Trading Update

Strong progress has been made across the Group in growing vehicles on hire (VOH) since the reporting of the Interim Results in December 2017.

As a direct result of the self help measures outlined during the Capital Markets Day on 4 October 2017, the UK business has progressed well with closing VOH at the end of Q3 now in year-on-year growth for the first time in three years of 0.7% (see appendix table 1). The trend in quarterly average VOH figures for the UK has continued to improve with Q3 now 2.0% lower than prior year, which also illustrates a substantial improvement versus Q2 (see appendix table 2). With the continued application of self help measures and with closing VOH now in growth, management are confident that the UK will meet its committed Q4 KPI of "average VOH being broadly flat versus prior year" and will turnaround the 7.5% decline reported in Q4 FY17.

In Spain, third quarter growth has been outstanding with average VOH up 14.2% versus prior year (see appendix table 3). This growth has been fuelled by significant uptake in fixed term products which continue to win market share from existing contract hire competitors as well as substitute for customer owned vehicles. Further strong growth is anticipated through the fourth quarter and management expects to significantly outperform the Spanish Q4 KPI of ">10% growth in average VOH".

As a result of the turnaround progress in the UK and continued strong growth in Spain, the Group achieved 5.0% growth in average VOH for Q3 versus prior year (see appendix table 4) and expects to achieve higher single digit growth in Q4 in line with the committed KPI range.

Marginal returns on capital (defined as revenue less all variable costs associated with serving new contracts divided by the capital cost of the required fleet at its purchase price) remain strongly ahead of Group WACC as growth is delivered. In the UK and Spain, the average marginal return on capital of all contracts won and renegotiated up to the end of December is in the low to mid 20% range. This marginal return on capital is expected to improve over the duration of the life of these contracts as the net book values of vehicles reduce while contract pricing remains largely constant.

In the third quarter, the rental margin for the Group improved by 0.4 percentage points driven by Spain where the rental margin improved by 3.3 percentage points compared to the prior year, as strong growth in VOH was delivered. In the UK there was a decline in rental margin of 1.3% as rental volumes remained slightly lower than prior year and we expect a further reduction in Q4 as pricing continues to be adjusted to position Northgate competitively in the market.

Management continues to see evidence of a clear structural shift from customers moving out of ownership and into rental and minimum term hire of vehicles and this, along with focused execution of Northgate's strategy, is expected to drive strong continued growth in vehicles on hire for the Group.

Following the interim results in December, where declines in PPU were greater than those expected, management undertook an extensive review encompassing (i) the fleet holding periods across the Group to ensure that these are set to maximise cash returns on the investment in new fleet and (ii) the Group's asset register in order to profile the current age and mileage of all 97,500 vehicles in the fleet as well as the age and mileage of those vehicles sold to generate disposal profits in recent years.

The outcome of this review has been to conclude that:

a)    Vehicles in Spain and the UK should be held for substantially longer than has been the case over recent years. Whilst this is dependent on the type of vehicle, and a minority can be rotated faster, the optimal holding period to maximise cash returns, and ultimately shareholder value, is 3 to 9 months longer than the current disposal ages in both the UK and Spain.

b)    The profile of disposal profits in recent years and under previous management has been made up of ever higher volumes of ever younger vehicles at ever lower PPUs. This is not viewed as a route that has led to the maximisation of long term shareholder value.

Following this substantial review and with due consideration of short term trading alternatives, the Board has therefore taken the decision to optimise holding periods in all territories starting immediately. As a consequence, vehicles will only be sold when they have reached an age which optimises cash returns unless constrained by operational factors such as mileage, condition or maturity of customer contracts. Disposal volumes will, therefore, reduce through the final quarter of FY18 and through the first half of FY19 as the fleet is allowed to age to its optimal level before disposal. Consequently, vehicle purchases will also reduce through this period.

This strategy will deliver a more efficient capital base for the business as net book values are allowed to reduce with more moderate capital expenditure and funding requirements in the short term supporting targeted increases in ROCE. Subsequently, cash returns will increase and headroom over the leverage covenant will improve.

This decision to extend holding periods, combined with continued progress in increasing the volume of disposals through the retail channel, will result in higher PPUs going forwards. Consequently, and in line with accounting principles, depreciation rates will be reviewed at year end. Any change to depreciation rates will be applied on a forward looking basis starting in FY19.

The KPIs outlined at the Capital Markets Day which relate to PPU and volume of disposals will be updated to reflect these changes at the presentation of the year end results.