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

Welcome to our Lynch Group FY '24 Investor Presentation. [Operator Instructions] Today, we're going to go through a formal presentation, then we'll leave room for questions at the end. But without further ado, let me pass over to our first speaker.

Thanks, Adrian, and good morning to everyone on the call. Thanks for your time. My name is Hugh Toll, and I am the Chief Executive of Lynch Group. And I'm joined by Steve Wood, our CFO, who will cover off the financials as part of his briefing. I'll move straight to the results presentation released to the ASX this morning and start with the financial year '24 Group highlights section on Slide 5. The Group's full-year results finished in line with the updated guidance provided to the market in early June at both revenue and EBITDA. The results reflect a 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. Our FY '24 results reflects 1% growth in group revenue year-on-year, 2% when adjusted for an additional week of trading in our Australian segment in the prior year FY '23. Australian consumer demand remained resilient across the year, with the bulk of our demand generated in the supermarket channel, where we again achieved particularly strong performance from our sale return store network. Australian revenue growth was adversely impacted by declines in our wholesale markets channel, which predominantly serves floral sales. China's revenue declined across the year off the back of weaker domestic and export pricing on higher production volumes. Sluggish economic conditions impacted by the prolonged property downturn and low consumer confidence in spending made pricing remain weak and below last year's levels across the financial year. Group EBITDA of $39.6 million fell short of last year's results by 7%. Australia's EBITDA results improved by 50% with margin recovery initiatives across procurement, freight, and latter, delivering a strong rebound in earnings. China's spendings decline reflected specifically weak trading conditions with a real portion in consumer spending having a significant impact on realized pricing. The strength with our operating platform and team and the quality and reliability of our products enabled an $8.6 million EBITDA contribution set against extremely challenging market conditions. As noted in our half-year update, the group recorded a noncash impairment charge against China's carrying value of goodwill of $30.1 million. The Group's confidence in the positive medium to long-term outlook for the China floral industry remains unchanged, and there's been no further impairment charge recorded at year-end. We continue to progress sustainability projects across the business, and we will release the Group's updated progress via our sustainability report in October as part of our annual report. Turning now to the Australian highlights on Slide 6. FY '24 revenue finished 3% up year-on-year, excluding the additional week of trading in the prior year. Customer demand for supermarket floral products remained robust across the second half despite increasing pressures on consumer conference and household spending. Sale return store growth continued to outperform core store growth across the year. Our key second-half supermarket events across Valentine's Day and Mother's Day were delivered in full and achieved very pleasing sell-through rates in-store for our customers. Demand from other wholesale and proposed customers remains subdued but stable across the year with flowers in general facing challenging trading conditions. Australian EBITDA margin recovery initiatives progressed to plan across the year. Steady improvement to overall buying rates via reductions in freight, ongoing range management initiatives, and great labor availability combined to deliver improved EBITDA performance. The bulk of international air freight reductions were realized in the first half of the financial year, with rates on key supply geographies remaining steady across the second half. Moving to China on Slide 7. Our China segment revenue finished 12% down year-on-year. The decline resulted from a combination of strong farm production volume growth, which tracked around 10% across the full year. Material declines in domestic pricing, which saw average pricing on our key ROCE products fall by around 18%, and export pricing declined by approximately 17%, which reflected the pass-through of savings on export freight rates to Australia. Weakness in local China flower pricing continues to be driven by very low levels of consumer confidence and spending, which is largely being impacted by the prolonged property market downturn and higher unemployment levels, for example, Chinese. Discernable volumes available on market for our auction have also been elevated around key event windows. Operational execution across our growing processing sales and distribution assets continues to be managed effectively and efficiently, delivering solid volume uplift over the year with costs well controlled. Strengthening our downstream distribution capability remains a key strategic focus for us in China, allowing us greater opportunity to value-add our products and reach a larger universe of customers across all market channels. In this vein, we successfully commissioned our second East Coast production facility in Guangzhou early in the second half, which has immediately provided additional sales reach in this large market across our wholesale, retail, and web shop channels. I'll now hand over to Steve, who will take us through the full-year financials.

Good morning, everyone. Our FY '24 results reflect continued margin recovery in Australia and the ongoing effects of weaker pricing in China. The results are in line with the guidance from June. Group revenue of $397.7 million was up 2% on a like-for-like 52-week basis compared to the prior year, with growth in Australia, driven by consumer dividend supermarkets and declines in China from the combined impacts of reductions in both domestic and export price. EBITDA for the year of $39.6 million was down 7% on FY '23 with material recovery in Australia and declines in China. In Australia, margins have recovered to 9.4% as procurement and labor initiatives mature and logistics normalize. In China, margins have declined on FY '23 but did improve in the second half with economic conditions in the domestic China market remaining challenging. Cash conversion for the full year was 99%, continuing the longer-term trend of cash conversion of close to 100%. The seasonality of cash with a high conversion in the second half as inventory build unwinds was again evident in FY '24. The Group has today declared a final fully franked dividend of $0.08 per share, with a record date of the 4th of September and an expected payment date of the 18th of September. This brings the total dividend to the year to $0.12, up from the $0.07 declared in FY '23. Moving to the Australian segment, which has delivered revenue and EBITDA growth during the year. Revenue was $329.6 million, which is a 3% increase on FY '23 on a like-for-like 52-week basis, with growth predominantly driven by consistent demand for floral products in the supermarket channel. Performance in the sale of returned stores remains in line with our expectations, with SOR now representing 26% of the store network. Revenue from wholesalers and florals served by the Group's market sites and flower brand has remained stable, but at a lower base than in previous years. Australia's EBITDA of $31 million is a 50% recovery on FY '23. This strong EBITDA has been delivered from executed margin recovery initiatives, which translated to cost improvements, in particular, in the areas of domestic freight, floral-line, and labor. Moderating freight rates from key international routes in Africa, South America, and Asia are now largely normalized. Labor availability is stable and has returned to normal operating conditions and not impacted operational efficiency during the year. Labor rate inflation remains higher than historical norms, reflecting the wider economic trends, and is the largest contributor to the increase in operating costs during the year. The full-year EBITDA margin of 9.4% demonstrates piece margin recovery and that EBITDA margin is ahead of recent years. The Group is also in the process of the first phase of the system upgrade of its ERP from SAP ECC6 to SAP S/4HANA. The first phase is expected to conclude within FY '25 with costs of around $1.5 million expected to be reported as underlying adjustments to the FY '25 EBITDA. Moving to the China segment. China revenue was $85.4 million, down 12% year-on-year. The drop in revenue is a combination of domestic price, domestic volume, and the export. Domestic gross pricing is down 18% on FY '23, which is also 32% on FY '22. Much of the price decline has been offset by increased volumes from current and prior year agreements with house expansion, although the rate of volume growth has slowed in line with the reduced expansion across '23 and '24. Export revenue has declined 33% during the year driven by air freight reductions with the savings passed on to Australia and less third-party products supplied from the China market into Australia. The volumes of Group-produced products exported are stable year-on-year. The cost of operating the China business have remained well controlled with key production costs, including heating, fertilizers, packaging, freight and labor, all in line with expectations. China's EBITDA of $8.6 million for the full year is reflective of that subdued domestic pricing, coupled with a largely fixed cost base. The full-year P&L shows an operating margin in line with last year, with Australia benefiting from operational improvements and China affected by the declines in domestic pricing. Operating costs were up 7%, driven by the higher inflationary environment experienced in Australia during the period. The largest impact is in employee costs where year-on-year increases are from a combination of rate and the resourcing of key roles in sales, HR, and safety. Depreciation and amortization increased by 7% with depreciation on property, plant and equipment, and right-of-use assets both increasing. Amortization is consistent year-on-year. Financing costs reflect the higher interest charges on Australian debt relative to the prior year. And the increase in income tax reflects the higher tax rate of Australia combined with Australia delivering a higher proportion of overall group profits. At the bottom line, net profit after tax adjusting for noncash amortization, or NPATA, is $9.2 million with Australia profitable and China in a loss-making position for the year. Moving to cash flow. Cash conversion is 99%, in line with prior year trends of near 100% cash conversion. The focus on decreasing inventory levels to free up cash has been successfully executed in Australia, leading to greater than 100% conversion for the Australian business. In China, working capital is negative for the year as some prepayments towards the FY '25-unit Volt program fell into the year. Lease interest, tax, and maintenance CapEx are around 20% higher than in FY '23 and the biggest contributor to this increase is income tax as Australian profits increased, resulting in a higher tax rate. Interest on debt was also up year-on-year as a full year of higher interest rates on debt in Australia was realized. And dividends there of $13.4 million are made up of $0.07 paid this time last year and the interim dividend paid in March of $0.04. CapEx spends of $11.6 million includes growth of $6.7 million and maintenance of $4.9 million. The reduced CapEx compared to FY '23 and especially FY '22 reflects the more cautious approach to the greenhouse expansion in China during the current economic conditions. Gross CapEx of $6.7 million includes investment in production capacity expansion in Australia and some moderate greenhouse expansion and other farm infrastructure in China. Greenhouse expansion includes progress payments on expansion from prior periods and other farm infrastructure includes investments to support the additional [indiscernible]. Maintenance CapEx of $4.9 million is a moderate increase on '23, reflecting the wider farming base in China. The company developed land area of 84 headsets in China to include 2 additional hectares developed during the year as CapEx plans remain moderated. Finally, on the statement of financial position. The Group's statement of financial position remains broadly similar to FY '23 with the exception of intangible assets, which have reduced from the noncash impairment charge to goodwill of $30 million in relation to the China Group from the first half. Due to the current economic conditions in China, detailed assessments of indicated impairment were conducted at the half year and again at the full year. As noted at the half, an increase in the discount rate applied to the China Group's cash flows resulted in the recognition of an impairment charge. At the end of the year, a slight increase in that discount rate was considered appropriate as the short-term economic conditions had not materially changed. Based on the updated cash flow model, no further impairment was realized at the year-end. These assumptions verified by our auditors and their independent experts resulted in the reduction in the carrying value of goodwill in China for the full year from $59 million to $28 million and importantly, our view on the medium to long-term outlook for the China business remains unchanged. Aside from the movement in intangible assets, inventories have reduced from $15 million in FY '22, $13 million in FY '23 down to $10.5 million in FY '24, reflecting the deliberate strategy for our cash. Other assets include volumes in Chile base to support the upcoming FY '25 program, as previously noted, and borrowings are unchanged at $55 million, with $22 million undrawn facilities remaining available to the group. The banking covenants for the period were achieved with satisfactory headroom. As usual, we've provided revenue, EBITDA, and key operating metrics split between geographies as well as reported and staff reconciliations in the supplementary pages at the back of the investor presentation back.

Thanks, Steve. And now turning to Slide 17, which goes to current regional trade settings. In Australia, current flow demand remained stable through our major supermarket customers with Australian revenue growth up 5% for the first 7 weeks of the new financial year. Sales growth from our supermarket solar return network remains materially higher. Amidst the backdrop of consumer spending caution, demand for supermarket flow floral products remains positive. Demand from wholesalers and florists is generally stable against the weaker FY '24 baseline. In recent weeks, we have successfully collaborated with one major customer in launching the new branding for their floral category, whilst also developing and launching a new in-house brand platform to support growth through our independent supermarkets channel. Both initiatives have demonstrated positive early sales momentum. Broader cost trends across international freight and labor are expected to remain stable for the foreseeable future. As Steve has already noted, we have recently commenced an upgrade to our ERP system, which we expect Phase 1 works to be completed during the current financial year. And in China, market demand for floral lines remains subdued with the economy experiencing low consumer confidence and spending, particularly impacting discretionary products. Our pricing for the first 7 weeks of FY '25 has been in line with the same period last year. Operational efficiency and cost control remain a key focus. And our primary objective is to maintain leading unit cost efficiency across production, pattern, and logistics. Costs continue to be well controlled as our operations and customer channels currently handle peak summer rose volumes. The Guangzhou production facility has added scope for new customer acquisition and has enabled access to further high-volume retail customer networks in the Southeast. Start-up [ Bocad ] production commenced during this quarter. We continue to carefully manage China's greenhouse expansion and capital deployment program given market conditions. Principal works this financial year will add a further 1 hectare for Amarilis production as well as additional heating capacity on our website farm. With consumer floral demand and general conditions in China remaining subdued, commitments for the new fifth farm and additional production facilities have been put on hold. Moving finally to Slide 18 for the Group's overall outlook. Australian revenue growth is expected to remain positive, supported by our product and service value proposition and the increasing floral industry share of our supermarket customers. China's revenue is expected to be adversely impacted by weak consumer sentiment in the short term and improvement in recovery of pricing remains closely tied to a rebound in consumer confidence and spending. Australian EBITDA margin is expected to track in line with the improved levels of FY '24, whilst the improvement in China EBITDA remains linked to a recovery in pricing. And finally, we will provide further trading updates at the Group's AGM in November. That wraps up the results presentation materials. Thank you for your time and interest. Adrian will now sort of collate and coordinate questions.

[Operator Instructions] So here's the first question, there's a fair few here, by the way. So the first one, double-barreled one. How many stores do you have on SOR now? And talk about tax cuts helped retail across the board, as we've seen, but how much has had an impact this has been seen in July and August.

Yes. Look, our turn store numbers, we've never quoted, but I think we're running about 26%, 27% of the motor, reasonably stable across FY '24. I think in the foreseeable sort of 1- to 2-year time frame, we'll start to push that number high. We went through a high level of conversion numbers sort of after the IPO, so in '21, '22. I think both customers will be in a position where they're pushing for more growth on that channel soon. But again, I think it will take some time in more towards the second half of this financial year. In terms of sort of tax and sort of consumer confidence in the market, it still looks difficult to us. We're obviously seeing higher foot traffic through supermarkets, which sort of plays to our category. In a similar plan, I think our price point, which will obviously come at a discount to floral products means that if people are trading down, they will buy more flowers through the supermarket. I can't expect to, I suppose, increase tax dollars yet. We're in, I think, 7 weeks into the new financial year. So wait and see. I think our expectation, though, is that with foot traffic and the recent trends we've seen in volume growth in our business, the extrapolation of what we saw in the first 7 weeks, mirrors what we were seeing in the final quarter of the financial year.

Next question, turning to China. So China prices have bounced considerably in recent weeks. What's driven this? You still seem to be quite cautious on pricing.

Yes. I think China is a number of events. One of the key Valentine-style events they have up there is late July, early August, and it's called Qixi. That fell on the 10th of August this year. So that is the first event of our financial year. So we absolutely saw pricing improve in the lead-up to that. I think the duration and I think the amplitude of that increase was disappointing to us in that we usually see event demand sort of pick up probably 2 weeks out from an event, and we'd see higher sort of price movement into that event. This year, it was really concentrated within about a week of that event and the price increases were substantial, but we would like to have seen better pricing. So that's probably the recent trend. In terms of our broader sort of outset or sort of poster on pricing, I think we haven't seen anything that sort of gives us sort of an indication that the consumer is sort of changing for the positive. It's been tough. We're in the middle of a peak volume segment of the year across summer in China. So there's a lot of products on market at this time of every year, and it is the weaker pricing period of the year. In terms of what is going to activate the consumer up there, I think a little bit of it is time. A little bit of it is a stabilization in property values as a lot of sorts of household wealth is tied to property out there. And I think a more stable employment environment up there for the 20- to 40-year-old category of age group. So I think we're cautious. Our view is that the pricing where it's been for the last 14 months from the back end of May last year, it's been weak, and it's been consistently weak over that period. So the catalyst for change is consumers wanting to spend more money. We haven't seen any signals or signs out of government around stimulus. We'll keep waiting for that. But I think any stimulus has to be very carefully crafted to make sure that it just doesn't end up getting trapped in people's bank accounts. So, at the moment, I think our view is that we are in a very weak situation. It's not getting worse. We're just waiting for the signal to see the consumer is feeling a bit better.

The next question just staying on China. And it really just goes to your ability to source new land in China. And really, is there a pause on that process?

We're in the middle of contract negotiations right now. It is hard at them. Land is under big focus from the government around sustainable sort of food production, food security, all of those sorts of things. So obtaining land is difficult. It is more difficult for anyone looking not to be producing sort of rice or corn. But depending on land classification and the governments you're working with; you can find it. If you're a foreign entity who has invested over a long-time frame is a stable employer who pays taxes and brings technology to bear in that market, you're in a better position than most. So, I think it's an active decision for us. We've got 6 or 7 hectares still to develop on our Leffingham, which we've slowed down on. We'll finish that before we contemplate the fifth farm. As I said, though, we're well positioned to hit a contract for a new farm now, but I think we need to be careful because as soon as you sign a contract, you're on the hook for moving CapEx at a certain speed to keep everyone comfortable up there. So yes, it is even more difficult on land. We are taking a conscious pause within our own needs.

Turning back to Australia. So great to see strength coming through in Australia in the first 7 weeks, up 5%. Has this primarily been volume-driven? And how much does this increase foot traffic through [indiscernible] drive performance?

Yes, we are in the volume. If you looked at FY '24 was characterized by price, and that is both through price increases and through a lot sort of ASP bracket creep across our value-added lines as people sort of buy up $25 instead of a $20 [indiscernible]. So, I think what we're starting to see now is more of a volume shift. Price increases were put through with our major customers back at the back end of FY '23. So I think foot traffic is a big part of it. I think people are naturally spending more time in supermarkets if they're not eating out, which means foot traffic is higher and people walking past our stands will stop to by flood. So, yes, I think the part of it is to do with the current economic settings, more people in stores. We've always seen and said about our business that we will slow down in a downturn, but we typically don't go backward. So I think when things are tough, people are being more careful about how they spend their money. They're still going to buy flows. People can trade down from higher-priced online operators or florists or where it happens to be. So at the moment, we are seeing more foot traffic through supermarkets. And I think the range proposition that we put up has met them up.

Back to China. Should we be viewing China's domestic pricing to start the year being flat on last year as a broad proxy for revenue?

Yes. With the exception being volume. So our volumes are certainly up. We are exporting more to Australia at the moment. So I think we are certainly positive on revenue into the new year in China. So yes, the sort of pricing paradigm we're in is very similar to last year. Our volumes are slightly higher than sort of caution people on volume because, as you know, you can see from our CapEx chart that a lot of our sort of hectare count went in about 2 years ago. So we've obviously seen a strong uplift in volume over the last couple of financial years. We're still cycling through that, and there is additional volume growth across the farms, but we are heading more towards sort of terminal yield rates across our 4 farms. So yes, positive that revenue predominantly to do with volume and some more export pricing stable on last year.

Can you talk us through the key drivers in what has given you the confidence to deliver EBITDA margins in line with the 2024 levels moving into 2025?

Yes. I mean as you know, the weakness that we suffered through across most of calendar year '22 was principally import freight rates out of our key geographies. A real lack of labor, meaning that we are running significant amounts of overtime in through our business. On top of that, inflation rates on things like domestic transport, insurance, and all those sorts of things start to creep up, and we have been able to push through price increases. So we're in a very difficult circumstance at that point. If you sort of fast forward to '24, we put through a couple of rounds of price increases with our customers across '23. We've started to see freight reduce across our financial mid-'23 principally out of Africa and South America, and a little bit more of that at the front end of FY '24, and we're seeing stable rates since. So, the bulk of the upward movement, which related to restrictions in the movement of passenger airlines across the COVID is out of the market now. We're back to freight rates out of our key geographies that are a whole lot closer to pre-COVID levels with the exception of China. And labor, as Steve noted in his section, availability of casual labor in our business really since January '23 has been far more normalized and our requirements to run over time, et cetera, has been minimized. As we mature as a business, we're doing a much better job at planning for, managing, and executing our events. As you can imagine, when you're running Mother's Day, Valentine's Day, or otherwise, you can have somewhere in excess of 3x or 4x the volume of product running through the business in a 10-day window. And that means flexing up labor and trying to squeeze more through the sausage machine in a limited amount of time. We've got better and better at that, and we learn from each event. We try to eradicate the stakes, et cetera. So I think, generally speaking, labor availability and our ability to control and improve efficiencies got better at midyear. One way to say, I think in terms of the key things that impacted margin from our '21 levels, we've worked through the system. We've recruited on labor and on the sort of major sort of import freight rates. And that has meant that I think our '24 number is a good proxy for EBITDA margin sort of looking at '25.

Next one, just turning back to China. How are you seeing the scope for market consolidation in China, i.e., would you expand? Or have you seen interest in your business?

Look, I think the first thing we're going to see is paid in that most of the market is losing money at the moment up there. So I think people are sort of holding on at the moment. And that ranges from the small grower who is seeing the family brought up to some of the new projects, which certainly don't enjoy, I think, the yield or the cost efficiency that we do in greenhouse. I can only assume if we're doing it tough, they're doing it a whole lot tougher. I think that has meant that there are plenty of grows up there at the moment that are picking products, they're not packing it and they're not distributing it because of where pricing sits. So I think that can only last for a certain amount of time. I think whilst there is some sort of state capital in major projects up there, which may have a longer pain threshold for making decisions about being in or out of the business. I think in the next 12 months, you're going to see people exit growing flowers. In terms of what that means for corporate activity, I think we will start to see closure first and then we might start to see some consolidation. So look at the current time, I think we've been asked questions before about would we buy assets up there. I think in the current environment, very careful. I think if the market did improve in the short term, some of these assets would be trading a whole lot better and they wouldn't be available. So happy to sort of answer that question in another time. But right now, sort of back and down the hatches and extract what we can from our asset base.

Staying with China. Can you also comment on the performance in the different channels in China in terms of the key retail wholesale and 2C channels? How is the Guangzhou facility operating? And has that created incremental demand?

Yes. I think if you looked across it, the emerging trend is all around live streamers. So looking if you went back a year or 2 ago, you have big volumes of product on the market sort of going out over the Internet with individuals talking out through WeChat and other platforms, selling product standing in the market. So, that's obviously a huge trend. It's coming to the flower business as well as it probably has into other consumer product categories. And that means that I'll sort of put that into our wholesale channel. We've seen more of our product go out via those live streamers. In terms of the health of the various categories, I think all of them are suffering. I think the retail have probably done better in that demand through our major supermarket and online customers have been pretty stable. We certainly haven't seen any declines in either volume or pricing through our major supermarkets and online customers. Wholesale is naturally more volatile because we're dealing in the market with 400 or 500 different wholesalers and different geographies day in, day out. Our webshop business, again, is stable. It still represents north of 10% of our sort of volume throughput up there. Increasingly, it's not just our farm product. We are one of the bigger buyers of local products now, which goes out both across web shop channels and increasingly through our wholesale and supermarket customers. So this is a product grown by other growers that we don't erupt and export to our Australian business. So, I would say in terms of where to, from here on retail, we've certainly taken on a few new customers, large customers in the last 3 months. So I think we've been quiet on customer acquisition for a couple of years from the early flurry of taking on the likes of Sam's Globe and Hema and Denton, et cetera, a couple of years ago, we've got sort of increased universe of customers we're dealing with. And that sort of finally comes back to the last part of the question, which is Guangzhou. So we're a lot more active in that southeast part of China now and some of the retailers that we're taking on are active in that market. So, Guangzhou has been important for us not only to sort of deepen our universe of full web shop customers that we can access locally in that market but it's meant that to get into the trade with retail down there, having stock in that market and being able to deliver that [indiscernible] meant that with one new business. So Guangzhou's been a win in terms of having more access to the market in that part of China.

Well, we've exhausted the group of questions. So I'll return to you for now for any closing remarks.

Okay. Thanks, Adrian. Thanks, everyone, again, for your time and interest on the call today. We'll be on the road speaking to investors over the next 3 days. So looking forward to seeing those that we've organized to fast-paced meetings. Thank you for your time and interest in the business.

Thanks, everybody.