Apiam Animal Health Limited (AHX.AX) Earnings Call Transcript

Good morning, and welcome to Apiam Animal Health's First Half Results Call for the 2021 Financial Year. Today's call will be hosted by Apiam's Managing Director, Dr. Chris Richards; and the company's Chief Financial Officer, Matthew White. We will start with the company presentation, after which there will be an opportunity to ask questions via the Zoom Q&A functionality. I'll now hand over to Chris and Matt to commence the presentation.

Thanks, Katherine, and welcome to Apiam Animal Health's H1 FY '21 Results Presentation. I'll kick off today by giving an overview of our H1 FY '21 performance. So in the first half, we generated revenue of $61.2 million, which was up 8.9% on the previous comparative period of the first half FY '20. Our gross profit was up 13.4% at $34.5 million. Underlying EBIT of $4.4 million was up 30.8%, and our reported NPAT of $2.6 million was up 53.8% on the first half of FY '20. The Board has announced an interim dividend of $0.012 per share, which is up 50% on the same period last year. I'll now just move on and give an overview of the highlights for the first half. So we've delivered some pretty strong revenue performance, which is clearly showing that we're executing on our strategy that we've got in place. The company has been able to capitalize on the acceleration of pet ownership as a result of COVID, and since then, where we're seeing growth in our regional growth corridors. And we've also been able to capitalize on the order momentum that's occurring in the dairy industry. Our acquisition strategy is delivering against the criteria that has strict criteria that we've got in place, and we're seeing a material earnings uplift, continued gross margin expansion and operating cost leverage. We have a solid balance sheet and cash flow that supporting dividends and reinvestment that we're undertaking in business plan. A bit of an overview on the company. We now have 55 clinics, including 3 new ones in the first half of the year. So 2 of those are ones that we've developed as greenfield and an acquisition. If you look at some of the other metrics on the company, you probably will have seen that there has been some media around vet shortages in the industry. I think from Apiam, from our point of view, we've been investing very heavily in our people, and you'll see some of the things today, where we think we're very well positioned to continue to recruit and retain vets to support our ongoing growth. We've had 103 people or over 20% of the employees who have undertaken that leadership graduate program or leadership program with our graduates. And we've got 40 Apiam mental health first aid officers to support our employees through the clinics. When it comes to service programs, we've seen significant growth in the first half of the year. We now have over 4,300 Best Mates members, which is our subscription program, companion animals. And we're also seeing about 40% growth, both in the Best Mates program in the membership as well as in our other service program ProDairy. And what that's resulting in is over 50% of our revenue is coming from our dairy and mixed animal clinics, which is our strongest segment at the moment and our higher-margin segment. I'll now pass on to Matt White to give an overview of our financials.

Thanks, Chris, and good morning, everybody. We're pleased to announce a strong uplift in NPAT to $2.6 million for H1 FY '21, which was a 53.8% increase on the prior comparative period. This was driven by strong like-for-like growth in dairy and mixed animal segment, good performance of our acquisitions and the leverage of our operating cost base. In revenue, we saw growth of 8.9% in the face of COVID-19 impacts and varying conditions across our animal segments. Revenue growth ex acquisition was 0.9% versus prior comparative period, and this reflected market cycles in feedlot and pig segments. We saw a continued gross margin expansion and that reflected increased revenue capture at our clinic level, changes in business mix strategy during FY '20 and where we saw the dairy mix contribution grow and strategic changes in the pig segment and, of course, the impact of acquisitions. Gross profit ex acquisitions increased 2.2% versus prior comparative period. As I mentioned, we saw leverage at an operating cost level and limited underlying operating expense growth of 2.9% ex acquisitions. The underlying increase in employment costs of 6% was due to organic business growth, particularly in dairy and mixed animal segment, and we saw some increased leave provision expense given the reduced annual leave utilization by staff through the COVID lockdown. And also importantly, we saw strong general cost containment with 5.9% reduction in other expenses versus prior comparative period excluding acquisitions. Now turning to the revenue and gross profit analysis. And on the left-hand side, you can see in the chart the gross margin development from FY 2019 through to FY 2021 on the first half. I just wanted to highlight that continued increase on a gross margin level across -- through that period, which reflects a strong performance at that level. There's no doubt that business mix is contributing to that, but also, it reflects the systems that we put in place that's enabling revenue capture at our clinics. Let's now turn to each segment. Dairy and mixed animals, we saw a strong performance in mixed animal revenue with significant Best Mates contribution and double-digit growth recorded across all regions. Favorable industry conditions since H2 FY '20 and the launch of ProDairy is driving strong dairy revenue uplift. In pigs, we saw a resilient revenue performance to slight challenges and market cycle. And we saw a strategic focus on higher-value consultancy services to support revenue. We have also seen the reduction in low-margin wholesale businesses as a result in pigs as a result of strategic approach. In feedlot, the feedlot segment was impacted by reduced animal numbers across the industry through H1 (sic) [ H2 ] FY '20 and FY '21. And this is coming off record highs in FY '19 and H1 FY '20. There's been reduced beef export demand associated with COVID-19 impact on the food service, but industry is building capacity for expected growth phase in the market cycle. Historical trends of cattle on feed have shown a sustained increase through the market cycle over time. Now turning to the balance sheet. Our working capital management has been a focus for Apiam, and we're seeing efficient management of receivables and inventory through H1 and an increase of payables in line with business and growth. PPE and leases have grown in line with organic business growth, greenfield clinic roll-outs and acquisitions during the period. And the intangibles reflects the acquisition of Don Crosby Vet surgeons in Dubbo completed in December 2020. Return to borrowings. Net borrowings have increased to $39.2 million due to the cash component of Don Crosby acquisition of $3.3 million, and the deferred earn-out consideration payment for ACE Laboratories of $2.9 million as well as the investment in roll-out of new greenfield clinics of $800,000. Operating leverage on a net debt basis is 2.3x versus a covenant net of 3.0x, and we've got significant headroom for growth opportunities and access to $19 million under our acquisition facility. Now turning to the cash flow slide. Operating cash flow in H1 FY '21 was $6.4 million, and this increase with strong earnings growth and improved working capital management. Cash outflows due to acquisition was $6.2 million, which reflected the Don Crosby acquisition and the earn-out payment to ACE. And CapEx for the period was $2.3 million, which reflected the rollout of new greenfield clinics of $800,000 and maintenance CapEx. And it is important to note that maintenance CapEx was heavily phased to H1 and is expected to be less in H2. Cash flow conversion of underlying EBITDA was up considerably at 106% for the period, and that reflects strong working capital management. In relation to dividends, Apiam has declared an interim dividend of $0.012 per share. The dividend reinvestment plan will be in place. The last day to elect to participate in the DRP will be 29th of March 2021. The pricing period will be a 5-day VWAP between the 30th of March 2021 and the 5th of April 2021, and the payment date is 23rd of April 2021. With that, I'll hand back to Chris.

Thanks, Matt. So next, I'll give an overview on strategic operations and our outlook for the rest of this year. If we look at our strategic framework for growth, there's 3 components to that. The first is having good operations, process and capacity, increasing our animal numbers and then leveraging services and products across that footprint. So if we look at the first part of operations, process and capacity, our practice management system that's been in place now across our whole clinic network, and they're starting to deliver some real benefits. We've been leveraging our cost base to deliver margin expansion on the incremental revenue. And as you may recall from previous presentations, we've got an operating cost base, which will support a far larger business than what we currently have. If we look to our product and service expansion, we continue on with our private label strategy. We've rolled out a number of new products in the first half of the year as well as the previous year. We've got some new product distributions that we've delivered and some more to come, and our specialist vaccine and diagnostic operations through ACE have brought some new products into the market and are expanding across our existing footprint vaccines that they already had in place. When it comes to animal numbers, this is where we're really going to be driving growth in the balance of FY '21 and beyond. We've got an ongoing acquisition program, a number of strong acquisition targets. We've got a greenfield clinic strategy, which we're going to -- where we kind of acquire clinics. And if the rationale is good, then we'll do some greenfield clinics in attractive regional growth corridors. And we've also seen our Best Mates and ProDairy program bringing on new customers, bringing -- and bring on new animals. So once we -- as we deliver on this strategic framework, our target, obviously, is to get earnings growth and shareholder returns. So I'll talk a little bit now just about some of the -- how we're driving regional clinic growth in FY '21, and this really started some of the greenfield sites that we're starting to do, where we see some exciting opportunities. So we're capitalizing on the rapid acceleration in regional animal ownership with a focus on expansion in the high population growth corridors and the peri-urban regions around the capital cities. We see this as a significant market opportunity. There's population rates that are surging in regional growth corridors on the back of COVID, where people are now moving out. Sort of within 150 kilometers of the capital cities, where they can transit into the cities for 2 or 3 days a week that work out in these lifestyle properties the rest of the time. We're also seeing a significant increase in pet ownership post-COVID. And if we look at Apiam, the expertise that's required to service these peri-urban regions and in regional areas where people have not just companion animals, but they may also have some cows and horses and chooks. Then Apiam is very well positioned to be able to meet these markets, which is a very different market to the metro focus models. And of course, the mixed animal clinics generally offer a higher-margin opportunities in our livestock-only clinics. Some of these clinics we're developing ourselves. Some of them we will develop it PETstock, which in 2008, we established a joint venture, where we put clinics within or adjacent to PETstock retail and pet services businesses. So when it looks -- when you look at the rationale and clinic economics on these new sites, again, we're assessing the sites. We're assessing the situation pretty diligently. We've got to see growth and margin opportunity. But our capital position does allow investment subject to strict return assessments. And if we see the right situation, that attractive clinic economics, then we'll develop these projects. And we're looking at large clinics. We're looking at clinics that will have 6- to 10 full-time equivalent vets that generate $3 million to $6 million. We expect that they would break even at a profit level in the second year and the full maturity around that 20% to 25% EBIT margin in the third year. So a bit of an update on what we've done in the first half of this year. We opened a clinic in January in Torquay North just out of Geelong, which is a very fast-growing regional hub. Torquay North itself is growing, but we're also pulling a number of clients out of the Armstrong Creek growth area as well. We've got a new clinic opening at Shepparton in a couple of weeks. So that's still in companion animals, but also, it's in a very strong dairy region, and we're providing dairy services through our ProDairy program through that clinic, and we've got a number of other clinics that are in the planning stage that we should expect to bring on in the next 12 months. I'll now talk towards acquisitions, and we have a very strong acquisition pipeline for strategic investments. We do take a very disciplined approach. And we've got a good, strong track record when it comes to execution of these acquisitions. We've made 6 acquisitions in the past 3 years, which included 8 clinics in the ACE Laboratory. And we've got purpose-built company infrastructure that we've been developing, obviously, over the last 4 or 5 years, which is going to deliver some real cost efficiency. So when you look at our acquisition criteria, we're really looking for clinics that: can expand our regional footprint; that have got attractive animal exposure; that got strong financial metrics; where we've identified some scale benefits and potential synergies that we can make sure that we leverage out the assets that we've developed; but also more importantly or as importantly, we want clinics that have a good culture, culture that fits in well with Apiam that have an excellent experienced team, and they've got a proven track record. So we do look at a lot of clinics, but we do have a very disciplined approach to those that we acquire. I'll now just talk a little bit about our service programs because these have been a real growth driver for the company. The first one, ProDairy, it's an innovative service model that offers end-to-end products and services to dairy farmers. And in the first half of this year, we've had 41.5% growth in dairy farm enrollments since the end of the last financial year. This program is being used by about 12% of Victoria's dairy cows, and we've also started expanding it into Tasmania and New South Wales in the first half of this year. Our strategy is to increase our market penetration in Apiam's other geographical areas. And part of that is 2 new ProDairy clinics, which are opening in over the next few weeks. The second service program, and this is a subscription model that we have, is called Best Mates program, and it's a service program, a whole of life for companion animals. It's a wellness program. We rolled this out in FY '20 and is now across a majority of our company footprint. And again, we're seeing very strong growth. We saw this during the COVID lockdown period, but we've seen it continue since those periods. Our member growth is -- again, it's 38.5%. So it's extremely strong in the first half since the -- compared to where it was at the end of FY '20. So we've got about 6% of our active patients as members. And we think that we can grow that up to between around 15% and 20%. So we've got a lot of growth opportunity in that area. I'll now just give an update on one of the products distributions that we've had that we think will be quite exciting for the company, and that's the Zoono disinfectant. So Apiam and Zoono, we entered into exclusive distribution agreement to -- for livestock in Australia and for swine in the U.S., and we've started putting that product into those markets. What's really -- in these markets, what's really important is that it's a solid production data and that we can really demonstrate a return on investment for farmers. So part of that is having some leading -- world-leading research to support the program. So we've been doing that in conjunction with Iowa State University, which is one of the most renowned universities for examining disinfectants against the various viral pathogens that affect pigs. The first stage -- the first study that we did a few months ago is where we tested the Zoono microbe shield on a surface. We let it dry on a surface. And then once it was dry, after about 90 minutes, we applied the 2 main pig pathogens, PRRS virus and PED virus, and we allowed contact for 6 minutes. And the disinfectant was highly successful with no survival of either virus after that 6-minute contact time. So again, that's pretty significant, and we know it kills the viruses. However, a lot of disinfectants also kill those viruses. So -- but it was -- certainly, from a basic point of concept to say, can a dry disinfectant kill a virus? Well, yes, this one definitely can. The second stage trial is really to demonstrate is if you apply it to a surface, and then a week later, you apply the virus. Does the virus live or die or to what level does it reduce? And this is the most recent trial that we've done. This has concluded in the last 2 days. And in that trial, we tested the -- a surface that was treated with the Zoono microbe shield. And 7 days later, we applied PED virus, which is the swine coronavirus and we saw a 3 -- up to 3 log reduction or a 99.9% reduction in the virus levels after a surface as being treated or 7 days after the surface has been treated with the disinfectant. So this is a pretty good start, particularly when you think about that most disinfectants, if not all disinfectants, really only work when they're in wet form. So to be able to protect the surface for 7 days, it really does demonstrate the efficacy of this product and its ability to be active a number of days after it's applied to a surface. The trial work we're doing now is really the trial work that enables this product to sit within the production systems in a piglet. So piglets and nursery pigs, they're really exposed for a 3-week period after they're born and they're exposed for a 3-week period after they've wean to a number of different viruses. That's really the most acceptable period. So what we need to do in order to really demonstrate a high return on investment for farmers to use this product is to show that against these specific viruses, it's going to be active for 21 days. So that trial is about to commence again in Iowa State University, and we expect to get those results in the next 8 to 10 weeks. So it's not a long time. We'll get them in -- by the end of April. So that's not to say we're waiting for those results to be selling the product. We're actively out there presenting the existing data to farmers and doing trials as we can at the moment. But certainly, when we get those results, it's going to be a pretty -- we're going to be in a pretty unique position compared to our competitors. Also in the -- as we move through the next 6 months, we're going to also test against some of the other important pathogens. But again, that's not stopping us from increasing our sales activity. We'll be certainly commencing or expanding our sales activities once we get the results from that 21-day trial. I'll now just give a bit of an update on our people, and it is really important. You'll see -- as I mentioned before in the media that, there's a lot of media around the ability of -- or the number of vets that are out there in Australia and the ability to recruit enough vets to service the increased number of animals that are -- that people are getting and the increase in farm animals that are also occurring as a result of good season that we're having. So recruitment, retention and developing people is really important to Apiam. And we certainly value our people and culture as a key asset of our business, and it's certainly intrinsic to our competitive advantage. So for a very high level, market-leading hotel practices and in order to attract the best talent to Apiam, we've got a number of initiatives that we've been developing and rolling out over the last couple of years. So there's a whole wide variety of leadership roles. We've got flexible work practices, which is very important when you have an industry where we have a veterinary -- the number of graduates or the percentage of graduates that are coming out of the veterinary skills are well over 75% female. So we're a company that certainly is looking to ways to improve flexible work practices. We have a strong culture of recognizing female talent. We've got a big focus on continuing education. I think we have recognition rewards programs that we think are very well suited to the veterinary industry. And we have a mental health support program, as I mentioned previously, to support what is a very challenging and stressful industry. But we are doing some pretty exciting things, and one of those things is our tele-triage initiative, and this was introduced in the first half of FY '21 to address work-life balance issues for regional vets. And the way this works is normally, vets would work during the day, and then they're also on call all through the night and they're also on call on weekends. And so what's interesting with that is that about half of those calls actually aren't being made for emergency services. It's actually to treat an animal. A lot of those calls are for a number of different reasons. They might be people wanting just to see what hours you're open. They might be booking and grooming for the next week or the week after. So we can certainly improve the work-life balance of our regional vets if we can have a triage service that makes sure that -- when people do have emergencies with their pets and our vets are always available to be able to service them, but they don't get the burden of those other calls. So we currently have a service where -- which is being rolled out across all our clinics. We've got it across the majority of them now, where after hours calls are taken by an experienced virtual support team, which are really experienced nurses who have 10 to 20 years' experience. They take these incidents and they triage them to ensure that they have best practice response to emergency care and things in animals that do need to be seen are seen rapidly by a vet, but then they're also dealing with a lot of the other noncritical matters. As part of this, we developed a proprietary software system, which enables us to allocate the appropriate resources and ensure that we can offer the best practice with veterinary services. And we have seen -- since we've implemented -- reduction in vet after hour calls or calls that need to actually go to a vet to respond to an animal, we've seen a reduction by 50%. And you can just imagine the number of calls that come in, particularly in the evening and on public holidays. So this is something that we see as pretty exciting. It's something that is scalable. And we believe it will change the way that regional and rural vet services are provided in the future. I'll now provide just an update on industry conditions. So if we look at the dairy and the mixed animal segment, Australian milk production is forecast to increase 4% in 2021. And as I've mentioned, the dairy industry is going quite well. We've had some very good rains over the last 12 months. So this growth is driven by favorable farm conditions. There's plenty of feedstocks out there. We've had additional summer rains over the last few months. And as a result of that, in the northern irrigation areas, we see a lowering water price. The companion animal ownership, as I've mentioned, has experienced strong growth. And as people continue to move into rural and region areas, we expect that to continue. As Matt mentioned, we have had challenges in the feedlot industry. The feedlot industry is an industry that does have market cycles that do swing quite rapidly. And you'll see that graph, the black line on the graph to the right, and that is basically the number of cattle that are on -- that are in feedlots or on feed over the last 25 years. So you can see that there's a continual increase in the number of the capacity of the Australian feedlot industry, but the numbers do go up and down based on various factors, whether that's around availability, cattle or grain prices or whether there's a [ drought ] or not. So despite a difficult 2020 where cattle -- cattle herd hit a 20-year low, the outlook for beef feedlot is largely positive. Our numbers in the first half are basically -- reflect a part of the market cycle where it's been down about 25%, 30% in terms of the number of cattle that are on feed. And so we expect that the beef production will tighten and continue to be tight in 2021 as the herd starts to rebuild. So you'll see that in -- that we've put there in December 2020, feedlots were at about 72.5% capacity. So there's -- what that means is that if you look at the number of spots that are available for cattle to go on feed in feedlots, they're sitting at about 72.5%. So the industry is continuing to build additional capacity to be able to meet the needs when the industry responds and more cattle come back on food. So there are some favorable things that are starting to swing that way in terms of grain prices. They have -- obviously, Australian farmers have delivered the second largest grain crop ever, and that will have a benefit on that side. In the pig industry, Australian sale numbers are forecast to rise marginally in FY '21, and there is some industry capacity expansion continuing to occur to meet those future demands. The other thing to look at from our input prices, of course, is that we are having a very good season. There's been a La Niña weather event declared by the bureau or as declared back in September '20, and this typically results in higher rainfall in east and northern Australia during the spring and the summer season, which we've seen over the last 6 months, and this possibly could occur for several years. So if I turn to our outlook for FY '21, we expect the Apiam business operations to remain strong and stable despite the challenges that are occurring in the world that COVID impacts and as well as the market cycles. We're continuing to drive clinic growth off the back of the rapid acceleration in pet ownership in the regional growth corridors, and this will continue to be a key management priority for FY '21. Our business reinvestment will continue to be carefully balanced against return on capital thresholds, and we're expecting a strong earnings outlook for the remainder of FY '21. So with that, I'll open it up to any questions.

[Operator Instructions] The first question is from [ Julian McGoldrick ]. Their question is, are you planning on acquiring any vets located in Sydney or Melbourne?

So our model at the moment is really to acquire vet clinics where -- in the rural and regional areas. So certainly, we are acquiring clinics that are in those peri-urban regions within sort of 30 minutes as opposed to the capital cities. But at the moment, we're playing to our strengths and the skills that we've got to grow out what is still a very fragmented market in rural and regional areas. So at this stage, that's where our focus is.

The next question is from [ Kam Siemens ]. How confident are you that there is a market for the disinfectant product you're testing?

There's definitely a market for the disinfectant product. I mean there's no other products that have the data to support an extended duration of efficacy in -- for the animal diseases. So we're very confident there's a market there. We've just got to do the work to -- do the scientific work to demonstrate that this product is effective against these viruses for the 21-day period, and this is no different to any other product that comes into the animal health industry. You've got to provide very good scientific data to back up any claims on the products. So if we deliver on what the product delivers on that R&D, then I think we'll see some very positive results.