Inghams Group Limited (ING) Earnings Call Transcript & Summary

Good morning, and welcome to Inghams Full Year 2022 Results Presentation. [Operator Instructions] I will now hand over to Managing Director and Chief Executive Officer of Inghams, Andrew Reeves.

Thank you, and good morning, everyone, and thank you for joining us today. As noted, my name is Andrew Reeves, Managing Director and Chief Executive Officer of Inghams. And it's my pleasure to welcome you to Inghams 2022 Annual Results Presentation. On behalf of Inghams, I would like to respectfully acknowledge the traditional owners, both past and present, as custodians of the land we are meeting on today. Joining me for today's presentation is our Chief Financial Officer, Gary Mallett. And at the conclusion of the formal presentation, we will take any questions you may have on our results and the business. FY '22 was a challenging year, marked by major operational disruptions caused by a variety of different events and factors throughout the year, some of which have lessened in effect, while some remain ongoing. Importantly, our business has been recovering from the worst effects of the Omicron wave experienced in the third quarter. Employee attendance levels have improved, and our operations are progressively returning to normal operating patterns and levels. So too is our channel mix. And as you will see later in the presentation, average selling prices have meaningfully recovered since this time. I'm pleased to be able to report that we're achieving good price increases across all channels and customers, with increases we have achieved in New Zealand contributing to FY '22, while Australian price increases will make a meaningful contribution in FY '23. Due to the commercially sensitive nature of our pricing discussions, I'm not able to provide specific detail on the rate of price growth we're achieving, but suffice to say that while there is some lag in these price increases taking effect, we are achieving increases that reflect our cost inflation environment. And also discussions remain ongoing with all customers, should we need to see further increases. We have spoken often of our operational efficiency program. While COVID impacts temporarily slowed our progress on the implementation of new initiatives, the program continues to deliver strong results and is expected to be an ongoing contributor to our future financial results. Overall, despite all that the business and our people have endured in the past year, Inghams has a strong long-term outlook. And the fundamentals of the poultry market and the business overall remain intact. Turning now to an overview of the business and an update on the financial year. As many of you know, Inghams is the largest integrated protein producer across Australia and New Zealand, providing chicken, turkey and plant-based protein products to major retail, quick service restaurants, food service distributors and wholesalers. Our diverse network provides us with a number of important advantages, including no poultry products can be imported into Australia, with the exception of certain [ food items ] from New Zealand. We provide a local supply for the network of regional operating facilities, and we fully service national and local customer requirements. This helps -- this network helps us mitigate agricultural risk and manage feed price volatility and manage buyer security and operational risk. And it gives us the optionality and flexibility for future growth. Inghams' operations are vertically integrated and hard to replace. Aside from the obvious barriers to entry that this creates, there are other important benefits that we derive from this model. By effectively controlling all elements of production, we are able to realize efficiencies across all aspects of our supply chain, which you can see being realized throughout the years of our continuous improvement strategy and process. Following from this, we are able to ensure we achieve the appropriate production balance in our operations which, combined with operational excellence, are keys to growing margins over time. I'd like to spend a moment outlining the case of poultry. We are seeing quite a significant acceleration in inflation in recent times, the result of a variety of simultaneous yet somewhat independent domestic and international factors. Against this backdrop, the long-standing affordability of poultry, we believe, is an important factor that will underpin future growth, demand growth for the sector. As you can see from the chart on the left, chicken consumption has been steadily growing for the better part of the last 60 years. And with significant pricing differentials that continue to be observed, as shown in the chart on the right, we believe the poultry sector is well placed to deliver future growth. The health and versatility benefits of poultry are well established, which aligns very well with the ongoing trends and consumer preferences for healthier lifestyle options. The third element underpinning the future of the industry is the sustainability of chicken. With a carbon footprint that is estimated to be around 5x smaller than red meat, chicken is the green animal protein, and this will continue to be important additional underpinning for the sector as we go into the future. FY '22 was characterized by a number of impactful events, including the ongoing effects of COVID-19, the effects of geopolitical events from third quarter onwards on feed and fuel costs and, of course, global supply chain disruptions. The effects of broad based inflation in Australia and New Zealand are well reported. And while our operational efficiency programs are helping to offset some of the inflation impact, they alone are not sufficient to fully offset these pressures. Over the course of the year, we saw an industry-wide volume shift to the wholesale channel, which was caused by an oversupply of chicken and, therefore, a significant price decline in the channel. I'm pleased to say that we have seen a strong recovery in wholesale prices during Q4 as processing normalizes. Pleasingly, we have made good progress in securing price increases during FY '22, with New Zealand prices increasing to FY '22 -- are contributing to FY '22 and future Australia and New Zealand increases to contribute throughout FY '23. Our capital position remains strong with net debt increasing modestly during FY '22 to $267 million, which is broadly in line with our first half '22 position, a good result given the softer second half trading. Due to our lower overall EBITDA in FY '22, this has meant leverage has increased to 2x the top of our target range. A final dividend of $0.05 per share has been declared, which reflects the reduced second half profitability. Including the interim dividend paid earlier this year, this equates to an FY '22 payout of 61.6%, which is within our policy range. As noted in my opening remarks, the business was faced with a variety of significant operational disruptions caused by events largely outside our control. While the effect of some of these has lessened and many remain ongoing in some shape or form, the recovery is underway. The effect of many of these ongoing issues has been to significantly increase the cost of doing business. To counter these effects on profitability, I'm pleased to say that we are achieving good price increases across our customer base. Our operations are progressively returning to normal operating levels and full product range production. I would note that there remains some ongoing variability in our operational tempo due to ongoing supply chain disruptions and labor availability issues, and we continue to work through this. The cost environment is challenging, and it's a challenging one for all businesses. And our costs remain elevated, mainly driven by feed and transport. Our continuous improvement programs continue to provide some offset to these pressures. Overall, the key message is that our operations and channels are recovering. Taking a look at prices, the following charts give a clearer picture of the core poultry average selling prices during FY 2022. As you can see from the group chart on the left, ASP declined quite significantly during the third quarter, driven by Omicron-related channel and product mix challenges. The significant industry-wide increase in supply to the wholesale channel due to the temporary rationalization of usual retail SKUs resulted in a large price declines channel which, together with the mix change, impacted our overall ASP. Our ASP has recovered strongly since then, increasing 6.6% between January and June as a result of both improvements in channel mix, the significant price recovery in wholesale and price increases achieved with customers. As noted in the previous slide, significant price increases are being achieved across all channels and customers. As you know, there are a lot of moving parts to FY '22. I don't propose to go through each individual item in detail. However, the following slides breaks down the year in more detail for you to look at the different quite distinct periods we faced during the year. The first half was defined by a challenging operating environment characterized by extended lockdowns and significant operational disruptions caused by pandemic conditions, with the results achieved being broadly in line or ahead of the first half of the prior corresponding period. Moving into the second half of FY '22. The third quarter saw a confluence of well-known factors to make this our most challenging period. The fourth quarter has been one of recovery. And while conditions have not yet returned to pre-pandemic levels, conditions have nonetheless improved greatly from earlier in this calendar year. So turning now to look at the channels in FY '22. As you'll note from the volume chart on the slide, there were 2 key changes that occurred in our channels during the year. Retail volumes declined slightly and wholesale volumes grew significantly. In retail, the impact of COVID-19 restrictions on processing and production capabilities and changes to consumer behaviors during the year resulted in some decline in volume, with lower foot traffic and higher online sales impacting demand for those chickens. In New Zealand, strict lockdowns meant less frequent larger shops, which impacted sales. While first half results were stronger as restrictions were lifted, the effect of the Omicron wave on operations also resulted in some channel mix shift to wholesale, as noted earlier. In QSR, Australian volume increased compared to prior period, reflecting the effect of COVID-19 restrictions on customer demand at various times during the period. Demand was noted as improving during Q4, supported by new product launches and promotions. New Zealand QSR demand was softer due to government-imposed operating restrictions resulted in trading largely ceasing during the first half. The food service channel recorded modest volume growth, with demand improving as restrictions eased and domestic travel activity resumed, resulting in stronger channel growth in regional centers. New Zealand demand growth was also stronger during the period. The wholesale channel, which is quite a diverse customer profile, saw a significant increase in industry-wide volume during the year. A combination of softer demand across other channels in the first half, followed by the impact of processing constraints in Q3, saw a sharp increase in supply from all producers to this channel, depressing wholesale prices for much of the year. Prices have recovered strongly in Q4 as supply levels have continued to normalize. Volumes in the export channel grew cycling prior corresponding period export restrictions due to the avian influenza outbreak and clearance of frozen inventory. I'll now hand over to Gary to present the financial results in further detail. Thanks, Gary.

Thank you, Andrew, and good morning, everyone. All financial data presented here today is inclusive of AASB 16 adjustments, unless we have stated otherwise. In the appendix to this presentation, you will find additional information and reconciliations that provide some additional detail on the results we are presenting today. Turning to our profit and loss for the year. As noted earlier, the group recorded core poultry volume growth of 4.2%, driven by a 5.2% increase in Australian volumes, with growth primarily in the wholesale channel. Revenue growth was more modest at 1.7%, reflecting a fall in average selling price from an unfavorable product mix and channel mix shift to wholesale in Australia during the COVID-19 Omicron wave, as Andrew discussed. Wholesale was in oversupply and had significantly lower pricing in the third quarter. This was partially offset by other customer price increases in both Australia and New Zealand. The group delivered statutory EBITDA of $370 million, representing a decline of 17% on FY '21, while statutory NPAT was $35 million versus the PCP of $83 million. In addition to COVID-19 disruptions, cost inflation is a factor in the second half. The price impact of feed is an additional $45 million cost for FY '22. Our operational efficiency programs made positive contributions during the year, especially in the first half. However, there were some disruptions to progress upon implementation due to the operational challenges in the second half. This year, statutory EBITDA includes $10 million of costs incurred in relation to our [ multiyear ] business process in light of the transformation project. There was a lower effective tax rate as we received an $8.5 million R&D tax credit this year relating to a prior period and also benefited from the part reversal of the provision from a historical tax matter that was settled. Turning now to the balance sheet. I'm pleased to report that our balance sheet is well controlled against the backdrop of softer trading conditions during the second half. Total inventories increased during the year by $56 million due to an increase of $47 million in the value of feed materials on hand, while poultry inventory decreased by $13 million. Feed inventory reflects both the higher price of feed and higher volumes of grain on hand procured directly from growers during the period. Direct grower purchases, part of our feed supply, delivered a benefit ahead to procuring from other sources. Group's payables balance has also increased partly from an increase in the inventory procurement trade payable related to these direct grower grain purchases. Our AASB 16 right of use assets continued to decline as expected in line with lease periods. Our net debt at period end has increased $27 million on the prior year. However, pleasingly, it is in line with December '21 despite the softer second half trading results. Moving to our cash flow. Our cash conversion ratio was broadly in line with PCP at 102%. This outcome reflecting our focus on working capital management during the year. Capital expenditure was $62 million, which was 7% lower than the PCP, reflecting capital discipline as the business navigated the challenges of COVID-19 and related project delays and supply chain disruptions. Key expenditure items during the year included $6 million finalizing the spend on the hatcheries in Victoria and WA; $21 million on our Northern New South Wales Breeder Triangle; and $6.5 million on the Auckland further processing [ for the core client ]. The group received $3.8 million in asset sales proceeds as recorded at the first half, largely from the sale of the Bungonia property in New South Wales. Now turning to our capital management outcomes. As already noted, our net debt at June 30 was $267 million, with our leverage at the top end of our stated range of 2x on the back of lower second half profitability. Our sustaining capital spend this period of $29 million represented 52% of depreciation, below the target range once again due to ongoing COVID-19 lockdowns and delays in equipment being shipped and accessing some sites. A fully franked dividend of $0.065 was declared in the first half. And as Andrew mentioned, with a final fully franked dividend of $0.5 per share declared today, which reflects the reduced profitability in the second half. Total dividends paid were declared for FY '22 of $0.07 per share, representing a payout ratio of 61.6%, which is within our stated payout range of 60% to 80% of underlying NPAT post AASB16. I would now like to make some comments on the feed market. Forecasts are for another above average wheat harvest, with key parts of Australia having a good start to proxies and following good rainfall. Overall, prices increased for wheat and soy during the year, which is remaining elevated into FY '23. As we had indicated previously, and as shown by the 2 charts on the left, feed costs have increased significantly during FY '22, with wheat and soy meal prices at our highest level in 10 years, as shown by the chart on the right. Since year-end, while wheat spot pricing was down slightly to around $430, ABARES noted in their June report that high grain and oilseed prices are expected to persist in 2022, '23 due to a tight global supply and uncertainties around production in Ukraine, and trade flows from the Black Sea region. Farming input prices have increased significantly, particularly for diesel, fertilizer, chemicals and machinery, and whilst producers also report supply chain disruptions affecting supply of chemicals and fertilizer. Soy prices have risen during the first quarter of FY '23 after stabilizing during the fourth quarter of '22. Brazil, Argentina and Paraguay that account for more than 50% of the world's soybean supply have been in drought since November last year. In addition, transport costs are a [ line item ] which is on top of the CME prices shown on the chart. Almost all of Argentina, the world's top soybean oil and meal exporter, is in drought, and this is affecting production of all crops. As there is a period of time between securing the feed and it being fed to our poultry and then the poultry being processed, there is a lag before the cost is recorded in our P&L. The feed prices shown in chart Q3 and for Q4 will largely be expensed in FY '23. As a result, we will see higher feed costs recorded into FY '23. Inghams continues to maintain forward cover between 3 and 9 months just procure supply, which is in line with our procurement strategy. I'll now hand back to Andrew to discuss the segment performance.

Thanks, Gary. Turning now to the segment results. In Australia, while core poultry volumes increased 5% during the period, revenue growth was more modest at 1.7%, due to the substantial industry-wide volume increase to wholesale channel, leading to a decline in pricing in this channel. External feed volumes declined 2.8% as customers transitioned supply away in preparation for the closure of our WA feed mill. Statutory EBITDA declined 16% versus the prior corresponding period to $312 million, in particular, reflecting the effects of second half impacts from COVID-19 disruptions and global events, which affected supply selling prices and the realization of operational efficiency. As discussed earlier, our Australian operations and all customer channels experienced COVID-related disruptions as the prevalence of Omicron in the community reduced labor availability and required temporary rationalization of higher-value SKUs and reduced output at processing sites. In New Zealand, trading patterns were similar to Australia, However, COVID restrictions were harsher in the first half, and the impact from the Omicron variant was felt later in Q3 into Q4. Core poultry volumes declined by 2%, reflecting the impact of stricter lockdowns in the first half on retail and QSR demand, and supply and processing constraints in the second half. A reduction in external feed volumes reflects the sale of the Hamilton mill in March of 2021. Revenue grew by 1.2% as we were successful in introducing price increases across all channels earlier in the period to help offset increasing food costs and other inflationary pressures. I would now like to make a few comments on our progress on our sustainability initiatives. This time last year, I talked at some length about the importance Inghams places on sustainability and some of the work we have done over a long period of time to embed sustainability into our business, which has resulted in us being recognized industry leaders in water stewardship, sustainable agriculture and sustainable food production. Our work continues, and FY '22 has been another year of good progress with our key measures showing improvements year-on-year. In line with our commitment to improving our sustainability disclosure and transparency reporting on our progress, we published our first TCFD report with our 2021 annual report in October last year and which included disclosure pathway, and we also published our new sustainability report. Our new reporting suite will be published in October, which will provide more detailed information on our ESG progress. So turning now to look at a couple of examples of our efficiency initiatives in action and provide some comments on our strategy. Our continuous improvement program has been operating in Inghams for the last several years, backed by a dedicated team, which operate under the lean manufacturing rules and principles. The team has a whole of business responsibility, focused to drive accountability throughout the supply chain to identify process improvements, cost savings and waste elimination, with the aim of lowering our overall operating costs. While some improvement opportunities are represented by large-scale projects, many others are found in simple daily activities that might otherwise be overlooked. In FY '22, while operating conditions met their progress and some initiatives were slowed, many others continue, and importantly, the financial benefits of those programs previously implemented continue to accrue to the business. There are 2 initiatives of the 300-plus we had identified this time last year that I briefly wanted to share with you today. The first example is a systems improvement that was made to a waterjet portioning system that is used at our Murarrie primary processing facility. The process works by scanning the meat brought into the system on a conveyor, with the information analyzed and sent to the cutters, which use high-pressure water to shape and cut the meat to required weight and proportions. Our team identified an opportunity to improve yield by implementing a software enhancer, significantly improving yield and reducing wastage, which will deliver meaningful savings of around $800,000 per annum. The second example I'd like to share is a process improvement was made at our Thomastown facility. We had a process for producing chicken kiev, which originally involved a 2-step manual handling process, which required additional labor and time to execute. By redesigning the process, our team removed the off-line element in the process, which reduced the labor requirement by half and also improved yield from the process. The reduction in manual handling also created safety benefits. The overall financial benefit from this improvement is estimated to be approximately $600,000 per annum. As I noted, these are 2 examples out of a far larger number of continuous improvement opportunities we continue to identify. Both initiatives highlight benefits of training and empowering our people and providing them with the appropriate tools to deliver on-the-job improvements to minimize waste and maximize output. Since I took over last year, as I've discussed with you previously, we have been reviewing and updating Inghams strategy. I highlighted at the beginning of this presentation, the poultry sector has a number of important structural underpinnings, which both we and our major customers see us providing the opportunity to grow both the size and the value of the category relative to other projects. The opportunity exists to partner and create this new value together beyond the traditional transactional relationship model. We see significant opportunities for innovation across the product range and customer experience of poultry. And Inghams is uniquely placed to have a kind of closer and more integrated relationship with our customers, which we believe is necessary to create these outcomes. We are clear on our strengths that will help create value with these partnerships, such as insight and innovation, brand investment, our network and production capabilities that support our customers' growth and a commitment to sustainability and the concept of raised right, which will only grow in importance. Underlying this, we will also continue to consider opportunities to improve the structure and efficiency of the network through various means, including continuous improvement, automation and plant specialization. Finally, we will continue to develop and transform the culture of our own business to reinforce the capabilities required to create value from a continued focus on leadership and people development. We believe this will create a platform of sustainable long-term growth through co-creating products and ranges for and with customers that are worth more and grow the profit pool, increase the distinctiveness of these products and making ourselves a more valuable partner. Supporting the growth of our customers, who are the leading players in their markets to support above-market volume and value growth for Inghams, creating the organizational workforce that can deliver this value better than any other and ultimately improving the returns on capital required to continue to grow the business. The poultry sector remains an attractive and growing one, underpinned by a number of significant advantages, including a large price advantage and well-established health benefits over red meat. A meaningful sustainability advantage for a carbon footprint that is 5x smaller than red meat. FY '22 has undoubtedly been a very challenging period for the business, our customers and our consumers and as a result of prolonged COVID-related operational disruptions, ongoing inflation pressures and supply chain interruptions. We are making good progress on increasing our prices in response to these inflationary pressures that we are experiencing, and they will have a more meaningful contribution in FY '23. I am pleased to say the recovery that commenced during the final quarter is ongoing. Our farming and plant operations are progressively returning to normal levels and full product range production. Similarly, customer service levels have improved significantly since the start of the year, and we expect these to return to normal in due course. Global events and supply chain disruptions are expected to continue to place upward pressure on the price of key inputs. Feed prices are expected to remain elevated due to tight global supply as a result of continued uncertainty surrounding production in Ukraine and related trade flows, poor growing conditions in North and South America and elevated transport costs. As noted earlier, we remain in active discussions to secure further price increases to offset ongoing feed costs and inflationary pressures should this be necessary. Our extensive continuous improvement program remains in place, and we are targeting to make meaningful progress on implementing the wide range of initiatives in the coming year. As noted earlier in the presentation, final dividend of $0.05 per share that has been declared reflects reduced profitability in the second half of the year. However, it does maintain the dividend payout ratio within our policy range. On behalf of the management team, I'd like to thank you for joining us today. And I'll now hand back to the operator, and we'll be happy to take any of your questions. Thank you.

Thank you. We have received a number of questions through the presentation, and we'll firstly deal with those written questions that have come through online. The first written questions are from [ Robert Crane ]. Robert's first question is what percentage of price increases on whole of business have been completed? And when do you expect to complete price increases?

So we'll not give out the exact percentage increase because, frankly, that's a competitive and commercially sensitive number. But I'm pleased to say that we've had discussions in Australia and New Zealand with all of our customers across all of our channels. And we largely have in place a program of price increases that has been in the process of being implemented now and will be continued to be implemented throughout the course of the year to help us recover the cost input pressure that we're experiencing.

Thank you. Robert's next question, do you expect price increases, when completed, will fully recover cost increases?

That's certainly our aim, and our objective is to do that. There is some lag, as you can appreciate, between the cost and the cost impacts, and we're getting those prices put to bed and then, of course, you've got the normal competitive pressures that take place throughout the course of any trading year. But that's certainly our objective.

Robert's third question. When do you expect customer mix, wholesale, food service, retail to normalize?

Well, we're actually in the fourth quarter of FY '22, and as we come into this first part of the trading in FY '23, we're certainly starting to see much more normal patterns of mix and trading across those channels. So that is making good progress and is well underway.

We'll now turn to some audio questions. The first of which is from Michael Peet.

Sorry. Can you hear me?

Yes.

Got it. Sorry about that. I was on mute. Just looking at Slide 18, the feed cost sort of chart you've got there, just suggest probably as you head into '23, the headwinds probably a bit higher than it was in '22. But could you just confirm that the price negotiations, are you going to -- are you looking to recover all those costs that you can see sort of in the -- in your forward sort of purchasing program? Or how often are you going to have to come back to sort of get further price increases as those sort of headwinds continue through your forward purchasing program?

Yes. Well, as I've said, we've had those discussions or are having those discussions with customers. We're looking to recover as much of that as we possibly can. There will be some lag. And that program will be implemented -- well, it's being implemented as we speak. So it's very much a part of the current year to do that. So yes, it's well underway.

Our next audio question is from Craig Woolford.

Andrew and Gary. Just -- so I got 2 questions. The first is just trying to understand sales mix or what you're indicating on sales mix, the table that has each of the quarters and how business is performing just suggest that one of the -- you're not quite back to normal trading in the retail channel. So I'm interested in whether you think the mix can get back to normal? Or is the problem one of demand where consumers have changed their attitudes? Or is it more around supply and the ability to supply the right products to those customers? That's my first question. And the second one is just on wages. And there was a comment in the Slide 11 that says you've got elevated position vacancies. I think you're still covered by an EBA, but I just noticed your wage growth was only 1% in the FY '22 period. I'm interested in how you see wage cost containment in FY '23?

Yes. So Craig, to deal with your first question. I mean, I think we're seeing a pretty good normalization of sales patterns across the channels getting much more back to what we would historically expect. A little bit of softness in retail. And probably as retailers put prices up, there will be some effect on demand, which will work its way through the system. But I think we're confident over the course of this first half as we head into the back end of the year, things are going to look much more like a normal trading pattern. Certainly, that's what our customers are planning for. There's been some disruption to customer service levels, as you'd expect over the year, there's some of that still in the system. That does have an effect by products being out of stock, obviously affects sales and demand. So we've got a little bit of that to work through, but it continues to improve. Labor is clearly an issue. There's -- it's well publicized. There's certainly a shortage of labor, probably even more acute in New Zealand than it is in Australia. We have a whole variety of enterprise agreements, some are in place, some are being negotiated. So we have to work our way through that. But there's likely to be some pressure on labor costs throughout the year as we navigate those shortages.

Our next audio question is from David Pobucky.

Good color in the presentation. Just the first one is on feed cost, up $45 million in FY '22, and that's expected to increase further in '23. So I just wanted to understand the potential quantum of the increase in '23? Do you think it will be greater than that $45 million increase that you realized this year?

David, it's Gary. No I can't absolutely give the answer to that question. One, because it's [indiscernible] but you can see the charts and you can see that there is a substantial increase that's flowing through for us into FY '23. But I can't be absolute on this.

Okay. And in terms of EBITDA margins on an underlying AASB basis was 5% this year. Are you confident that you can get to an aspirational 9% margin at some point? Or do you think there's something structural in the industry or business that would mean you can get back to those sorts of levels?