Heating and Ventilating

In the first six months of 2010 Travis Perkins has experienced a gradual return of confidence in both its performance and prospects, which has led to excellent results, the resumption of dividends and activity to continue the expansion of the group – most notably through the offer, announced shortly after the period end, to acquire The BSS Group plc (“BSS”).
During the winter the markets continued to show signs of stabilisation and despite a poor start in January and February because of the bad weather, the first half-year saw a strong rebound in construction activity, led by a pick up in new house building.

The change in trading conditions prompted the company to revert its trading stance to the successful strategies it deployed before the recession. This has meant it is once again out-growing its trade and retail markets on a like-for-like basis, while continuing to achieve industry leading operating margins.

Better market conditions, and better relative performance from Travis Perkins has enabled the group to report profits ahead of original expectations for the period, despite being behind after only two months of the half-year.

For the six months to June 30 2010, revenue, at £1,522.1million, was 4.7% up compared with the same period last year. Travis Perkins Group adjusted operating profits were up 2.4% to £120.4million, with adjusted profit before tax ahead by 23.7% to £111.8million. Adjusted earnings per share were down 6.4% to 39.6 pence, reflecting a weighted average 30.9% more shares following the rights issue. During the half-year, the year-on-year trend of monthly profit showed consistent improvement, and this has led the board to approve payment of an interim dividend of 5p per share.

Exceptional costs of £4.6million relate to the BSS acquisition and are estimated to total (excluding integration costs) £18million by the year end, assuming completion of the BSS transaction.

The group's adjusted operating margin fell slightly, at 7.9% against 8.1% last half-year. This reflects higher merchanting operating margins offset by lower retail margins. The rate of year-on-year merchanting gross margin decline has stabilised as competitive conditions have eased. This is attribute to the availability of more construction activity and an approximate 6% reduction in sector capacity since the recession began. Retail gross margins were up by just under 2%.

In view of the change in market conditions, the group began cautiously to invest in new capabilities, particularly in retail and also in capacity to support further improvements in its offer and service levels to customers. While this has increased overheads, the company has seen gains in productivity, and it aims to gain the benefits of operating leverage as volume continues to pick up.

The group generated adjusted free cash flow of £137.7million in the first half of 2010 and net debt was reduced to £410.5million. For covenant purposes adjusted net debt was £336.7million, giving a net debt / EBITDA ratio of 1.19 times. Interest cover was 16.75 times.

This lower level of net debt left the group with significant unused capacity in its banking facilities, and during the period, in agreement with the lenders, it bought in, but did not cancel, £84.3million of its £1,000million revolving credit facility in return for a profit of £2.6million, which has benefited its finance charges in the half-year income statement.

The gross deficit of the pension scheme decreased by £6.5million to £36.5million in the six months to June. This was assisted by a £34.7million one-off pension contribution and other company contributions of £9million which more than mitigated adverse investment markets and a reduction in the corporate bond rate increasing liabilities in the period.

The group has recommended resuming the payment of dividends based on its prospects, the strong first half trading performance and strong cash generation. Initially it will be basing this off a conservative level of cover with an interim dividend level of 5p per share. The group's objective is to grow dividends ahead of earnings to reduce the current level of cover during the medium term until a satisfactory level of dividend cover is attained.

The interim dividend will be paid on November 15 to shareholders on the register at close of business on October 22.

MARKETS

After the significant and rapid falls in construction activity experienced in the first half of 2009, the market stabilised towards the end of that year. From March 2010 onwards the company saw a strong rebound in activity and a reversal in the divergent fortunes of the trade and retail markets. Although the rebound has continued in July, it expects the rate of recovery to moderate.

Given the unprecedented scale and rapidity of the contraction in activity in 2009, it is perhaps no surprise that the company has recently seen a sharp year-on-year increase in activity. Against the historic levels of new building and repair works, the market has only progressed from appalling in 2009 to miserable now.

However, the current low level of activity on this perspective still represents a significant gain in market volume from the troughs of last year. Since activity is still some way off peak levels, it expects further growth, albeit gradual.

Significant uncertainties remain and the company expects any recovery to be uneven and gradual. Public sector new construction, which Travis Perkins estimates represents less than 10% of its revenue, is certain to come under considerable pressure but with the full effect probably not emerging until the second half of next year.

New house building, from which it estimates it now derives 17% of revenue, is unlikely to continue the very strong rate of growth seen in this first half which was spurred on by house builders opening mothballed sites to re-build their inventories. Indeed, recent lead indicators suggest new house building activity is likely to slow in
the second half-year.

However, the group expects the difficulties with mortgage availability and low consumer confidence are only likely to dent the second half rate of gain over the very low levels of building in 2009, rather
than produce another contraction.

Against these more volatile segments of the market, Travis Perkins Group expects to see a continuation of the gradual recovery in the more resilient repair, maintenance and improvement ('RMI') sector. The RMI sector which, the company estimates, represents some 70% of its revenue, is driven by a range of diverse factors, including consumer and corporate confidence, public sector budgets and activity in the secondary housing market. While signals here are mixed, once again activity levels could remain low on an historic perspective, and yet still show significant improvement over 2009.

Commercial and industrial markets, which represent less than 10% of turnover, and have the greatest impact on the specialist merchanting business, were relatively weak during the period.

Materials for RMI work are purchased by both consumers and tradesmen. Both types of customer use the retail and merchanting outlets but consumers are much more strongly represented in Wickes, Tile Giant and ToolStation, TP's retail brands.

In 2009, the group was pleasantly surprised by the shallow trough experienced in the retail market, where it had expected a much larger fall in volume.

The fall in private individuals' property costs and lower than expected
unemployment no doubt helped consumers considerably, with an increase in funds available to them after spending on non-discretionary items. With the rate of VAT returning to 17.5% in January, the strong market trends seen as 2009 closed were rapidly reversed as the group came into 2010.

The hike in VAT also seemed to signal a change of sentiment among consumers, and it was this, together with poor weather through until March, which caused a number of lost days trading and meant the retail market started the year poorly.

Although market trends improved in the second quarter, retail volumes were down overall for the first half-year compared with last year. In 2010, with no further interest rate reductions available to cushion consumers from the effect of continued high inflation, the retail DIY market has contracted, in contrast to the bounce back in activity in the trade market. With price inflation running at about 3.4%, TPG estimates retail market volume is down by about 3% during the first half of 2009.

In contrast, the trade market, which had a much worse time last year benefited from the recovery in housing noted above, and grew by an estimated 5%. With price inflation of 2.8%, volumes were up by 2.6%. RMI volumes in the trade market were also ahead, reflecting a recovery in the use of tradesmen for RMI work, who
are typically used by corporates and public sector clients, and for more demanding and larger projects.

Travis Perkins Group continues to see a slight contraction in sector capacity, with competitors announcing a few branch closures each month, most of which have come from publicly-owned networks.

Independent merchants have generally performed relatively better through the recession because of their strong customer relationships and an injection of cash from lower working capital.

OPERATIONAL PERFORMANCE

Turnover in the merchanting division was up 6.0%. Overall earnings before interest and taxation ('EBIT') increased by 13.6% to £95.3million. Like-for-like turnover per trading day was up by 5.4 %. The trend of like-for-like turnover in the last two months has been strong, at 10.4%.

The company's general merchanting business, operating in four distinct business units under the Travis Perkins brand implemented a number of improvements to its service to builders, with increased product availability, and better ranges in branches which are more adapted to local market requirements.

Travis Perkins also expanded its sales resources under a restructured sales organisation and invested in new technology to support sales activity.

Further contract wins have been achieved in the local authority and social landlord stores market. It has seen good growth in both fleeted and re-hire toolhire business with recent improved demand for larger plant and site accommodation. These initiatives have contributed to gains in market share, and it is once again out-growing the market on a like-for-like basis, against both national and independent merchants.

The company has continued to leverage flexibly in its new warehouse facility in Northampton, centralising the distribution of more products to increase product availability, improve gross margin and support xpansion of direct sourcing.

The success of its work here has led the company to expand its central warehouse facilities, and it has taken a lease on a further large (491,000ft²) warehouse near its existing facilities in Northampton. The expansion of supply chain capacity boosts gross margin via increased product centralisation and expansion of its direct sourcing activities. It is targeting $100million of purchases of directly sourced products and aims to expand further to strengthen its ability to withstand market pressures on gross margin.

The four specialist merchanting businesses, Keyline, CCF, City Plumbing and Benchmarx, have also experienced a recovery in their markets and have all grown their revenues on a like-for-like basis in the first half-year.

Keyline and CCF have both benefited from the new housing recovery but are still experiencing falling volumes from large commercial construction projects. While the performance of both businesses continued to improve as the period closed, CCF, with its greater exposure to commercial projects, is having a tougher time. In contrast, City Plumbing has enjoyed strong volumes, partly boosted by the boiler scrappage scheme, while the progress of Benchmarx in the trade kitchen market has accelerated.

The company says it continues to exploit customer dissatisfaction with the longer-standing merchants in this market, and has achieved exceptionally strong like-for-like sales growth. Benchmarx has generated profit in recent months, and TP expects its growing awareness among small specialist joiners to support further profitable market share gains.

There has been no significant network growth although smaller Benchmarx units have been successfully implanted into a number of Travis Perkins and Keyline branches, and similarly the rollout of City Heating Spares has commenced in the City Plumbing branches.

Overall, the merchanting division achieved an operating margin of 9.3% over the six-month period, 0.6% higher than last year. While gross margins were 30 basis points below last year's level because of market pressure on commodity items, overheads as a percentage of sales decreased by 90 basis points (including 30 basis points
relating to increased property profits). Total headcount in the merchanting division at the end of June was 2% higher than at the same point in the previous year.

Retail>

Against the unpromising market background TPG continued to take share on a like-for-like basis and a number of improvements in the proposition delivered good sales growth.

For the first half Wickes overall revenue increased by 1.7%. Like-for-like turnover per trading day was down 0.5% with core products down 3.3% and kitchen and bathrooms (K&B) turnover up by 11.6%. This strong performance in K&B (representing around 22% of Wickes' turnover) reflects the cumulative impact of a number of initiatives taken by the company, including the advertising campaign and the introduction of new bathroom ranges.

It has, however, become evident in recent weeks that the market for such big ticket items has become more difficult and this is reflected in the first quarter K&B sales growth, which was significantly ahead of K&B sales growth in the second quarter.

The company also enjoyed success with initiatives in core products, including a new paint range, and expansion of its multi-channel range, where it now offers all products, including so-called 'big and bulky' products, for next day delivery. These core product initiatives were feasible only with support from essential group functions such as the supply chain and have been formed with a combination of skills from both retail and merchanting disciplines.

The group believe this gives it advantages in the building materials market, and aims continuously to improve its propositions in both markets to introduce enhancements that competitors, without this combination of skills, will find difficult to replicate.

Consistent with its view of market influences, those of the stores with a greater proportion of trade customers shared greater market out-performance than those with more consumer oriented, retail customers.

The company has added three Wickes stand-alone kitchen and bathroom stores in the first half and plan a further two in the second half.

Following its acquisition in November 2007 the group continued to grow Tile Giant and take market share, on both a total and a like-for-like basis. Like-for-like turnover for the six months was up 3.5%. There have been six more outlets added during the period, taking the total to 92 at the end of June.

The momentum built up by the retail initiatives and store expansion during the last two years has meant the company has grown market share in gross terms, and also outperformed the market on a like-for-like basis during the first half year.

Apart from a brief bout of market madness just before Easter, competitive conditions have remained tough but rational. While the occasional promotional campaign might be expected from time to time, the strength of the propositions continues to ensure the group can outperform the market in the long run.

Overall the retail division achieved an operating margin of 5.2%, 2.0% lower than last year, reflecting the fall in volume, with revenue from its initiatives unable to completely compensate for the contraction in the market.

In addition margin was diluted slightly from the launch cost of the initiatives, which increased market share and are back on track to deliver a good cash payback.

ToolStation

Associate company, ToolStation, also outperformed its peers in the multi-channel sphere, with like-for-like sales growing by 50%.

ToolStation traded from 66 stores at June 30 2010 having opened 33 stores since December 2008 and expanded its central distribution facilities with a new warehouse in Redditch. More than one third of its stores are making a positive contribution, with those stores that have reached their forecast maturity date exceeding the contribution levels set in the original investment case - and still growing ahead of market growth rates.

Property

TPG has continued its policy of actively managing the property resources, and achieved some significant successes in the first half year.

The company completed five medium-sized projects, and one large project - Guildford - during the period, securing its full year ambitions for cash and profits by the end of June. TPG does not expect any significant property profits in the second half of 2010.

The Guildford project will allow the company to establish a Wickes store and a range of trade offers, including new Travis Perkins and City Plumbing facilities, on the busiest trading location in the town.

The group continues to look to deploy the cash generated from the programme in further development opportunities and land purchases, with the aim of protecting and improving the trading position in each catchment area and providing further property projects in the longer term.

There are a further 70 projects in progress and the company is confident of sustaining its targets for cash and profits as a perpetual feature of its financial performance.