Australian Agricultural Company Limited (AAC) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Australian Agricultural Company Limited FY '22 Half Year Results Conference Call and Webcast. [Operator Instructions] I would now like to hand the conference over to Mr. Hugh Killen, Managing Director and Chief Executive Officer. Please go ahead.

Good morning, and thank you for joining AACo's Half Year Results Presentation for Financial Year 2022. I'm Hugh Killen, Managing Director and CEO of AACo, and joining me today is our Chief Financial Officer, Nigel Simonsz. I will start our presentation today by running through the key highlights of AACo's interim performance. I will then discuss our progress against strategy so far in FY '22. And after this, I'll go through our regional and brand progress for the half. I'll then hand over to Nigel to take us through the financials, after which I'll briefly discuss our Sustainability Strategy Framework, and I'll finish up with an update on our operating environment as we move into the second half of the financial year. Moving on to Slide #4. I'm pleased to report that AACo has delivered a strong set of results for the half. Our operating profit increased by 28% to $30 million. We have continued execution of our branded beef strategy. Our team has improved average price per kilo by 9% through strategic allocation to high-value markets around the world. We have continued to increase the proportion of branded meat sold through our Westholme and Darling Downs brands. And this work, together with continued cost discipline, has helped drive overall improvements in meat sales margins. This half, we've seen the continuation of record high cattle prices and this has helped push our cattle margins higher as well. We've worked hard to develop our new sustainability strategy framework. I'll be formally launching this tomorrow. However, I'll make some brief comments about this important work later in today's presentation. On the finance side, we've successfully refinanced our debt facilities, giving AACo increased capacity and flexibility for the future. And this will be integral to our next phase of growth as we build on a strong position today. Our balance sheet has strengthened further from a good position last year. The value of our net assets now exceeds $1.1 billion, and AACo's net tangible assets per share has increased to $1.88. This is all combined to deliver an $83 million statutory net profit after tax, which is an $85 million improvement on the first half of FY '21. Importantly, we've delivered these results despite lower meat volumes sold, which I'll talk to in more detail on the next slide. As discussed at our FY '21 full year results presentation, we're seeing lower volumes in meat sales this half. This comes off the back of lower carving levels between 2018 and 2020, as a result of prolonged drought conditions and also the Gulf flood. Lower volumes have been reflected across the wider Australian beef industry. National herd levels reached 25-year lows in 2020. And the MLA is forecasting slaughter rates dropping to 36-year lows by the end of 2021 as a result of ongoing supply constraints. These rates aren't expected to return to normal in calendar year 2023. And at AACo, we anticipate lower meat sales volumes through the rest of this year and also into FY '23. At the same time, our AACo cattle herd rebuild is continuing well. Brandings are up during the half year. Total kilograms produced are also up 31%. And this gives us confidence that production is continuing to move strongly in the right direction. Turning now to Slide 6 and our progress against strategy in the first half of FY '22. Our overall strategic focus is on delivering outcomes in 3 key areas: consumer and customer centricity, operational excellence and our team. I'm pleased to report good progress across these areas in the first half of FY '22. In terms of consumer and customer centricity, our strategic focus is on building stronger connections with our brands. In particular, we've continued to drive sales through a very strong Westholme and Darling Downs brands. In the most recent half year, 83% of our branded meat sales were through these brands compared to 75% in FY '21. The team have been working hard to build brand awareness amongst consumers. And we're seeing strong progress through our Westholme influencer strategy, which has multiplied our audience reach by 8x. This work has driven important results in North America in particular, where branded meat sales have increased 55% compared to the prior period. And this has been supported by strategic reallocation of higher-value cuts into this market at premium prices. And this has supported an overall 9% increase in our average price per kilo of meat sold. Our second strategic focus is operational excellence. This is where we continue to concentrate on creating a simpler and more efficient AACo. Ongoing cost discipline has continued over the half of good results. We've seen 13% lower cost of production this half compared to the first half of FY '21. This has included production efficiencies through the supply chain as well as reduced adverse seasonal impacts. Another key efficiency driver within our operations is effective supply and demand planning. We are continuing to become more accurate and forward-looking, helping to manage costs throughout the whole supply chain. And importantly, this helps us make better investment and operational decisions as we grow. We've also continued our focus on creating a high-performance culture where our people can thrive. As part of this, we worked hard in refining our guiding purpose and vision, which we relaunched during the half. And we're investing in the mental first -- mental health first aid skills of our people. We also saw a 17% improvement in our lost time injury frequency rate compared to pcp and overall team engagement improved by 3 points this half. Now turning to Slide 7 and our commercial review. Strategic Revenue Management is another core part of our business strategy and operations. This includes a relentless focus on maximizing returns from every cut of meat that we produce and leveraging our global distribution network to get the right cut to the right market opportunities at the right time. In the first half of FY '22, this has produced important results. Overall, strategic market allocation has helped support a 9% improvement in price per kilo compared to the prior period. A particular highlight to note is our performance in North America, where our average price per kilo of branded beef sold is up 33% compared to PCP. This reflected strong demand for higher marble score loins and rumps in the region. Our team are able to redirect product away from Asia to capture these premium prices. Asia continues to represent our largest meat sales region at 53% of total meat sales revenue in the half. The Australian market is our heartland and very important to who we are as a company, and we continue to manage volumes to optimize returns in this market. Across all regions, we're seeing COVID-19 vaccination rates wind back restrictions and drive a return to food service options for consumers, and we'll continue to respond to this situation as it continues to develop. Moving on now to Slide 8 and the development of our Westholme brand. As mentioned previously, we've seen good progress in execution of our branded beef strategy over the half year. A key component of this work is our in-market efforts to build brand awareness for Westholme. This has included engaging with customers and consumers through digital channels in North America. We've adopted the approach of engaging with chef and influencers online, and this has been supported by creation of content designed to spark conversations between chefs. As a result of these campaigns, we're seeing positive growth in engagement and audience reach. We've also continued to build brand awareness through our online gourmet e-marketplaces over the half year. And we are leveraging shopper analysis and insights from these sites to further develop our knowledge of consumer habits. Closer to home, we are continuing to refine and build the value of Westholme in Australia. This includes continuing to support the foodservice industry in Australia as it reopens. So far, we've run a number of programs with our Australian food service customers during the half and we'll continue to partner with good initiatives that let us connect with chefs in the wider food service industry at home. Moving now to our Darling Downs brand on Slide #9. Our focus on Darling Downs from the first half of 2022 has been increased consumer engagement in South Korea, where we have launched our first promotion in South Korea to drive user-generated content. Earlier this year, I mentioned our Darling Downs brand refresh in Korea, and this has generated good results in terms of sales. Off the back of these positive results, we extended that refresh of our Darling Downs brand into Hong Kong. I'll now hand over to Nigel, who will take you through our financials for the half year in more detail.

Thank you, and good morning, everyone. And thank you for your interest in what has been a positive half year for AACo. I can report that the business has achieved some notable highlights during the first half of FY '22. Firstly, meat sales price per kilogram grew on average by 9% versus the prior period. This was largely off the back of optimizing our strategic market allocation and product, combined with continued progress in executing against our branded beef strategy. The increase in price has offset lower volumes of meat sold during the period, as Hugh referred to earlier. The business has delivered increased profitability during the half. This included a 28% increase in operating profit and, notably, an improved operating profit margin as a percentage of sales of 20.9%. Both of these results were driven by improved sales margin across both meat and cattle sales. And for noting, the prior comparison period included $6.7 million in operating profit and $4 million in operating cash flow relating to JobKeeper. Net operating cash flow for the half was a positive $17.3 million for the period. We've also seen a strong 7% improvement in net tangible assets versus year-end FY '21 with further strengthening of our balance sheet. And now turning to Slide 12, where I'll talk to revenue in some more detail. Overall, total revenue has remained largely in line with PCP at $143 million. This result has been supported by higher pricing, which has been offset by lower volume sold. Meat sales revenue has remained flat on PCP at $102.9 million, and this is largely been driven by a 9% increase in average wagyu meat sales price per kilogram, which was worth an additional $8.5 million this period. Notably, this was achieved despite an adverse foreign exchange variance of $6.9 million versus PCP. And as referred to earlier, lower carving in previous years continue to impact the business, which has translated into an 8% decrease in volume sold during the half, also worth $8.5 million, which equally offset meat sales price gains. Cattle sales revenue decreased marginally on the prior period to $14.5 million, and this has largely come off the back of 17% lower cattle sales volumes worth $7 million. And this reduced cattle sales volume has been partially offset by a 19% increase in price worth $6.4 million. The cattle price increases are reflective of the record high trading and restock or cattle market pricing the industry is currently experiencing. Now moving on to cost reduction on Slide 13. This half, we have seen a 13% decrease in cost of production versus the prior period. This comes off the back of improved seasonal conditions as well as a 31% increase in kilograms produced this half compared to the prior period, particularly in the breeding part of our business. And more broadly, the business has continued its disciplined focus on costs. These results contribute to the overall cost of our F1 Wagyu animals, which accumulates over their approximate 3.5-year life cycle as they progress through the supply chain. And now turning to operating profit on Slide 14. As mentioned earlier, operating profit has improved by $6.5 million compared to the first half of FY '21. This was largely driven by improved meat and cattle sales margins through higher average sales pricing. And also, as mentioned earlier, this was achieved despite the adverse foreign exchange variance of $6.9 million in sales. And this should be looked at in conjunction with the favorable variance of $4.6 million, primarily in FX hedging gains and losses versus the prior year. And now moving to Slide 15 and our profit and loss summary. In addition to the comments on operating profit driving already noted, we have also seen a strong improvement in net profit after tax of $85 million versus half 1 FY '21. This result comes off the back of a positive, unrealized mark-to-market adjustment in the half of $87 million to the value of the underlying herd. This adjustment was largely driven by current record Australian cattle prices. Now moving on to our cash flow summary on Slide 16. The business generated positive net operating cash flow for the period of $17.3 million compared to $22.3 million during half 1 FY '21. The key drivers of this variance are outlined in the waterfall chart on this slide. These include increased cash expenditure due mainly to higher insurance and freight costs, which were offset by the impact of lower cattle purchases and favorable net working capital movements and the receipt of JobKeeper in the prior period. And now turning to the balance sheet on Slide 17. AACo's net assets now exceed $1.1 billion, reflecting strong growth in the value of our herd and land assets. This has translated into a higher net tangible assets per share of $1.88. And in all, this constitutes a 7% increase compared to our full year 2021 results and the 22% increase compared to the same time last year. We also successfully completed the refinance of our debt facilities during the half. This has increased our borrowing capacity by another $50 million. And our total capacity is now $600 million, which leaves us with $240 million in available borrowing capacity. Our gearing ratios remained well within our targeted range of 20% to 35%, and we maintain substantial headroom within our covenants. This new refinancing agreement will assist the business through its next phase of strategic growth. And with that, I will now hand back to Hugh to take you through AACo's sustainability strategy framework.

Thanks, Nigel. I want to briefly touch on our commitment to sustainability. Sustainability has always been at the heart of AACo as it is for all rural and regional communities. For almost 200 years, we've cared for some of the most important [ country ] in Australia, and we take this responsibility very seriously. Tomorrow, we'll take the next step in this journey and release our Sustainability Strategy Framework. This framework will be used to prioritize the work we do and the goals we set ourselves as a sustainable business. This will include immediate steps as well as longer-term strategies that are our blueprint for action. And this work will underpin the company's future as a food producer and also as a landowner. Moving to our operating environment. We're starting to see a number of important dynamics playing out in the global beef market in FY '22. While we tend to focus on more premium and less commoditized product, these dynamics will have important implications for AACo. The first of these dynamics is very strong global demand for beef, continued protein shortages in China as a result of African swine flu contributing to this demand growth. And we're also seeing increased demand from developed markets as COVID-19 restrictions are lifted. The second important dynamic we are seeing is clear merchant constraints on supply. Supply from key export players, including Argentina, Brazil and Australia already appear to be restricted. And U.S. production and export numbers are forecast to be lower in 2022, and this reflects the likely peak in the U.S. herd rebuild this year. Turning, please, to the home on Slide 21. In Australia, the national herd rebuild is still going on in earnest as producers look to rebuild stock. Demand exceeds supply in the market, which has helped drive the EYCI to an all-time high this week. Order rates are forecast to reduce to 36-year lows this calendar year. And MLA are suggesting slaughter will only return to normal levels in calendar year 2023. Off the back of these macro themes, we expect these high cattle prices to remain for some time. In closing, I'd like to thank the AACo team for their continued hard work through the first half of the year. We've made material progress executing against our strategy, and we have delivered a strong result. Moving forward, our focus is on continuing to execute against our branded beef strategy, and this still remains the strongest pathway to delivering long-term value for our shareholders. Thank you for your time this morning, and this ends our presentation. And Nigel and I are happy to take any questions.

[Operator Instructions] Your first question comes from Jonathan Snape from Bell Potter.

Just a couple of questions. One, around the pricing move that you got in the first half. You've called that part of it was, I guess, moving stuff to different markets. How much of that 9% gain do you think was, I guess, the underlying commodity value move relative to, I guess, mix in there? Just -- and then how should we be thinking about that in the second half? Like is there a difference in the mix profile that you've got on hand?

Jon, I think there's 2 parts to your question, obviously. One is there's rising tide -- does a rising tide lift all boats? And I think to a degree, obviously, we're seeing very strong demand dynamics for red meat more broadly. And we're obviously getting the benefit of that. But we talk about optimizing our revenue and making sure we allocate correctly across the markets. That's definitely a factor in it. And one of the things we're doing is taking down opportunity in a very targeted way, which is another reason why you're seeing product move from Asia into the U.S. at the moment. So that gives us the ability to take advantage of the current dynamics, but it also gives us the ability to optimize our overall allocation.

Okay. And look, I'm just trying to figure out sourcing. I think you guys flagged back at the full year that there'd be quite with external sourcing of cattle this year. And looking through the numbers, it didn't look like there was much at all, maybe a couple of million bucks if I was going through the cash flow. Is there a shift in the program? Or should I be expecting that there's more external sourcing to come in the second half than maybe we saw in the first half?

Look, I think the first thing for us is we are -- as we've been talking to the market, kilos are down for the reasons we've been describing around droughts and floods, et cetera. We purchased $14 million worth of cattle in H1. I'd expect to see some supplementary purchases as we flow through in the second half of the year. The important thing, I think, to note, Jon, now is those purchases are obviously down on a margin basis as well. So our ability to look through from a margin perspective before we buy those cattle is a really important part of the results as well. So clearly, we'll remain supply constrained as the Australian industry does for the next little while. And I think some ancillary purchases will be required in the second half of the year, but they're pretty well managed.

All right. Great. It was a good number. That's, what, 5 halves of operating profit, if I'm reading it right?

That's right, mate. Yes. No, it's a really pleasing result under the circumstances. So we're very happy with that.

[Operator Instructions] Your next question comes from Paul Jensz from PAC Partners.

Excellent. Similar to what Jon was saying, you've got operating profit of over 5 halves. Just wanted to talk through, I suppose, your metrics around the cash flow and how you are looking to optimize the -- I suppose the operating cash flow and the free cash flow now and into the next couple of years?

Nigel, you might want to take that question.

Yes. No problem. Paul, I think as we've shown over the last few halves, we've continued to demonstrate an ability to deliver a positive operating cash flow, both from a continued discipline on cost side. So -- and we've made continued progress on that over the past 3 years, but also really a relentless focus on maximizing value from a revenue perspective that we derive over the whole of the animal. And clearly, the focus for our branded beef strategy remains our primary focus. So really, it's looking at both the revenue and cost side, Paul, to really drive maximum value across the supply chain.

Okay. And I suppose how far are you through, Nigel and Hugh, on the -- I suppose the higher end branding of the beef versus, I suppose, the cost out story. So maybe you can talk about percentages of the way through on the cost out story and the percentage of the way through on upgrading to that high grade, obviously, cost of wagyu and the other brands.

Well, looking at cost out to me, you've heard me present this, talking about creating simpler and more efficient AACo. I'll never take away that focus on cost. This is obviously a very cyclical business, and you need to make sure you manage it through that -- throughout the cycle, so we'll continue to do that piece. As you can see in terms of price per kilo achieved, the growth in our brands as well in terms of the percentage of meat that's sold under our brands, how that continues to grow. Our focus on key markets, especially now that COVID is starting to wane, I think, will be a key part of the strategy and continue to build brand awareness and especially in those really critical markets such as the U.S. So I don't know if I'll put a percentage on our journey in terms of brand building, but -- and that's something that's absolutely key for us and brands take a very long time to build, but we're starting to see really positive traction in terms of Westholme and Darling Downs in particular now. And I think there's a whole lot of opportunity there to continue to grow those brands and the focus we're putting into them. I would say, just to echo a point that Nigel was talking about in the -- your first question and focusing across the entire CapEx. For us, we need to optimize every kilo of beef that we sell. And from a brand perspective, there are absolutely options for us to actually build out and add value in different cuts and different parts of our business outside of just our premium Westholme and Darling Downs brands as well, which is a key part of our strategy that we'll be working on over the next period.

And the final area is just what sort of operating cash flow to asset sort of ratio are you after? An all-encompassing type number? Is that something that's in your [ Board box ]?

Well, I guess it's something that we know as a Board we -- and management team we obviously discussed, but I don't think [ I'd sort of be willing to share here ] at the half year, mate.

All right. Well, you're going in the right direction. Obviously, there's a bit of a hit here with COVID this half, but yes, the general direction is very, very solid. So well done to you and the team. It's not [ a mean feat ].

No, no. Thank you, Paul. I mean, obviously, COVID's been a difficult situation for all companies to manage. But I think the company has navigated that pretty well. So thanks for your questions.

Your next question comes via the webcast. The question is what's the future of the meat processing facility outside of Downs?

Thanks for the question. Look, I've been on record a number of times now saying that I believe there is absolutely key strategic value in Livingstone as a cornerstone asset, especially for the North. I think I gave pretty good context in terms of my prepared comments and slaughter levels, obviously at 36-year lows. And at the end of the day, I don't think the MLA are forecasting that to return to normal levels until sometime like 2023. So from my perspective, the fact that the Livingstone facility is not operational in that environment is a really good thing. I absolutely -- and the company shares this aspiration to have that asset running at the right time. I don't think, given where we are in the cycle at the moment, it's particularly conducive with the start-up. But we are working hard to make sure that when the conditions are right, that the asset is in the right position to be able to restart effectively and efficiently. So it's a supportive comment around the Downs facility, I think there's a lot of optionality there. We retain that. It's a small cost operationally to support it. But certainly, at the right time, I think it's an asset we'll be looking to run.

Your next question via the webcast asks, when will the next revaluation of property assets be completed?

We do a revaluation of our property assets on an annual basis. So actually, it takes quite a long time to do. Actually, it takes a few months for us to run through given the size of the business that just starts in the next -- in the few weeks -- in the next few weeks, and we don't report our revaluation until the full year on 31st of March.

Your next question asks, please explain the company attitude to retaining heifers from the branded program versus feeding them. Are you retaining significantly more heifers?

Look, our focus is always on maintaining AACo's core herd to support our branded beef program. So obviously, there's a balance between having the right breeding stock coming through from a heifer perspective, and obviously supporting our branded beef business. Now we don't disclose the mix of that. But ultimately, given where we've been from a seasonal perspective as well as the industry in terms of the impacts of the drought and the flood, we're retaining as many productive females in our herd as we possibly can. So we'll continue to do that. That's a fine balance between actually making sure we've got the right number of cattle in our feedlots for our branded program. But ultimately, we want to make sure we have the right cattle on hand from a branding perspective. And so what I would say is the productivity of the female herd, both in terms of the age of our [ cattle herd ] and heifers retained across AACo is very supportive of growing our herd in the right way over the next couple of years.

Thank you. There are no further questions via the webcast. We'll pause a moment for any final questions to come through. Thank you. There are no further questions at this time, and that does conclude our call for today. Thank you for participating. You may now disconnect.