Lynch Group Holdings Limited (LGL) Earnings Call Transcript & Summary

[Audio Gap] from management, and I'll let them to introduce themselves in a moment, both here on seat. But just for your information, as we go through and when we get towards the end of the presentation, we'll move into Q&A. And at the bottom of your screen, if I could get you to enter any questions you may have, and we'll work through all of those at the end of the presentation. So without any further ado, let me hand over to you, Hugh. Thank you.

Good morning to everyone on the call, and thank you for your time. My name is Hugh Toll. I'm the Chief Executive of Lynch Group. I'm joined by Steve Wood, who's our Chief Financial Officer, who will cover the financials as part of the briefing. I'll move straight to the results presentation released to the ASX this morning and start with the first half financial year '23 Group Highlights section on Slide 5. Our first half results reflect challenging operating environments in both key geographies. Australian margin recovery was impeded by order declines with a major customer and general cost inflation. And in China by escalating COVID restrictions across the half, followed by the impact of the first wave of infection during reopening in December. Group revenue finished 5% ahead year-on-year, 3% when adjusted for an additional week of trading in our Australian segment. EBITDA declined year-on-year, reflecting the delayed recovery in Australian margins and due to COVID restrictions impacting demand in China leading to declines, particularly over the December quarter. Due to the decline in performance across the half, we will not declare an interim dividend for the half. We expect to resume dividends as profitability and cash flow improve across the second half. We continue to progress sustainability projects across the group and will release the group's first sustainability report with our full year results. I will cover off second half outlook later in the presentation. However, I will note that we are delivering significantly improved trading results in both geographies across January and February. Turning now to the Australian summary on Slide 6. First half revenue finished 4% up year-on-year, including the additional week of trading. This reflects material core store order declines with a major customer tied to the implementation of a new ordering system. We estimate the impact of these order declines to Australian revenue growth across the half at approximately 3%. Underlying consumer demand remains strong, indicated by the performance of our broader customer base and via our sale return network where we control order volumes. Our first half events across spring and Christmas were delivered in full with strong sell-through rates. International freight rates moderated over the half with rates on key supply routes from Kenya and Colombia, reducing for both forward freight agreements and spot pricing. Local foil pricing also moved lower in line with the landed cost of imports and due to greater availability, meaning our overall flow buying rates move closer to target over the December quarter. Broader cost inflation across local transport and labor effectively delayed our margin recovery efforts with inflation on these lines surpassing customer price increases and margin management activity within our product ranges. Construction of the New South Wales Ingleburn facility was completed during the half and operations commenced on site from mid-November. The site increases our operating footprint by 80% to 11,400 square meters, significantly upgrades our temperature control infrastructure, translating to better quality outcomes, upgrades to our processing lines to drive greater productivity and efficiency and allows us to harvest and utilize rainwater, better manage waste and efficiently manage energy usage. The site is now a blueprint for future upgrades for our Victoria and West Australian facilities. Moving now to China on Slide 8. China first half revenue finished 9% higher than last year. Our farms delivered strong production volume growth, which was offset by significant year-on-year declines in pricing, particularly across November and December. Tightening COVID regulations and control over much of the half impacted customer demand and pricing with large-scale and lengthy lockdowns led to declines in consumer confidence. Across the half, we experienced periods of disruption to our farm operations and in logistics. However, through good planning, we're able to limit any material impact to production, waste and costs. Community and business restrictions reached a peak before COVID-zero was abandoned in early December. Disruptions then shifted to workforce, supplier and customer issues as the country dealt with a deep and widespread first wave. The business experienced our sharpest year-on-year clients across this period. On Slide 9, we've included domestic China rose volume and pricing across calendar year '22 to highlight key trends in our business. Volume is presented on an LTM basis, demonstrating strong and consistent year-on-year growth in line with our plans. Pricing is presented on a monthly actual average basis across all domestic rose grades for a year-on-year comparison. Across the first half, the sharpest year-on-year declines occurred across November and December, where we experienced the back end of the tightest COVID-related restrictions, which then moved into the exit wave period across December. Post balance date across January and February month to date, we've seen pricing rebound and trend very close to prior year levels, reflecting renewed strength in customer demand across all channels. I'll now hand over to Steve, who will take us through the half year financials.

Good morning, everyone. Our half year revenue of $180 million includes growth in both segments over the prior year. Underlying demand for floral product remained strong with volume growth driving increased year-on-year revenue in China. Underlying profitability has been impacted by a slower supply chain cost recovery in Australia, in particular, international freight and its flow-on effect to local pricing of flowers as well as labor availability and freight costs. In China, significant COVID disruption impacted customer demand and pricing. Group EBITDA was $13 million, which is at the low end of the range revised at the AGM in November. Cash conversion of 37% is impacted by the EBITDA decline with first half working capital running at a similar level to the previous year. We're expecting substantial unwind of that cash conversion in the second half, and I'll talk more about that in a minute. Due to the decline in EBITDA across the half and our objective to manage our capital as prudently as possible, we have not declared a dividend for the half. However, we do expect to resume dividends in the second half as EBITDA and cash improve. Looking at the Australian segment now. Revenue is $156 million, which is a 4% increase on the prior year, driven by strong underlying consumer demand. The current period does include an additional week due to the retail accounting calendar the Australian segment operates on. On a like-for-like basis, excluding this additional week, revenue would have been $152 million, which is 2% up on the prior year. This is below the longer-term CAGR of 11%, which you can see on the left-hand chart there, with the current period impacted by order declines relating to a new system implementation from a major customer and higher waste. And as Hugh mentioned, based on internal targets, we estimate the impact of this for the half is around 3% in Australian revenue. Australia EBITDA of $7.7 million sits in the middle of the AGM range of $7 million to $8 million. EBITDA performance is in line with the previous half, but remains below historical levels with elevated freight rates and local buying costs persisting during the half. International rates on some routes, Africa or in South America, have started to trend down with more reductions expected into the second half with relief on our key China routes expected shortly post the reopening of Australia-China travel in early 2023. The unrecovered impact of elevated international freight costs and associated local buying added around $1.5 million in costs compared to the prior period. But we do believe the peak of these costs have now passed and expect reductions moving forward. Labor availability remained challenging throughout the period, with shortages leading to additional overtime, especially during event periods. This led to incremental costs compared to the previous period of around $1.5 million. Cost inflation, as seen in the wider economy, is also a factor in our first half result, particularly in domestic freight with fuel surcharges and rate increases, adding around $1 million compared to the previous period. These combined effects of these factors exceeded the positive impact from customer price increases and range modifications achieved during the half. Moving on to China. The China segment has maintained revenue growth despite significant economic headwinds during the half. Revenue was $39 million, up 9% on the previous period, delivered on the back of volume growth. Domestic rose volumes were 1/3 up on the last 12-month basis as a result of yields from nearly developed areas, but also from the ramp-up maturity profile of areas previously developed. Considered in light of the COVID restrictions, which became most pronounced in November and December, the operational execution across the 79 hectares and farm areas delivered a really strong volume result for the half. COVID lockdowns throughout the period and the exit wave of infections in December especially impacted price with the average domestic rose selling price down 30% for the half. This decline had an impact of around $7 million in revenue. Normalizing for the price impact would have delivered revenue of around 46% for the half or 28% up on the previous period. Following the lifting of COVID restrictions, pricing into Jan and Feb has improved significantly. The China EBITDA of $5.4 million sits just outside the AGM range of $6 million to $7 million as a result of lower pricing during December where the China economy suffered the widespread lockdowns. In addition to the pricing impact, which flowed straight through to EBITDA, the China segment cost base reflects the 18 hectares increased greenhouse space now in production with overall costs broadly in line with internal targets. On a rate basis, energy costs associated with heating greenhouses have increased. Our heating program across November and December was carefully managed to balance profitability and product quality and to ensure adequate supply of product as we move into the second half. The full year P&L shows an EBITDA margin of around 7%, a decrease on the previous half of around 4%, which can be largely attributed to the price decline in China. Operating expenses have performed in line with internal targets. And below EBITDA, depreciation and amortization reflect the capital expansions in China. Financing costs have increased also as a result of higher interest payable on the group's debt facility. And based on IBA guidance as well as the timing of rate increases in the first half, we would expect financing costs to increase further in the second half. NPATA at $1.4 million, sits slightly below the AGM range of $1.5 million to $2 million as a result of China performance in December. On to Slide 15 and cash. Cash conversion is 37% for the half, impacted by the EBITDA decline and working capital. The working capital impact of around $8 million is reflective of seasonal increases in winter cheap bulbs and biological assets, which is an agricultural accounting standard similar to work in progress in China. Importantly, this will substantially unwind in the second half as the tulip season progresses and wraps up. And indeed, a large chunk of that has already unwound as we've moved into the second half. Growth CapEx is $5 million for the half, which is around $8 million less than the previous 2 periods and reflects the temporary pause on that expansion in China. And the May good payment there reflects payments made under lease obligations on the exit of the group's legacy New South Wales site in November. CapEx spend of $7.7 million reflects the temporary pause on expansion in China. The growth CapEx of $5 million includes a component of fit-out costs for the New South Wales site relocation, some investment in Australian farms and installment payments on prior year expansion in China. Maintenance CapEx of $2.7 million includes some one-off investment in Australian farms as well as ongoing WHS and IT infrastructure costs. And we've noted that the full year FY '23 capital is forecast to be between $17 million to $19 million, with the expansion program in China to recommence in the second half. The group statement of financial position has material impacts from the capitalization of the New South Wales site and right-of-use assets and lease liabilities. The lease arrangement entered into -- to increase production capacity has a lease term of 15 years and a capitalized value of around $20 million. This increase, combined with the decline in EBITDA has a material impact on the group's net debt-to-EBITDA ratio, which has increased to 2.5x from 1.1 in June. But as we've noted on the bottom of that slide, normalizing for AASB16, net debt-to-EBITDA was 1.4x compared to June of 0.6x. A result of the decline in EBITDA and cash, noting cash includes some of those seasonal working capital impacts, which we expect to unwind in the second half. Elsewhere, the increase in inventories reflects the winter bulb program in China and associated biological assets, which will reduce as the inventory sell-through in the second half. The decline in intangibles reflects amortization and foreign exchange translation in China. And as usual, we have provided segment and key operating metrics in the supplementary pages at the back of the pack.

Thanks, Steve. Now moving to Slide 19. Our strategic priorities remain consistent. For Australia, this means delivering a higher scale and more efficient merchandising platform, leveraging the capabilities of our newly rolled out merchandising technology to drive like-for-like sales growth and improve store profitability, driving sales growth by continuing to work with our customers to grow the sale or return network and increasing merchandising coverage to more core stores. Also further developing our wholesaler and florist channel through our markets operation and building further scale and productivity improvements across the group by replicating the New South Wales site upgrade into other state operations. And for China, strengthening our domestic team's capabilities in product development and scaled value-added production to support growth with our retail customers who are certainly looking for more growth after a period of lockdown. Continuing our farm production footprint expansion, as Steve noted, and securing a lease for a long-term commitment to a fifth farm over time. And also by building further distribution capabilities for the supply broadened range offerings from both Kunming and within our other major metropolitan areas that we service. Moving to Slide 20. We continue to implement initiatives to underpin growth and improved margin performance across the second half. In Australia, we are progressing a further round of price increases with our major customers to reflect recent cost inflation. We're working closely with our major customer to address the first half order to clients while managing order volumes to both deliver profitable growth and minimize week-to-week volatility. And we're further progressing productivity gains across our merchandising network to optimize stock allocations, minimize waste and drive cost efficiencies across labor and transport spend. In China, following a period of significant disruption, we have refreshed our capital planning for our existing farm base for short-term recommencement of development. We've reengaged with government for securing an additional farm for development from CY24 after a period where government's predominant focus has been managing the COVID-zero policy. And pleasingly, we've recommenced travel into China, which means we can provide more support to our team on the ground. Turning now to Slide 21, which goes to current regional trade settings. In Australia, customer demand for floral product has remained strong over recent weeks. We delivered particularly pleasing results across January, reflecting strength in demand across our entire customer network and also cycling the week on a current period last year. Valentine's Day was executed well at both the top line and operationally, delivering improved results year-on-year despite cycling higher floral and charter freight costs in the prior period. The event was a sellout for our major customers. We continue to see reductions in spot international airfreight rates for our major supply routes from Africa and South America. The first round of China airfreight reductions in almost 3 years commenced this month. Refrigerated sea freight rates are also improving for South American and Vietnamese routes. Challenges in sourcing casual labor are also abating with increased availability evident over the last 2 months, particularly across peak requirements during the lead up to Valentine's Day. In China, domestic activity levels rebounded strongly in January after very difficult trading conditions across November and December. The speed and depth of the exit wave post reopening [indiscernible] consumers were able to move back to the activity very rapidly from January. Pricing across January and February has trended very close to prior year levels with strong demand across Chinese New Year and Valentine's Day. We expect these demand trends to remain in place during the major festival windows across the second half. Our operational performance across the farms continues to see production volumes exceed our targets. Moving finally to Slide 22 for the group's overall outlook. Second half Australian revenue growth is expected to continue at the current trend rate of greater than 7%. We expect EBITDA to finish in the range of $11 million to $13 million with steady margin improvement across the half. In China, we expect pricing to track closer to prior year levels on increased production volumes and EBITDA to finish in the range of $12 million to $14 million, and we'll provide a further update on trading after this year's Mother's Day in May. But this wraps up the formal presentation materials. I'll hand back to Adrian, who will moderate questions that have come through online over the course of the call.

Thanks, Hugh. [Operator Instructions] Here, we've got a bunch of questions here. So let me just step through first one, and you've made comments on this already through your presentation, but just to reiterate. Are you expecting price increases to be possible in the second half of 2023?

Yes, absolutely. So we've submitted price increase requests with all our majors over the last few weeks. So they're in progress. And I think certainly, with the cost inflation across the economy and a lot of our competitors and other suppliers into these networks pursuing similar claims, I think we're pretty comfortable that we'll be successful.

Next question. On the key events in Australia are heading into the second half. Can you comment on labor shortages and freight costs?

Yes. Look, in terms of shortages, they were still evident across much of the first half, right through to Christmas. But moving into Valentine's Day this year, we've certainly seen more availability, people answering phones and strong numbers turning out. So clearly, absentees and from the moment we're dealing with [Technical Difficulty]

2023. I think CapEx there depends the scale of [indiscernible] so the conversation was around that [indiscernible] as well. Depending on where the [indiscernible], we did expand the level of CapEx and the timing of that CapEx as well in terms of how we can roll that out. So yes, fair question, I think we want to provide more guidance on that once we give the scale of the fifth farm.

Next question. It looks like we're turning to China. So can you discuss what you are seeing by channel in China with respect to supermarkets versus softer markets? Are you progressing with your large served market customers? Or has that slowed given the lockdowns and other issues?

Yes. It depends on which month you ask me a little bit at the moment. I think it's fair to say that there was a slowdown in retail trade across the December quarter. Store closures and also consumers' ability to visit stores is obviously impeded, less so for our online sort of grocery customers. But very strong rebound in their demand from January onwards. So clearly, the events are a good driver of foot traffic and demand for these customers. And we've seen very strong uptake from retail over the last 8 weeks or so. And order volumes for everything from International Women's say right through to Mother's Day and Qixi will be good.

Just sticking with China. Can you give some color on your relationship with the key retailers in China? What their view on flower category when China reopens now?

Look, the attitude is still good in that the volume growth and the performance of the category for them in terms of margin capture, et cetera, has been good. This -- the disappointing part really has been, I suppose, impeded by COVID is the push into broader range of offerings. And that's the next cap off the rank for us is to broaden out what we do with them to move from more basic straight products into more value-added lines across [indiscernible] and arrangements can to what we do down here. So that's been slower than what we'd expected, but I think that's the next push for us.

A couple coming back to Australia. Where do you think the SOR network can grow to from 25% in Australia and given the outperformance of them against other stores?

We put a target or a ceiling on it. It's a constant process that we run, which is to look at high-performing stores that are in our core network for conversion to sale or return [indiscernible] direct store delivery and increased merchandising it brings with it. So there's a bit of an efficient frontier to make sure that we get the right economics out of the conversion. But if we find that we have good demographics, good foot traffic and sales opportunity, the limit is well north of where we sit at 25%.

Sticking with Australia. Are you seeing a recovery in florist within Australia? The entire line is strong, just not customer issues. How you're holding the share gains in this channel [indiscernible].

Look, I think our wholesale share has trended up. We've obviously taken on that Queensland business a bit over 12 months ago. In terms of florist activity, it's always hard to sort of talk about what's going on in their backyard. But I think higher price points, a sustained period where floral costs have been high and operating costs for labor and rent, et cetera, and maintenance has been a pretty tough time for florist. So my suggestion is that the florist trade is more difficult than it has been for quite some time.

And back to China. Previously, you disclosed the yield per square meter on Chinese farms. Is there any color on this in the first half?

Revenue per square meter, I think we've disclosed. Look, yes, the key point there is pricing. So I think in terms of what goes into that calculation is obviously our hectare count at commencement and conclusion of each period. Two is obviously pricing and 3 is volume. So hectare count has been obviously consistent across the first half. Two is, obviously, we've seen pricing declines for our rose business, steep declines across the half. And we've seen good volume growth. So they are the mechanics of what go into that figure. The key outlier is pricing.

Next one is on guidance. Looking for a little bit more color. Can you talk to your confidence in guidance for Australia and China? The comment here, lots of moving parts that tend to set these buckets of costs and assumptions within that.

Yes. Look, I'd say we've got a lot of confidence in what we've put out there. That's a live forecast, obviously, prepared with a lot of diligence. So in terms of key drivers in Australia, I think in terms of operating cost metrics that we obviously watch week-to-week and rate variances on key lines across production labor, buying local freight, et cetera. The trends are all heading in the right direction, and we've had a lot more stability in margin performance in our Australian business over the last couple of months. So in terms of [indiscernible] the growth rate that drives that range at the top line, we've got a lot of confidence that both -- the demand will be there, and we'll be able to generate that sort of high single-digit growth rate for revenue across the half. And in terms of tailwinds on freight reduction for landed cost of product, so international freight and also work we're doing to reduce absolute cost of our domestic freight and the removal of fuel surcharges, et cetera, mean that the margin impact of those gains, we're very confident on how that spits out. In China, I think our view is that the Band-Aid came off early December. That was good news. The second piece of good news is that our first wave was pretty condensed across that 3-week period through to the end of December. And we moved from what was our most difficult month of December and our most difficult week of that month, the last week of December into a very robust trading period from the 1st of January. We're really pleased that first wave is behind us that consumers are back in business. Our customers are recording good sell-through to their florist customers and retail chains. They're reordering more rapidly. So in terms of the new normal and the new reset in China for pricing and demand, I'm really pleased with where we've landed over the last 8 weeks or so. So in terms of the key determinants of where China heads to, we've obviously got a very good handle on our operating costs. We've got a stable hectare count that we'll be operating across this half. We've got a strong view that pricing will be tracking pretty close to last year levels, which it already is. And three, that volumes will continue to hit our targets. So I think we've got a lot of confidence in the China numbers as well.

A couple more on China. Are you able to provide any color on how much the Lynch's Chinese produce has been brought to Australia percentage-wise?

Look, we can get a bit of a line of sight in terms of the revenue consolidation between the 2 countries. There's a bit of noise in that number because we do bring a lot of our live lines in as well. But the sort of overall percentage for Australia has declined because our absolute volume in China has increased. Steady volume into Australia over the last couple of years. So the percentage of this of volume coming off our farms, heading towards Australia is typically tracking 7%, 8%.

Looks like the last one here, and it's on China as well. So how should we think about China EBITDA margins once the business conditions normalize in FY '24?

Well, clearly, across a financial year where we have stable and predictable pricing, which moves in similar trends that we achieved across '21 and '22. You'll obviously see margin improvement across the financial year '24. We'll obviously have a better half in the first half. So I think the answer is that you're moving back towards a 22% margin level. But again, we'll obviously provide some comments on that when we report later in the year with outlook for '24.

It looks like we've exhausted the group. So I'll just hand back to you for any closing remarks.

Look, thanks for your time on the call today, everyone, and thanks for your questions. So that wraps it up from our end.

Thanks, everybody, and good morning. This ends the webinar.