Convatec Group PLC (CTEC) Earnings Call Transcript & Summary

Good day, and welcome to the ConvaTec Conference Call. At this time, I'd like to turn the conference over to Jonny Mason, who's our CFO. Jonny, please go ahead.

Thanks very much, and good morning, everybody. Welcome, as Scott said to our trading update for the 10 months year-to-date. I'm going to make a few opening remarks, and then we'll be happy to take any questions that you may have. The strong performance seen in the first half of this year continued, and we're very pleased with the progress on executing our FISBE strategy. This performance was further confirmation that ConvaTec has pivoted over recent years to a higher level of organic sales growth. For this year, we're on track to deliver the higher growth, which we guided to -- at the half year. And today, we're narrowing that range towards the upper end, reflecting the strong delivery to date, and the shorter period of the year still to go. We're also on track to deliver expanded operating margin this year of at least 20.5% on a constant currency and then to continue to increase the margin to the mid-20s by 2026 or 2027. And this increase in operating margin and the sales growth will lead to double-digit compound growth in EPS and free cash flow going forward from 2024. So looking at the 10 months to the end of October, organic revenue growth was 6.7%, and on a reported basis, it was lower at 2.5%, principally reflecting the exit of the low gross low-margin Hospital Care business last year. In Advanced Wound Care, organic growth was high single digits consistent with the first 6 months and the main 3 sources of growth there were in Global Emerging Markets where we grew in the mid-teens and continued to gain share. in China, we did see a small impact from the nationwide antibribery and corruption campaign because of the reduced access to health care professionals of the last few months, but we think this is temporary and will normalize next year. And in fact, companies of strong governance practices may benefit from this over time. But the impact on the overall group was not material. Secondly, in the antimicrobial segment, where we are a world leader. Our AQUACEL Ag+ Extra products continue to grow well globally. And then thirdly, in biologics, our InnovaMatrix product the unique placenta [indiscernible] extracellular matrix, continued its strong growth and was significantly additive to the category as it was in the first half. We continue to expand our InnovaMatrix sales force, targeting physicians' offices. And InnovaMatrix was also successfully added to some hospital GPO contracts as we began to sell into the hospital setting as well, leveraging the synergies of our strong U.S. sales and distribution network. Moving on to Ostomy Care, we delivered mid-single-digit growth as anticipated. Growth in Convatec's Ostomy products, which is what drives the margin expansion was strong and in line with the first half. The reduction in growth in this categories from Flexi-Seal, which is our leading fecal management and which we reported at the half year, that improved to a reduction of mid-single digits as we pass the high post-COVID comparatives, and this drag is going to phase out by the end of the year. Notably in FMS, we've won the HPG contract, the HealthTrust Performance Group GPO contract, which will support FMS sales in the future years. And growth of Ostomy continued to be very strong in Global Emerging Markets where there too, we continued to gain share. In Continence Care, growth was mid- to high single-digits. And remember that this is predominantly a U.S. business, the growth was delivered with continued very good customer satisfaction and loyalty scores and with strong price growth. There was slowing moderation in growth since the first half, which was phasing and was as expected and was in line with the guidance for the year. In Infusion Care, growth high single digit and was slightly stronger than in the first half. There was good growth across the portfolio from our established products with our biggest customers, from our existing portfolio of Infusion sets but deployed with new insulin pumps and new customers in diabetes. For new and innovative Infusion sets such as the extended wear infusion set, which is the only product in the market, which [indiscernible] and that's twice as long as the current standard of care. And finally, from applications outside of diabetes, which are lower in double digits. And last on the topic of Infusion Care, I thought I'd address the GLP-1 question of which there has seen obviously a lot of coverage. We don't expect GLP-1s to have a material impact on our Infusion Care business and let me explain why. When it comes to incident -- intensive-insulin therapy, GLP-1s are effective medicines for patients who produce some insulin. For GLP-1 wants to work with the pancreas, the boy needs to capable of producing sufficient insulin. Our products are used in the treatment of insulin-intensive patients and this is a 10% of all people with diabetes who do not produce sufficient insulin. 33 million people who need to inject into it to manage the blood sugar in their body and GLP-1s don't in these circumstances. All these insulin-intensive patients, 95% of them still use multiple daily injections to manage their condition. And only 5% currently use pump therapy despite its [indiscernible]. So growth in our business is predicated on the increase in the penetration of insulin pump therapy, displacing multiple daily injections over time. It's about supporting more patients with ultimate insulin delivery systems, and specifically, our presence, we serve just over 1 million patients, and there are more than 30 million patients who are insulin intensive and do not currently use pump therapy. So we do have confidence in our ability to grow a high single digits for the following reasons: First of all, the opportunity to penetrate the 95% of multiple daily injection users, as I've just described. And we are working with partners on the wide variety of developments in insulin pump therapy, which will provide better choices for patients and encouraging conversion. And the attractive opportunity for Infusion that's outside of diabetes, where we see a couple of points of growth from new therapies, which use subcutaneous infusion including Parkinson's, immunoglobulin deficiency and pain management. That covers the performance in categories. Now a few words on our strategic progress, and you can read the bullets in the release. So I'll just make a couple of observations. New product launches, especially in Wound Care and Infusion Care are progressing well. That's includes the InnovaMatrix, ConvaFoam, extended wear infusion sets for Medtronic 780G, sets for Tandem's Mobi and AbbVie's new Parkinson’s therapy, in particular. In Ostomy Care, the development of our new one-piece convex pouching system Esteem Body is progressing well and on track for launch early next year. And this is very exciting. This is competent first significant new product launch in an Ostomy in near a decade. In Continence Care, we began launching our new GentleCath Air for women in France. And this is a compact capital offering using our proprietary FeelClean technology, which is designed for urethral protection and to reduce the risk of UTIs. This will help to fill our commercial presence in the European Continence market. And we also completed 2 acquisitions for $28 million together, which will further strengthen our Home Services Group in the U.S. In operations, as announced earlier this year, we are closing our EuroTec facility in the Netherlands and by creating manufacturing to our larger and more efficient sites in Slovakia, which is expected to be completed by year-end. And we're also restructuring some of our management activities in Switzerland. And this is all part of our network optimization program to improve gross margin through operating efficiencies. And finally, we solve extended our global business service to improve G&A efficiency by having a number location in Asia to provide around the clock services support to our organization. So let me just summarize. We're very pleased with the progress this year. ConvaTec has pivoted to a higher level of organic sales growth over recent year. We're on track to deliver our increased sales growth guidance for this year, narrowing the range to the upper end as the year progresses. And we're also on track to deliver expanded operating margin this year and mid-20s in 2026 or '27. And the combination of our sales growth and EBIT margin expansion will lead to double-digit compound growth in EPS and free cash flow from 2024 onwards. That's my summery, and we will now be happy to take any questions that you may have. Thank you very much.

[Operator Instructions] We'll take now our first question from Jack Reynolds-Clark from RBC Capital Markets.

I have two to start with, please. So just on the tightened range. Just wondering kind of if you could talk us through what's giving you confidence in that tightened range and the factors that kind of might impact where you come in that range. Obviously, the growth in the first 10 months was kind of slightly below the bottom of that range. So I guess, what needed to get you to the top of that range? And then also on Wound Care, I think the guidance from H1 implies -- I mean acceleration there in the final 2 months of the year, just kind of wondering what visibility you have on achieving that?

Okay. Well, those 2 questions are related. And I guess, we do expect acceleration in sales growth towards the end of this year. Hence, the bottom of our range is slightly above year-to-date. And there are 3 main factors in that. One is FMS, as I mentioned in my summery, that was going through some tough COVID related comparatives at the beginning of the year, which will have phased through by the end of the year, coupled with winning the new GPO contract means that FMS sales growth will be stronger. In Wound Care, we've also got the building effect of InnovaMatrix where it was organic only for 3 months in the first half and it will be organic for the full second half year. So that will also help to grow the Wound Care sales. And that will -- because I think with your second question, which is why will Wound Care accelerate towards the end of the year, it's mostly driven by InnovaMatrix. And then there are some comparatives at the end of this last year, which were a bit weaker than we're expecting them to be this year to just a normal phasing. But when you combine all of those 3 effects. That's why we are confident that sales growth for the remainder of the year will be stronger than it was for the 10 months to date. Albeit, we're very pleased with the 10 months to date, 6.7%, we think that's a pretty good growth performance.

Okay. Great. That's actually clear. And if I could just squeeze in one more. You mentioned the contract wins in InnovaMatrix in hospital. I was wondering if you could give us some more details around that and how you see that developing as a driver of the segment?

It's very early days. I think we've said previously that the vast majority of our sales in InnovaMatrix are in physician offices and that's where we are driving the majority of the growth this year and going forward. But we are starting to benefit from the synergies with our existing Wound Care sales force, which is very strong and well distributed, and we've got ourselves listed on some of these GPO contracts. So it's a small start but it's a promising start, and we'll look forward to developing that business through hospitals steadily as we go forward.

We'll take now our next question from Hassan Al-Wakeel from Barclays.

I have three, please. Firstly, Jonny, could you talk about the headwinds you're facing in Wound in China? How much is China down in the Wound Care business, I guess, over the last few months? And when do you expect this to receive? And is double-digit growth still realistic for this year and what about full year '24? Secondly, Karim talked about improving inventory in the second half when we caught up in September. How is that progressing? And how should we think about working capital and free cash flow improving this year given that it has lagged margins? And then thirdly, as you look into FY '24, could you talk about any key growth considerations, whether you expect any regulatory reform? And ultimately, if consensus expectations of mid-single-digit growth is reasonable for your mind?

Sure. Okay. So China first, headwinds in China. Yes, we have seen Care slow a bit in China. It is still double-digit growth. I think it's important to say but lower than it was before. We do think that, that will pass through and will normalize next year. But it has taken a little bit of the Wound Care take growth this year. And therefore, will it still be double-digit growth this year? It will be clos. Without the China effect, we have been confident on reaching double digit. It will be close to double digit, I think it's fair to say, and there's still a bit of trading to be done. So let's see. I think you might have asked about 2024 as well. And just important to say, when we referenced Wound Care and double digit, that was specifically for 2023. What we have said is that Wound Care is a high single-digit business growing going forward. And that's what we'd expect it to be in 2024 as well. I think that was the first question. So then inventory. Obviously, this is a trading update. We're not updating on a margin and cash flow and the full works until our full year results in March but I think it's fair to say that inventory is improving in the second half. We referred to various factors at the half year, which were temporary, such as the closure of one of the factories in the Netherlands and building for a specific contract. Those factors have passed through. It will still be a year of significant inventory build. But we will, this year, have reached what we think is the right level of strategic resilience in our inventory holding. So there will be improvement in the second half but it will certainly be a build year-on-year and then we'll be normalizing going forward thereafter. Cash flow, in general, we're on track for the leverage that we thought we would be when we disclosed that at the half year, except that we've made 2 small acquisitions in addition. So adding $28 million to the debt leaves us at this year-end about 2.3x in terms of leverage. And then we're not guiding on 2024 today and you wouldn't -- I don't think you'd expect to see. That will come next time we speak. But we set out at the half year that we're expecting Ostomy Care and Continence Care to be mid-single-digit growth. And Infusion Care and Wound care are going to be high single-digit growth. And nothing has occurred to change our view on that. So if that is what you should be looking forward to in 2024 as well as continued progression on our operating margin expansion towards mid-20s by 2026 or 2027.

That's really helpful. Just to follow up, anything on any regulatory reform that we should expect? And what's the base case on China resolving in terms of timing, please?

We -- the regulatory reform not particularly. And in terms of China, look, we think it will start to normalize and we'd expect to be doing double-digit growth there in Wound Care next year. Important to say in Ostomy Care, the growth is still mid-teens. That's less effective because it's more of a direct-to-consumer sales channel. So we're expecting good growth in China next year. I think that's as much as we want to say at this stage.

We take now our next question from Anchal Verma from JPMorgan.

I have two questions, please. Firstly, on the EBIT margin guidance. That's been reiterated despite the narrowing up of the revenue guidance. Are you seeing any specific headwinds at the EBIT level that's refrains you from raising the EBIT margin guidance? Or are you just being conservative? And then secondly, and this is building on Hassan's question. For next year -- can you just provide us an update of the product pipeline looking into next and what are the key launches that would be growth catalyst for next year?

Sure. So first of all, on EBIT margin, no new headwinds that we haven't referred to before. Inflation this year is turning out in the range that we expected it to, which was 5% to 7% for this year, albeit, towards the top of that range. And in terms of pricing, pricing is firm this year as we reported. Half year -- second half consistent, no real change there. And just reconfirming that we're on track with everything we set for March. So I think that's how you should interpret the update today. Yes. And then in terms of product pipeline, the most exciting one that we're looking forward to next year, you could say, is Esteem Body, which is which is our new one-piece convex Ostomy products. And that will be out early in the new year. And then obviously, GC for women is launching now in France. And that then will launch in other markets next year. So very, very much looking forward to that. AbbVie has launched in Japan already. So the Parkinson's treatment in our Infusion Care business and that too will roll out next year. And then obviously, we're building and continuing to launch Conva and ConvaFoam has been progressing well in the U.S. in its early stages of evaluation. We're looking forward to sales of ConvaFoam growing and then to be -- to be launching that in new markets outside of the U.S. as well. So across all of the categories, Wound Care, Ostomy Care, Continence Care and Infusion Care, we've got new product launches adding to our pipeline and building our sales growth in the new year.

That's very clear. And if I could just have a quick follow-up on the inflation comments around for this year. Is it fair to assume a similar run rate going to FY '24? I know it's still early days, but just any early indication you guys have seen if you've gotten around budgeting for next year?

No, we're expecting inflation to be less next year, 5% to 7% this year. Our guide for next year is in the kind of 3% to 5% range. So still higher than it was pre-COVID terms, but lower than this year. And why is that? We can see clearly, prices of some of our materials, some of the cost of goods have been starting to come down, resins, materials, freight, utilities, the price rises have been moderating. So we still think prices will be going up but that has slowed rate than they have been this year.

We'll take now our next question from Kavya Deshpande from UBS.

It's Kavya from UBS. I've two, please. So first, it's early days but in the update, you talk about double-digit EPS growth from 2024. So just to clarify, should we assume double-digit growth in 2024? And then secondly, just going back to your launch pipeline, very interesting launches next year. The Tandem Mobi is obviously the first fully wearable diabetes pump for which you'll be making Infusion set. Just curious, should we be as excited by this as we were by the 7-day extend wear pump, which has obviously gone very well?

So the first question is, yes. That's what we mean by that. So double digit just double-digit growth in EPS and cash flow measures will be in 2024 and thereafter. Tandem Mobi, you asked. Look, it's an exciting development. And should you be excited about it, yes and so are we, but it's only one. Extended where is particularly exciting for us of course because it's something unique to ConvaTec, which is performing really well. It has very good feedback from customers, from patients in terms of the utility that they're getting out of that improved product. And so currently, yes, it's with -- it's supporting [indiscernible] 780G but that extended wear technology is a platform that we are applying on being able to use the other applications going forward as well. We should be excited about the Tandem Mobi and the AbbVie products too.

We'll take now our next question from Lisa Clive from Bernstein.

Just a follow-up on China. Can you remind us of your actual proportion of sales in Wound and Ostomy coming from China, just given how much this market is fluctuated for various parts of medtech, it's just helpful to get a better view on your specific exposure. And then could you comment on the U.S. Ostomy market, have you seen any impact from Coloplast gaining share there? Or is that mainly affecting [indiscernible] they have 50% of the market? Clearly, your performance in Ostomy globally has been much better and actually sort of in line above market the last 2 quarters, it looks like. So just wondering how that differs perhaps across U.S. and Europe.

Lisa, it's a bit hard to hear you. I think the question was -- the first question was Ostomy and Wound in China, what proportion is that. Look, China for us is still a relatively small presence. We -- it's in low single digits in terms of our total sales but growing very nicely. And we're roughly equally represented by Ostomy and Wound in China. So I suppose that's why when we see impacts, it's less of a material impact on the group than others [ might have ]. But very important for us in the future. We're making great progress, and we're very excited about the prospects in that market. In terms of Ostomy in the U.S. Look, we've been improving our performance in Ostomy in the U.S. And we have stabilized what was previously a position of declining market share. And we've stabilized new patient starts, and that has been delivered by improved commercial execution fundamentally, focusing on applying our commercial activities properly across the continuum of care and targeting the right hospitals, the right outpatient clinics and deploying our Home Services fleet to start growing Ostomy sales direct to the customer. But we're only claiming stabilization at this stage. And all of that is before launching new products. I think, as I mentioned earlier on, ConvaTec hasn't launched new product in Ostomy for nearly a decade. And that's why we're really particularly excited about the coming new Esteem Body product, which will give us the tools to start tackling growth and market share more actively in certain markets, including the U.S.

We'll take now our next question from Sam England from Berenberg.

And the first one, you called out positive pricing in the U.S. [indiscernible]. I was just wondering how pricing development is looking across the other segments, given the work you're doing with the pricing center of excellence and how to think about pricing as we head into 2024? And then secondly, in Wound, just wondering how you're thinking about the reimbursement landscape of biologic given some of the changes in the U.S. and the commentary from some of the larger biologics players in doing recent month?

Yes. So I caught second questions. I didn't catch the first one. Did you get? Pricing of what? Okay. So I think -- I'm sorry that I couldn't hear the first question, but I think it was pricing across the group and in Continence, was it? Sorry, go ahead. Please clarify.

No, you called out positive pricing in Continence care. So I just wanted to hear any comments on pricing in the other segments as well.

Yes, got it. Okay. Right. So with pricing in general, we have been pointing to a small positive impact from pricing across our categories in general. This is a reversal of historic trends where pricing had a negative impact on margin. The impact of improving our pricing practices with our center of excellence has meant over the past couple of years a 50 to 100 basis points positive price move generally across the business. And that's what you should continue to expect this year. At the half year, it was a bit more than that. And the reason I called out Continence was because in continence this year, we have benefited from an increase in the reimbursement rates, which has taken our average price across the group, up higher than normal but that is a onetime effect, and we wouldn't expect that to continue. And going forward, back to that 50 to 100 basis points price contribution is how we would suggest plan for it. And then in terms of Wound Care reimbursement, look, there's been a lot of coverage of this with an LCD issued by 3 of [ max ] and then withdrawn. We're watching it carefully. We're not expecting much change in 2024. We do think at some point in the future, there will probably be a reimbursement correction for some of the biologics pricing levels. But that is a changing situation with [indiscernible] it will be and it's not likely to be in 2024 in our view, might be a bit later than that. I hope, I've got you questions at the end but...

Yes, that was great.

Our next question from Robert Davies from Morgan Stanley.

I had a couple. One was just if you could provide a little bit more color on your comments around China and some of the hospital access issues, just to sort of clarify some of the time lines for that to improve? And the second one was on your medium-term outlook or targets, I guess, the margins for 2026, 2027 getting to mid-20s. Could you just kind of remind us the kind of key building blocks to get there because, I guess, sequentially, over the last sort of 2, 3 years, that's a bigger jump up than you've already posted. So I just wondered where did your confidence come to seemingly, I guess, in theory 500 basis points in 3 years' time of a margin step-up.

Yes, sure thing. Look, China I'm not sure how much there is to say really, but we spend time, our commercial teams talking to the health care professionals, sharing education and training with them, inviting them to seminars to educate them about our products and our services and what we can offer for the benefit of customers. What we've observed is that the impact of the nationwide anticorruption campaign is that they've been less interested in participating. I guess a bit of a caution on their part. And so we see already that it looks like that might be past this peak, and we expect that to normalize through next year. It has very much an impact on Wound Care. I think I mentioned this already, our Ostomy Care business has more of a direct-to-consumer channel. And therefore, that's less impacted. And then on a margin, mid-20s, yes, we remain confident on delivering that margin target because it's by operating levers, which are in our control. The major pieces of it, and this is consistent with what we've set out previously. First of all, it's cost efficiency. And we call that to simplification and productivity in 3 different areas: G&A, we could make good strides in G&A, improving G&A over the last few years, and we've set out a target of 7 points of sales, and then we'll see. With G&A, we're not doing anything that others haven't already done before. We're establishing a global business services operation. We're standardizing processes. We're centralizing activities. We're getting economies of scale, and we're using experts to do things excellently with the best digital tools. So it's a path driven by others and that's why we're confident we can get there. The second piece of simplification and productivity is in operations. We have 5 big factories altogether. And of those factories, openly on is currently fully automated. The second one is on the way, and then others will follow. Again, this is not doing things that others haven't already done but by automating a lot of work on continuous improvement that our operations teams are pursuing, we can drive efficiency in operations that improved its margin as a result. And I referred earlier in the call to our network optimization strategy. We've closed one of the small factories. The year before, we closed another one. Just bringing the operations up to a fully automated and efficient scale is the second of our big building blocks. And then the third one, simplification of efficiency is in the commercial area, sales and marketing expenditure, which is our biggest single expenditure and only recently have we finished rolling out a basic CRM system across the globe. Previously, we didn't have that. So standardizing the approach to commercial expenditure, rigorous reporting and analysis, ensuring productive use of time and of that significant expenditure will also enable our commercial expenditure to leverage the sales over time. And then beyond -- just one last -- let me just make a couple more points. Beyond simplification of productivity, we've got mix. We are improving the mix of our business. First of all, there was the corporate focus, getting out of hospital care and into biologics makes a big difference, exiting a low margin, low growth business into a high-margin, high-growth business. Then across categories, our higher-margin businesses being Infusion Care and Wound Care, are growing faster than the others. And then within categories, we are continuously improving the mix of profitability of the SKUs we sell. Notably, in Ostomy, we've been rationalizing the portfolio of SKUs. In Continence, we've been improving the mix ConvaTec manufactured SKUs. so all of those mix factors are important levers in delivering the operating margin. Importantly, we are reliant on price increases. We're not banking on price increases to deliver this margin increase. We are expecting price to be roughly neutral, marginally positive as a factor. And then now that we've got the top line moving, of course, the operating leverage helps to absorb the ongoing inflation in the cost lines. So that's the plan.

We'll now take over the next question from Kane Slutzkin from Numis.

I've actually got [indiscernible] back end, everything has actually been addressed. But just one -- just quick one, Jonny. Just can you remind me, InnovaMatrix, just how much is that adding to growth for the full year? Or could you just remind me for the first half? Or was it 2% exit growth?

Next year growth. Yes, what we said for metrics InnovaMatrix in first half of this, that it's added 2 points of organic growth to Wound Care category.

Okay. And then you obviously had better [indiscernible] for 3 month?

So, [indiscernible] Wound Care was 7% organic growth. And the -- effectively, the preexisting portfolio was above 6%. So InnovaMatrix was adding over 2. That's the same sort of pattern you should expect for the rest of the year.

We take now our next question from Sebastien Jantet from Liberum.

Jonny, can you hear me right?

Yes, I can.

Okay. So just a quick couple of questions around the extended wear sets. So I'm just wondering, I can't remember whether the extended wear set is exclusive to Medtronic or whether you also sell it to your other partners? And secondly, just picking up on your point about it being a differentiator. I'm just wondering, do you have any IP protection around that? Are you aware of any other kind of companies working on extended wear sets?

Yes, the moment extended wear is sold just with the Medtronic sets, the 780G product, and it's proving, as we've said, very popular with patients and customers. We do, of course, have IP around that technology. I think I referred to in the call, the concept of extended wear is something that we -- that is very interesting to our customers and partners, and we're in conversations. Reflective of the conversations generally around this fast-changing suite of technology products serving the insulin-intensive customers as we talk to our partners about developing the new products, they're very interested in extended wear within the concept of extended wear. So let's see but it shouldn't be a surprise if that feature of extended wear becomes more widely available in over future years.

We have no questions. Sorry.

No, I was to say that things in, which is I think it looks like we have used all of our questions. So I think it just remains to say thanks very much for your time and your attention. Our idea today was to say we're very much on track to deliver the targets we set out at the half year in this full year, which is stronger organic sales growth and an expanding operating margin, leading from next year to the double-digit growth in EPS and cash flow. Very much on track is our message today. Thanks very much for your time, and we look forward to seeing you after the year end.

Thank you very much for joining today's call. You may now disconnect. Thank you.