid of certain stock. But again, it’s not huge. Those are the 3 sort of drivers.

In terms of cost plan and how it would alter the 10% drop-through, I still think that the drop-through is a good proxy if you take the total company. If you look at our numbers on the first half, if you would do the calculation, the drop-through was around 9%, slightly lower. But it’s a mix. So I think the cost plans don’t fundamentally alter that sort of broad-brush number of 10%.

And in terms of how much we will see of the benefits of the GBP 90 million this year, I think there are sort of 2 things happening. We have quickly taken out a lot of cost, part of which was not going to be structural. And we have benefited from some government programs. And you’ll see now movements of the more structural savings coming in and some of the first 2 elements going out. So I think overall, yes, some benefits this year still. I think the more important, let’s say, or easier compare to make is between what we expect in ’21 versus ’19, if you like, where we would expect the majority of the savings to be there.

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Operator [23]

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There are no further questions on the conference call. So I will hand back over to your host for closing remarks.

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Duncan Tait, Inchcape plc – Group CEO & Director [24]

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Well, thank you for your questions, and thank you to everyone else on the line who joined us this morning. I look forward to speaking and hopefully meeting with you all in the coming months. As always, if you’d like any follow-up on anything, please do get in touch with Raghav. Thank you very much, everybody.

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