EBOS Group Limited (EBO) Earnings Call Transcript

Thank you for standing by, and welcome to the EBOS Group Limited FY '22 Full Year Results Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, the 24th of August 2022. I would now like to hand the conference over to your first speaker today, Mr. John Cullity, CEO, EBOS Group. Please go ahead, John.

Thank you, Dylan, and welcome, everyone, to EBOS Group's Full Year 2022 Results Presentation. My name is John Cullity, CEO for EBOS Group. And I'm joined this morning by Leonard Hansen, our CFO; and Martin Krauskopf, our GM for M&A and Investor Relations. Before presenting our results, I'd like to start by highlighting that in 2022 EBOS is celebrating 100 years of its history. From the commencement of operations in 1922, Early Brothers Trading Co., the founding corporation of today's EBOS, provided a broad range of products and wholesale services that cater to the needs of communities across New Zealand. It is with a great deal of satisfaction that 100 years later, through our diversified range of Healthcare and Animal Care businesses, EBOS continues to serve and provide for communities across New Zealand, Australia and now Southeast Asia. Our annual report contains further information about our story and provides readers with an insight into how we became the company we are today. We are very proud of our heritage, and we thank all of our stakeholders who have been part of our journey, and we look forward to the next 100 years. It is therefore fitting that in our centenary year we are able to announce another record results including revenues exceeding $10 billion for the first time. Our FY '22 results has been driven by strong organic growth in both our Healthcare and Animal Care segments as well as strong growth from acquisitions. Key highlights of this year's results include double-digit earnings growth, the acquisition of LifeHealthcare as well as 4 additional bolt-on acquisitions, continued investment into our operational infrastructure to support our growth, maintaining a strong balance sheet within our target gearing range and increasing dividends to shareholders. Before we go through this morning's presentation, I should point out the following. The results are expressed in Australian dollars, unless otherwise noted. And the presentation refers to both statutory and underlying results. The underlying results exclude $25.6 million of one-off costs after tax related to the significant M&A activity undertaken during the period. My commentary this morning is predominantly based on our underlying results, and we have included in the appendix a reconciliation between the reported and underlying numbers. The key financial headlines of our full year results are revenue increased by 16.6% to over $10.7 billion, underlying EBIT increased by 20.5% to $355 million, and underlying net profit after tax increased by 21.3% to $228 million. In light of the group's performance, the Board has declared a final dividend of NZD 0.49, which brings full year dividends to NZD 0.96, representing an increase of 8.5%. The group once again saw strong performances from both the Healthcare and Animal Care segments, highlighting the benefits of our diversified portfolio of market-leading businesses and our strategy of investing for growth. Our Healthcare segment increased underlying EBIT by 24% driven by our Community Pharmacy, TerryWhite Chemmart, Institutional Healthcare and Contract Logistics businesses. Key highlights of this performance were the growth in Community Pharmacy was driven by customer and market share gains, increased sales of high-value medicines and the return of Pfizer products to the wholesale channel. TWC store network now exceeds 500, and the network delivered total sales growth of 13.9% and like-for-like sales growth of just under 12%. And our Institutional Healthcare division continued its strong performance driven by sales of specialty medicines as well as organic and inorganic growth in medical consumables and medical devices. During the financial year, we completed 5 acquisitions, which contributed to the growth of the Institutional Healthcare division. Our Animal Care segment delivered EBIT growth of 15% as it capitalized on strong pet care market conditions. Our key brands, Black Hawk and Vitapet, continued to increase or maintain their leadership positions in their respective markets. And I'm pleased to announce that we have now completed the commissioning phase of our new state-of-the-art pet food manufacturing facility in Parkes, New South Wales. We continue to see increased consumer demand for Black Hawk. And in response, we are currently preparing to commence a third shift at that site earlier than initially projected. And therefore, the site will operate 24 hours per day, 5 days per week. At the group level, we recorded underlying operating cash flow of $291 million, return on capital employed of 18.6%, and we ended the financial year with a net debt-to-EBITDA ratio of 1.94x, well within our target gearing range. Leonard Hansen will take you through each of these points later in the presentation. As you're aware, the macroeconomic environment is one of material uncertainty due to COVID-19, supply side constraints and cost increases. I will provide a brief overview of how each of these items has affected the group. COVID-19 continues to both positively and negatively impact on our various businesses. Overall, we estimate that COVID-19 has had a positive net impact on our earnings in FY '22. The key positives include stronger foot traffic in pharmacies due to COVID-19-related products and service demand; continued demand for medical consumables and PPE within our Institutional Healthcare division; growth in demand for Contract Logistics services associated with COVID-19-related products; and our Animal Care segment benefiting from increased consumer spending on pets. On the other side, the key negative impacts include a reduction in the number of elective surgeries impacting on our sales to hospitals; a higher rate of supply out of stocks across our wholesale, consumer and animal care product ranges; and operational inefficiencies due to COVID-19 safety measures and labor constraints. Despite our strong performance, like many companies, EBOS has been impacted by supply-side constraints and cost inflation. In terms of supply-side constraints, our businesses have been enacted by some manufacturer out of stocks as well as availability of staff and other key inputs. In terms of inflation, we've seen cost increases in cost of goods sold, labor, freight and rent. Each of our businesses have strategies in place to mitigate these cost increases. And to date, we have been able to successfully preserve our margins, reflected in our EBIT margin slightly increasing in FY '22. On this page, you can see that each of our divisions has contributed to our growth, with Institutional Healthcare being a particularly strong performer as a result of both organic growth and acquisitions. This year saw a higher-than-usual M&A activity with 5 acquisitions completed. The acquisition of LifeHealthcare was completed on the 31st of May and firmly establishes EBOS as one of the largest independent medical device distributors in Australia, New Zealand and Southeast Asia. I'm pleased to report that since completion integration into our broader medical device distribution operations has been progressing well. In June '22, the first month of our ownership, LifeHealthcare contributed EBITDA of $9.5 million, which was in line with our expectations. As our organic growth has continued, we took the opportunity to reinvest into our operational infrastructure. And these investments included completing the construction and commissioning of our new pet food facility in Parkes, New South Wales; completing the construction of 2 new medical consumable distribution centers in Sydney and Perth; we also expanded our pharmaceutical wholesale distribution centers in Brisbane and Melbourne; and we have commenced the construction of new Contract Logistics distribution centers in both Sydney and Auckland. These investments are consistent with our strategy of investing for growth and will position the group to continue expanding services to our customers. In terms of sustainability, EBOS continues to make progress on its ESG program. And this year, we have developed strategies for several high-priority matters that are important to our stakeholders. This included setting targets, milestones and KPIs for areas including environmental stewardship, consumer packaging, ethical sourcing and our people. Our Board has recently approved the scoping of an 18.8 megawatt solar array to demonstrate the group's commitment to cutting carbon emissions. This array will be sized to meet the current and estimated future electricity needs for all of the group's Australian operations. Further information on our sustainability and community initiatives is available in our 2022 sustainability report, and I invite all our stakeholders to have a read of that document, which is now available on our website. This slide provides further details on the group's financial performance on both a reported and underlying basis. The increase in underlying EBIT of $60.5 million or 20.5% reflects an increase in revenue of 16.6% and a slight expansion of our EBIT margin from 3.2% to 3.3%. During the period, underlying net profit after tax grew by $40 million to $228.2 million, representing growth of 21.3%, and underlying earnings per share grew by 12.2%. The difference between NPAT growth and EPS growth reflects the mismatch in timing between the LifeHealthcare capital raising and completion of the acquisition at the end of May. As I mentioned earlier, we saw a higher level of M&A activity during the year. And as a result, we incurred $25.6 million of one-off M&A costs post tax. These costs are excluded from our underlying earnings. FY '22 continues our long-term track record of delivering strong and steady performance with a focus on earnings and dividend growth, cash flow generation, return on capital and maintaining a strong balance sheet. Moving now to our segment performance. Healthcare generated revenue growth of 17% and underlying EBIT growth of 24%, with both our Australian and New Zealand Healthcare businesses growing earnings at broadly consistent rates. This performance was driven by strong organic growth across our pharmacy wholesale, TerryWhite Chemmart, medical consumables distribution and our Contract Logistics businesses, supplemented by the completion of the 5 acquisitions. Moving now to the specific components of Healthcare and starting with Community Pharmacy. In Community Pharmacy, we occupy the leading wholesale market position in both Australia and New Zealand. The Community Pharmacy business built upon the strong growth we saw in the first half and recorded a 19.5% increase in revenue and a 14% increase in gross operating revenue for the year. There were several key drivers of the results, including increasing our market share as a result of above-market growth by our major wholesale customers as well as winning business from our competitors. Strong performance was also seen from our Community Pharmacy retail brands including TerryWhite Chemmart. Ethical sales were particularly strong, growing at 19% in part due to the increased sales of new high-value medicines and the return of Pfizer to the wholesale channel. OTC sales grew by approximately 26%. This represents a return to growth in our OTC product category following previous year declines due to COVID-19, with key categories such as cold and flu, natural medicines, weight management, children's health and pain relief all performing strongly. The GOR margin percentage reduced slightly here, reflecting product mix and increased sales against the fixed CSO income pool. Our TerryWhite Chemmart business, which is reported within Community Pharmacy results, achieved a significant milestone, adding 51 new stores to exceed 500 total stores in the network, reinforcing its position as one of Australia's leading community pharmacy networks. Total network sales increased by 13.9%, and like-for-like sales grew by 11.9%, a really strong result that was driven by new store growth and continued investment in marketing and media, maintaining our position as the second largest advertiser in the Australian retail pharmacy sector. Additionally, the TWC pharmacy network has been responsible for delivering approximately 20% of all Australian Community Pharmacy-delivered COVID-19 and flu vaccinations, respectively, highlighting the important role our pharmacists have played during the pandemic. Our Institutional Healthcare business saw a strong period of growth, increasing gross operating revenue by $122 million to $378 million. Key drivers of the results were increased sales of new specialty medicines into the hospital network, continued strong demand for medical consumables including PPE, benefits from the 5 acquisitions mentioned earlier including the 1-month contribution from LifeHealthcare and an uplift in the GOR margin due to higher contributions from our expanded medical devices and medical consumables businesses. To support the ongoing growth of this division, 2 new medical consumables distribution centers were opened in Sydney and Perth. Contract Logistics has delivered another very strong performance with GOR growth of 40%. In this division, we saw our Australian business continue to grow its market share. The business also grew as a result of increased demand for the storage and servicing of protective equipment, testing kits and COVID-19 vaccines in New Zealand. As flagged in previous reporting periods, we are investing in a new Contract Logistics distribution center in Sydney to cater for our market growth. And we're also pleased to announce that we've commenced development of new Contract Logistics center here in Auckland. We anticipate that both of these new facilities will be operational in 2023. Turning now to our Animal Care segment. Our Animal Care business also had a strong performance for the year with revenue growth of just under 9% and EBIT growing by 15.3% as we continue to benefit from strong pet market conditions. These strong trading conditions are a result of the combination of an increased pet population, the humanization of pets and the premiumization of pet products, which we have highlighted in our past results. Pleasingly, our key brands, Black Hawk and Vitapet, continue to either increase or maintain their leadership position in their respective market segments. We're also pleased to announce that we have launched a new range of Black Hawk treat and puppy food products, consistent with our strategy of leveraging the strong brand into new product categories. In relation to our new pet food manufacturing facility, we successfully completed the construction and commissioning of the facility, and we are steadily increasing our commercial production rates. The completion of this facility has been very timely in an environment where global supply chains have been challenged. Having our own local manufacturing capability provides us with a real competitive advantage in a market where supplier out of stocks have been commonplace. And as mentioned earlier, in response to the increased consumer demand for Black Hawk, we will be shortly commencing a third shift at our facility, which is earlier than initially projected. Black Hawk, Vitapet and Lyppard all demonstrated solid growth during the period. Black Hawk, our premium dog food brand, capitalized on its leading position to continue to take market share in the pet specialty channel across both New Zealand and Australia. Vitapet remains the leading dog treats brand in the grocery channel in both Australia and New Zealand. And Lyppard also experienced strong growth at the GOR line, with lower revenue growth being a function of reduced exposure to lower margin business. And that concludes the commentary on our segment performance. I'll now hand over to Leonard Hansen, our CFO, to cover the financial information. Thank you, Leonard?

Thanks, John. Underlying cash flow from operations for the 12 months to June '22 was $291 million. Underlying cash flows exclude one-off payments of $42.2 million in relation to M&A transaction costs for the year. The decrease in underlying operating cash flows of $11.2 million compared to the prior year was attributable to the additional investment made in working capital to support the sales growth for the year and higher tax payments made partially offset by the higher underlying earnings, up $70 million compared to the prior period. Capital expenditure for the year was $89.2 million, comprising our business-as-usual CapEx of $59.2 million and a further $30 million to complete the construction of the new pet food manufacturing facility that commenced operations in the second half of FY '22. We also invested approximately $1.3 billion on acquisitions and deferred consideration payments for prior period acquisitions. The majority of the spend in relation to our acquisition was in relation to the acquisition of the LifeHealthcare Group for $1.15 billion, which was announced in December '21, with the transaction completing in the second half in May '22. Moving on to working capital. Working capital continues to remain a key focus for the group with the cash conversion cycle of 15 days as of June '22, similar to that on prior periods. Working capital has increased by $140 million from the prior year, largely attributable to the working capital acquired from the acquisitions undertaken during the year, which added approximately $120 million of working capital to the group's balance sheet. Return on capital employed for the year was 18.6% and is a record for the group and above our 15% return on capital employed target and also last year's reported ROCE of 18%. This is on the back of our strong earnings growth and continued disciplined approach to managing cash flow. Net debt for the group excluding leases was $860 million as at 30 June '22, an increase of $589 million on the prior year. This is primarily attributable to the group's undertaken acquisitions of $1.3 billion during the year. These proceeds were associated to capital raisings of $787 million. Our net debt-to-EBITDA ratio was 1.94x. It is higher than the 0.85x reported last year but within our target gearing range and well positioned after the LifeHealthcare acquisition. Our conservative gearing also provides capacity for further acquisitions and growth in business. In conjunction with the acquisition of LifeHealthcare in May '22, the group increased bank funding facilities by a further $540 million split evenly over the 3- and 4-year maturity tenor. At 30 June, the group has combined undrawn debt facilities of over $900 million available. And as at 30 June '22, EBOS' weighted average debt maturity profile was 2.6 years. Turning now to earnings per share and dividends. Underlying EPS for the year is $1.29 per share, growth upon FY '21 of 12.2%. The EBOS Board has declared a final dividend of NZD 0.49 per share, and this will be increased up to 25% and fully franked for Australian tax resident shareholders. The total dividend for the year are therefore $0.96, up 8.5% on last year, with a payout ratio for the year on an underlying basis of 74%. The group's Dividend Reinvestment Plan, which was strongly supported by shareholders previously, will be available for the final dividend. Shareholders can elect to take shares in lieu of a cash dividend at a discount of 2.5% to the volume weighted average share price. Thank you, and I'll now hand you back to John.

Thank you, Leonard. So in conclusion, we are pleased with our strong performance in FY '22, which included revenue exceeding $10 billion for the first time, double-digit earnings growth, the acquisition of LifeHealthcare as well as 4 additional bolt-on acquisitions, continued investment into our operational infrastructure to support our growth, a strong balance sheet within our target gearing range and increasing dividends to shareholders. Looking ahead, we expect another year of profitable growth in FY '23. Our portfolio of businesses have proven to be very resilient through COVID-19 pandemic. However, given the global economic and geopolitical environment, there are material uncertainties that may impact upon the group due to trading performance. We expect capital expenditure for FY '23 to remain elevated as we embark on facility expansions and upgrades to support the growth in the business. Our balance sheet is well within its target gearing range, and we remain well positioned to support the capital expenditure requirements and pursue our growth opportunities. So with that, I'll conclude the formal part of the presentation and hand back to the operator to facilitate any questions. Thank you.

[Operator Instructions] Our first question comes from the line of Daniel Hurren (sic) [ Dan Hurren ] from MST Marquee.

If I have this right, you can back out the gross operating revenue for Animal Care, but I don't think it's in the presentation. And it appears to be down sharply on FY '21, which compares to a very strong EBIT growth on FY '21. Could you talk about any changes there that have driven that gap?

Sorry, Dan, can you just repeat that question? If you -- you were talking about backing out the gross operating revenue for Animal Care, which is in the presentation?

No, no. Sorry, the gross operating revenue for Animal Care is not in the presentation as far as I can see. But if we have it right, we can back it out, and it's down quite sharply versus FY '21, yet you've got quite strong EBIT growth.

No. No.

That's not right?

That's not correct. No, no, Dan, in the presentation, on Page 8, under the business and segment performance, you can see that the Animal Care gross operating revenue was up $20.3 million or 14.8%.

Right. My apologies. Sorry, there's a lot going on this morning.

No, that's okay. That's okay.

Rather than that as my question, I'll sneak in another one. Look, you've talked about COVID impact today. I was just wondering if you could talk about the big impacts like rapid antigen test, Paxlovid, et cetera, and how they sort of fared first half versus second half and what the impact was across divisions or segments.

Maybe to provide a little bit more insight into the profit performance of the group because this will probably come up in additional questions as well, but if you take the EBIT growth for the group at, say, 20.5%, we estimate that COVID provided a net positive impact to the group's growth rate of about, say, 2% to 3%. We also estimate that acquisitions provided a contribution to the growth rate of about 8% and that, therefore, the organic growth rate for the group is about 10%, right? So I don't have the split on that first half, second half, but we would have communicated that in the first half, yes.

Yes, sure. And just across the divisions, I mean, has that been fairly even across divisions, across the segments?

It's really -- that COVID impact is really concentrated in the Healthcare division, right, because there was additional activity around -- particularly in New Zealand, around distribution of vaccines, PPE, equipment, et cetera. So that was the benefit. And then the downside is we also -- and also the high foot traffic going into pharmacy, right? And then the downside is we also called out, which affected both divisions, Healthcare and Animal Care, which is supplier out of stocks, inefficiencies within operations. It's a real mix of things.

And I show our next question comes from the line of Saul Hadassin from Barrenjoey.

Can you hear me?

Yes, we can, Saul.

Right. John, just 2 questions from me. The first one, just looking at the Healthcare divisional operating costs particularly in the second half, just noting the material step-up both sequentially and also versus PCP, I think they're up 40% versus second half '22 -- '21. And you touched on some of the cost pressures in your commentary, John. But just wondering, as we move into FY '23, I mean, is that an expectation that, that second half cost base is now the base to work off into '23? Or do you think you can achieve a degree of leverage in that cost line into FY '23 particularly with the integration of LifeHealthcare? Just wondering how you see that operating cost line moving into the next fiscal year.

Yes. No, Saul, it's an interesting question. I think in terms of the cost base, of course, when you're looking at a run rate for this year, you've got a significant impact with the acquisitions that we have undertaken, and we also had a heavy spend in our marketing line particularly in the second half of this financial year. Probably broadly speaking, if I can provide just maybe some insight with the major cost variables that will impact on the business going forward, right, and they are the ones particularly we called out. So we see labor probably increasing around the 3% to 4% mark going forward. We see freight probably up around about the 5% mark. And then you've got rentals around about the 3% mark. Basically, those 3 line items would make up, I'd estimate, probably about 90% of our costs, right? So that's what we would expect to see in any given year, I'll say in FY '23, excluding, say, the impact of acquisitions that have impacted on the prior year base, right?

And then second question, again, just on working capital and that slight increase in cash conversion days, just cognizant of sort of what medical devices does to your overall working capital and particularly cash conversion. Is the expectation there that you can get those days back down slightly? Or is this sort of the new normal based on the LifeHealthcare transaction?

Saul, it's Leonard here. I would expect we would see a deterioration further on the cash conversion cycle in regards to bringing in LifeHealthcare to the group, first, on a proportionate basis what you saw in FY '22. I think what we're going to see is the days that go from 15 to sort of maybe 17, 18 days as we see the impact of LifeHealthcare and their devices business. And that's really just to accommodate the customer base, to service those customers over that period of time. What I would say is that we're probably looking at a working capital impact year-on-year of approximately sort of $40 million, $50 million in regards to an increase of working capital to support those sort of the group customers, including the LifeHealthcare devices businesses.

And I show our next question comes from the line of Matt Montgomerie from Forsyth Barr.

John, just checking if you can hear me okay.

We can, Matt, yes.

Perfect. Well done on another solid result. Maybe just firstly on broader market conditions within the pharmacy business, I appreciate you've outlined the issues you're seeing on the supply side and cost increases within your business itself. But just wondering if you could make any comments on impacts, I guess one step further down at the pharmacy and consumer level and if you're seeing a normalization in industry conditions as a result of broadly similar factors.

Matt, what we've seen and probably what we continue to see is that at the pharmacy level, it's still very strong. These type of growth rates that we've had now for a couple of years are certainly well above norm, no doubt assisted by the outbreaks of COVID. So what we see in the business is we have the outbreaks of COVID like we did in Australia early in the New Year, January, et cetera, through to February. Then we had another outbreak around June, July, you see the pharmacy distribution business is very strong. And then on the counter side, you'll see our sales into -- medicine sales into the hospital network soften up a bit, and that also includes the devices piece. So we're still -- what happens in -- throughout FY '23, time will tell. We can't really predict that. What we are very confident about is our ability to continue to increase our market share, grow our TerryWhite Chemmart business, and therefore, we should, in ordinary course of events, deliver a growth rate that's above market. And that's what we strive to do.

Okay. That's good color. And then secondly, on Animal Care, clearly another strong full year performance. It appears to me that revenue was down half-on-half sequentially. Just wondering if there's anything you can talk to here, if that's a function of broader pressures at the consumer level or if there's anything in particular.

Yes. No, that's really a factor, Matt, and you can see it in like Page 22 of the slide presentation. That's really a factor of our slower growth or lower growth in our Lyppard wholesaling business. So the wholesaling business from Lyppard comprises about 50% of the revenues in the Animal Care segment, right? So in fact, the branded business, the higher-margin business still had a very strong second half, right, from a revenue perspective and also from a profit perspective. We lost some lower-margin customers in that wholesaling business, so that affected the revenue growth rate in the second half but wasn't detrimental basically to the profit from that business. So that's what's going on there.

And I show our next question comes from the line of Mathieu Chevrier from Citi.

My first question was related to LifeHealthcare. You have previously guided to calendar year '22 EBITDA of $110 million to $114 million. And I was just wondering how has that evolved since December. And obviously, we had Omicron and whether that's impacted your ability to meet with customers.

Yes. Mathieu, so we said at the time of the capital raising, and correct me if I'm wrong, that we believe that the LifeHealthcare business would deliver that EBITDA on a CY '22 basis or, in effect, on a 12-month post-acquisition basis. We've reported 1-month result since ownership, which we've highlighted in the presentation, and contributed EBITDA of $9.5 million. So we sit here today comfortable that, that guidance is still appropriate and that business is performing in line with expectations.

Okay. And then just looking at your -- or the Community Pharmacy revenue growth was again very strong in the second half. Do you expect that run rate to be sustainable going to FY '23?

We're not really commenting, Mathieu, on FY '23, and I did provide some flavor on the previous question. And we all note that the run rate and the strength in Community Pharmacy has been very strong for a couple of years now. And COVID had a large contribution to do with that as well as the sales of high-value drugs. And also, we will start to cycle the inclusion of the Pfizer volumes in FY '23, so it would be unlikely, I think, that we would continue to sustain that type of revenue growth rate. If I give you some flavor into that growth rate for FY '22, so of the revenue growth of just under 20%, then we assess that the contribution of Pfizer and high-value drugs into that growth rate was about 9%, right? So if you take that out, you're talking about sort of like an organic growth rate of 10%, which is still very high compared to historical norms. At some point, that's going to level off, right? But what that point is, we don't know.

Understood. And maybe just one for Leonard on the D&A and interest that we should be expecting in FY '23 with now the acquisition of LifeHealthcare being included in the results.

Yes. So that sort of is about approximately $15 billion to $20 billion of additional D&A to our numbers based on carrying through what they've got. What I would call out, though, is that we do have to go through the quirks of acquisition accounting under accounting standards, so we will need to do that process. And it will potentially include additional amortization that comes through, which will be noncash that will be reflected in our numbers. But we will call that out separately as we go forward and reporting.

And I show our next question comes from the line of Adrian Allbon from Jarden.