Sigma Healthcare Limited (SIG) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Sigma Healthcare Half Year Results Briefing. [Operator Instructions] Please be advised that today's call is being recorded. [Operator Instructions] I'd now like to hand the conference over to your speaker today, CEO and Managing Director, Mr. Mark Hooper. Please go ahead.

Thanks, and welcome, everyone, to this morning's half year results. With me today is Jackie Pearson, who's our Group CFO; and Gary Woodford, our Corporate Affairs Manager. So just moving past the notice before I get into the results. As I flagged at the full year results, we ended the FY '22 year confident about further organic growth and with an increasing focus on business development opportunities. I'm pleased to say that we've made good progress on both fronts during the first half. In terms of the format today, I'll start with some brief commentary around business performance over the last 6 months, and then I'll hand you over to Jackie to take you through this in more detail. I'll then finish with some further commentary around operational performance and business outlook. Let's get straight into it with a brief overview of the business performance for the first half. Sigma continued to perform quite strongly, and underlying EBITDA was up 14.7% for the first half to $39.2 million. As in the first half of FY '21, there was no reliance on additional funding such as JobKeeper. It's worth noting, however, that while COVID-19 had a slight positive impact in the first half of last year, it was a slight negative impact in FY '20 -- in the first half of FY '22, mainly impacting sales and promotional income without the benefits of the spike in PPE sales we saw last year. We expect this impact to be slightly higher in the second half of this year, and I'll talk to that further later in the presentation. Total sales for the group were up by about 5.5%. And while part of this has been driven by the full return of the Chemist Warehouse FMCG volume, we still saw good growth across the rest of our business, remembering we're recycling above-market growth in the prior year. We have largely completed our business transformation process, and the balance sheet remains in good shape. And Jackie will talk about this more later in the presentation. Just as critically, our team member and customer engagement scores continue to improve, which has been a consistent theme for the last 2 or 3 years. I'll now hand you over to Jackie for a more detailed discussions on the results themselves.

Thanks, Mark. Turning to Slide 6 now. As already highlighted, Sigma has delivered a strong result in the first half of FY '22 with underlying EBITDA up 14.7% to $39.2 million. This is on the back of good revenue growth and reduced operating costs. Overall, sales revenue has grown by 5.5%, which includes 13.6% growth in wholesale pharmacy sales. Non-Chemist Warehouse sales have grown by 3%, reflecting strong growth from our retail brands, which were up 8.7% on a like-for-like basis. Wholesale pharmacy sales in the current period also benefited from the full run rate of sales from the Chemist Warehouse account, which fully transitioned back to Sigma in June last year. As a result, sales to Chemist Warehouse were up 46% compared to the prior year and are now achieving the full run rate that was expected when the return was announced. We've also continued to see strong growth in our hospital business with sales up 8.9%. These positive sales outcomes have been partly offset by lower export sales as well as lower sales in the personal protective equipment category as well as medical consumable product sales compared to the same time last year. This is further evident in our gross profit, which is reduced in the current year, reflecting a return to a more normal product sales mix following a spike in higher-margin PPE and second-line wholesale pharmacy sales in the first half of last year that was not repeated this year. We've seen an increase in the underlying other revenue, which has grown by 9.9%, primarily due to an increase in merchandise income. Whilst we're not back to pre-pandemic levels, we did see an increased level of promotional activity earlier in the first half compared to the prior year. This has been partly offset by a reduction in supplier rebates associated with lower PPE sales. Pleasingly, our underlying operating costs have reduced by 5.5%. Our warehouse and delivery expenses were down 3.4%, which reflects a decrease in our efficiencies and automations across the distribution network and an offsetting increase in volume growth, primarily from the Chemist Warehouse Group and also annual payroll cost increases. Sales and marketing expenses were down 24.5%. However, it's worth noting that the prior period was impacted by additional provision for doubtful debts as well as redundancy in transformation costs. When we exclude these items, expenses were down 4.9%, which was attributable to the cost efficiencies associated with our transformation programs. Our administration expenses were up 1.4%. However, this was impacted by the change in the accounting policy associated with Software-as-a-Service arrangements. Excluding this impact, expenses were down 6.6% due to cost efficiencies associated with the transformation programs as well as lower headcount. Finally, whilst net interest is relatively flat year-on-year, for the current period it includes $3.3 million for lease liabilities. Our actual debt interest was only $1.9 million, which is down 55% on last year, reflecting our lower net debt position as well as low interest rates. Turning to Slide 7 now. And as Mark has highlighted earlier, we're pleased to be announcing a fully franked $0.01 dividend per share. This represents a dividend payout ratio of 75% of underlying NPAT for the period. In terms of the share buyback, whilst it does remain an option for us, we are not currently buying. Our preference remains to pay fully franked dividends and invest in acquisitions that are aligned to our strategy. From a CapEx perspective, we still expect to spend between $55 million and $60 million this year as we conclude our infrastructure and IT transformation programs. For the sake of clarity, this includes our Software-as-a-Service project costs that are no longer captured as CapEx. Looking ahead, we expect business as usual CapEx to be around $10 million per annum. So we move to Slide 8. As is always the case, Sigma continues to have a strong focus on return on invested capital. Underlying ROIC is currently 9.8%, and we expect to close out the year above 10%. Our cash conversion cycle has remained steady at 31 days, reflecting an increase in wholesale volume as well as the timing of payments and receipts. We have invested in additional inventory during the pandemic and as we complete our IT and infrastructure transformation projects. Therefore, as these items conclude over the balance of this year, we expect our cash conversion cycle to return to the high 20s in FY '23. Finally, net debt at the end of the half was $82 million, and we expect month end debt to peak at around about $130 million towards the end of the year. Free cash flow will then reduce debt as we move into FY '23. Just moving through to Slide 9 now. In addition to delivering a strong financial result as part of our IT transformation program over the past 18 months, the Sigma team have been working hard to replace our legacy ERP system with SAP's S/4HANA. This has been included -- this has also included implementing a number of additional Software-as-a-Service applications as well as replacing our data and analytics platform. It's been an enormous undertaking and is, in fact, the largest SAP implementation that's taking place in Australia. Despite the significant challenges that have been imposed by COVID-19, the project was able to go live on the 29th of August within budget and broadly on time. Given the size and complexity of this transformation, we have experienced some operational issues during our hypercare period, which our team and our project partners are focused on resolving as swiftly as possible. Once these initial teething issues are resolved, we're confident that we will have the best IT infrastructure in the industry that will be a critical enabler for our future growth and success. I'll now pass back to Mark for an operational update.

So I think just a general comment on the result. I mean in difficult circumstances and cycling some benefits out of COVID last year, we feel really pleased that we've been able to generate growth of around 15% for the first half. And we're seeing the benefits, I think, of some of the reinvestment that's happened in the business. So let's turn to the next slide to walk you through a little more detail on some key areas of our operations, just starting with the pharmacy business. Jackie has already mentioned that wholesale sales were up by 13.6% for the first half of this year. Obviously, that benefited from the return of the CW FMCG volume. When you take that out, wholesale sales growth was around 3%, which is broadly in line with market. I think that's actually a much stronger result than it appears at first glance because you might recall when we were talking about the first half result in 2021, we benefited from customers who were using other wholesalers actually using Sigma when the pandemic was at its peak because our operations coped more efficiently with the spike in demand. So we were cycling some one-off spike in sales from last year. So the 3% is sort of taking that into account, and we're still in line with market. Within this, the trend of higher PBS sales offset by lower OTC growth has continued. You can see the PBS growth is around 6% and OTC growth down about 3% or 4%. Cough and cold categories are down. Export categories are down. So I think we were hopeful that, that would return in the first half of this year, but the trend we saw throughout 2021 has continued. Pleasingly, the like-for-like sales within our brands were again a standout, up by 8.7%, which is off the back of similar growth in the FY '21 year and around 12% in the FY '20 year. So we've seen very consistent growth in that over the past 3 years. I guess from a branding perspective, the pipeline of members is still strong. And in particular, the new brands we've been developing around WholeLife, which is a health foods-based concept; and Amcal+ Life Clinic, which is a more professional services-based offering with allied health care as part of that, have seen strong interest from pharmacists and provide us with further confidence around growth in the brands moving forward. Turning to the next couple of slides, which go through our expansion businesses. Hospitals have been comfortably delivering above-market sales growth over the past few years and again delivered another strong performance during the first half of this year. Sales were up by about 9% compared to market growth of 5%. It's worth noting that the overall market in hospitals was impacted by price erosion on some high-cost drugs, particularly biological products, and the COVID restrictions on elective surgery. Contract logistics has also continued to perform well. We're now at the point where we've had the need to invest in an additional 10,000 slots of pallet storage at our Kemps Creek facility in New South Wales, which is the main facility we use to support 3PL and 4PL work. And to broaden the base of opportunities that will be available to us in that space, we've recently got ISO accreditation, and we're also moving towards having GMP accreditation, which is well underway. Turning to the next slide. MPS, as you know, is our Medication Packaging business. We believe the MPS business is really well placed given it's one of the few TGA-accredited medication packaging services in Australia, I think more so post the Royal Commission into Aged Care, where quality accreditation standards will become more critical. We've invested in this business quite heavily over the last sort of 6 months, both in terms of packing equipment but also from a technology perspective, including upgraded eNRMC capability, which is basically electronic charting of medicines within aged care facilities. We're participating in the trial there that the government has had going, and we've got an end-to-end solution there that we're finding is being quite a powerful basis on which to attract new business to MPS. So we continue to be very confident about that business into the future, notwithstanding the fact that over the last 6 months, dose packaging into aged care facilities has been impacted by COVID-19 just simply because residential aged care numbers aren't as high as they were and getting access to homes to onboard new groups has been a little more challenging than it would have been without COVID-19. But we're still very confident about that business moving forward. As we've mentioned a few times during the presentation, MIA last year was the beneficiary of some additional sales of PPE during FY '21. And I guess the other fact there was these were generally of higher margins given the very high demand that was experienced in that sort of first and second quarter of last year. While there's still good demand for these products, obviously, given everything that's going on, supply has increased significantly over the last 12 months. It's a natural reaction to an increased demand for those sorts of products, which has lowered the absolute level of sales for MIA and also the margins that are available. So we're seeing that flow through into the first half results for this year. We still believe that the med cons and devices sector is an area of growth for Sigma, both organically and from an M&A perspective. So we'll continue to work on growing that business for the medium and longer term. The next slide covers some commentary -- some more specific commentary on the ongoing impact of COVID-19. From a practical perspective, we've worked really hard with community pharmacy, hospitals, aged care to manage the ongoing impacts of COVID-19 and I guess as part of that more recently to support pharmacies who are getting ready to deliver COVID vaccines on a broader basis. That's been accelerating over the past few months. With the Moderna vaccine coming in over the next few weeks, pharmacy will be involved at a much higher level. So we've been supporting them whichever way we can, including training and support. We've also been in regular contact with the TGA throughout the last 12 to 18 months and the Department of Health to manage ongoing supply challenges. And we've been very proactive in managing the impact on our Sigma team. It's not been an easy time for anyone in the workforce. And what we do at Sigma is make sure people get access to their medicines, so helping making sure that we help our team members cope throughout that period has been a key focus as well. As I mentioned earlier in the presentation, well, COVID-19 was a slight benefit in the first half of 2021, whereas this year, it's been a slight negative. The major impact, as I touched on, was from lower supplier income and reduced sales in certain pharmacy locations and the impact on PPE sales, which I've already mentioned. While both of these impacted FY '21, this has had a more sustained impact in the first half of 2022. And there's no offsetting benefit, as I said, that came out of the PPE sales or indeed the spike that we saw in March, April last year. Unfortunately, as we entered the second half, when we had more sustained lockdowns, particularly in New South Wales and Victoria, these impacts are going to be felt further into the second half of this year, and I'll touch on that when we get to outlook. Just turning now to some comments on strategy. The work we've done over the last couple of years has obviously delivered a more sustainable and efficient business. We're obviously in a position where we can now deliver organic growth, but it also provides a fantastic platform for future M&A activity. While we don't have anything to announce today, we have been much more proactive on the M&A front over the last 6 months. And in that context, the overall objective of delivering a mixture of organic and acquisitive growth remains. I guess that's only possible if you've got an engaged team that can execute on that strategy, and I'm very confident that we've got that at Sigma. The team has done a great job over the last 12 to 18 months in very difficult circumstances. So just a few concluding comments on outlook. You'll see here, we've included the commentary we gave at the full year as a reference point. We always like to be consistent in terms of the messaging we give to the market and the reference points we used. When we presented at the full year results, we were targeting underlying EBITDA growth of 10% for the next 2 years. Given the continuing impact of a number of factors, including COVID-19, we now think that will be closer to 5% for the current financial year. The target for FY '23 remains at $100 million. But given the uncertainty of the current environment, we've changed it slightly to be a range rather than a definitive number. I think current circumstances just make that too difficult to sort of pin yourself to a single number. So we've made it a range rather than where we were. We'll obviously have a better idea of what that looks like when we get to the full year results, and we'll provide a further update then. As Jackie has already touched on, we still believe that the FY '22 ROIC will continue to be above 10%. And the first half dividend is consistent with the announced target dividend payout ratio of at least 70% that we announced at the full year results. On the business development front, as I said earlier, we've been more proactive in recent times, and we'll be hopeful of finalizing another -- a number of these opportunities in the not-too-distant future. Jackie and I are now happy to take any questions.

[Operator Instructions] Our first question comes from Philip Pepe from Blue Oceans Equity.

Just a couple of quick ones. Firstly, on the costs, obviously, reasonable difference between the one-offs and the recurring, which you've carved out for us. Will there be more in the second half? Or is that -- those -- the one-offs largely now spent?

Well, we obviously continue to invest in the new ERP system, right? So we'll continue to have those costs that previously we would have capitalized but because of the change in accounting standards we're now expensing. So that will be the main one-off cost we've got into the second half, I would have thought. Jackie, any further cost...

A little bit of dual operating one-off costs associated with the finalization of elements of the DC optimization program as well.

Okay. And secondly, on the M&A front, obviously, there's other stuff going on in the sector at the moment. Does that change the competitive landscape for the M&A opportunities you're pursuing? Does it potentially take out a competitor? Or does it change the strategy at all?

No. I think, Phil, it's always been a competitive landscape in M&A land. And I think one of the things that we're seeing is for companies that have got a reasonable balance sheet, there's lots of people that are now actively pursuing growth. I mean we've always found it reasonably competitive in that M&A space, which is why we try and focus on assets where we can sort of speak to a vendor and sort of have that conversation outside a public auction if we possibly can. So no, I don't think the current circumstances changed that dramatically.

[Operator Instructions] Our next telephone question is from Ross Curran from Macquarie Group.

Jackie, it's probably for you. It's again on the same [ discussed ] topic. If we flip to Slide 7, that CapEx profile in the -- the gray color on the stack, is that what we should be putting through as one-off costs over the next few years? Is that how it plays through the P&L?

Yes, it will. So those gray costs, I guess, to keep it consistent in terms of what we're sort of spending, I guess, in terms of investing in improving our infrastructure and our operating platform, we've still captured in that CapEx slide, albeit obviously the change in terms of accounting policy means it will now be expensed through the P&L. So if you look at those gray bars, they are effectively the elements that are now Software-as-a-Service and will be expensed through the P&L and will be one-offs during that period.

Ross, this is one that's impacting a lot of people, right, because it's not an on-prem version of the software. I mean the way we look at it, we're investing in an ERP system that will support the business for the next 25 years. But because it's in the cloud rather than on-prem, right, the accounts have twisted themselves into knots and decided that should be written off. Of course, you don't hold the physical asset, right? So you see lots of companies reporting this impact both at the June half year and since, and ours is just a bigger number because we're physically in the process of doing the implementation, right? So we had to do the restatement for last year and this year. I mean I still think given it's going to have a benefit for 20 years, the right approach would be to capitalize it. But from a practical perspective, it just means we've got a couple of lumpy years where you put these one-off costs through.

The nature of IT spend is it never really goes away. There's always a new IT project once the current one finishes. Will the business be profitable at a reported profit number over the next 2 or 3 years?

Well, I would have thought so, yes. I mean think about it another way, Ross. If we had the physical computers on-site, it would be okay to capitalize it, right? So it's just a difference that's in the cloud that's sort of forcing this change. So it doesn't detract from the fact that you've invested in a software platform that will benefit for the business for the next 20-odd years. So I think you should trade it as an accounting anomaly rather than something that's sort of a fundamental indicator of a level of IT spend in the business. I mean we're not going to spend the better part of $50 million or $60 million every year into any IT systems.

Okay. Excellent. So the underlying profit number is the one we should be looking at, not the reported profit number?

Absolutely.

Yes. And then secondly, you can go back to the Phil's question before. How do you think your strategy needs to change, reflecting Wesfarmers' interest in the space?

Well, I think having someone like Wesfarmers potentially come into the space obviously means that changes the competitive dynamic slightly. I don't think it fundamentally changes our approach to the strategy too much, right? I mean we're obviously going to continue to try and optimize and grow the core pharmacy business and look for those adjacent opportunities that sort of diversify margin and income into other areas like we've outlined today. So I don't think it fundamentally changes the approach we'd take. I mean I guess there's a view about what Wesfarmers might or might not do to the competitive dynamic there, but I mean, it will take a while for that to settle down. So in the short to medium term, I think we're more aware that there's a change in that competitive landscape. But fundamentally, I don't think it changes too much.

Next telephone question is from David Stanton from Jefferies.

I'd like to go to the guidance and the change in the range or giving us more of a range in terms of the longer-term guidance from $100 million to $95 million to $100 million in underlying EBITDA. Just want to explore that. Is it purely due to the underlying effects or the longer-term effects of COVID? Or is there something else that's -- that we should be thinking about there, please?

That's the main driver, David. I mean I think in a perfect world, if we hadn't put the guidance out -- because remember, we put this guidance out originally 4 years ago, right? I mean I don't think we'd be going out past the end of this year given the uncertain world that we live in, right? So I think we're just reflecting -- the ranges simply reflect a high level of uncertainty in the world generally rather than anything specific.

Okay. Understood. But that said, should we get back to pretty much the status quo and no longer-term effects from COVID? And we all hope that happens. It's fair to say that the guidance really is still in that $100 million number or that...

That would still be the target, right?

Yes. Understood. Understood. And previously, you've talked to -- you've given us some color around D&A and interest for the full year. I note that's not in -- or if it is in the releases, I haven't seen it. Can you talk to that, please? Any color there would be greatly appreciated.

So D&A from an interest perspective? Or are you after...

So you talked last time to depreciation and amortization, you expected to see a moderate increase in 2022. Is that still the case? And interest, you talked to less than $5 million worth of interest in 2022. Is that still the case?

Yes. Absolutely. So debt interest was $1.9 million for the half year. So that's down quite considerably on last year. The comparative period was $4.3 million. So we do expect to be beneath that $5 million on an annualized basis for the full year in terms of debt interest. In terms of depreciation, it does include, of course, the right of use assets. So it was up slightly at $5.3 million, so up $0.9 million from the last period. And that really just reflects the sale and leaseback transactions completed at Kemps Creek and Berrinba middle of last year.

Understood. And finally, could you give us a clue as to what you think your market share is now in the hospital business given it continues to grow very strongly?

It would be in the low teens now, Dave. I think we talked about it being around 10% at the half year, so to be sort of comfortably in the low teens. Now I haven't got an exact number. We can chase that up for you, but yes, sort of around that sort of 12%, 13% would be my guess. I mean that business has grown quite strongly now for 4 or 5 years off a relatively low base, but we continue to see market share gains year-on-year.

Our next telephone question is from Gretel Janu from Credit Suisse.

Firstly, I just wanted to touch on the cash flow. So negative operating cash flow in the half. I guess what was really driving that? And when exactly do we expect that to turn positive?

Yes. So the negative operating cash flow was driven by the change in the accounting standards around those SaaS arrangements. So $17.1 million of expenses went through operating cash as opposed to investing cash flow, where it previously would have been recorded. If you exclude that, then operating cash flow was positive by around $8.5 million to $9 million.

Okay. That's helpful. But then just looking at gross cash conversion then relative to EBITDA, it's still quite weak. So expectations for when that will improve.