Adcock Ingram Holdings Limited (AIP) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Adcock Ingram Interim Results Presentation. [Operator Instructions] Please note that this call is being recorded. I would now like to hand the conference over to Andrew Hall. Please go ahead, sir.

Thank you, Irene. Good morning, ladies and gentlemen. Welcome to the results telecon for our 6-month period that ended on 31 December, and for taking the time to show interest in the company on a busy budget day. I'll take you through an overview of what we consider to be a satisfactory trading performance for the period under review, particularly given the constrained consumer environment and the adverse impacts of the COVID-19 pandemic. In addition to that, there have been number of other factors that have negatively impacted the business this period, particularly the weakening of the rand and declines in demand for certain categories of medication and products. As we all know, the pandemic has almost devastated some sectors of our economy with a rapid increase in the unemployment levels in the country. Once I'm finished with my overview, I'll hand over to Dorette Neethling, our CFO; and Dorette will talk you through a detailed overview of the financials, and we're happy to take some Q&A at the end of the session. So the numbers that you see in front of you, effectively, where we are reporting a COVID-19 period against a comparative that had no COVID-19. So lot of the movements, I guess, need to be considered in that context. To date, within our company, we've recorded 364 positive COVID-19 cases, thankfully 358 of those employees have had full recoveries. But unfortunately and very sadly, we've lost 6 of our employees to this virus. And our thoughts remain with their families, their friends and their colleagues. The company and its people play a crucial role as an essential service provider in the health care industry during the pandemic, and we've been fortunate enough to be able to continue to produce and supply medicines, particularly life-saving medicines, such as intravenous fluids, ARVs that are needed for the country as well as acute medication and hygiene products that have played an integral role in treating and preventing COVID-19. The pandemic has also highlighted the importance of South Africa's frontline health care workers, who've worked tirelessly to say save lives. And from our company, we applaud them and are grateful for the selfless role that they continue to play in the country. If we take a look at the overall business performance in an exceptionally challenging macroeconomic environment, the company delivered a resilient trading performance. Turnover increased by 4%, in a market that is measured by IQVIA, declined by 2%. There is deleveraging evidence at the gross margin level, which decreased from 38% to 35% This was all impacted by the unfavorable exchange rate, which Dorette will elaborate on later, a relatively unfavorable sales mix and low throughput at our Clayville factory due to the weak demand for cough, cold and flu products during the 2020 winter. Operating expenditure decreased by 4%, and that's despite the inclusion of Plush, and some COVID-19 relating cost -- related costs. The cost-saving initiatives that we implemented in the late part of the previous financial year have started to be realized. So all of that worked down to a trading profit decline of 12%. In response to the weak economic environment, the declining demand and ongoing pressure on margins due to the price regulations in the pharmaceutical industry, a Section 189 process was unfortunately necessary in the company that started in November of 2020 and effectively took a couple of months to roll out, and has resulted in 360 employees leaving the company, and you can see the related retrenchment costs of ZAR 33 million reflected in the nontrading expenses. Turning to the regulatory environment. You will all be aware now that we've received a single exit price adjustment for 2021. The 3.68% announced in February is certainly suboptimal from our perspective and significantly lower than the 6.3% that the industry had argued for. The announcement of the increase is also later than what is traditionally the case. So our submissions for the price increases on all our products are currently in with the Department of Health. And we expect to implement the price increase by no later than 1 April. Looking at the trading performance of each of the business divisions. Our consumer division competes in the health care, personal care and home care segments of the market, includes products in analgesics, energy, personal care, vitamins and supplements and some shoe care and cleaning products. The turnover of that division increased by 42% to almost ZAR 600 million, and that ZAR 600 million includes the contribution of the Plush business in the 6-month period. The division had a nice launch of a Bioplus Vit-ality range during the period to further extend its reach into the vitamins, minerals and supplements category. Immune-boosting products such as Gummy Vites and Viral Guard had a very good COVID-19 demand, and those grew respectively two- and threefold in the period that we're reporting on. What is pleasing is that the division's flagship brands, Panado, Bioplus, Compral and ProbiFlora, all showed growth over the comparative period. And the trading profit for this division is ZAR 109 million, 48% ahead of the comparative period. Our OTC division is the part of the business that focuses on pain, coughs, colds, flu, allergy and digestive therapeutic categories and operates mainly through the pharmacy channel, most of the products being Schedule 1 and 2. The turnover of that division declined by 17%. It was adversely affected by the absence of a traditional cold and flu season in South Africa in 2020. In fact, that basket of cough cold and flu products is down 29% relative to the comparative. Despite this disappointing reality, if you look at IQVIA, which measures the market growth and market share in Schedule 1 and 2 medicines, Adcock Ingram is growing at 3% in a market that's declining at 1%. The trading profit for this division declined by almost 50% to ZAR 109 million with the deleveraging quite severe in that business. The Prescription division increased their turnover by 6% to ZAR 1.5 billion. They had a very good 6 months in terms of the ARV portfolio. That grew 40% to just over ZAR 300 million. And we've seen decent demand, particularly on the state tender, which has supported those sales. However, the branded prescription portfolio, especially acute medicines in pain, dermatology, urology, ophthalmology as well as ophthalmic surgical products and instrumentation was negatively impacted by the COVID-19 pandemic. As you're all aware, there were lower levels of patients consulting doctors and -- during COVID-19, this, of course, results in lower dispensary traffic in pharmacies. And we also had a lot of postponement, understandably so, of elective surgeries in the hospitals. The evidence of COVID-19 is shown by IQVIA that this segment of the market has declined by 6%. Adcock Ingram is also negative in the market, albeit that our growth -- our decline is not as poor as 6%. The recovery in our generics basket, which grew by 3% in a market reported to be declining at 4% was very pleasing. So we're happy to see that a lot of those generic products have turned around in the period. Trading profit in the division was flat despite the revenue increase, and that's mainly a factor of mix with ARVs contributing quite a bit in this period. The hospital division at Adcock Ingram is the leading manufacturer and supplier of critical care and hospital products in South Africa. This division's turnover increased by 5% to ZAR 870 million. The growth was largely attributable to COVID-19-related therapies, such as acute renal dialysis and many of the injectables that are used in the ICU setting to treat this condition. However, during the peak of the pandemic, including during the second wave, which has just come through, there was understandably weak demand for products normally used for surgery, trauma and medical cases with a focus on COVID-19 and very little else happening in hospitals unless of an emergency nature. What we are pleased about with the hospital division is that it's continued to move into adjacent categories. We've been selected by Roche to commercialize a portion of their renal portfolio from January 2021 onwards. As you know, we are a big renal therapy company. The turnover of that division -- that part of the business in the division is around about ZAR 300 million per annum. So this will boost that nicely. We've also signed a 10-year sales, marketing and distribution agreement with Sanulac, which is the clinical nutrition division of Lactalis, and we expect to launch those nutritional brands late in this financial year, probably only in June. The division also now represents Abbott diagnostics on the entire clinical point-of-care portfolio in South Africa. And this is effectively a range of test kits for a number of infectious diseases, including HIV, TB, malaria and COVID-19. We took over that agency in December, and in fact, sold out, as you can imagine, all the inventory of rapid COVID-19 antigen tests in the month. Just moving on to our manufacturing facilities. The Clayville facility, which is the high-volume liquids facility, has been adversely impacted by the lower demand for OTC products during the pandemic. And we also had a full shutdown of that factory for a week in this period because of COVID-19. We have had a site inspection there recently by SAHPRA. It was done at the end of November, and we're currently awaiting their report. And we're hopeful that their report will allow us to commence commercial production in the newly constructed ophthalmic facility on that site. At Wadeville, that facility is still not operating at sustainable capacities, albeit that we are putting through some production of the triple combination ARVs after we did some equipment upgrades in the period. So we're hopeful that things will start improving there, particularly with the better demand from the state. Our critical care facility really has been just on ensuring that the demand for life-saving medicine is met. And we've had very good throughput in that factory in the period, running effectively at full capacity. Just looking -- we mention in the results a small acquisition that we've just managed to conclude. So outside of the approximately ZAR 180 million in the numbers that comes from new products across the divisions, in late February, we've concluded an agreement with Aspen on a range of products that will go into our OTC, prescription and hospital divisions, there are 17 brands in the basket. What's good for us about this portfolio is that it fills a portfolio gap in our hospital business with the paracetamol intravenous product. We currently don't have one. There are also 4 OTC products in the basket. And those of you who follow the industry will know that acquisition opportunities in OTC products are very, very rare. So we were delighted to get those products into the basket. And then there are a few generic products that will go into our prescription division. On the transformation front, we were rated in November and have achieved a Level 3 B-BBEE rating. So that's our rating for the year going forward until the end of November 2021. So that's an overview. Dorette will now take you through the detailed financials.

Thank you, Andy. I'll start on the income statement. And for those of you who have printed the booklet, it's on page 5. So revenue during the period under review increased to ZAR 3.8 billion, which is 3.6% ahead of the comparative period, driven by an increase in mix of 4.9%, which includes Plush and an average price realization of 4.7% with organic volumes declining by 6%, indicative of the depressed business environment with the impact of COVID-19, similarly like to that experienced in the last quarter of the previous financial year. The gross profit of ZAR 1.3 billion ended 6.9% lower than the comparative period, with the margin achieved of 34.5% in this 6-month period, which is below the margin of 38.5% achieved in the comparative period. And as Andy mentioned, this was mainly as a result of the weaker exchange rate, some unfavorable sales mix and lower factory recoveries at Clayville due to the weak demand for cough, cold and flu products. So with regards to the [ assets ] impact of the weaker currency, I'll run you just through some of our foreign exchange details. During the current 6-month period, the following material foreign currencies were [ bought ], EUR 24.3 million at an average rate of ZAR 19.12 compared to an average rate of ZAR 16.67 achieved in the comparative period, which represents a 14.7% weakening. And USD 30.6 million at an average rate of ZAR 16.92 compared to an average rate of ZAR 14.79 achieved in the comparative period, representing a 14.4% weakening. With approximately 52% of FECs in dollar and 47% in euro, the weighted cost of our basket of all currencies increased by 14.5% in the current reporting period compared to the comparative 6-month period. At 31 December, at the reporting date, the business was carrying the following open FEC. We had EUR 11.3 million at ZAR 19.07, which is slightly better than the average FEC rate, which we achieved in the first 6 months. And we had USD 24.9 million at ZAR 16.50, which is an improvement of almost 4% compared to the average FEC rate for the first 6 months. Operating expense discipline has been outstanding, and it's the fourth period that we are reporting, showing a decline in operating expenses. So expenses at ZAR 865 million for the 6 months ended 4.4% lower than the prior period despite the inclusion of Plush in the current year as the cost-saving initiatives we implemented in the latter part of the prior financial year started to materialize. As a result, trading profit of ZAR 433 million is 11.7% below the comparative reporting period. Nontrading expenses of ZAR 47 million includes retrenchment costs of ZAR 33 million, share-based expenses of ZAR 13 million and transaction cost of ZAR 1 million. Operating profit of ZAR 386 million ended 16.5% below the comparative periods. The net finance costs for the 6-month period is ZAR 21 million and includes the IFRS 16 lease finance costs of ZAR 14.6 million, with the comparative period figure being ZAR 14.3 million. Our equity accounted earnings from the joint ventures for the period, which arise from the National Renal Care JV with Netcare and our JV in India with Meiji of ZAR 59 million, 4.5% below the comparative period. The good performance of the Indian JV over the comparative period was dampened by the results of National Renal Care which were adversely impacted by COVID-19 expenses, understandably so if one takes into account that many of their staff served on the front line. Profit before tax for the 6 months is ZAR 424 million, down 17.4%. The effective tax rate adjusted for equity accounted earnings is 50.1% with nondeductible expenditure causing the increase over the statutory rate. Headline earnings for the period under review amounted to ZAR 312 million compared to ZAR 373 million in December 2019. This translates into headline earnings per share of ZAR 1.865, a decrease of 14.6%, better than the headline earnings decline due to the share repurchases by the group. The group now has 8.7 million shares in treasury. Then looking at the segments, which the details you can find on page 10 and 11 of the booklet. I will start with the consumer division. Revenue for consumer of just short of ZAR 600 million ended 42% ahead of the comparative period supported by the inclusion of ZAR 120 million of Plush sales. Excluding Plush sales, still ended an impressive 14% higher than the prior period, evidencing the consumer confidence in the brands in this portfolio, the strong performances from Panado, Compral, Bioplus and ProbiFlora, and significant demand for immune-boosting products due to COVID-19. The gross margin is below the comparative prior period, impacted by the weaker rand and the inclusion of Plush, which is at a lower margin. As a result, trading profit of ZAR 109 million ended 48% or ZAR 35 million ahead of the comparative period. And moving to the OTC business, with sales of ZAR 785 million or 16.5% below the prior year, with the start of the financial year significantly impacted by the absence of a flu season in South Africa. Volumes declined by 13%, evidenced by the weak demand for our cough and cold brands, such as Alcophyllex, Corenza and Dilinct. In addition, the repatriation of certain products, which were being distributed on behalf of Aspen in June 2020, further exacerbated the decline in sales compared to the comparative period. Gross margin ended lower than the prior period, adversely impacted by the weaker rand, lower factory recoveries at Clayville due to a decline in demand and a COVID-19 shutdown for a week in July during the peak of the first wave. As a result, trading profit of ZAR 109 million was disappointing, ending ZAR 89 million below the prior period. In looking at prescription, sales of just over ZAR 1.5 billion ended 5.6% ahead of the comparative period, aided by a price realization of 3.9% and a mix benefit of 2.5%, which more than compensated for the organic volume decline of 0.8%. The ARV portfolio value grew 40% to ZAR 310 million, benefiting from orders for the DLT combination on the state tender. This partly compensated for the decrease in demand attributable to the COVID-19 outbreak. As Andy mentioned, which resulted in lower levels of patients consulting doctors, lower traffic in pharmacies, the postponement of elective surgeries, which impacted quite a few of the categories or portfolios in that division. The gross margin ended lower than the prior period, impacted by the weaker currency once again, and an unfavorable sales mix with a higher proportion of ARV tender sales at low margins. With group cost control, trading profit of ZAR 142 million ended in line with the comparative period, a satisfactory performance in the current environment. Lastly, in looking at the hospital division, sales of ZAR 870 million or 5.4% above the prior period. The average price realization was 6.7%, with mix contributing 1.3%, partially offset by a decline of 2.6% in organic volumes. The renal segment benefited from the increased acute renal dialysis treatments, which compensated for the decline in demand for products used in the elective surgeries which was significantly reduced as a result of the COVID-19 pandemic. The gross margin ended in line with the prior period despite the weaker rand as they benefited from an advantageous sales mix in the private market and had excellent throughput in their factory. As a result, trading profit of ZAR 76 million ended 5.7% above the comparative period. In looking at the balance sheet, which is on Page 7 of the booklet, I'll just talk to some items that have made some movements. In looking at property, plant and equipment, depreciation charges amounted to ZAR 95 million compared to the ZAR 92 million in the comparative period and it includes depreciation of ZAR 21 million on the separately disclosed right-of-use assets, which is capitalized in terms of IFRS 16. In intangibles, which you all know by now, including the goodwill which we recognized on the acquisition of Genop in 2019 and Plush at the end of the previous financial year, we have recorded amortization in this past period of ZAR 4.7 million, which is in line with the prior period. Looking at current assets, maybe the most disappointing part of the results is the working capital. Our inventory of ZAR 1.96 billion increased due to an investment in active pharmaceutical ingredients related to the ARV tender, and higher safety inventory helped to address global supply constraints consequent to COVID-19. The days in inventory improved to 132 days compared to 137 days at the end of June. Trade accounts receivable of ZAR 1.7 billion are shown net of provisions, and that balance increased since June 2020 due to an increase in sales in the later part of the reporting period, that book is still very well-managed, and the days in receivables of 60 days, a reduction from the 66 days reported in June 2020. 18% of the total gross debtors book relates to government, with 77% of this customer's total outstanding amount due within 60 days or less. If we look at the bottom part of the balance sheet, the issued share capital and share premium reduced by ZAR 16 million following the share buyback by the group during September 2020. The group now has shareholders' funds of ZAR 4.7 billion. The [ ZAR 82 million ] movement in the nondistributable reserve since June 2020 relates to a decrease in the cash flow hedge accounting reserve of ZAR 44 million, a decrease in the FCTR of ZAR 52 million and an increase in the share-based payment reserve of ZAR 14 million. The early liabilities just short of ZAR 300 million relates to leases. I'll hand back to Andy to close the session.

Thanks, Dorette. So I guess if we look forward a little bit, with the uncertainties that the pandemic brings, we still think that the economy is going to remain constrained. The difficulty in looking forward at the moment is trying to understand what the cold and flu season will look like in South Africa in 2021 because, clearly, we're still going to have a lot of social distancing, mask-wearing, hygiene practices and the like, which, of course, we support. And with the lack of -- relative lack of travel, the likelihood, I think, of a flu season is low. On the margin side, we're still going to experience some difficulty. The single exit price increase of 3.68% relative to the exchange rate decrease is certainly far from optimal. And if we still get a decline for cold and flu products, we could experience some more strain at the Clayville factory in terms of output there. So we think it's sort of a relatively long road ahead for South Africa's economy to recover. So from our perspective, we'll continue to maintain a tight operating expenditure control like we've done over the last 24 months. We will prioritize the cash generation in the short term because a lot of that working capital should start unwinding now. And we'll preserve our balance sheet, but we will continue to seek acquisitions that can broaden our portfolio as we've done over the last couple of periods. So I thank you all for dialing in, and I'll hand back to Irene, in case there's any Q&A. Irene, are you with us?

[Operator Instructions] Our first question is from James Corkin of Steyn Capital Management.

Just 2 questions from me, please. You mentioned that the higher receivables were due to some sales late in the period. I was wondering if you could just maybe chat a little bit more to that and what drove that and what it's attributable to. And then the second question I had was just in the annual report last year, you mentioned that, obviously, category Schedule 0 medicines are not -- are exempt from SEP requirements and that this is being reviewed in December 2021. I was wondering if you could just give a little bit more detail around that and what your expectation there is, please?

Sure, James. No problem. I think your question on the accounts receivable is interesting. So unfortunately, we can only report to the market as we do twice a year. But if you look at the way that the 6 months rolled out, we had an extremely, extremely poor first quarter. So July, August, September were really, really slow relative to a year ago. October showed a little bit of improvement. And then for some reason, and it is inexplicable, November and December were very, very big months. So I looked in the numbers, our November and December sales were 40% higher than the May and June sales, which we would have reported on at the year-end. So you can see what sort of impact that would have had on the accounts receivable book. Then on the Schedule 0 exemption, this is a standard exemption we get that's reviewed every 3 years. We don't foresee any reason for them to remove the Schedule 0 SEP exemption. But we don't know what the position is until it's given effectively at the end of the year. So we've never not received that exemption, so I don't think it's a risk area for the business. And it's interesting, if you look at our consumer business, as Dorette mentioned, our price increase there in this period, our price realization was 8%. So it does show the benefit of having non-price-regulated products within the basket, whether they be health care or anything else.

Our next question is from Itumeleng Seanego of Benguela Global Fund Managers.

Just 2 questions from my side. I mean you still say that H2, the second, you still expect cost of sales to come under pressure margins due to the currency exchange rate movement. But I mean subsequent to December, we've sort of seen the rand appreciate. I mean, if one assumes that it stays at this levels for throughout the second period and the -- are we only going to see a benefit in 2021? Maybe just a color in terms of how that works in terms [ teaching ] on around that? And just in terms of the income statement, I mean, I see dividend income was about ZAR 82 million are related to, I mean, 31 December of ZAR 2.3 billion. So just in terms of why that dividend was lower? The dividend income amount.

Okay. Thanks, Itumeleng. I'll answer the margin pressure question and then Dorette will talk to the dividends, and I'm out of my depth from that one. You're right, the rand has improved for us. The real issue is that we take out forward exchange contracts at Adcock on all of our foreign-denominated orders. And that book tends to have around about a 3-month rollout period. So the numbers that Dorette gave you relative to the current FEC book that we carry, which I think in euro terms was about the same as the 6-month period; and in dollars, it was about 3.5% better, will still only wash out over the next 3 months. And then the other issue is, bearing in mind that we sit on inventory of roundabout -- at reporting period about 150 days, a lot of that inventory was purchased at the historical rates that we just mentioned in the presentation. So the improvement in the rand, we are likely only to see in the second half of this calendar.

Itumeleng, with regards to your dividend income question, the dividend income relates to the dividends we received in the Black Managers' share trust or from the Black Managers' share trust on behalf of employees. So -- and it's, in essence, a factor of how Adcock Ingram and Tiger Brands, if you recall with the historic Tiger Brand scheme, how they declare dividends, which then gets received by the Black Managers' Trust. And as you know, Adcock didn't declare a dividend in the previous cycle and Tiger Brands' dividend just fell out of that cycle. So that's a clear factor of that.

Our next question is from Grant Morris of ClucasGray.

Just a point of clarification, if you wouldn't mind. The ZAR 33 million retrenchment cost and the treatment of that in headline earnings, my comprehension is that headline earnings have not been adjusted for that cost. Is that correct?

Yes, you are correct.

Okay. That's helpful. And then just with regards to some of the comments around the inventory build, which you made, particularly around having to build some safety inventory. Are you seeing pressure on the supply chain system in terms of sourcing the right materials? Is that alleviating? Can you maybe just give us some detail around sourcing of APIs?

Yes. Grant, I just -- I also think I should just comment a little bit on that inventory build. You'll recall that when COVID hit in South Africa, we had that massive panic buying spree, particularly in March 2020, and then it also fell into about half of April. So I remember that in March, Adcock Ingram had the biggest month that it had ever had in its history. It was that sort of thing. So there was a large amount of replenishment that went on sort of from mid-April into May and June because of the products that had moved. And a lot of them, if you recall, with cold and flu and analgesic products. So mainly not in the prescription segment. So what then happened, of course, is all of these products were in the market. So generally, wholesalers and pharmacies were full and we had very little offtake from customers of those products because there was no winter season. So we kind of were settled with those products for, let's call it, this 6-month period. So that's the primary reason that we experienced the inventory build. On global supply chain constraints, I can say that the only product -- the only active that we're currently seeing some difficulty with in terms of our portfolio in material terms is paracetamol. And what has happened is there's a -- one of the ingredients that goes into making raw paracetamol, the biggest supplier of that product in China has been closed down by the government there for some sort of pollution problem. And they will only be up and running again in August. But we've got sufficient safety stock here, both of raws and in India of raws and of our finished goods to sort of cover us through until at least June or July. So we -- unless that problem extends beyond August, we should be okay in terms of global supply issues.

That's great. And maybe one last question, if you don't mind. The Trends that you saw in November and December, were those across the board, in other words, across divisions? Or was it quite specific to certain areas of the business? And I'm referring to the improvement that you alluded to.

Yes. It's interesting, and that's why I said it was inexplicable because it happened across the business. So in November and December, we saw demand for Corenza C and some of our cough products that we would have expected, of course, to see in June, July and August, which never happened. So there may be an element here there wholesalers or big customers maybe were at the point where they just weren't carrying sufficient inventory holdings. And in fact, we did an audit of all our big customers inventory holdings in January. And in general, we found that there was probably a capacity for about 2 weeks' worth of stock in the market, where the customers decide to fill that 2 weeks or not is up to them. But it was pretty much across the board. And it came literally as that second wave was starting and then into its peak. So it might also have been people just being nervous, trying to make sure that they had stock on their shelves in case some sort of logistical problems or whatever might have happened in the market because of the second wave.

Next question is from Irina Schulenburg of Foord Asset Management.

If you can just give us an indication -- you mentioned the Roche contract on the renal dialysis, can you give us an indication of the duration of the contract? What potential contribution could it have to the business? And whether you are looking at kind of additional revenues from similar sources, be it Roche or another multinational. And then I apologize if I have pronounced incorrectly, but the Sanulac nutritions range, how big could it be for the business? Is it a second new growth sector that you're looking at? And then just lastly on acquisitions. I mean, clearly, you have had a tough 6-month period, so have some of your competitors in the unlisted space. Have you been approached perhaps by some of the smaller guys kind of looking to consolidate or looking to partner up in any way?