Annual Report to 31 December 2019

RNS Number : 9811I

Trian Investors 1 Limited

07 April 2020

7 April 2020

TRIAN INVESTORS 1 LIMITED
(the "Company")

Full Year Results

Annual Report and Financial Statements for the year ended 31 December 2019

The Company announces its Annual Report and Financial Statements for the year ended 31 December 2019.

For further information, please contact:

Ocorian Administration (Guernsey) Limited
(Administrator and Company Secretary)
+44 (0)1481 742 742
Mariana Enevoldsen

Overview of the Company

Trian Investors 1 Limited (the "Company") is a Guernsey-domiciled limited company incorporated on 24 August 2018. The Ordinary Shares of the Company were admitted to trading on the Specialist Fund Segment of the London Stock Exchange ("SFS") on 27 September 2018 ("Admission").

The investment objective of the Company, through its investment in Trian Investors 1, L.P. (Incorporated) (the "Investment Partnership"), is to generate significant capital appreciation through the investment activity of Trian Investors Management, LLC (the "Investment Manager") and its parent, Trian Fund Management, L.P. (collectively, "Trian"). Trian's investment strategy is to act as a highly engaged shareowner at the companies in which it invests, combining concentrated public equity ownership with operational expertise.

In accordance with its investment policy, the Company has made a substantial minority investment through the Investment Partnership, in the amount of approximately £250 million, in Ferguson Plc ("Ferguson"), where Trian believes it has developed a compelling set of operational and strategic initiatives that will help generate significant shareholder value.

Chairman's Statement

For the year ended 31 December 2019

Dear Shareholder,

On behalf of the Board of Directors (the "Board"), I am pleased to present to you the Annual Report of the Company covering the period from 1 January 2019 to 31 December 2019.

On 12 June 2019, the Board announced that funds managed by Trian, including the Investment Partnership through which the Company invests, had acquired a 5.98% interest in shares of Ferguson, valued at approximately £736 million at that time. The Company, through the Investment Partnership, invested approximately £250 million in Ferguson at an average cost basis of £52.85 per share.

The initial results of the Company's investment were favourable. Ferguson's shares appreciated in value, and the Company's net asset value increased in turn. By year-end the Company's net asset value per Ordinary Share was 121.34 pence, approximately 23% higher than the 31 December 2018 figure of 98.35 pence per Ordinary Share.

Since the year-end, Ferguson's shares, as well as most global equities, have been significantly impacted by the economic consequences resulting from the coronavirus (COVID-19) outbreak, with Ferguson's share price falling by approximately 35% from its 31 December 2019 level as at 3 April 2020 (see note 18 to the financial statements). Trian has kept the Board informed about its engagement with Ferguson's management team and board of directors and, as described in the Investment Manager's Report, it continues to believe that Ferguson represents an attractive investment opportunity. Specifically, Trian believes that Ferguson has significant scale advantages over its competitors, and a balance sheet and cash flow profile which should allow it to withstand the current economic disruption and generate attractive returns over a long-term holding period. Trian also believes that the strategic initiatives being pursued by Ferguson can generate significant value when macroeconomic conditions stabilise in the future.

Subject to the Company receiving distributions from the Investment Partnership, the Board is committed to returning cash to shareholders over time through dividends and share repurchases, and on 12 February 2020 the Board announced a dividend of 0.52 pence per share. Subject to its continued investment in Ferguson and receipt via the Investment Partnership of sufficient dividend income, the Board intends to declare an additional dividend of not less than 0.52 pence per share in the third quarter of the calendar year 2020. The Board intends to review the Company's dividend policy for future years if Ferguson modifies its own dividend program. In respect of share repurchases, the Board announced on 12 February 2020 its intention to use approximately £3,000,000 to repurchase Ordinary Shares. The Company completed the share repurchases on 25 February, which resulted in the total number of Ordinary Shares in issue (excluding treasury shares) being reduced by 2,760,830.

The Board is grateful for your continued support and we will continue to keep you informed of developments at the Company as appropriate.

Yours sincerely,

Chris Sherwell

Chairman

6 April 2020

Investment Manager's Report

For the year ended 31 December 2019

Dear Shareholder,

In April 2019, we recommended that the Company invest in Ferguson, the largest U.S. distributor of plumbing supplies, pipes, valves and fittings and fire and fabrication products and one of the largest U.S. distributors of industrial and heating, ventilation and cooling (HVAC) products. We believe that Ferguson possesses an underappreciated and attractive U.S. business:

· Ferguson's organic sales growth has averaged 7.5% over the last five years, which is 3%-4% better than the market, while the company has delivered improving operating margins and returns on capital.

· Ferguson's U.S. business primarily sells to commercial and residential trade customers, who we believe place significant value on the convenience and availability provided by Ferguson versus competitors.

· Most of Ferguson's US sales originate or are distributed from branches or showrooms (its "blended-branch" business), which in our view helps to insulate Ferguson from Amazon and other e-commerce competitors.

· Approximately 60% of Ferguson's sales are oriented towards repair, maintenance and improvement activity, which is less cyclical than new construction.

· As a leading player in a highly fragmented sector, we believe that Ferguson has the ability to be a prudent consolidator in the industry and significantly enhance its market share over time. The company completed 15 acquisitions last fiscal year alone.

· We believe that Ferguson will benefit from continued reinvestment in growth initiatives such as e-commerce (which currently constitutes approximately 25% of Ferguson's overall business based on revenues).

At the time we invested in Ferguson, we believed that the company was mispriced and misunderstood for a number of reasons. First, we believed that Ferguson's North American business (which constituted 95% of 2019 fiscal year earnings before interest, taxes, depreciation and amortization (EBITDA) at the time we invested) was structurally more attractive than its much smaller United Kingdom business (constituting 5% of 2019 fiscal year EBITDA), but the company was not valued accordingly. We also felt that Ferguson was under-owned by U.S. institutions, who we believed should be the natural owners of the company, and that it received minimal U.S. research coverage. Furthermore, despite having a market structure and growth profile similar to U.S. specialty distributors, such as Pool Corp., Watsco, SiteOne Landscape Supply, and Beacon Roofing Supply, investors and analysts rarely compared Ferguson to this peer group, and instead typically compared Ferguson to building materials and U.S. broadline distributors with lower valuations.

One of our Partners, Brian Baldwin, shared our views on why Ferguson possesses an attractive but underappreciated underlying U.S. business at the Sohn Conference in London held on 14 November 2019, and we encourage you to review our presentation from that conference, which is available at www.trianinvestors1.com .

¹ All data contained in this Investment Manager’s Report is based on FactSet and publicly available information from Ferguson’s periodic reports, investor presentations and regulatory filings. Please see “Investment Manager’s Report Disclosure Statements and Disclaimers” below for important information regarding this Investment Manager’s Report.

Value Creation at Ferguson

Since announcing our investment in Ferguson in June 2019, Trian has constructively engaged with Ferguson's management team and board of directors. We've developed productive relationships with both John Martin, Ferguson's former Group CEO, and Kevin Murphy, who succeeded Mr. Martin as Group CEO in November 2019, and have met with them and other members of Ferguson's senior management team on several occasions. We have also had constructive meetings with both Gareth Davis, Ferguson's former Chairman, and Geoff Drabble, who succeeded Mr. Davis as Chairman at Ferguson's 2019 Annual General Meeting.

Since our investment was announced, we believe that Ferguson has undertaken a number of actions that should help to create long-term value. On 3 September 2019, Ferguson announced its intention to demerge its UK operations subject to shareholder approval, creating a company wholly focused on its attractive North American markets. Ferguson expects the UK demerger to be completed in 2020, at which time Ferguson's Group CEO and operational management team will be based in North America and the entirety of its revenues and profits will be generated there. In addition, on 4 February 2020, Ferguson released a statement acknowledging that "the U.S. is the natural long-term listing location for Ferguson" and that the "Board believes that it would now be beneficial to have direct access to the substantial incremental pool of capital in the U.S." As such, Ferguson announced that it was proposing to seek shareholder approval for either an additional or primary listing of Ferguson's shares on a major United States stock exchange. Ferguson noted that it would undertake a period of consultation with its institutional shareholders on these two listing structure options, and that the Ferguson board of directors expects to make a further announcement, likely in the spring of 2020, following the conclusion of the consultation.

Ferguson has also continued to complete bolt-on acquisitions to expand its market share. For example, in December 2018, Ferguson announced the acquisitions of Blackman Plumbing Supply, one of the U.S. Northeast's largest distributors of plumbing supplies, and Wallwork Bros, Inc., a leading supplier of HVAC and Waterworks products and solutions in the Northeast, in order to expand its presence in the New York metropolitan area.

Finally, on 4 February 2020, Ferguson announced its intention to buy back up to $500 million of its shares over the next twelve months (after recently completing another $500 million buy back in December 2019). Ferguson noted that its capital allocation priorities remain unchanged: It will continue to remain focused on achieving organic growth that exceeds underlying market growth, funding ordinary dividends through the cycle (with the aim of increasing dividends in line with long-term underlying earnings growth) and investing in bolt-on acquisitions. Ferguson also stated that its balance sheet remains strong and that it will continue to target net debt in the range of 1x to 2x EBITDA.

Trian's Perspective on Ferguson's Investment Prospects

On 17 March 2020, Ferguson reported its financial performance for the first half of its 2020 fiscal year (the six months ending 31 January 2020). The results at its U.S. business were strong, highlighted by 5% sales growth on a year-over-year basis (3% on an organic basis, 13% on a 2-year organic basis) and 6% underlying trading profit growth (excluding the accounting impact resulting from the implementation of International Financial Reporting Standard (IFRS) 16). These results were encouraging given U.S. category growth was flat, which suggests Ferguson continues to take market share and is demonstrating strong cost discipline. On a consolidated basis, Ferguson grew sales organically 1% (2% excluding the UK), underlying trading profit 3%, and headline earnings per share 2%. (Earnings per share growth was negatively impacted by an increase in Ferguson's tax rate resulting from Swiss tax reform.) Ferguson continues to deploy capital in a shareholder friendly manner: it announced that it is raising its interim dividend per share by 7% and that it had invested $141 million in acquisitions in the first half of fiscal year 2020 and completed nearly $100 million of its recently announced $500 million share repurchase program. Ferguson also noted that the demerger process for its UK business remains on track to be completed in calendar year 2020 and that it will update shareholders on its listing structure later in the spring.

Like most businesses , Ferguson's near-term performance will be significantly impacted by COVID-19 and the economic disruption resulting from the spread of the virus. The majority of Ferguson's sales are driven by residential and commercial remodelling spend, which is sensitive to the underlying economic environment in the U.S. Furthermore, we expect Ferguson's operations to be affected by ongoing disruptions relating to social distancing and other virus-spreading prevention strategies . In particular, Ferguson's showroom network and branches are currently closed to walk-in trade (although most branches remain operational for curbside pick-up or delivery). In the announcement made on 17 March 2020, Ferguson noted that due to the dynamic situation unfolding around COVID-19, it is too early to understand the virus's impact on current trading. With that said, Trian believes that its long-term investment thesis regarding Ferguson remains intact. Ferguson still possesses an attractive underlying business, and it operates as the largest player in a fragmented, growing industry, which we believe should allow it to sustain long-term market share gains . The company's balance sheet remains strong at 1.6x lease-adjusted leverage, which we believe should help Ferguson maintain liquidity in a downturn and enable it to continue to invest to strengthen its business for the future. Moreover, we believe that Ferguson's cash flow profile is resilient, with a large variable cost base and counter-cyclical net working capital requirements that should free up cash in a recessionary scenario.

We also believe that there are opportunities for continued value creation at Ferguson. We are pleased with Ferguson's decision to demerge its UK operations and its announcement that the company will consult with shareholders regarding U.S. listing options. We believe that the demerger should allow management to better focus on Ferguson's stronger North American business and help the company earn higher returns on capital, and that a transfer of its listing to the United States, if completed, could result in numerous benefits to Ferguson, including higher ownership among U.S. institutions, increased U.S. research coverage, comparison to a more appropriate set of peers, and increased employee engagement (as most of Ferguson's employees are based in the U.S.).

As always, there are risks to our investment outlook, including management's ability to execute on its operational plans and Ferguson's significant exposure to residential repair and remodelling activity in North America, as well as the duration and severity of the COVID-19 outbreak and its impact on the global economy and Ferguson's operations. Please also refer to the Company's Prospectus dated 21 September 2018 (the "Prospectus") and the section titled "Principal risks and uncertainties" in the "Report of the Directors" for further information on the risks associated with an investment in the Company.

Ferguson's Foreign Currency Exposure

Although Ferguson shares are currently traded in Pounds Sterling, Ferguson receives the vast majority of its revenues and profits in U.S. Dollars and therefore, from the perspective of a Pound Sterling investor, the Company's Ferguson investment may be adversely affected by the appreciation of Pounds Sterling against the U.S. Dollar. In order to mitigate this risk, the Company through the Investment Partnership entered into a currency hedge in June 2019, in the form of an option to purchase £125,000,000 Pounds Sterling for US$165,875,000, to offset a portion of the Company's U.S. Dollar exposure resulting from its investment in Ferguson. This option expires in June 2020. In addition, the Company through the Investment Partnership recently took advantage of attractive pricing of option premiums following a sharp decline of Pounds Sterling in March 2020, and entered into a second option to purchase £125,000,000 Pounds Sterling for US$165,875,000, expiring in March 2021. Trian believes that Ferguson will continue to have significant U.S. Dollar exposure for the foreseeable future, and the second option is designed to hedge a portion of Ferguson's U.S. Dollar exposure for an additional nine months. However, there is no assurance that either option will be effective at managing the Company's currency exposure.

Concluding Thoughts

Despite the current economic disruption caused by COVID-19, we believe that Ferguson is positioned to withstand a market downturn and continue to believe it will generate attractive returns over a long-term holding period. We look forward to further constructive engagement with Ferguson and working with its management team and board of directors to help create additional long-term value. We appreciate your ongoing support and will continue to work diligently towards fulfilling the investment objective of the Company.

Yours sincerely,

Trian Investors Management, LLC

Report of the Directors

The Directors present their annual report on the affairs of the Company, together with the audited Financial Statements, covering the year ended 31 December 2019 (the "Year"). The comparative period was from 24 August 2018 to 31 December 2018.

Incorporation

The Company was incorporated in Guernsey under the Companies (Guernsey) Law, 2008 as amended (the "Companies Law") on 24 August 2018.

Principal activities and investment policy

The Company is a Guernsey domiciled limited company. The ordinary shares of the Company were admitted to trading on the SFS on 27 September 2018.

The Company, via its wholly-owned subsidiary Trian Investors 1 Midco Limited ("Midco"), holds an approximate 99.8 per cent interest in the Investment Partnership.

As described in the Chairman's Statement, the Company has made a substantial minority investment through the Investment Partnership, in the amount of approximately £250 million, in Ferguson, where Trian believes it has developed a compelling set of operational and strategic initiatives that will help generate significant shareholder value. The Company's investment, through the Investment Partnership, has been made alongside other investment funds and vehicles managed by Trian (the "Trian Funds"), and collectively the Investment Partnership and the Trian Funds held a 6.12 per cent aggregate interest in the shares of Ferguson as at 31 December 2019.

The Company's intention since inception has been to invest in only one company at a time (the "Target Company") through the Investment Partnership, subject to certain exceptions described in the Prospectus. Thus, the Company will not seek to reduce risk through diversification.

The Investment Partnership may engage in hedging transactions, both for investment purposes and for risk management purposes. Similarly, the Company and the Investment Partnership are permitted to undertake borrowings, subject to certain limitations described in the Prospectus. As further described in the Investment Manager's Report, the Investment Partnership has entered into a currency hedge to offset a portion of the U.S. Dollar exposure resulting from its investment in Ferguson.

Business review

A review of the Company's business and an indication of its likely future development is provided in the Chairman's Statement and the Investment Manager's Report.

Dividend policy

As noted in the Prospectus, the Company's original dividend policy was to pay dividends to shareholders following receipt of any distributions from the Investment Partnership, subject always to compliance with the statutory solvency test prescribed by the Companies Law and the right of Directors to retain amounts at the Company for working capital purposes (the "Minimum Capital Requirements"). However, on 12 February 2020, the Company announced an update to its dividend policy to allow the Company and the Investment Partnership to retain a portion of dividends from the Target Company and use those dividends for other purposes, such as repurchases of Company ordinary shares or hedging activities designed to mitigate foreign currency risk . The Board instructed Numis Securities Limited and Jefferies International Limited (collectively, the "Corporate Brokers") to consult with shareholders of the Company on this update to the dividend policy, and the shareholders with whom the Corporate Brokers have spoken have been supportive of the update.

In the event that the Company receives an in specie distribution of shares in Ferguson from the Investment Partnership, the Company may, but is not obligated to, distribute those shares in specie to shareholders, subject to compliance with the statutory solvency test prescribed by the Companies Law.

No distributions or dividends were declared or paid during the Year or during the period ended 31 December 2018. Subsequent to the Year end a dividend of 0.52 pence per share was declared on 12 February 2020 to be paid to the Company's shareholders of record at 21 February 2020, amounting to a total payment of £1,407,000.

Share capital

As at 31 December 2019 and 31 December 2018, the Company had issued 270,585,977 ordinary shares of no par value (the "Shares"), all of which carry equal voting rights. Details of the Company's share capital are provided in note 8 to the Financial Statements.

Shareholdings of Directors and key persons

Directors who held office during the Year and held interests in the Company as at 31 December 2019 and 31 December 2018 were: