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Operations North America

Market

The Group's activities in North America centre around two main market areas - plumbing and heating distribution, which are served by Ferguson and Wolseley Canada and building materials distribution, which is served by Stock Building Supply.

Ferguson is the largest wholesale distributor of plumbing supplies, pipes, valves and fittings in the USA and a major distributor of heating, ventilation and air conditioning systems¹. The company also distributes waterworks products, fire protection products and industrial pipes, valves and fittings as well as operating a number of speciality businesses, serving markets such as the nuclear industry and a maintenance, repairs and operations management services business. Ferguson is managed through "business groups" such as Heating Ventilation and Air Conditioning ("HVAC") and Waterworks. These business groups allow management to focus on the specific needs of key groups of customers. Ferguson is present in 50 states, as well as the District of Columbia and has 1,237 branches (2005: 941 branches).

Wolseley Canada distributes plumbing, heating and piping products, including heating, ventilation and air conditioning, waterworks, refrigeration, industrial pipes, valves and fittings and fire protection products as well as industrial plumbing supplies to customers through its 246 branches (2005: 238 branches).

Stock Building Supply is the largest supplier of building materials to professional home builders and contractors in the USA². Stock Building Supply is present in 33 states with 314 locations (2005: 255 locations) and provides contractors with building materials such as structural timber products, roofing products, windows, insulation and hardware. Stock Building Supply also assembles and sells a variety of engineered wood products and offers customer delivery, design, installation as well as financing and credit services.

In general, the North American plumbing and heating distribution market is fragmented with an estimated 95% of distribution operations employing less than 100 people. Consolidation of market players has accelerated with some of the major retailers having moved more significantly into the market. The North American building materials market is also very fragmented with no company enjoying more than a 3% market share³.

Both markets have shown good growth in recent years reflecting low unemployment rates, relatively low interest rates and strong real GDP growth. Wolseley has shown impressive organic growth, outperforming the market and gaining market share.

Demographic trends support high rates of home ownership and residential construction with "baby boomers" entering their peak earnings time and purchasing second or trade-up homes while immigrants are buoying the entry-level market. Baby boomers, who are thought to control a majority of the wealth in the USA, are also expected to have a significant effect on the repair and remodel market as their decision to improve their existing homes will be less influenced by the state of the economy.

The plumbing and heating distribution market is driven by new construction and remodelling sales. The latter market is less cyclical. The building materials market is influenced similarly although Stock Building Supply's business is currently more focused on the new residential construction sector. Annualised housing starts in the USA at 31 July 2006 were just below 1.8 million per annum⁴, but there are indications that the market will continue to soften.

Splitting the US into four geographic regions using US Census information, it is possible to analyse the number and growth in new housing starts by region. This can then be compared to Wolseley's share of its business in each of these regions although it should be noted that this will also reflect sales into non-residential sources.

	New residential		Remodelling		Wolseley
Region	Calendar 2005 share of starts	Growth versus 2004	Calendar 2005 share	Growth versus 2004	share of revenue in 2005/6
Northeast	9.2%	8.0%	17.3%	12.6%	6.9%
Midwest	17.3%	0.6%	23.4%	8.3%	15.0%
South	48.2%	9.6%	35.7%	14.9%	46.5%
West	25.3%	1.7%	23.6%	13.8%	31.6%

Note: US Census information relates to calendar years whereas the Group information relates to the year to 31 July 2006.

In the South and West areas which in 2005 represented 73.5% of new housing starts and 59.3% of remodelling activity, the division had 78.1% of its business and hence is well placed to exploit these key markets.

Management has estimated overall market sizes for North America. For the materials market, market size is based on the final selling cost to the installer or end user. For construction services, the market only includes those activities currently serviced by Wolseley. Management's best estimate of both Wolseley's activity in each market and the total size of these markets are set out below:

	Wolseley North America			USA
	Revenue £bn	Estimated market size £bn	Estimated market share %	Sales £bn	Estimated market size £bn	Estimated market share %
Plumbing, Heating & Air Conditioning	3.0	38.1	8%	2.6	32.7	8%
Electrical	0.1	37.9	0%	0.1	30.9	0%
Building Materials	2.7	187.4	1%	2.7	173.1	2%
Civils/Waterworks, Industrial & Commercial	2.7	111.6	2%	2.5	107.4	2%
Construction Services	0.5	84.7	1%	0.5	64.5	1%
Total	9.0	459.7	2%	8.4	408.6	2%

	Canada
	Sales £bn	Estimated market size £bn	Estimated market share %
Plumbing, Heating & Air Conditioning	0.4	5.4	7%
Electrical	0.0	7.0	0%
Building Materials	0.0	14.3	0%
Civils/Waterworks, Industrial & Commercial	0.2	4.2	5%
Construction	0.0	20.2	0%
Total	0.6	51.1	1%

Management has also estimated the business drivers for its revenues in a consistent manner to the European division. The results are shown below:

	Sales £bn	Sales %
Residential:
New construction	4.1	46%
Repairs, Maintenance and Improvements	1.4	16%
Non-Residential:
New construction	1.8	20%
Repairs, Maintenance and Improvements	0.9	10%
Civil infrastructure	0.8	8%
Total	9.0	100%

In general the division shows a broad spread of business across the categories. While residential new construction has slowed, the other segments continue to show growth. Actions are being taken to widen the business base and increase Wolseley's presence in these other market segments. The use of the business group model providing dedicated focus on customer segments in North America is providing focus towards this objective.

Wolseley remains confident that with the continued development in the strength and depth of its management and the investment being made in the supply chain, the business is well placed to succeed in meeting its growth targets and improve margins over time.

Divisional performance

Wolseley's North American division performed strongly in the year to 31 July 2006 with significant rises in revenue and profits, maintaining its position as the leading distributor of construction products to the professional contractor market in North America.

Reported revenue of the division was up 36.1% from £6,619 million to £9,008 million, reflecting organic growth of 16.4%, net gains from price fluctuations in commodities, acquisitions and the beneficial impact of currency translation. Trading profit, in sterling, increased by 41.5% from £426 million to £603 million, after an increase of £10 million in North American central costs, reflecting the creation of the new North American management structure with effect from 1 August 2005.

Currency translation increased divisional revenue by £274 million (4.1%) and trading profit by £18 million (4.2%). There was a net increase of 363 branches in North America to 1,797 (2005: 1,434).

US Plumbing and Heating

Ferguson produced another outstanding performance generating strong organic growth from its focus on selected markets, new branch openings and driving further commercial advantage from its distribution centre ("DC") network. These factors contributed to significant market out performance in the year.

Local currency revenue in the US plumbing and heating operations rose by 35.1% to $9,651 million (2005: $7,144 million) with trading profit up by 40.4% to $676 million (2005: $481 million). Organic revenue growth was 24.3%. The second half gross margin benefited from further increases in commodity prices, mainly copper towards the latter part of the financial year. Ferguson's scale and distribution capability allowed it to take advantage of price movements in a rising commodity market to secure additional one-off profits amounting to around $35 million in the second half in addition to the one-off gains of around $8 million in the first half. Taking into account the one-off gains, the trading margin increased from 6.7% to 7.0%. The underlying trading margin was approximately 20 basis points higher, year on year, increasing from 6.5% to 6.7%, despite significant revenue investments.

Volumes through the DC network grew by 34% compared to the prior year and more than 50% of branch sales now go through the network. Further investment was made in the DCs with an additional 700,000 square feet of capacity added through the expansion of four existing facilities. Board approval has recently been given for new DCs in both Florida and northern California, which should be operational within 12 months.

Of the markets in which Ferguson operates, the commercial and industrial sectors continued to improve and although new housing slowed towards the end of the financial year, other housing related activity remained strong, with the positive economic environment benefiting the repairs, maintenance and improvement sector. RMI is becoming an increasingly important element of overall construction spend in the USA. To address this opportunity, Ferguson opened a further 64 XpressNet branches and 30 new showrooms during the year. More than 60 new specialist branches for heating, ventilation and airconditioning or waterworks were also opened and this focus should lead to further growth opportunities.

As well as new branch openings, investment in people and IT continued during the period. More than 4,300 people joined the business and the new warehouse management system is being introduced into the large branches. This should lead to better customer service as a result of faster and more accurate product picking and more efficient inventory management.

Ferguson's total branch numbers increased by 296 during the year to 1,237 locations (2005: 941 branches).

US Building Materials

The strong performance of Stock Building Supply benefited from improved market focus which was brought about by the recent business restructuring and from acquisitions. Reported figures also benefited from currency translation.

In local currency, Stock Building Supply's revenue was up 27.4% to $5,305 million (2005: $4,164 million) with trading profit up by 40.6% from $244 million to $343 million. Organic revenue growth was 4.1%, reflecting some commodity price deflation in lumber and structural panels. These commodity price movements had the effect of decreasing Stock Building Supply's local currency revenue by $167 million (4.0%) in the year compared to the prior year with the greater impact being in the second half. Acquisitions contributed $970 million (23.3%) to revenue growth.

Stock Building Supply's trading margin increased significantly from 5.9% to 6.5% primarily as a result of a more favourable sales mix arising from increased management focus on value added products and installed services, both of which represent significant growth opportunities.

For the majority of the financial year, new residential housing starts were around record levels at between 1.9 and 2.0 million starts, although there were significant regional variations. The markets in Georgia, Utah, Texas and the Carolinas have been the strongest throughout the year whereas the weakest markets have been in the upper Midwest and the Northeast. As expected, housing starts declined in the final quarter of the year as a result of rising interest rates, increased inventory of unsold houses and a reversal in the trend of house price inflation. Housing starts ended the year at just below 1.8 million per annum, with the previously buoyant markets such as Washington DC, Florida and Las Vegas showing significant fourth quarter year on year declines. Management action has already been taken to reduce headcount and indirect costs and to shift emphasis to the more resilient housing markets and increase penetration of the RMI and industrial and commercial markets. Initiatives are also being taken to expand the product range throughout the branch network, which should help Stock Building Supply continue to outperform in these softening market conditions.

Value-added sales were up 31%, construction service and installed business sales were up more than 140% and sales to commercial and RMI contractors increased by 47% and 20%, respectively. As well as achieving this through its existing branch network and acquisitions, Stock Building Supply opened 19 new greenfield branches and these initiatives further complement Stock Building Supply's installed service expertise.

Stock Building Supply's branch numbers increased by 59 during the year to 314 locations (2005: 255 branches). The branch opening programme has continued so that Stock Building Supply currently operates in 33 states.

Wolseley Canada

In Canada, the construction and housing markets remained mostly strong, while the buoyant energy sector in Western Canada helped sales in the industrial and commercial sector.

Local currency revenue increased by 13.0% to C$1,330 million (2005: C$1,177 million). Of this, 10.7% of the revenue growth was organic, ahead of the market generally. Gross margin improved and local currency trading profit rose by 12.4%, resulting in an unchanged trading margin of 6.9%.

Work continued to consolidate back offices, recruit additional people to fill management and trainee positions and to improve logistics. The second of three regional supply centres for larger inventory items was opened in Quebec in October 2005, with the third likely to open near Toronto in Spring 2007. These regional supply centres should lead to lower inventory levels and enable the branch network to be utilised more effectively.

Wolseley Canada's total branch numbers increased from 238 to 246 locations.

¹Source: Supply House Times, May 2006
²Source: ProSales, 2006
³Source: IBISWorld
⁴Source: US Census Bureau