Paul Scott interviews Andy Gossage, MD of UP Global Sourcing (UPGS)

UP Global Sourcing Holdings (LON:UPGS)

I reviewed results for FY 7/2022 here in the SCVR for 3 Nov 2022.  It all looked good, so I asked management to do a Qamp;A session at very short notice, and MD (and 9% shareholder) Andy Gossage kindly rearranged some meetings to fit me in.

I’ve spoken to him before, just when covid was starting, audio is here from Feb 2020. Back then, his thoughts amp; experience of supply chains, sourcing from China were really insightful, and of wide read-across.  As he predicted at the time, UPGS was able to navigate the massive challenges of the pandemic very well.

Hence today seemed like an ideal time to have another catch up. He didn’t disappoint, with an interview full of insights again.
Here is today’s audio recording.  Even if you’re not interested in UPGS shares, I think this interview is essential listening for a broader view of supply chains amp; the outlook into 2023.

Exclusively for Stockopedia subscribers (please don’t copy it anywhere else!) here is a transcript I’ve typed up for you. Hopefully it should be obvious who is saying what below.

1. We last spoke in Feb 2020 here just as the pandemic was starting, I remember your insights were fascinating.
   Yes it feels like a lifetime ago!
2. Disclaimers – not advice or recommendation, not charging a fee, and I don’t hold any personally.
3. Congratulations on strong results for FY 7/2022, in line with expectations.
4. Brief description of the business please.
   We’re a consumer products business, best known for the Salter brand (scales), also cookware, kitchen amp; electrical. Beldray (150 years old). We sell beautiful products, mass market, with products that are high standard, but aesthetically pleasing, and affordable. HQ in Oldham, plus Cologne office/showroom, and a large sourcing office in China. Kitchen electrical, floorcare, laundry, Kleeneze, Progress (bakeware), and Petra (German coffee maker brand, just relaunched, going well).
5. Sainsburys, Howdens Joinery, and you, all reported today, saying that trading is going well. So where is this consumer downturn?!
   Cost of living crisis is reducing household spending. Trade off between food amp; non-food. We’ve seen this before – e.g. after Brexit, with smaller baskets, and people prioritise food, with general merchandise suffering. But it is a huge market, and there are always opportunities – e.g. low energy products are now in strong demand. Broad assortment of 3,000 products, so there’s always something selling well. We’re a small player in the UK, and in Europe we have close to zero market share! So for us, it’s always been about gaining market share in huge markets. Our products are affordable, vital in a cost of living crisis.
   (Paul: yes we’re seeing this from Shoezone, Dunelm, etc, companies offering value for money are still doing well).
   Things have been tough – China going in amp; out of lockdown, pandemic, shipping crisis, ships caught in Suez Canal, disruption from Brexit. So continuous disruption for last 3 years. Yet we’ve still managed to increase EPS by 75% over those 3 years.
   In future, operational disruption is fading, but the demand side of things will be more difficult. We plan on confounding expectations to the upside again.
   A lot of this is down to execution – this is why some businesses do well in difficult markets. When things get tough, it’s an opportunity to shine. It’s hard work though. I think we will (shine), through taking market share.
   (Paul: well you’ve certainly demonstrated in the last few years that you’re flexible amp; resilient, defying everyone’s expectations)
6. Let’s touch on European growth, particularly good in today’s update. How come? Any disruption from Brexit? Do you have European distribution hubs, or supply from the UK?
   Only about 10% of our revenue crosses borders from UK to Europe or back. We send product direct into the EU from the Far East, not via the UK. Brexit has brought more paperwork amp; admin. Relentless focus on process, and automation. We have a DC (warehouse) in Netherlands, operated by a 3PL (third party logistics) partner. Brexit has created frictions, it’s a bit of a nuisance, but like all businesses, we just deal with whatever is thrown at us.
7. Talk to us about supply chains, margins, and shipping costs.
   The last 3 years has seen extreme supply chain challenges – factories amp; retailers opening amp; closing, haulage problematic, shipping crisis in all of 2021, and much of 2022. Those challenges are fading. Shipping slowly improving. China still affected by covid lockdowns, but no longer impacting production. Not back to normal, e.g. our China office has to close last week on another lockdown, but our staff can now work from home fine, if they need to. So supply chains are getting better for some months. Albeit still some bumps in the road, e.g. strikes at ports.
   Shipping – in Dec 2020, a 40ft container from China to UK was c.$2,500. In Jan 2021 it went up to $10,000 dollars. It peaked at $18-19k in 2021. We adapted to that, it was a huge credit to our commercial teams, through product innovation, a different mix of product, and some pass through to customers. The container rate, 6 weeks ago, was $8k per container. It’s now $3k. Has largely normalised. My personal view – it may overshoot on the downside to maybe $1k, before returning to long-term average of $2-3k.
   The main headwind now is forex – dollars are now low 110s, was high 120s not long ago.
   Our view is that forex headwind (strong dollar) will be offset by lower freight costs tailwind, giving us a stable gross margin in 2023.
8. You forward buy a lot of your dollars, I see from today’s results.
   Yes, we’ve developed a sophisticated hedging strategy. We lock in the gross margin on taking a customer order, by buying the dollars in advance. We came into this year with a lot of dollars bought at highish 120s. That gives us a breathing space, while the lower freight costs come through.
9. Presumably you’ll have to raise prices for your customers at some stage?
   No I don’t think we will. We had all of the input cost inflation in 2021, both in terms of factory gate, and freight costs. Now our input inflation is going to be broadly level, so we won’t need to, or want to raise prices. If we hold our prices, it’s good for volumes. No need for us to raise pricing over next 12-18 months.
10. How interesting. NEXT said recently they would have to raise prices by 8% in 2023 due to the strong dollar.
    Yes I remember reading that, but I suspect that was just before freight prices really dropped heavily.
11. You’re paying spot rates on containers then?
    Yes we are.
    (Paul: that’s good, so you didn’t lock in to higher freight rates)
12. Roughly how much value of product would there be in a typical 40 ft container from the Far East?
    Varies quite a lot. For reference, furniture (we don’t do that) can be very freight cost hungry.
    For us, it can be from $30-100k in each container, in cost of product.
13. So the cost of freight going up from $3k to $19k, and now back down again, would make a massive difference to gross margin?
    It does, yes. As freight comes down, it will also have some effect on product mix, as it affects products differently.
14. As other currencies have also fallen against the dollar, does this mean factory gate prices in China, converted into dollars, have fallen?
    It does help, and there has been a weakening of the Renminbi against the dollar. Factories in China are very quiet, because there’s a lot of stock in the West, and retailers are working through that stock. Some of our suppliers’ factories in China are going to close early in December, for Chinese New Year (which is not until 21 January). So normally, it’s a mad rush up to the finish. This year, some of the factories are so quiet, they’re closing 3 weeks early. Chinese factory order books are very light. This will have a knock on effect on shipping, which is why I think shipping costs could fall so low. Just my personal opinion.
    So we are not seeing factory gate inflation, in fact we’re more likely to see price reductions, because demand is lower. Overlay the weakness of the Renminbi, which really helps as well.
    Although just be a little careful because many factory input costs are often denominated in dollars – e.g. buying steel in dollars. But wages costs are in Renminbi, which is weaker against the dollar, which certainly helps when it’s weaker.
15. Thinking about your customers, you mention today that supermarkets are your biggest sales channel. They’re notoriously tough on price negotiation, and slow payment. How do you handle this, and why don’t they source products themselves?
    The reputation is slightly unfair. Supermarkets do pay more slowly than discounters, which is why our debtor days has increased. It varies a lot from customer to customer. They’re reliable payers – if you’ve agreed 60 days, they pay on 60 days. Supermarkets are governed by the supermarket ombudsman, so the reputation of old is unfair now.
    Re sourcing products themselves – remember they are mainly food retailers. So non-food is non-core. Our brands offer the retailer a product which is branded, but at a price point not much above their own label. So we try to make it a no-brainer for the supermarkets – offering them an attractive margin, for branded products that will sell better than their own label products. So they make a normal retail margin, and if our products sell well, then next season the supermarket repeat orders our products. We’ve seen Beldray for example, deliver +30% sales growth compared with the supermarket’s own label product. Hence there’s a stickiness to our products, so we retain the business.
16. Online growth – is this still important? I see you prioritised your retailer customers when stocks were difficult to get hold of.
    Absolutely, online growth is still key. Last year, if we had 2 containers, but we could only ship one, we would ship the Tesco container. We would prioritise them, to deliver on our promises. Pure play online retailers are struggling, but for us online will return to growth, because the 2021 comparatives are now soft, when stock was scarce.
17. Do you dispatch all your own online sales?
    There’s a mix. We have some drop-ship accounts, we pack amp; dispatch some. Plus we have Amazon Vendor, where they buy our stock amp; sell it from their own distribution centres (DCs). Various elements to it, mixed.
18. I wrote a positive piece about your results on Stockopedia today. My only quibble was on the balance sheet – a lot of cash has been sucked into working capital – inventories amp; receivables up a lot, trade payables unchanged. That resulted in bank debt going up a lot, and divis paid effectively out of bank debt. Are you being too generous with the divis, and will cashflow improve in future?
    You’re a tough guy Paul! (laughter). All those observations you’ve made are correct, but the context needs more explanation. Inventories – that was normalisation (from shortages in 2021). On debtors, there was an increase in debtor days from the move to more supermarket sales, but from a commercial point of view, that was a positive decision to build up supermarket sales, resilience amp; sustainability, so it’s a price worth paying. We have bank facilities that do flex with our working capital (e.g. import facilities, invoice discounting). Look at our working capital over time. We’re a relatively capital-light business. Over time, we pay out half earnings in divis, and we retain the rest, which reduces leverage. We were virtually debt-free in June 2021, as retained profits repaid debt since IPO. Then we bought Salter, using a bit of new equity, and some debt, which has enhanced EPS. I think we’re in a strong position in our balance sheet. The cash will come through. We’re well hedged on interest rates for the next few years. I’d also like to get debt below 1x EBITDA (from 1.3x now).
    (Paul: I’m not ringing alarm bells here, just saying that, for me, gross debt is probably as high as I’d want to see it, which sounds like you’re saying the same thing).
    Also, there’s debt and there’s debt. So debt to fund capex, may or may not work. Whereas all our debt is used to fund working capital, which converts into cash very quickly. Stock + debtors relative to our debt, is covered 2-3 times.
    (Paul: yes, and money going into working capital is not cash “burn”, so it all sounds fine).
19. China – does it still make sense to use China for most of your manufacturing?
    We are looking to diversify. At the moment it’s 80-90% product from China. There aren’t many other options. Gradual process, we have a team exploring this. The West buys nearly all consumer goods from China. Rebalancing will take a while, gradual process. We’re now incentivising our buyers to start to move sourcing to other countries. China is really, really good at manufacturing, it’s not just about cost. Their attitude to quality, and following what we need them to do, the Chinese are very good at it.
    We’ve diversified a lot in terms of customers – 45% of revenue for top 2 customer at IPO, it’s now below 20% for top 2. We were 65% dependent on discounters. It’s now spread about a third between discounters, supermarkets, and online. When we IPOd, our main brands were licensed. Now only 1 is licensed. Even in China, we’re diversified over 200 factories. Dependence on China is a weakness, but it will be hard to diversify.
20. Thank you very much for your time, for a very interesting briefing.

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