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

Good afternoon. Good morning, and good evening, ladies and gentlemen, and thank you for joining us second day of the Goldman Sachs 42nd Annual Global Healthcare Conference. It is with great pleasure that I am kicking us off today with Fresenius SE represented by Stephan Sturm, Chairman of the Management Board; and Markus Georgi, Head of IR. Thank you guys for being here.

Hope everybody is well.

Excellent. I'm going to kick us off with some questions, but just from a logistical perspective, if anyone would like me to ask a question, please, you can either submit them on the webcast chat or you can e-mail me directly at [email protected], and I promise I will ask that question. But let me kick off with my own, if that's all right, Stephan.

I'm asking this every sort of company presenting here this week. Just to kind of get a little bit of a pulse before we start talking about the Fresenius business? Or what do you think the sort of broader utilization backdrop is. What are you seeing in the various markets? And maybe give us your best guess, if you kind of benchmark utilization and procedure volumes versus pre-COVID levels? How far or how close are we to the normalized level of activity?

Thank you, Veronika. As far as our German hospital operations are concerned, we started the year at about a shortfall of 15% or so in case numbers relative to the pre-COVID base. We have made a gradual progress in closing that gap. We do expect that also at the end of the year, there is still going to be a bit of a residual shortfall. But that has been duly factored into our model and that informed our guidance. As far as Spain is concerned, we are virtually back to normal. It is difficult to assess when we're now tracking even slightly above the pre-COVID-19 levels, whether how much of that is pent-up demand and how much is actual longer-lasting market share gains. So we hope there's also a bit of the latter. In Latin America, albeit small, but still the situation resembles fairly closely what we're seeing in Spain. In general, I would say there is also what I'm hearing and seeing in other markets that is informative for our Kabi business, we're seeing a correlation between, on the one hand, pace and penetration of vaccinations, and on the other hand, what we're also observing, that also explains the difference between Germany and Spain. The lesser developed a hospital system is, it seems the faster the road to normalization.

That's very helpful, Stephan. And maybe let's dive into some of these bits and pieces. So I think one of the big discussions at your Q1 results was the sort of difference in the pace of recovery between Germany and Spain. And also kind of your best guess for where pent-up demand is. And you said on the Q1 call, you didn't really think there was much pent-up demand in Germany, more as in Spain. Obviously, there clearly is some. What are you seeing from that pent-up demand in Spain? And has your thinking on Germany changed at all when it comes to procedures that were canceled last year that might or might not be coming back?

In Spain, it seems to us that quite a few patients are taking advantage of what they believe is a lesser-demand environment. And that, therefore, they now may have a better chance to get an elective treatment with a shorter wait time. That appears to us to be the key driver. And yes, there was a waiting time also when the pandemic broke. And on that basis, I would expect that there is meaningful pent-up demand built into that -- built into that outperformance that we're seeing relative to the '19 pace. But as I said a bit earlier, I would hope it is also a bit more because we have held up extremely well during the pandemic and have certainly also done quite a lot to further build our public reputation. In Germany, again, we're lagging behind. Waiting times, waiting lists are pretty much unknown. Here in Germany, when it comes to elective treatments, and therefore, that strong desire to go about it is less pronounced. We are seeing the all along expected shift towards more ambulatory treatments now reinforced. In that sense, we believe that COVID has acted as an accelerator and that is the key reason why we believe that, also towards the end of the year, we will not have closed that gap, but that there is a sustainable one. Having said that, that also means that the average severity of the cases has moved up, and therefore, please do not translate a shortfall in case numbers necessarily in the very same shortfall in sales.

Okay. That's helpful. And obviously, we heard this from a couple of the companies yesterday who have more U.S. exposure, but there's a little bit of debate on, obviously, the medical need hasn't gone away. Why do you think people are not rushing back to a hospital to get their hip replaced or get their knee replaced? What are you hearing, I guess, as the single largest hospital provider in Europe, what's the patient psychology like right now? And is that really the issue? Or is it other stuff that you think is preventing people from coming back?

I believe it is 3 reasons and in no particular order. One, people truly felt there was elective surgery necessary, but they literally just sat it out, and they now feel much lesser need. Secondly, I would say, yes, as I alluded to, given a heightened infection risk that is being perceived despite us doing quite a lot to convince the patients, the relative, the doctors of the opposite. There is this notion that you run a higher risk when being hospitalized, and therefore, they much rather go for ambulatory treatment. And what plays a role in that as well, frankly, is that, up until recently, any hospitalized patient could not receive any visitors. And thirdly, no, it was those 2 reasons. Sorry, Veronika.

Well, I was going to say no visitors could be a third one. So it depends on how well you get on with your family. Sometimes that might be an advantage. No, all joking aside, maybe just kind of -- and I want to talk about the ambulatory shift and what that means structurally. But before we do maybe just a quick pulse check on the guidance. I guess, given everything that you've seen when you think about Spain and when you think about Germany, what's your degree of confidence in the guidance that you have provided for the remainder of the year? And how large a role do you expect pent-up demand to play as you think about the second half? How crucial is that to you guys meeting the expectations that you've outlined for Helios?

We were positively surprised with Quirónsalud's Q1 performance, and therefore, there, my confidence level exceeds the one for Helios in Germany, but that isn't to say that I have that in our ability to achieve also the German guidance. Pent up demand, as you pointed out and reminded everyone on the call, we have not factored in any pent-up demand for Germany for the remainder of the year. So when there is discussion about how would we cope with potential capacity constraints, we do not believe that, that's going to be the issue at the same time. If it became one, I am absolutely certain that we would have a way to deal with that problem that will be nice to have. As far as Spain is concerned, again, we're tracking above -- slightly above our earlier expectations. And so there is no more pent-up demand needed in order for us still to get to our targets.

Okay. That's helpful. And before you move to the other parts of the business, kind of bigger picture you've alluded to this ambulatory care shift. I'm kind of curious how you think Helios is prepared for that? I mean, in Germany, in particular, it's been a notoriously inpatient market for a very long time. And maybe remind us of some of the initiatives you have in place to try to participate in that ambulatory care shift? And how important of a midterm earnings driver will that become for the business?

We've seen that shift coming for quite a while. If people cared to go back to us announcing the Quirónsalud acquisition in 2016, that was one of the key reasons why we were so intrigued by that target. We felt that they were much further advanced in managing that stationary ambulatory interface, and that there was quite a lot that we could learn from them in Germany, and so it happened. We have further built our ambulatory care center network. Typically, those are adjacent to our hospitals, and I believe that is the best of both worlds, where you can treat patients in an ambulatory setting, but still, if necessary, can make use of the installed medical equipment in your hospital, and where you can also have a very short pathway to transfer a patient if necessary into a stationary environment. I would argue that nobody is more advanced in managing that interface and also in building the infrastructure in Germany than we are. Having said all that, at least for the time being, I need to recognize that the margin situation in an ambulatory setting is somewhat lower than in our stationary business, and therefore, yes, we're going to grow this. It's going to provide some extra growth. It's going to provide some extra EBIT. But for those of you who are focused on the margin, it is going to lead to a bit of margin erosion, offsetting otherwise not implausible margin expansion in the stationary business.

Okay. And when you fast forward, let's say, 5 years from now, what's your expectation of the revenue mix in your German business inpatient versus outpatient?

Stationary inpatient is still going to be the vast majority and the dominant factor. But at the same time, I would very much expect that outpatient is going to grow in rate year-over-year.

Okay. And what about other changes as a result of COVID? Has that changed how you think about kind of hospital infrastructure investments into CapEx? And then I think the other kind of big theme related to that, that we've heard a lot about is digitalization. How are you thinking about those 2 areas, maybe both -- not just in Germany, obviously, but also in Spain?

I believe investments into superior medical equipment are absolutely worth our while. That is a differentiating factor. Patients, relatives, doctors are increasingly discerning as far as the equipment is concerned. At the same time, investments into more bed capacity, they rank pretty low on our list. But that has been the case already before. If you recall also in connection with the acquisition of Quirónsalud, we spent quite some time explaining to TheStreet how much better Spain was in terms of average length of stay. And that there was some additional learning that we could take from them. We have made for further progress here, and therefore, arguably, there isn't incremental bed capacity necessary. That wouldn't -- will not preclude us from doing upgrades here and there. At the peak of the, I believe, first or second wave, I forget, Veronika, we were also discussing capacity constraints given social distancing also in hospitals that the few remaining 3 bedrooms will have to be converted into 2 bedrooms and single bedrooms. But that, in my mind, does not pose a capacity constraint on us because at the same time, we're working away with the reduction of the average length of stay.

Okay. And digitalization? I know you guys have done a lot of work there. How do you think about it?

It is an absolute mast. And also, here, COVID has acted as a catalyst or accelerator. We have a variety of efforts, be it the patient portal, be it the digital interactions with surgeons, be it the digital matching of appointments, that is all that we do that is patient-facing at the same time, we have stepped up the efforts when it comes to more digitalization in our internal processes. Arguably -- well, we have done that for a long period of time already and arguably with the regulatory change with the [ cover of nursing cost, some of that investment has been dropped off it's return. But still thinking about the medium to long term, this is still the right way to go, and we will further invest into that, absolutely.

Okay. And appetite for M&A, has COVID changed how you're thinking about adding more countries? And we just had one of your, I don't know, calling them a competitor is maybe not fully right because the geographic overlap isn't particularly large, but one of the other large hospital providers in Europe moving to the U.K. Is that a market that's getting more exciting? Or at this point in time, you're happy with where you are?

At this point in time, we're happy with where we are. I want to stress the point that when we have been selective and extremely disciplined in going after acquisition targets in Germany for quite a while now, I believe that we're going to be at least as disciplined going forward. We would look at acquisition targets, frankly, only if they fit into an existing regional cluster of ours, and therefore, very tangible near-term synergies can be achieved. As far as Spain is concerned, we are more open. You will recall that at the time of the acquisition, 2016, '17, we were observing the high level of fragmentation in Spain. Unfortunately, the expected and hoped for availability of acquisition targets that has not materialized, at least not to the degree that we had hoped for, and -- but that is still something that we are keenly interested in. A third country, from my perspective, given all that you just heard from me about the good interaction and what Spain brought to the German market, and frankly, also vice versa. So a third European market, from my perspective, structurally still makes sense. For the time being, given balance sheet constraints in particular, I -- there are no plans, and that is rather something for the medium to longer term.

Understood. Understood. Let's move on and talk about Kabi. That's okay. And I want to start in North America. Give me an update on where you are with Melrose Park? When do you think the FDA might come back and do a reinspection? And any guesses on whether a warning letter is coming or not at this point in time?

No recent interaction with the FDA. Plant, in the meantime, running back at normal levels. We have to acknowledge that given back orders building and customers not being entirely happy about us not being in a position to fill that demand that they have turned elsewhere. This is a fluid market, and therefore, market shares lost are typically regained with a bit of effort in a relatively short period of time. I vividly recall, Veronika, our discussion about market shares gained and lost in the aftermath of McPherson. And I would describe that situation very much to the one that we're currently in. Apart from the fact that Melrose Park is a very important manufacturing plan for Kabi and for Fresenius as a whole, it is also a fairly important one for the U.S. patient base, and therefore, I would have expected that under normal, i.e., non-COVID -- in a non-COVID environment, a physical inspection by the FDA would have happened already. Given still persisting travel restrictions, that inspection has not happened. But I would be surprised if we didn't receive a visit over the course of the second half. We are preparing ourselves for that. I believe we have a reasonably good story to tell when it comes to how we dealt with the issue once we had detected it, but obviously, the FDA will be acutely interested how it could come that far and whether there was a way to detect that earlier. I believe also there, we have a reasonably good story to tell that, that remains to be seen. After such a visit, I would expect 6, 8 weeks are going to pass until we will get word of the FDA's formal view. And I remain of the view that I cannot rule out a warning letter, but, at the same time, I also wouldn't be surprised if we got spared.

Okay. Okay. And I know you were sort of retesting some of the batches that you thought might have been contaminated. Have you now released all of that into the market? And I guess, just following on your comment, clearly, you have lost some market share. Does this kind of incremental product availability let you go back in at a lower price? Or is the way to win back that share going to be just being disciplined and good supplier, but maintaining the prices that you had pre the issues?

All of these originally withheld batches were double and triple checked. We did not find anything out of the ordinary. We weren't surprised by that, but still we had for good order go through that loop. Those batches have been released in the meantime. I'm primarily talking about situations where a GPO or a network and that is typical has more than one supplier on contract, and we're -- given our temporary inability to supply volumes within those 2 contracts were shifted, and therefore, it may come to us have to rebid and also having to lower price. But by and large, I would rather expect that we need to demonstrate superior service, superior availability to reverse that shift between 2 existing contracts.

Okay. That's helpful. And kind of stepping away, and I know Melrose has obviously been a headwind to your growth rate. But even kind of adjusting for that a little bit, maybe my math isn't perfect on that, but it seems to me you are lagging a bit behind some of the growth rates that we're seeing from our peers. If I look at the business versus Hikma for instance, what do you think hasn't gone, right? Is it really just Melrose Park? Or is there something else that you need to fix in the business? And if so, how long until you can get back to those type of growth rates that we're seeing from the market more broadly?

Veronika, I can assure you nobody aids negative growth rates more than I do. Nobody is more ticked off by a comparison with seemingly -- with competitors seemingly growing faster than I am. So we have spent quite some time in analyzing this situation. In the products that we're competing in, the result of our analysis show that we actually have not lost market share. But that is market-driven and that the performance differentials appear to be primarily driven by a different composition and a different -- [ of the ] portfolio and a different degree of exposure to elective surgery.

Okay. And just a quick mark-to-market on where you are with the ANDA pipeline. I guess, remind us, are you still on track for the sort of 10 to 15 approvals this year, your degree of confidence in that?

I would actually hope that we get more towards the upper end of that range that you just mentioned. Yes, we are only at 5 year-to-date. But that is consistent with our original expectations, and therefore, that target remains intact.

Okay. And before we move away, I guess, the sort of bigger debate in the space has really been around competitive intensity. And you're not alone in calling out this dynamic of a bit more pricing pressure. Is it getting worse? Or are we kind of -- is this the new normal? And what are you watching for? What are some of the things that you're monitoring to help you think about are we going to move from a pricing environment that was down low-single-digits to one that's now down mid-single-digits, that could be down 10% in 2 quarters? I -- kind of give us a little bit of your thoughts on that.

My take on this is not only, but in particular, in the U.S., we have fairly stable manufacturing capacity. At least I don't see, I'm not aware of any major upgrades or expansions, let alone new plants being built. And my take on this is that in this relatively stable installed capacity environment, COVID-related shortfalls in volume demand, given the lack of elective surgery, lead to an underutilization of these installed capacities. And in a fixed cost leading business, some of our competitors feel probably a bit more willing to make price concessions to get to a better coverage of their fixed cost. And that, in my mind, is the key driver of price erosion inching up ever so gently. It's not the first time that we're seeing this. Typically, it is a clogged pipeline at the FDA and a lack of new product approvals to the market that is the driver of such a phenomenon. Anyway, then we're watching the normalization of the COVID situation. We're watching the return of elective surgery and the commensurate volume demand in our minds. We have a good chance with that normalizing also price erosion returning to the low-single-digit levels. If that analysis or if that assumption is flawed, then we have to take yet another closer look. But for now, I would very much expect that, that is the dynamic.

And presumably, that would also mean you're still very confident in your mid-30s margin target for the injectable generics business in the U.S., correct?

I am comfortable with that structural margin expectation. Yes.

Okay. Okay. Excellent. Let's talk about China. I hate that I'm just asking you questions about pricing pressure, but we might as well stick with the theme while we need to. You have mentioned a number of products potentially to national tender this year. Maybe just refresh our memory in terms of what proportion of the China portfolio is actually subject to the national tender? And I guess your expectations for what happens with pricing here as we move into the second half?

I cannot provide you with an exact guidance. I just don't know. The Chinese have been opaque as to what the criteria are that they want to apply when it comes to national tenders. What is clear is that our hallmark propofol is -- or has been subject to a national tender. It remains to be seen whether the occasional clinical nutrition product or other parts of our portfolio will also be -- will also be subject there. I would be surprised if it came to enteral nutrition, I can't rule out our enteral nutrition.

Okay. So if you kind of sum it up, what's that if you think about your China business, what proportion is going to face incremental pricing pressure that wasn't there before?

It could be a meaningful portion. I would be surprised if you were the majority.

Okay. And any insights into the type of pricing reductions that we should be anticipating? And I guess, the time lines, when are they coming through?

Look, as so often, we have seen a bit of a time lag between announcement and actual implementation, and therefore, I would not be surprised if we saw more pronounced initiatives on the [ late ] this year with an effect for '22. At the same time, propofol there, we are going to see an effect in the second half of this year. Now there are meaningful price cuts typically coming out of such a tender. The quick [indiscernible] is that you guarantee that you receive guaranteed minimum volumes. And what that means is that in an environment where we have 3,000 sales people across the country, and the commensurate SG&A charge that you also have quite a few levers to pull when it comes to getting your cost base again in sync with a reduced gross margin. That is not to indicate that this could be earnings neutral. It won't. But that is to indicate that the impact, I believe, can be managed.

Okay. Okay. That's helpful. Quickly, when I -- before I move to some strategic stuff, I quickly want to ask you about biosimilars and sort of where you are, a bit of a mark-to-market. My sense is you're annualizing probably less than EUR 100 million of revenues today. Obviously, you have your high triple-digit million sales target. Are you still confident in getting there by 2024? And what's the sort of single biggest lever that gets you there? And then I'll ask you one other question after that, but let's get this one out of the way.

I'm glad to hear, Veronika, that one of the largest biosimilar skeptics used biosimilars now as a nonstrategic but rather tactical issue. Thank you. That makes it more tangible. And yes, I do still stand by my expectation. What am I watching, obviously, further penetration, market share gains for other in the European arena. We need to watch when, finally, we're going to get an approval for Pegfilgrastim both in the U.S. and in Europe for the injection application that can be -- that is slightly delayed. Also COVID-related, we ourselves already we're waiting for the inspections by EMA and FDA. Not the end of the world because the much larger, much more interesting application is the on-body device that was planned for '22 anyway, that, for now, is very much -- remains very much on track. Tocilizumab on track for 2023, but the all-important launch is adalimumab in the U.S. in Q3 of '23. That was, I would say -- well, not necessarily conservative, but not unrealistic assumptions is going to take us to breakeven in '23. And with an annualized effect and with the inclusion of that should take us to the high single digits in '24 and beyond.

Okay. And obviously -- I think I've asked you this question again, I'm going to ask it still. I think biosimilars, very exciting in theory, but obviously, it's a business that's weighing pretty significantly on your near-term earnings right now. Would sort of -- at what point in time, if things are not going to plan, would you consider scaling down those investments? Is that something you'd be open in the next 12 to 24 months? Or do you really want to get all the way out to 2024 before you start thinking about the degree of R&D and investment that you were putting into the business?

It is a weight on our earnings, yes, absolutely, and we have paid dearly for it in terms of our valuation and the share price. But I will tell you, Veronika, most of the investor conversations that I'm having these days are actually pointed in the other direction. And I am very frequently being asked, when is the time to further scale up and to broaden the portfolio. Because we, on the investor side, are seeing that you master at least the regulatory challenge, and wouldn't it be better for market access if you had a fuller portfolio. And they are -- now coming back to what you were actually asking. There, I'd say, we have a commitment of an investment seeding that I still very much bound by . And I don't want to unnecessarily blur the situation by adding something and incurring for the development cost prematurely. And -- but at the same time, I obviously see it the same way, a broader portfolio, just as we make the case for bundled the transactions vis-à-vis the GPOs portfolio, biosimilars portfolio in essence, could make sense. Whether I necessarily want to wait for '23 and that breakeven, that remains to be seen. But if we get back to the market in line with the expectations, if the early signs as far as market access and revenue generation, point in the right direction, then I might be inclined to look at an in-licensing opportunity here or there.

Okay. That's helpful. And sticking with the kind of structural changes theme. You did say earlier this year that if you felt that the business wasn't seeing the type of growth that you think it should be delivering, you would be open to looking at the structure of the company. What's your latest thinking on this review? When should we expect to hear more from you? And what are some of the things that you are thinking about when you think about the structure of the business?

That is obviously also a very frequently asked question, albeit typically much more bluntly asked than in our polite way just now. Very much driven by this yellow tress article in Germany, not too long ago. We are working away on that analysis. But as part of our shareholder meeting, just on the back of that article being published. I have made it clear again that we very much like our group structure. It has served us well. It is, in my mind, also very well -- a very suitable structure for the challenges and opportunities that are ahead of us. I have said that we need now to return to more visible earnings growth, after, in particular '20 and also '21 falling short of original expectations COVID related. And so give us the remainder of the year, I will update the Street as part of our full year results, where we stand and what our conclusions are. This is both internal analysis, also external. What can we do to still preserve in a somewhat changed group structure, the interest cost advantages, the tax advantages, on the other hand, externally looking how sustainable are these shareholder value gains that we've seen in other transactions, and can we really work on the assumption that they stick and -- but at the same time, plan A remains in the current structure, return to earnings growth and on that basis, ideally drive valuation.

Okay. And we are basically out of time. So maybe with that, that sort of leads me to my final question, which is your degree of confidence on the earnings growth rate for this year given how second quarter has progressed. Incrementally, are you tracking in line, slightly better, slightly worse than where you were in April?

Incrementally to us providing the guidance end of February, I feel at least slightly encouraged. Incrementally to us publishing and discussing our Q1 results. Frankly, Veronika unchanged. I have only seen April results -- may results are coming in while we speak. At least not bus than in the first days of May when we were discussing Q1.

Okay. Fantastic. With that Stephan, thank you for joining us, and thank you, Markus, as well. I hope you guys stay well, and we will see you soon.

Thank you, Veronika. Thank you all. Take care.