Earnings Call: H1 2017

Jul 13, 2017

Ladies and gentlemen, good morning. Welcome to the DKSH Half Year twenty seventeen Results Analyst Conference Call. I am Alice, the Chorus Call operator. I would like to remind you that all participants will be in a listen only mode and the conference is being recorded. After the presentation, there will be a Q and A session. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Thier Leisner, Head of Investor Relations of the DKSH Group. Thank you very much. Thank you, and good morning, Alice. Welcome, everybody, to the first half twenty seventeen results conference call of DKSH. Next to me, I have Stephan Buds, our CEO and Bernard Schmidt, 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. Then Bernhard will take over to walk you through the financial performance Before Stefan will present the outlook and his closing remarks, we will then open the lines for questions. And with that, Mr. Buds, I hand over to you. Ladies and gentlemen, good morning from Zurich. My name is Stephan Butz, and I would like to welcome you to DKSH Analyst and investor presentation on our 2017 half year results. It's 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've spent over 80% of my time on the road. DKSH is a real people business, so 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 2 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 the company is, do we need a new strategic direction? DKSH strategy It's 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 and in our outlook, You will agree there's 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 4 business units, we are active consolidators in a generally highly fragmented industry. There is still tremendous potential for DKSH. Therefore, we all agree, both in the Board of Directors and in the Executive Board, 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 and 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 DTAM KELA Services Asia and Siebe Higner, 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 To our employees, I'm deeply convinced team player and more than ever I will ensure that our capabilities are leveraged Together, so 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 year half year results. Net sales in the first half year of twenty seventeen increased by 3.8 percent to CHF 5,300,000,000. 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 138,800,000 EBIT increased by 2.3% compared to last year's level. Profit after tax was slightly above last year as well. And the free cash flow was 56,700,000, 35 percent up from 42,000,000. 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 Europe, Continence, 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 Vijaxana, 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. And we have managed to fill one other white spot on our map. Please note that this is a market entry only. In other words, to ensure long term success, 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. And as DKSH business model being based on scalability, this is a necessary step. A couple of words about the company. Vijayak SANA was founded in 'seventy three and has been listed on the Indonesian Stock Exchange since 'ninety four Distributes consumer goods and healthcare products in Indonesia. With 32 distribution centers across major cities in Indonesia And 8 70 specialists, the company generated net sales of more than CHF 60,000,000 in 2016. Of the 650,000,000 people in Southeast Asia, 260,000,000 live in Indonesia alone And around 90,000,000 people from the Indonesian middle class, a number that is predicted to increase to 130,000,000 by 2,030. Indonesia is set to become the world's 7 largest economy by then. These figures Tell you a lot about the medium and long term potential for DKSH in this country together with VJAK Zhanna as Our new platform for growth. Under the condition of course that we successfully built up the market over the next years. I would now like to hand over to our CFO, Bernd Hart Schmid, 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'm pleased to present to you the details of our half year result 2017. In the first half year, net sales increased by 3.8 percent to CHF 5,300,000,000. 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 138,800,000 was 2.3% above previous year. Profit after tax amounts to CHF 93,300,000. Despite the challenging market positions, our results are above last year. As you can see, we again demonstrated the robustness of our business model. The free cash flow in the first half of twenty seventeen was CHF 56,700,000 and there was above the previous year period. During the first half of the year, we paid our dividends of nearly CHF293 1,000,000. Nevertheless, our net cash position is still strong and amounts to CHF273,500,000 per end of June. Roanoke, 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 4 business units. In Business Unit Consumer Goods, net sales decreased slightly by 3.1 percent to CHF 1,800,000,000. 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 45,500,000 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 percent to CHF2.9 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 underpenetrated. 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 percent to CHF76 1,000,000. Let me move on to the business unit performance material. We achieved net sales of CHF449.6 million, an increase of 3.5 Compared to last year. The EBIT of CHF 37,400,000 was at last year's level. In 2016, the EBIT was positively impacted by the appreciation of the euro and the yen. Costs of specialty raw materials converted into euro and yen decreased last year due to appreciation of these currencies, resulting in higher operating profit. In the first half of twenty seventeen, 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 CHF185,900,000, 6.5 percent 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, Gerhard. Despite the challenging environment in several of our markets, I see substantial growth potential in the region over the next years to come. And 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 field 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 and 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 1st 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 So should they be value enhancing? Internally, we will continue to improve our processes and we'll 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, And 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. The first question comes from Mr. Roy Mackenzie from UBS. Please go ahead, sir. Yes. Good morning, everyone. It's Rory from UBS here. My first question is on the minus 3.4 percent revenue growth in Consumer, Well, 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. Now the market data still says it's tough, but doesn't show a big deterioration. So where have you seen the biggest declines coming? What's really changed versus H2 last year and what's pushed you into decline in the consumer? We see mainly reduction in demand in our big markets like Thailand and Malaysia. It's driven by consumer competence 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. So what we see as a GDP growth in Thailand, which looks quite impressive at 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. And if you look at The results of our of some of our big clients, you can also see how they are below the previous year growth. So this is unfortunately more or less in line with what is coming from their side. Our other markets, Especially the inter China ones are still growing very nicely and very quickly. So all in the long term, we are still quite optimistic on the consumer goods field. Okay, great. Thank you. And then, 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? I mean, 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. So it's a very successful company and we will, As I said before, we maintain our strategy to deliver growth for our clients and customer. So it's not that much about major change. It's more about fine tuning operations to improve that the strategy is Continuously or consistently, sorry, implemented across the region, make sure that we get as close as possible You know to our clients and build even stronger relationships to really make sure that we capture you know all of those growth opportunities. Okay, great. Thank you. And then just one on the margin, which held up relatively well given the weaker sales growth. Obviously, your EBIT includes EUR 7,000,000 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? So basically stripping out that gain on sale, please. So the gain on sales was a sale of infrastructure real estate piece, Which is in line with our asset line strategy. We have a couple of those smaller ones still around. So we sold that off. But 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 2 CEOs, we had what they put M and A projects, we had costs on due diligence. So we have negative effects as well. We onboarded very declined like P and G. So I think those would be netting off. If you ask which BUs, this was an infrastructure which was used jointly. So it's across the BUs. So I wouldn't consider this There's a change in EBIT overall if you do your modeling. Okay, sure. I can understand that 2 CEOs indeed is quite the expense. I'll leave it there. Thank you. The next question comes from Mr. Parker Foehrge from Vontobel. Please go ahead, sir. Good morning, gentlemen. So just a follow-up question on Thailand. So If I do the math, I imply like a slowdown of minus 4.8% in the first half year, so quite weak after Sequential improvements over the past half years, which we have seen. So just my question, did you lose market share there or any large Okay. Contracts, in addition, just to get a feeling how this happened. And then 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. And then my third question is with regards to your cash flow statement. So here, I saw an outflow to inventories of like €61,000,000 Was this related to the new contract such as Forscoch or Procter and Gamble, for instance, still? Or 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 results of the big modern trade Companies, we seem to be more or less in line with them. So 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. So 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. So yes, 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, etcetera? And on Indonesian acquisition, the company is coming in at low margin and when do you expect these margins to turn The group level. Thank you. Okay. PM, So 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 that offset plus or minus Depending what it is, usually in the finance result. So 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 say, as you correctly say, a relatively low margin acquisition. We will have to bring first the company on our levels. And then the in parallel we will have our BD teams trying to get more product and more clients in. We had interest in the past already from many clients for this country. So we are quite optimistic on that. And 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 an exact timeline obviously. Okay, understood. Thank you. Welcome. The next question comes from Mr. Josh Pudl, Berenberg. Please go ahead. Yes. Hi, good morning, everyone. My first question is on the margin in Healthcare. It's broadly flat looking year on year. You've had very strong top line growth there. So I just wondered is there are you seeing operating leverage in that business? And if so, what's offsetting that? And then could you comment on what you expect there for the second half? And then my second question, I just wondered how much longer Should we expect the dual running CEO costs to last? Thank you. Okay. So maybe on healthcare, I mean in healthcare we have seen very solid growth across all markets In Asia, the slight margin decline you are mentioning is driven by some The spillover effects from some legacy contracts and it's a mix issue between different margins and the product portfolio. As well as in 2016, as you know, we sold off 1 own brands business. Regarding the outlook, you know, we are very optimistic that, you know, healthcare is continued to deliver, you know, And I'm sorry, specifically on the 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 de la Grenz, Bank of America Merrill Lynch. Please go ahead, sir. Yes, good morning, guys. 2 for me, please. First one, just following up On the Thailand growth in the second half, which it was pointed out was almost minus 5% 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 Slow down in healthcare in Thailand as well or is it really just isolated to consumer goods? And then the second question is just On the Zirlig Pharma, your biggest competitor in the healthcare space, Obviously, has always 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 regard to a potential tie up with Zernig. Thanks. Okay. When it comes to healthcare in Thailand, That has been proven to be quite resilient. I mean, I think we said this in the past many times, if you're used to a certain level of health Care coverage, you will save anywhere, just not on the healthcare side. So I think that's what we see at the moment as well. Rather safe on consumer goods side than on the healthcare side. So we have seen no decline there, yeah. Okay. So it's basically a consumer good thing. For Suttig 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 are particularly strong in the Philippines and Indonesia and we are in the other markets. But obviously, I mean, would the company come officially for sale? We would be interested To look at it and talk, as of today, that is not the case. We assume that You know, they are dealing with the recent changes and making up their mind how they want to take the company forward. Thanks. That's very, very clear. And 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. Lovely. 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 health And the rest has been pretty much stuck. And you still seem to show the same pattern with a very weak growth in Thailand In the first half. So 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 you the asset allocation is going to pan out in light of this. And you discussed a bit of the view you on Zwelig, but Does 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 perhaps exiting some of your activities in the rest of the portfolio? Or if not, Could you give us a better sense of the type of investments that are required? We already see a bit more acquisitions being done. And you mentioned some start up costs as well. So just to get a sense of the growth potential in the non health care activities, which Currently are difficult to predict. And so 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. Then 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 quite very highly cash flow generational. So We have no limitation in allocating capital at the moment provided it gives me enough return on net operating capital, which we have done consistently in the past. So 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. Yes. So let me try to answer your point. I mean, 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 4 business units. And according to the strategy, it's our intention to grow all for GDP plus. In terms of consumer goods, please don't forget, yes, we are currently challenged You know, primarily in 2 markets, but we are still seeing growth in Indochina And in some other parts of Asia as well. And 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 and we are very optimistic Again, Oateson, those two business units medium churn. So we don't see any reason To switch the priorities, we will continue to support all 4 of them. And if you look at You know our cash flow and our strength on the balance sheet, this can be easily pursued moving forward. So 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. And then in terms of allocating, does that mean that today you're happy with the portfolio, therefore we should assume that Spread across the various unit and with no specific priority more opportunistically effectively. I mean, first of all, I mean, our focus is always on organic growth, and we will continue to invest into our Organic growth across those 4 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 and A. And I think historically on average, you know, DKSH has done 3 acquisitions per year. As you heard, we have done already, I mean, 3 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. And in terms of the allocation, I mean, we will always make sure that every acquisition will enhance strategic and financially And while you enhancing strategically or financially and look at every single one of them. Okay. Thank you. The next question comes from Mr. Daniel Hobden, Credit Suisse. Please go ahead. Good morning. Thank you. Just 2, if I may. Consumer Goods division, the margin appeared although up 10 basis points year on year, down 40 to 50 basis points from H2 last year. I was just wondering how should we think about that moving into H2 'seventeen and what are the component parts of that? And the second one is regarding the infrastructure disposal. And I think you mentioned an infrastructure light 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? Or is that as and when they become less relevant for you? Thank you. Okay. For the consumer good margins, at this stage, I would think Well, 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, but we would only sell them if we can of course get the right price. But it's not going to be big amounts any further. The biggest one we sold 2 years ago in Malaysia, which was more than €20,000,000 That was by far the biggest piece we still had in the portfolio. Okay, excellent. Thank you. Thank you. The next question comes from Nilu Bank from Goldman Sachs. Please go ahead. Good morning, gentlemen. 2 from my side. First on the M and 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 Azulik Pharma? And also that internally, do you have the right setup and the right people and infrastructure to manage the process? And secondly, a follow-up on the capital allocation. What can we expect in terms of shareholder returns? You've highlighted again that the progress of different policy Reiterated this morning, but what in terms of increased shareholder returns with your strong balance sheet? Okay. Maybe I start with the M and A question. I mean, yes, I mean we are working on building a very strong pipeline. As you know That is a process that takes some time and we always had a strong pipeline and there are Opportunities out there in the market, so we will further strengthen those and look at those opportunities. You need a strong pipeline to close at least You know a couple of deals and I'm very optimistic then at least we can keep the pace. In terms of having the internal resources, yes, I mean, there is a solid experience In acquiring organizations and integrating them into the DKSH family, so there is a solid team Available to support further M and A activities. In terms of capital allocation, I hand over to Bernhard. Thank you. So we have, as a company, always been committed to a progressive ordinary dividend increase year over year, And we tend to keep it like that. And that's the one thing we try forward. We have increased in the past our dividend Payout ratio, as you probably are aware, we're now we're going now up to 50% if necessary. And also what we always consistently said, if Consistently cash builds up on the balance sheet, we will consider a special dividend. But of course, that's at the end the decision by the shareholders. Okay, understood. Thank you very much. Welcome. Ladies and gentlemen, that was the last question. And this concludes today's conference. You may now hang up. Thank you very much.