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Celesio Annual General Meeting 2008
Extracts from the speech by Dr Fritz Oesterle, Chairman of the Management Board and Chief Executive Officer
Although 2007, just like twenty years ago, was a year in which we increased our revenue and our profit, it was nonetheless a special year; last year the foundation was laid for our success story, now spanning 21 years - something which is certainly not found all too often in Germany - to have to be interrupted briefly this year. 2008 will be a year in which we are compelled to slow down and take a deep breath, so that we start the coming year afresh and in the customary Celesio style.
First and foremost however, 2007 was - as I said - the 21st year in succession that we increased revenue and profit. Given the fact that the underlying conditions became increasingly difficult for the Wholesale and Pharmacies divisions in the course of last year and the exchange rate of the pound sterling further burdened us in the fourth quarter, we are - on balance - still satisfied with what we achieved last year.
Celesio Group: key financial figures
Our group revenue grew by 3.6 per cent in comparison to 2006, rising from 21.57 billion to 22.35 billion euro. Our pharmacy acquisitions spread over the year and the mail order business of DocMorris Pharmacy, which we purchased last year made a positive contribution to this growth.
Revenue growth was hampered in the first place by a manufacturer changing its distribution in the United Kingdom over to a direct-to-pharmacy model, a so-called DTP modell. Under this model, wholesale is no longer used by the manufacturer as a trading partner, but purely as a logistics partner. Therefore no more trade turnover is made with the medicinal products of this manufacturer. To summarise: wholesale lacks revenue from these medicinal products.
Secondly, our revenue pattern last year was affected by our losing market shares, which means business and revenue, in our German wholesale business. We had anticipated loss of market share as an emotional market reaction to the DocMorris acquisition fuelled by the pharmacists' associations.
Despite substantial government economy measures, gross profit in the group increased by 3.8 per cent to around 2.5 billion euro. The growth rate is therefore slightly above percentage growth in revenue, which means that the gross profit margin showed a slight rise over last year - i.e. by two basis points to 11.29 per cent.
This - albeit slight - percentage improvement in gross profit is largely due to the positive growth in gross profit in the higher margin pharmacy business. This is also evident from the fact that Celesio Pharmacies increased its share in gross profit of the group by 2 basis points, from 48.5 per cent to 50.5 per cent. With this, Celesio Pharmacies contributed more than half towards gross profit for the group for the first time.
Alongside Celesio Pharmacies, last year the Solutions division also improved its contribution to group gross profit to 6.4 per cent.
EBITDA, in other words earnings before interest, taxes, depreciation and amortisation, rose by 4.8 per cent in 2007 to 842.5 million euro, hence more strongly than revenue. The return on sales relative to EBITDA was 3.77 per cent last year, four basis points above the figure for the prior year.
Growth in EBIT, earnings before interest and tax, was considerably stronger than EBITDA, rising 6.1 per cent to 727.7 million euro. The reason for this relatively stronger increase in EBIT as compared with EBITDA is that depreciation and amortisation was lower in 2007.
With 3.2 per cent and 608.8 million euro the rise in pre-tax profit was slightly less than EBITDA. This is largely attributable to the acquisition-related, higher average indebtedness.
Let me point out here that our 2007 pre-tax profit also reflects that with the acquisition of DocMorris Pharmacy we made a strategic investment. With this investment we have positioned ourselves for the future of the German pharmacy markets anticipated by many, in the knowledge that this acquisition cannot make any positive contribution to our group result in the first few years. On the contrary; in 2007 interest expense exceeded contribution to operating results. And this will not change very quickly. We shall invest and have to go on investing in the DocMorris Pharmacy business, without it 'paying off' in the short term in the income statement. I am firmly convinced that this investment will however yield high returns in the medium and long term.
As our tax expense in 2007 rose by 5.4 per cent to 173.4 million euro, and the tax ratio was 60 basis points up on last year's figure due to declining tax revenue unrelated to the accounting period at 28.5 per cent, we 'only' improved our net profit by 2.3 per cent to 435.4 million euro.
Earnings per share rose from 2.49 euro to 2.53 euro - by 1.7 per cent.
Although we are already aware today that the current year will be a difficult year for Celesio, we intend to continue our longstanding dividend policy and our shareholders will benefit once again from the 2007 result with a dividend payment of around 30 per cent of net profit. The Supervisory Board and Management Board are therefore proposing a dividend of 77 cent per share, this dividend being 2.7 per cent higher than the prior year. This is the highest dividend we have ever paid our shareholders.
Celesio Wholesale, the Number 1 in European pharmaceutical wholesale, basically did with great success what it has been doing for many years. It improved its operational organisation and operational sequences continuously, i.e. organised them more efficiently and cost-effectively. Above all, in France we also pressed on with the restructuring of our branch network we had already introduced at the end of 2006. We only had 50 branches in France at the end of the year. At the beginning of 2006 there were still 53 branches. In addition to the ongoing operational optimisation, last year Celesio Wholesale directed its attention in particular to services it is able to offer its customers, the pharmacists, over and above the mere supply of medicines. This ranges from the developing and concept of own brands suitable for pharmacies, the DeutschlandCard, a loyalty card with which the customers can collect bonus points in their pharmacy, through to customer support by pharmacies. Celesio Wholesale offers these additional services using country-specific names and country-specific content.
Since the end of 2006 we have therefore had in Germany a constant rise in the level of discounts and a consequent decline in the gross profit margin for pharmaceutical wholesale. By our purchase of DocMorris Pharmacy it has certainly not helped slow this trend down. It has now reached the point where - in our estimation - no one is really earning any money any more in German pharmaceutical wholesale.
In Germany this trend has, of course, also left its mark on the overall growth of Celesio Wholesale. This was only moderated somewhat in that at the end of last year we ceased our wholesale activities in Romania and Croatia. The sale proceeds cushioned Celesio Wholesale's negative development in profit, caused mainly by Germany. However, now you should not conclude from this that Eastern Europe had lost its attractiveness for us in principle. In fact, the opposite is true. Our interest in the Russian market published last year made this very clear.
Unlike Germany, Wholesale in Norway, Slovenia and the Czech Republic developed well. The positive growth in these markets was however unable to compensate for the absence of contributions to profit from Germany.
Despite a 1.5 per cent increase in revenue to 17.73 billion euro, gross profit with 1.087 billion euro fell short of the level for 2006. The gross profit margin reduced by 18 basis points to 6.13 per cent. By contrast, EBITDA rose slightly - also thanks to sales in Croatia and Romania - as compared to the prior year by 1.3 per cent to 431.5 million euro and EBIT by 5 per cent to 377 million euro.
In addition to DocMorris Pharmacy, which I shall deal with in detail separately, Celesio Pharmacies purchased 149 pharmacies in 2007. Taking into account the additional 41 new openings and 17 pharmacy disposals and closures, as at 31 December 2007 Celesio Pharmacies all in all had 2,273 pharmacies. The revenue of 3.62 billion euro generated by them in 2007 was 10.7 per cent up on the revenue for last year. Gross profit of 1.28 billion euro exceeded last year's figure by 8.2 per cent. Growth in gross profit was therefore not as strong as revenue, which means that the gross profit margin fell, specifically by 81 basis points to 35.24 per cent. The reason for this decline in the gross profit margin lies in the inclusion of the mail order business of DocMorris Pharmacy in the Celesio Pharmacies division. The gross profit margins generated in the mail order business are typically lower than in the fixed-location pharmacy business. Also, reimbursement prices in the United Kingdom for generic products were reduced as of 1 October 2006, again on 1 July 2007, and once more on 1 October 2007. The extent of the reduction in reimbursement prices as of 1 October 2007 was hardly expected by any of the market actors or even only to a perceptible degree. This government intervention in the United Kingdom alone negatively affected gross profit and the result of our British pharmacy business with around 30 million euro in the fourth quarter of 2007. The whole-year effect of this pricing measure alone will - before taking counter-measures - amount to around 120 million euro in 2008.
Celesio Pharmacies improved EBIT from 351.7 million euro to 386.8 million euro and hence by 10 per cent compared to the prior year.
I advised you of the acquisition of DocMorris Pharmacy with its mail order and franchise business at our last annual general meeting. Since then DocMorris Pharmacy has developed in line with our expectations. The mail order business showed significant growth last year. The number of brand partnerships, i.e. pharmacists who renamed their pharmacy to DocMorris Pharmacy or who has opend a DocMorris Pharmacy, rose from 20 opened DocMorris Pharmacies on 26 April 2007 to over 100 opened DocMorris Pharmacies today. Today there are DocMorris pharmacies in every federal state of Germany. I told you last year that DocMorris Pharmacy is by far the strongest pharmacy brand name. With this now even stronger brand name we are quite excellently positioned for the liberalisation of the German pharmacy market, expected by so many. This also applies to other companies who then muscle in on the German pharmacy market. These may indeed have a strong brand name in their traditional sector, but not one of these brand names stand either for pharmacy or for pharmaceuticals.
What we are currently concentrating very hard on with DocMorris Pharmacy is to increase the attractiveness of DocMorris-brand partnerships for the owner-managed pharmacy. This we shall achieve primarily by offering our brand partners new service packages which are important and attractive for customer and patient care. We have therefore developed the healthcare programme 'Alles im grünen Bereich' [All in the clear]. At the moment it comprises diabetes tests and an anti-smoking scheme. With these and similar services our brand partners are able to distinguish themselves on the one hand in performance competition with other pharmacies; on the other hand we and the brand partner pharmacies will ensure that the brand name DocMorris Pharmacy will become a leading mark of quality in the pharmacy market.
So once again, with the purchase of DocMorris Pharmacy we made precisely the right decision, even from today's perspective and regardless in fact of how the European Court of Justice decides in the end. Today DocMorris Pharmacy already has two attractive, promising divisions with the mail order and franchise business. The fact that DocMorris Pharmacy, with the strength of its brand name, is also our 'Plan B' in case the German pharmacy market is liberalised by judgment from Luxembourg, is a nice and completely intentional side-effect of our acquisition.
Celesio Solutions has developed well overall. The business unit Movianto increased gross profit by 7.7 per cent to 161.5 million euro in 2007. The growth-drivers were the concluding of both new and also the renewing of existing contracts, primarily in Germany, Spain and the Czech Republic.
Although our Celesio Solutions division is still young and, within a group context, a small division, we are addressing many changes in our markets using precisely this division. This is particularly true of services with which we approach pharmaceutical manufacturers as customers. We develop a range of services such as this together with pharmaceutical manufacturers in the form of partnerships. Even though this is a development that initially is a small step, we are one hundred percent convinced that Celesio Solutions is a part of our response to the changes in our traditional markets.
We have identified another customer group new to Celesio in patients who need to be provided with individual medication and cared for at home, known as 'speciality pharmacy' business. With 'Evolution Homecare' we are building a new business model in the United Kingdom designed for the needs of this customer group.
Market in transition
Ladies and Gentlemen,
If you will now allow me to highlight - as announced - one or two developments which brought us to make our annual report under the motto 'Market in transition', and to which we are already adjusting today. This therefore demands expenditure and investment today; so although there is no immediate contribution to profit, we are convinced this will offer Celesio great medium and long term potential.
Firstly there is the discussion about liberalisation of the pharmacy markets extending right across Europe. This widespread discussion was instigated by the European institutions, in particular by the EU Commission and the infringement proceedings meanwhile initiated by the EU Commission against member states. The EU Commission argued that the restrictions in the respective national pharmacy markets in Italy, Spain, Austria, Portugal, France, and, since the beginning of this year, Germany, were inconsistent with EU law. The EU Commission criticised particularly the ban in these countries on third-party and multiple ownership, hence first and foremost prohibiting corporate entities from owning and operating pharmacies, and the prohibiting of owning more than a certain number of pharmacies. One of these infringement proceedings, brought against the Italian government, is already pending before the European Court of Justice in Luxembourg. The same also applies to a preliminary rulings procedure. In addition to these endeavours at European level, however, there are also initiatives by national political decision-makers in some EU member states to open up their respective national pharmacy markets.
With France there is therefore intense national discussion in Europe's second largest pharmaceutical market concerning the structure of the French pharmacy market. And Sweden, after Norway being the second and largest Scandinavian pharmaceutical market, is facing liberalisation.
Since the end of 2006, new wholesale capacities have been built up in Germany. Until then only pharmaceutical wholesalers operating regionally had begun to increase their geographical presence in Germany at the end of 2006. This trend in providing the market with new capacities by extending or building new branches persisted throughout the whole of 2007. From a commercial and supply perspective we in Germany need more wholesale capacity about as much as you and I need a hole in the head, so not at all. Germany is oversupplied with wholesale capacity.
In the fourth quarter of 2007 two further pharmaceutical manufacturers made changes in their British distribution system. Both in fact are retaining the wholesale model but are reducing the number of wholesalers with whom they work. In both cases our British wholesale AAH is the trading partner. In February 2008, another large manufacturer - again in the United Kingdom - introduced a further direct delivery model. In the interests of improved availability of his preparations, however, he supplies his range through two logistics providers, one of these again being our British company. This trend towards greater control of the supply chain by the manufacturers is not restricted to the United Kingdom. We see similar intentions, tendencies and approaches all over Europe. There are very intense discussions concerning changes to pharmaceutical distribution in Germany.
In addition, to the new diversity of distribution requirements on the part of industry, the purchasing behaviour of our wholesale customers is changing. The formation of more and larger purchasing cooperatives in Germany particularly has brought about a hitherto unknown pressure for discount.
These structural changes in our markets and our entrepreneurial responses to them are accompanied by government measures with which an attempt is made to derive actual or even just perceived economic and price reserves in the supply of medicines. For us government measures such as this are nothing new and nothing special. We know how to deal with them. This is provided, however, that government intervention and its scope are relatively predictable and can therefore be planned for, so that we can be proactive in preparing for it and take counter-measures immediately. Exactly the opposite occurred as regards the reduction in the reimbursement price for generics implemented by the British government on 1 October 2007. The British government reduced the reimbursement price for generics to a degree and level unanticipated by any of the market players.
Therefore the impact hit us with virtually full force in the fourth quarter of last year. The same will certainly also apply in the first two quarters of 2008. Counter-measures taken by our British pharmacies will only take effect gradually in the course of 2008 and hence cushion the effect of the price cut gradually. For this reason alone in 2008 we will only be able to offset part of the burden on profit caused by the price cut with the aid of counter-measures. The whole-year effect of the price cut means - excluding counter-measures - around 120 million euro less profit for Lloydspharmacy, our British pharmacy business.
If you compare our share price of 40.64 euro per share at 31 December 2006 with the share price of 42.50 euro at 31 December 2007, the negative effect our ad hoc press release in September had on the share price is not at all so obvious. Between the end of last year and today our share has continued to depreciate significantly. This is certainly just as unsatisfactory for us as for you.
The fact that 2008 will be a difficult year for us, and the fact that a liberalisation of one or other of the European pharmacy markets did not occur as quickly as was perhaps expected by one or the other, more than absorbed or concealed Celesio's medium and long term potential in recent weeks. In other words, the fact that after 21 years of continuous growth in profit, in the 22nd year Celesio will probably for once have to take a deep breath, and is at the same time optimistic about the subsequent years, does not justify the share performance of the last weeks.
The first half of 2008 will be significantly weaker by comparison with the previous year, also significantly weaker than the whole of 2008 by comparison to the whole of 2007. The reason for this lies in the so-called basic effect, i.e. the situation where the negative effects arising in 2007 and affecting the current year 2008 as a whole, only affected in the second half of the year. This means that the relative difference of the first half of 2008 compared with the first half of 2007, still largely unaffected by government measures, will be quite pronounced. This so-called basic effect in 2007 will lead in the first quarters of 2008 to an especially distorted, negative development in profit.
Development in the second half of 2008 will improve in relative terms from today's perspective. In the second half of 2008 the so-called basis effect will be of less significance.
Today we are already optimistic about 2009 and anticipate a marked increase in the group operating result.