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

Good morning, good afternoon, everybody. This is David Adlington from the JPMorgan med tech team in Europe. It's my pleasure this morning to start off with Stephan Sturm, CEO of Fresenius SE. Stephan is going to make some, I think, brief introductory comments, and then we're going to head into Q&A. Thanks for joining us today, Stephan, and over to you for those comments.

Thank you, David. Thank you. Good morning, everyone. Your interest in Fresenius is appreciated, as always. Happy new year, even though 2021 has already started. Very briefly, we have had a different and a difficult 2020 by normal Fresenius standards. We had a good Q1 but had a trough in the second quarter where, in particular, the lack of elective surgery at our hospital businesses were felt. We were saying at the time that we were convinced that Q2 would mark the trough in this past year, and we went on to a solid third quarter. It is now too early to talk about the fourth quarter in the detail that you are used to. We are looking to releasing our Q4 and full year earnings on February 23. But as so often in these past years, I would be surprised, and you should be surprised, if the full year guidance that we slightly adjusted as part of our Q2 earnings call would be missed. We would work on the assumption that our Q4 has been trending in line with expectations and to remind you, that we'd still foresee for the full year revenue growth, albeit in the low to mid-single digits, and earnings growth more towards the lower end of a range of minus 4% to plus 1% at constant currency. All in all, I would say that hadn't it been for COVID, 2020 would have been a year of solid earnings growth. But as we all know, COVID is a reality and is going to weigh on us for a little longer. Notwithstanding that, given the circumstances, I am reasonably okay with the way 2020 has worked for Fresenius as a company. Thank you, David. Happy to take your questions.

Great, Stephan. And I will be keeping an eye on the line, just in case, to see if we have any coming in, but I've got some prepared remarks -- or questions here. So we've had an ongoing discussion now for probably, I don't know, 2 or 3 years, the last 2 or 3 years, around the bigger picture for Fresenius SE. Is it growth? Value? Defensive? I know you see -- firmly see it as growth. I'm not sure the Street necessarily fully agrees with you. But maybe it would be just worth touching on the growth drivers you see across the businesses. How they've played out sort of top line versus bottom line over the last couple of years? And how you see the dynamics over the next 2 to 3 years?

David, you're right, and that is a discussion that we're leading with the buy side also, and therefore, it is an absolutely fair question. My observation would be that over the last years, fairly consistently, and 2020 is no meaningful exception to that, the group as a whole as well as the business segments have continued to generate organic top line growth. Over the years, we have capitalized and tried to capitalize on nonorganic growth opportunities, not so much to broaden the spectrum of the group but rather to capitalize on consolidation opportunities. I believe where the debate is coming from is that over the last 2 years, unfortunately, the bottom line has decoupled from the top line. And that, first and foremost, in my mind, has been driven by conscious investments that not only have gone through the balance sheet but also through our P&L. And they were affecting, by and large, all of our businesses, be it home dialysis or the rollout of dialysis service in China, be it biosimilars for Fresenius Kabi or be it clustering and alternative business models, risk prevention at Fresenius Helios. What I believe, against the backdrop of the major disappointments that we created for our investors at the back end of 2018, we need to do is to demonstrate, over an extended series of quarters, that those investments have been worth our while. And therefore, we need to demonstrate that we can also grow our bottom line. Hence, my comment a minute ago where I was saying hadn't it been for COVID, I believe that we should have tracked at least at the top end of our original guidance for 2020, and we could have shown that return to earnings growth. We now have got to watch how the early signs for 2021 stack up and whether 2021 is going to be the year where we can show some earnings growth and the end of that decoupling.

Perfect. And you mentioned inorganic growth there. I mean are there any parts of the business we're more or less likely to see M&A in, in the next couple of years?

I would be surprised if we didn't see M&A because when -- organic growth has been the lead driver of the overall growth of the group. We have always complemented that with selective and, ideally, bolt-on acquisitions. And so I would like to continue that routine also going forward. As of now, when we are tracking more towards the upper end of our self-imposed leverage target corridor, I'm hesitating to do anything of size. But once we have grown -- or degrown back more convincingly into that 3 to 3.5x target range, I would be open also for some larger consolidation steps.

Perfect. I mean you added the Eugin fertility business at the end of last year. I mean not massive, but maybe you could add some color on, first of all, what you've done since that? Maybe just add some color on the opportunity you saw there and what the business brings as a platform for a wider move into fertility?

I believe that fertility medicine is an area that bodes well as far as sustainable growth is concerned. All the demographics point into that direction. Secondly, we have, as Helios and even more so Quirónsalud, a foothold in that business already, even though it has been dispersed across our various hospitals in Germany and in Spain. But we know what we're talking about. Thirdly, fertility is a business area that is fragmented and offers all the right ingredients for a roll-up, at least a scale-up. Fourthly, I believe that with our quality approach, there is something that can be done in terms of convincing patients, we shouldn't be calling them patients, customers, to turn to us to get a high-quality, reliable service that leads them to the result that they are looking for. And fifthly, that is an area that overall also lends itself to a more digital approach very consistently with the approaches that we have taken in our more legacy businesses within Helios. And we will try our utmost to add our digital expertise to what you Eugin and our preexisting businesses have to offer already now. All in all, I'm very excited about this business opportunity. And I think it can be, from a small base, a meaningful growth driver going forward.

Perfect. So just to conclude on the sort of big picture here, if we put all that together, how are you thinking about the top line and bottom line growth over the medium-term for the business?

David, I think that is an implicit question about our medium-term targets, and the answer is we are still, as we should, going through a very thorough bottom-up exercise to validate our initial thinking on the 2021 guidance. And as part of that, we would also validate our medium-term targets. Now we will be definitive as part of our February 23 statement. But as of today, I have no reason to withdraw or put any doubt over the validity of these medium-term targets. And therefore, I continue to believe in mid-single-digit organic revenue growth. And ideally, our earnings growth should beat that at least marginally. We're going to be, as far as our midterm targets are concerned, back-end loaded. But that is no surprise. That has been clearly communicated right from the time when we first talked about these medium-term targets. That is driven by the expected market launch of biosimilars in the all-important U.S. market. As far as our biosimilars activities are concerned, I have nothing to complain about. And much rather, I am fairly satisfied with the performance that we've seen. And so I take that also as a factor that is underpinning our medium-term targets.

Perfect. And then you touched on it in your opening statements that in terms of the sort of disconnect between the Street and your own growth assumptions, at least in terms of you're not getting full value for the expected growth. As a management team and a Board, how do you discuss how you might change the Street's perception of the business? You talked about sort of consistent delivery, particularly to the bottom line. Is there anything else that's been contemplated in terms of exposing the value?

Share price development and share price performance or underperformance, unfortunately, is a standard feature, unfortunately, of management Board meetings. We even go as far as discussing analyst reports from time to time, including yours, David. And I believe our conclusion for now is that we have to extend a series of meeting investor expectations to reinvigorate trust in us as a management team and in our ability to grow also the bottom line. Over and above that, I believe that the Street is focused on only a few parts of the Fresenius business overall. And so for 2021, what we would like to do is to make our investors, buy-side, sell-side analysts, more familiar with very valuable parts of the overall Fresenius Group that do not get the attention that they deserve. More to that, I guess, as far -- as part of our February 23 presentation.

Okay. I won't push here this point then. So maybe if we look at sort of 2020, I mean, most of the companies we cover walked away completely from guidance back in March, April, given what was going on with COVID. You updated guidance. You didn't really make a lot of changes to the original guidance you gave this time -- about this last year, and you kind of stuck with that. And it sounds like you're happy with coming in line with that guidance when you report in February. I know when you stood up in San Francisco this last time last year, people thought you were going to be very conservative with your guidance. I wouldn't say it was super conservative, but in terms of having to make very limited changes, was that because the guidance was conservative because you -- like you say, you needed to deliver on those expectations? Or have you been able to mitigate a lot of the headwinds?

It was by no means a super conservative guidance. Of course, we got to meet expectations, but at the same time, already, when you issue a guidance, you've got to meet certain expectations. And therefore, I believe the guidance that we issued about a year ago broadly met expectations. We were off to a good start pretty much across our businesses and pretty much across all geographies. Then came COVID. I guess, at some point in time, people were even wondering whether net-net, we wouldn't be a beneficiary of the pandemic. That clearly hasn't been the case. And we communicated in a very transparent way what were the puts, what were the takes. So net-net, much rather, we were seeing some downside. But yes, volume demand for some -- many of our services and products were still there. But obviously, we were also helped buy some compensation payments, be it for Fresenius Medical Care in the U.S. or be it for our Helios business in Germany. So when I look at the downside, then it is primarily the effect at our Spanish hospital business in the second quarter where we had to keep beds free and the fixed-cost clock was still ticking without any government compensation. And also, then Q2 onwards, the lack of elective surgery for both our German and Spanish hospital business and a knock-on effect on our Kabi injectable generics business. But all in all, I'd say, moving our earnings guidance down by 5 percentage points, that is -- you may say it was hardly a move for us. It was a difficult move to make. And I would -- again, I would have preferred strongly to show some earnings growth last year. That will be the task for 2021.

Perfect. If we dive into some of the business matters, so I'm not going to touch on Fresenius Medical, they're represented tomorrow. So -- but just on Kabi, I mean, again, bigger-pictured question, investors that we talk to are starting to think about the generic cliff on the injectable side beginning to roll off over the next 2 to 3 years. How do you think about that and the impact it has on the growth profile of Kabi? And how much offset do you think biosimilars will bring to that?

In general, I would agree that, yes, there is going to be a generic -- a slowdown of generic launches. I'm hesitating about the word cliff because in my observation, this is going to be a more drawn out process. But as an insurance policy against such a generics cliff, we bought ourselves the biosimilars business in 2017, and that is actually meant to offset the growth potential that we may be missing going forward. But when I look at our ANDA pipeline in the U.S., then that continues to be filled at a near record level, above 50 ANDAs that are waiting for approval. And as you know, we have a pretty good track record in terms of turning applications then also into approvals, and subsequently, to launches. And with our typical run rate of, say, somewhere between 10 and 15 new launches per annum, that is going to carry us well for the next 3 to 4 years. And in any case, it's going to carry us until we can launch Idacio, our biosimilar version of Humira, then also into the U.S. market.

Perfect. And then you touched on COVID-19 and the impact on Kabi. Obviously, elective surgeries got hit, but there were some tailwinds, I think, also relative to treating the COVID caveat. How did that dynamic pan out? And how are you seeing those evolve with the recent spiking of cases in some markets?

Early in 2020 when the treatment regimen was still under discussion and evolving, state-of-the-art was to mechanically ventilate patients right from the beginning. And in order to do that, what you needed are sedatives, and our key anesthetic, propofol, was the product of choice. And therefore, as far as propofol is concerned, also as far as infusion pumps were concerned, we saw a spike in demand late Q1, early Q2, then again, more towards late Q2, early Q3. But those spikes were actually spikes and, therefore, very shortly lived and couldn't compensate for the shortfall in elective surgery will, knock-on effect on the volume demand in our key product categories. Over the course of 2020, the treatment protocol has evolved. Mechanically -- mechanical ventilation is now not any longer state-of-the-art, it is being applied only later in the process. And therefore also, the volume demand for propofol has more normalized over the course of the year. Net-net, Kabi has suffered from a shortfall of elective surgery. And hence, we had to trim our original guidance.

And in terms of the spike in recent cases, obviously, we're going into now kind of pretty much a full lockdown in the U.K. I think there's continuing various stops on elective procedures in various countries across the world. How is that panning out versus the kind of -- what you saw back in Q2?

It is less pronounced because what we were suffering from in Q2 was either a strict imposition of a prohibition of elective surgeries or at least a very strong advice only to go about cases that were absolutely necessary. And that meant that in very many hospitals across Europe, and we felt that particularly hard at our Spanish hospitals, we had neither COVID patients nor elective surgery patients. And therefore, over and above the direct impact on the profitability of our hospitals businesses, we had the indirect impact on the lack of volume demand for the largest part of our Kabi portfolio. That strict prohibition of going after elective surgeries, that is also a trend that has evolved and is not imposed as strictly as it was. And therefore, the effects over the course of Q4 have been more benign than what we had seen in Q2.

And geographically, I think we're going to see some evolution through the fourth quarter and first quarter, which is going to be slightly different as well. I mean we're getting the impression that China -- we saw that in Q3 that China had rebounded pretty strongly and had presumably stayed that way through the fourth quarter. Is that the right way to be thinking about it? And how are you thinking about Europe and the U.S. through the end of the quarter and into the early part of 2021?

You are right. At the end of Q2, I was somewhat disappointment with the pace of recovery in China. But over the course of Q3, we saw a recovery almost to pre-COVID levels. That, without going into too much detail, by and large, has continued over the course of Q4, and I do expect some growth over the course of 2021. Therefore, China and ideally also the rest of Asia are going to outperform the rest of the world as far as Fresenius Kabi's top line is concerned. And it remains to be seen what the impact of the lockdown across large parts of Europe does also mean for our Kabi revenues.

Okay. Perfect. And then just moving on from revenues to margins, I mean in the first half, they were actually -- I think held up really well, particularly in the U.S. with 39% in the first half. Maybe you just make some comments in terms of given the competition coming back, the impact on price and how sustainable you think those margins are over the medium-term?

The margin picture, in particular in the U.S., actually was a fairly stable one, and that -- notwithstanding the fact that we committed ourselves to price stability against the backdrop of those spikes in demand, in particular for propofol, as I alluded to a bit earlier. But when -- for our largest product, we have some extra demand, and we can afford to keep prices stable, that bodes well for the rest of the portfolio and the margin picture that we're seeing there. In general, what we do need is volume growth to offset the ongoing low single-digit price erosion that we would also expect for this year. I believe that there is a good chance to see some volume growth, in particular if the vaccinations that are ongoing lead to a higher degree of elective surgery in the latter parts of this year. And therefore, I believe that there are -- that there is at least a good basis to expect margin stability going forward.

Perfect. And then just whilst we're on this as well, it came up in the third quarter that you had -- you found -- or had a couple of quality issues in one of your plants in the U.S. I just wanted to get any updates around that.

The issues actually occurred in the third quarter, and we were reporting about them as part of our Q3 call. We detected some of our former employees not sticking to standard operating procedures that we had imposed on that plant. I'm consciously talking about former employees because we had no choice but to make them redundant instantaneously. We have gone through an extra quality loop. And even though we had no reason to believe that any product was manipulated or that was out of specification, we still wanted to make absolutely sure that no patient could be harmed. We have completed that quality loop without -- extra loop without any findings. And therefore, we'll now be working at reducing the back orders that had built over the course of the third quarter and early Q4. I believe when we were talking about these issues voluntarily and in a very transparent way, the Street reached the consensus conclusion that there was no alternative but for us to receive a warning letter. I cannot rule out us receiving a warning letter. At the same time, I do not think that there is an automatism and that -- and therefore, we have not heard back from FDA but feel good about the remediation action that we have taken.

Perfect. And then maybe just to conclude on Kabi, on the biosimilar side, you obviously got -- you mentioned Idacio biosimilar, Humira. I think you've now launched in 9 European countries, but we haven't seen a great deal of impact so far, and certainly, it's going to be top line. Just maybe in terms of where you are versus your original expectations? Probably not helped by COVID-19, is that fair to say? I'm just wondering, again, how you expect it to evolve from here.

As I said earlier, I'm overall satisfied. But you are also right, David, COVID-19 clearly has not helped. I believe that we have made good progress in the tender markets across Europe. But at the same time, I think I said it already on a previous occasion, just because Fresenius Kabi launches Idacio, no country government will immediately launch a new tender. We, in quite a few instances, have to wait for the current tender to expire and for a chance for us to compete in a new tender. Those tenders that we have competed in over the second half of 2020, we have been fairly successful. I believe that we have demonstrated our competitiveness. We have won quite a few regions within Italy. We have won certain provinces in the U.K. Yes, we have lost the Hungarian tender, but I would've been surprised if we won everything, then I would have to take another close look at our pricing. But that actually bodes well. What -- why you're not seeing a larger effect on our top line is that, unfortunately, on quite a few occasions, COVID has also held back the implementation of those tender results. And therefore, not everywhere where we have won, we can now also start to sell. In the other markets, the prescriber markets where we really got to work from door-to-door and make a case for our Idacio at individual prescribing doctors, obviously, the lockdowns across Europe have hindered our ability to see doctors and to establish our presence there. But again, we have a high-quality product. Pricing wise, we can be competitive and are prepared to be competitive. I am working on the assumption that we will be able to demonstrate that once COVID is behind us.

Perfect. Okay. Let's just quickly move on to the hospitals business. Slightly a tale of 2 cities between Germany and Spain, which you mentioned earlier. Maybe you could just give us an update in terms of the -- I suppose, particularly for Spain, which is where I think most of the investor focus is in terms of reimbursement for those postponed elective procedures and how you're feeling about that, obviously, back end of last year, but again, as we go through the first quarter and as cases start to spike again?

I want to remind everyone, when I'm talking about compensation, then what I mean is monies received for reserving capacities, whereas reimbursement is receiving monies for actually treating patients. And so we've seen a recovery in Q3 of those elective surgeries. More towards the end of Q3, I was talking about that in our Q3 call, following some catch up, we were seeing more of a normalization that was ahead of the second COVID wave really hitting also Spain. So all in all, again, without going into too much detail, I stick by the guidance that we had given for Helios as a whole, but also, more specifically, for Helios Spain and for Helios Germany. But we have got to -- we still have not received any compensation monies for unutilized beds, and I also do not expect that to happen retrospectively for 2020, but also not for 2021. As far as Germany is concerned, we are still tracking, as far as case numbers are concerned, below where we thought we would be pre-COVID, also below the 2019 level, but that was part of our model and part of the guidance. As you know, as we talked about, there is a safety floor that has been installed, and that is also giving me some comfort for the -- over the course of 2021.

Perfect. Great. And then maybe just finally on Vamed. I've got a couple of questions that come into the mind. Just finally on Vamed, obviously, that's a business we don't spend a lot of time generally talking about, but this year has probably been -- the business has been impacted the most, both in terms of percentage but also absolute quantum as well. Is that business that's lost, is that all just deferred? Or is it -- some of that has kind of permanently deleted in value?

I would say both. I would like to believe that most of the delayed orders in our project business are still generally alive. Obviously, those that we have started already are alive and wait for a continuation once the pandemic permitted. Those project orders that we had been working on and that we were waiting for definitive signatures, some of them will be lost because when it comes to the financial spend, in quite a few of the emerging markets, there is going to be a reprioritization. And therefore, I am working on the assumption that some of the projects that we were hopeful for are not going to materialize. Many others, though, will, and there, I believe, we continue to be in a very good position to capture them. As far as Vamed's service business is concerned, that also has seen a knock-on effect from the lack of elective surgery, and that's my expectation right now should normalize also over the course of 2021. As far as the post-acute business is concerned, the very same applies. And if you have no elective surgery patients, then you also, by definition, have no post-acute patients. But with a bit of time lag, that should also return to some normality over the course, say, of Q3, Q4 of this year.

Perfect. And just -- we're over time, just a couple of minutes left here. So just on the lines, first question is: do you believe that a diversified health care company can become a winning model again? Or are there some structural issues with the business?

I believe the diversification has served us well over the decades. It is a particularly attractive feature for our lenders. And don't forget, we consciously use leverage to drive -- to finance our growth. I believe nobody took issue with our diversification as long as we were able to demonstrate earnings growth. The key task is to demonstrate a return to earnings growth. If, however, that should not materialize -- I don't foresee that, but if that should not materialize, then we also need to be open to look at structural issues.

Interesting. Second question, is it -- are you able to quantify the shortfall in the Spanish compensation not coming through?

I believe that -- well, we can quantify that once we have our definitive Q4 results and full year results, but the shortfall relative to the original guidance, that is, to the most degree, the lack of compensation payments.

Perfect. And then final question, your ROIC has come down slowly over the past few years. Is that down to M&A? And if so, why is more M&A the right path here?

We have seen some outperformance -- well, given by mishaps by competitors that were driving our ROIC up. And so part of that erosion is also, I would say, a normalization. The caller or the person asking the question is correct. M&A, large M&A also typically plays a role. In my experience, it always takes 3, 4, 5 years before a large strategic acquisition, like, for instance, Quirónsalud, meets the blended ROIC of the preexisting group. I would still very much say that Quirónsalud has been a successful transaction that we're going to reap the benefits from in the short, medium and long term. And I would -- as I said at the outset, I would be hesitant, for various reasons, to go after large strategic M&A for the time being. But bolt-ons, where we have a near-term synergy potential and that, therefore, are much less, if at all, ROIC dilutive, that should remain on the agenda also in the near term.

Brilliant. Stephan, I'm afraid we're out of time. Thanks very much for joining us, again, today. I appreciate you taking the time, and we'll speak soon. Pleased to have you.

Thank you, David. Thank you all. Look forward to speaking with you.