Libstar Holdings Limited (LBR) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the results presentation of Libstar Holdings Limited for the 6-month interim period ended 30 June 2024. A special word of welcome to our Board members, the investment community, media and colleagues. This morning's presentation will follow a familiar format. As I start the presentation with an executive summary of the results before handing over to Terri, our Group CFO, to take us through the detailed financial review. Thereafter, Cornel, Executive Director and also Perishable Products Category Managing Executive will elaborate on the operational and trading performance of our categories. He will then hand over to me to close out the presentation with an overview of our second half strategic priorities and the outlook for the remainder of the year. Starting with the highlights for the period under review on the left-hand side of the slide. The group continued to show progress in executing its 3-pronged strategy of simplification, growth and sustainability. Starting with the theme of simplification, the group has resolved to exit the beverage manufacturing operations of Franschhoek-based Chamonix Spring Water with effect from 31 August. This marks the exit from a category which has delivered limited growth and return over the past number of years. Following the conclusion of the reporting period and as announced to the market this morning with our results, the group entered into a sale agreement to dispose of its interest in Chet Chemicals. This represents a significant step forward in aligning the group's portfolio composition towards value-added food categories. In relation to our operating structures, an extensive fact-based strategic review was undertaken of the perishable products category resulting in a significantly simplified operating structure across the 3 subcategories of dairy, value-added meats and convenience meals. Finally, within the Ambient Products category, we successfully concluded the integration of the Cape Herb & Spice and Khoisan Gourmet divisions as well as the simplification of leadership structures within the wet condiment subcategory, which now operates under a single category head. From a trading perspective, the volume declines that were previously reported were halted by a resurgence in dry condiments export demand as well as improved contract manufacturing volumes of wet condiments. Improved utilization of our capacities in our dry condiments and wet condiments facilities, a focus on procurement savings, production efficiencies and effective price management all contributed to the sustained improvement of gross profit margins. Lastly, our One Libstar Culture Campaign was launched successfully, accompanied by a management roadshow to all operations during the second quarter. We used the opportunity to communicate a unified set of values and better high-performance culture within the business and develop greater collaboration between previously decentralized divisions. In alignment with our previously communicated objectives, the group continued to focus its capital allocation towards focused capacity enhancing critical maintenance and efficiency projects. This resulted in a lower capital investment of ZAR 80 million relative to the prior year's ZAR 125 million, which together with the improved trading result contributed to an improved gearing ratio of 1.6 relative to the 2.1 reported in the prior reporting period. A further solar PV installation was completed at Amaro Foods in Cape Town, delivering 168-kilowatt peak of power with a full integration into our existing backup generation system. Moving on to challenges experienced during the reporting period. On the right-hand side of the slide, the retail consumer landscape remained constrained, marked by intensified competition and promotional activity. Notwithstanding this, the Lancewood brand maintained its market-leading position. Demand in the total food service channel slowed from the start of the year, particularly in the quick service restaurant subchannel which impacted our value-added meats and baking subcategories. Channel revenue was additionally impacted by the loss of revenue -- of volumes rather arising from dual supply strategies implemented by a value-added meats category customer in the second half of last year. The remaining food service subchannels delivered an outperformance relative to the market. Production yields of fresh mushrooms improved significantly relative to the prior period, although the unit continues to dilute our core margin and return metrics. Lastly, we experienced operational challenges within our Snacking operations which delayed new product launches and caused production inefficiencies. Remedial actions have been implemented and we have seen an improvement from the start of the second half of the year. The group's new strategic direction contributed to a resilient first half performance. Group revenue grew by 5.2 percentage points with volumes marginally down by 0.2% and a price/mix contribution of 5.4%. Gross profit margins improved to 21.5 percentage points with normalized operating profit and EBITDA growing by 5.3% and 13.4%, respectively. Normalized headline earnings per share grew by 11.4%, aided by an improved operating result as well as lower finance charges resulting from lower average net borrowing levels during the period. Total diluted HEPS increased by 32.4%. The main difference between normalized HEPS and total diluted HEPS results from the unrealized foreign exchange gains of ZAR 5.5 million, which are included in total diluted HEPS but excluded from normalized HEPS, that's a one-off. As mentioned earlier, the group's gearing ratio improved significantly to 1.6x normalized EBITDA. Lastly, the group remains resolute in its efforts to improve return on invested capital. And as a consequence of the improvement in key trading metrics delivered an improvement in ROIC from 8% in the prior year to 9.6% in the current period. Moving on to the direct impact of load shedding, the slide on the left depicts the extent and regularity of load shedding during the period under review, noting that the months of April, May and June benefited from no load shedding compared to the prior period. Given our significant investment in generator capacity during the past number of years, the capital cost of generators was limited to ZAR 4.2 million in the current period. On the right-hand side, the group recorded a saving diesel expenses, down from ZAR 45.1 million in the first half of last year to ZAR 13.7 million. However, nearly half of this ZAR 31 million saving was expensed in additional electricity cost during the period. Looking at the group's channel performance. The retail and wholesale channel delivered 7% revenue growth, with volumes down 5.3% and a price/mix contribution of 12.3%. Retail volumes were lower, predominantly due to the implementation of a direct import model by a customer in the meal ingredients subcategory of Ambient Products. The direct import model implementation also resulted in a positive change in mix within the channel. Food service channel revenue declined by 5.8 percentage points, mainly driven by lower volume demand in QSR and the implementation of supply diversification, which was mentioned earlier. Export revenue grew by 2.7 percentage points, largely driven by a strong pipeline of orders for private label dry condiments in the retail channel. To contextualize that number, the group recorded no exports of value-added meat products in the first half, as demand, particularly in the Middle East, softened dramatically impacted by conflict in the region. However, we continue to pursue export opportunities in this and other regions such as Mauritius. The strengthening of the rand against major currencies resulted in an adverse price/mix contribution in the export channel. Industrial and contract manufacturing revenue grew sharply, mainly as a result of increased orders for wet condiments within the Ambient products category. The channel contributions to group revenue on the right-hand side remained largely in line with the prior period, with minor increases to the contributions of retail, industrial and contract manufacturing as well as declines of the food service and export contributions. I will now hand over to Terri to take us through the detailed financial review.

Thank you, Charl. Looking at the face of the income statement. We note the transition to new auditors in the current period and as such, the group performed an extensive analysis of account classifications across the business units. This resulted in the reclassification of accounts in the income statement, balance sheet and cash flow statement. These restatements had no impact on profit before tax, earnings per share, headline earnings per share, net assets or net cash flows. As Charl noted, revenue is up 5.2% on the prior period, driven by a 0.2% volume decline with a 5.4% price/mix improvement. Gross profit increased from 21.2% to 21.5%. Other income decreased from ZAR 22.3 million to ZAR 7.3 million, noting that the prior period included ZAR 10.3 million relating to the insurance proceeds received in respect of the Denny mushrooms fire. Operating expenses increased by 8.2% on the prior period. This was driven by higher insurance costs with the group expanding its right rep cover and the adjusting industry risk rates as well as consulting fees given the strategic initiatives underway relating to the operating model planning, the One Libstar Culture Program and divestment advisory fees. Salaries and wages increased ahead of CPI adjustments due to vacant positions being filled compared to the prior period. Normalized operating profit and normalized EBITDA were up 5.3% and 13.4% on the prior period, respectively. This was largely due to improved gross profit margins. The group finance costs decreased by 11.1%, reflecting the lower average borrowings held during the period. The group's effective tax rate is slightly lower than the statutory rate at 25.1%, while the prior period was impacted by the finalization of prior year tax assessments which reduced the tax liability, resulting in an effective tax rate of 16.6%. Moving to the balance sheet. Net working capital as a percentage of revenue increased from 16.6% to 17.6%, driven by increased inventory days. The higher inventory days were due to continued shipping delays and increased stock holding in the dairy subcategory. Given the continued shipping delays, the group expects its investment in net working capital as a percentage of revenue to remain in the 15% to 17% range. Moving to the right-hand side of the slide. The group continued its focused capital allocation strategy with expenditure down 35.7% to ZAR 80.4 million. This is below the group target range of between 2% and 3% of revenue, but is largely driven by the timing of projects with the group expecting to be within the range by year-end. Capital projects included a ZAR 36 million investment in capacity-enhancing projects, consisting of ZAR 10.6 million on an effluent treatment plant and a new natural cheese slicing line in the dairy subcategory, ZAR 5.8 million in facility upgrades with new lines to increase capacity and value-added chicken and ZAR 5.1 million in facility upgrades for wet condiments. ZAR 36.2 million invested in replacement and maintenance projects as well as quality and improvement projects as well as a further ZAR 8.2 million investment in energy and electricity generation projects. Looking at our key ratios. And as noted by Charl, the group's gearing ratio has improved from 2.1x to 1.6x, which is in line with our internal target of below 2x. The interest cover ratio increased from 5.2 to 5.6, which is well ahead of our internal target of greater than 3.5. Our return on invested capital has increased from 8% to 9.6%. Cash preservation continues to be a key priority for the Group. The cash conversion ratio of 54% is below our internal target of above 65%, largely due to the investment in net working capital during the period. We expect the ratio to improve in line with our trading seasonality in the second half of the year. Looking at the cash flow analysis on the right-hand side of the slide, cash generated from operations increased by ZAR 41 million on the prior period. Working capital changes increased from an investment of ZAR 123 million to an investment of ZAR 163 million, while net finance costs decreased by ZAR 13 million due to the decreased average borrowings for the period. This resulted in increased cash generated from operating activities of ZAR 134 million. Investing activities reduced from ZAR 105 million to ZAR 45 million due to the reduction in capital expenditure. The investment in financing activities increased from ZAR 105 million to ZAR 196 million, as there were no drawdowns on group facilities in the current period. This resulted in a closing cash balance of ZAR 295 million with facilities of ZAR 1.2 billion remaining available to the group. I'll now hand over to Cornel to take us through the category performance.

Thank you, Terri. Good morning, everyone. Before I start, just a reminder that we're now reporting according to our 2 new super categories, Perishable Products and Ambient Products. This slide shows the different subcategories with Ambient Products on the left and Perishable Products on the right. Note that the various business units are categorized according to the different subcategories. We will start with the underlying margin performances of our Libstar categories against the respective targets for 2024. The Ambient Products category achieved a normalized EBITDA margin of 11.2% aligned with the target range. The Perishable Products category showed improvement with an EBITDA margin reaching 5.8%. However, this remains below the target range of 9% to 11%. We expect further improvements in H2, although we anticipate falling short of the target range. The Household and Personal Care category increased its margin to 7.5% within that target range. Turning our attention to the Ambient Products category, which contributes 48% of the total group revenue. If you look to the middle of the slide, we can see that revenue increased by 9.1%, with an increase in volume and price/mix of 1.6% and 7.5%, respectively. This growth can be attributed to several key factors, including volume improvements in the contract manufacturing and export channel with notable advancements in our wet and dry condiment subcategories. As seen on the right-hand side of the slide, the gross profit margin for Ambient Products was 25.3%, down 0.4 percentage points year-on-year. However, our normalized EBITDA increased by 14.2% to ZAR 311 million, underscoring our commitment to improving operational efficiencies and effective cost management strategies. EBITDA margin improved to 11.2%, an increase of 0.5 percentage points. RONA has remained in line with the prior year at 16.6%. In summary, the Ambient Products category has demonstrated resilience and adaptability, positioning us well for continued growth. Next, we will assess the performance of the Perishable Products category, which represents 47% of our group revenue. As seen in the middle of this slide, we achieved revenue growth of 2% in the first half of the year. While volumes declined by 2.2%, we saw a positive shift in price/mix of 4.2%. The gross profit margin for the category improved to 17.3%, reflecting a 0.6 percentage point enhancement. Our normalized EBITDA rose by 11.8%, reaching ZAR 159.3 million. Looking towards the bottom of the slide, the EBITDA margin increased to 5.8%, up by 0.5 percentage points. RONA was 10.1% for the reporting period versus 9% in the prior year. Strong retail performance partially mitigated the volume decline, especially in our dairy, value-added chicken and Frozen Convenience Meal segments. We encountered challenges within the food service and export channels, mainly driven by the loss of volumes from the value-added meat subcategory. In light of this, we will continue to invest in strengthening our brand portfolio to meet the changing demands of consumers and focus on margin-accretive innovation. We remain committed to enhancing our supply diversification strategies as well as addressing operational hurdles to capitalize on growth opportunities within the category and the benefits from our newly formed operating model. Finally, the Household and Personal Care category accounts for 5% of total group revenue. In the first half of 2024, we experienced a revenue increase of 1.3% totaling ZAR 304 million with a volume decline of 0.9% and a price/mix increase of 2.2%, as seen in the middle of the slide. The gross profit margin for the category was reported at 22.9%, reflecting a notable improvement of 2.4 percentage points. Our normalized EBITDA increased to ZAR 22.8 million representing 9.8% growth. The EBITDA margin improved to 7.5%, an increase of 0.6 percentage points, indicating our effective cost and operational efficiency management. Notably, the RONA for this category was reported at 5.5%, an increase of 10.7 percentage points. In summary, our category performance in the first half of 2024 presents a blend of growth and challenges. The Ambient Products category has exhibited resilience while Perishable Products and Household and Personal Care are in the intended recovery path supported by improved margins. We are dedicated to leveraging our strength and proactively addressing challenges as we advance. I will now hand back to Charl to take us through the strategic priorities for the second half of the year.

Thank you, Cornel. Having already shared the highlights relating to our strategy implementation at the beginning of the presentation, the next slide will focus on our strategic priorities for the second half of the year, noting that these form part of a longer-term strategic plan leading up to 2027, as communicated in our previous presentation. Firstly, in terms of the simplification of our portfolio and operating structure, we continue to investigate divestment opportunities in relation to our remaining HPC division, Contactim. We also continue to explore strategic options relating to our fresh mushrooms operations, both of which we are prioritizing to finalize by year-end. Our newly implemented Perishable Products category operating model will take full effect during the second half of the year, benefiting from a sharing of our best resources whilst we also shift our attention to a similar fact-based strategic review and operating model simplification within the Ambient Products category by the end of the year. Various growth initiatives are being implemented throughout the business. This includes the support of retail growth with innovation and promotional activity and additional investment in our front-end capabilities in the Ambient Products categories food service team. We will benefit from new contract manufacturing volumes for value-added meat products in the Perishables Products category and continue to execute on a strong pipeline of export orders whilst further embedding our company culture and values with dedicated programs. Moving on to our sustainability initiatives. Our cash generation and focused capital allocation remains on track to deliver an improved gearing ratio below 1.5x normalized EBITDA by the end of the year, as we also continue to execute initiatives to deliver procurement savings and the group's ESG objectives. Notably, our renewable energy rollout program will continue, notwithstanding reduced load shedding, as we continue to deliver cost efficiencies throughout the business. In conclusion, as we look at the group's outlook for the balance of the year, as shown at the top left-hand side of the slide, consumers are expected to remain under pressure as we await the much-needed relief forthcoming from interest rate reductions and stimulated demand from the implementation of the 2-part retirement system in the third and fourth quarters. Port efficiency remains a key contingency to the execution of our pipeline of import and export shipments. Looking at our post period. The group experienced subdued trading across the retail and food service channels in the 8 weeks after the close of June. The inclement weather in the Western Cape also resulted in export shipment delays in the months of July and August. These factors have caused some moderation in the group's year-to-date revenue growth. However, we have noted some improvement at the start of September in the run-up to peak season. In terms of our key opportunities in the second half, as shown on the right-hand side of the slide, we are on track to deliver a significantly simplified operating structure and portfolio by the end of the year as well as to meet our leverage target set at the back end of last year. Although our net working capital investment was higher than usual in the first half of the year, we entered the second half with sufficient inventory to profitably participate in planned promotional activity. Finally, we expect to continue to benefit from strong export order pipeline of dry condiments, new product launches within the dairy subcategory and improved capacity utilization of our value-added meat facilities from a new contract manufacturing customer. As we drive the execution of these opportunities, whilst navigating the challenges mentioned, we remain confident that the portfolio strategy will be able to deliver an improvement in cost competitiveness, earnings quality and return on invested capital in the coming years. Thanks for listening, and please stay online. We will play a short video before we proceed with our Q&A session. [Presentation]

[Operator Instructions] We've got some questions already. The first one is from Charles from Titanium Capital. Value-added meats, is Libstar connecting with the original -- sorry, competing with the original founder of this business [indiscernible]. What is the risk of further volumes here?

Exercised offerings where we've seen some margin pressure over the past number of years as a result of a change in consumer behavior, where we've seen a change in mix within the category towards your lower-value peanuts and raisin mixes as opposed to the others. But if you look at the entire category, there's a high level of value-add, which contributes to the margin performance of the category.

I have another question from Lwando from All Weather Capital. It's actually 2 questions. We'll start with the first one. How big was Chet Chemicals within your HPC business? And what proceeds are you expecting from the sale of your interest?

Thanks. I'll take this one. And so the Chet Chemicals business, I mean, the prior period was about ZAR 440 million of turnover at about a 5% EBITDA margin. At this stage, we're not disclosing the details of the transaction and will be included in our year-end results when the transaction concludes.

Okay. Second question, was the additional contract in value-added meats products sufficient to offset the lost McDonald's contract?

Okay. So the additional contract was to a well-known brand owner, and that's on value-added chicken patties. Unfortunately, that won't offset. But if you analyze the volumes, it will be close to 20% offset of the loss in these volumes.

Next question is from Nomtha from Umthombo Wealth. Is management is able to comment on the extent of promotional activity during the period relative to H1 2023? Has this been a catalyst for improved volumes? Is there scope for further promotions without hampering margin growth guidance? And then also how much additional energy capacity is expected once all projects have been completed? Quite a few questions there. Does management have a consumption contribution goal from alternative sources? And how much do you see electricity costs being reduced by?

I'll take the first one and then maybe hand over to you, Terri, for the energy questions. As mentioned in the start of the presentation, we have seen some intensified competitive actions within the market during the first half of the year. That certainly has been a function of the consumer landscape, which we all understand quite thoroughly at this point in time. It would be a catalyst for improving volumes and improving the throughput through our facilities. However, we have been careful to manage the balance between promotional activity and our margins as one can see in the improvement during the first half of the year. As such, and as mentioned in the presentation, we go into the second half of the year planning certain categories to participate in additional promotional activity, but not at the cost of margin in that respect.

Okay. If we look at the energy questions. So as Charl mentioned in the presentation, we will be continuing our alternative sources of energy projects in line with our sustainability goals. At this stage, we don't have set targets, but they will be implemented with our annual report by the end of this year as we revisit our energy targets in light of our current load shedding status.

We've got another question from Charles from Titanium Capital. Is Denny considered to be a core business? It seems that the owners of this business over time have struggled to generate acceptable returns.

Charles, I think we've been careful and learned from the past in terms of referring to businesses as core and noncore. But if you look at our strategic direction, it is firmly rooted in simplifying the portfolio towards value-added categories. And if one analyzes the nature of the farming operations of Denny, I think it's difficult to conclude that, that has a high level of value-add. So we are investigating all of the various options in terms of unlocking some of the value and reducing the group's exposure to this underperforming business.

We have another question from Johan. How lumpy are contract manufacturing orders or is it relatively constant throughout the year? In other words, do clients go through restocking and destocking cycles?

I'll take that one. Johan, it can differ during the course of the year. The clients do go through different restocking and destocking cycles, as you mentioned, and that may have shorter-term fluctuations in our production capacity. However, we try to address that proactively with our customers, looking at longer-term forecasting in order to ensure that we have optimal capacity available when required to do that.

No other questions at the moment. We'll give it a bit more time. No other questions. That concludes our Q&A session for today. Thank you, everyone, for joining us. And please be in contact should you like to set up a meeting with management over the next few days or if you have any further questions. Thanks again for your time, and enjoy the rest of your day.