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

[Audio Gap] '24 investor presentation. As I'm sure many of you know to ask questions, just go to the bottom of your screen in the Q&A section and just add them and we'll get to those at the end of the formal presentation. But without any further ado, let me pass over to Hugh Toll, the CEO of Lynch Group. Over to you, Hugh.

Thanks, Adrian. Good afternoon, everyone, and thanks for your time and interest. Look, as Adrian mentioned, I'm Hugh Toll, I'm the Chief Executive of Lynch Group. I'm joined by Steve Wood, who is our CFO, who will cover off the financials as part of the presentation. I will turn to Slide 5, which is the key drivers page just on overall group performance. Our first half results exceeded guidance provided to the market in November at both revenue and EBITDA. Results reflect continued recovery in margins in our Australian operations and a decline in China's performance due to ongoing weakness in consumer confidence and demand, impacting realized pricing across our sales channels. First half group revenue grew 3% year-on-year, 6% up when excluding the additional week of trading included in the first half FY '23 results. Australian revenue growth was supported by consistent customer demand by the supermarket channel, which was partially offset by declines in our wholesale channel serving florists. China revenue declined off the back of weaker domestic and export pricing on higher production volumes. With low levels of consumer confidence and higher volumes on market, pricing remained below expectation across the half. Group EBITDA at $16.7 million was up 28% on the first half of last year. This reflects significantly improved contribution from our Australian operations as a result of stable demand and good progress on ongoing margin recovery initiatives. China's results were primarily impacted by weak market demand and pricing. The group's first half results recorded a noncash impairment charge against China's carrying value of goodwill of $30.1 million. The impairment charge reflects a review of recent volatility in the group's earnings in China and current weakness in market demand and pricing, resulting in the application of higher discount rates to unchanged underlying assumptions for China's medium- to long-term growth and returns. The impairment charge represents a write-down against the FY '23 year-end goodwill balance of $58.7 million. The group's confidence in positive medium- to long-term outlook for the China floral industry remains unchanged. Turning now to the Australian highlights on Slide 6. Australia's first half revenue finished 4% up year-on-year, excluding the additional week of trading in the first half of FY '23. Despite a general slowdown in consumer spending and confidence across the half, demand for supermarket floral products remained resilient. Higher-volume first half events across spring and Christmas were well executed with our customers, resulting in strong sell-through rates in stores. Demand from florists remained generally weak across the half, impacting sales through our wholesale markets channel. Trading conditions for many florists remain challenging. Australian margin recovery initiatives progressed to plan across the half. Steady improvement to overall buying rates via reductions in freight and greater labor availability led to improved EBITDA performance. Pleasingly, we were able to operate across the first half in the absence of any major supply chain disruptions or challenges in securing labor. The Australian port disputes created cost and delays to our sea freight program towards the end of the first half, albeit impacts were manageable in scale. Moving to China on Slide 8. First half China segment revenue finished 8% down year-on-year. The decline resulted from a combination of strong farm production volume growth, which tracked at around 15% up; a 4% decline in domestic pricing, which was cycling the weak first half pricing performance of FY '23; an 18% decline in export pricing, reflecting the pass-through of reduced China export freight rates; and lower exported volumes of third-party procured product to Australia. As noted in our previous full year results presentation, following a very strong rebound in demand after cessation of China's COVID 0 policy in early 2023, our operations experienced a marked downturn in customer demand and pricing from late May. This continued across the first half of FY '24, reflecting a general weakness in consumer confidence and spending as well as an uplift in volumes on market. Operational execution across growing, processing, sales and distribution continue to be managed efficiently and effectively, delivering a significant volume lift over the first half with costs well controlled. We continue to take a measured approach to greenhouse expansion given current market conditions, with the first half addition of 1 hectare to support our expanding tulip production program. Preparations were made during the first half to open a second East Coast production facility, and the new Guangzhou site was operational from late January. The site provides additional sales reach across our wholesale, retail and web shop channels in an affluent and high-density population catchment, similar to our current operations in Shanghai. I'll now hand over to Steve, who will take us through the half year financials.

Good afternoon, everyone. Thanks for your time this afternoon. Our first half FY '24 results reflect margin recovery in Australia and the effects of weaker pricing in China. The results exceeded the earnings guidance range provided at our AGM on the 24th of November, with both revenue and EBITDA ahead of that guidance. Group revenue of $187 million was up 6% on a like-for-like 26-week basis compared to the prior year, with growth in Australia driven by consumer demand and supermarkets, and declines in China from the combined impacts of reductions in both domestic and export price. EBITDA for the half is up 28%, with Australia ahead of the first half in FY '23 and China behind. Margins in Australia have trended up to 8.7% as margin continues to recover. Margins in China have declined as a result of pricing during the period. Group EBITDA achieved for the first half of $16.7 million is above the guidance range of $15 million to $16 million from the 24th of November. Cash conversion of 66% for the half is a pleasing result against the same period last year with working capital outflow down year-on-year as inventory management improved. As in prior years, cash conversion is expected to increase for the full year from the seasonality impacts of a large cash-generating first half and a high cash-generating second half. And the group has, today, declared an interim fully franked dividend of $0.04 per share with a record date of 6th of March and expected payment date of the 20th of March. Moving to the Australian segment, which has delivered revenue and EBITDA growth during the half. Revenue was $158 million, which is a 3.9% increase on the prior period on like-for-like basis, driven by consistent demand for floral products in the supermarket channel. Performance in sale or return stores remains strong with growth in the number of sale or return stores during the half. The number of sale or return stores as a proportion of the store network remains at approximately 25%. Revenue from florists served by the group's market sites and for our HQ brand has declined against the same period last year. However, demand from florists has been largely stable during the half, but this is at levels materially down on the first half in '23. The Australia EBITDA of $13.7 million has been delivered on the back of executed margin recovery initiatives, which translated to cost improvements during the half. International freight rates from Middle Eastern and South American routes have stabilized at levels similar to those experienced in '21, although these rates remain higher than those experienced pre-pandemic. Labor availability has not impacted operational efficiency during the half. However, the labor rate inflation is higher than historical norms, reflecting wider economic trends. EBITDA margin for the half is 8.7%, which is ahead of both the second half FY '23 and the same period last year. Moving to China now. China revenue was $36 million, down 8% year-on-year. The key driver of the revenue decline is a reduction in export pricing as freight rates reduced post the China reopening with these savings passed on in the transfer price to Australia. China freight rates remain elevated relative to FY '21 levels and have not declined to the level experienced on Middle East and North South American routes. Domestic gross pricing was down 4% on the same period last year and now down to 33% on the same period in FY '22. Higher rose volumes have been achieved from prior year greenhouse development, delivering high revenue overall from China domestic customers relative to the first half of '23. The China EBITDA of $3 million is reflective of the subdued domestic pricing experienced during the half. Operationally, production volumes and costs remain on track with the major production costs of heating, fertilizers, packaging and freight well controlled. Slide 12 shows the profit and loss statement. The full year P&L shows an improvement in operating margin of 270 basis points over the same period last year, which is reflective of flat direct costs on higher revenue. Operating costs are up 7%, driven by the higher inflationary environment experienced in Australia during the period. And the largest impact is in employee costs where year-on-year increases are from a combination of rate increases and resourcing of some key roles within the business. Depreciation and amortization is also up 7% due to depreciation from China growth asset investment and right-of-use asset depreciation from property leases. Financing costs reflect higher interest charges on Australian debt relative to the prior period and additional lease liability interest from the property leases. And all that leads to a net profit after tax adjusting for noncash amortization of $2.2 million, up from $1.4 million in the prior corresponding period. Cash conversion is 66% for the half, with changes from working capital, a deficit of $5.6 million for the first half compared to a deficit of $8.2 million in the first half of the prior year. And this improvement is largely as a result of careful inventory management during the period. As in previous years, there is a seasonality element to the group's cash flows, which will see a substantial unwind of the working capital deficit in the second half. The year-on-year increase in cash outflow from leases, interest, tax and maintenance CapEx is driven from additional interest and tax payments in Australia. Growth CapEx of $5.5 million is broadly in line with the prior year, which leads to free cash flow for the year of a deficit of $5.2 million, with net cash flow after dividends paid in September, a deficit of $13.5 million. Moving on to the capital expenditure and land. In China, CapEx spend of $7.7 million is in line with the same period last year and slightly below the previous half. The reduced CapEx compared to FY '23 and FY '22 reflects the more cautious approach to greenhouse expansion in China during the current economic conditions. Growth CapEx of $5.5 million includes investment in production capacity expansion in Australia and greenhouse expansion and other farm infrastructure in China. Greenhouse expansion includes progress payments and expansion from prior periods and other farm infrastructure includes investment to support additional credit volumes. The maintenance CapEx of $2.2 million is broadly consistent with previous periods. The closing developed land area of 83 hectares in China includes an additional hectare developed in the first half of the year. And full year CapEx is currently forecast at between $12 million and $14 million, which includes a further hectare in the second half and finalization payments for existing development as well as moderate ongoing farm infrastructure and everyday [indiscernible] business or maintenance CapEx in both countries. The great statement of financial position includes a noncash impairment of goodwill in the China group. In title, an impairment charge of $30.1 million has been recognized for the half, which reduces the carrying value of goodwill in China from $59 million to $28 million. This impairment has been recognized following an increase in the discount rate applied to the China group cash flows. Our underlying discounted cash flow model remains unchanged from previous periods in terms of medium- to long-term outlook. However, due to the current volatility and decline in pricing as well as the current economic conditions in China, we have deemed it appropriate at a company-specific risk factor to our long-term view on weighted average cost of capital. These assumptions, they are filed by our auditors and their independent experts, have resulted in an impairment of the China cash-generating unit. Importantly, our view on the medium- to long-term outlook for the China business remains unchanged. Aside from the movement in intangible assets, increases in trade and other receivables and trade and other payables reflect the seasonality of the business relative to the June period. Borrowings are unchanged at $55 million with $22 million undrawn facilities remaining available to the group. Banking covenants for the period were achieved with satisfactory headroom. And we have provided revenue EBITDA and key operating metrics split between geographies and as well as reported to stat reconciliations in the supplementary pages at the back of the investor presentation pack. And I'll hand back to Hugh.

Thanks, Steven. And now turning to Slide 17, which goes to current regional trade settings. In Australia, current supermarket customer demand remained stable with the first 7 weeks of the second half flat on the same period in FY '23, cycling a strong January result last year. Wholesale demand from florists has also stabilized at a lower base against the same period last year. The Valentine's Day event was well executed at an operational level with the event delivering strong year-on-year revenue growth and sell out results for our major customers. The event result is a strong indicator of ongoing supermarket demand for floral products despite a softer environment for consumer spending. Freight rates for our import program remain above pre-COVID levels, but we continue to see periodic reductions in air rates on some routes as capacity rebounds over time. The current Middle East situation does increase risk to capacity availability and rates for both air and sea over the coming period. Port labor disputes in Australia have created disruptions and additional costs over recent months, requiring a switch back to high-cost air freight on some routes. These changes are expected to be short term in nature. In China, market demand for floral lines remain subdued with the economy experiencing low consumer confidence and spending, particularly impacting discretionary products. Market volumes also remained elevated on last year levels. Average pricing performance for our farm rose and tulip volumes over the first 7 weeks of the second half has tracked circa 30% below last year's levels, cycling the strong post-COVID lockdown rebound in market demand last year. Operational efficiency and cost control remains a key focus. Our primary objective being to maintain leading unit cost efficiency across production, packing and logistics. Costs continue to be well controlled as our operations and customer channels handle continued growth in volumes. Operations commenced at our second in-market production facility in Guangzhou in late January. The facility is similar to our current operations in Shanghai, allowing further development of our customer demand base across wholesale, retail and web shop channels to market. We continue to carefully manage China's greenhouse expansion and capital deployment program given current market conditions. We expect to finish FY '24 with 84 hectares in production, having added a further 5 hectares from January last year. Before financial year-end, we also expect to be able to provide an update on negotiations for the addition of a fifth farm to enable capacity for long-term expansion beyond FY '24. And moving finally to Slide 18 for the group's overall outlook. Second half Australian revenue growth is expected to follow the first half trend rate of around 4%, underpinned by a stable demand across our customer store networks. Second half China revenue is expected to remain adversely impacted by weak consumer sentiment over the short term with pricing forecast to remain below last year levels. FY '24 full year group EBITDA is expected to finish in the range of $40 million to $43 million with continued margin recovery across the major high-volume events in Australia and price declines negatively impacting China's margin performance. We'll provide a further trading update after this year's Mother's Day event in May. So that wraps up the results presentation materials. Thanks for your time and interest. I think I'll hand back to Adrian, who can coordinate questions that you submitted online.

Thanks, Hugh. [Operator Instructions] So Hugh and so, we've got a bunch of questions, which kind of go around the grounds, and everybody gets a chance to contribute here. So let me start with the first one, and it starts in Australia. Can you talk to the channel performance in Australia? Florists sound like a lot of downgrading. Supermarkets is a cost of living hit good or bad for you and potted the CBA data talking to soft garden sales through the second quarter of FY '24. So florists, supermarket and potted.

Sure. Look, tough times for florists, generally speaking. I think given price points that they are typically targeting, they will be more cautious about spending, et cetera. There's certainly been a reset down in terms of the revenue they've been able to generate. There's no public data to point to, but anecdotally, that could be anywhere between 25% and 30% down reset. We see that through our wholesale operations, selling through the markets and direct to florists. But I think it's also -- depends on where you are and who you are in terms of how that's played out, but there's certainly been a downward reset there. And I think it's all about price point. In terms of supermarkets, I think as you've seen in other foreign markets, I think convenience setting for buying flowers has proven to be the right place to be. Certainly, prominence of floral stands in supermarkets over the last 20 or 30 years, this meant that people are happy to buy good quality at an attractive price point when they're doing their shopping. So we've seen through various cycles over the last sort of decades plus that things may slow down, but they're not going to go backwards in supermarket settings for flowers. The rate of growth will decline, but it's very rare to go backwards in these types of environments. So look, I think the supermarkets are in good shape in terms of being a setting for moving for floral. Look, potted has been a volatile game. I think during COVID, in particular, lots and lots of people being at home, were buying potted lines to decorate and cheer themselves up at home. So potted business for nurseries for Bunnings, for the supermarkets boomed across '21 in particular. And you can see that from the metrics on the back end of our slide presentation that you've seen a retraction in that market over the last couple of years. So that's stabilized, but I think the potted business certainly had a boom, and it's quiet and down over the last couple of years.

That's great. Okay. Next question. More recently, how was Valentine's Day? And are you seeing any green shoots in China. So jumping around here a bit and suggesting that some of the FMCG data has improved recently.

Look, Valentine's is good in terms of the things that are within our control. In terms of how logistics played out for product delivery into our business, how we functioned operationally, the product quality this year was outstanding. So I'm very, very happy with how we controlled what was under our own watch. In terms of customers, each customer goes with sort of different growth rates to the target consumer demand within their own networks, and growth was really solid. I think both our ability to control -- we can control what went on in store, the growth rates that were targeted and the ultimate sell-through rates were excellent, in many respects, one of the best events we've managed. So really pleased with how it played out. There was a second part to that question.

Yes. Just in terms of [indiscernible].

Look, we certainly saw pricing improve into winter and Christmas, which you'd expect seasonally, and then stabilize across January when we would have expected a further increase. So I think it's okay, but not great. We're not saying anything at the moment that's the same if there's any sort of near-term recovery in sort of consumer sentiment or otherwise. I think sort of the service-based economy is still in reasonable shape. I think sort of household goods, et cetera, is still -- it's pretty hard going. So look, from our point of view, it remains tough up there. We haven't seen anything over the recent weeks that suggest it's turning around anytime soon.

Just back to Australia. So the Australian result looks impressive. It looks like you're tracking back to the margin level seen previously. Is this a fair observation? Or are there other reasons why this is not the case?

Yes. Look, it's been a lot of hard work. I mean, you can see from the results we delivered across calendar year '22, we're facing a lot of pressure in terms of obviously, inbound freight costs, disruptions to the supply chains creating additional cost burdens in our business, trying to find people to work and the amount of overtime that we're running, plus also some issues with customers along the way, too, in terms of how they're buying our product. So we're very pleased that, that sort of margin trajectory has turned the corner from the beginning of last calendar year. A lot of hard work has gone into that. And I think the trajectory into the second half is where it should be. So we're heading in the right direction, but we're coming back from a very tough calendar year '22.

Next question. I read the channel mix. I think this is more Australia. What is the percentage of revenue from florists to these supermarkets?

Look, we've never disclosed that. I think the -- our principal business is obviously the supermarket business working with the major customers here. So the bulk of our Australian revenue obviously is working with supermarkets, but a sizable chunk is through our wholesale network, what we call our markets business, which is obviously, leveraging our own procurement platform to trade product with other wholesalers and directly into florists. So we've never provided that split.

So just turning a direction to China. So just with respect to the impairment. Why was the impairment so large? And what are the main drivers for this change?

Yes. So the impairment -- the way we modeled the impairment, as I've sort of mentioned briefly in my commentary, we do a discounted cash flow model. And those assumptions, we do that every year as part of the assessment of intangible assets. We do it every 6 months, and we do it in detail in June. This time, we did it in detail in December as well. And our underlying assumptions of that cash flows haven't changed, okay. But there is some short-term volatility and the pricing has jumped up and down a little bit recently. So what we thought it was prudent to doing the work this year was to up the risk rating in that model. And it's really sensitive. Upping it by just 1% here or there has quite a big impact. So we did a range of scenarios, but all of those scenarios involve the cash flows long term staying the same as they are. And this is where we've landed. So it is approximately half of the goodwill that has been written down in that business. But the important message there, Adrian, is that the -- our medium- to long-term view of that market is unchanged, and that's what the modeling says as well.

So another question, just sticking with China. So what new customer channels are being developed from the Guangzhou facility?

Look, the web shop is a small but really important part of our business. So we're effectively selling product direct to florists and small community buyers across the country. Having a facility in market there means that not only are we combining our own product with third-party product, we buy we're able to deliver that into some of these customers' homes within a 24-hour window. So it's a growing part of our business. So that's new customers that are retail, let's call it, florists or community buyers in that market. Second thing is that our retail customer network also pushes into that part of Southeast China. So doing more work delivering direct into DC from our facility in Guangzhou, working with our existing retail customers with the store network in that region. And then wholesale. So it means that, clearly, we work with larger regional wholesalers in that province, but being able to move into a second tier of smaller to midsize wholesalers means that there's a new set of customers that are prompted by having that facility in that market. So really, it just expands the universe of customers on sort of all 3 channels to market.

A couple of questions here on China. I might combine these ones because they're relevant to the hectares that are actually there. So what's the outlook for hectares in -- the new hectares in China? Could you do 5 to 10 a year? And have you secured new lands? And really just with respect to that, what's the kind of small sustainable CapEx level in China given this half was 6.2% versus 5.2% last half. So on the land but also the CapEx required coming forward.

Yes. Okay. So look, we cap out mid-90s. So we're getting closer to our land capacity for the 4 farms that we have. Two of our farms are complete. The other 2, we're nearing completion on. So certainly, to be putting on 10 hectares a year, we do need that fit farm, and that's something we've been working hard on for the last year or so. We're very close on that. But I think with COVID and then sort of delays across last year in being able to negotiate a suitable outcome that worked for us. We're at the front end of '24 now. So we're not too far away. As I said in my speaking notes, we're certainly hopeful that we'll have that squared away by the time we report the full year '24. In terms of appetite for growth, we can move very quickly in terms of hectare expansion if the market supports it. So I think we're being more cautious at the moment because we have seen volatility in pricing from late '22 right through until late '23. So our view is that we can bring volume and capacity to market reasonably rapidly and a lot of it will depend on sustainability and stability in pricing. So we're very watchful about generating an appropriate ROI on our CapEx spend. So we do it with a measured and sort of cautious approach depending on what's in front of us. So I think no hesitation in saying that our capacity and willingness to sort of go harder on hectare expansion remains. But again, we keep a watchful eye over to the market, and we do have a requirement to get that fifth farm banked before we can sort of really push ahead harder.

Steve, a couple of questions for you on cash and balance sheet. So firstly, on cash. So cash conversion was low in the half. The question is, is this seasonal? And if so, what will it be closer to by the end of the financial year?

Yes, sure. Yes. I mean it is seasonal. And in the first half of the business is usually always working capital negative. And that is -- yes, that's a driver of the seasonality and most of that comes back in the second half. I mean we were close to 100% last year. We've had a good run on inventory management. We put a lot of work into reducing our inventory holdings. Obviously, the life product comes in and out of the business in no time, but I'm talking about more of the long-term things like ceramics, some of the wraps and so on, there's been big focus areas on that in the business to reduce our holdings, and that's to try and free up some working capital. And some of that's come through. And the inventory level is quite a lot lower this December than they were the December 2023. So a lot of work done there. It will substantially unwind in the second half. And so I'm expecting a much higher cash conversion rate at the end of the year.

Steve, well, I've still got you, another question just on the balance sheet. More broadly, you've mentioned some of the working capital items. But just the question is more about your comfortable -- the level of comfort with respect to the other financial drivers within the balance sheet.

Yes. No problem. Yes. So I've talked about the intangibles. That's obviously the biggest movement on the balance sheet for this half, and we've talked about that impairment write-down. Noncash, obviously. Working capital is good and will improve as the year goes on. I'm happy with the inventory levels. And the borrowings is, I suppose, the other big part of the capital management. Borrowings is almost exactly the same number as last year. It's sitting at around $ 55 million. And the borrowing covenants that we have locally here, we're satisfied with reasonable headroom. So yes, I'm not concerned about anything that's sitting on the balance sheet.

Hugh, back to you, just on China. So let me combine a couple of questions here. So it's with respect to -- do you expect Chinese prices to recover? What are the catalysts and other peers making money? And just apropos to the earlier conversation from Steve, why are you still so confident about the medium to longer-term outlook for China?

Sure. Look, my personal view on market situation up there at the moment is that we're sort of facing multiple headwinds, which means that I don't think things can get much worse, which is a dangerous thing to say. But I think right now, we're seeing a significant volume step-up on market, which comes from the smaller growers but also some larger projects that have come to market in the last couple of years. So a volume uplift in an atmosphere where consumers are being much more cautious on how they spend means that we're obviously seeing pretty tight pricing. And we've seen that consistently for the last 7 or 8 months. In terms of where to from here, I think people will be a whole lot more cautious as we are about putting on space anytime soon. And when it comes to the larger projects that have come to market in the last 2 to 3 years in China have really all been state backed. So I think sort of capital heading towards this space in China is going to be a whole lot more cautious about adding capacity. So my sense is that as you see consumers being a little bit more free with their spending, you're going to see that sort of -- you're going to see an improvement in pricing. So my sense is that things are pretty dark at the moment. We're close to dawn, and that we'll see pricing improve over the next 12 months or so, but it's not near term. So I've got confidence that the usual drivers of China, which is that transition to middle class, people's affinity of loving, buying, giving and receiving flowers, like in any other market, will play out. Per capita spend up there still remains low. The prognosis or the prospects for the flower market up there are really sound. So very happy to continue to say that. Sorry, my second part, I always forget.

No, no. That's all here. I think we've exhausted the group. So I think you probably answered all those questions anyway. So I'll just pass back to you to wrap up.

Yes. Okay. Well, look, thanks, everyone, for joining the call. Thanks for your time and attention and interest in our business. I'm hopeful that we'll see quite a few of you on the road over the next week or so. So look, thanks for your time, and look forward to catching as many of you as I can in person.