Fonterra Co-operative Group Limited (FCG) Earnings Call Transcript & Summary

Thank you for joining us. I'm Miles Hurrell, CEO, and joined here by Marc Rivers, CFO. I'm going to take you through the overview of our results and some of the progress we're making across a number of our regions. Marc will then take us through a more detailed analysis of the numbers before handing back to me, and we'll take you through what we can expect for the second half of the year. But before I get into things, I want to highlight this will be our first interim results of reporting under our new customer-led operating model. So you'll see more emphasis on the 3 regions in today's presentations. Those regions, of course, are Asia Pacific, Greater China and the rest of the world we refer to as AMENA. And within each of the regions, you'll still see our 3 channels of Ingredients, Foodservice and Consumer. So let's get into it. The team have delivered a positive set of results for the first 6 months of F '21. Sitting here in New Zealand, we've been relatively sheltered by the full impact of COVID-19. But for many of our people on the ground and in our markets around the world, it's been a very different story. The pandemic has been rough, and some of our people and customers have found themselves in lockdowns some 12 months on. This hasn't been easy. We're proud of how our people have responded to this situation. They've support each other, focused on what's in their control and worked together to create demand for our New Zealand milk and managed our supply chain challenges so customers can rely on us to get products to market. And you'll see this in the results and our headline numbers. Firstly, we have a $7.30 to $7.90 milk price range. Our reported profit after tax is $391 million. We're very pleased with this number. And while it was down on the headline number versus F '20, last year, of course, we reported the gain on sale from both DFE and foodspring divestments. Our net profit after tax is $418 million, which is up 43%, and we're paying an interim dividend. All of this shows that our strategy, which we refreshed in F '19, is now up and running, but most importantly, starting to deliver results. Our strategy has ensured that our teams are all heading in the right direction. And in COVID world, where there's a lot of uncertainty, this has been really important. It's all about chasing value and not volume. It means we're prioritizing New Zealand milk and growing demand for it by really understanding our customers and differentiating our Co-op's milk through innovation, sustainability and efficiency. We're not a one-trick pony, and you can see how we go to market. We plan across 5 categories: Core Dairy, Foodservice, Pediatrics, Sports and Active and Medical and Healthy Aging. This kind of diversification has been a real strength through COVID, and it's allowed us to move milk into the products and markets where the demand has been the highest, and we've made the most of it. Let's now take a look at what the strategy has looked like in each of our regions. Starting with APAC. Our EBIT here is up 9%, with the vast majority coming from Consumer. We saw more people cooking at home, and more importantly, cooking with dairy. And New Zealand Consumer business has put a substantial emphasis on sustainability this half, gaining zero carbon certification for Anchor Enrich Milks and launching a plant-based bottle for a 2-litter Anchor Blue Milk here in New Zealand. It's been great to seeing the Co-op getting behind foodbanks and helping get our products to those that need it most. One of the challenges, though, for us in APAC has been our Australian Ingredients business, which has been impacted by challenging trading conditions, including the China trade relations, contraction of the Daigou channel and some shipping delays. Greater China has been our standout performer. EBIT is up 38%. Almost 2/3 of Greater China's $339 million EBIT came from our Foodservice business, which increased EBIT by 64%, a phenomenal result. This has been achieved on a similar metric tonnes, but have moved more milk into higher-value products such as our UHT cream. We've launched new products like our first ambient cream and developed 80 new ways of taking these products to market over the last 6 months. This has also helped increase utilization of our Darfield cream cheese plant, and also our Clandeboye, [ Montreal ] factory. The team have increased demand through entering more cities and innovation, and now we're in over 370 cities across China. But new news today is for China that we've agreed with a joint venture partner to undertake a sales process for our JV farms in China. Reason for this divestment is the same as why we want to sell our own China Farms. It's about allowing us to focus even more on our New Zealand milk. It's clear China is one of the most important strategic markets. We're committed to growing the value of our China business, which we'll do by bringing the goodness of New Zealand milk to Chinese consumers. Our third region is AMENA. It's Africa, Middle East, Europe, North Asia and the Americas. It's been a bit tougher here, unfortunately, as you will see this reflected in the reduction in EBIT. The main reason it's down is because of reduced sales volumes and lower margins in Ingredients. We've shifted milk from AMENA to higher returning markets. And while this may not be so positive for AMENA, if you take a Co-op wide lens, it's a good thing to have made the most of our ability to move milk around to higher returning markets and products. On a positive note for AMENA, we've seen a really strong performance from Chile and across all markets within the AMENA have reduced their costs. It was great to see new Sports and Active products launching, that's the NZMP Milk Phospholipids 70, which is our first product designed for mental wellness such as stress, mood enhancement and cognitive performance. Behind these 3 regions is a big engine room of the Co-operative. Without it, we wouldn't have products to sell in the regions. It include activities like milk collection, manufacturing and innovation and R&D. It's also where the decisions get made about how best to connect with customers and assets, farmers and markets to turn the milk we collect into the most valuable products. It's a big part of our business, employing over 10,000 people, and there are plenty of highlights for the first 6 months. We already talked about the optimization of our milk, and how we've moved into products and markets with the highest value. We also talked about how we're dealing with supply chain challenges. You can see here that 71% of our product deliveries have been made in full on time, minus -- plus or minus 1 week. Prior to COVID, this number averaged about 90%. However, despite this reduction, our performance is considered reliable relative to the market. The recent rollout of the milk vat monitoring systems that has been installed on farms has improved the quality of our milk supplied to our factories and create opportunities to optimize our tanker pickup schedules, with the success of the implementation so far allowing us to budget for the removal of 5 tankers for next season. I'll now hand over to Mark to take us through the numbers in a bit more detail.

Great. Thank you, Miles. So looking at our total group performance, which is inclusive of our discontinued operations, our milk collections are slightly down on last year. We've had strong demand and sales book is well contracted. And you can see the impact of the well-documented global supply chain challenges, with sales volume down 41,000 metric tonnes or 2%. But sales book is well contracted, and we expect to have caught up on those delays by the end of the financial year. Revenue is down, in part due to the delayed shipments, but it's predominantly down as a result of our average prices compared to the prior period. Our total group gross profit increased $54 million due to our gross margin increasing from 16% to 17.4%. Operating expenses are down $37 million as a result of the businesses focusing on what's in their control, like targeted selling and promotional spend during lockdown periods. I will note that we expect to increase our A&P spend in the second half. Improved gross margin and the focus on managing costs has resulted in our normalized EBIT, increasing 17%, up $100 million to $684 million. Our net financing costs are $32 million lower due to lower average debt and a reduction in global interest rates. The strong first half earnings equate to normalized earnings per share of $0.25 after deducting noncontrolling interests. Next slide. Our net debt is down $0.2 billion to $5.6 billion. Please note that the seasonal profile, of course, of our working capital requirements. It typically means that our debt level is higher in the first half compared to the full year as the working capital needs are reduced. Our target is to have our year-end gearing come in below 40%, and we are continuing to stay focused, of course, on working capital management as well as receivables and payables. And we began the first half of the year with higher levels of inventory carried over from previous year, which, combined with lower sales revenue, has resulted in a higher inventory -- in higher inventory days. And as a result of the higher inventory days, our working capital days are higher. The business remains focused on the timely collection of receivables and the receivables days are consistent with last year and overdue receivables are actually down. Payable days are also at similar levels as last year. Next slide, this slide shows the matrix of our business by markets and channels and just highlights really the diversity across them. Our 3 regions have similar revenues, but, as you can see, we do have a higher EBIT margin in Greater China. It also shows the region's earnings are dominated by different channels. So Greater China, you see the importance of Foodservice. Asia Pacific, you see the importance of the Consumer business. And in AMENA, the Ingredients businesses. It is a similar situation for the channels, except the Ingredients channel, which AMENA contributes the most earnings to, but Greater China is also a strong contributor. These next 2 slides show the margins by -- first by region and then by channel. Greater China's gross margin is increased from 14.3% to 17.7%. We continue to shift milk into high value product, having released 3 new cream products, 1 of those is the Anchor Easy Topping Cream. It's the first ambient cream, which enables us to enter into new cities, which do not have extensive cool supply chains. Greater China operating expenses have increased $13 million as we continue to develop demand. However, in the context of $94 million or 38% increase in our Greater China EBIT, it's money well spent. Asia Pacific increased earnings $16 million to $190 million. The majority of our consumer markets and brands within Asia Pacific benefited from the COVID-19 stay-at-home culinary trend, including our Australia consumer brands like Western Star, which aided in extending our market leadership position in chilled spreads, where our value share increased from 33.1% up to 35.7% and in volume from 25.4% to 27.7%. Now while our gross profit declined $61 million in AMENA, we did divert milk to other channels and regions, which preserved the AMENA margin overall, which was up slightly at 14.7%. All 3 channels in AMENA reduced operating expenses, which helped to partially offset the lower gross profit, with AMENA EBIT down only $15 million. So next slide, once again, you can see the strength of the Greater China Foodservice business, with the Foodservice gross margin increasing from 18.6% to 26.1%. All 3 regions had improved earnings in their Foodservice businesses. Foodservice EBIT increased $115 million or 80% to $258 million. And the final point to make on Foodservice is that despite allocating more milk into our Foodservice channel, we actually sold fewer metric tonnes, and that's just due to product mix. So the products we allocated more milk to, such as UHT cream, use more milk solids than, say, UHT milk. The Consumer channel, mentioned earlier, benefited from the COVID-19 stay-at-home culinary trend. However, we've also had success with new product development. In Chile, we launched a new yogurt and dessert product, and both products won product of the year as voted by Chilean consumers in their respective yogurt and desserts categories. This success has helped us grow our value and volume share in the Chilean consumer channel, where value share is up 0.6% to 30.2%, and volume share is up 0.5% to 31.3%. So it's another good success story. And back to you, Miles, to discuss the outlook.

Great. Thanks, Marc. Our results today show that demand for dairy is resilient in a COVID world. While we've had a strong first half, we are expecting our earnings to come under significant pressure in the second half. And the simple reason for this is our increased input costs as a result of the higher Farmgate Milk Price. A strong Farmgate Milk Price is good news for the Co-op’s farmers and New Zealand, with a midpoint of $7.6 per kilogram of milk solids, would see us contribute over $11.5 billion into the New Zealand economy. But it does put a lot of pressure on our margins, and this will be seen in our earnings performance in the second half. Our teams understand the challenges that will come with a high Farmgate Milk Price, and we already see the extra effort we're putting in to drive sales. we're staying on strategy, focusing on what's in their control and driving demand for our New Zealand milk. There's still more work to do, but our improved performance and reduced debt levels are helping us build the financial strength of the Co-op. I'll now hand back and ask for questions. Thank you.