Sigma Healthcare Limited (SIG) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Sigma Healthcare Full Year Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I will now hand the conference over to your speaker today, Mr. Mark Hooper. Thank you. Please go ahead, Mark.

Thanks, Myles, and welcome, everyone, to the Sigma Healthcare results presentation for the full year ending January 2020. To say it's an unusual world we're living at the moment is a gross understatement, so we're doing things slightly differently this year. And can I just briefly apologize for the delay in getting the call up. There was just quite a few people trying to dial in. So we wanted to make sure we gave everyone the chance to get on board. So just moving into the presentation itself. As I said last year, it's never a dull day at Sigma, and it's continued over the past 12 months, and I suspect it's going to continue for quite some time yet, given everything that the entire country is going through right at the moment. And while there's been no shortage of challenges on the way through, we finished the year in a really strong position with the platform for growth that we would expect to deliver over the next 2 to 3 years. While I'll touch on the actual results over for the last 12 months, the drivers of this outcome really aren't relevant for the business into the future, so I'll pick them up in various parts of the presentation. And I will touch on a couple of the headline results, but the main focus of the presentation will be on the outlook for the business moving forward. So this next slide shows you to determine the detail that underpins the confidence we have in the future. Just quickly touching on the results themselves. Underlying EBITDA of $46.7 million was bang on line with guidance with ongoing sales growth, excluding Chemist Warehouse, of 8.5%, so a really strong result against a market that was probably broadly flat. This included like-for-like growth in our pharmacy brands that was even stronger at about 11.7%. We do think we provide a great solution for pharmacists. So being able to demonstrate double-digit growth on a like-for-like basis is a really strong validation, I think, of what we have to offer pharmacists through one of our brands or even through our independent offers. We've continued to invest in infrastructure, both warehouse and systems, and we've made good project -- progress on Project Pivot, which is our business transformation program. It was also pleasing to see against the backdrop of significant change, both our team member and customer engagement scores, both improved. So we're now close to completing the investment in our new DCs. We're also reviewing the possibility of a sale and leaseback structure, which would release value from the balance sheet not currently recognized by the market. So I'll work through all of those issues in more detail as we go through the presentation. When we presented to you at the half year, we actually -- we gave you a listing of all the things that you should expect out of the Sigma business in the next 6 months. So the next slide is designed to actually report against those undertakings we gave you at the half year. And overall, I actually think we did pretty well. When we presented at the half year from a revenue perspective, we told you that we expected to see a continuation of the growth rate we've seen in the first half, which is around 7% at the time. And non-Chemist -- and that was for non-Chemist Warehouse sales. And during the second half, you would see the exit of the remaining Chemist Warehouse FMCG product. In practice, we actually delivered stronger growth in the second half. So the 8.5% is for the full year. So the second half was probably closer to 9%, 9.5%. We've obviously ended up signing a new 4.5-year deal with Chemist Warehouse for their FMCG product. As a result of the Chemist Warehouse volume returning, you'll also note that we've had to reinvest some of the costs that we stripped out when we were building towards a full exit. That's understandable and still a business that gives us a return, but we just need to reinvest in some of the people and infrastructure to support that. Other revenue was broadly in line with what we would have expected. The only sort of slight miss was probably in terms of sales and marketing and admin costs, which did benefit from Project Pivot but there were some timing issues there. And so we're still likely to see the full benefits from the programs we've got in place, but they'll be delivered in FY '21 and '22 as a result of that deferral. Next slide shows a few key metrics from a capital management perspective. Our cash conversion cycle continues to reduce and finished at around 26 days by year-end. It's still impacted by the gradual exit of the Chemist Warehouse PBS volumes over the last 12 months. And I guess, in the medium term, we'd expect it to stabilize in the high 20s. It's still a significant improvement from where we were a few years ago. So it's important that we maintain that discipline in the business. A combination of continued investment in the year of reduced earnings has unfortunately impacted our return on invested capital. We'd expect it to show a gradual improvement in that over the next couple of years, in line with the improved earnings that we expect over that time frame. Just briefly on the CapEx front, we still have around 12 to 18 months to go to complete our DC optimization and ERP upgrade. After this, we'd expect CapEx to return to nominal levels of about $5 million to $10 million per annum in the medium term. Over the past 4 years, Sigma has invested a significant amount of capital in new warehouses and we've talked to you a lot about that in previous presentations. As we also flagged during that process, the decision was made to own the land and buildings both to introduce the level of gearing onto the balance sheet. We're effectively an all equity-funded business 3 or 4 years ago. But it also gave us the opportunity to control the overall design and build as we went through those various warehouse constructions. Our intention was always to review our longer-term capital structure we've got close to concluding the program. We're now undertaking that process. In total, we spent about $160 million on land and buildings, so that's excluding the automation. And based on indicative valuations, that's increased by over $100 million. So as we announced a week or so ago, we believe there's an opportunity to release balance sheet value not currently recognized by the market, and what that would do is reduce our overall debt levels and provide future capacity for growth. We haven't made a final decision yet. There's some chance that we may choose to only sell part of the assets. So we may look at a joint venture structure and just do a 50-50 joint venture. That really depends on, I guess, the attractiveness of the deal at the time. It's still, I think, appealing for us to have some level of control over those critical assets. So whether we choose to exit the assets completely or keep control, we still yet to make a call on that. So just to flag that there's a possibility that ends up being on parts rather than a whole exit. The objective here would be to complete this by the third quarter of this year. And it's pleasing to see we've already had 1 or 2 unsolicited offers that would be supportive of the valuations that we've indicated in the presentation today. Just a few slides now with some further detail from an operational perspective. As I mentioned in my opening comments, sales growth has been particularly strong over the last sales month -- last 12 months. Wholesale sales, ex Chem Warehouse, are up by 8.5% over last year with over $180 million of annualized sales coming from new customers. Importantly, that's been underpinned by a range of smaller customer wins rather than larger groups, which is a great reflection of the quality people we now have in the sales team. They've just done an outstanding job over the last 12 to 18 months, not only in bringing new customers on, but also building a pipeline of new customers into the new year. So whilst we've had strong growth over the last 12 months, we entered 2020 with a strong pipeline of new prospects, and we'll see that strong sales growth continue into 2020. Obviously, we've also been -- we've also announced in recent times, re-signing the Pharmacy Alliance contract, and I've already mentioned the new Chemist Warehouse contract. So we end up with a really strong sales platform essentially built into 3 pillars. There's the Chemist Warehouse pillar, there's the brand pillar and there's the independent pillar underpinned by our relationship with Pharmacy Alliance and our own offerings through PharmaSave and truly independent offering. So we're feeling very confident about the sales pipeline as we head into the new year. And as I mentioned in my opening comments, our customer engagement measure has been -- has increased by 39 points over the past 12 months. So a great validation from our customer base of the job that we're doing on the way through. Just touching a little more on the Chemist Warehouse contract because obviously this was finalized in November last year, so it's -- it happened between results. The contract covers FMCG products only, which was the portion that had previously gone to DHL and it runs through to the middle of 2024. We largely exited this business by the end of October last year when we effectively had exited it all. So we sort of had to turn ourselves around and start bringing them back on board. You can't do that in one big go, particularly as we're coming up to the -- up to Christmas, which is a busy period for the business anyway. We've been gradually bringing them back on board over the last few months. So around 60% of product has transitioned back with the balance completed by June this year. At full run rate, we'd expect sales to be around $800 million a year. That includes a portion from PBS sales as well because we're a second line supplier to Chem Warehouse on that front as well. And I guess the other benefit of having this contract now is when we look at our sales mix. It now means that around 50% of Sigma's earnings come from non-PBS activity, so we don't have that same exposure to regulatory risk that we did previously. Just looking at some more detail on our retail brands. As again, I mentioned in my opening comments, one of the really pleasing aspects of the results is the continued strong growth in like-for-like sales. I mean this has been a feature for us now probably over the last 3 or 4 sets of results. So like-for-like sales in the Sigma brands were up by 11.7%, so a really strong result. It would be remiss of me not to mention the fact that our Guardian brand won the 2019 Roy Morgan Customer Satisfaction Award. Again, a great reflection of how consumers are feeling about our brands. We also launched 2 new sub-brands during the year, first being the Amcal + Life Clinic, which is our allied health care pharmacy model. That's been a big success and created a lot of interest within the pharmacy circles where pharmacists are looking for their ability to offer a broader range of services as part of their pitch to consumers. And also the wholesale -- the WholeLife Pharmacy offer, which brings both pharmacy and health food options for pharmacists. And again, we've attracted a lot of interest from pharmacists who are looking for a differentiating factor for consumers. It's -- we opened our first store in Victoria just in the last few weeks, getting some really fabulous feedback from pharmacists and from consumers on both of those. I guess just in closing, it's worth reminding people that in the 600-plus pharmacies we have in one of our brands, we do represent around 20% of all the retail spend in pharmacy. So behind Chemist Warehouse, we would be comfortably the second most important group from a retail spend perspective. Just a couple of slides now on areas that we're looking in terms of diversification. We continue to push into the hospital space. Growth over the past 12 months, ex Hep-C, is around 26%. So again, this is a very consistent picture of strong growth year-on-year over the past few years. We're now about 10% market share across the country with our most significant market shares in Vic and WA. Now the hospital team has been doing a lot of work with our customers as we were in the COVID-19 environment. Obviously, making sure that hospitals are properly supported during this time has been a key priority for us. And I'm pleased to say that the feedback we've been getting has been really positive from our customers in terms of the service we've been able to provide during these difficult times. Another area of focus for us has been 3PL and 4PL business. So this is third-party logistics and fourth-party logistics, bulk storage and, I guess, admin support for manufacturers primarily. Our focus over the past 6 months has been to build further core capability in this space. Obviously, with Kemps Creek, our new facility in New South Wales opening up, we've got a significant amount of space now dedicated to this part of the business. But we've also been doing a lot of work in terms of building up our quality and services footprint. We'll be moving towards potentially TGA and GMP accreditation in some of our DCs over the next 12 to 18 months, which further expands the opportunities that we can take on. We did have a few customer wins during the year, but they weren't -- during the past 6 months rather, but they weren't ones that contributed significantly to earnings. I'm pleased to say we're in the process at the moment for a number of larger opportunities, which we would hope to have some success on over the next 6 months, and I can report to you on those in future presentations. I still think this is a really significant opportunity for us if we can get this one right. It's a $37 billion market. I'm not sure that everyone's happy with the way existing providers are sort of performing. So we think we've got a great platform to offer a unique proposition for people who are looking for perhaps more bespoke services. Another area where we're continuing to build a presence is in our dose administration business, MPS. While it has a significant presence in the aged care space, it remains a bigger opportunity in the community setting through pharmacy particularly given the age profile of the Australian population. Again, it's worth calling out all the great work these guys have been doing during the current coronavirus crisis. Obviously, aged care settings are more critical in terms of making sure that the disease doesn't spread in those settings. And these guys were on to it very, very early. So we've been -- we've had processes and procedures in place for quite a bit of time, both monitoring staff members and isolation and work practices to make sure we do everything we possibly can to protect the health of aged care patients. So as I say, the guys have really sort of taken their responsibilities very seriously and making sure that we can provide that ongoing support for our customers. Just a few slides now on business transformation and investment. I think one of the things I've been really proud of in the business, and I've made this comment in previous presentations is, whilst we have had some challenges in the business over the last 12 to 18 months, we have continued to invest in the things that matter. So I just want to take you through a few slides on that front. First of all, starting with Project Pivot, which is just to remind everyone, this is the business transformation program we developed in response to the decision to originally exit the Chemist Warehouse business. And our original target was to generate benefits in excess of $100 million. And I guess what we talked to people about was we were targeting to generate 60% of those benefits in the year that's just finished and the balance delivered in 2021. I'm pleased to say that this still remains on track both in terms of the overall quantum, and we've delivered on that target for the first year. I think the only thing I would say and we did -- I think we flagged this in the guidance that we put out to the market late last year, the additional effort that we've had to take on and bring back the CW FMCG business. And I guess, in the current environment we're in with coronavirus and off the back of the bushfires as well, there's going to be some timing slippage, I think, on some of the benefits. So as I say, well, we're still quite confident of the quantum. Some of it's probably going to bleed into FY '22. The bulk will still be delivered this year, but you might see some of it slipping to FY '22. But we're still very confident about the overall quantum. And it's been great to see how the team has sort of stuck to the execution task there. Next slide is just an update on our distribution center investments. And I've got to say, over the past 6 weeks, this has delivered in spades. I mean if you ever want to have a brand-new network that's delivering in line with what you expected it to do, the last 6 weeks is when you want to have it. Over the past 3 or 4 years, we've opened 4 new DCs. So we opened new DCs in Queensland, WA. And in the last 6 months, we've also opened up a new warehouse in South Australia. And literally in the last 2 months, a new warehouse in New South Wales. We've said to you before, these DCs add significant capacity and a more efficient operating platform. And in the current situation we're in, where somewhere like Kemps Creek that's been open for 2 months and had to handle double the volume that we're expecting, and it hasn't missed a beat. It's been absolutely fantastic to see. And it's nice to see reward for making long-term decisions that actually support what you need to do in the business. And there's no doubt in my mind, if we had the old infrastructure that we had, say, 3 or 4 years ago, we would really be struggling to cope with where we are right at the moment. But as we stand here today, the Sigma network is coping reasonably well with all that we have in front of us. And whilst part of that's due to the great effort of the Sigma team, the new platform that we had to operate from has been a huge benefit at this particular point in time. Equally important has been the continued investment in systems. The project to implement our new ERP system, which is SAP S/4HANA, kicked off early in February, supported by Accenture and Infosys. Along with the investments in our new DC infrastructure, I guess, this is the last significant investment we need to make in improving our base operating platform. We've continued -- we've also recently implemented a single CRM solution. We previously had a number of systems operating the business which produced a whole range of inefficiencies. So the new system sales force was deployed in early March. And I guess, both of these investments complement a range of other systems and investments we've made, including our customer ordering portal connect, which we upgraded a couple of years ago. So again, a reflection of our continued commitment to make sure that we've got the right infrastructure in place to support our customers. Just before I make a few concluding comments, I want to touch on a couple of key issues that are not only impacted Sigma but the broader community over the past few months. The first of those was the drought and the bushfires experienced over the Christmas breaking into the new year. Unfortunately, it now seems like a long time ago, but if you cast your mind back to that time, it was just an incredible impact on the Australian community in general. And it's also one of those times where businesses like Sigma because we are the invisible arms and legs that make sure patients ultimately get their medicines come to the fore. I mean we undertook a whole range of initiatives during this time, both separately and also partnering with Essential Services to make sure affected Australians still got their medicines. We worked with the armed forces to get medicines down to Mallacoota and things like that. So it's just a lot of great work done by a lot of people throughout that period. We also provided some direct financial support to affected communities and, in cooperation with our suppliers, got products to people who really needed it at a time of great stress for their community. So I'd say, it's a bit of a pity that maybe those people are forgotten in the current times, but it is worth reminding ourselves of how we all pulled together to address those sorts of challenges. And I guess, secondly, with one of the areas of greatest interest for people is going to be what's happening with COVID-19, which is obviously having a profound impact on everybody right at the moment. Obviously, given what we do, it's critical that Sigma remains operational. So this means minimizing ongoing business risks and supporting our team members as they do the very important jobs they've got to perform. So that's -- it's not always an easy balance to strike, but particularly for many of our team members working in production environments, both in the DCs and places like customer service, where it's harder to rotate people in and out. So the DC teams and the teams inside MPS and our customer service guys just been doing an outstanding job on the way through. And we haven't been able to perhaps give them the breaks that we would have liked, but they all understand these are challenging times, and we've got a very important role to play in the world that we live in right now. And whilst there's the odd complaint on the way through, we just had some great feedback from our customers and suppliers about that support that we've been able to provide. And I guess, just to give you some context about how that's impacting our business on a day-to-day basis versus what we would have expected to do from a volume perspective, march to date, and we're sort of about 3.5 weeks in the month is up by 80% from a volume perspective, and sales are up by around 50% on the same time last year. So a really significant increase in volume over the past few weeks. We obviously had to throw a lot of cost at that to facilitate that, which is fine. That's just what we need to do. It's probably not efficient costs we've added to the business because it's unplanned volume. Anyone who's got a logistics background will tell you, you can handle increased volume. But when it's unplanned, it's when it's always the most inefficient. So we've had to throw quite a bit of cost at it, but it has had quite a significant impact over the last few weeks. That said, and I touched on this when I was talking about the DCs, our DC network has been coping pretty well. If we get product in from suppliers, we're pretty much getting it away on the same day and having it available for patients on the same day. Our delivery runs to pharmacy. Again, there would be delays through the network, sometimes slipping to the next day. But again, pretty much we're hitting most of our delivery window. So our biggest challenge is just physically replenishing stock. Suppliers have got their own challenges at the moment. So beyond that, as I say, the Sigma network is actually coping pretty well. And to the extent there's any shortages in the stock positions we've got, because we do have some, it's largely timing rather than anything fundamental. I mean there's some obvious stuff like hand sanitizers and face masks and stuff where there is genuine shortages. But for most of the rest of the supply chain, it's just you've got strong short-term demand that we just can't match because we can't get the replenishment completely lined up with that spike in demand in the short term. But hopefully, a little like the supermarket situation. If we can see some reduction in that panic buying, we can see that leveling out. As I say, we're very confident we can play our role in making sure we get medicines to Australian patients as quickly as we possibly can. So just finishing with a couple of concluding comments on outlook. I mean consistent with most other businesses, we won't be giving any formal guidance for the current year. I mean the current impact of COVID-19 just makes that too difficult. The start to the year has obviously been stronger than what we would have expected, but it's not really clear for us just yet whether that is timing and whether that's permanent. Look, in the absence of that, we would have still expected reasonably strong growth for the coming 12 months. Our sales growth for February was about 9% or 10%, which is what we would have expected. It's obviously a lot stronger in March. So when we've got a clearer picture and we're able to sort of provide some sort of guidance, we will. But for the moment, we won't be making any statements about future earnings. We'll continue to progress options for the sale and leaseback transaction on the land and buildings we purchased for the new DCs. As we said a number of times, it's created significant additional value for Sigma. That will let us reduce our debt position and then that gives us significant flexibility for the business moving forward. And I do think that's a key advantage for the Sigma business. If you think about the wacky world we're living in at the moment, strong balance sheets will rule. And being able to free up that capital and put ourselves back in a strong position, I think, is a significant advantage for Sigma when we've already made most of the significant investments in putting in place new infrastructure that we need to do. I guess most critically, we will continue to focus on supporting our customers, suppliers and the government with whatever it needs to do from a COVID-19 perspective. I mean we have been in close liaison with the Department of Health and the Minister's office, as all the wholesalers have, to make sure we're doing whatever we can. The Sigma team's just done an outstanding job to support everyone involved in this process. And as an organization, we are committed to doing whatever we can to help the country through all of the challenges that we're facing right at the moment. So I'm happy to throw open to questions.

[Operator Instructions] Your first question today comes from the line of Tom Godfrey from UBS.

Can I just start with the March trading update and the 50% surge in sales? I'm just wondering what you're seeing in terms of the impact that's having on your operating margins. Is the fixed cost leverage you're getting through that offsetting the additional costs you had to throw in at all? Or what are you seeing in terms of that operating margin?

Yes. Clearly, when you get a surge in volume and you've got a large fixed cost base, there's some margin benefit. I guess the point I was just trying to make is when we've added back in labor and stuff like that, it's casual labor. So it's less efficient from a cost perspective, and it's not planned, so it's less efficient. But there's clearly some leverage from the fixed cost base.

So net-net, can we assume an improved percentage EBIT margin, I suppose, Mark, if I had to push it?

For the 3.5 weeks, that's happened, yes.

Okay. That's great. Just secondly, in terms of the net working capital reduction of about $180 million this year. I think the original target from transitioning out of the entire Chemist Warehouse contract was about $300 million. So can you just help us bridge that $120 million difference in terms of how much has gone back into the FMCG contract, and how much is just winning new business?

So look, I mean, at full run rate, I'm guessing, we'll end up with a receivable for Chem Warehouse of somewhere around sort of $70 million to $80 million is probably where it's likely to land. We've obviously had to reinvest additional working capital because our sales, separate to Chemist Warehouse, has grown so strongly. So that's probably another $20-odd million and the rest would just be timing differences, to be honest. But they would be the main factors.

Okay. Got it. And then just one final one. Just on the Project Pivot savings. So you're still confident in getting the gross $100 million of cost savings through that by FY '22. I'm just wondering what's the net figure once you do include the reinvestment from the FMCG contract?

Well, the net -- I guess, the net figure would be higher, right, because you got additional margin that's coming back. I guess that's the way you need to think about it. So you're not reinvesting the cost without making a profit that's higher. So to the extent you need to reinvest, you would be making more money. So if you want to think about in that context, the net benefit when it would be higher overall. But I guess, it's just a case of how you think about it.

Okay. Maybe just asking it a different way. What is the incremental sort of annualized OpEx to service that FMCG contract?

Oh, look, I couldn't tell you off the top of my head. But you can assume we wouldn't have taken it on if we weren't making some level of profit from it. So...

Your next question comes from the line of Philip from Blue Ocean Equities.

Firstly, congratulations on continuing -- well done on continuing to service the network during the challenging times. It seems like doing very well in the current conditions, which kind of reminds me the next PBS reform or next document was due very soon. This is obviously a reminder of the importance of the distribution in getting key drugs and medication to pharmacies. Has this changed? Or what's the latest on the latest negotiations with the government on the next agreement?