Financial review

Strong and resilient trading performance

Ferguson delivered a strong and resilient trading result for the year, achieved despite the pandemic which started to emerge from March 2020 onwards. The business has demonstrated an agile cost base, a robust cash flow performance and retained a strong balance sheet and great liquidity.

Key highlights

– Revenue 0.9 per cent lower reflecting the impact of COVID-19. – Ongoing gross margin unchanged at 30 per cent, ongoing underlying trading profit margin up 20 basis points. – Headline earnings per share of 511.6 cents 1.1 per cent lower than last year principally due to the increased tax rate. – Total basic earnings per share of 427.5 cents 11.2 per cent lower than last year due to increased exceptional and amortization charges in the year and exceptional discontinued disposal gains in the prior year. – Completed six acquisitions for total consideration of $351 million. – Returned $778 million to shareholders during the year including $451 million by way of share buy backs. – Return on gross capital employed decreased from 26.2 per cent to 23.9 per cent.

Statutory results

The financial results have been prepared under IFRS and the Group’s accounting policies are set out on pages 119 to 124. On August 1, 2019, the Group adopted IFRS 16 “Leases” using the modified retrospective approach to transition. The impact on the opening balance sheet at the date of initial application was the creation of a right of use asset of $1,220 million and a lease liability of $1,481 million. See note 1 on page 119 for a reconciliation of the operating lease commitments previously reported under IAS 17 at July 31, 2019 to the opening lease liability. The impact on the income statement for the year was to decrease rental costs by $337 million, increase depreciation by $268 million and increase finance costs by $53 million, resulting in a net increase to profit before tax of $16 million. There was no impact on the net increase in cash, cash equivalents and bank overdrafts.

Revenue Operating profit Net finance costs Share of (loss)/profit after tax of associates Gain on disposal of interests in associates and other investments

2020 $m

2019 $m

21,819 22,010 1,422 1,402 (144) (74)

(2)

2

7

3

Impairment of interests in associates

Profit before tax

(22) (9) 1,261 1,324

Tax

Profit from continuing operations

(307) (263) 954 1,061 Profit from discontinued operations 7 47 Profit for the year attributable to shareholders 961 1,108

Revenue of $21,819 million (2018/19: $22,010 million) was 0.9 per cent lower than last year as strong growth in the first half of the year was offset by the impact of COVID-19 on trading. Operating profit of $1,422 million (2018/19: $1,402 million) was 1.4 per cent higher than last year, with trading profit growth in the USA and the positive impact of IFRS 16 on operating profit ($69 million) partially offset by a fall in trading profit in the UK and Canada, an increase in the amortization of acquired intangible assets and higher exceptional costs. Profit for the year attributable to shareholders decreased to $961 million (2018/19: $1,108 million) as a result of marginally higher operating profit as mentioned above, more than offset by a higher tax charge due to a higher effective tax rate due to previously announced tax reform, and exceptional disposal gains in the prior year.

Reconciliation between ongoing underlying trading profit and statutory operating profit

In order to monitor performance on a consistent basis, the Group uses certain alternative performance measures which enable it to assess the underlying performance of its businesses. The Group’s key financial performance metric is “underlying trading profit” which is operating profit before exceptional items, the amortization and impairment of acquired intangible assets and the impact of IFRS 16. The Group’s definition of exceptional items is defined in note 2 to the financial statements.

In accordance with IFRS 5 “Non-current Assets Held for Sale and Discontinued Operations”, the Group has businesses which were classified as discontinued operations in the current and prior year and are excluded from continuing operations. In addition, the Group has disposed of a number of businesses which do not satisfy the criteria of IFRS 5 and are therefore included in the Group’s results from continuing operations. The results from businesses that have been disposed of or that the Group is committed to exiting included in the Group’s continuing operations, referred to as “non-ongoing” operations, are excluded from the Group’s alternative performance measure of “ongoing” results. Any reference to “ongoing” operations relates to the USA, Canada and central costs and excludes the performance of the Group’s discontinued and “non-ongoing” businesses.

See note 2 on pages 124 to 127 for further information, definitions and reconciliations of alternative performance measures Ongoing underlying trading profit is reconciled to statutory operating profit as shown in the table below:

Ongoing underlying trading profit Non-ongoing underlying trading profit

Continuing underlying trading profit

Impact of IFRS 16

Continuing trading profit

Exceptional items Amortization of acquired intangible assets

Statutory operating profit

2020 $m

Restated 2019 $m

1,595 1,532

8

74 1,603 1,606

69

1,672 1,606 (120) (94) (130) (110) 1,422 1,402

Operating profit

Performance of the ongoing business

Revenue Gross profit Operating expenses Underlying trading profit Gross margin Underlying trading margin

2020 $m

Restated 2019 $m Growth %

19,940 19,549 +2.0% 5,983 5,870 +1.9% (4,388) (4,338) +1.2% 1,595 1,532 +4.1% 30.0% 30.0% –

8.0% 7.8% +0.2% Ongoing revenue of $19,940 million (2018/19: $19,549 million) was 2.0 per cent ahead of last year but 0.1% lower on an organic basis. Inflation in the year was broadly flat. Ongoing gross margins of 30.0 per cent (2018/19: 30.0 per cent) were in line with last year as a result of good pricing discipline, reflecting the value we deliver to our customers. Operating expenses in the ongoing business were tightly controlled. In addition to temporary measures such as a hiring freeze, reductions in overtime and temps and temporary layoffs, we took decisive actions to right-size the cost base for the market environment. During the year we reduced net permanent headcount by approximately 2,100 across the USA, Canada and UK and made 94 branch closures.

Ongoing underlying trading profit was $1,595 million (2018/19: $1,532 million), 4.1 per cent ahead of last year as the actions on costs contained the profit reduction from lower revenue in the second half. There was one additional trading day compared to last year which increased ongoing underlying trading profit by about $17 million. Acquisitions generated revenue of $356 million and trading profit of $16 million in the year.

Non-ongoing underlying trading profit

The Group’s non-ongoing businesses, which comprised the UK business and in 2018/19 also the Group’s Dutch business, Wasco, and UK business soak.com, generated revenue of $1,879 million (2018/19: $2,461 million) and underlying trading profit of $8 million (2018/19: $74 million). The lower revenue and underlying trading profit generated by the UK business was principally a result of the national lockdown which severely impacted demand.

Impact of IFRS 16

The impact of IFRS 16 was to increase trading profit by $69 million to $1,672 million, as rental costs decreased by $337 million, partially offset by an increase in depreciation of $268 million.

Amortization of acquired intangible assets

Amortization of $130 million (2018/19: $110 million) represents the charge in respect of the Group’s acquired intangible assets. The Group reviews the carrying value of its goodwill and acquired intangible assets annually and when there is an indicator of impairment during the year. No impairment of goodwill or acquired intangible assets was identified as part of the annual review. Goodwill, with a carrying value of $1,721 million (2018/19: $1,656 million), remains on the balance sheet and is supported by value in use calculations.

Exceptional items

Net exceptional charges in operating profit totaled $120 million in the year (2018/19: $94 million), comprising a $3 million loss on disposal of businesses, $93 million of business restructuring charges and $24 million of other exceptional charges, principally in relation to the proposed UK business separation and planned US listing. The restructuring charges were principally in relation to cost actions taken in the USA, UK and Canada to ensure the business is appropriately sized for the post COVID-19 operating environment.

Net finance costs

Net finance costs were $144 million (2018/19: $74 million) with $53 million of the increase due to the adoption of IFRS 16. The remaining increase was principally due to a higher level of average gross debt than last year.

Tax

The Group generates 97 per cent of its ongoing trading profit in the USA and 3 per cent in Canada, before central costs. The Group’s profits are therefore subject to different overseas tax rates and tax laws.

Other than intra-group financing and the recharging of shared management services costs, the Group currently has no significant transfer pricing arrangements. The Group’s Tax Strategy is to maintain the highest standards of tax compliance. We support the execution of the Ferguson business strategy by managing our tax affairs in full compliance with local laws and international guidelines while seeking to maximize shareholder value and serving the interests of all our stakeholders. The Group Tax Strategy can be found at www.fergusonplc.com. The Group incurred a tax charge of $307 million (2018/19: $263 million) on profit before tax of $1,261 million (2018/19: $1,324 million) resulting in an effective tax rate of 24.3 per cent (2018/19: 19.9 per cent). The ongoing tax charge is $376 million (2018/19: $339 million) which equates to an ongoing effective tax rate of 24.9 per cent (2018/19: 23.3 per cent) on the ongoing profit before tax, exceptional items, the amortization and impairment of acquired intangible assets and the impairment of interests in associates of $1,512 million (2018/19: $1,456 million). The increase is primarily due to tax reform.

The wider macropolitical and economic situation is uncertain in some of the main territories in which Ferguson operates and changes could adversely impact the Group’s business as well as the Group’s future tax rate. A combination of growing international trade pressures, including trade-related actions taken by the USA and China and rising debt levels, especially as a result of governments’ responses to the COVID-19 pandemic, is creating political and regulatory uncertainty which could lead to changes to the prevailing tax regime and adversely impact the Group’s results. The Group is engaged with the relevant tax authorities and will ensure any changes are reflected in Ferguson’s tax strategy. The Group will continue to monitor and assess all external developments which could potentially impact the rate. The Group paid $225 million (2018/19: $242 million) in corporation tax in the year. The corporation tax paid in the year will typically differ to the total tax charge in the income statement as a result of: – non-cash deferred tax expense or income arising from accounting requirements in IAS 12 “Income Taxes” to recognize tax which may become payable or recoverable in future periods; – adjustments to the current year’s tax charge in respect of the under or over provision of tax for prior years; and – timing differences between when tax is reflected as a charge in the accounts and when it is paid to the tax authority.

Earnings per share

Headline earnings per share decreased by 1.1 per cent from 517.4 cents to 511.6 cents. Basic earnings per share from continuing operations were 424.4 cents (2018/19: 460.9 cents) and diluted earnings per share were 420.4 cents (2018/19: 457.5 cents). Total basic earnings per share, including discontinued operations, were 427.5 cents (2018/19: 481.3 cents) and total diluted earnings per share were 423.5 cents (2018/19: 477.8 cents).

Cash flow

The Group has continued to generate strong cash flows during the year with cash generated from operations of $2,252 million (2018/19: $1,609 million) and a good cash conversion ratio of cash generated from operations/Group adjusted EBITDA of 125 per cent (2018/19: 90 per cent). Cash generated from operations in the year includes the impact of IFRS 16 of $348 million. Without this, the cash conversion would have been 106 per cent.

2020

2019

Net debt excluding lease liabilities $m

Lease liabilities $m Net debt including lease liabilities $m

Net debt $m

Operating cashflow 1,904 348 2,252 1,609 Interest and tax (331) (53) (384) (319) Capital expenditure (302) – (302) (418) Acquisitions (351) – (351) (657) Dividends paid (327) – (327) (445) Share buy back (451) – (451) (150) Disposal proceeds 52 – 52 303 Lease liability additions, disposals and remeasurements – (131) (131) –Other items (17) (38) (55) (38) Net movement 177 126 303 (115)

Acquisitions and capital expenditure

Acquisitions are an important part of our growth model and during the year we invested $351 million in six bolt-on acquisitions, principally in the USA. During the initial uncertainty of COVID-19, the Group paused acquisition activity. We now intend to resume our focused acquisition program, funding selective bolt-on acquisitions to improve our market leadership positions or expand the capabilities of our existing business models. The strategy of investing in the development of the Group’s business models is supported by capital expenditure of $302 million (2018/19: $418 million). Investment was higher in 2018/19 primarily due to one new freehold distribution center in the US. The Group also continues to invest in strategic projects to support future growth such as distribution hubs, technology, processes and network infrastructure.

Returns to shareholders

Given the initial uncertainty of COVID-19, the Group took prompt actions to optimize cash flow including suspending the $500 million share buy back announced on February 4, 2020 and after careful consideration withdrawal of the interim dividend due for payment in April 2020. Taking into account the Group’s prospects and financial position, the Board has decided to propose a final dividend for the year ended July 31, 2020 of 208.2 cents per share which effectively reinstates the previously withdrawn interim dividend. Thus, in a year of slightly higher underlying trading profit with excellent cash generation and strong balance sheet, the Board is recommending an overall dividend in line with last year’s total dividend (2018/19: 208.2 cents per share). During the year the Group returned $451 million to shareholders through share buy backs including $350 million from the share buy back program announced in June 2019 and $101 million from the share buy back program announced in February 2020 prior to it being suspended.

Return on gross capital employed

Return on gross capital employed decreased from 26.2 per cent to 23.9 per cent. The decrease was due to an increase in capital employed.

Net debt excluding lease liabilities

Net debt excluding lease liabilities decreased during the year by $177 million to $1,012 million at July 31, 2020. Strong operating cash flow generation of $1,904 million was partly offset by acquisition and capital expenditure of $653 million, interest and tax payments of $331 million and shareholder returns of $778 million.

Pensions

At July 31, 2020, the Group’s net pension liability of $61 million (2018/19: asset of $153 million) comprised assets of $2,122 million (2018/19: $1,904 million) and liabilities of $2,183 million (2018/19: $1,751 million). The change in the net pension liability is primarily due to the impact of changes in actuarial assumptions on the UK defined benefit obligation. IAS 19 (Revised) “Employee Benefits” requires the Group to make assumptions including, but not limited to, rates of inflation, discount rates, and current and future life expectancy. The value of the liabilities and assets could change if different assumptions were used. To help understand the impact of changes in these assumptions we have included key sensitivities as part of our pension disclosure in note 23 (iv) on page 151.

Other matters

Capital structure

The Group’s sources of funding currently comprise operating cash flow, access to substantial committed bank facilities from a range of banks and access to global capital markets. The Group maintains a capital structure appropriate for current and prospective trading and aims to operate with investment grade credit metrics and within a through-cycle range of net debt excluding lease liabilities of one to two times Group adjusted EBITDA. The Group is highly cash generative and the Board has established clear priorities for the utilization of cash. In order of priority these are: (i) to reinvest in organic growth opportunities; (ii) to fund the ordinary dividend to grow in line with the Group’s expectations of long-term earnings growth; (iii) to fund selective bolt-on acquisitions to improve our market leadership positions or expand the capabilities of our existing business model; and

(iv) if there is excess cash after these priorities, return it to shareholders reasonably promptly.

Liquidity

The Group maintains sufficient borrowing facilities to finance all investment and capital expenditure included in its strategic plan with an additional margin for contingencies. The Group aims to have a range of borrowings from different financial institutions to ensure continuity of financing. During the year the Group issued $600 million principal aggregate amount of bonds at 3.25 per cent with a 10-year maturity. At July 31, 2020, the Group had total committed facilities, excluding bank overdrafts, of $5,118 million (2018/19: $3,870 million). Of the Group’s committed facilities at July 31, 2020, $2,200 million (2018/19: $1,573 million) was undrawn. $2,085 million (2018/19: $1,610 million) of the total facilities mature after more than five years.

Financial risk management

The Group is exposed to risks arising from the international nature of its operations and the financial instruments which fund them. These instruments include cash, liquid investments and borrowing and items such as trade receivables and trade payables which arise directly from operations. The Group also enters into selective derivative transactions, principally interest rate swaps and forward foreign exchange contracts, to reduce uncertainty about the amount of future committed or forecast cash flows. The policies to manage these risks have been applied consistently throughout the year. It is Group policy not to undertake trading in financial instruments or speculative transactions.

Other financial risks

The nature of the Group’s business exposes it to risks which are partly financial in nature including counterparty and commodity risk. Counterparty risk is the risk that banks and other financial institutions, which are contractually committed to make payments to the Group, may fail to do so. Commodity risk is the risk that the Group may have purchased commodities which subsequently fall in value. The Group manages counterparty risk by setting credit and settlement limits for a panel of approved counterparties, which are approved by the Group’s Treasury Committee and are monitored regularly. The management of customer trade credit and commodity risk is considered to be the responsibility of operational management and, in respect of these risks, the Group does not prescribe a uniform approach across the Group. The Group’s principal risks (including strategic, operational, legal and other risks) are shown on pages 53 to 59.

Mike Powell

Group Chief Financial Officer