Merck KGaA (MRK) Earnings Call Transcript & Summary

Hello. This is Zafar Aziz speaking, and welcome the Deutsche Bank Depositary Receipts Virtual Investor Conference, dbVIC. I'm pleased to announce that our next presentation will be from Merck KGaA from Germany. Before I introduce our speaker, a few points to note. [Operator Instructions] Once the Q&A session has ended, don't log out, you'll ultimately be transferred to the Merck booth where you can continue to ask questions via the chat facility and access shareholder materials. On a final note, all today's presentations will be recorded and can be accessed via the Deutsche Bank website, adr.db.com. At this point, I'm very pleased to welcome llja Doering, Investor Relations Director, Merck, which trades on the Deutsche Börse under the symbol MRK and in the U.S. on the OTC market as MKKGY. Welcome, and over to you, llja Doering.

Thank you, Zafar. Happy to give you an update on the company today. I will be reiterating all key points that Marcus Kuhnert, the group CFO, gave in the Q3 2020 earnings call last week, so still fresh from the press, so to say, at least in a digital sense. And I will be happy to take any questions you might have at the end of the presentation. So with this, let me move on to Slide #5 in your deck. Overall, Q3 was very strong and is yet another proof point for the successful execution of our strategy. Organically, group sales increased by 7.2%, while EBITDA increased by 52.6%. As you know, earnings included a major boost from the Biogen provision release. However, even when stripping this out, organic EBITDA pre growth was remarkably strong at 19.8% despite tough comps. We saw FX headwinds in Q3 was also the last full quarter having consolidation benefit from Versum. As a result, reported sales growth was 2.5 percentage points ahead of our organic performance and reported EBITDA pre growth was in line. The next -- the net effect of COVID-19 was about neutral in Q3. In fact, we saw a significant recovery across various franchises and increasing tailwinds in others. Thanks to our successful crisis management, we continue to cope very well with the challenges during this pandemic and continue to adapt business processes accordingly. This also means that in many instances, the border between COVID-19 effects and underlying performance becomes increasingly blurred, but you can rest assured that we will continue to be as transparent as possible. Based on the strong 9-month performance, we are raising our earnings guidance for the full year. In particular, we now expect net sales in the range of EUR 17.1 billion to EUR 17.5 billion, EBITDA pre in the range of EUR 5.05 billion to EUR 5.25 billion and EPS pre in the range of EUR 6.50 to EUR 6.80. Last but not least, we are proud to be introducing our new sustainability strategy, and I will talk more about this later. And with that, let's go to Slide #6 for an overview of Q3 by business sector. Looking at organic sales development, Life Science had a record quarter with growth in Q3 at more than twice the rate of H1, while Healthcare returned to positive territory after the dip in Q2 and momentum in Performance Materials also improved markedly. Another way of looking at our business, which we introduced at our recent Capital Markets Day, reveals that organic growth in the quarter was primarily driven by the so-called big 3, namely the Healthcare pipeline, Process Solutions and Semiconductor Solutions, while the rest of the business was about stable. Significant FX headwinds of minus 4% on group sales were more than offset by portfolio effect from Versum, resulting in total group net sales of EUR 4.5 billion, up 9.7%. Regarding Healthcare, please note that the core business recovered strongly and was almost flat year-on-year in Q3, while Mavenclad and Bavencio showed impressive double-digit growth. And Life Science, Process Solutions marked new all-time highs with organic growth of plus 27%, while Research Solutions picked up significantly after the dip in Q2 and Applied Solutions also saw improving momentum. In Performance Materials, good organic growth in Semiconductor Solutions continued, while declines in Display and Surface were much less pronounced than in Q2. Regarding earnings, group EBITDA pre came in at EUR 1.7 billion, which corresponds to an exceptionally strong margin of 38.2%. However, even when excluding the EUR 365 million provision release, the margin was up by 260 basis points at 30%, reflecting strong top line growth and ongoing focus on costs. Also note that nonrecurring income in Healthcare was about EUR 70 million higher last year, partially mitigated by lower travel expenses this year, but still suggesting underlying margin expansion of more than 300 basis points. On to Slide #7 with a few comments on the regional sales development. Our 3 main regions, APAC, North America and Europe returned to organic growth in Q3, reflecting easing of adverse effects from COVID-19 paired with successful crisis management. In each of the 3 regions, Life Science posted mid- to high-teens organic growth and Healthcare contributed positively, thus more than offsetting the organic declines in Performance Materials. Lat Am also turned positive after the Q2 dip, while Middle East and Africa turned negative amidst delayed impacts from the pandemic. So now let's take a closer look at our financial performance and key developments in Q3. Let's take a brief look at our reported figures on Slide #10 -- sorry, slide seems to be moving, but I think I'm there now. While EBITDA pre increased by EUR 589 million, reported EBIT increased by EUR 558 million. Difference mainly stems from higher D&A., partly mitigated by lower intangibles amortization on the one hand and higher adjustments on the other. The financial result was lower, largely due to lower LTIP provision and lower interest expenses. The effective tax rate was within the guided range of 24% to 26%, and consequently, reported EPS came in at EUR 1.85 compared with EUR 0.79 in Q3 last year. With that, let's move on to the review of our business sectors, starting on Healthcare with Slide #11. Healthcare had a good quarter with sales up 3.2% organically, as a 1.4% decline in other core business was more than offset by strong double-digit growth of new products, in particular, Mavenclad and Bavencio. The adverse effects from COVID-19 were much less pronounced compared to Q2 as is most evident in the strong recovery of Fertility as well as the reacceleration of Mavenclad. Overall, our active crisis management continues to bear fruit. Yet we still face some headwinds here and there. For example, Fertility in APAC and the dynamic MS market remain muted. So our best estimate is that COVID-19 reduced organic sales growth by 2 to 3 percentage points in the quarter. Healthcare EBITDA pre surged 94% organically or by 20% if you exclude the Biogen provision release. This is despite lower nonrecurring income versus last year, which was partly mitigated by a meaningful cost benefit from reduced face-to-face activities in light of the pandemic. Earnings growth was also supported by solid top line performance and stringent underlying cost control. In fact, we continue to step up to our efforts to drive profitable growth further and have earmarked a provision of around $100 million, which will be booked under adjustments in Q4. Acting from a position of strength, this amount will be used over the coming quarters for ongoing optimization of our organizational structures, consistent with our focus on execution of the earnings phase of our strategic agenda for Healthcare as a global specialty innovator. Finally, based on our strong 9-month performance, we are increasing our Healthcare guidance for the full year. Organic sales growth now expected at 2% to 3% and organic EBITDA pre growth at 6% to 8% or 25% to 27% when you include the Biogen provision release. For Q4, this guidance implies stable to slightly growing sales and EBITDA pre, which you need to put into perspective of higher comps and initial effects from the third round of volume-based procurement in China. And with that, let's go on to Slide 12 for a review of Life Science. Life Science had a truly outstanding quarter with organic sales growth of 15.6% or more than twice the rate of H1 and well ahead of our recently upgraded midterm ambition. COVID-related headwinds in some areas started to fade as expected, while tailwinds in others increased, leading to significant net benefit, which explains about 40% to 60% of the growth in the third quarter. All of our 3 main regions, North America, Europe and APAC saw accelerating organic growth into the mid- to high-teens territory. Similarly, we also saw a significant acceleration across most customer segments. Pharma and biotech as well as diagnostics and testing were particularly strong. And while industrial and academia remain impacted, the latter recovered strongly from the dip in Q2. From a portfolio view, Process Solutions was the star performer with organic growth accelerating further to an impressive 26.5%, mainly driven by bioprocessing and including a substantial boost from COVID-related demand. More on that in a minute. Research Solutions saw a major swing from the worst to the best quarter in terms of organic growth, i.e., from minus 7% in Q2 to plus 9.5% in Q3. All businesses contributed to growth. And there were multiple drivers that work, including catch-up and pull-in effects related to COVID-19 as well as some underlying improvement. Applied Solutions also accelerated, albeit less pronounced, with organic growth of 3.7% compared to a stable development in H1. Almost all business lines were up while the picture remained mixed across customer segments, as indicated before and the effects from COVID-19 were still slightly negative on balance. EBITDA pre came in strong at EUR 630 million, reflecting organic growth of 25% or a margin expansion of 200 basis points to a record level of 33%, mainly due to operating leverage, positive pricing, good cost control and a favorable product mix. Based on the strong 9-month performance, we are raising our guidance for the full year and now expect organic sales and EBITDA pre growth of 9% to 10% and 13% to 15%, respectively. For Q4, please note that this implies somewhat lower growth in margin versus Q3. However, this is mainly due to tough comps in process, the aforementioned catch-up and pull-in effects in research and the mix. Before moving on to Performance Materials, let's take a closer look at the COVID-19 implications for Life Science on Slide #13. Back in August, we shared so-called 2020 heat map, illustrating that there are different factors that work across business units and customer segments. The conclusion was that downsides would fade as lockdowns are lifted, while some upsides would remain. Q3 already proves a strong evidence of this as the next effect from COVID-19 turned significantly positive. Process Solutions, in particular, is benefiting from major tailwinds due to increased demand from portfolios focusing on COVID-19 therapies and vaccines. About half of the growth in Process Solutions this quarter stemmed from COVID-19-related business. And order intake has further accelerated to over 50% in the 9 months period. However, please also note that lead times have extended markedly. In addition, many of our customers working on COVID-19 topics are producing at risk and different products come with different requirements. Hence, while visibility is good going into the next couple of quarters and we're making meaningful progress on capacity expansions, the potential longer-term upside remains difficult to predict. Finally, let me also briefly comment on Research and Applied, both developed positively in Q3, mainly on the back of improving trends in academia. Both include headwinds as well as tailwinds related to COVID-19. But unlike in Process Solutions, they're generally more balanced, at least when you look over a couple of quarters. In summary, the outlook for Life Science remains strong, underlying demand is robust, and while though difficult to predict longer term, net upsides from COVID-19 are starting to visibly materialize. With that, let's move on to the review of Performance Materials on Slide #14. Overall, the picture on Performance Materials remains mixed. However, momentum has improved substantially compared to Q2. Reported sales growth was strong at over 40% in Q3, reflecting moderate FX headwinds and a significant portfolio effect from Versum. Organically, sales declined 5.4%, which is much better compared to the minus 13.7% seen in Q2. About half of this improvement came from easing COVID-19 headwinds, while the rest can be attributed to normalizing comps in liquid crystals and improved underlying performance. Semiconductor Solutions, the largest business unit in Performance Materials, delivered another strong quarter with organic growth of 8%. And while you will have noticed that this is slightly below the growth of the previous 2 quarters, it is still towards the high end of our midterm guidance. Also note that growth of legacy Versum was consistent with this, and the integration continues to run smoothly with synergies coming through even faster, i.e., we now expect about EUR 30 million in 2020. Sales in Display Solutions declined 9.9% organically given normalizing comps in liquid crystals, prevailing but easing adverse effects from COVID-19 and a solid underlying performance. In Surface Solutions, organic sales declined 12.6%. Similarly, Display Solutions, the rate of decline was less than half of that seen in Q2, mainly due to a less pronounced impact from COVID-19. And earnings, reported EBITDA pre increased 43.3% as a moderate organic decline and currency headwinds were more than offset by the Versum portfolio effect. Costs continue to be well managed, supported by strong execution of our Bright Future transformation program and COVID-19 countermeasures, resulting in a stable margin of 30.4%. Based on a solid 9-month performance, we are slightly upgrading our full year guidance for Performance Materials and now expect organic sales and EBITDA pre declines of minus 4% to minus 5% and minus 6% to minus 9%, respectively. The portfolio effects from Versum in the mid-30s percentage range for both sales and EBITDA pre is confirmed. And for Q4, please keep in mind that we will have no portfolio effect from Versum and expect very strong organic growth also due to low comps in connection with the change of control post the Versum acquisition. A brief look at the balance sheet on Slide #15. As you can see, there is not much change compared to year-end '19. Cash and cash equivalents continue to remain some EUR 750 million higher, in line with the end of the 2 previous quarters and reflect our prudent approach to secure liquidity during this time of crisis. Our equity ratio remains above 40%, and net debt-to-EBITDA pre improved from 2.8 at the end of December to 2.3 at the end of September. Let's now take a closer look at cash flow on Slide 16. Operating cash flow came in strong at EUR 1.17 billion, up EUR 240 million compared to Q3 last year. Adjusted for the Biogen provision release, cash conversion as a percentage of EBITDA pre improved mainly due to reduced net working capital outflows. Investing cash flow was up significantly, primarily reflecting temporary investments of excess cash. CapEx was also up. And as you may have noted already, we are raising our full year CapEx guidance by EUR 100 million, mainly due to accelerated spending on growth projects, for example, in Process Solutions. Last but not least, financing cash flow in Q3 was on a more normal level, while last year, it included significant effects in connection with the financing of the Versum acquisition. And with that, let's move on to the outlook. Before going into the details of our guidance upgrade, let me start by reflecting on our performance in the context of the COVID-19 pandemic. At our recent Capital Markets Day, we have laid out the significant progress on transforming into a globally leading science and technology company, both from a portfolio as well as a cultural perspective. Following a period of major investments, we entered the growth and expansion phase of our strategic agenda last year, promising to you that Merck KGaA, Darmstadt, Germany will stand for profitable growth with high margins and a low-risk profile. 2019 marked a strong start into the space. And while we're heading into 2020 with a lot of momentum, the COVID-19 pandemic turned out to be a major test. Clearly, we couldn't fully decouple from what has become the deepest global recession in over 70 years. However, we will deliver profitable growth even in this turbulent year 2020 and confidently reaffirm the aforementioned promise today. Guided by a clear set of priorities and as illustrated on this chart, we have successfully managed various challenges while simultaneously identifying and capitalizing on new opportunities. As a result, our business performance is strong, and we are well on track to mitigate the effects of the pandemic even slightly ahead of plan. I'm now on Slide #19 with a brief reminder of the key earnings drivers for 2020. As you can see, not much change compared to the version we shared in August. So one notable addition is EUR 365 million provision release related to the patent litigation with Biogen. So let's go straight to the group guidance on Slide 20. As already mentioned earlier, we now expect group net sales in 2020 in a range of EUR 17.1 billion to EUR 17.5 billion, EBITDA pre in the range of EUR 5.05 billion to EUR 5.25 billion and EPS pre in the range of EUR 6.50 to EUR 6.80. We've narrowed our guidance corridor for group net sales by EUR 400 million, while leaving the midpoint unchanged as better organic growth of 4% to 5% is offset by greater FX headwinds, now assumed at minus 2% to minus 3% versus 0% to minus 2% previously. For EBITDA pre, we have narrowed the corridor by EUR 200 million and lifted the midpoint by EUR 500 million. Out of this upgrade, EUR 365 million relates to the Biogen provision release, while the remainder reflects better organic growth of 6% to 8%, partly mitigated by greater FX headwinds, now assumed at minus 3% to minus 5% versus minus 2% to minus 4% before. For EPS pre, we have narrowed the corridor by EUR 0.35 and are upgrading the midpoint by almost EUR 0.70, including about EUR 0.63 from the Biogen provision release. Finally, please note that the anticipated portfolio effects from Versum are confirmed as a positive mid-single-digit percentage effect for both net sales and EBITDA pre. Let me also briefly comment on our business sector guidance that you can see on Slide 21. While so far, this has been qualitative, we are now providing quantitative targets per sector. And as you can see, we have slightly upgraded our organic sales and EBITDA pre assumptions for all business sectors, while for Healthcare, we have additionally included the Biogen provision release. And with that, let's move on to Slide 22 for a specific topic, namely our new ESG targets. Future growth will not only be driven by the sheer amount of new business and already today, the success of the company is no longer exclusively measured by financial KPIs. With our transformation into a leading science and technology company, we developed the necessary mindset to connect business and societal values successfully. Be it this place with low energy consumption or enabling scientists to develop new therapies technical expertise, innovation power and a sense of unmet need and the pharmaceutical life science and electronics space already led to a number of pioneering products from Merck KGaA, Darmstadt, Germany. Operating from leading sustainability platforms like analytics or MSCI confirmed that we're already on the right path to contribute positively to sustainability. Just a while ago, The Wall Street Journal ranked us #4 out of the 100 most sustainable companies and #1 in social responsibility. But to further improve and keep pace with the fast developments in the ESG area from a reputational as well as from a business perspective, we decided to implement the ESG focus even more strongly into our business, R&D and governance. Therefore, we developed 3 new sustainability targets and 7 focus areas, which match our special strength in innovation and will guide important actions on our way to further improve our contribution to sustainability. Our first target takes into account the contribution of all 3 sectors, the human progress and well-being. In 2030, we will advance human progress for more than 1 billion people through sustainable science and technology from Merck KGaA, Darmstadt, Germany. Our second target reflects the need to integrate sustainability in our value chain to further develop various fields of governance and operations in changing environments. This includes, for example, our culture and value transparency in our supply chain as well as risk and life cycle management. With more than 50,000 employees and more than 50,000 suppliers, this is a huge and inputfull task. Our environmental approach is reflected in our third target. By 2040, we aim to achieve climate neutrality and to significantly reduce our resource consumption regarding waste and water. And the new sustainability strategy is an integrated part of our overall strategy. We will enhance in-depth steering of operations, design, tailored KPIs for reporting and reflect all of this in our compensation systems. Let's go to Slide #24 for an overview of our potential contributions too and benefits from ESG. The strategic exercise of the past month has sharpened our understanding of the 7 sustainable development goals defined by the United Nations, on which we have the strongest impact. You can see our 5 most relevant SDGs on this slide. Most obvious fits is with SDG 3, good health and well-being. Here, Merck KGaA, Darmstadt, Germany, is well placed to contribute with dedicated products and initiatives in pharma, science and technology. The same is true for SDG 9 which we address in our innovation power. And for the other 3, we believe there is strong rationale for how they can connect to our strengths and targets. Finally, we are convinced that sustainability can be a benefit for both society and business. In particular, we expect our new targets to be helpful guardrails towards even greater resilience on the one hand, and on the other hand, further economic growth through new partnerships and business opportunities. And with that, let's go to the final slide, which outlines our ESG road map in the years ahead. We have made significant progress during 2020 by conducting an in-depth analysis of our operations and focus areas and changing regulatory environment and the needs of our stakeholders. Based on that, we reassessed our sustainability strategy, which resulted in our new targets and ambitions, as shared with you today. Please also note that we will continue to review and further develop our targets as we appreciate that the overall ESG topic remains very dynamic. We are currently building a capable data platform to improve our internal steering of sustainability-related processes. Based on this, we will develop ESG KPIs for external reporting and integrate those into the compensation schemes of the Executive Board as well as senior management from '22 onwards. We are already working on an integrated approach in all businesses and will further develop strategies to fundamentally integrate ESG in R&D, controlling, M&A and in our supply chain. All in all, we're confident that this will help us to make the right decisions on dedicated investments and initiatives to achieve our new targets. And now to your questions.

So let's see. We had a couple of questions come in. Let's just have a quick look at them. So we have a question coming in, whether our debt-to-equity ratio is in line with management expectations. And the answer to that is a clear yes. So as we have communicated also at the Capital Markets Day, our target is to deleverage below the ratio of 2 by '22, which will then give us, again, significant sort of maneuver capability in terms of further M&A activity, and we have also outlined in the Capital Markets Day that given the setup that we have right now and given the trust that we have in the 3 sectors, we see a higher probability, a higher likelihood for a sort of string of pearls approach. So a series of smaller to midsized bolt-on acquisitions rather than sort of transformational M&A, although we're not excluding the latter. Another question was whether the drivers behind Mavenclad growth are sustainable? And also here from our perspective, the answer would be a clear yes. We have seen, and I'm sure you who follow us have also seen in the prescription data that Mavenclad has recovered strongly since June and continues on that journey, and we believe that definitely, this trend is sustainable and will help us reach our, again, reconfirmed target of EUR 1 billion from the Healthcare pipeline by 2022. Yes. So there was a question on discussing projects and initiatives in the focus areas of climate change and emission and how -- and what we will do to achieve climate neutrality and reduce the resource consumption by 2040? So as I read out on the last 3 slides, there are various projects that have already been defined and carried out, and we are now in the process of further detailing this out, defining KPIs and implementing it all the way even up to the management compensation. So I'm happy to provide additional details on this in a follow-up by e-mail. So we have about 1 minute remaining. And I see still a couple of open questions that I'll -- I think most of them will take a little bit longer than a minute to address. So I'll be happy to make sure to answer those questions that we didn't have a chance to address during this call by e-mail. I would like to thank you very much for the interest in the company. I wish you a great day ahead and a great week ahead. And with this, I'd like to close my presentation.