Fresenius Medical Care AG & Co. KGaA (NYSE:FMS) Q4 2022 Earnings Call Transcript

Fresenius Medical Care AG & Co. KGaA (NYSE:FMS) Q4 2022 Earnings Call Transcript February 22, 2023

Operator: Ladies and gentlemen, thank you for standing by. I am Nicolas, your Chorus Call operator. Welcome and thank you for joining the Fresenius Medical Care report on Fourth Quarter and Full Year 2022. Throughout today’s recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by question-and-answer session. I would now like to turn the conference over to Dominik, Head of Investor Relations. Please go ahead, sir.

Dominik Heger: Thank you, Nicolas. Good afternoon or good morning depending on where you are. I would also like to welcome you to our earnings call for the fourth quarter. As always, I need to start out the call by mentioning our cautionary language that is in our Safe Harbor statement as well as in our presentation and in all the materials that we have distributed yesterday. For further details concerning risks and uncertainties, please refer to these documents and to our SEC filings. Due to the deconsolidation announcement, I have to add that we will be filing a registration statement with the SEC with respect to the conversion. The prospectus for the conversion will be available on the SEC website and will contain important information.

You should read the prospectus and other documents we file with the SEC for the conversion when they are available. With the Q4 results, we traditionally share an update on our strategic ambitions. Therefore, we have more to cover than in the other quarters. I’m aware that there is a lot of information from Fresenius and us to digest today. Given that we have only 60 minutes, we need to limit the number of questions again to two in order to give everyone the chance to ask questions. Should there be further questions and time left, we are happy to go a second round. It would be great if we could make this work again. With us today is Helen Giza our new CEO and Chair of the Management Board. Helen will start with insights in the new strategic aspirations followed by a short review of the quarter and the outlook.

Then we are happy to take your questions. I will now hand over to Helen. The floor is yours.

Helen Giza: Thank you, Dominik and a warm welcome to you all. It really is an honor to be speaking with you today as CEO of Fresenius Medical Care. And these are exciting times for sure as we embark on the next chapter in the company’s history and there is a lot I want to cover today as Dominik already mentioned. Before I start with my prepared remarks, I would like to take a moment to recognize the hard work and dedication of our great teams around the world. We are all united behind our common vision of creating a future worth living for our patients worldwide every day. I would also like to express my special thanks to our teams in the Ukraine and in Turkey. My thoughts and prayers are with all of those affected and I thank you for being on location working tirelessly to provide aid and helping our patients.

I will begin on Slide five with our strategic aspiration. As the new CEO, my overarching strategic aspiration is to unlock value as the leading kidney care company and to drive up shareholder return. Today, I will introduce the key elements of the strategy roadmap and we will also host the Capital Markets Day on April 19th to delve deeper into these topics. The right corporate structure is key in our ability to unlock value and we are taking important steps to simplify and optimize our structure. Since the first of the year, we have fully implemented our new operating model, reorienting to two globalized operating segments: Care Delivery, our health care services business; and Care Enablement, our med tech business. This new operating model not only provides increased transparency internally, but it will also bring enhanced transparency to our external financial reporting.

We will spend time detailing the new reporting structure, along with historical figures and future expectations, during our Capital Markets Day. As you will have seen in yesterday’s announcement, Fresenius is planning to deconsolidate Fresenius Medical Care. The necessary change in our legal form, will create a simplified, more agile and efficient governance structure, which will enable full independent decision-making and at the same time, strengthen the rights of our free float shareholders. I will speak more about that later. Another critical step, is taking a more rigorous approach to capital allocation. I have implemented a disciplined financial policy, to drive the much needed improvement in our return on invested capital. I am proud of what we’ve accomplished today, with our FME25 transformation program, and we will further accelerate and extend it within the new operating model.

In addition, we are implementing operational efficiency and cost reduction measures beyond FME25. And with a disciplined lens and focus on the core business, and improving profitability, we are further optimizing our portfolio. I will speak about what these measures entail for both Care Delivery and Care Enablement respectively, in a moment. Finally, I am a firm believer that culture eats strategy for breakfast. And none of these measures will be successful, if we don’t have a winning culture in place. This includes fostering a clear culture of accountability, and with the successful implementation of our global sustainability program through 2022, and we have laid a strong foundation to drive integration of sustainable principles into our business.

We have decided on new global sustainability targets for the coming years, focusing on enhancing quality of care and access to health care, reducing the company’s environmental footprint and building the best team to serve our patients. As part of this, we continue to promote diversity, equity and inclusion and I’m proud of the initiatives we continue to advance here. Next on, to Slide 6. As I mentioned earlier, our new simplified operating model went into effect as of January 1. Our two global segments now have complete end-to-end P&L responsibility. This new structure provides increased transparency, and enables us to compare directly to our peers. It also provides the basis to drive targeted improvements of our business performance. With our globalized and fully allocated G&A functions, we have the flexibility to scale these functions as needed, to provide an appropriate level of support to the respective segments.

And for me, it’s remarkable to see the difference the new structure has made already particularly around visibility and transparency, and it has opened up further possibilities to unlock value and improve profitability. This new model also positions us to truly realize the full extent of benefits from our vertically integrated business model. Next on, Slide 7. After simplifying the structure we are working with, the simplification of the structure we are working in, is an important step. The announced intent by Fresenius to deconsolidate Fresenius Medical Care and the proposed corresponding change of legal form to a German Stock Corporation would significantly simplify the governance structure of Fresenius Medical Care. With this change, we would move from a controlled structure with several decision-making Boards to a standard German two-tier system with one Supervisory Board and one management Board.

This will strengthen the rights of the free-float shareholders. One clear hurdle will be overcome with this proposed change. The KGaA structure has been a challenge for many investors. Turning to slide 8. In addition to the improved shareholder rights, there are important business relevant benefits too. This governance structure enables faster and fully independent decision-making, and it also provides more optionality on our future strategic direction. The change removes the operational and coordination burdens of us being part of a larger group organization. It frees up time and capacity of the executive and management team, and enables them to focus solely on Fresenius Medical Care. It also avoids potential conflicts of interest within the group.

The new legal structure enhances our flexibility to manage capital allocation and shareholder returns. It also provides us with an unrestricted approach to access capital markets from a financing perspective. With the conversion of the legal form, Fresenius will not be a controlling shareholder any more. Consequently, as a large German corporation, we would move from an indirect codetermination via the Fresenius Supervisory Board to a direct codetermination where all Supervisory Board members would be committed solely to the future of Fresenius Medical Care. With the separation, the credit ratings may not benefit from the group structure, with some rating agencies take into account. With our focused capital allocation priorities to which I come later, and our strong track record of deleveraging, we expect only limited weighting pressure resulting from the deconsolidation.

As a well-known issuer, we are confident to maintain our good access to the capital markets. We will also need to carve out in some, although rather limited areas where we share services with Fresenius in Germany such as G&A services for payroll, taxes or treasury, which are already contracted at arm’s length. And there will be an additional administrative activities needed to convert to the new legal form. An extraordinary shareholder meeting is required later in the year, currently assumed to be in July. The one-time costs associated and corresponding carve-out measures are assumed to range from €50 million to €100 million, which we will treat as a special item. And the final decision will require a 75% approval by our shareholders. We expect that the entire process of the conversion into a German Stock Corporation will be completed by no later than the end of this year.

Next on slide 9. Additionally, we are working towards strengthening our financial position, with a disciplined approach to capital allocation and improving our return on invested capital. Given our current leverage position and the high interest rate environment, deleveraging is our primary capital allocation priority. We are committed to maintaining our investment-grade status and to managing our net financial leverage in the self-imposed range of 3x to 3.5x. Any potential divestiture gains from portfolio optimization will be used for deleveraging. We are committed to a dividend policy in line with our earnings development. Consistent with the decline in earnings in 2022 we are proposing a 17% reduction in our dividend. And finally, with a laser focus on driving organic growth in our core portfolio, our investment activities will be limited.

We expect minimal acquisition activity and restrictively managing CapEx. Turning to Slide 10. I’m very excited about what’s been achieved to date with our FME25 transformation program as well as the extended opportunities to improve profitability. With particular acceleration in the fourth quarter, our FME25 program delivered sustainable savings of €131 million, well above our expected range for the year. Additionally, we have increased the scope of the program, largely comprising of additional opportunities to improve the profitability of our Care Enablement segments that continues to be heavily impacted by inflationary pressures. We now expect sustainable savings of €650 million by 2025 with onetime costs of up to the same amount. We expect incremental €120 million to €170 million sustainable savings in 2023, which will bring us to €250 million to €300 million exiting the year.

And to achieve this, we now expect onetime cost of €250 million to €300 million. Moving to Slide 11. With our new operating model in place, we now have clear line of sight and the leadership accountability in place to drive performance and run the segments like the two separate businesses that they are. This will allow for further operational efficiencies and portfolio optimization beyond FME25. On this slide, we have outlined our path to unlock value in each of our operating segments. In Care Delivery, our turnaround efforts are focused on productivity and efficiency measures. And in the US specifically, we have focused on labor stabilization, growth and improving our operating leverage and we have already started clinic closures. We have around 50 to 100 clinic closures in the US in our first wave.

We are streamlining our portfolio by exiting unsustainable international markets and divesting non-core service assets. In Care Enablement, our product margin has been severely impacted by macroeconomic inflationary and supply chain pressures and is falling short of our aspirations. To improve profitability, we are focused on pricing initiatives, productivity measures and reviewing our manufacturing footprint. We are also taking a hard look at our product portfolio and are in the process of rationalizing our global R&D programs and divesting non-core product lines. This will enable in the future a more focused capital allocation towards the areas of higher profitable growth in the core business. As I mentioned earlier, the proceeds from these disposals will be used to further deleverage.

With the move to the new operating segments, a reallocation of goodwill and the recoverability of goodwill is required. The current estimate indicates no impairment risk. I have flagged throughout the last year that our products business has faced significant margin pressure. And as the evaluation also takes into account interest rates, WACC and changes to the macroeconomic environment possible changes to those factors may result in a goodwill impairment in Care Enablement in the future. To be transparent about the potential risk, I wanted to share this reorientation of the goodwill calculations. Before I turn to our financial performance, I would like to emphasize that our strategic aspiration and planned initiatives are tangible. We are actively implementing and executing on these initiatives already.

This gives me the confidence for a recovery of earnings growth in 2024 and beyond, and I look forward to sharing more details during our Capital Markets Day in April. Now I’d like to change course and move to our fourth quarter business update on Slide 13. In the fourth quarter, we continue to deliver organic growth. Currency effects extended our revenue growth to 8% reported and 2% at constant currency. In line with expectations, our operating income declined by 8% on a constant currency basis and before special items. Our net income declined by 14% on the same basis. In the fourth quarter, our headwinds and tailwinds developed roughly as communicated. And as expected, our business development continued to be impacted by higher labor costs and macroeconomic inflationary pressures.

While the US labor market remained challenging, our labor stabilization efforts continues to drive gradual improvements in our labor KPIs. Next on Slide 14. On a constant currency basis, healthcare services delivered revenue growth of 2%. This was mainly driven by organic growth in EMEA and Asia Pacific. The North American region delivered stable organic growth and improvement from the third quarter, despite the impact from accumulated excess mortality, staffing challenges and capacity constraints in certain clinics. Revenue for the Products business was flat for the quarter, as higher sales of in-center disposables were offset by lower sales of machines for chronic treatments also resulting from delays from the lifted FDA shipment hold. Turning to Slide 15.

On a year-over-year basis, we experienced the largest margin contribution from business growth, including COVID effect. This was partly driven by reimbursement increases as well as a negative human site investment remeasurement effect in the fourth quarter of 2021. The most significant margin detractors were macroeconomic inflationary pressures, including labor cost increases and the year-over-year headwind from applied US provider relief funds. These headwinds were partially offset by the acceleration of our FME25 program, which led to higher savings in the fourth quarter. The FME25 one-time costs which we treated as a special item was also higher in the fourth quarter. Other one-time costs consist of the remeasurement effect of our investment in human sites and impact from the Ukraine war, which included the impairment of a production plans, resulting from economic sanctions imposed on Russia.

Next on Slide 16. The year-over-year decline in our operating cash flow was mainly due to the lower net income. However, the focus on lower CapEx resulted in a stable free cash flow development year-over-year. At 3.4 times net debt to EBITDA, we were at the upper end of our target leverage corridor and it is a priority for us to stay within this self-imposed range. For me, cash is king. And as I mentioned earlier, future deleveraging is at the top of our capital allocation priorities. Turning to our outlook on Slide 18. With our new financial reporting structure, and in line with our DAX peer group, we will now change to an annual outlook for revenue and operating profit. It’s important for me to continue to be transparent about the assumptions we are making.

And for 2023, I really want to focus on the key assumptions and drivers, of expected earnings development. Despite some stabilization, we are assuming a continued headwind of €200 million to €240 million from the inflationary cost environment, resulting from the annualization impact from these costs, plus although on a lower level, a continuation of the inflationary environment. This remains a headwind in particular in Care Enablement. As you know, we have many moving parts on labor. However, we are seeing gradual improvements in the challenging US labor market. And as outlined last year, of the defined labor cost headwind, a portion was expected to become a tailwind for 2023. And some of the permanent measures we implemented in 2022, were always expected to have an annualization effect We are assuming a merit increase of 3% to 4% across the globe.

Although we met all of these facts and assumptions it result in a labor cost headwind year-over-year of a €140 million to €180 million. In the US, we are assuming a broadly stable dialysis treatment following developments for the full year, that could range from plus 1% growth to a minus 1% decline. As I mentioned earlier, we are assuming sustainable FME25 savings of €250 million to €300 million by the end of 2023. And last year, as we all know operating income was supported by €277 million of US provider relief funds and we do not assume any additional funds will be made available in 2023. And to provide a comparable basis for our 2023 operating income outlook, we have adjusted the base accordingly. Next on, Slide 19. As always, our outlook is in constant currency and excluding special items.

In 2023, we expect low to mid-single-digit revenue growth. On the adjusted basis that I just explained on the previous slide, we expect a flat to high single-digit percentage weight decline for operating income in 2023 and from a phasing perspective, we do expect the low point in our operating income development in the first quarter. The first quarter is expected to provide only a mid-teens percentage share of the 2023 operating income. To help you with your 2023 modeling, we are assuming a tax rate of 25% to 27% and financial cost of €350 million to €380 million at constant currency. While 2023 will be a year of level setting, we are confident in our path to unlock value as the leading kidney care company. We expect to come out of 2023 stronger, and well positioned to drive sustainable, profitable growth with the recovery of earnings growth in 2024 and by 2025, with an improved operating profit margin of 10% to 14%.

And when you look at the 2025 margin aspiration, please keep in mind, that this includes the assumed strong revenue growth of our value-based care business, which comes with an incremental, but lower margin and therefore, dilutes the overall margin. With that, I know I’ve covered a lot. And I imagine, you have some questions for me and I’ll hand it over to Dominik, to begin the Q&A.

Dominik Heger: Thank you, Helen for the presentation and for many insights. And with that, I hand it over to Nicolas please open the lines for the Q&A.

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Q&A Session

Operator: Thank you, ladies and gentlemen. At this time; we will begin the question-and-answer session. The first question is coming from Graham Doyle from UBS. Please go ahead.

Graham Doyle: Good afternoon guys. Thanks lot for taking my questions. Just one firstly on this year’s guidance. So when I look to the pushes and pulls, you’ve kindly given us, it implies that there’s maybe $130 million of business growth in 2023 to hit the midpoint of your guidance. Is that fair? And how do you go by doing that? And then the extended FME25 program, if you hit the top-end of — if you do deliver that, so does that allow you to then hit the top-end of that 10% to 14% range? And should we assume that all cost savings drop through to the EBIT line? Thank you very much.

Helen Giza: Maybe I’ll take your second question first. In terms of the margin range for 2025, as I’m sure you can appreciate there’s a lot of these initiatives that I’ve outlined today that will gradually pay off between 2023 and 2025. And you’re absolutely right, of course, FME25 is a big piece of that. However, these underlying measures that I speak about in efficiencies on the productivity, improving the operating leverage, as well as certain pricing measures will also contribute to that margin expansion. Additionally, we do expect some reimbursement catch up here with PPS over this period through 2025, as well as the patient growth recovery. So I think what we can see is we’re looking at this three-year window is the combination of all of these measures coming and coming to fruition that gets us back closer to historical profits, but I think with a leaner more focused approach on the operations here.

With regard to the 2023 guidance, of course, the delta is business growth. Bear in mind that that labor number is a net number, which includes the merit increase as well. But, of course, what we were trying to do was just tease out the main headwinds and tailwinds, but of course there’s an underlying business performance here as well. And rather than just putting that in as a — maybe last year we had it in at a plug for everything else. We’ve just now, this year just trying to focus on the main pluses and minuses and it’s not meant to be a complete exhaustive list as I’m sure you can appreciate it.

Graham Doyle: Okay, super. Thanks a lot guys.

Operator: The next question is coming from Hassan Al-Wakeel from Barclays. Please go ahead.

Hassan Al-Wakeel: Thank you for taking my questions. I have a couple, please. Firstly, could you talk about the bridge to 2025 margin targets in the key building blocks to achieving this? What are your assumptions around pricing, wage inflation and cost out given, EBIT growth at the midpoint based on your margin target vastly outpaces revenue growth over this period. Secondly, could you talk a bit about the potential for disposals, where these could it perhaps in the Care Coordination portfolio or maybe some of the lower growth or margin regions? How long is this list? Is anything being assumed for 2025 in terms of the margin target? And how significant could it be?