Ladies and gentlemen, good morning. Welcome to the DKSH Half Year 2017 Results Analyst Conference Call. I am Alice, the conference call operator. I would like to remind you that all participants will be in listen-only mode, and the conference is being recorded. After the presentation, there will be a Q&A session. You can register for questions at any time by pressing star and one. The conference must not be recorded for publication or broadcast. At this time, it is my pleasure to hand over to Mr. Till Leisner, Head of Investor Relations of the DKSH Group. Thank you very much.
Thank you. Good morning, Alice. Welcome everybody to the first half 2017 conference call of DKSH. Next to me, I have Stefan Butz, our CEO, and Bernhard Schmitt, our CFO. Before we start, the usual comment, please have a look at the disclaimer of our presentation. Let me give you a quick overview of today's agenda. First, Stefan will briefly present to you the highlights of the first half year and provide you with some more insights about our recent acquisition in Indonesia. Bernhard will take over to walk us through the financial performance before Stefan will present the outlook and his closing remarks. We will open the lines for questions. With that, Mr. Butz, I hand over to you.
Ladies and gentlemen, good morning from Zurich. My name is Stefan Butz, and I would like to welcome you to DKSH Analyst and Investor Presentation on our 2017 half year results. It is an exciting moment for me today, as you can imagine, this being my first earnings call at DKSH. I have been with the company since the beginning of the year, first as a member of the executive board, and since the end of March as CEO. In this short period, I have visited 20 DKSH countries, met around 2,000 colleagues, and had exchanges with over 50 of our most important clients and customers. In total, I have spent over 80% of my time on the road. DKSH is a real people business. Feeling the pulse of employees, clients, and customers is extremely important and a top priority for me personally.
I can share with you that the handover was extremely well-planned. I got a personal introduction to our most important clients by our chairman. The two of us met with employees and business partners all over the world. The important question you have to ask yourself when you become the CEO of a company is, do we need a new strategic direction? DKSH strategy is very well-defined and openly communicated. If you look at our development or track record over the past few years, the company positioning the environment we are active in and our outlook, you will agree there is absolutely no requirement to change our strategy. We provide our clients with best-in-class outsourcing solutions, not just in one country, but across Asia and in different sectors. We help our business partners grow and gain market share in the most exciting markets of the world.
Through our four business units, we are active consolidators in a generally highly fragmented industry. There is still tremendous potential for DKSH. We all agree, both in the board of directors and in the executive board, that our strategic direction is right. In other words, expect an evolution and not a revolution. This does not mean, of course, that we will rest on our laurels. It rather means that we will continue to focus our efforts on streamlining internal processes. We will find new ways to synchronize and leverage the interfaces between clients and customers even better. Today, more than 30,000 specialists make up the DKSH family. 15 years ago, when DKSH was formed from the merger between Diethelm Keller Services Asia and Gebr. Hegner, that company had less than 14,000 employees. Since then, sales increased 2.5 times, and profits have grown more than 5-fold.
Keeping pace with this growth requires special skills. We owe our success to DKSH's strong leadership team and, of course, to our employees. I'm deeply convinced team player. More than ever, I will ensure that our capabilities are leveraged together. We will be able to ensure continuous improvement and put customer centricity at the heart of what we do. Having said that, let's now have a look at the 2017 half year results. Net sales in the first half year of 2017 increased by 3.8% to CHF 5.3 billion. We achieved this despite a challenging market environment, especially in the Consumer Goods sector. The lasting political uncertainty and high household debt levels in Thailand resulted in subdued consumer sentiment. In Vietnam, Myanmar, Laos, and Cambodia, however, DKSH grew strongly. Our business unit, Healthcare, grew sharply in nearly all countries.
At CHF 138.8 million, EBIT increased by 2.3% compared to last year's level. Profit after tax was slightly above last year as well. The free cash flow was CHF 56.7 million, 35% up from CHF 42 million. Not only has DKSH been able to achieve growth in all key indicators, the company has also improved its market position in Asia, and we continue to have a strong balance sheet. Organic growth has constituted the greater part of the increase over the past month. In addition, DKSH made 3 acquisitions in fast-growing markets in Southeast Asia and further drove market consolidation in Asia. At the beginning of the year, DKSH acquired Europ Continents Cambodia. The company is a specialized distributor of medical devices in Cambodia. Still a small market in absolute terms, but with very impressive growth rates. In Vietnam, we strengthened our field marketing business by acquiring Innovative Marketing Actions.
Last but not least, with the acquisition of PT Wicaksana, we achieved a strategic milestone. As announced 2 days ago, we will enter Indonesia with 2 of our largest business units, Consumer Goods and Healthcare. We have managed to fill 1 other white spot on our map. Please note that this is a market entry only. In other words, to ensure long-term success for our international client base, we now need to become established in that market. If we want to grow to a respectable size in Indonesia, this will require both some time, local knowledge, and investment. As DKSH's business model being based on scalability, this is a necessary step. A couple of words about the company. Wicaksana was founded in 1973 and has been listed on the Indonesia Stock Exchange since 1994 and distributes Consumer Goods and Healthcare products in Indonesia.
With 32 distribution centers across major cities in Indonesia and 870 specialists, the company generated net sales of more than CHF 60 million in 2016. Of the 650 million people in Southeast Asia, 260 million live in Indonesia alone, and around 90 million people from the Indonesian middle class, a number that is predicted to increase to 130 million by 2030. Indonesia is set to become the world's seventh-largest economy by then. These figures tell you a lot about the medium and long-term potential for DKSH in this country, together with Wicaksana as our new platform for growth. Under the condition, of course, that we successfully build up the market over the next years. I would now like to hand over to our CFO, Bernhard Schmitt, who will walk you through our results in more detail. Thank you.
Thank you, Stefan. Dear ladies and gentlemen, I also welcome you to our conference call. I am pleased to present to you the details of our half year result 2017. In the first half year, net sales increased by 3.8% to CHF 5.3 billion. The organic growth was 2.8%. 0.2% of this growth was derived from acquisitions. While currency fluctuations had a positive impact of 0.8% on net sales. The operating profit, EBIT, of CHF 138.8 million was 2.3% above previous year. Profit after tax amounts to CHF 93.3 million. Despite the challenging market conditions, our results are above last year. As you can see, we again demonstrated the robustness of our business models. The free cash flow in the first half of 2017 was CHF 56.7 million, and there is above the previous year period.
During the first half of the year, we paid our dividends of nearly CHF 293 million. Nevertheless, our net cash position is still strong and amounts to CHF 273.5 million per end of June. RONOC, the return on net operating capital, is a solid 24.2% and continues to be on a high level. Now, I would like to give you an overview of the performance of the four Business Units. In Business Unit Consumer Goods, net sales decreased slightly by 3.1% to CHF 1.8 billion. Continued political uncertainty and high household debt levels in Thailand, as well as the economic stagnation in Hong Kong, resulted in subdued consumer sentiment. The EBIT of CHF 45.5 million was slightly above the previous year. For the luxury goods business, DKSH continues its restructuring and improved results for this segment compared to last year.
Despite recent positive signals from the luxury market, we do not observe a broad-based upturn and therefore continue to drive our restructuring. Business Unit Healthcare reported an increase in net sales of 8.4% to CHF 2.9 billion, thereby recording net sales growth in almost all relevant Asian markets. This demonstrates how well our underlying business grows as most of the Southeast Asian healthcare markets are still highly under-penetrated. This means that pharmaceutical products are still not fully available to all consumers. Therefore, the healthcare business in the countries we are operating in continues to have a good growth potential. EBIT rose by 7.3% to CHF 76 million. Let me move on to the Business Unit Performance Materials. We achieved net sales of CHF 449.6 million, an increase of 3.5% compared to last year. The EBIT of CHF 37.4 million was at last year's low.
In 2016, the EBIT was positively impacted by the appreciation of the EUR and the JPY. Cost of specialty raw materials converted into EUR and JPY decreased last year due to appreciation of these currencies, resulting in higher operating profits. In the first half of 2017, we experienced the opposite effect. Adjusted for this effect, EBIT would have been increased in the first half of this year. Finally, I get to Business Unit Technology. In terms of net sales, we reached CHF 185.9 million, 6.5% more than last year. Especially in China, Taiwan, and Japan, we recorded a high demand for capital investment goods and analytical instruments. The order book for technological products shows higher deliveries of large projects in the second half. This should have a positive effect on the results for 2017. In summary, DKSH improved sales, profit, and cash flow compared to the previous year.
This is a good track record and demonstrates how robust our business model is. With this, I say thank you and give back to Stefan.
Many thanks, Bernhard. Despite the challenging environment in several of our markets, I see substantial growth potential in the region over the next years to come. What's more, Asia will remain the region with the greatest potential worldwide. Market Expansion Services is one of the most promising areas of the outsourcing industry, especially in Asia. In the fields of marketing, sales, and distribution, we see more and more clients consolidating the number of partners they work with. In other terms, instead of working with, say, 25 to 50 different local partners today as they now want to reduce this number to a small circle. DKSH is often part of that small circle. Our other growth drivers are the rising middle class, the increasing inner Asian trade, and the trend among our clients in general towards more outsourcing.
The fact that these three growth drivers have remained intact is basically one of the main reasons that we will stick to our proven strategy. Let's now come to the outlook. We will continue to grow, first and foremost, organically. We will continue to invest, in particular, to make out of our Indonesian entry another successful market for our clients. We will continue further acquisitions should they be value-enhancing. Internally, we will continue to improve our processes and will move forward with the restructuring of the luxury goods business. From today's perspective, net sales and profit growth should continue in 2017 for DKSH. We will further pursue our progressive dividend policy that has proven successful for many years. We will continue to follow our successful corporate strategy to help our clients and customers growing their businesses. Thanks for your attention, and we now look forward to your questions.
We will now begin the question and answer session. Anyone who wishes to ask a question may press star and one on the touchtone telephone. You will hear a tone to confirm that you've entered the queue. If you wish to remove yourself from the question queue, you may press star and two. Participants are requested to use only hands for asking a question. Anyone who has a question may press star and one at this time. The first question comes from Mr. Rory McKenzie from UBS. Please go ahead, sir.
Good morning, everyone. It's Rory from UBS here. My first question is on the minus 3.4% revenue growth in Consumer, where the trend is a lot worse than what you saw in the second half of last year, where I think if you ignore your contract exits, actually you're growing at high single digits. The market data still suggests it's tough, but doesn't show a big deterioration. Where have you seen the biggest declines coming? What's really changed versus H2 last year and what's pushed you into decline to Consumer?
We see mainly reduction in demand in our big markets like Thailand and Malaysia. It's driven by consumer confidence mainly, especially in Thailand, where we have a government which is still not able to install optimism into the economy and into the consumer confidence. What we see as a GDP growth in Thailand, which looks quite impressive with more than 3%, the projection at least, but that is mainly driven by infrastructure investments by the government. It's driven by increased exports and higher tourist arrivals. We expect that sooner or later, this should, with a time lag, translate into consumer confidence.
At the moment, at least, the growth is actually not on the Consumer side. If you look at the results of some of our big clients, you can also see how they are below the previous year growth. This is unfortunately more or less in line with what is coming from their side. Our other markets, especially the Indochina ones, are still growing very nicely and very quickly. Overall, in the long term, we are still quite optimistic on the Consumer Goods field.
Okay, great. Thank you. Stefan, as you started as CEO, what are your first priorities in the business that you want to change to improve and accelerate that sales growth?
First of all, I think DKSH is set up very well to capture the growth opportunities in the Asian market, short term and medium term. It's a very successful company, and we will, as I said before, maintain our strategy to deliver growth for our clients and customer. It's not that much about major change. It's more about fine-tuning operations to improve that the strategy is consistently implemented across the region. Make sure that we get as close as possible to our clients and build even stronger relationships to really make sure that we capture all of those growth opportunities.
Okay, great. Thank you. Then just one on the margin, which held up relatively well given the weaker sales growth. Obviously, your EBIT includes a CHF 7 million benefit from the gain on sale. Can you clarify what that was, which divisional margin that benefited, and what the underlying margin run rate into H2 is? Basically stripping out that gain on sale, please.
The gain on sales, it was a sale of infrastructure real estate piece, which is in line with our asset-light strategy. We have a couple of those smaller ones still around. We sold that off. Please keep in mind, these one-offs, normally, we don't report anything below 10%, because that's, for me, the normal variations we have. There are other one-offs on the negative side, like we had for a while, two CEOs. We had, for the M&A projects, we had costs on due diligence. We have negative effects as well, or we onboarded very big client like P&G. I think those would be netting off. If you ask which BUs, this was a infrastructure which was used jointly, it's across the BUs. I wouldn't consider this as a change in EBIT overall if you do your modeling.
Okay, sure. I can understand that two CEOs indeed is quite the expense. I'll leave it there. Thank you.
The next question comes from Mr. Pascal Burger from Vontobel. Please go ahead, sir.
Good morning, gentlemen. Just a follow-up question on Thailand. If I do the math, I imply a slowdown of -4.8% in the first half year, quite weak after sequential improvements over the past half years, which we have seen. Just my question, did you lose market share there or any large tail contracts in addition? Just to get a feeling how this happened. Maybe a second question. You mentioned the setup costs for new contract. Can you quantify them and do you expect any additional costs in the second half of the year? My third question is with regards to your cash flow statement. Here, I saw an outflow to inventories of CHF 61 million. Was this related to the new contracts, such as for Scotch or Procter & Gamble, for instance, still? What happened there? Thank you.
Okay. I hope I can answer all the questions and don't forget one. Thailand first. No, we don't think we have lost market share. If you look at the results of the big modern trade companies, we seem to be more or less in line with them. No market share losses. We did some portfolio management as well, of course, because if you have lower sales, you have to look into those smaller contracts, but that should have not had a major effect. On the setup cost, again, I really don't want to comment on these little plus and minuses in total. I just mentioned it before because the question came with a plus on the sale of real estate. Normally, we would not comment on this. That's why I don't want to go into details in this area.
On the cash flow side, clearly, we had an increase in inventories from new clients, and one you mentioned yourself. Yeah, your assessment in that respect is correct.
Thank you.
Welcome.
The next question comes from Mr. Sarikonda Srini from HSBC. Please go ahead.
Hi, this is Srini from HSBC. Could you give us some color on Performance Materials segment, please? How is the trading environment, pricing, et cetera?
On Indonesian acquisition, the company is coming in at a low margin. When do you expect these margins to turn to group level? Thank you.
Okay. PM. The trading, I have to say in general in PM, we see very positive development in practically all markets. As I mentioned, we have these currency impacts, which we have every year, which is then offset plus or minus, depending what it is, usually in the finance result. We have seen no change in the margin profile or actually we see very good growth in most, especially also the Asian markets. Indonesia, it's as you rightly say, a relatively low margin acquisition. We will have to bring first the company on our levels, and then in parallel, we will have our BD teams trying to get more clients in. We had interest in the past already from many clients for this country, so we're quite optimistic on that.
With that, economy of scale should start to work, and we should get step by step to our normal margin levels. I can't give you.
Okay
An exact timeline, obviously.
Okay, I understand. Thank you.
Welcome.
The next question comes from Mr. Josh Puddle, Berenberg. Please go ahead.
Yeah. Hi, good morning, everyone. My first question's on the margin in Healthcare. It's broadly flat looking year-on-year, but you've had very strong top-line growth there. I just wondered, are you seeing operating leverage in that business? If so, what's offsetting that? Could you comment on what you expect there for the second half? My second question, I just wondered how much longer should we expect the dual running CEO costs to last? Thank you.
Okay. Should I take that, yeah?
Maybe on Healthcare. In Healthcare we have seen very solid growth across all markets in Asia. The slight margin decline you are mentioning is driven by the spillover effects from some legacy contracts. It's a mixed issue between different margins and the product portfolio. As well as in 2016, as you know, we sold off one own brand's business. Regarding the outlook, we are very optimistic that Healthcare has continued to deliver significant growth rates in the years to come.
I'm sorry, specifically, can you comment on what you expect for the H2 margin in Healthcare?
As you know, we are not giving specific business unit guidance.
Okay.
The next question comes from Mr. Nicolas Delagrange, Bank of America Merrill Lynch. Please go ahead, sir.
Morning, guys. Two from me, please. First one, just following up on the Thailand growth in the second half, which it was pointed out was almost minus five in constant currency. We obviously know Consumer Goods in Thailand is weak. You've said that Healthcare, you had good growth in almost all markets. Is it fair to assume that there was a slowdown in Healthcare in Thailand as well? Or is it really just isolated to Consumer Goods? The second question is just on Zuellig Pharma, your biggest competitor in the Healthcare space, obviously has or is going through a bit of change at the moment, and your chairman has indicated in the past that DKSH would have a strategic interest in that business. I was wondering if you can comment on what your current thoughts are with regards to a potential tie-up with Zuellig. Thanks.
Okay. When it comes to Healthcare in Thailand, that has been proven to be quite resilient. I think we said this in the past many times. If you're used to a certain level of Healthcare coverage, you will save anywhere, just not on the Healthcare side. I think that's what we see at the moment as well. People rather save on Consumer Goods side than on the Healthcare side. We have seen no decline there.
Okay.
It's basically a Consumer Goods thing. For Zuellig Pharma, Stefan, you want to comment?
Yes, maybe, referring to what our chairman said in the past, it's one of our key competitors, even not in all of those markets because they're particularly strong in the Philippines and in Indonesia, and we're in the other markets. Obviously, would the company comes officially for sale, we would be interested to look at it and talk. As of today, that is not the case. We assume that they are dealing with the recent changes and making up their mind how they want to take the company forward.
Thanks. That's very clear. Sorry, just one on the Healthcare follow-up. You said there's no decline. Is Healthcare actually growing in Thailand?
It's growing, but not on the rates we would see in other countries.
Perfect. Thank you very much.
Lightly.
Welcome.
The next question comes from Mr. Aymeric Poulain, Kepler Cheuvreux. Please go ahead.
Yes. Good morning. Since the IPO, the group has not been growing at a very high pace, and most of the growth has come from Healthcare, and the rest has been pretty much stuck. You still seem to show the same pattern with very weak growth in Thailand in the first half. In terms of the strategic vision, you said there's no change in strategy, but I would like to have a bit more clarity on how the asset allocation is going to pan out in light of this. You discussed a bit of the view on Zuellig, but doesn't it make sense to focus on the Healthcare business, which is obviously the fastest growth business and the crown jewel in the portfolio, and perhaps think about exiting some of your activities in the rest of the portfolio?
If not, could you give us a better sense of the type of investment that are required? We already see a bit more acquisitions being done. You mentioned some startup costs as well. Just to get a sense of the growth potential in the non-Healthcare activities, which obviously currently are difficult to predict. Just to understand the rationale for adding investment in that part of the portfolio.
Let me first answer the capital allocation piece. The way we look at capital allocation is we want to see at least 15% return on net operating capital. We would look into acquisitions similarly, also to take on a new client, for example, because in that sense, it's the same. Allocation as such is not a problem at the moment because we are very highly cash flow generational. We have no limitation allocating capital at the moment, provided it gives me enough return on net operating capital, which we have done consistently in the past. This must be very clear that from that point of view, the way the business is structured with a solid cash flow all the time, capital allocation is not an issue. I can allocate to any Business Unit at the moment at least, whatever they need.
For the strategic piece, I pass to Stefan.
Let me try to answer your point. First of all, as I was saying in my few words in the beginning, we strongly believe in the medium-term, very strong market outlook for all of our four business units. According to the strategy, it's our intention to grow all four GDP plus. In terms of Consumer Goods, please don't forget, yes, we are currently challenged primarily in two markets, but we are still seeing growth in Indochina and in some other parts of Asia as well. I don't know if in Technology, for example, a growth rate of 6.5% or 3.5% in PM, I also consider as material. We are very optimistic, again, also in those two business units, medium-term. We don't see any reason to switch the priorities. We will continue to support all four of them.
If you look at our cash flow and our strength on the balance sheet, this can be easily pursued moving forward.
Perhaps, just to follow up, in terms of the use of capital and the balance sheet to produce that growth, does that imply that we should assume that the group is ready to do more acquisition or perhaps put more CapEx working capital at work to drive further growth first? Then in terms of allocating, does that mean that today you're happy with the portfolio, therefore we should assume that it's spread across the various unit and with no specific priority, more opportunistically effectively?
First of all, our focus is always on organic growth, and we will continue to invest into our organic growth across those four business units. In terms of acquisitions, yes, as we were saying before, this is still a fragmented market where there are opportunities to buy through M&A. I think historically, on average, DKSH has done three acquisitions per year. As you heard, we have done already three in the first half of the year, and one acquisition is a significant one with tremendous medium-term potential by entering the largest country in Southeast Asia for Consumer Goods and Healthcare. In terms of the allocation, we will always make sure that every acquisition will enhance strategic and financially and value enhancing strategically or financially and look at every single one of them.
Okay. Thank you.
As a reminder, if you wish to register for a question, please press star and one on your telephone. The next question comes from Mr. Daniel Hodel, Credit Suisse. Please go ahead.
Morning. Thank you. Just two, if I may. Consumer Goods division, the margin appeared, although up 10 basis points year-on-year, down 40-50 basis points from H2 last year. I was just wondering how should we think about that moving into H2 2017 and what are the component parts of that? The second one is regarding the infrastructure disposal, and I think you mentioned an infrastructure-like project and program. Does that mean we should see, or we could potentially see further one-off gains coming in the next or in H2 and into H1 next year? Is that as and when they become less relevant for you? Thank you.
Okay. For the Consumer Goods margins, at this stage, actually, sorry, we don't give forecasts on business units at all. You nearly got me, sorry.
Thank you.
On the infrastructure side, there are still a couple of assets, we would only sell them if we can, of course, get the right price. It's not going to be big amounts any further. The biggest one we sold two years ago in Malaysia, which was more than CHF 20 million. That was by far the biggest piece we still had in the portfolio.
Okay. Excellent. Thank you.
Thank you.
The next question comes from Milou Berg from Goldman Sachs. Please go ahead.
Good morning, gentlemen. Two from my side. First on the M&A, you alluded just before that the pace is picking up. What can we expect from here? Can you give any color on the pipeline? Are there bigger deals that you would still potentially pursue, outside, of course, Zuellig Pharma? Also internally, do you have the right setup and the right people, infrastructure to manage the process? Secondly, a follow-up on the capital allocation. What can we expect in terms of shareholder returns? You've highlighted again the progressive dividend policy reiterated this morning. What in terms of increased shareholder returns with your strong balance sheet?
Okay, maybe I start with the M&A question. Yes, we are working on building a very strong pipeline. As you know, that is a process that takes some time. We always had a strong pipeline. There are opportunities out there in the market. We will further strengthen those and look at those opportunities. You need a strong pipeline to close at least a couple of deals. I'm very optimistic, at least we can keep the pace. In terms of having the internal resources. Yes. There is a solid experience in acquiring organizations and integrating them into the DKSH family. There is a solid team available to support further M&A activities. In terms of capital allocation, I hand over to Bernhard.
Thank you. We have, as a company, always been committed to a progressive ordinary dividend increase year-over-year, and we intend to keep it like that. That's the one thing we drive forward. We have increased in the past our dividend payout ratio. As you probably are aware, we're going now up to 50% if necessary. Also what we always consistently said, if consistently cash builds up on the balance sheet, we will consider a special dividend. Of course, that's at the end, the decision by the shareholders.
Okay, understood. Thank you very much.
Welcome.
Once again, to ask a question, please press star and one on your telephone. Ladies and gentlemen, that was the last question. This concludes today's conference. You can now hang up. Thank you very much for your participation.