Earnings Call Transcript - HLN Q2 2023

Sonya Ghobrial, Head of Investor Relations

Good morning, everyone, and welcome to Haleon’s Half Year 2023 Q&A Conference Call. I'm Sonya Ghobrial, Head of Investor Relations, and I'm joined this morning by Brian McNamara, our Chief Executive Officer, and Tobias Hestler, our Chief Financial Officer. Just to remind listeners on the call that in the discussions today, the company may make certain forward-looking statements including those that refer to our estimates, plans, and expectations. Please refer to this morning's announcement and the company's UK and SEC filings for more details, including factors that could lead to actual results differing materially from those expressed in or implied by such forward-looking statements. We've posted today's presentation on the website this morning with prepared remarks running through the results in detail. So, with that, we'll go straight and open the call for Q&A. Thank you.

Operator, Operator

And our first question today comes from Iain Simpson from Barclays. Ian, your line is open. Please go ahead.

Iain Simpson, Analyst

Good morning, everyone. Two questions from me please. Firstly, that 7% to 8% full-year 2023 organic sales growth guide implies 4% to 6% in the second half, which is obviously in line with your medium-term guidance. Is that how you should think about it? You're basically booking the strong first half and just delivering on the algorithm in the second half? And in terms of the moving parts within that second half, there was some nervousness that tough cold and flu comps and respiratory might be an H2 headwind. Do you feel more relaxed about those now, or do you expect strength elsewhere in the business to offset tough respiratory comps in the second half? And then in terms of the second question, just wondered if we could unpick the moving parts in the margin. So you're guiding 7% to 8% organic, top line 9% to 11% constant FX EBIT, so margins adding 2% to 3% to EBIT. But then in terms of FX impact on the business, we seem to be looking at sort of 4% top line, 6% to 7% EBIT, so 2% to 3% drag from FX. So in terms of margins for the year, should we be thinking underlying margin delivery a little bit better than expected FX headwinds, maybe a little bit worse than expected? Net-net margins probably staying flat in line with your previous guidance? Thank you very much.

Brian McNamara, CEO

Thanks Iain. I'll take the first question, and I'll pass it to Tobias on the margin. So as you said, we had a very good first half and we feel good about the growth in the first half and the fiscal year outlook. I think there's two things in the first half that won't repeat in the second half. The first one you mentioned is cold and flu. If you look at the 22% growth we had in the first half, that contributed about two points to our overall growth. This outlook expects an average season, which would be below last year from a volume perspective. Now I want to be clear it's hard to predict cold and flu seasons these days, but we've taken an assumption that we believe is right at this point. So we're talking about volumes being down, but pricing largely offsetting that, resulting in roughly a flat category in the second half. Also, in the first half we did see strong growth in China with over 20% growth, particularly in Fenbid and Contac. We had good performance across the portfolio, which saw significant demand coming out of COVID lockdown. As a reminder, during zero COVID, those brands were actually on sales restriction because they treated COVID symptoms. Thus, as we move forward, it's critical to understand both dynamics at play in the back half. So, yes, you're right that the back half would imply 4% to 6%, and we're thinking about the dynamics there based on what we're seeing. Tobias?

Tobias Hestler, CFO

Yeah. So on the margin, we've said 7% to 8% on top line for the year 9% to 11%. I think that gives you a very strong underlying margin improvement. To clarify, that includes offsetting the transactional FX losses in the business. We had 60 basis points of margin improvement operationally that fully offset these transactional losses. So underlying is absolutely an upgrade and an improvement is coming through on the margin from the strong performance in the business. FX depends a bit on how you build that into your models. The consensus was around 5% to 6% constant exchange rate growth. Our improved guidance is 9% to 11%, so at the midpoint, you should expect four to five points of profit growth. Then, we must deduct the incremental translational impact, which is about 6.5%. So we expect a slight downward adjustment on adjusted profit growth.

Operator, Operator

The next question comes from Guillaume Delmas from UBS. Guillaume, your line is open. Please go ahead.

Guillaume Delmas, Analyst

Many thanks. Good morning, Brian, Tobias, and Sonya. Two questions for me please. The first one is on pricing. I was wondering what the outlook was for pricing as we think about the second half. Specifically, are you planning additional pricing actions, or would you be looking at some downward price adjustments, maybe increasing promotional activities to maintain your competitiveness and possibly improve your volume share momentum? I noticed that 55% of your portfolio was gaining or holding shares at the end of the first half versus two-thirds at the end of last year. Any color on that would be helpful. My second question is on translational FX because it’s looking like it will be a significant headwind this year that you'll be able to mitigate. But big picture wise, how should we think about this impact? Is it the case of trying to offset it when it goes against you and letting some of the benefit fall through to the bottom line when translational FX is more favorable? For instance, if we were to see some reversal next year, should we expect better than moderate margin improvement in 2024? Any insights on your mindset regarding translational FX would be very helpful. Thank you.

Brian McNamara, CEO

Great. Thanks, Guillaume. Let me address the question on the 55% share, then I'll pass it over to Tobias to discuss pricing in the back half and the big picture. Yes, year-to-date, we are at 55% of the business maintaining and gaining market share. We have seen that number strengthen in recent months. There is a positive trend there. But as you mentioned, this is a value share measure. Earlier in the year, we were impacted by the timing of price increases. For example, in our US business, we took price increases towards the end of Q1, while some competitors took them earlier. We are now back to strong share growth. Promotions tend to be low in our business strategy as we invest more heavily in other consumer touchpoints. We don't anticipate changing this strategy and OTC generally is a lower promoted category. Tobias?

Tobias Hestler, CFO

For the pricing outlook in the second half, it will likely carry over from what we've done in the first half. We did increase pricing during the second half of last year as well. In emerging markets, we will keep pricing up where we can and would look at adjustments if opportunities arise but I wouldn't expect widespread further pricing increases. Brian has clarified the promotional question on pricing, so I wouldn’t anticipate changes there either. Regarding translational FX, I can't plan for that. What I can say is we've guided and made adjustments based on profit growth expectations in CER, and I'll update you quarterly about the translational impact.

Guillaume Delmas, Analyst

Thank you.

Operator, Operator

The next question comes from Rashad Kawan from Morgan Stanley. Please go ahead.

Rashad Kawan, Analyst

Hey. Good morning, Brian and Sonya. Thanks for taking my questions. Just two for me please. The first on VMS was positive in Q2 but in the present, as you mentioned, you expect continued pressures on immunity in the U.S. with emergency situations specifically. Does that alter your midterm outlook on VMS for mid- to high single-digit growth overall? And then, just a second question on consumer behavior broadly. Are you seeing any changes in terms of behavior or any shift towards private label particularly in Europe, especially as you've taken more pricing? I know volume dynamics still seem robust, but any color you can shed would be great. Thank you.

Brian McNamara, CEO

Great. Thanks Rashad. So first on VMS, we were down 3.7% in Q1 and up 2.7% in Q2, leading to a full year decline of 0.5%. Breaking this down across regions, we see mid-single-digit growth in Europe, Middle East, Africa, and Latin America but double-digit declines in North America, influenced by capacity coming online last year and a change in consumer behavior regarding immunity, reverting back to pre-COVID levels. The VMS category had strong demand during COVID spikes, which is expected to normalize back to a healthy mid-single-digit growth rate. For consumer behavior in Europe, we aren't observing significant changes. There is very little private label in Oral Health, and in the OTC business sold through pharmacies, we see little impact from private label products. Monitoring the situation closely for any shifts, but we've observed categories holding up satisfactorily.

Tobias Hestler, CFO

Rashad, I think you noted no visible changes regarding private label in our category. In aggregate, private label shares are slightly down across most of our categories, despite some subcategories showing slight increases. There aren’t noticeable shifts in consumer behavior regarding private label when they are in front of the shelf.

Rashad Kawan, Analyst

Thank you very much.

Tobias Hestler, CFO

Thank you.

Operator, Operator

Your next question comes from Chris Pitcher from Redburn. Chris, your line is open. Please go ahead.

Chris Pitcher, Analyst

Thank you. A couple of questions. Firstly, on China. Thank you for the extra detail in the presentation. Can I just make sure I've got the messaging right for the second half? Growth moderated but was still double digits in Q2 based on your disclosure. You're talking about a normalization in Fenbid, but it looks like there's still strong opportunity amongst VMS. Could you talk a bit about Oral Health and how you'd look to grow that in terms of the strength of local and international competitors? And regarding your raised full-year guidance, does that still imply double-digit growth in China in the second half? Secondly, regarding the Lamisil divestment, could you give us an idea of the sales and profit impact, including the cash impact from that? Thanks very much.

Brian McNamara, CEO

Thanks, Chris. I'll take the first question and then pass it to Tobias. So as you said, we had a strong first half in China with over 20% growth, primarily benefiting from the easing of the COVID lockdowns, particularly for Fenbid and Contac. Our VMS business also remains strong. With respect to Oral Health, we noticed a continuing decline in the category at the year's start but expect stabilization in the back half. We feel confident about Sensodyne in China, though competitive dynamics with local brands must be considered seriously. In reflecting on the back half of the year, we anticipate positive outcomes but will have less impact from prior COVID restrictions. Specific guidance on that, however, we won’t provide just yet.

Tobias Hestler, CFO

On the Lamisil divestment, it was £54 million in revenue last year, yielding a very healthy gross margin as an OTC brand and low advertising and promotions costs. We expect a negative hit to operating profit and margins from the £54 million, but we sold it at a very favorable price which accounts for a revenue multiple of 4 to 7 times. For the sales decline, it's minor, and we expect to offset this negative impact on profit with benefits from the productivity program next year.

Chris Pitcher, Analyst

And just as a follow-up, should we expect similar brands potentially to come out, or are you done now with divestments?

Brian McNamara, CEO

No, as I've previously stated, we're active with our portfolio. You've seen us divest Lamisil at a good price, confirming we found a better owner for that brand. It’s important to maximize value for all our approximately 100 brands, and we will assess the market for opportunities but can't predict the outcomes of those evaluations. Expect us to remain active, and we'll communicate any relevant developments.

Chris Pitcher, Analyst

Thanks very much.

Operator, Operator

The next question comes from Alicia Forry from Investec. Alicia, your line is open. Please go ahead.

Alicia Forry, Analyst

Hi. Good morning, Brian and Tobias. A couple of questions from me. Could you update us on the inflationary picture across your operating cost base beyond cost of goods sold? Any color would be helpful. Regarding A&P spend, I assume given the market share performance that you're positive with your current A&P spend versus sales. Should we expect any changes in the growth rate of A&P relative to sales going forward in the near term? Thank you.

Brian McNamara, CEO

Tobias?

Tobias Hestler, CFO

On inflation, to start with commodities, there has been some stabilization, but we haven't seen product prices come down significantly. Sugar and orbital prices remain very high, while packaging has decreased slightly but remains above previous pre-inflation levels. Beyond that, we are closely monitoring labor costs due to inflationary pressures. From what we have seen, we managed strong operating leverage in the first half to offset costs quite well through pricing and efficiency gains. Regarding A&P, we are satisfied with our current percentage of revenue. We increased our consumer-facing A&P spend by 8%. Investment behind our brands is healthy, and we would anticipate a balanced approach to maintain this spend relative to organic sales growth across the board. While we will pursue efficiencies in non-consumer A&P as well.

Alicia Forry, Analyst

Thank you.

Operator, Operator

The next question is from Iain Simpson from Barclays. Iain, your line is open. Please go ahead.

Iain Simpson, Analyst

Thank you so much for allowing this first question. I'm going to be cheeky and ask another two questions if I may. Firstly, could you just remind us how we should consider working capital seasonality? This is something to get our heads around being a relatively new company. Typically, we see working capital outflow in the first half and inflow in the second half for consumer companies. Would you be any different, or how should we think about that? Secondly, regarding your efficiency program, you're discussing substantial gross savings. You also mentioned that you think A&P is in the right place as a percentage of sales. I'm curious about how we should view where those efficiency savings will go. Will they go back into the business? If so, where, given your comments on A&P, or how much might translate to the bottom line in the medium-term? Thank you so much.

Tobias Hestler, CFO

Thanks, Iain. Regarding working capital, we align with your observation. In the first half, we typically see working capital outflows driven by building inventories for the cold and flu season in Q3. This year was pronounced due to high sales growth. Our days sales outstanding improved from 55 to 50 days in the first half, reflecting our sell-through. Generally, you can expect working capital outflow in the first half and inflows in the second half. As a result, we anticipate stronger free cash flow performance in the second half. Also, regarding cash flow, I wanted to note that for this year, we are accounting for interest costs, given that payments are on an arrears basis, which has normalized alongside the cash tax situation.

Brian McNamara, CEO

On your question about the efficiency program, as previously communicated, we are targeting £300 million in gross savings, mainly occurring in 2024 and 2025. As previously discussed, we believe our A&P allocation is appropriate for this year. Moving forward, we'll provide guidance on what that looks like, but that £300 million offers flexibility as we evaluate opportunities for growth against the right return profiles. If we identify more growth opportunities, we will allocate effort strategically, but this will be further clarified at year-end as we get a better picture.

Iain Simpson, Analyst

Thank you so much.

Operator, Operator

The next question is from Olivier Nicolai from Goldman Sachs. Nicolai, your line is open. Please go ahead.

Olivier Nicolai, Analyst

Hi, good morning Brian, Tobias, and Sonya. Just two questions on my side please. First, regarding China and Sensodyne. Growth last year for Sensodyne was affected by the lockdowns, and Oral Health was impacted in general by restrictions. How are we comparing it to pre-COVID levels? Is there much of a catch-up for Oral Health to be done in China? Secondly, Tobias, you are expecting strong growth for this year compared to the beginning. Your cash flow tends to be stronger in H2. You've done one divestment at a favorable price, and most of your debt is in dollars, which is weakening. Can we expect your net debt to EBITDA to drop below 3 times maybe at the beginning of 2024, still within guidance or even at year-end? Thank you.

Brian McNamara, CEO

On China, we are seeing some softness in that category. Our decline is slightly less than the category overall, so there is some share growth noted. We anticipate stabilization in Oral Health. Throughout last year, we were expecting better performance, and now in the back half, we hope to see the category held more consistent. Regarding the overall performance, we fully expect to improve as we see less impact from past restrictions.

Tobias Hestler, CFO

Regarding leverage, we expect it to be below three during 2024. The divestment strengthens our confidence in reaching this goal. As mentioned, we can see currency benefits with our US dollar debt. However, adjust this also against the adjusted EBITDA as translational currency impacts must also be considered. A bit of an offset is expected in the immediate future, but over time, this will generally balance out.

Olivier Nicolai, Analyst

Thank you.

Operator, Operator

The next question comes from Bruno Monteyne from Bernstein. Bruno, your line is open. Please go ahead.

Bruno Monteyne, Analyst

Hi, good morning. Tobias, I just want to come back to something you mentioned earlier; investors might not want A&P to grow beyond your 10% organic sales growth. I don't recognize that sentiment. Many investors would prefer A&P to be increased ahead of sales growth if it strengthens future growth through operating leverage. Was this just a brief observation? How do you view this in the medium and long term?

Tobias Hestler, CFO

Thanks, Bruno. That's a fair point. It was intended as a short-term comment. When we're experiencing benefits in the short term, we shouldn't be spending aggressively on A&P during those high-growth periods. Long-term, as previously stated, we absolutely want to invest more in A&P to capitalize on growth opportunities.

Operator, Operator

The next question comes from Tom Sykes from Deutsche Bank. Tom, your line is open. Please go ahead.

Tom Sykes, Analyst

Yes, morning. Thank you. I wanted to clarify some details about the APAC margin, as I noticed minorities were up significantly, even by around 60%. Most of that I thought related to your joint venture in China. Could you explain what's happening with profitability outside of the JV? Also, could you remind us what portion of the joint venture's revenue is factored into that minority?

Brian McNamara, CEO

Sure, Tom. The joint venture in China encompasses the over-the-counter medicines business, contributing about a third of sales in China. We saw a significant increase in revenue due to the strong demand for Fenbid and Contac as restrictions eased. While that performance yields shared revenue with our JV partner, it ultimately enhances our production capabilities. This strong performance in the first half was influenced by local production, which runs continuously. Thus, we saw a rise in minority interest, especially compared to our overall region margins.

Tom Sykes, Analyst

Okay. Thank you.

Operator, Operator

As we have no further questions, I'll hand the call back to Brian McNamara for closing remarks.

Brian McNamara, CEO

Great. Thanks everyone. Appreciate your time and questions. As we said, we feel great about how the first half has gone, and we're confident in the outlook that we laid out today. I hope you all have a great summer. If you have any further questions, feel free to reach out to Sonya and the Investor Relations team. Thanks again for your interest.