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Edited Transcript of API.AX earnings conference call or presentation 20-Apr-17 12:30am GMT

Thomson Reuters StreetEvents

Interim 2017 Australian Pharmaceutical Industries Ltd Earnings Presentation

Syney, NSW, Apr 29, 2017 (Thomson StreetEvents) -- Edited Transcript of Australian Pharmaceutical Industries Ltd earnings conference call or presentation Thursday, April 20, 2017 at 12:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Richard Vincent

Australian Pharmaceutical Industries Ltd. - CEO

* Peter Mendo

Australian Pharmaceutical Industries Ltd. - CFO

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Conference Call Participants

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* Simon Conn

Investors Mutual Ltd. - Analyst

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Presentation

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Richard Vincent, Australian Pharmaceutical Industries Ltd. - CEO [1]

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Good morning, ladies and gentlemen. Welcome to the presentation of API's financial results for the half-year ended February 28, 2017. I will provide a quick overview of the group results and highlights and our CFO, Peter Mendo, on my right, will provide -- on my left, sorry -- will provide details of our financial management performance. I will then wrap up with an operational summary and the forward outlook before taking any questions from those present in the room.

Once again, it is pleasing to report a strong profit growth delivered through our Priceline Pharmacy network and pharmacy distribution business. Underlying impact was 15% up on the prior corresponding period to AUD29.1 million and EBIT was 9% up to AUD48.6 million. This result shows we were once again able to optimize the operational performance with a focus on financial management to improve the overall business position.

Underlying return on equity was up 10.7% on the prior corresponding period and was return on -- as was return on capital employed, which increased 21.7%. Total revenue was up 12.7% to just over AUD2 billion. Underlying earnings per share was up 15.4% and the Board has declared a fully-franked dividend of AUD0.035 per share. This continues the trend of increasing the rewards to shareholders and is up 40% on the prior corresponding period.

The business is well-placed to adapt to any further changes in the environment, having developed a strong financial, strategic, and operational base. In financial terms, as we stated at the AGM, we expect to eliminate reported net debt by the end of this calendar year. This is indicative of our overall balance sheet strength, also shown in our improving returns on equity and capital employed, which has given the Board increased flexibility to look at longer-term options.

Our strategic positioning has proven successful in expanding the Priceline Pharmacy network to be our primary growth vehicle. We have also invested wisely to effectively manage PBS reforms in our pharmacy distribution business.

Despite the recent uncertainty in the retail market, the fundamentals remain strong for API. There remains a robust pipeline of stores wishing to join our Priceline network. We are growing health and beauty market share. We are managing a range of PBS issues while delivering better services to independent pharmacies and increasing efficiency and cost control through our recent investments.

I will talk in more detail about our operational performance and our outlook after Peter's financial summary. So on that note, Peter, over to you.

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Peter Mendo, Australian Pharmaceutical Industries Ltd. - CFO [2]

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Thank you, Richard, and good morning, everyone. As Richard has outlined, API continues to deliver growth in both earnings before interest and tax and net profit after tax. As you will note from the presentation, NPAT, ROE, and ROCE have all increased by double-digit numbers. And I would particularly like to draw your attention to the compound annual growth rate over the past three years of 13.8% for EBIT and 21.6% for underlying impact.

These earnings reflect CapEx investments made over prior years, which have enabled API to achieve its strategic plans and to deliver sustainable shareholder value. A number of factors have generated this value and I will elaborate on each of these in the next few slides.

Pharmacy distribution revenue, including hep C sales, was up 18%. API's gross profit increased 2.9% to AUD244.9 million. Pharmacy distribution GP is 7.4% and GP for retail, which includes API company stores and franchise income, has increased to 23.3%.

We have been able to grow earnings in our business with our ongoing focus on operational efficiency. Costs increased by less than 1% to AUD198.5 million for the half. When depreciation is excluded, the increase is negligible.

We continue to have productivity improvements in our supply chain while containing expense increases to inflation. Admin and general expenses decreased, which reflects savings and efficiencies through both process improvements and cost reduction programs.

Revenue growth, combined with operational cost efficiencies, have resulted in underlying earnings per share of AUD0.06 per share for the half. Our net financing costs for the half decreased by 22.6%, due to improved working capital and debt management. This trend is in line with the second half of FY16 and we expect further improvement.

This result has allowed the Board to declare a AUD0.035 fully-franked interim dividend, which is in line with the payout ratio of around 60%. Additionally, we have sufficient franking credits to maintain fully-franked dividends going forward.

As expected, API's working capital position improved significantly when compared to the first half of 2016. Working capital has improved by AUD48 million. Overall, cash conversion days improved to 26.9 days compared to 37.4 in the prior corresponding period.

A comparison between August and February is not always informative as results will always be different due to the seasonal nature of our business. And in addition, the slowing of hep C sales has impacted our ratio of creditors to debtors on net working capital since August.

We continue to focus strongly on all elements of working capital management. The key take-out from cash flow and net debt is the improvement in our position on the prior comparable period. The net debt position has improved by AUD84.4 million.

If you refer to the [4D] cash flow, you will note that this has been achieved in a half despite tax plus dividend payments increasing by AUD21 million over the first half 2016.

In addition to a reduction in net debt, our focus on net debt management continues. We terminated a securitized debt facility in October 2016. We are currently in the final stages of refinancing our largest securitized debt facility for three years to take advantage of current favorable market conditions, which will result in improved pricing and terms.

Previously in the second half FY16 we reduced our core debt facility from AUD80 million to AUD40 million, all of which will result in continued reduction in finance costs. As you can see on the slide, it is pleasing to note that each of our debt-related metrics have improved half-on-half.

Our elevated return on equity and return on capital employed showing compound annual growth rates of 20.9% and 22.4%, respectively, reflect the strong profit results for the half and the improvement in working capital. The upwards trend in both of these ratios reflects our consistent strategy, scale, and operational efficiency, which are continuing to deliver improved returns for our shareholders.

Both operational and capital management are critical to improving our metrics and we continue to focus on both. Finally, we expect our FY 2017 CapEx to be lower than our annual depreciation cost.

Thank you and I would now like to hand back to Richard.

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Richard Vincent, Australian Pharmaceutical Industries Ltd. - CEO [3]

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Thanks, Peter. Now turning first to our retail business for more detail. Our Priceline Pharmacy network delivered another strong result. Total network sales, including hep C, were up 7.2%. Excluding hep C, the growth rate was still healthy at 5% and we grew our Priceline and Priceline Pharmacy network to 450 stores as at the end of February 2017.

As you can see from the slide, we have again presented register sales, excluding dispensary, and our sales were up 2%. This strong result was achieved in the face of a general softening in consumer spend. Like most other retail sectors, we have seen ongoing subdued spending since the Christmas trading period. In our case, the effect of this was a softening of our comparable store sales growth rate to 0.4%.

Importantly though, despite the lower growth rate in this half, we grew our share of the health and beauty category on an MAT basis but also in the last quarter. This growth is driven by consumer traffic in stores remaining high, but that said, we are seeing Australian women being more selective in purchases than ever before.

We remain particularly strong in the key health, color cosmetics, and skincare categories. We've demonstrated how we can leverage our unique market position in a category like hair care, where our revitalized range and services have shown excellent growth in a category that has been flat in the broader market.

I mentioned earlier that our pipeline of stores wanting to join the brand is strong. In large part that interest is due to our ability to keep delivering for our existing franchise partners.

It is their endorsement of the value of Priceline Pharmacy that drives interest for new recruits, so it's particularly pleasing to report that our satisfaction levels from our latest franchisee survey remains high. Our scores continue to place us in the upper quartile when compared to other franchise operations. And most tellingly, the satisfaction with the relevance of Priceline Pharmacy brand to consumers remains particularly high.

Now there's no doubt in my mind that the competitive environment will only get tougher and consumer confidence will remain challenging. As you know, we've previously invested in infrastructure to deliver efficiencies inside of API. Now we are turning our focus to investing in the customer experience to deliver increased satisfaction and more personalization. That means we remain totally focused in delivering the favorite health and beauty destination for Australian women.

Our Sister Club loyalty program, our product range, and our in-store environment are our strongest assets and differentiate us. To that end, our Sister Club program remains completely unrivaled in the sector. Quite simply, there's nothing like it and we now have 6.7 million members.

To ensure we remain relevant, we have relaunched the Sister Club program this month. While all members will continue to enjoy unique offers, our higher spenders will now receive greater rewards, more personalized offers, and greater recognition.

Now this is the first step in making our loyalty program more sophisticated so that it remains the best in the industry and we are now assessing the next investments to keep it there.

Complementing our loyalty program, our marketing is unashamedly targeted at Australian women. Our new campaign, We're 100% for Women in Sport, reflects that unwavering focus. We've developed a new suite of sponsorships for women.

Adding to our long-standing netball sponsorship, we have added the current champions of the women's Big Bash League, the Sydney Sixers, and I'm proud to say that we are a sponsor of the Western Bulldogs in the inaugural season of the AFL competition for women.

The experience our customers have in store is crucial. To that end, we have increased our investment both in training [more] specialist roles and providing career paths so that we keep the best people so that our service remains unmatched in the sector.

To complement the service standards, last year we revealed our next generation of Priceline Pharmacy. As many of you know, the key improvements include much higher visibility of different categories and brands, making it easier for shoppers to navigate the store. Our customer research has confirmed the effectiveness of our new design and the key elements of our next-generation stores are now being included in all new stores and refurbished stores.

In a tough market like this, having a pipeline of new and exclusive offerings is essential to satisfying our customers, so we will continue to work hard on being the preferred retailer for all of our key supplier partners. All of these elements give me confidence that we can manage the current conditions and retain our market position.

Now turning to pharmacy distribution. It provides a steady earnings source, generating cash which is important to providing future value-adding options for API's shareholders. Our first half saw revenue increase 18% with underlying growth of 5.9% once the impact of hep C and PBS reforms were removed.

We intend to skew our investment for our Saul Pattinson, Pharmacist Advice, and Club Premium members more towards services, as this will be an increasing part of their future remuneration. Our aim is to assist independent pharmacists enhance both their community pharmacy and front-of-shop offerings. Given the competitive environment and regulatory changes, most pointedly PBS reforms, this business continues to deliver a consistent return due to sound management.

In recent times we've grown our pharmacy customer base in WA. Consequently, in June we are opening a new distribution center in the Perth suburb of Forrestfield at a cost of AUD5 million. This investment will result in more timely and efficient stock management for both our growing independent pharmacy customer base and our Priceline Pharmacy network. Like our other recent CapEx investments, we expect that this will improve our cost of doing business to help ensure our ongoing competitiveness.

Finally, the sector is awaiting the government's review of pharmacy remuneration and regulation. We provided our input to that review by the National Pharmaceutical Services Association and we will work constructively with the government and other key stakeholders during the next stage of that process.

The performance of our New Zealand business has been affected by declining demand in the Australian market. The planned changes to coding products on the PBS means earnings will be lower than the prior year. We have advanced plans to secure new business and we expect to return to normal earnings levels in the 2018 financial year.

Now moving to the outlook. While management will assess other growth opportunities that complement the existing business as they arise, we are firmly concentrating on the core assets. The CapEx investments we made in prior years equip us to make further reductions in operating costs. This will help offset the impact of what we expect to be a subdued retail environment.

Our pipeline of new Priceline stores remains strong and we expect to finish the year with at least 462 stores. We expect to deliver another record full-year net profit after tax with a minimum 10% up on the prior year, assuming the current trading conditions persist.

So thank you all for your attendance today and those that have joined on the webcast. I would now like to throw it open to the floor here for questions, and if you could direct those questions through me, that would be great.

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Questions and Answers

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Unidentified Analyst [1]

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Good morning, Richard. Can you just outline what you anticipate are the expected impact of the arrival of Amazon, please?

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Richard Vincent, Australian Pharmaceutical Industries Ltd. - CEO [2]

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It's a very popular topic at the moment. Look, the first thing I would say is that Amazon has been in this market for some time, so when it comes to health and beauty, what we have learned is that they haven't focused as heavily in that space. Not to say that we will underestimate their entry into the market.

What I would say to you is this: We will be focusing on our own offer and things that I've just talked about today, the personalization of our consumer offer and our customer offer inside of Priceline. What we've done already in terms of the new store format and creating playgrounds and creating that in-store experience is critical to our customers remaining loyal to us.

So we will play our game; we will focus on our game. Obviously, we've invested previously to lower our cost of doing business.

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Unidentified Analyst [3]

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Do you expect -- I understand that, but do you expect that when they've completed their [strategy], particularly if they concentrate on beauty and health products, do you expect prices to come down substantially and, as a result, you have to continue to capture cost of doing business?

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Richard Vincent, Australian Pharmaceutical Industries Ltd. - CEO [4]

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So you would expect the market to become even more competitive; there's no doubt about that. But when I say they've been in the market for some time, clearly they are in the market in health and beauty products. We haven't seen a decline or a compression of margin around our product range.

And one of the things I would say is I mentioned before about our relationship with major suppliers. It's the new products; it's the innovation that we bring to market that allows us to maintain margins over time.

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Unidentified Analyst [5]

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Richard, good results. Just on the Sister Club members, now 6.7 million as you said. A few months ago you had a retail strategy there where you talked about how you've segmented those customers.

To what extent do you think now you are actually getting value from those customers and how much more is there to be done to understand who they are and get some more sales out of them I suppose? Whether Amazon comes or not, how can you get more sales from that customer base, member base?

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Richard Vincent, Australian Pharmaceutical Industries Ltd. - CEO [6]

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That's a good question. So part of the reason we've revamped our Sister Club is to focus more on the tiers of customers inside of our Sister Club. So we have -- if you look at our top tier of customers, which are our Pink Diamond customers, they spend substantially more than other customers in the Sister Club.

We can personalize -- I talked about personalization. We can personalize offers and opportunities and benefits and rewards to those customers in that top tier and the middle tier and the bottom tier accordingly to drive more sales.

We already know that those customers spend probably 50% more than a typical customer inside of Priceline. So it's all about a deeper connection with those customers through the new loyalty club.

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Unidentified Analyst [7]

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Just as a follow-up, do you measure to the extent of actually purchasing a store versus online and what (multiple speakers)?

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Richard Vincent, Australian Pharmaceutical Industries Ltd. - CEO [8]

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Yes, we absolutely do. So we can look at the different segments of our customers in our loyalty club. We know how many times they've purchased in-store versus online. We've got that for the various segments and it is a blend.

So it probably leads to another piece that we didn't talk about is that digital is part of our strategy. It's all through our strategy, because that's the way she shops today.

Any other questions? Okay, well thanks. Sorry, Tony, one more?

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Unidentified Analyst [9]

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When will we know the (inaudible)?

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Richard Vincent, Australian Pharmaceutical Industries Ltd. - CEO [10]

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Look, the new agreement with the PBS -- if we talk about, first of all, the community pharmacy agreement goes out to 2020, so there's absolute certainty around the wholesaling arrangements out to 2020. The pharmacy review will look at not only pharmacist remuneration, but wholesaler remuneration and provide a number of options.

Those options have been pending for a number of months for one reason or another. We just have to wait until we see what comes out of that and obviously, as I mentioned, we will participate in discussions with the government.

We have a new health minister. He has a really good understanding of the space and he has already demonstrated he is prepared to work with all key stakeholders. So I'm feeling reasonably comfortable and confident around having good discussions with the health department.

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Simon Conn, Investors Mutual Ltd. - Analyst [11]

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Simon Conn, IML. Just a couple questions. Can you just -- obviously the comp store record of 0.4 was quite weak. Can you just talk about what you saw through the half and how you are seeing current trading conditions?

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Richard Vincent, Australian Pharmaceutical Industries Ltd. - CEO [12]

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So up to Christmas strong trading and then subdued trading after Christmas, and I think it will remain as it is. There's nothing on the horizon that suggests that it's going to change. Our growth around key categories has remained the same since the last week of Christmas.

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Simon Conn, Investors Mutual Ltd. - Analyst [13]

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Can you just comment secondly on the much improved outlook for the balance sheet; what you intend to do with dividends, capital management, or if acquisitions are on the horizon? Because I know there's been a few things floating around the press that you've been mentioned in relation to.

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Richard Vincent, Australian Pharmaceutical Industries Ltd. - CEO [14]

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So first of all, you'd noticed, Simon, that our dividend has increased 40% in this half. That is in line with what we talked about at the AGM that we'd moved that up to around 60%.

Look, that is -- ultimately, we will provide a number of options for directors and the Board and that's a decision the Board will take in the second half. There's nothing -- in terms of acquisitions there's nothing on the immediate horizon. Clearly, we will assess opportunities as they come up and that will go into the mix of the capital management strategy for the Board to consider.

All right. On that note, if there are no more questions, thanks for attending this morning. For those on the webcast, thanks for listening and have a great day.