EBOS Group Limited (EBO) Earnings Call Transcript

Thank you for standing by, and welcome to the EBOS Group Limited First Half FY '21 Interim Results Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, the 17th of February 2021. I'd now like to hand the conference over to your first speaker today, to Ms. John Cullity, CEO of EBOS' Group. Please go ahead, John.

Thank you, Kevin, and welcome, everyone, to EBOS Group's Half Year 2021 Results Presentation. My name is John Cullity. I'm the CEO for EBOS Group. And I'm joined this morning by Leonard Hansen, our acting CFO; and Martin Krauskopf, our GM for Investor Relations. I'm very pleased to report that EBOS' strong performance has continued with another record result and double-digit earnings growth, driven by both our Healthcare and Animal Care segments. Before we go through this morning's presentation, I should point out the following points. The results are expressed in Australian dollars, unless otherwise noted. The presentation refers to both statutory and underlying results. The underlying results exclude one-off costs related to M&A activity. Both statutory and underlying results include the impacts of IFRS 16 for both the reporting period and the prior comparative period. The commentary this morning is predominantly based on our underlying results. For those that closely follow our company, you will note that this period, we focus on EBIT as our preferred measure of operating earnings, which is a departure from our historic focus on EBITDA. This change is being made as a result of the move to IFRS 16 reporting. The appendix to this presentation contains additional disclosures and reconciliations to assist you. Now moving to the key financial headlines for our first half, which are revenue increased by 6.3% to $4.7 billion. Underlying EBIT increased 11.5% to approximately $148 million. Underlying NPAT increased 14.2% to $94 million and underlying earnings per share increased 12.7% to $0.578. In light of the group's performance, the Board has declared an interim dividend of $0.425 -- that's NZD 0.425 -- representing an increase of 13.3%. We are very pleased to continue to deliver strong and increasing dividends to our shareholders in a low-yield environment. The group's double-digit earnings growth was driven by strong performances from both the Healthcare and Animal Care segments. This again demonstrates the benefits of our diversified portfolio of market-leading businesses and our strategy of investing for growth. Our Healthcare segment increased underlying EBIT by 11.2%, driven by our Community Pharmacy, TerryWhite Chemmart, Institutional Healthcare, and Contract Logistics businesses. The key highlights were really above-market growth from our major community pharmacy wholesale customers. The 7th Community Pharmacy agreement did provide the group with increased CSO funding. The TerryWhite Chemmart network continued to grow its network with 22 new stores added in the period. And our Institutional Healthcare business benefited from increased demand for specialty medicines and medical consumables. Our Animal Care segment had an outstanding result, increasing EBIT by 26% driven by the continued strength of our key brands, Black Hawk and Vitapet, as well as our Australian vet wholesale business Lyppard. Each of these businesses achieved double-digit revenue growth and were supported by very strong tailwinds in the Australian and New Zealand pet care market due to established trends that were further accelerated by COVID-19 restrictions. At the group level, we reported an excellent cash flow result, a record return on capital employed, and we further strengthened our balance sheet. Leonard will take you through each of these points later in the presentation. Consistent with our strategy of investing for growth, we completed 2 acquisitions during the period for an aggregate investment of approximately $23 million. In November 2020, we acquired the vet distribution business of CH2. This business has been successfully integrated with our Lyppard business and further consolidates our position in the Australian vet wholesale market. As previously announced at our annual meeting in October last year, we also acquired Cryomed, which is our second medical devices acquisition. We are now generating annual revenue of approximately $60 million in the sector, and we intend to continue to expand our presence with the objective of creating a significant new business division for the group. Both of these acquisitions are EPS accretive to EBOS shareholders in their first year. We have an active M&A pipeline, and we will continue to explore opportunities for inorganic growth across our businesses. Some comments now on ESG. As flagged in our 2020 annual report, EBOS is progressing the implementation of a formal ESG program. We acknowledge that as Australasia's leading healthcare and animal care company, we have a responsibility to our stakeholders and the community to conduct our business in a socially responsible manner and act as a good corporate citizen. Our ESG program will measure and report our progress across a range of ESG areas that are important to EBOS. The areas listed on the page have been identified through a comprehensive international benchmarking and stakeholder engagement process. Our work is ongoing in this area, and we look forward to providing a further update at the time of our FY '21 annual results announcement. This slide provides more details on our group financial performance for the half on both the reported and underlying basis. The increase in underlying EBIT of $15 million or 11.5% reflects an increase in revenue of 6.3% and an expansion of our EBIT margin to just under 3.2%. With respect to the impacts of COVID-19, there are a range of positive and negative impacts across our businesses. On an overall basis, we estimate that the impact on the earnings was positive by just under 2% at the EBIT line. Our strong balance sheet with net debt of 1x EBITDA places us in a flexible position to pursue our growth strategy for the remainder of FY '21 and beyond. This slide illustrates that each of our businesses with the exception of consumer products contributed to the group's earnings growth. Institutional Healthcare, Community Pharmacy and Animal Care were the primary drivers of increased earnings and contract logistics also grew at double-digit levels. This slide illustrates that our first half growth was very strong by historic standards. Group underlying NPAT growth of 14.2% builds upon our previous record result in FY '20 and was approximately double the compound average growth rate recorded in the 3 prior half year periods. Healthcare's double-digit earnings growth this period is particularly pleasing as it cycles the significant step-up in earnings we recorded in FY '20 on the back of significantly increased wholesale revenues. As you can see from the chart, Animal Care has undergone a step-change in its growth this period as a result of our market position, supported by strong tailwinds in the pet care market, and I'll provide further comments on those dynamics later in the presentation. We now move to the individual segment performances in Healthcare. Healthcare generated revenue growth of 5.9% and underlying EBIT growth of 11.2%. Our Australian and New Zealand Healthcare businesses contributed equally to this earnings growth in relative terms. Our New Zealand performance is pleasing as it represents a rebound following a softer result in FY '20. At a high level in reviewing the performance of our Healthcare business, in its growth was primarily driven by increased wholesale and CSO revenues, continued growth within our TWC business, strong demand for specialty medicines and medical consumables and further productivity improvements within our operations. EBIT margins for the Healthcare segment expanded to 2.92% from 2.78% with improved margins across both Australia and New Zealand. Moving now to the specific components of Healthcare. We occupy the leading market position in Community Pharmacy wholesaling in both Australia and New Zealand. The Community Pharmacy business recorded a 4.8% increase in revenues and a 4.7% increase in gross operating revenue or GOR. This result cycle is a full period of the Chemist Warehouse medicines distribution contract, which commenced on July 1, 2019. Key drivers of the result were continued above-market growth by our major customers, and productivity improvements across all of our wholesale distribution sites, reflecting the benefits of the capital investments made in our networks in prior years. The result also reflects increased CSO funding as a result of the commencement of the 7 CPA agreement, partially offset by PBS pricing reforms. TerryWhite Chemmart business, which is reported within our Community Pharmacy result has further strengthened its position as one of Australia's leading community pharmacy networks. It's over 2 years since we acquired full ownership of TWC and the strategic initiatives investments since then are enabling excellent performance by our store network partners. Pleasingly, we welcomed a further 22 new stores to the TWC network during the period. With the majority of these stores migrating from competitive banners, reflecting the attractive proposition, TWC office pharmacists. Network sales increased by 5.8%, and like for sale -- like-for-like sales grew by 4.2%. This performance was driven by new store growth, continued increases in media spend -- which was up by 40% in the first half -- and continued improvement in promotional and category initiatives. As recently announced by the government, Australian pharmacists will play an important role in vaccinating the community against COVID-19. TWC is proactively supporting its network partners to prepare for this program, and it represents an excellent opportunity to further endorse our capabilities. Our Institutional Healthcare business has continued its strong performance and was the largest contributor to group earnings growth in the first half. Within this business, we occupy the leading market position in hospitals wholesaling in both Australia and New Zealand, and we further increased our market share during the period. The Institutional Healthcare business recorded an 8.7% increase in revenues and a 15.5% increase in GOR. Key drivers of the result were increased sales of specialty medicines, continued strong growth in the medical consumables market and our growing medical devices business, which is the key driver of the increase in GOR margin. Moving to contract logistics, which had another strong period with GOR growth of 12%. Growth during the period was primarily driven by existing customer growth and increased volumes in New Zealand, mainly for protective equipment. In this business unit, we are an important part of the medical supply chain for over 160 pharma manufacturers. We occupy the leading market position in New Zealand. Our Australian business is a more recent entrance, where we see market share upside over the medium- to long-term. Our Consumer Products business, which represents 4% of group GOR, continues to be impacted by COVID-19 as a result of both lower demand and product supply issues. Revenue and GOR decreased by 10.1% and 6%, respectively. Demand for our consumer products has been impacted by COVID-19 in a range of ways. For example, a number of our products, including Red Seal Toothpaste, are exposed to the daigou channel, which has softened due to border closures. Other products have suffered reduced revenues this half due to stay-at-home and social-distancing practices, such as our pharmacy choice cold and flu medicines and our Quitnits head lice treatment. Despite these challenges, we are pursuing a range of measures to turn around performance, including expanded product ranging in Asia, investments in marketing and new product development as well as optimizing our manufacturing and supply chain to drive additional improvements. Turning now to our Animal Care segment. The market strength of our key brands, Black Hawk and Vitapet and our Australian vet wholesale business Lyppard, ideally positions us to take advantage of very strong tailwinds in the pet market. As a result, there has been a step-change in earnings to the segment with EBIT growth of 26% to more than $30 million for the half. Globally, there are tailwinds in the pet care market, which are well-established due to factors such as the humanization of pets and premiumization of products. Our Animal Care segment has been benefiting from these trends for several years now. However, it has been evident that COVID-19 has further accelerated these trends as restrictions have resulted in people spending more time at home with their pets. Each of our Black Hawk, Vitapet and Lyppard businesses generated double-digit sales growth for the period. Black Hawk remains the leading dog food brand in the pet specialty channel in Australia and continues to increase its market share in New Zealand. Vitapet remains the leading dog treats brand in the grocery channel in both Australia and New Zealand and further increased its market share in both countries. Both of these brands continue to benefit from substantial marketing investment. Our Lyppard business also experienced strong growth from customers in the vet and online channels. The acquisition of CH2's vet distribution business has made a contribution for approximately 1 month during the half. So this concludes the commentary on our segment performance. So I'll now hand over to Leonard to cover off on the financial information.

Thank you, John. Statutory cash flow from operations for the 6 months to December 2020 was $98.7 million. This represents an improvement of $24.5 million on the prior corresponding period, due to earnings growth while maintaining our disciplined approach to working capital management. Capital expenditure for the period was $10.1 million, and this comprises spend on minor capital projects. CapEx for the half is down on our own internal expectations attributable to operating in the COVID environment and seeking to restrict access of nonessential workers to our facilities across the group. We've also invested approximately $23 million for the first half of FY '21 on acquisitions. Both of the acquisitions undertaken during the period only commenced trading under EBOS' ownership in the last month of the period. Working capital management remains a key focus for the group. Our investment in working capital of $339 million is up $34 million from June, but consistent with our debt reported at December 2019. Our cash conversion cycle of 16 days, as at December 2020, is also consistent with December 2019 and similar to that reported at June 2020, which was 15 days. Return on capital employed is at 31% for 2020, up 17.5% as a record for the group and well above our internal target rate of 15%. Improvement in return on capital employed from the 17.1% reported at June 2020 is attributable to a continuation of our strong earnings growth and disciplined capital management. Net debt for the group, excluding IFRS 16 leases, was $309 million as at December 31, 2020, favorable to both December '19 and June '20 by $83 million and $18 million, respectively as a result of the strong cash performance by the group for the period to December 31, 2020. Our net debt-to-EBITDA ratio was 1.0x, a further improvement on the 1.11x we reported at June 2020. Our load gearing also provides significant capacity for further acquisitions and growth investments. In August 2020, we also extended the tenor of our $400 million securitization facility by a further 3 years. Subsequent to December 31, 2020, we've also refinanced $443 million of current debt facilities, increasing the finance facilities to $465 million. EBOS now has no debt maturities until the second half of FY '23 and has achieved an improvement in our maturity profile spread from our existing debt facilities with this refinancing. Underlying EPS for the half is $0.578 per share, growth upon the same period for FY '20 of 12.7%. The EBOS Board has declared an interim dividend of NZD 0.425 per share. This will be imputed to 25% and fully franked for Australian tax reasons for shareholders. The FY '21 interim dividend is an increase of 13.3% on the FY '20 interim dividend and represents an underlying payout ratio for the period of 59%. Reflecting on the group's operating performance, cash flow and balance sheet, the DRP will not be available for this interim dividend. Thank you, and I'll now hand you back to John.

Thank you, Leonard. So in conclusion, we have recorded a strong financial performance in the first half with double-digit earnings growth, excellent cash flow and returns on capital and a further strengthening of our balance sheet. The robust trading conditions that drove our first half FY '21 performance remain in place. In January of '21, we recorded group earnings growth at levels consistent with our first half FY '21 growth. We continue to closely monitor COVID-19 developments. However, the group is not presently experiencing any associated material negative financial impacts. Given our scale and market-leading positions in stable industries as well as our strong balance sheet, we are well placed to respond to any challenges that may arise. So with that, I'll conclude the formal part of the presentation. I'll hand back to the operator, Kevin, to facilitate any questions.

[Operator Instructions] Our first question is from Chelsea Leadbetter from Forsyth Barr.

I guess just starting off with the margin side of the result, obviously, a pretty good period. And if I think back 6 months ago, you were sort of, I guess, guiding to fairly stable or flat margins through the period. Just kind of interested in, one, what's changed versus then? And I'm guessing some of this -- or at least most of it may be volumes, certainly surprising on the upside. But also interested in sustainability or, I guess, how you're thinking about the outlook from margins going forward, particularly in the Healthcare segment for the second half.

Okay. So I'll refer to EBIT margins, Chelsea, which I think you're referring to. We did have an expectation at FY -- the conclusion of our FY '20 results that we would hopefully see some margin expansion. So that's not -- it's not unexpected for us. The key drivers are really -- there's a benefit to the EBIT margin from both Healthcare and Animal Care. But if I concentrate, say, on the Healthcare part of the business, then you can see the benefit of the extra volumes coming through from our devices business is assisting in that margin. We've also been able to improve our margins or get some margin growth from -- volume growth in the medical consumables side of things. Our HPS business has also made a contribution to that margin expansion. And we also -- within our operations, we've also had further benefits from the economies of scale. So we continue to generate additional productivity improvements throughout the operations network, which is pleasing. So all of those factors are really contributing to that margin expansion, you see.

So if I'm kind of hearing you right, these all sound like relatively sustainable benefits. And therefore, I guess, is there still upside to come from here? Is that the way I should be taking that or thinking about things?

We certainly think the margin is stable from here. We'll always drive for further margin improvement, as you know. So that's -- but that will depend upon if we can continue to generate the growth in those particular categories that I just referred to, and we're confident we can. We're confident we can continue to build that. So certainly, as a management team, we'll certainly be striving for further margin improvement.

Okay. No, that's clear. And then just in terms of the corporate cost line in this particular result, just interested in what's driven the uplift. It is fairly substantial on a percentage basis. And also, how should we think about the second half run rate, is this sort of a new normal level to think about?

I'll probably defer to Leonard on that one. Are you okay to handle that, Leonard?

Yes. I'll take it, John. So yes, the increase really is in relation to a couple of factors, Chelsea. It's -- if I break it down, there's some additional insurance costs that are coming through insurance markets. As our broker describes at the moment, a bit of a bloodbath, particularly the D&O market. So there's been an increase in insurance costs as it comes through. We've also expanded our LTI program to more participants within the group. So more employees are now participating in that, and that's coming through in those results. We've also introduced an employment -- sorry, an employee share scheme to all employees across the group as well as, contributing, we've included or resized, I think, the corporate team structure and also look to -- as part of their support initiatives such as ESG. So if you're looking forward to the full year, I think the first half probably is probably going to be consistent in the second half. Maybe a little bit down with the profile of the cost we've incurred in the corporate area in the first half, I wouldn't expect it to be any higher. Noting also that the second half, I think, last year was a bit higher as well. So I wouldn't expect the same sort of increase in the second half, but the costs should be broadly in line, if not a little bit lower in the second half.

Okay. No, I appreciate the color. And just last kind of question from me for now. In terms of the balance sheet -- and obviously, the free cash flow results are very strong through the period -- I'm just kind of -- appreciate you like to keep headroom and firepower for M&A, and you have said there's an active pipeline, but it is getting quite low in terms of your gearing profile. And how are you thinking about that -- I mean, in terms of your acquisition outlook, but also, is there a potential here that we start to think about lifting the dividend payout further if you don't manage to find sort of big opportunity?

Yes, Chelsea, it's a good question. As you know, we're very -- and have historically been very acquisitive, and so we see no change to that strategy. There are always a number of opportunities that we work upon in the pipeline. We recently -- over the last 12 months, we've added another 2 people into our M&A team within the corporate team. So we're confident that we continue to add to the business. And at this point in time, we'd like to -- just prefer to keep that firepower up our sleeve. And at a point in time, if -- due to the ongoing strength in the cash flows of the business -- we can combine both with an active M&A, continued M&A program as well as a higher dividend, then that would be a nice outcome for shareholders, but we're probably not at that point right now.

Our next telephone question comes from Andrew Paine from MST Marquee.

I actually think it might have been myself, Andrew Goodsall. I don't know if you can hear me. You got the 2 Andrews. But I was just going to quickly ask just and one of the standouts, I thought, was the GOR on your Institutional sales. Just trying to understand, there's a big gap between your sort of top line sales and your GOR, I was -- just sort of what the driver of that was it -- I'm guessing it was sort of volume-based purchasing and being able to get better pricing. Is that the right way to think about that?

There's the type of businesses like devices, our devices business and also our HPS and consumables business sort of can generate the -- what we call other income, Andrew? And that's the key driver in that particular line item.

And is that delta likely to continue? I guess, whether volume is a factor or not, is the structure likely to continue where you can outpace your top line there?

We'd like to think so. Yes, we'd like to think so, but I suppose each period is going to be different. So it's a bit hard to forecast that, but we certainly like to think so.

And then I was just going to ask you around just getting a bit of flavor on the second half. Just sort of -- you mentioned that TerryWhite is getting ready for vaccination, but I imagine that's just vaccination at the shop front, just whether you're involved in either Australia, New Zealand or any other countries on the vaccination distribution chain. I know DHL had a star role, but whether the AstraZeneca one, whether you've got a role? And just any other flavor in the next 6 months that are perhaps different, this time last year's possible sort of stockpiling quite significantly, just whether you sort of -- just any thoughts around those sort of trading items.

Yes. So on the vaccine, so in New Zealand, we do have involvement in the distribution of vaccine. However, that's subject to fairly strict confidentiality. So we can't expand more upon that. In Australia, at this point in time, we have no direct involvement in the distribution of the vaccine. Other than what I mentioned on the call, being our pharmacy customers. We'll have, of course, a role in the administration of the vaccine. And so that's a positive for our TerryWhite Chemmart network members and increase, hopefully, the footfall traffic that goes into those stores. So we're benefiting directly from that. But no, to answer your question, no direct involvement in the distribution of the vaccine in the Australian market at this point in time. And then your latter question was, I think, was on the hospitals and the stockpiling themes or trends. So certainly, what we have seen over the last 2 years is really, Andrew, was very strong performance in the hospital segment. And that continued in the first half. Although towards the end of the first half, we did see that starting to come down so -- off its highs. And that sort of decline also came through in January as well. So not -- it's too early to tell what that means for the next half or into even FY '22, but certainly, in the most recent months, the hospital's business hasn't been -- in terms of revenue, hasn't been as strong as what it was in the first -- the majority of the first half.

Okay. Okay. Yes, I guess we'll try and think of that in the sequence of sort of stockpiling for COVID recovery from COVID perhaps? And then the final question for me, sorry...

I was going to say that's probably what it was. It's probably that stockpiling thematic and maybe that's winding down a bit.

And then just on the outlook for PBS. I mean you called out some $39 million worth of impact. Just I imagine that -- obviously, that's ongoing, but just whether there's any sort of big-name drugs that you think you're going to be sort of coming through that price reduction process in the second half or any other movements in PBS or thoughts around underlying PBS?

Yes. No, I think in terms of trying to get insight into that, it's always very difficult in terms of what the actual numbers are. That -- the impact of PBS reforms -- so for the benefit of everyone who's on the call, the impact of PBS reforms have a negative impact on revenues of about $40 million. We'd expect that to continue into the -- at that rate, into the second half. So we'd expect a full year impact of reforms of about $80 million, which, of course, offsets the benefit we're getting through the additional CSO funding that came as a result of 7th CPA. There's no single item that I'm aware of -- or drug, Andrew, that I'm aware of that's sort of leading to that, that $80 million impact. It's on a broad range of drugs.

And if I sort of look at government outlook for PBS, you sort of think roughly sort of similar in terms of the outlook just for the underlying growth.

It's always hard to determine. You always ask me and I never really enlighten you much, I don't think, on that...

It's a million dollar question for all of us and for the government.

It is. But he thinks I know more than you. I don't think I do. But look, we've been getting -- we have been in our business, and as you can see in the numbers, we've been quite pleased with the ethical volumes we've been getting in that wholesale business, and a lot of that's driven by our major customers, and some will think that's just CW, but it's not just CW. We've got a lot of major customers, and they've all been getting -- driving fairly strong ethical growth. So look, we would like to think that, that can continue into the second half at around about the 3% to 4% mark. If I can do that, then we'll be happy with that. I can't really share with you any insights beyond that.

3% to 4% is sort of where we were. And I think even at those levels, I get a sense, you're taking the shares. So that's great.

[Operator Instructions] Our next telephone question is from Saul Hadassin from UBS.