Equity Research Report

REH

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Generated on: 24 February 2025, Time: 11:06 GMT

Result Summary

Reece Limited has demonstrated a track record of resilient performance and strategic growth, expanding from its Australian origins to become a leading distributor of plumbing, waterworks, and HVAC-R products across Australia, New Zealand, and the United States. The company's recent financial performance reflects both its market leadership and current cyclical challenges, with HY25 revenue declining 3% to $4,402m and EBIT falling 17% to $305m. Despite these headwinds, Reece has maintained its strategic focus on network expansion, adding 32 net new branches during HY25 while completing the rebranding of its US operations under the unified Reece brand.

The industry landscape continues to evolve, with intensifying competition and accelerating digital transformation reshaping traditional distribution models. Reece has responded proactively to these changes, acquiring digital product agency Shadowboxer to enhance its technological capabilities while maintaining its commitment to network density and customer service excellence. The company's strong market position, particularly in ANZ where it holds approximately 40% market share, provides a solid foundation for navigating these industry shifts. Management's focus on "the fundamentals of trade distribution" while investing in digital capabilities demonstrates a balanced approach to industry evolution.

The macroeconomic environment presents significant challenges, with elevated interest rates impacting residential construction activity and persistent cost inflation pressuring margins. This is particularly evident in the US market, where revenue declined 5.2% in USD terms amid "softness in the residential new construction sector, ongoing price deflation in select commodity related categories and increased competitive pressure." Despite these headwinds, management maintains that "fundamentals in our sector remain positive, with demand for housing and infrastructure supported by long-term structural factors in our regions."

Risk factors for Reece center around three key areas: the interest rate environment impacting construction activity, persistent cost inflation affecting margins, and execution risks associated with US market expansion. The company's net leverage ratio has increased to 0.8x (from 0.6x at FY24), though this remains conservative and provides flexibility for continued strategic investment. Recent leadership transitions, including Peter Wilson's appointment as Chairman & CEO and Sasha Nikolic as Group President and Managing Director, add an element of execution risk during a challenging market period.

Near-term outlook remains cautious, with management explicitly stating that "soft trading conditions to continue across both regions." This is reflected in the reduced interim dividend of 6.5 cents per share (down from 8.0 cents) and ongoing margin pressure from cost inflation and competitive intensity. However, the company's long-term perspective remains intact, with management noting that "while we know the short term will have its challenges, the current environment is one Reece has seen before." The continued investment in network expansion, digital capabilities, and brand development positions Reece to potentially emerge stronger through this cycle, though meaningful recovery may require normalization of interest rates and construction activity.

Outlook & Market Conditions

Reece's recent performance reflects significant headwinds from challenging macroeconomic conditions, particularly in residential construction markets. The company reported a 3% decline in group revenue to $4,402m for HY25, with EBIT falling 17% to $305m as both regions faced margin pressure from lower volumes and persistent cost inflation. Management has maintained a cautious near-term outlook, explicitly stating that "soft trading conditions to continue across both regions." The US business has been particularly impacted, with revenue declining 5.2% in USD terms due to residential construction weakness, commodity price deflation, and intensified competition. Despite these challenges, management continues to execute its long-term growth strategy, maintaining investment in network expansion (+32 net new branches), digital capabilities (Shadowboxer acquisition), and brand development (US rebranding completion).

Market expectations are likely to moderate following the weaker-than-expected first half performance and cautious management commentary. Consensus estimates will need to factor in continued pressure on residential construction activity from elevated interest rates, persistent cost inflation impacting margins, and intensified competition in both regions. The reduction in interim dividend to 6.5 cents (from 8.0 cents) signals management's conservative approach to capital management in the current environment. While the company maintains strong market positions and continues to invest for growth, the near-term trading environment suggests earnings expectations may need to be revised downward, particularly given management's explicit commentary about ongoing challenges in both regions.

The operating environment remains challenging, characterized by high interest rates impacting residential construction activity, persistent cost inflation pressures, and intensified competition in slower markets. In the ANZ region, while revenue has remained relatively stable (+0.4% in HY25), cost growth has been more pronounced due to ongoing investment and inflationary pressures, leading to significant margin compression. The US market faces additional challenges from residential construction weakness and price deflation in commodity-related categories, though management continues to execute its growth strategy through network expansion and brand development. Despite these near-term challenges, management maintains that industry fundamentals remain positive, supported by long-term structural factors including housing demand and infrastructure investment. The company's strong balance sheet (net leverage 0.8x) and continued investment in growth initiatives position it to potentially emerge stronger through this cycle, though the timing of any meaningful recovery remains uncertain given the current macroeconomic headwinds.

Group Summary

| 1H25 / Feb-25 |

Metric Value (now) Value (pcp) YoY Change
Revenue $4,402m $4,537m -3.0%
EBITDA $475m $526m -9.7%
EBIT $305m $367m -17.0%
NPAT $181m $224m -19.1%
EPS 28.0c 34.6c -19.1%
Interim Dividend 6.5c 8.0c -18.8%
Net Debt $646m $518m +24.7%
Net Leverage 0.8x 0.6x +0.2x
Operating Cash Flow $256m $378m -32.3%
Free Cash Flow $127m $263m -51.7%
ANZ Revenue $1,980m $1,972m +0.4%
ANZ EBIT $193m $233m -17.2%
US Revenue (USD) $1,596m $1,683m -5.2%
US EBIT (USD) $74m $87m -14.9%
Branch Network 936 904 +32

Group Summary Report

Reece's first half performance for FY25 reflects challenging trading conditions across both its ANZ and US operations, with group revenue declining 3% to $4,402m. The revenue softness was particularly pronounced in the US market, where sales fell 5.2% in USD terms due to weakness in residential construction, ongoing price deflation in commodity-related categories, and increased competitive pressure in a slower market environment. The ANZ business demonstrated more resilience with flat revenue growth, supported by recent bolt-on acquisitions offsetting modest volume declines in the underlying business.

The group's profitability metrics saw more material declines, with EBIT falling 17% to $305m as operating cost inflation and continued investment in growth initiatives compressed margins. This was evident in both regions, with ANZ EBIT down 17.2% and US EBIT declining 14.9% in USD terms. The impact of lower operating leverage combined with elevated depreciation and amortization charges from network expansion and US rebranding activities contributed to the earnings decline. Despite these headwinds, the group maintained its strategic focus on growth, adding 32 net new branches across both regions and completing two bolt-on acquisitions in ANZ including ReFire.

The balance sheet position remained solid although showing some strain from lower cash generation and continued growth investment. Net debt increased to $646m, pushing the leverage ratio to 0.8x (from 0.6x at FY24), while working capital expanded due to inventory build and lower payables. Operating cash flow declined 32.3% to $256m, reflecting both lower profitability and working capital investment. The group maintained its commitment to organic growth with capex increasing to 2.9% of sales, funding network expansion, US rebranding, and branch refurbishments. While the interim dividend was reduced to 6.5 cents per share (from 8.0 cents), this largely reflected the earnings decline with the payout ratio remaining relatively stable.

Segment Breakdown

| 1H25 / Feb-25 |
| ANZ Division |

Metrics Value YoY Change Strategic Impact
Revenue $1,980m +0.4% Flat growth despite market headwinds
EBITDA $271m -12.0% Margin pressure from cost inflation
EBIT $193m -17.2% Investment in growth initiatives
Branch Network 675 +14 net new Network density improvement
EBIT Margin 9.7% -210bps Cost growth exceeding revenue

| US Division |

Metrics Value YoY Change Strategic Impact
Revenue (USD) $1,596m -5.2% Market softness and price deflation
EBITDA (USD) $135m -5.6% Cost efficiency partially offsetting volume decline
EBIT (USD) $74m -14.9% Higher D&A from network investment
Branch Network 261 +18 net new Accelerated expansion
EBIT Margin 4.6% -50bps Operating deleverage impact

Segment Commentary

ANZ Division: The ANZ business demonstrated resilience in a challenging market environment, with revenue holding steady at $1,980m despite softer underlying volumes. This stability was supported by recent bolt-on acquisitions including ReFire, which added five branches to the network. However, profitability was materially impacted by cost pressures and strategic investments, with EBIT declining 17.2% to $193m. The division continued its network expansion strategy, adding 14 net new branches during the period to reach 675 locations. Cost growth was more pronounced in ANZ due to investments in long-term growth initiatives and ongoing inflationary pressures, particularly in labor costs. While near-term trading conditions remain subdued due to higher interest rates impacting construction activity, the division's exposure to essential repair and maintenance work provides some resilience. Management maintains its commitment to network optimization and capability building despite the cyclical headwinds.

US Division: The US operation faced significant headwinds in the first half, with revenue declining 5.2% to US$1,596m amid softness in residential construction, commodity price deflation, and intensified competition in a slower market. Despite implementing cost efficiency measures, EBIT fell 14.9% to US$74m, impacted by negative operating leverage and increased depreciation charges from network expansion and rebranding activities. The division maintained its growth trajectory, accelerating branch network expansion with 18 net new locations to reach 261 stores. A key milestone was achieved with the completion of regional rebranding activities, unifying plumbing, bath+kitchen and HVAC branches under the Reece brand. While near-term market conditions remain challenging, particularly in residential new construction, management continues to execute its long-term strategy of building scale and brand presence in the US market.

Top 3 risk exposures

  1. Interest Rate Environment:
    The elevated interest rate environment represents the most significant near-term risk to Reece's performance, particularly impacting residential construction activity across both ANZ and US markets. With rates at cyclical highs, new residential construction has materially slowed, evidenced by the 5.2% revenue decline in US operations. This external factor sits largely outside management's control and operates with significant lag effects, meaning any improvement will take time to flow through to business performance. The impact manifests through reduced project volumes, intensified price competition, and margin pressure as fixed costs are spread across lower revenue. Management's mitigation strategy focuses on growing market share in repair/maintenance segments, which show greater resilience to rate cycles. Near-term impacts include continued pressure on revenues and margins, while medium-term consequences could see market share opportunities as weaker competitors struggle with the extended downturn. The risk particularly affects the US business where Reece has higher exposure to new construction activity.

  2. Cost Inflation:
    Persistent cost inflation, particularly in labor and operational expenses, continues to pressure margins despite management's efficiency initiatives. This is evident in the ANZ region where cost growth was more pronounced despite flat revenues. While partially controllable through pricing and efficiency measures, the broader inflationary environment limits management's ability to fully offset these pressures. The impact is most visible in EBIT margin compression, with group EBIT declining 17% despite only a 3% revenue decrease. Near-term consequences include continued margin pressure and working capital challenges from inventory management in an inflationary environment. Medium-term implications could see improved competitive positioning as Reece's scale and operational efficiency programs provide advantages over smaller competitors, though this requires successful execution of current initiatives. The risk affects both regions but is more pronounced in ANZ where labor costs form a larger portion of the cost base.

  3. US Market Execution:
    The execution of Reece's US growth strategy represents a significant internal risk given the scale of investment and importance to long-term growth. The completion of rebranding activities, acceleration of network expansion (+18 net new branches in HY25), and ongoing capability building all carry execution risks. While management has demonstrated success in the ANZ market, the US business operates in a different competitive environment with lower margins and higher sensitivity to construction cycles. Near-term impacts include elevated costs from the investment program and potential integration challenges from rapid expansion. Medium-term consequences could see improved returns as scale benefits materialize and brand recognition strengthens, though this requires successful execution across multiple initiatives. The risk is particularly important given the US market's significance to Reece's growth strategy and the current challenging trading environment.

Profit & Loss Metrics

| 1H25 / Feb-25 |

Metric Value (now) Value (pcp) YoY Change
Revenue $4,402m $4,537m -3.0%
Gross Profit $1,285m $1,309m -1.8%
EBITDA $475m $526m -9.7%
EBIT $305m $367m -17.0%
Net Profit After Tax $181m $224m -19.1%
EPS 28.0c 34.6c -19.1%
Interim Dividend 6.5c 8.0c -18.8%
Gross Margin 29.2% 28.8% +40bps
EBITDA Margin 10.8% 11.6% -80bps
EBIT Margin 6.9% 8.1% -120bps

Balance Sheet Metrics

| 1H25 / Feb-25 |

Metric Value (now) Value (pcp) YoY Change
Total Assets $7,282m $7,095m +2.6%
Net Debt $646m $518m +24.7%
Net Assets $4,098m $3,884m +5.5%
Inventory $1,566m $1,496m +4.7%
Trade Receivables $1,316m $1,369m -3.9%
Trade Payables $1,085m $1,240m -12.5%
Net Working Capital $1,797m $1,625m +10.6%
Working Capital/Sales 18.0% 17.8% +20bps
Net Leverage Ratio 0.8x 0.6x +0.2x

Cash Flow Metrics

| 1H25 / Feb-25 |

Metric Value (now) Value (pcp) YoY Change
Operating Cash Flow $256m $378m -32.3%
Capex $129m $115m +12.2%
Free Cash Flow $127m $263m -51.7%
Capex/Sales 2.9% 2.5% +40bps
Operating Cash Conversion 84% 103% -19pts
Dividend Payout $115m $110m +4.5%