Discover Financial Services Q4 2021 Earnings Call Transcript

Participants

Corporate Executives

• Tim Stacey, Group Chief Executive Officer
• Mike Schmidt, Group Chief Financial Officer
• Hollie Haeney, Group Financial Operations Director

Analysts

• Andrew Wade, Jefferies Financial Group Inc.
• Jonathan Pritchard, Peel Hunt
• Michael Benedict, Berenberg Bank
• Georgios Pilakoutas, Numis Securities Ltd
• Eleonora Dani, Shore Capital
• Saranja Sivachelvam, UBS Group AG
• Caroline Gulliver, Stifel Nicolaus

Presentation

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Good morning, everyone, and welcome to the DFS Financial Year '21 Results Presentation. I am Tim Stacey, the Group CEO and I'm here with Mike Schmidt, our Group CFO. We're pleased to present a record set of results in a challenging operating environment, representing another year of progress on our strategic agenda to lead sofa retailing in the digital age.

Now, our presentation today will cover three areas. Firstly, I'll begin with a brief summary of our progress in the year. Secondly, Mike will deliver the financial overview. And finally, I'll present my strategic update before finishing with a Q&A.

So, I'm pleased to report a record set of results in terms of revenue, profits and cash flow, reflecting a very strong bounce back from FY'20's COVID impacted performance. We've delivered another year of progress on our strategy to lead sofa retailing in the digital age with gross sales via our online channels increasing by over 184% compared with the year earlier to over GBP400 million. Now, the strength of our online performance remains a key driver behind that 2 percentage point market share growth over the year as a whole.

While showrooms were closed for around 21 weeks in the financial year, consistent surges in demand, as we emerge from government lockdowns, highlight just how much customers appreciate our integrated retail offer. We strongly believe that the combination of a digital and the physical channels is the right long-term approach to address consumers within the sofa market. Beyond our core upholstered furniture market, we're successfully accelerating our push into the beds and living room furniture markets targeting a GBP5 billion TAM opportunity.

In terms of current trading, demand for our products remains strong with better-than-expected order intake so far this financial year. That said, we are clearly facing a challenging operating environment and I'll come on to talk about that in a moment. Reflecting this financial performance and our outlook, we're also resuming distributions to shareholders with a proposed final dividend of GBP0.075. Now, these results are only possible due to the supreme efforts of our colleagues, and I want to take this opportunity to thank them all for their incredible support during this year, and also thank customers, in particular, and other stakeholders for their patience and loyalty due to the external challenges that we faced.

Now, just taking a step back, I wanted to give you a sense of the current market environment. In broad terms, we're seeing a very resilient demand, which continues to outstrip an unpredictable supply environment. Market demand has been stronger and more sustained than we expected with consumer spending still focused on the home and underpinned by better-than-expected consumer confidence and a resilient housing market. In addition, our Group continues to outperform the market, achieving at least a 2 percentage points incremental market share growth from we believe the successful execution of our strategy.

Now, on the supply side, as I'm sure you're all aware, companies around the world have been struggling to cope with the strength of the recovery, having scaled back their operations during the peak of the pandemic. Now, for us, this is resulting in a range of challenges from input cost inflation, manufacturing and logistics bottlenecks, as well as continued COVID disruption to supply chains around the world. That said, we are leveraging our structural advantages to mitigate these challenges. And these include leveraging both our scale and our experience of mitigating cost inflation wherever possible. We've also secured additional manufacturing capacity, which will come on stream at the half two.

And finally, we're investing in our own logistics platform and key suppliers to increase our delivery capacity. In overall terms, this means that we are working hard to meet these high levels of customer orders, while managing the greater demands on our colleagues and our infrastructure.

So what does this environment mean for our Group? Well, we believe that the Group remains very well positioned due to the fundamental attractions that we set out in detail at our recent interim results. As today's record results show, with our market leadership, our integrated retail business model, a sustainable approach to business, supported by a favorable homeware market, we're unlocking and delivering sustainable growth. This growth comes on several fronts, market share growth in our core sofa business, enhancing existing scale economies that generates healthy cash flow to fund future investment. And we believe the significant medium-term opportunity in the GBP5 billion non-sofa home market. And there is future opportunities to leverage our asset base.

Looking ahead, it's been over two and a half years since we set out our strategy to lead sofa retailing in the digital age. And we are well on the way to delivering the GBP40 million profit uplift by FY'23 that we identified back in 2018. We're pleased with the performance and resilience of our integrated retail business model, particularly during the last 18 months, which has placed exceptional demands on our infrastructure, but also underlined the importance of the combined showroom offer and digital presence. We're pleased with the performance to date of the Sofology acquisition, which is integrating well with our Group platforms.

And as we get closer to FY'23, our strategy is set to evolve from the current 3x3 digital age model to a new model, unlocking new growth from our evolving pillars and platforms strategy. Now, we've been building our platforms for the past few years, and these will underpin the retail brands of DFS, Sofology and our emerging home business. Leveraging our scale and the platforms of technology and data, logistics and operations, and our worldwide manufacturing and sourcing capabilities will enable us to accelerate our drive for sustainable growth. We've also integrated our ESG strategy, it's everything we do. And it is our intention to lead the industry in this space.

So, I'll now pass over to Mike, who will present the financial overview.

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

Thanks, Tim. I'll begin with some overall context on the year that we've had. So we've delivered an unprecedented revenue performance. Looking back comparing against the 2019 financial year pre-pandemic, we've seen growth of 9.7%. And so, this has been achieved both through order intake, but also the benefits of a higher order bank beginning the year. Notably, though, despite seeing up to 21 weeks closures for many of our showrooms, order intake across the year has actually been well above the revenues that we've delivered in the period. And this trend has continued into the first 12 weeks of this financial year. Our strength of trading has meant that our order bank has grown significantly. And it creates resilient foundation for our positive outlook for the current financial year as we'll come on to.

As with many retailers, we have significant operating leverage within our model and the drop-through of the additional revenues has driven strong profit growth with underlying profit before tax reaching GBP105.8 million. And with these strong profits and order intake has come good cash flow, reducing our bank debt to near zero and our leverage to 0.2 times. Even excluding temporary working capital benefits, we still believe our leverage is well within our target debt range. And with the return of lower leverage and the greater certainty on trading environment, we felt comfortable restarting our dividends with a final payment of GBP0.075. We published very recently our revised dividend policy, I think that was back in March time, and as a reminder, this highlighted that we would look to pay out as ordinary dividends 40% to 50% of underlying cash generation with an intention to hold or grow these payments over time in line with the earnings growth and the prospects of the business.

So diving into the results in a bit more detail. Looking at gross margins by brand, both DFS and Sofology have held or grown retail gross margins in each channel despite cost price inflation pressure. For Sofology, this performance is immediately visible on the chart with margins now up to levels broadly consistent with the DFS retail brand. It's very much helped by the scale and the Group relationships we hold on sourcing. For the DFS brand, there are two mix effects going on in the reported numbers shown on the graph that I feel distort our true performance. Firstly, as expected, we saw the percentage mix of margin accretive internal manufacturing decrease. And then, furthermore, the strong web performance by DFS in the year, particularly through the second half during the lockdown periods has also depressed the margin through a sales channel mix effect. We do see a lower margin in the web channel, albeit given the cost-to-serve is lower and the overall profitability of a digital transaction is similar to in-store, we remain broadly channel agnostic.

And if I look at the margin earned by the separate channel. For in-store transactions and the digital transactions, we have helped the DFS margins by channel, offsetting the cost inflation that we have seen. And looking forward, we have seen some significant cost price inflation across all our finished goods products in the 5% to 15% range. But we do believe that we're better positioned than most in the industry to manage these effects, given our scale and the fact that we can monitor trends across both two retail brands, but also our own internal manufacturing. We are mitigating these cost inflation trends through range optimization. However, we're also able to look at passing these costs on while maintaining the same cash profit per transaction. We do expect that the pass-through of some cost price increases will slightly depress retail reported margins in the 2022 financial year probably by up to 100 basis points. However, the cash margin per transaction will be unchanged.

Okay. So now, moving on to our operating cost base. We have seen a step-up in underlying operating costs of approximately GBP10 million, which, for context, is around a 2% increase in our operating cost base. This is a combination of some investment in our digital capabilities, some higher costs to support higher volumes, but also COVID-linked costs such as sick pay, PPE and the increased cleaning. Notwithstanding the increase in absolute operating costs, it is important to note that operating cost margin is coming down by 3.5 percentage points, which drives our PBT margin and which we believe is a trend we will sustain into the 2022 financial year, with absolute operating cost growing, but costs as a percentage of sales reducing slightly.

So turning to cash generation, we have seen a significant reduction in our net bank debt. There's two key factors behind this. Firstly, the significant operating profit and then secondly, a total of GBP85 million of working capital inflow, which is largely underpinned by an increase in customer deposits, and also an increase in trade payables. We do recognize and expect that around GBP70 million of this working capital inflow will likely reverse as our lead times normalize across the future financial periods.

In terms of other movements, alongside our expected cash capital expenditure, we took advantage of an exceptional opportunity to acquire the freehold of one of our store leases. This was actually a top 10 trading location for the Group and the situation where our legally binding future rental payments over the next nine years were actually greater than the acquisition price that we paid for the property. The initial yield on the GBP12.7 million acquisition cost is 13%. And this yield will actually grow into the future as we avoid a fixed rental uplift that was in the lease contract. Clearly, a very attractive opportunistic situation that we took advantage of, but actually not one that we expect to be repeatable. We also made progress on our financing structure in the year, introducing an ESG-linked pricing element based on existing external targets into our RCF agreement, which gives us a beneficial interest cost as we make progress against our stated ambitions in our ESG plan.

Finally, I think a big picture reflection that I really felt was worth drawing out in this slide. Our free cash generation across financial year 2021, excluding the exceptional working capital release was GBP68.7 million. And that actually would have been even higher excluding the store lease acquisition. Notably, that is a 9.8% yield based on the market capitalization as it stood at the start of this week. This business has outstanding cash generation that we believe we can use to drive value for shareholders either through reinvestment or through capital return.

So, a core part of our approach to good cash generation is disciplined capital investment, where we are constantly measuring and testing the returns and we're adjusting our approach on the investments that we're making. We will only deploy significant capital if it's essential maintenance spend or if we've got the clear evidence to support strong future returns. That being said, we do believe we've got some excellent investment opportunities available that strengthen our competitive position and drive future profits. Our cash capital expenditure spend last year was GBP36.5 million, excluding the lease acquisition. And we see a slightly lower level of cash spend around GBP35 million or so this year. We do also expect to sign up to around GBP10 million of leased assets, principally this is the replacement cycle in our vehicle fleet where we saw some deliveries of vehicles deferred from the prior year.

Our logistics activities utilize around a third of our annual overall spend, split broadly 50-50 between maintenance and new capabilities. We secured some great recent efficiency on our leased vehicle maintenance spend through switching to operational rotors through the Sofa Delivery Company, which increased the working hours of our final mile vehicle fleet by over 40%. And in terms of new capabilities, in addition to significant space growth, we are adding a consolidation center to allow us to trial ranges from new suppliers that otherwise would struggle to efficiently distribute products through our network. It will also give us a stockholding capability, one that we're already using to trial offering short lead-time products and to sell our sofa in a box proposition.

Our showrooms account for another third of the spend overall. Half of that showroom spend is on fitting out new locations where we expect to get within two year cash on cash payback, the remainder is on maintenance and on optimizing the current footprint formats, bringing in new home product categories and introducing strong branded base.

Finally, in terms of the areas of our spend, we remain committed to continuing to invest in our technology, which accounts for a third -- a final third of our spend and it is an important part of our growth strategy. Tim is going to come on and talk about the power of our online presence. But it is something we're really excited about. We're also investing heavily in the efficiency of our platforms with plans for an upgraded warehouse management system and the middle mile logistics system, which will be combined with a stronger customer data platform. And we do also have some significant interesting new innovation spend well underway to create differentiated customer proposition in our category, but we won't be saying more on that quite at this stage.

So, turning to our current trading and our view on the 2022 financial year. The strong customer demand, which has been evident together with the 2 percentage points market share gain that we experienced through the pandemic has very much continued into the current financial year. This has actually driven order intake well ahead of the previous expectations we shared. And therefore, we have uplifted our previous case -- our previous order intake guidance in the medium case from 7% to 15% with performance over the first 12 weeks having been well above that level overall. It does also mean that our order bank stands at a record high as demand has outstripped our capacity to produce. We're making progress in increasing capacity with existing third-party suppliers. And as Tim will talk about, we will shortly start delivering products from additional new suppliers. However, in the year-to-date, production has once again been impacted by COVID absences and well-publicized disruption in logistics. This does mean that our revenue performance will likely be half two weighted as more supply capacity comes on board through the year.

We have also been experiencing material cost inflation in parts of our business. And we expect to incur cost of goods inflation and higher operating costs including logistics across the remainder of the year. While we believe that we can protect absolute operating profits through range optimization, we do expect that average order values will be higher than previously expected, while our expected cash profit per transaction is unchanged. This means that the three scenarios for the current financial year that we previously shared back in June have been updated. The increased average order values that we are expecting feed through to higher revenues. However, profit before tax in each scenario remains in line with previous guidance. And while we are pleased with the order intake that has been above expectations, it has delivered revenues that really will drive our profits and the global disruption that we have seen in logistics has prevented above expectations performance on deliveries to date. Of course, the uplift in order intake in each scenario offers a positive sign for the closing order bank in 2022 financial year. And the resilience that we may hold going to the 2023 financial year.

And finally, I think recognizing that the 2021 and 2022 financial years are being distorted by the buoyant consumer market and strong order intake, I'm going to conclude with some thoughts about the sustainable financial model that we expect to operate with from 2023 onwards. And to try and give a simple to digest view, we'll compare our thoughts on the drivers back to a pre-pandemic normal operating environment, which is financial year 2019 when we had approximately GBP969 million of pro forma revenues and approximately a 5% profit before tax margin.

On revenues, in our core upholstery category, I think we already see evidence of two percentage points of market share gain, which when combined with the AOV increases equates to over 10% of sustainable increase in like-for-like sales from 2019 levels through to 2023. So that's an additional GBP100 million or so of revenues.

By 2023, we will also have added 20 new showrooms as well, which should also give up to around GBP100 million of additional revenues as well. And so, looking at that in aggregate, we think, therefore, a realistic revenue base in 2023 could be over GBP1.15 billion with growth from there coming from continuation of above market growth rates, driven by structural advantages, and also growth from our new beds and living room accessories categories. Of course, if we still have an elevated order bank entering the year to convert or if we see additional market growth, then we may find revenues are higher than this level suggested. But we do believe that we already have evidence for the sustainability of that GBP1.15 billion level.

So moving on to profit before tax. Looking at that line, we've previously shared our 7 percentage point plus PBT margin target, we believe that this should be deliverable in 2023 underpinned by the cost efficiencies our strategy has driven, but also from the increased revenues that we've touched on, combined with our operating leverage. And, of course, on cash generation and capital structure, we believe that we're already within our target leverage range and we believe that over 75% of profit before tax will be converted to cash, which will underpin our ordinary dividend policy and will also likely give a choice on how we may deploy remaining cash generation to drive value for our shareholders.

Finally, we do focus on return on capital employed, and we believe that we'll be achieving return on capital employed at our targeted high-teens levels. So while we're, of course, truly pleased by our 2021 results, and positive about our 2022 progress, it is actually the sustainable financial performance that we see for the future for 2023 and beyond that is particularly exciting as well.

So, I'll now hand back to Tim to talk about the operational and strategic performance that is driving the financials.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Well, thanks, Mike. I will now provide an update on our strategy. So you're hopefully all familiar by now with our 3x3 strategy matrix. And our strategies remained broadly unchanged since early 2019 and is focused on three core pillars: drive the DFS core business; build the platforms; and unlock new growth. I'm pleased to report that we've remained focused on the execution of our strategy despite the challenges of the pandemic. And indeed post lockdown one, in the U.K., we accelerated execution on a number of fronts. We continue to target a GBP40 million incremental profit before tax benefit from this range of initiatives, and I'll highlight our progress on the next slide.

So this slide highlights how we're progressing towards our GBP40 million target. And we now estimate that we have achieved a net GBP33 million benefit -- incremental benefit to date, compared to around the GBP20 million that we reported at the interim stage. Particular highlights include the strength of the DFS brand performance overall driven by our integrated retail offer. The efficiency benefit of our marketing transformation program, which has been driven by our data platform we've built and a greater shift towards digital marketing has improved the returns on marketing investment.

And finally, the progress we're making as we unlock new growth from Sofology's geographical expansion. Our targeted GBP3 million plus logistics savings from the development of the Sofa Delivery Company remain on track and are expected to be achieved from the end of FY'22 onwards.

Now, we'll take a more detailed look at progress on our three core strategic pillars, starting with drive the DFS core business. Now, the DFS brand is the largest and most profitable in the Group and the key priority for this pillar is to drive growth across all channels. Our DFS brand delivered strong growth in revenue and profits in the period relative to both the previous year and the pre-pandemic FY'19 financial year. We've extended our market leadership in the period and we estimate a 2 percentage point market share gain for the year as a whole. Now, we believe that this market share gain reflects the strength of our integrated retail proposition and the successful investments we've made in recent years, which have proved their worth, particularly during the pandemic.

In relation to our seamless customer journey, we've delivered on a range of initiatives, including faster page load speeds for our websites, improved imaging, the rollout of shared customer baskets, which enables the integration from website to showroom channels.

Turning to our product portfolio, we've continued to innovate in the year, launching attractive new ranges that combine design appeal with a greater focus on sustainability, such as our grand designs collection pictured here, featuring fully recycled or recyclable materials.

And finally, we are constantly refining and improving the DFS showroom proposition. And we took advantage of the showroom closures in lockdown three to refurbish 14 showrooms into our latest format. The new format features more sofa base and improved customer experience, which has driven average order values and conversion. We are planning to refurbish 16 more showrooms in financial year '22.

Now, when we talk about leading sofa retailing in the digital age, the DFS brand is very much leading the way. Now, over the years we've built a truly integrated retail business model and we believe, for the upholstery category, it's the combination of physical and digital channels that is the winning business model. Highlighting our strength in the digital channels, it's worth repeating that DFS is the number one search term on Google in the sofa category, well ahead of both sofa and sofas. Our marketing transformation and investment in digital marketing means that DFS has a far greater share than all of our shared competitors on -- from a visitor point of view, it's around 40% of all visitor traffic.

Our historical investment and innovation in our websites, means that we have a greater market share online than we do off-line. We do continue, though, to see our showrooms as critical to our offer, given the nature of our product and the sit test that we've talked about before that customers enjoy, the brand experience that we can bring to people with our inspirational living room settings. So continued investment and innovation in our website is driving conversion and AOV and it means DFS websites over the years have delivered a CAGR of around 20%. This online strength supported the DFS business during the lockdowns and resulted in a record year of over GBP350 million of the revenue in FY'21, up 184% year-on-year.

Moving on to build the platforms is our second strategic pillar. So this pillar focus on capturing Group-wide benefits from leveraging existing infrastructure, systems, processes and data. In financial year '21, our focus was on achieving cost savings and efficiency targets across our showroom estate, our property costs. It's also about driving a range of marketing efficiency improvements and continuing our plans to develop the best two-person sofa delivery company in the U.K.

With regard to property cost savings, we've achieved a further GBP1.3 million of annualized savings in financial year '21. This takes the cumulative savings since the start of this project to GBP5.6 million and we remain on track to achieve, as a minimum, the GBP6 million to GBP8 million annual savings targeted by FY'23. And recent lease re-gears are still running at over 30% saving. We also expect to achieve further significant savings in the medium-term, as leases expire beyond FY'23.

Turning to logistics, we're progressing well with our objective of building a leading Group-wide supply chain platform known as the Sofa Delivery Company. Now, following the completion of our colleague consultation process, and the creation of an independent subsidiary, the Sofa Delivery Company now offers Group-wide extended hours delivery to customers seven days a week, which is increasingly important given our revenue growth and also customers' busy lifestyles. We're also completing the rollout of our new branding and vehicle delivery across our CDCs, our plans are on track. And as we work towards achieving annualized savings of GBP3 million, which will come into place by the end of financial year '22.

Finally, our ongoing marketing transformation program continues to move ahead at pace. Now, we're using data and insights to increase the return on investment of our marketing spend and extending that best practice across the Group in order to support the development of our Sofology brand. Following a review of the DFS retail brand activities, we've also appointed a new communications agency to help support and drive the next phase of our DFS brand marketing. In overall terms, we've now achieved around GBP8 million of net cumulative marketing efficiencies, and we're confident in our ability to drive further returns as we increase our mix of investment towards digital marketing.

Our third strategic pillar is to unlock new growth by driving incremental revenue and profit, particularly at our Sofology brand and our emerging home business. Now, following a pause in new store openings in financial year '20, as we appraise the property market conditions around the pandemic, we've opened five new Sofology showrooms in FY'21 on favorable lease terms. We plan to open another eight showrooms in the current financial year. We've already opened five of these so far. We continue to invest in the brand and in retaining a clear differentiation versus the DFS retail brand. Sofology's latest advertising sees Helena Bonham Carter encouraging customers to bring imagination to life in the way that they make their homes, and it's been incredibly successful.

In terms of product, building on Sofology's reputation for style and sustainability, launch highlights this year, include the Pioneer eco sofa in the first half, which features zero foam, a 100% recycled springs, sustainably sourced timber and fabric made from recycled yarns plus a 20-year guarantee. We've also recently launched a uniquely stylish capsule range designed by the singer, songwriter, Paloma Faith. We remain very positive on the potential of Sofology and see the opportunity to grow the brand to 65 to 70 showrooms in the medium-term from the current at the end of the financial year 50, as I stand here today 55. We're targeting annual revenues of over GBP300 million and a pre-tax profit margin of between 6% and 7%.

Now, within the interim results, we set out a clear medium-term opportunity to extend into the beds and living room furniture market where we have less than a 2% share in a total addressable market of about GBP5 billion. Now, we're focused initially on the online bed market, leveraging our existing strengths in our DFS digital channels, our supplier relationships to create unique products, and our existing manufacturing partners who already manufacture upholstered bed frames. With new partners such as Silentnight, we're also testing in-store space in DFS to grow our share in the medium-term. And this is an image of our beds proposition in the DFS showroom at Leeds, Birstall. We remain very positive on the beds opportunity and have been investing in our infrastructure to support the next stage of growth.

We've now fully integrated Dwell into the DFS platforms and are leveraging Dwell supplier relationships and infrastructure to expand the Group's offering into the adjacent living room product areas, such as coffee tables, lighting and accessories. During the year, we also re-platformed the Dwell stand-alone website utilizing the DFS technology stack. And we've recently switched to free delivery for Dwell. Both of these things are driving incremental conversion and profitability.

So, just stepping back to give you a bit more color on what's happening in the end-to-end supply chain given the well-documented global challenges that many businesses are facing. Now, we're setting out here from our perspective, the key market factors that are impacting our industry, the structural advantages that we have to tackle these challenges and the actions that we have already taken or are taking right now to ensure delivery of performance and also delivery to customers.

Now, there are several sources of market-wide disruption well-documented, raw material shortages and price volatility, and increased shipping costs from the Far East, but also in the U.K., driver shortage in the U.K., and limitations on worldwide manufacturing capacity given the higher-than-average global demand. But we believe our Group has a number of structural advantages that leave us better placed than our competitors in order to tackle these external challenges and specifically, our economies of scale, due to the U.K. market share of being around 3 times our nearest competitor, gives us an ability to negotiate with suppliers. We've got long-established relationships with our key supplier partners around the world and we're working in partnership with them. Our own vertical integration in the U.K., both in terms of our own manufacturing and our own logistics is also a key factor, especially with the current U.K. driver shortages. We also have a wealth of experience in maintaining our gross margins across a range of macroeconomic environments, such as when the Brexit vote happened we had a weaker pound.

On the right-hand side of this chart is listing some specific actions that we've already taken in the last few months to preserve our competitive advantage and also ensure delivery of performance. As I've said, we've been working closely with existing but also new exclusive suppliers to meet our higher order intake and have recently signed exclusive contracts with the largest furniture manufacturer in the world, and we'll bring them in as a key new supplier delivering products from half two. We're investing in our logistics teams with a view to having some of the best working practices in the industry. And finally, we're pulling a range of pricing and product optimization levers in order to manage our gross margins.

Look, in conclusion, it's clear that the external challenges are going to remain for the rest of the financial year and probably beyond. But we think we are relatively well-placed to outperform the market despite the disruption in the supply chain, and we are very focused on delivering for our customers and facing into these challenges head-on.

Now, our ESG strategy only officially launched a year ago, but as you can see from this slide, we've made good progress on a number of fronts. Our environmental highlights in the year include our progress on our Phase 1 sustainable leather and textile sourcing targets and the introduction of targets for other materials and chemical products. We hosted our first ESG Supplier Conference in March, which set out our intent to work collaboratively with our suppliers to innovate and develop new ways of making our products and our business even more sustainable and transparent. In June, we also completed our formal materiality assessment in order to identify and prioritize all of the Group's sustainability risks and opportunities.

Our Phase 2 ESG targets include an increased focus on social criteria and incorporate our work on diversity and inclusion. We've been listening, learning and educating ourselves around the different races, genders, abilities, sexual orientations, disabilities, religions and nationalities, with the aim of being a Group where everyone is welcome. We've also strengthened our main Board credentials with the appointment of a diversity and equality expert, Loraine Martins. And governance is an area where the Group has traditionally performed well, but we continue to strengthen our processes, and we've just established a Responsible and Sustainable Business Committee to ensure Board oversight at the execution of our ESG strategy. We've also embedded both environmental and social elements into management remuneration targets across the Group.

Looking further out, on the right-hand side of this slide, you can see the commitments that we've made in relation to a number of key environmental targets. As I mentioned earlier, we are committed to building the leading sustainable business model in this industry.

So, in summary, we have delivered record revenue, profits and cash flow and increased our market share by over 2%, driven by our scale and our integrated retail model. We've delivered another year of progress on our digital strategy, and we are well on our way to achieving the GBP40 million incremental profit target we set out back in 2018. We've created a sustainable base for further growth in market share, for further growth in cash flow to fund our investments and to accelerate into the GBP5 billion TAM non-sofa home market. We're examining new opportunities to leverage our asset base. With this target in sight, we're evolving our strategy towards the pillars and platforms model, and we'll look forward to sharing more details with you in the spring of 2022.

I'd like to end by thanking, again, our colleagues, our customers and our wider stakeholders for their support during this incredibly challenging sort of last 18 months. As a Group, I feel fundamentally that we emerged from the pandemic stronger than ever.

Thank you very much for listening today. And I'd now like to open up for questions.

Okay. Thank you. I've got Hollie here to facilitate some questions. So, over to you, Hollie.

Questions and Answers

[Hollie Haeney, Group Financial Operations Director at Discover Financial Services]

Thanks, Tim. So, we've got a few people on the line here with some questions. And first is Andrew from Jefferies.

[Andrew Wade, Analyst at Jefferies Financial Group]

Hi, there. Good morning, guys.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Good morning, Andy.

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

Good morning.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

How are you?

[Andrew Wade, Analyst at Jefferies Financial Group]

Yeah, good. Thanks. But two for me. Obviously, there's plenty to ask about supply chain, but I'll leave that to the other guys and girls. And first of all, I was going to ask, in terms of your FY'23 base scenario. It's GBP1.15 billion of revenue, and you talk about there. But looking at that scenario versus FY'19 that -- so all of the difference -- well, the difference is really driven by the like-for-like gains that you've got, the new showrooms that you've made, that you know you've made over that period. So within that, you're not assuming that the market is sustainably bigger, which it could be. And is it fair that FY'19 wasn't that great a year for the market anyway? I mean, it was sort of GBP3.2 billion, wasn't it? So I was just interested in -- as where you think the market could actually be bigger than that, couldn't it? I'm interested in your thoughts on that? That's the first one.

And the second one is, in terms of adjacent categories, just thinking about the biggest unlocks that you've got coming up to progress that journey and what are sort of timescales until those adjacent categories really start to move the needle on the like-for-like given it's a relatively small part of the business at the moment?

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Yeah. So, maybe if I do the adjacent categories one, Mike, do you want to just talk a little bit about the first question around the base in the market?

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

Yeah. So, I mean, I think what we were really trying to do is recognize that 2023 environment is going to be different from '21 and '22 and give almost a clean read of a normal environment, Andy. And so, we haven't assumed particularly any market growth between 2019 and 2023. We do believe fundamentally, this is a market that does grow driven by sort of structural demographic factors, we've consistently seen a 1, 2 percentage points growth rate in the market. But we're not sort of presuming that. Clearly, there are some sort of broader uncertainties around where the world will be in 2023 and would rather people form their own view.

I think what we would say is that, in the long-term, the market is driven by consumer confidence and it is driven by, to some extent, housing transactions, consumer confidence, and the replacement cycle being probably about 80% of the driver of demand. And we do see those trends at the moment sort of holding up pretty well. So, although, we are benefiting clearly from a bit of a shift in consumer mindset in the short-term, what we're not currently anticipating is any sort of sudden drop-off in that.

[Andrew Wade, Analyst at Jefferies Financial Group]

Yes. And FY'19 just to be clear, was not -- certainly, not a high point in terms of that replacement cycle, was it?

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

No.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

No.

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

No.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

But I think it's quite early to be giving specific guidance on '23, which is -- there could be a quite a shift in consumer spend back towards holidays, etc. I know we're all desperate to go on holiday. So, proper holidays, not Cornwall. So, sorry, anybody from Cornwall. So yeah, I mean, it could change again, Andy. So, I think what we're trying to say is, we're not reliant on that. The things are within our own gift, the things that we're doing, we feel underpin the kind of the baseline that we put out there.

I think in terms of your second question around adjacent categories, the biggest unlocks and the timescales, our priority and focus is online beds. The biggest unlock there is coming this autumn in terms of where we're investing quite a lot changing our website to cater for people who are searching for beds. So in terms of how they search for beds and what attributes they look for relative to sofas is different. So that's coming in the autumn. And also new ranges, new product developments that we're working on. We just launched 16 new bed frames, exclusive branded, etc. So it's very much an online focus in the rest of this half, we're trialing and testing, as you can see, from some of the images in a few stores, probably half a dozen stores, some bed centers, which we'll learn more about in half two. So it's beds, pretty much the focus for this financial year.

In the background, the third unlock is around building a warehouse stock management capability to fulfill the living room furniture, because it needs to be a stocked category as opposed to beds, which is more akin to sofas, the negative working capital-type model. So, for this financial year, focus on online beds, building the infrastructure for living room, which will drop into '23. I think what we're talking about is materially, we will see gains coming through probably more like '24 onwards. It will take us a number of months to kind of get some of these foundations in place. But we're looking forward with sort of optimism around the opportunity really, Andy.

[Andrew Wade, Analyst at Jefferies Financial Group]

Brilliant. Really helpful. Thank you.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Okay.

[Hollie Haeney, Group Financial Operations Director at Discover Financial Services]

Thanks, Andy. Next should be Jonathan from Peel Hunt.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Good morning, Jonathan.

[Jonathan Pritchard, Analyst at Peel Hunt]

Yeah, good morning. I have three. One on the manufacturing capacity, you've struck a deal with the world's biggest manufacturing. What's the back story there? And kind of why weren't you with -- dealing with them before? It seems practical that the UK's biggest -- world's biggest.

And then on Sofology, sort of, the road really [Indecipherable] 70, but in terms that 70 could be a higher number, smaller format, bigger format. So one, you'll probably going to be on the policy of one to [Technical Issues]. Any opportunity there?

And then we the brand that you've gotten from Wedding Crashers, it's somebody who actually films now. I might not have definitely watched, but quite high end. How was the response to that? You said it was quite positive, but just where is the -- that's [Technical Issues] I'd say, it's [Technical Issues] where the brand is moving today?

[Hollie Haeney, Group Financial Operations Director at Discover Financial Services]

Hi, Jonathan. I think your connection is a little challenged and...

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

I've got the first two questions. The third question I didn't quite hear, Jonathan. Could you repeat that, please?

[Jonathan Pritchard, Analyst at Peel Hunt]

About Wedding Crashes [Indecipherable] film, you would have...

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Owen Wilson, yeah.

[Jonathan Pritchard, Analyst at Peel Hunt]

[Indecipherable] about, what's that saying about the sort of brand voice [Technical Issues]?

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Okay. Good question. Good marketing question, let me think about that one. So on the manufacturing side. So, I guess, the partners that we've had for a long time, the Far East partners and our UK partners have been more than capable from a design, a quality and a capacity point of view to meet the demand that we've always had. I think we've had conversations with the company that we're -- you're referring to for a number of years, but in terms of giving them the volumes that they would need, because they are a massive volume player, that would mean changing our mix of suppliers quite dramatically. So, we've not really had that opportunity to push the volumes that they would want to have with us.

I think what's changed is volume. So -- and what's changed is, we're also increasing the amount of sofa base in the DFS stores. I know you've been to Milton Keynes, part of our re-formatting, we're moving from an average of 60, 65 ranges in store to 75, 80. So we're growing our sofa space, growing our volumes. And with our existing suppliers, pretty much at full capacity, it gave us the opportunity or -- and so need to engage with this company. And they are a great partner, working with us, co-creating designs, spotting gaps in our range. And they have a number of different approach whether it's recliners, whether it's leather, whether it's fabric. So they offer a very broad spectrum of products.

So we've got a number of models on the shop floor now in DFS that are coming from China. And then in the -- towards Christmas, we'll have more models coming from Europe. So they've got operations worldwide, which helps with lead times, etc. So, I think we'll start to see big capacity increases coming through half two onwards. And hopefully, start the long-term relationship that keeps everybody happy with the new volumes and new base that we've been talking about. So hopefully, that answers the first one.

Yeah. So the Sofology, yes, as we sit here today 55. We've got another three to open in this financial year. And then we've got a pipeline of another 10 that we can see in clear white space around the country, which I think will take us another 18 months. At that point, we will assess where we still think there is white space. So, for example, in the Republic of Ireland, there is no Sofology presence and we have a number of stores for DFS that trade incredibly well. So, I still think there is possibly opportunity beyond the 70, but that's a conversation we'll have with the new MD, who is coming in at the back end of this financial year -- back end of this calendar year I should say.

But I do think there is more road to go there, Jonathan. And that includes looking at slightly smaller formats, for example, in Cheltenham. We've got a slightly smaller format that unlock some of those smaller towns and cities, which has proven quite successful. So, I think if I come back with that in the spring as to whether we can go beyond 70, but I probably think we could.

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

We've certainly had a lot of experience of doing that with the DFS estate using the data that we hold on where each customer for each showroom lives to spot that white space opportunity and to really drive the profitability of the DFS showroom estate by taking it up from probably about 75 up to over 100 as it sits today.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Yeah. I think the last one on Sofology marketing. So I'm not a marketing expert and Jan and the team at Sofology will be watching this answer, so I'll be very careful. I think, Owen Wilson and he is kind of personality around Sofology was incredible cut through and very memorable in terms of an ad. But I think what we felt was we wanted a quintessentially British and really stylish, and just a little bit different person Helena is a fantastic. It's the brand scores that we're seeing coming through in terms of stylish and innovative and different are really strong.

So I think -- and also being a really strong female well-known British actress is, it just perhaps reconnects people, it's bit more accessible, she is a bit more accessible to people in the UK. So, I think that was a change. What we're trying to do is, clearly, differentiate between the Sofology brand, which is a bit higher-end, bit more stylish, higher average order values. DFS team is the biggest in the market, it's got incredible style credentials. We're just trying to push the brands, make sure we get two and two equals four.

[Jonathan Pritchard, Analyst at Peel Hunt]

Great. Thank you.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Okay. Thanks, Jonathan.

[Hollie Haeney, Group Financial Operations Director at Discover Financial Services]

Thanks, Jonathan. And next, we go to Michael from Berenberg.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Hi, Mike.

[Michael Benedict, Analyst at Berenberg Bank]

Good morning, both. Thanks very much for taking my questions. I have three, if that's okay. Firstly on capital allocation, I think if we put together your guidance and cash conversion targets, it looks like the leverage range looks very manageable indeed. I wondered, if you could update us on your priorities for capital allocation, whether that be M&A, activities [Phonetic], buybacks, what would your preference be there?

Secondly, in your FY'22 central scenario, could you give a ballpark figure for what FY'23 tailwind that would result in, in terms of the heightened order bank?

And thirdly, could you just give us a reminder, please, on why the AOV increases you've seen should be sustainable? Thank you.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

In terms of the first one, capital allocation priorities.

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

Yeah, sure. So, we do have a published capital allocation policy that I think just saves the order of priorities for us is, firstly, to invest in the needs of the business. Secondly, to look at an ordinary dividend. And thirdly, to the extent that there is additional capital, free cash flow available, which we think it's likely, there will be to look at how we deploy that potentially through returning it to shareholders in some way. And I think very much in terms of where we are today, I think the guidance we've given today around the capital needs of the business is, all of you, on the right investment level, organically within the business in terms of what we want to drive. And so, it does imply that there will be additional capital.

I think we've shown with the store lease acquisition that we made, which has been a really strong financial return that we are willing to act opportunistically if the right sort of case presents itself. But in terms of the needs we see sort of strategically, it's all covered by the capex guidance that we have. And so, there really will be potentially a question in due course. We're not there yet, but there will be a question in future as to how we deploy our excess cash flow that we start to generate.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Yeah. On question two, in terms of the tailwinds from FY'22 and '23, I mean, obviously, it depends on a couple of factors, isn't it? So, as we -- the fact is, as we sit here today, the order bank is probably double what it would normally be, so there is a couple of GBP100 million more. It depends on our ability to convert that from a manufacturing point of view, I'm not concerned, it's more about the middle mile being able to transport that -- those products from particularly the Far East into UK and then the UK into distribution center. So, the middle part of the -- of our supply chain is the key, key challenge that we're focused on.

The last mile, in terms of our capacity to deliver to customers through our Sofa Delivery Company, I'm not worried about. We're investing heavily, we're taking on more warehouse space, more people. We've got great conditions for our drivers and we look after them as best we possibly can. So, that's where we are. It's going to depend on our ability to convert.

Secondly, it will depend on the level of order intake that we see going into the autumn and beyond. And then I think -- depending on that, I think we'll get to spring and clearly, we'll have a better view. Our ability to convert GBP200 million by the year end, I think it's going to be challenging, as I do think we'll have a higher-than-normal order bank at the end of financial year '22. But I generally couldn't quantify that at this moment in time, Mike, just given the variable factors that we have going on. But I suspect there will be a little bit of a tailwind, but I don't think we'll have fully caught up by then, is that fair?

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

Yeah. It will be a gentle tailwind into 2023 based on our -- based on the scenarios we've got.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

I think in terms of average order values, Mike, we've -- a lot of it's structural, so it's not transient price rises that will drop back down, they're structural changes to our hierarchy. So, the teams across Sofology and DFS has been working really hard on the classic entry good, better, best and making sure that we've got the right product innovation, particularly at the top end which frames the range. And so, I think what we're seeing is -- I genuinely think it's sustained AOV growth from where we were in '19. We've added a lot more exclusive brands top end range, in fact, if you look at the front of our presentation today, you'll see a fantastic new product in DFS, which is flying. So, these sorts of ranges are proving incredibly popular people.

Consumers are trading up into the better ranges. So I think there is a trend that we've seen start post lockdown one where people are actually trading up into the better range that we're putting out there. And therefore, we're innovating in that space, as well as holding our entry levels wherever we can. So, I think structurally it's built into the hierarchies now. And I don't necessarily see the cost price inflation that we're seeing dropping back off. I think there are structural changes in the way that timber is produced, particularly if you're looking for FSC-sourced timber, which is scarce. If you're looking for some of the foam, which is we've had foam challenges, I think that's the price of that is baked in now. So, I don't think we're going to go see a deflationary environment. If anything, I think as part of the guidance for '22 we're seeing more of an inflationary environment. So hopefully, that answers the question, Mike.

[Michael Benedict, Analyst at Berenberg Bank]

Very helpful. Thank you, guys.

[Hollie Haeney, Group Financial Operations Director at Discover Financial Services]

Great. Thanks, Mike. And now, we move to George at Numis.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Hi, George.

[Georgios Pilakoutas, Analyst at Numis Securities]

Good morning. First one is, you're talking about a couple of investments initiatives and increasing your kind of stockholding base. So am I coming through a bit accurate?

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

A little bit breaking up. So investment in stockholding, I think you said.

[Georgios Pilakoutas, Analyst at Numis Securities]

Yeah. Just wondering what your capacity is going from to?

Second one is around marketing spend. I presume at the moment everyone is being very low customer acquisition cost. That's really more about having us shorter lead time as possible. In a more normalized environment, and just limited by your thoughts to dominate the online channel kind of easing your scale advantage rather than having 40% share, having 70%, 80% share kind of underpin market share and easing your scale advantage there.

Third one was on smaller competitors, just wanted to kind of get how you think they are dealing with the supply chain issues, discuss lead times? And if they are less hedged, do they having to put prices up more than yourselves?

And then final one was just quick comment on international, I don't think you really spoke too much there. So I just wanted an update.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Right, good ones. Okay. So briefly on stockholding, really the only sort of stockholding that we'd be looking to invest in the future is in the living room furniture and accessories area. So, all of our sofas, as you know, made to order. We do have stock in terms of clearance stock or return stock or ex-showroom, but that's just part run-of-the-mill business. So specifically, the difference going forward in the future will be investment in stockholding for things like coffee tables, lamps and mirrors. At the moment, that's a relatively small number, probably GBP4 million, GBP5 million. I think it will grow as we develop our ranges, and we're investing in warehousing space in Milton Keynes with stockholding system, which will be summer of next year that will be on stream.

But in terms of the quantum, in terms of tying up working capital, we're not talking much more than maybe GBP10 million, GBP15 million of that. And looking for a relatively curated range and then churn quickly. And then we'd look to do more of a dropship-type arrangement with third-party vendors. So we don't hold the stock risk. That would be common in marketplace-type approaches. So that will be, hopefully, that kind of give you a sense, George, is what we're thinking. So we're not talking about hundreds of millions, we're talking a small amount of stock investment on a few SKUs, which turn quickly. And the longer tail being dropship.

And marketing spend, I think what we're seeing is, I think the levels that we're investing now are sustainable in terms of the returns on investment we're getting. We've shifted quite dramatically into digital more and more as we get better and better data about who's in market and targeting them appropriately. I'm sure our digital marketing teams will be delighted to hear that they want -- you want to get to 80%. But I think it's competitive out there. There's a lots of players out there bidding from a market -- digital marketing point of view. But yes, if you looked at DFS plus Sofology, we will be probably pushing north of 50% share. I think the 40% number was just DFS. So, I think we'll continue to push hard on that because in the end, if you're coming to the website you're interested, you're in market, so the more we can get eyeballs on to our websites, the better. And we're probably be pushing that higher -- as high as we can.

Smaller competitors, it's really challenging. If you haven't got forward contracts with the shipping lines and you're having to buy spot, a container from China today at spot rates probably what $15,000. It makes it ridiculously unprofitable to bring products over from China for the smaller competitors. I know that a lot of them have either stopped selling those types of products or massively pushed the lead times out in the hope that the rates come down. So I think it is impacting some of the independents. And that's -- it's not good for the industry, because the independents thrive when -- and they have a broad range.

From our perspective, we have forward contracts with the shipping companies, have a long relations -- long-term relationships with them. And we'd be looking to do that, again, as we roll into calendar year '22 to protect our supply and our margins. So, I think it's really challenging for people who don't have those forward rates locked in.

I don't know if there is anything else you'd add to that?

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

No, I think that's right. I mean, I think it is a structural advantage of scale in this industry that we do hold.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Yeah. And then, I think on international, obviously, the last 18 months have been impacted as much as the U.K. And so, it's difficult to take a read on anything there in terms of what's happening there. We have added a new store in Breda in the Netherlands, trading well. Every new store that we add is marginally profitable. So it contributes to the P&L. We see -- as we've said before, a medium-term option for growth. We don't want to close that option down. We see the teams have worked incredibly hard to make the range appropriate for the Dutch market and also the Spanish market. We've learned a lot. We continue to learn. They're incredibly dedicated. So, we need to keep that option open for the future. That's our view.

And Mike, is there any thing to add?

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

I think that's well said, yeah.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Thank you. Thanks, George. Hopefully, that answer the question, George. Is that okay?

[Georgios Pilakoutas, Analyst at Numis Securities]

Yeah, great. Thanks.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Okay. Thank you.

[Hollie Haeney, Group Financial Operations Director at Discover Financial Services]

Great. Thank you, George. And now, move to Eleonora from Shore Capital.

[Eleonora Dani, Analyst at Shore Capital]

Yes, good morning, Tim.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Good morning.

[Eleonora Dani, Analyst at Shore Capital]

Thank you for taking the questions. So I had two, but then Andy stole one. So thanks, Andy. I guess, I just want to tight [Phonetic] a little bit and just look at the future demands. So that you would have been a bit conservative. But on the other hand, what gives you the confidence that the demand would be there in the first place, given that consumers might be travelling a bit more and spending experiences? Is it just about the arrangement [Phonetic] cycle?

And the second one was given that the last mile delivery is becoming increasingly [Indecipherable], how long would it take a competitor to replicate the infrastructure that DFS has?

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

So, good question. Do you want to take the first one around future demand, and also the consumer confidence point?

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

Yeah, absolutely. So, as touched on earlier, Eleonora, over the long-term the market has always been underpinned by a replacement cycle, which does, sort of, fluctuate slightly driven by consumer confidence and the number of house moves going through. I think in terms of what we've seen in terms of our read of consumer data, shows very little evidence of over trading or pull forward. I think actually all of the demand that we've been sort of seeing coming into the business, thus far, just seems largely seems supported by the market share gains that we've seen and the AOV growth that we've been seeing. So that's really an indication that consumers feel that they've got more money in their pockets.

And so, they're willing to spend more on getting the home right for them. But in terms of pull forward of demand or acceleration of replacement, the sort of the best read of the data we have shows that, that's quite limited in terms of that cycle and certainly, we haven't seen a big shift in terms of what consumers are saying in terms of their replacement cycle at this point in time. So I think that means we don't foresee a cliff edge in 2022 or 2023, but we do know that this is a market that's sort of they can pull over time in the short-term and we're just used to absorbing that and dealing with that,but actually focusing on the long-term and doing the right thing in the long-term.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Yes and I think it's important to look at the long-term, you will get the fluctuations, you'll get a warm spring or a warm summer and football events, whatever, it kind of doesn't matter in terms of the long-term trend. The long-term CAGR in the market is about 2%. We intend to grow above that. So from our perspective, the order bank that we now have gives us that ability to smooth our deliveries and make sure that we've got everybody working at full capacity, the maximum efficiency. So I think yes, there probably will be a shift towards consumer spending on holidays and leisure, etc, but long-term, we're well placed to win in the market I think.

Last-mile delivery, how long would it take competitors to build the infrastructure? I think that's a challenging one. It's been years and years of investment. We're operating nearly 300, 7.5 tonne vehicles, 1,000 people. We've invested in systems, AI systems to help dynamically route our vehicles to be super efficient, which is good for the green agenda. We've got warehouse space all over the country, which we're adding to. We train our people. We give them physio. We've got all sorts of initiatives in there to look after them.

We've just shifted to four on, four off shifts, which gives a seven-day coverage for customers, late night deliveries. So I think it's hard to replicate in the short-term organically internally for some of the competitors. Clearly, you've got really excellent 3PL, third-party logistics players who are out there, but they're all full, everybody is busy. So I think it's -- we think it's a real source of advantage. I think that -- and we're really proud of our delivery teams who go into customers' homes, 10 or 12 customers every day and it's that brand experience that they give, that last brand experience, which I think is really important.

We use recycled packaging. We're looking at electric vehicles. It's a source of pride and putting the two teams together and the two fleets together over the course of last year and the systems together is not without challenges. We're going to have challenges for probably the rest of this year, but in terms of the assets that we're building, both from a financial point of view, operational point of view, but also brand experience point of view, I think it's quite hard to replicate and therefore, hence why we've done what we've done, if that makes sense.

[Eleonora Dani, Analyst at Shore Capital]

Yes, [Indecipherable] Thank you.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Thank you. Have a good day.

[Hollie Haeney, Group Financial Operations Director at Discover Financial Services]

Thank you very much. And next we have Saranja from UBS.

[Saranja Sivachelvam, Analyst at UBS Group]

Good morning, Tim, Mike. Thank you for taking the question. I have three, if I may. The first is on digital. The second is on the footprint of stores. And the third one is a follow-up on the share buyback question. I hope my line is coming through clearly.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Yes, very clear.

[Saranja Sivachelvam, Analyst at UBS Group]

Okay, thanks. So on digital, in the medium-term, where do you think online might settle in terms of contribution to sales? And thank you for sharing the Google trends, but what about other platforms like Instagram or Pinterest, which might be quite popular as well with millennials and competitors like MADE.com and Swift [Phonetic] are quite prevalent on those platforms.

The second one is on footprint of stores. You mentioned a couple of locations in the press release and on the presentation, but what type of stores do you think you might be focusing on in terms of format and where the biggest white space opportunities are?

And the final question is on share buybacks. Obviously, you have your capital allocation policy and what I'm trying to get at here is the kind of preference between specials and share buybacks. Are there any covenants around limitations like free floats on [Phonetic] share buyback.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Digital, so that's a good question. So pre-pandemic, the digital -- the percentage of transactions that were closed through digital channels about 20%. Obviously, FY '21 is an anomaly given that we have 21 weeks where stores were closed. So I think what we're seeing post lockdown three, is that settling at about 22%, 23%, so slightly higher, but not a fundamental shift and what we've always said is that about half of that is what we call pure digital, so e-commerce add to basket and then half is customers who have been into the store, sat on the product, thought about it, gone home and then closed through the digital channels. So the pure-play element of our business will probably be about 11%, 12%, something like that.

Will it grow dramatically from where it is? We don't think so. It probably has grown about 1 percentage point a year. So that's kind of structurally how we see it. I think I'll come back to the point that we've got a greater share online than we have offline and continue to invest in the website, big investments going in this autumn.

I think in terms of things like digital marketing, you're absolutely right, around Instagram, Pinterest, Facebook and part of the growth that we've seen and the marketing transformation that we're seeing is a bigger push into that space. We have great brands, great ranges, exclusive ranges, and we can target very specifically the different customer demographics who might want those ranges. So I think you'll see increasingly us push more into that space over the next sort of -- well, from now on, well, we've been doing it for a while, but accelerating there. So we see good opportunity there.

Store footprint, I think we've been very clear now, we're very clear that we focused on the larger footprint, creating real destinations for customers to visit. We've seen interestingly post pandemic or post the lockdowns is that where consumers used to go around maybe five or six furniture stores, they're now short listing two or three and we need to be on those two or three and therefore, we need to create destinations that are typically edge of town parks, that are typically 20,000 square feet.

We found through the brilliant work of the commercial teams, both in DFS and Sofology that the ranges that we have can comfortably fill 20,000 square feet. So I think we're more focused on that size than perhaps where we were in the past, which is looking in a city type stores, etc. So I think we're more focused on that format and some great new stores opening recently in Giltbrook in Nottinghamshire, which demonstrate where we're headed.

I think white space, as we come back to is probably Sofology is the biggest opportunity, currently at 55%, will go to 70% and I think, as Jonathan alluded to earlier, we then need to have a look at where else could we go. So I think there's probably another at least 15% [Phonetic], but possibly a good level more on maybe a slightly smaller footprint in some of the smaller cities. Anything to add on that? No. So that leads you to share buybacks preference, etc.

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

Yes, I mean, I think we all have to recognize it's a very early stage to be asking that question, but I think what I can say is that we will have a choice if we were to look at capital returns. Clearly, we know our cost of capital. We understand our cost of capital. If you are running that analysis now. Then potentially a share buyback would look particularly favorable, particularly accretive and I think that's something we're sort of well aware of, but we also do recognize and do know that a lot of our shareholders do have a preference towards dividends and dividends are helpful.

And so we'll take into account both that sort of cost of capital calculation and the value accretion calculation, but also where our shareholders' views are likely to be if and when we reach that stage of capital return conversation. I think the -- clearly, any shareholder that does receive a dividend also does have the choice to reinvest in the shares as well if they agree with us that there's a valuation opportunity. The final thing, the final part of your question was whether there are any constraints around that. And no, I think, is the simple answer. I think we think both options would be fully open to us based on all of the agreements we have in place.

[Saranja Sivachelvam, Analyst at UBS Group]

Great, thank you very much.

[Operator]

Great, thank you. And now we move to Caroline at Stifel.

[Caroline Gulliver, Analyst at Stifel Nicolaus]

Good morning to Mike. Hopefully, you can hear me. I had a few questions around ESG, please, and then a few more questions around the home expansion strategy. Starting with ESG. I just wondered if you could give us some more color on the Grand Designs sustainable range that you launched earlier this year and what you're seeing in terms of consumer demand for sustainable materials?

The second question related to that is how quickly do you think you can incorporate sustainable materials across all your ranges noting, of course, you did say that there is some supply constraints around FSC timber and so on and so forth.

And then the third question on ESG, was you mentioned that there were ESG targets for management across the group and I just wondered if you could give us some color on how you're perhaps incentivizing store managers in this regard? I'll start with that, then I'll come back to home.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Okay, so good questions, Caroline and so on grand designs, we're seeing good demand, I would say, in the DFS stores and also, we have another couple of models. So there's a modeling French Connection that's got similar credentials, which is doing incredibly well. I think what you find is the first thing is the model has to be right. It has to be stylish and sit right. One of the things we've found because Grand Designs has 200 recycled plastic bottles as its interior and it's quite a soft sit, which suits some people, but not everybody.

So we're working on innovating to create sort of a -- as well as a softer set to medium and a firmer sit, but you have to use recycled materials. So that's a challenge, I wish -- the suppliers are working with us on innovating, but the demand is good. We just need to be able to broaden that. I think we found that you can't really charge us super premium for it. I think if the model is good, it sits well, but it's a super premium, it won't sell. You've got to fit it within your hierarchy.

So these are some of the lessons we've learned. And actually, the French Connection model is doing incredibly well fits within the hierarchy, has all those criteria and has a slightly firmer fit as well. So there's a lot of things we're learning positively and we're using it as a way to then think about how we then democratize those types of materials across our range. I think that's going to take longer than we perhaps anticipated because some of the materials we need, then they're just not mass-produced in that way at this moment in time.

So we're working with all of our suppliers. We had our supplier conference in March and we're talking to them about how do we move forward that agenda, but clearly, with the volumes that we've got on the manufacturing capacity issues that we've got, getting the focus on that as well as doing everything else is proving understandably challenging. But we want to innovate, we want to lead and we welcome partners to come and help us with that. I think it's going to take a bit longer Caroline than we thought.

Targets across the group. What we're talking more about there is, so for example, Mike and I have got targets within our bonus, which is quite substantial. For example, mine's around making sure we've got Science Based Targets for all of our products from a carbon footprint point of view. You've got carbon reduction across the whole store estate, etc. So we've got it at the management level, director level and then we incentivize our store managers, for example, on Sofa Rescue.

So what percentage of products or that service do we offer to customers in terms of rescuing sofas from landfill and ensuring that it doesn't go through landfill. So it kind of goes deep within our organization. Our buying teams are incentivized on hitting things like FSC targets and recycled leather targets. So it's quite specific depending on the role if that makes sense, which I think is the right way to embed it into people's jobs.

We've always had, if you broaden the ESG targets, we've got targets around gender diversity, we've got targets, which is at the store manager level. So I think it's now getting deeply within our business, embedded into the way we do things, which we think is the right thing to do rather than make it an initiative over the top. It's just how we go about doing things, if that makes sense.

[Caroline Gulliver, Analyst at Stifel Nicolaus]

That's really helpful. Thank you very much. If I can just follow-up with a couple of questions on home. And apologies, this might just be for my clarification. Thinking about both beds and then living room furniture, who is the target customer? My sense is that in beds, it might be the DFS customer, but in living room, it might be the Sofology customer, so I could be wrong. And who are you taking market share from?

I know there's been some high-profile exits in the market, but where do you see the market share opportunity? And then just finally, following up on some of the earlier questions on marketing, how does the customer acquisition cost compare for both beds and living furniture versus, say, sofas, and I'm assuming obviously you've got some synergies from selling to existing customers.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Good questions aren't they? So beds primarily at this moment in time is focused on the DFS customer demographic, which is very broad, as we know. So part of the reason why we're looking at extending partnerships in it from say like Joules and French Connection, etc is there's a clear read across from customers that are coming in to buy those types of brands and then seeing the design cues and the fabrics and the style. So there's a cross-sell opportunity is the obvious thing to say.

And of course, if you're buying a new home or you're doing up your home, there's a real opportunity if you bought the sofa to then offer an adjacent category into beds and given the eyeballs that we have on our website and the product ranges that we've got there, it's primarily a cross-sell opportunity to DFS customers. A lot of sort of CRM involved with that -- digital CRM. Cost of acquisition, low, quite low in both living room furniture and beds. Living room furniture is really both brands.

So if you go and see a sofa room set in any of our showrooms, what we want to be able to do is you can buy the whole lot. You can buy the room set. And that will be the coffee table, the lamps, the mirrors, the rugs etc, they accessorize that and those bays will be specific to the brand. So Sofology will have a slightly different design, handwriting then DFS, but in the end, we want people to buy the whole look.

So it's basically another obvious cross-sell opportunity, particularly when you've got interest-free credit as a tool to help customers access that. So I think from a cost of acquisition point of view, we see it as relatively lower than trying to get new customers in. We're trying to -- we've already got a good 750,000, if not more, customers a year, that we can offer those sorts of things too.

Who are we taking share from? Do we want to talk about that? I think clearly, the beds opportunity, a) it's a bigger pound notes opportunity in terms of the TAM and b) we think we can do a good job online with beds and we think in the store trials that we've got, we can present the beds in a pretty stylish and interesting way, perhaps a bit different.

So I think we'd be looking -- I mean, the bed market is -- there's a couple of dominant players there. So we see an opportunity to take share probably from that middle market, not the entry level, not the high-end level, but probably from the middle market is probably the best way to say it. Living room furniture, it will be -- again, that is a hugely fragmented market with lots of players doing a great job. So we only need a small percentage of attachment to sofas to make a dent into that GBP1 billion opportunity.

[Caroline Gulliver, Analyst at Stifel Nicolaus]

That's really helpful. Thank you guys.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

Thanks, Caroline.

[Hollie Haeney, Group Financial Operations Director at Discover Financial Services]

Great. Well, thank you, everyone, for some terrific questions. We have had a few come in via the website. So I think we've probably got time to squeeze a couple in. Just a quick one. So the first one was really from a consumer perspective, how do we see demand changing in the next year? We talked about previous market drivers of consumer confidence, housing market and so on. Is that still relevant or is it something else to think about?

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

I think we tried to touch on this earlier. It is still relevant. So the fundamental drivers in the long-term of the market remain consumer confidence from a replacement cycle point of view, housing transactions, which is about 20% and then the availability of credit. And those three things, if you look at them relative, and I think Mike asked the question about relative to '19, they're quite strong.

So fundamentally, it underpins the kind of long-term CAGR of 2%. In the short-term, I think we see good tailwinds from demand from home and the housing transaction has been quite high at the moment, but I expect in '22, that might settle down as consumer spending shifts a little bit more towards back tools, holidays, etc. So we don't see a cliff edge. We see a long-term structure in this market being in growth, low growth, which we allow to hopefully outperform.

[Hollie Haeney, Group Financial Operations Director at Discover Financial Services]

Great, thank you. And I think our last question then is around -- it feels like the management priority in the short-term is on operational execution and investment in manufacturing and supply chain rather than omni-channel. Do you think most of the hard yards in digital retailing have been achieved?

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

No. I think if you -- it's not either/or, it's both ends. So we've got to focus on -- when I think Mike outlined where we invest our money is in three areas and you have to continue to invest in omnichannel and digital to pace and ahead of the market probably because if you stand still or you distract from that, then you fall behind very quickly. So you have to keep going on that. Yes, we've done lots of hard yards, but there's always more to do and more to innovate. The focus is on operational execution. It's on delivering for customers. It's on dealing with some of the logistics challenges that exist in the market, but we've got a big team and we divide and conquer and try and make sure that we have a balanced approach to the way we do business, clearly. And hopefully, that answers the question. Anything to add?

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

No, I think we've long said that we believe the winners in this market will be those who are able to offer that integration between the physical and the digital channels and the physical and digital experience and I think the results of the performance we're seeing across recent years just start to evidence that.

[Hollie Haeney, Group Financial Operations Director at Discover Financial Services]

Great, thank you very much. Well, that's all our questions.

[Tim Stacey, Group Chief Executive Officer at Discover Financial Services]

All right. Well, thanks very much for tuning in and have a great rest of the day.

[Mike Schmidt, Group Chief Financial Officer at Discover Financial Services]

Thank you.