Propel Funeral Partners Limited (PFP) Earnings Call Transcript & Summary

Thank you for standing by. And welcome to the Propel Funeral's Partners Limited 1H FY '20 Results Briefing Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Albin Kurti, Managing Director and Head of Investments. Please go ahead.

Thanks, Taylor. Good morning, everyone, and thanks for joining. Before we start, I'd like to acknowledge the devastating effects of the recent bushfire disaster in Australia. The loss of life property, livestock and the impact on local communities is difficult to comprehend and our thoughts are with those affected. Fortunately, there's been no fire damage to Propel's network. I also take this opportunity to thank all of Propel staff in Australia and New Zealand, who do a wonderful job in serving families at a difficult time. Turning to today's presentation. With me are my colleagues, Lilli Gladstone and Fraser Henderson. In terms of the agenda, I'll start by summarizing the key highlights of the first half of FY '20, and will then provide a brief overview of the business; Lilli will cover the financial results in more detail; Fraser will touch on industry trends and acquisitions; and finally, I'll make some concluding remarks on the outlook before taking questions. The 3 key takeaways from today's presentation are: firstly, Propel experienced significant growth in the first half of FY '20, with material increases in funeral volumes, revenue and operating earnings. Secondly, Propel remains well placed in what is a fragmented and essential services industry with favorable demographic tailwinds. And thirdly, recently completed acquisitions and expanded funding facilities ensure Propel is well placed to continue its growth momentum in the second half of FY '20 and beyond. Please turn to Slide 6 for the key highlights. First half revenue increased 21% to $57 million on the back of a 17.8% increase in funeral volumes, including contributions from acquisitions, with average revenue per funeral, up 3.2%. Propel continued to grow earnings with operating EBITDA up 42.1% to $16.6 million and operating NPAT up 22.6% to $7.8 million, including the impacts of the new accounting standard for leases, AASB 16, which the company adopted on 1 July 2019. Lilli will step through the impacts of AASB 16 shortly. However, it's important to note that on a consistent accounting basis, that is excluding the impacts of AASB 16, both operating EBITDA and operating NPAT increased materially, up circa 25%. And this noncash accounting change has had no economic impact on the company, its cash flows or its operations. Cash flow conversion remained strong at 99.2%, which is pleasing. From a capital management perspective, the Board has declared an interim dividend of $0.04 per share, fully franked, representing a payout ratio of 78%. Propel ended the first half with a net leverage ratio of 1.9x. And in December, the company expanded its senior debt facilities with Westpac to $150 million, of which approximately $65 million remains available to support the company's growth strategy. In terms of growth, Propel added 8 locations during the first half, bringing its total network to 128 locations as at 31 December 2019. Management has been focused on executing Propel's acquisition-led investment strategy, committing approximately $125 million on acquisitions since the company's IPO in November 2017. During the first half, we expanded in New Zealand and in Queensland, including our largest acquisition to date, Gregson & Weight, which completed in November, and we've purchased 2 freehold properties that were previously tenanted by Propel. In terms of our outlook, Propel expects to benefit from a growing and aging population, its recently expanded funding facilities, acquisitions completed prior to and since the start of FY '20 and other potential future acquisitions. I'll talk more about our outlook towards the end of the presentation, and will now provide a brief overview of the business. Slide 8 illustrates how Propel's network has evolved over the past 6.5 years. We started with one funeral home in Queensland. And today, we operate from 128 locations across Australia and New Zealand, including 31 cremation facilities and 9 cemeteries. Of those 128 locations, the company owns 71 of the properties. Slide 9 shows Propel's main operating brands in Australia and in New Zealand. Each brand has a distinct identity and is well known in their respective markets. Some have been around for many decades. For example, in Tasmania, Millingtons has been operating in and around Hobart for over 100 years; and in New Zealand, Davis Funerals has operated in and around Auckland, since 1875. The green dotted lines show those brands added to Propel's network and announced prior to and since the start of FY '20. These brands are an important part of the goodwill of each business we've acquired. The charts on Slide 10 illustrates Propel's historic growth in funeral volumes and revenue. As you can see on the left, the company performed over 6,600 funerals in the first half, up 17.8%. The chart on the right shows the Propel generated revenue of $57 million in the first half, up 21%. The charts on Slide 11 illustrate Propel's historic growth in operating earnings. As you can see on the left, the company generated operating EBITDA of $16.6 million in the first half, up 42.1%. On a consistent accounting basis, operating EBITDA growth was 25.9%. The chart on the right shows the Propel generated operating NPAT of $7.8 million in the first half, up 22.6%. On a consistent accounting basis, operating NPAT growth was 24.6%. The chart on Slide 12 shows Propel's average revenue per funeral since FY '14, which has grown at a compound annual growth rate of 2.7%. In the first half of FY '20, average revenue per funeral was up 3.2% on FY '19. Turning to Slide 13. Cash conversion continues to be a key focus. As you can see from this chart, Propel's cash conversion has remained consistently high averaging above 98% during the last 5.5 years. In the first half of FY '20, cash conversion remained strong at 99.2%, which is pleasing. I'll now hand over to Lilli, who will provide some further detail on the first half financial results, including the impacts of the new accounting standard, AASB 16.

Thanks, Albin, and good morning, everyone. This morning, I will cover 5 key areas of Propel's first half performance. Firstly, I'll provide an overview of the statutory financial results via an analysis of the income statement. Secondly, I'll highlight the key impacts of the new accounting standard for leases, AASB 16. Thirdly, I'll touch on key growth drivers of revenue, operating EBITDA and margin. Then I'll provide an analysis of the cash flows, and I'll wrap up by touching on the balance sheet and capital management. Please turn to Slide 15. Propel generated revenue of $57 million in the first half, an increase of 21% on the PCP. The increase was driven by the full period impact of 5 acquisitions completed in FY '19 and the part period impact of 2 acquisitions completed during the first half. The performance was also impacted by growth in comparable funeral volumes and average revenue per funeral. Propel recorded a gross margin of 71.5%, which was 130 basis points higher than the PCP. The increase was primarily due to sales mix and the financial profile of recent acquisitions, which included cremation facilities. The company generated statutory operating EBITDA of $16.6 million in the first half, an increase of 42.1% on the PCP. It was positively impacted by the adoption of AASB 16, which I'll cover shortly, acquisitions and the releverage of higher funeral volumes. In terms of other items of note on the income statement, as disclosed in November, a $4.1 million performance fee was paid to the manager following a total shareholder return of 24.2% during the calculation period, which exceeded the benchmark of 8%. Acquisition costs of $1.4 million were materially higher than the PCP, primarily due to stamp duty in connection with the acquisition of Gregson & Weight. Net interest expense increased as a result of AASB 16, and the company increasing its net debt position. And the reported noncash net financing charge on prepaid contracts was lower than the PCP, largely due to a reduction in Propel's implied cost of borrowings to 2.6%. Propel generated operating NPAT of $7.8 million in the first half, up 22.6% on the PCP, which translated to adjusted earnings per share growth of 22.1%. The effective tax rate for the period was 29.5% after adjusting for non-assessable income and nondeductible expenses. The next 2 slides summarize the impact of AASB 16 on operating EBITDA and operating NPAT. Propel adopted AASB 16 on 1 July 2019 under the modified retrospective approach, and therefore, the PCP has not been restated. For ease of comparison, on Slide 16, we have shown operating EBITDA on a consistent or pro forma accounting basis compared to the PCP, that is excluding the impact of AASB 16. On that pro forma basis, operating EBITDA growth was 25.9%. Under AASB 16, occupancy and other lease expenses are excluded and therefore, operating EBITDA increased by $1.9 million during the reporting period. This partially contributed to the 42.1% increase in statutory operating EBITDA. Slide 17 sets out the impact of AASB 16 on operating NPAT. Essentially, occupancy and other lease expenses have been replaced with depreciation and interest charges resulting in a slight decrease in operating NPAT. On a consistent accounting or pro forma basis, operating NPAT increased 24.6%. And on a statutory basis, it increased 22.6%. Importantly, the adoption of AASB 16 had no cash impact and resulted in no change to Propel's operations. Please note that more detailed disclosures relating to AASB 16, are set out in the appendices of today's presentation and the interim financial report. The waterfall on Slide 18 sets out the sources of the revenue growth on the PCP. The chart shows the full period impact of acquisitions made in the PCP, the impact of acquisitions completed during calendar year '19 and organic growth for businesses held for the comparable period. As you can see from the comments on the bottom left of the slide, in the first half, average revenue per funeral increased 3.2% and funeral volumes increased 17.8%. In terms of organic growth in the center of this slide, comparable businesses also experienced a 3.2% increase in average revenue per funeral, which was primarily influenced by pricing and sales mix. In most markets in which the company operates, debt volumes increased in 2019 following a decline in the prior year, with Propel's comparable funeral volumes increasing by 252 funerals or 2.4% in 2019. As you can see on the bottom right of this slide, the operating EBITDA margin was 29.1%, 430 basis points above the PCP. The margin was influenced by the impact of AASB 16, which accounted for 340 basis points. Improved gross margin, the releverage of higher fuel volumes, good cost control with comparable funeral OpEx, up circa 2% on a per funeral basis and the financial metrics of recent acquisitions. On a pro forma or consistent accounting basis, the operating EBITDA margin was 90 basis points above the PCP. As you can see on Slide 19, cash flow from operating activities increased to $7.6 million. It was impacted by the payment of the performance fee and the increased net debt position. This was offset by lower outflows in respect of reclassifications of lease payments net of interest due to AASB 16, net inflows from acquisitions and organic growth. Positive movements in working capital contributed to strong cash flow conversion of 99.2%. In respect of investing activities, Propel deployed approximately $45.5 million in connection with acquisitions, acquired 2 previously leased properties and incurred capital expenditure of $1.9 million. Of which $1.7 million related to maintenance CapEx. Financing activities largely reflect drawing on $54 million of senior debt, primarily to fund acquisitions. In respect to AASB 16, the cash flow statement was impacted by the reclassification of lease expenses to interest and other financing cash flows. But as mentioned earlier, this did not impact cash flow conversion. Moving to Slide 20. There are 4 main points on the balance sheet. One, as that period end, Propel had net debt of $60.5 million. Two, the 71 freehold properties owned by Propel are held at cost at approximately $103 million. Three, in connection with AASB 16, Propel has recognized right-of-use assets of $40 million and lease liabilities of $41 million, resulting in an immaterial change to net assets. And four, Propel's prepaid contract funds totaled $48.5 million. The funds associated with prepaid contracts are largely invested with third-party friendly societies to invest the funds in cash and fixed interest. In accordance with accounting standards, the asset increases by the investment return generated during the reporting period and the liability increases by the financing charge. The difference between those 2 amounts is recognized in the income statement. The contract turned at need when the service is delivered at that time, revenue is recognized and the liability is extinguished. In the reporting period, approximately 9% of Propel's Australian funeral volumes were attributable to prepaid contracts that that turned at need, which was in line with the PCP. I note that there are no prepaid contracts in the New Zealand business. Turning to Slide 21. In respect of capital management, Propel expanded its senior debt facilities to $150 million, which now comprises of 4 tranches. Tranches A, B and C mature in August 2022 and tranche D matures the following years. After allowing for funds required for the Dils acquisition and the interim dividend declared, Propel had available funding capacity of approximately $65 million. And as at 31 December 2019, Propel remains comfortably in compliance with its debt covenants, reporting a net leverage ratio of 1.9x. I'll now hand over to Fraser, who will cover industry trends and acquisitions.

Thank you, Lilli, and good morning, everyone. Some of you may be familiar with the graph on Slide 23, which shows that the number of deaths is forecast to both increase and accelerate in the countries in which Propel has operations, namely Australia and New Zealand. In Australia, death volumes, which is the most significant driver of revenue in the deathcare industry, the ABS forecasted death volumes will increase to 2.5% per annum from 2018 to 2029 and 2% per annum from 2029 to 2050. And Stats NZ forecasted death volumes will increase to 0.9% per annum from 2018 to 2029, accelerating to 1.8% per annum from 2029 to 2050. Few industries have the benefits of the certainty of that sort of tailwind. However, that volume growth is not linear and can fluctuate month-by-month, quarter-by-quarter and year-by-year. The funeral industry is highly fragmented in both Australia and New Zealand, with Propel the second largest in both countries. Slide 24 highlights the more than fivefold increase in Propel's estimated market share in Australia, based on reported number of funerals performed and estimated deaths in 2019 from circa 1.2% in 2015 to circa 6.3% in 2019. However, it is worth noting that notwithstanding that significant increase, approximately 70% of the market is still owned by entities other than Propel and the largest operator. Turning to Slide 25. Propel remains focused on executing its acquisition-led investment strategy. Since its IPO in November of 2017, Propel has deployed and/or committed approximately $125 million on acquisitions. As illustrated in the table on this slide, the acquisitions in aggregate are on an annual basis, expected to contribute more than 5,400 funerals and over 3,000 third-party cremations to the group and over $49 million in revenue. The acquisitions are geographically spread across Australia and New Zealand, have brands with distinct identities and are well known in their respective markets. We are delighted that our new partners and their dedicated teams have joined or will shortly join the Propel network. In connection with the proposed acquisition of the Dils acquisition of the Dils Group, it is currently expected that this will complete by the end of this financial year, following the satisfaction of the various conditions precedent. Moving forward, management will continue to explore other potential acquisition opportunities, but the timing of any future acquisitions, as you would appreciate, remains uncertain. I'll now hand back to Albin.

Thanks, Fraser and Lilli. In terms of the outlook, Propel continues to be well positioned to generate sustainable long-term growth and value creation. The company operates in a fragmented and essential service industry with assets and infrastructure that are difficult to replicate, which stands to benefit from favorable demographic tailwinds. As a business, a guiding principle is to do the right thing by the deceased and their families. Propel supports any review that seeks to improve overall standards across the funeral industry. Although death volume growth is certain, unavoidable and predictable over the longer term, it's not linear, and it fluctuates over time. In other words, death is certain, but its timing is not. The company's positive trading momentum in the first half of FY '20 has continued into the start of the second half. In the first 7 weeks of 2020, Propel's total funeral volumes were materially higher than the prior corresponding period. However, it's still early in the new calendar year and given death volumes fluctuate, caution is required when forecasting over short time horizons. For the second half of FY '20 and beyond, we expect key growth drivers to include a growing and aging population, the recently expanded funding facilities, acquisitions completed prior to and since the start of FY '20 and other potential future acquisitions. In conclusion, and as I summarized at the outset, I think the 3 key takeaways from today's presentation are: one, Propel experienced significant growth in the first half of FY '20, with material increases in funeral volumes, revenue and operating earnings; two, Propel remains well positioned in what is a fragmented and essential service industry with favorable demographic tailwinds; and three, recently completed acquisitions and expanded funding facilities ensure Propel is well placed to continue its growth momentum in the second half of FY '20 and beyond. With that, I'll hand back to the moderator to invite questions.

[Operator Instructions] Your first question comes from Sam Haddad from Bell Potter Securities.

Congratulations on the strong result. Just first on the margin result. That's good to see that lift there with the volume recovery. And I also note that you'd flagged some improvement in gross margin, cost control and business mix. I just wanting -- wanted to work out what was the main driver there? Was it spread across all those factors? Or was one factor -- did one factor stand out between those.

Sam, it's Lilli here. So there was a number of factors. As you said, the releverage of funeral volume. So obviously, this time last year, we talked about the deleverage of volumes on margins. We've had an increase in volumes this year. And given the fixed cost base of the business, we've seen that releverage just fall to the margin, which has been pleasing. From a gross margin perspective, also a couple of positives there, some positive areas around sales mix and then just some of the recent acquisitions that we've completed have crematoria facilities, and they generate a higher gross margin typically. So it's a number of those factors that contributed to the margin accretion, excluding the impact of AASB 16.

And where do you think margins can get to given your current business mix if one assumes volumes continue to normalize?

Sam, I think we've previously said that excluding accounting changes that operating EBITDA margins tend to hover in the mid-20s. And that's, I think, nothing has changed from our perspective in that regard.

Yes. I'm just wondering because your recent acquisitions, from my understanding that got freehold and some crematorium methods. I would have thought there was some sort of higher mix benefit there over time.

Yes. Let's say potentially, Sam, but it is highly dependent, of course, on the profile, the financial profile of future acquisitions as well. So it's difficult to be too prescriptive.

Okay. And just can you talk about how widespread the volumes improved across your network? Was it -- were there any areas that dragged or which really where haven't you expected? Or was it sort of quite widespread?

Look, I won't go into too many specifics, Sam, but I think we've said that in most markets in which Propel operates, death volumes increased in 2019 following the prior year decline, and one example that we have called out is in Tasmania, where the registered number of deaths increased by 394 in 2019, following a decline of 484 in 2018. So I suppose that's a good example of what we consider to be a partial recovery in death volumes year-on-year. But as I said, in most markets where we operate, there was an increase.

And just related to in terms of your outlook, you've mentioned that you're materially up on a total basis, is organic volume also materially strong versus PCP? And also comment on your average revenue per funeral in the first 7 weeks.