Fresenius SE & Co. KGaA (FRE) Earnings Call Transcript & Summary

Good afternoon, good morning, ladies and gentlemen, and thank you for joining us for another session of our 41st Goldman Sachs Global Healthcare Conference webcast. My name is Veronika Dubajova, and I'm the medtech analyst at Goldman Sachs in London. And it is with great pleasure that I am joined today by the management team of Fresenius SE, Stephan Sturm, CEO; and Markus Georgi, Head of IR. Thank you guys for being here and greetings to Bad Homburg. We are going to conduct the session entirely as Q&A. [Operator Instructions] So Stephan and Markus, thank you for being here.

I want to start with the topic du jour, which is Helios and COVID. And this has obviously been a big discussion point for everyone. But can you maybe give us an update on where you are in terms of volume and utilization levels, both in Spain and in Germany? And how has the progression been as we moved from March through April into May?

First of all, thank you for having us. And to all investors out there, good morning, good afternoon. Thank you for your interest. We have clearly seen a pickup in terms of patient numbers and utilization from, however, low troughs. The development has been cautious but steady. I would expect that positive development in terms of elective procedures to continue. For the time being, we are still capacity constrained given distancing regulations imposed on us. But with that constrained capacity, we are welcoming a growing number of patients. I do believe that, that bodes well for the further development.

And if you kind of were to put an index on it, Stephan, to the extent that you're willing to, I mean, are we talking about 50% of the way back towards normal, 70%, 30%? Where are we on that sliding scale? And maybe differences that you see Germany versus Spain?

I'm not a quantitative person, Veronika, you know that. And -- but I would say we are clearly off of the trough. We are well on our way back to normalization. However, given that we have spent so much time neglecting elective surgeries, I am asking myself what the new normal is. And so we are pretty far away from a level that would indicate a catch-up, but we are not that far away from a normal relative to before. However, what we do need to bear in mind is that bed capacity that we were in a position to open up is constrained. Having said that, I want to remind you and our investors that in the recent past, we have pretty consistently looked at a capacity utilization over the course of a year, that was about in the mid-70s. So -- and that was a blended mix of some particular peaks, say, in a February, March time frame up to Easter and also, say, in an October, November time frame, but pretty pronounced troughs in vacation time. My expectation would be that those peaks and troughs are going to be less pronounced going forward, that we're going to see a more even capacity utilization. And that, that is going to be a reflection of waiting lists, queues that I wouldn't be surprised to see. And that, therefore, we, at least on an interim basis, also can get by with constrained capacity without seeing the population suffer.

That's helpful. And then you've kind of alluded, we're not fully back, but there is still a lot more to go forward to catch up on procedures. What's about the patient ?

?

Yes.

That is very true. And it is, on the one hand, a reflection of constrained capacity. It is, on the other hand, still in our observation, some caution that is being applied by elective surgery patients. There is still an elevated perception of risk when it comes to getting near a hospital. And frankly, that, to a large degree, is in our camp. We ourselves are absolutely certain that our hospitals are a safe place. I think we need to improve our efforts, and we are in the process of doing that to also communicate that more effectively.

Okay. Let's talk about funding. I think there was a letter from the hospital association in Germany last week, maybe 2 weeks ago, suggesting that the funding that the government has put forward for COVID-19 for hospitals is not sufficient. Do you share this view? One. And I guess, what are your expectations? Does that letter lead to some changes either in the duration of the compensation or the magnitude of it?

Yes, I would be a bad businessman if I said now that the current funding scheme was excessive. Of course, it's not. But as we said earlier, at the time when the original package was communicated by the government, we get by and for the avoidance of doubt, we get by fairly profitably. But we were talking about a negative but manageable impact. And again, for the avoidance of doubt, the impact is not relative to a 0 baseline. The manageable negative effect is relative to our original pre-COVID expectations. And so yes, I can see that other hospitals that are less efficient than ours have trouble getting to breakeven on the basis of these reimbursement rates. We stand by our original statement. However, in the meantime, we have seen an amendment of this original schedule. And that is meant to reflect complaints, in particular, from the larger and most complex hospitals. So in particular, the university clinics. And there, where the most complex patients were -- or cases were treated, they, as a matter of fact, found it difficult to get by with EUR 560. But -- so the solution for this is now a much more differentiated approach where small, unsophisticated hospitals get EUR 360, and then in EUR 100 steps up to the top bracket of EUR 760. We are, by and large, with our hospitals in the very same EUR 560 bracket. We've seen a few downgrades, a few upgrades. We are still working on giving you a bit more precise an answer as to what the net-net effect of that is. But for the time being, I want to express some cautious optimism that this amended rule is not going to make -- put us -- it's not going to put us in a worse situation than the original.

And what about Spain? Obviously, [ bear the funding ] has been a lot less clear. Do you have an update on where you are both in terms of the funding for treating patients with COVID-19 and to the kind of bed reservation fee that you've mentioned in the past?

Not a lot of specifics that I can provide as an update. Number one, we have seen an okay -- take that as an okay with a typical Fresenius caution, an okay reimbursement level for COVID patients in Catalonia. The formal adaptation -- I'm sorry, adoption of this reimbursement level by the other regions is still outstanding. But it is our firm belief that the other regions are also going to follow the Catalonian precedent. More importantly, that reservation fee there, there is a constructive dialogue, which, however, in my mind, has not reached the stage of a negotiation yet. The latest, you may recall that on our May 6 Q1 earnings call, I was referring to a EUR 10 billion package for the Spanish health care system. So in the meantime, that number has slightly shrunk to EUR 9 billion. On the other hand, it is our observation that those EUR 9 billion are substantially more tangible than the original EUR 10 billion, in particular, because there is now a bit more certainty about the funding of Spain by Brussels. On that basis, we are in discussions, in a good dialogue, as to how the funding that is being allocated to the individual regions. And that mechanism in the meantime is also meaningfully clearer, how the regional funds are then going to be allocated to the individual participants of the health care infrastructure. There, the distribution keys are still under discussion. Seems to me that number of COVID patients do play a role, which is a bit of a surprise to me. But as what is more intuitive, from my perspective, namely, just like in Germany, installed hospital infrastructure as the key distribution or allocation parameter is also something that is being discussed. Frankly, I picked up that you mentioned a number for us. I want to leave the speculation to you, Veronika, because I'm asking for your understanding. Any number that I would mention would immediately be held against my Spanish colleagues, and I don't want to put them in a difficult situation.

Of course. But maybe help us think through the sort of dynamic of what the business looks like without this funding versus with the funding. So I guess, one of the worst-case scenario, I mean you couldn't get reimbursed, what would the margins in Spain look like for Q2 and then for the year?

The analogy that I was using that, in my mind, is still valid is that of a typical third quarter. Where in a normal Q3, we are, in particular, looking at an August where there is hardly any elective surgery, which has to do with patients spending their time on the beach, but just as important also our doctors being away. And therefore -- and that is in the middle of a so-so July and a slowly recovering September. Now you will recall that a typical Q3, whilst profitable, is still well below the normal margin levels that Quironsalud performs at. Now Q2 this year could end up like a normal Q3 and maybe even a bit worse because April and May, given the government instigated state of alarm, has seen us hardly perform any elective surgery. And now in June, we're looking at a recovery, which hopefully can resemble something like a September. So before you ask the question, I would say there is a good chance that we can end this Q2 profitably, marginally profitably, but at the same time, it is too early to rule out that Q2 EBIT in Spain can also be negative. Having said that, with the momentum that we're seeing, it may well be that we see a bit of a reversal. And that your typical Q3 looks much more like Q2 and vice versa. Because remember, most of our hospital doctors in Spain are self-employed and use our infrastructure. And therefore, they are looking at a pretty large hole in their personal P&L in Q2. Probably don't feel like going to the beach in Q3, but rather making up to cover some fixed cost. And therefore, if in absence of a second wave and with a bit more -- a bit higher comfort level among our patients, I would hope, at least, that we're not going to see a typical Q3 this year.

And what about looking beyond the very near term? How do you think about kind of your cost growth capacity and your operating costs? Are there a lasting impact do you see from COVID beyond this year when you think about the sort of 2- to 5-year outlook for that business?

I think it was -- nobody is going to net-net benefit from this. And this is all about to which degree are the negative effects being offset. And I don't think that there is anyone out there where we get fully back to a fully neutral position. So everybody is going to be slightly -- at least slightly weaker. And therefore, I do believe that, that is just the circumstance that is going to trigger at least a bit more consolidation in the industry and a bit more taking out of excess capacity that we still have in the industry as a whole. I'm sorry for the avoidance of doubt, I'm talking about Germany now. And when it comes -- we're seeing the first inklings of that already. And the situation is going to become, I'd say, more pronounced once the municipalities are getting the full and very ugly picture about foregone trade tax income, which typically they have used to subsidize their loss-making public hospitals. In Spain, obviously, everything is going to come down to what that government support package is going to look like. In my mind, it is only hypothetical that there is not going to be some sort of government support. It is the magnitude of it. We're not going to see it in time for our Q2 results. But I'm firmly working on the assumption that we're going to see something in the second half, probably in Q3, but then being applied retroactively. But also here, I would firmly work on the assumption that nobody is going to get out of this without at least a small negative impact. And that, therefore, I would expect the weaker market participants to try and get some support potentially from us.

Okay. And I think you announced that acquisition in Germany just last week. Is that the first sign of this pressure point that you're alluding to or not yet? And I guess, when you do think about the opportunities, how meaningful could they be further out based on what you're seeing and hearing?

That hospital that we announced the acquisition of a few days back, that is unrelated to COVID because the seller, the Order of Malta, they announced their intention to divest of all of their hospitals, 8 in total, already last fall. That was one of the situations that let me alert our investors as part of the Q3 call that we started to see a few more consolidation opportunities. And their original plan was to divest the entire chain, 8 hospitals, to 1 single buyer. We, on the other hand, had told them right from the beginning that there was only 1 single hospital that we were interested in, that was the one in Bonn. They started the process, had no luck, returned us, and we were able to pick the hospital that we wanted. That is exactly what I meant when I was saying we're going to be even more disciplined than before. This is a hospital that is right adjacent to an already existing Helios Hospital. The specialties as far as indications are very complementary between these 2 hospitals. There are very near-term intangible synergies. And without going into detail, that acquisition wasn't exactly expensive. And so I would like to do more of these, but this is -- well, I hope it's not going to be a one-off, but at the same time, you shouldn't expect one a quarter.

Okay. And a question that someone's just e-mailed to me. Just how are you thinking about preparation for a second wave? Obviously, this remains a concern and I think for hospitals in particular, what has the Helios business done to prepare for this? And kind of is this -- if there is a second wave, do you think it'd be a more significant or less significant headwind to the business than the first?

Personally, I have my doubts whether we're going to see a second wave just because the population as a whole as well as the administration is better -- even better prepared than first time around. I think in Germany as well as in Spain with a largely decentralized decision-making, we have done the right preparations for that. We will continue to see local areas of infection. But I would also expect that those can be fairly rapidly contained. I literally come out of a video conference with Ms. Merkel and various ministers of where Telekom and SAP have informed us about the COVID-warning app that's going to be rolled out as from next week. They have solicited the support of all the very large German employers. And I think that is also going to be an effective tool to contain infections. As far as Helios is concerned, number one, we entered the first infection wave, which wasn't really a wave in Germany, with pretty good inventory levels as far as PPE is concerned. We have replenished those, sometimes even done a bit more. Secondly, as per the request of the government, we have substantially increased the number of ICU beds of ventilation systems. They are obviously here to stay. Number three, we have gone more about the system of creating transparency, both inside the Helios hospital chain, but also with interfaces to other hospitals to make sure that available resources become more transparent. And that would facilitate shifting patients or shifting resources to where they are needed or taken -- can be taken care of, respectively. Just a few highlights. I think we were pretty well prepared first time around. We should be even better prepared for what may be coming now.

Let's move on to Kabi. And one area of big discussion has been North America. You had very strong numbers in March, but quite a reversal in April. Can you give us a sense kind of what are you seeing on [indiscernible] and how much of that April reversal do you think was stocking reversal as opposed to a function of lower electives? Maybe let's start there.

Happy to talk about North America, but what I'm about to say applies pretty universally, maybe with the exception of China. And that is that, yes, towards the end of Q1 and in the first days of April, we were seeing a spike of demand pretty much across the board, but with a particular focus on COVID-related drugs and other Kabi products. And it is our impression that the key driver for this demand was actual utilization with a higher number of COVID patients. But that on top of that, we were also seeing some stockpiling. Everybody wanted to be prepared for a second, third wave or for even more patients coming through in that first wave. In the meantime, as we all know, with a few exceptions around the world, the infection situation has stabilized and therefore, I am not seeing any destocking from elevated inventory levels. And I also would not expect any destocking. Everybody is fearful of a second or third wave. Everybody wants to be prepared for that. Nobody wants to be in a situation that they can be accused of not having prepared themselves. So that higher inventory level is here to stay, at least until next year in our minds. But from that higher level, the actual volume demand is much more in line with the actual drug utilization, and that is constrained by the lack of elective surgery. And hence, what we need to wait for is that gradual resurgence of elective surgery that is then going to drive drug utilization and is then going to drive demand out of our manufacturing facilities.

Are you seeing any improvement in momentum? I kind of reflect on some of the companies that we've heard from over the past couple of days, they are talking about utilization definitely getting better in the U.S. as we move through May and into June. Is that something you're seeing on the ground in your numbers or not yet?

Bear with me.

Okay. Fine. And I think your guidance for Kabi North America.

I would hope that, that is realistic. Again, we had a short-term blip that led us to higher inventory levels. From here on, it's about utilization. What I was describing for our hospitals in Germany and Spain, trying to be a bit more constructive is also something that we're hearing out of the Kabi organizations in other countries. And on that basis, there is a reason to be optimistic about at least a gradual resurgence. It is way too early, I believe, to talk about a catch-up. And in very many countries, there is also not the hospital capacity to cater to a catch-up. And therefore, I think getting to the original expectation would be a success.

And a brief word on kind of broader competitive dynamics? Any changes you've seen in the last couple of quarters, either in terms of shortages, pricing behavior, competition, new entrants, anything worth flagging?

I believe that this pandemic, in quite a few countries, but probably most pronounced in the U.S., has again shown the importance of local manufacturing. And therefore, we have observed, you obviously have also observed that there is a public appeal for more localized manufacturing. Now that is right down our alley, as you know. We have said all along that in order to be successful in the U.S., you've got to have a manufacturing infrastructure there. We feel very comfortable with our 3 large plants. And I believe there are quite a few examples where the supply chain, not only as far as the early stages on the API side, but also as far as finished dosage forms are concerned, have been interrupted. And therefore, we will continue to upgrade and expand our U.S. manufacturing infrastructure. And I would expect that, that is going to prove -- has proven already and is going to continue to prove a competitive advantage.

Helpful. Let's talk about China. Maybe let's start first with kind of the recovery that you've seen there. How far off are you from last year's levels from a revenue perspective? And how long until you get there? Or are you there already?

I will spare you numbers, but we are not there yet. We're still in recovery mode even though speed, magnitude of the recovery has been at least in line with our earlier expectations. Whether it's already in Q3 or only later in the year when we see a recovery to previously normal levels remains to be seen. But my expectation would be that over the course of the second half, we're going to go back -- get back to normal, obviously, with the caveat of the absence of the second wave.

And sort of other headwind that you had flagged for [ trying to condition heads ] in pricing and you had some expectations of maybe some more significant pricing pressure in 2020 than you've seen in the past. Has that played out as you've expected? And is this something that you expect to become a norm now going forward every year? Or is 2020 an exception?

I don't think that 2020 is an exception, and we didn't plan it on being an exception because the historical corridor for price erosion ranges from about 0% to minus 5%. And we, also for this year, expected to be within that corridor, albeit at the upper level, so the minus 5%. That was basically the exit value in Q4 '19, and we had assumed that, that would persist throughout 2020. Now Q1 has been obviously distorted by COVID effects. You know that we were completely sold out, in particular, as far as Propofol is concerned and that we felt obliged to pledge price stability. So there, obviously, you had a meaningfully lower level of price erosion. But whilst difficult to judge accurately, our sense is still that the level of price erosion, also excluding COVID, was a bit lower than originally assumed. Now we need to judge, again, sorry to be so boring about it, but we need to judge again what the pace of resurgence of elective surgeries is going to be. And the longer it lasts with installed manufacturing capacity as being ready, I guess, the higher the risk that we're going to see some more price pressure. But I would work on the assumption that with the momentum that we're observing right now, that can be avoided. And that, therefore, for the year as a whole, we would still be at least in line with our expectation.

Now thinking about the guidance for the year, it excludes COVID right now, but I'm just curious, how are you thinking about the trajectory with COVID? The net income growth range of 1% to 5%, is that achievable even with COVID, maybe at the lower end? Or you think based on what you have seen so far and the recovery that you expect, that range is kind of out of reach now?

As I was saying earlier, I cannot see that there is a net positive effect for us. So COVID means a bit of a dent in profitability. And that is even including a Spanish government support package. And therefore, I would expect that the upper end of that original range, excluding COVID, is out of reach. The bottom end is going to be very much a stretch. My current expectation -- and it would be a huge success, but it is too early to rule it out. And I'm saying that now also because our first quarter has clearly been ahead of our original expectations. And as I was saying in quite a few investor meetings, if it hadn't been for the COVID impact, on May 6, we would have at least, very positively, reconfirmed our original guidance.

Okay. And what are the biggest variables? Is it Spanish reimbursement? Or is it something else that you see sort of as the biggest variable as you think about the range of effect?

I think the largest variable is, as you say, the Spanish compensation mechanism for reserved capacity. We haven't talked about our Vamed business yet, where we were saying on the Q1 call that Vamed this year may easily be the third Fresenius business that is hardest hit. But also there, we're down to the development of elective surgery. As you know, Vamed is our internal champion for post-acute facilities. No COVID patient requires post-acute treatment. It is elective surgery patients that require post acute. And if there are no elective surgeries, then there's also no post acute. So with a bit of time lag, I would hope and expect that also Vamed's post-acute business is going to kick in again, but that is also a fairly meaningful variable.

And we're almost out of time. So I want to ask a question about capital allocation and M&A. I'm curious kind of how your -- the current environment changes your thought process on that. In terms of how likely you are to pursue M&A, what is of interest and what isn't. And maybe just an update on your thinking on entering a third country.

What remains top of our list is facilitating organic growth. And we see strong organic growth opportunities across all of our businesses. And therefore, before you ask that midterm top line growth guidance that we have given, I stand by fully. But it requires investments into capacity expansions, and that is, therefore, something that is high up on our list. Secondly, we continue to be very proud of our dividend track record, 26 consecutive years of dividend growth. We most certainly want to protect that. Thirdly, lower risk, small, medium-sized bolt-on acquisitions. Be that in Kabi land with an expansion of our geographical reach or be it in German and Spanish hospitals. I'm very open to doing that. Fourthly, strategic M&A for various reasons, takes a bit of a backseat for the time being at least. I am meeting quite a few investors who know other investors that are concerned about our leverage. I have not met anyone who was outright concerned about a lack -- an insolvency risk or having to issue equity risk at Fresenius, but people seem to know others. And therefore, I think I recognize that the implementation of IFRS 16 optically has done us a disservice, and our reported net debt is now at an optically high level. I really would like to make sure that we delever into that target corridor that has served us extremely well for about 2 decades. And I would hope that, that alleviates some concerns that appear to exist out there. At the same time, I see no reason whatsoever to adjust that target corridor. And once we have proven again our ability to delever, and once also the market situation out there returns to a bit more normality also as far as strategic sellers are concerned, we may also turn on strategic M&A targets again.

Very helpful. With that, I'm afraid we are out of time. So Stephan, Markus, thank you for joining us. All the best, and we hope to see you in person soon.

I would hope that the virtual Goldman Sachs conference is a rare exception, and that we can come back to see each other in sunny California next year. Thank you for having us. Take care.

Thank you so much, guys. Take care.