New Zealand King Salmon Investments Limited (NZK) Earnings Call Transcript & Summary

Thank you for standing by. And welcome to the New Zealand King Salmon FY '20 H1 Results Announcement. [Operator Instructions] I would now like to hand the conference over to Mr. Grant Rosewarne, Chief Executive Officer. Please go ahead.

Good morning, everybody. I've got Andrew Clark with me here today, our CFO. And as usual, we'll split the presentation between us. Firstly, I'd like to say that we're very pleased with our first half results, and I'd like to set the scene for you. So as you all know, last summer, we had a poor outcome due to the high temperatures, but we still achieved the lower end of the guidance that we gave. So as a result of that, we've had to slow and ration our product. So this does 2 things: it sort of evens out our volume across the years, but more importantly, it creates more biomass. So when we have less fish because of the summer event, we grow the remaining fish larger, and in that way, we partially compensate for the loss of biomass. And we've certainly done that this year. So when we slow sales, we do that by rationing but also by increasing the price. And we try and do that in a coordinated, sensible way. For us, this is a one-way value creation. So when we take our price up, we don't see that we ever need to bring it down when volume does come back online. And the reason for that is instead of doing that, we step up our sales, marketing efforts and we expand our geographic base. And when I say that, that's a city-by-city expansion, not a country-by-country expansion. So that sets the scene for the remainder of the presentation. So as I've said, we're pleased with our results. You see our price up $1.50 per kilo, and it's going to move closer through to $2 by the completion of the full financial year. You see our volume restrained from where it was, down to 3,442 metric tonnes for the reasons that I've outlined. And this, of course, affects our revenues. So revenue at $84.2 million, down from $87.8 million due to the reduced volume partially offset by the higher value. Our pro forma operating EBITDA of $16.5 million compares reasonably well with $17.3 million in the prior half, and our pro forma net profit after tax was $8.7 million compared to $9.7 million in the prior half. Our statutory net profit after tax was up $5.7 million at $20.8 million compared to $15.1 million. We had our new aquaculture model in place, and we're pleased with the way that's been implemented and what it's doing for us. We have a fully imputed final dividend of $0.02 per share declared and paid on the 20th of March 2020. Our guidance remains exactly where it was reaffirmed by our Board yesterday with an operating EBITDA somewhere between $25 million and $28.5 million. Then flipping over the page, this shows graphically some of the things I've spoken to. So you see our pro forma operating EBITDA in a half-on-half comparison for the last 3 years. You see that coming down, and that's all volume related. You see our GAAP EBITDA going in the opposite direction. That's with us creating more value. Then you see our geographic spread, and that's quite topical at the moment. You see that we have a relatively small commitment to China -- commitment is the wrong word. We have a small amount of volume in China. China probably has as much potential as the U.S.A., but that's over the long, long term. It takes a long time to develop that market. I'd say Europe has the same potential as the U.S.A. and would be available now if we had the volume. We've got Southeast Asia there at about 6% equal to Australia. Again, probably, it has about half the potential of the U.S.A. Japan, we used to sell 100% of our products to Japan. It's down to 4% and still strong potential there, but not -- it will never be what it used to be to us. The other important factor here is not only do we have a geographic spread, we have a channel spread. So we have a mix between retail and foodservice, and we can flex in and out of those. So if people dine out less, we can ramp up our retail sales. Now I'd like to hand over to Andrew Clark.

Thanks, Grant. So moving now to Slide #5, health, safety and wellness. Health and safety is job #1, and we're not satisfied with our current performance. We continue to focus on critical risks and have seen the long-term injury rate generally being of a more minor nature, so slips and strains and so on. And we're also seeing some pleasing results from early intervention hitting off in LTI in the first phase. Moving on to #7, sustainability. We continue to ramp up our efforts to ensure our business operates in a way that's enduring and that we're proud of. Very happy that the Monterey Bay Aquarium's influential Seafood Watch recently renewed its green Best Choice rating. That's for the entire New Zealand salmon industry as the leading seawater producer that's -- we're a key part of that. Very proud to have achieved Aquaculture Stewardship Council certification for our pilot site, which was the Clay Point farm, and that's part of our commitment to the Global Salmon Initiative. That's the group of about half of the world's salmon production companies by overall volume, and it's all about increasing transparency of operation of salmon industry and sharing learnings to achieve best practice. So it's a key commitment that we've made over the last 6 to 7 years. Slide #8. We have committed to the United Nations Global Compact, and that's got some key responsibilities that we signed up to around human rights, labor, environment, anticorruption. So that's a new initiative. And that's about being -- us being a responsible community citizen. So that's part of our ongoing commitment to one of our key stakeholders, which is the community that we operate in. We're doing a lot to -- of work to understand what our current position is, for example, around carbon footprint. And so we've had -- we've done a life cycle analysis recently and looking at packaging and supply chain areas as well just to gauge where we are and what opportunities there are to improve our sustainability situation. Moving on to the financials on Slide 10. As Grant mentioned, in the first half, we had very solid pricing. We've had to restrain our sales somewhat to ensure that we do have supply for the longer term and are able to deliver to our customers and look after them. We've seen margins up and the EBITDA percentage consistent. But overall, EBITDA is slightly lower, as Grant mentioned, after a slightly smaller sales volume in the first half. Our statutory net profit after tax improved year-on-year, and that's driven by stronger fair value gains, which is the future profit that we would expect to make off the fish after deducting the costs to get them through to harvest and to market. On Slide 11, just a word around the difference between statutory and pro forma. So as usual, we've incorporated fair value gains into the livestock and finished goods inventory. This slide provides a bit of explanation on the process, and there's a reconciliation, a couple of slides at the end of the presentation. There's a new standard, IFRS 16 Leases, which does impact these results. And so in essence, what that's led to is a $5 million asset and liability being recognized in our balance sheet, relating to leased offices and vehicles. Again, there's a reconciliation slide at the end of the presentation that illustrates the P&L impact. Moving now to the harvest by farm on Slide 12. So our new aquaculture production model is now in place. We've got the key implementation ready prior to the summer, so that was delivered in full on time by the team. That has changed the timing of our harvest. So for example, ordinarily, we would have harvested the Otanerau farm, on the second line there, during our first half year, whereas this cycle, it will actually be early in the new financial year FY '21. We harvested around 3,700 tonnes in the first half, as Grant mentioned, and you can see the breakdown of which farms that came from. We do expect around 7,800 tonnes for the full year, so indicative where that's going to come from in the second half on that table. On the next slide, water temperatures are just one factor in the survival. They've certainly been relatively favorable so far this year. We are, of course, in the middle of the most challenging time, which is February through to about the middle of April. So as usual, we will come back after that period is completed and provide a post-summer update in due course. Fish health on Slide 14. So our new aquaculture production model, as I mentioned, it's in place. We've got quite a number of initiatives to protect fish health and, therefore, survival in place before the summer. That means that we're handling the livestock less, so not towing pins with livestock in them. We carry out a full site clean and fallow, which means leaving it empty for a period after we'd harvested out the farm. We've got upwelling in place. That's around generating extra oxygen and flow -- water flow on the sites and taking advantage of any thermocline difference in temperature between down and close to the seafloor and the surface temperature. Some of the farms we've seen a little over a degree difference, so that's been very useful. Other farms is less of a difference. So we're learning that it's generating some good support there, we think, for the summer performance. Immunization appears to have helped us manage the impact of the -- one of the bacteria that's present in the environment. The other one, Tenacibaculum does remain a challenge that we're working on. So in summary, we're continuing to put the new aquaculture production model in place. We're continuing to refine that, and we do expect that, that will be able to further reduce variability and risk over the coming cycles. On our balance sheet, Slide 15. So balance sheet is in a strong shape. We had net debt of $25 million at the end of December. We have a $60 million funding facility in place, so plenty of headroom there. At this December, we do have additional inventory, and that's around stock build with harvest in excess of sales, again, smoothing the supply so that we can deliver to our customers as they're wanting. Major investments in fixed assets during the period. So we completed the feed barge Thomas Song; quite a bit of investment in upwelling and this new aquaculture model; some additional pen infrastructure and farm infrastructure on Forsyth and Waihinau and grading panels to maximize the harvest of each farm. As I mentioned, we've also got the IFRS 16, which has a separate line there for right-of-use assets and the lease liabilities. I'd like to pass back now to Grant on the sales overview.

All right. Thank you, Andrew. So we'll just go through market by market. So firstly, North America. Traditionally, this is where our marketing and story has been most understood, appreciated and embraced, and that still remains the case. So we've seen continued growth in this market, and we expect that to go -- to continue to go for some time. As I said earlier, we add more cities if we need to grow volume. The last city that we added with support was New Orleans, for example. And in Asia, it was Shanghai. So we haven't had to add new geographic cities for some time because we haven't had significant additional volume to deal with. But just to make the point about flexing between foodservice and retail. As you know, there's 400 supermarkets in New Zealand. If we wanted to add 2,000 supermarkets carrying our Regal smoked brand in the U.S., probably take us about 6 months to do that. Then looking at China. So our sales to China are temporarily suspended due to the coronavirus. We reallocated all that volume seamlessly at equivalent margins. So no issue there at all. We're just about to restart. We're testing whether the border is open. We expect that it will be. And our retail sales will pick up immediately, and 2/3 of our sales were in retail. Then our other export markets. So Australia has been a bit of a problem child over the years. And I would say that problem child is now fixed. That is a true premium market for us. Atlantic salmon prices are higher in Australia than anywhere else, and we weren't achieving the premium there that we would have hoped. But we've now fixed that. So we've got a great team in place. They're in the right customers. You'll see our brand name on more menus, actually, even though the volume is down. I'll remind you that we had to bring the volume down. We've largely used price to do that, that we've done that in Australia, and we're now really pleased with the base that we have there. Asia, excluding Japan and China, has always been strong for us and continues to be. So a slight pullback in volume there as a result of some of our initiatives. Japan, as I mentioned, it's the home of sushi. Salmon is more -- well, it's more like chicken is in New Zealand, perhaps. So that is an issue that we have to work hard up against. We have to prove ourselves to be a true super premium up against what is seen as a more commodity offering in Japan. And we've got a great team doing that in both foodservice and retail in Japan. Europe has incredible potential for us. The tyranny of distance means we've never really been able to engage as we would have liked, and we've never had the volume to do so. So we look forward to developing that market at some future date. Then looking at the domestic situation, this is Slide 19. We really addressed our value creation in this market, if I put it that way. We've taken the opportunity to even out the margin across all of our markets. So the U.S. used to be a bit of a standout for us, and now all markets are equal roughly, including New Zealand. We've launched Regal Epicurean, which is our Atlantic offering. So finally, we are unbounded in volume. We can get as much Atlantic salmon as we need to bring in to support the growth in this market. And importantly, Regal Epicurean, Atlantic salmon changes the power balance between us and the retailers and improves our position there because we can supply, we don't have to turn them away, we're not restrained from developing our brand. And already within foodstuff, where that product is ranged, it's at a 2% market share. And why is -- this is also important to us from a margin proposition. Let's just say, our average margin -- let's just use a fictitious number. Let's say it's around about $8 a kilo. So -- and you've seen, we've gone up $1.50. So there's a huge effort to go from, say, $8 to $9.50 in margin. But if we can bring in Atlantic salmon and only $1.50 margin, it's created the same value, in fact, because if we take margin -- take a product out at $8 margin and put it in somewhere at $9.50, we've only made $1.50 because there's no upside in our volume base. So Atlantic salmon filling the role of supporting our brands, improving our power position, and for the long term, it assists with our margins. Then Slide 20, average price, you can see that we've addressed the situation more in the domestic market than the export market. I know some of you are going to ask me questions about where we go from here. So I'll leave that to answer those questions, but I would say there's limited potential now in the New Zealand market, and there's some remaining potential in our export markets. Then Slide 21, fish performance. So you can see the harvest decrease that we've talked about there. Still looking to achieve around about our guidance level, 7,800 metric tonnes. A really good feed conversion results there. And that's partly due to the number of small fish that we've got. But we also had a standout performance of our farm at -- of our Ngamahau farm. So fully harvested out, large size, achieved an FCR of around about 1.5, maybe a bit more than that. So that's a great performance. It shows what can be achieved when all the stars align. So that says, right, technically, that's possible. So how can we now take that across our other farms? And I don't want to say that's simple. It's not. But it shows if you can do it once, you can do it more than once. Fish survival is in line with last year. We've had very strong winter growth, which is great. Feed costs are up slightly, 2%. Going back to price increases, we can always under all scenarios recover at least inflation as a minimum. Then looking to our outlook. So future farming initiatives. I hope you've all heard of Blue Endeavour. That is our 1,800 hectare site, 7 km north of the Marlborough Sounds. That is our strategy to address many things: It addresses our volume situation. It's an opportunity for us to further increase our margin in the long term because it enables us to grow a more differentiated product in the future. It helps address climate change for us. In fact, we see it as the main strategy to address climate change. So the open ocean and all it offers is key to our future. And we're pushing very hard on that. We've got a hearing date for the 22nd of June with the Marlborough District Council, and then there'll be a 3-day hearing approximately. And then we get a result 20 working days after that. The capital cost for Blue Endeavour, it's far less than we first thought. We've got a range there of $25 million to $35 million in CapEx. Phase 1 of Blue Endeavour will produce 4,000 metric tonnes of additional salmon. It's on an 18-month cycle. So that's great news, I think. Into the RMA process. We don't have control of that process, but we've put our best foot forward with a great application. We've had 39 people in support of it and only 14 opposed on local environmental issues, which we believe we -- well, we know we can address. And I note that I think all of those negative submitters had previously proposed that we should go into the open ocean, which is great. The farm relocation is with the minister. Clearly, nothing is going to happen this side of the election. We hope for a result in the following year. Then on to our expectations. We are going to build our frozen inventory in the remainder of our financial year. I want to reassure you, though, that that's high value for us. So we make the same margin, at least, on our frozen inventory as we do on our fresh products, which is not -- that's not the way it used to be. Our pricing remains very strong. In fact, I've said, we've done a great job with $1.50. That's going to play out close to $2 over the full year. We're diversifying our offerings, whether that be in our existing brands like Ora King, Regal, Atlantic salmon, pet food, and we're doing that to create resilience for our business. We've not seen an impact from the coronavirus as yet. We recognize this is an extremely fluid and dynamic situation. We're not only looking at what is the sales impact, which there hasn't been any yet. We're looking at do we flex out of foodservice and more into retail. And we're also looking at our supply chain of our various inputs, how are they affected by potential disruption. But we do think we've got that all under control. We are able to reallocate products between markets and between channels, which is great. That will help us depending on how the coronavirus unfolds. We're on track to spend our $20 million worth of CapEx. We've got a depreciation of $8.2 million. We're really pleased with the way our new aquaculture model has gone. That was a significant part of our CapEx, about $4 million, I believe. There's no reason for us to change our guidance. Our Board reaffirmed $25 million to $28.5 million pro forma EBITDA yesterday. We're working hard on that water space, and that is absolutely key for the future. So expectations in terms of volume, around about 8,000 metric tonnes, FY '21; 9,200, the year after. And as always, summer is really key to our achievement of results and volume. So with that, that's the end of our presentation, and we're turning that over to questions.

[Operator Instructions] The first question from Guy Hooper with Forsyth Barr.

First question for me, just focusing on fish health. You mentioned -- now forgive me if I mispronounce it. But Tenacibaculum concerns around the disease and its impact, could you just provide a little bit more color on it?

Yes. So I'll start, and maybe Andrew can add some. So Tenacibaculum is a ubiquitous organism that exists around the world. And as far as I'm aware, it's in every sea and ocean. It is a known problem for aquaculture, and other jurisdictions have learned how to live with it and control it. We've recently increased our ability to be able to detect the organism and, therefore, more correlate it with any issues that we've got. I note there are some vaccines that are available to deal with Tenacibaculum. We've done some trials on that already. We think it is part of the summer equation. So as usual, these things are never simple. They're multifactorial. There's definitely temperature in the equation. There are definitely microorganisms in the equation. Tenacibaculum is one of them. Other jurisdictions have learned how to deal with it. And we're well on our way to doing that, we believe. It's great that we've got this additional information about how is it -- well, what its effects are. And so -- and of course, rather have been really helpful in determining that. So we think with increased knowledge and learnings from around the world, we will get on top of the situation. We -- again, we think the open ocean is part of the answer to that. The environment is so good in the open ocean. We don't think Tenacibaculum will be a problem out there. Certainly, it could be if conditions weren't as good, but as I say, we've got a depth, a temperature and a flow out there, which is fantastic. But Andrew, any comments?

No.

Okay.

And I was just following on from that. In terms of the farms that you have shifted your operating model onto a single-year class, can you give us a sense on what the performance difference you're seeing between those, between ones that have shifted and ones you haven't? Or...

Okay. So Guy, for clarity, we haven't really -- there's the relocation process, which is an effective shifting of farms. So what we've done is taken all of our assets, and we've reallocated how and when we farm on those sites. And we've created a fallowing period for all of our farms, and that was previously only true of our Pelorus farm. So we haven't actually shifted them. We just spread out our production. We've brought through sites that had been fallowed for a long time back into production, for example, Forsyth. We're using new techniques on all of those sites. And we're seeing results that we're pleased with. But summer is always a difficult time for us. So far, it's been a very cool summer, but it's not over yet.

All right. I suppose one last question from me. I mean you mentioned, I suppose, water applications under the RMA process continue to be dragged out or perhaps isn't, I suppose, the best way to go about it. Given the government strategy announcement, do you see changes to how water space gets allocated into the future?

I would say, Guy, yes, in the long term, yes. But in the short term, it's still the RMA. But when we turn up to a hearing, and we say here is the government-initiated strategy, so this wasn't borne out of industry. Government came up with this strategy themselves. It's an all-of-government strategy. It's to take the industry from $600 million to $3 billion. And Guy, I think you know my view is that open-ocean aquaculture could become New Zealand's most valuable industry, and its greenest primary sector. So it's incredibly helpful to us. However, we would like to see the government come up with more concrete initiatives to enable open-ocean aquaculture. So the RMA is not a great tool for allocating water space, and I think there are initiatives underway to be more rational about that and to get a better allocation process. But for the time being, we're working well with the Marlborough District Council. That's where the decision will be made. We're going to the place that pretty much all of our detractors have said we should go to, the open ocean. I don't think anybody per se opposes that outright. It's more, okay, what does it look like when it goes out there, what's the scale of it, tell us how it operates. It's all those sort of things. So we are hopeful that what we've got, the RMA will deliver on or about the 22nd of June. And -- but we think we need further central government support with enabling legislation to really maximize aquaculture.

The next question comes from Jack Crowley with Jarden.